Column: October rain has passed

Written by Madan Sabnavis | Updated: Oct 26 2013, 08:26am hrs
The month of October has been quite eventful in world historyfor example, the October Revolution in 1917 saw the Bolsheviks depose the Russian Tsar. This October, too, there were fears of a revolution, albeit of a different sort, with the US government shutting down and a default looming large as the Congress battled it out on the debt ceiling. The rock group Guns N Roses would have probably crooned October (November) rain or storm, but finally, it was not to be and turned out to be a damp squib. The problem, though not solved, has at least been deferred, and the global economy can breathe easy till early next yearJanuary 15 is when the federal government's funding comes up for approval again and February 7 is deadline for raising the debt ceiling. Given the backdrop, certain points need to be ruminated on.

First, the quality and role of politics is the almost the same across the globe. While we are overtly critical when there is an impasse in our Parliament and get ballistic with terms like 'policy paralysis', the same happened in the USrealpolitik dominated the day with the Republicans and Democrats not willing cede their respective grounds on the Affordable Care Act. Why do we in India make a big deal of the Food Security Act (FSA) when the largest economy in the world isn't doing any lesser Just that, in our case the issue is food for the poor, in theirs, it is health. So, the US impasse was indeed a case of politics dominating economics with the world watching in disbelief. Everyone knew that there would be a solution simply because things could not be left in a state in which there was no solution. The suspense, however, was around how exactly the impasse would end.

Second, the fact that the policies of the government have to be sanctioned time and again by statute has lessons for us. We have the FRBM Act which lays down rules to be followed. However, resetting fiscal deficit targets is the prerogative of the central government and this is where we can borrow from the US story. Can expenditures be capped, as they are in the US, so that separate permission from Parliament will be required if they have to be exceeded This way there will be an additional layer of discipline. Presently, the financial minister has worked well around the 4.8% fiscal deficit target, but the issue is whether we can go further. The US model is quite interesting because all such bills need to pass through the Senate and the House of Representatives (where President Obama does not have a majority).

Third, a curious fact that got little notice is that even though the US was on the brink of a default for the second time in the last 3 years or so, the credit rating of the country remained intact. It is true that being the anchor currency in the world, dollars can be printed at will, though this is, quite prudently, constrained by regulation. But, despite the fact that the default was credible, on the back of the shutdown, none of the global credit rating agencies have gone for a downgrade. This is where there is ambivalence in the outlook of rating agencies, where India is under the scanner almost every month for a possible downgrade, whether the heat is over the FSA or a high current account deficit or growth figures. This is a pertinent issue which the Indian government has to contend with on a regular basisthe anomaly stands out with the US retaining its rating. It is not surprising that the world is asking for alternative approaches to credit rating which are less skewed. The question is whether or not we are missing something somewhere considering that the possibility of a credible default did cause upheavals in the forex, money and capital markets across the globe where the losses outweighed the gains.

Fourth, unless the US changes its laws giving the President unlimited powers to raise the debt ceiling on his own without having to go through the channels, the issue to be debated is whether or not it makes sense to invest in US treasuries. Today, out of the US's $16.7 trillion debt, $5.6 trillion is held by other countriestheir surpluses are invested in these bonds. Will this continue with the same level of comfort as before Countries will soon be looking for alternatives though, admittedly, the options are dwindling with the euro being fragile as well while no developing country's currency is acceptable yet to the developed nations. While gold is an option, given the volatility in gold prices, this may not be meaningful at this juncture. Therefore, the dollar will prevail for some time.

Fifth, any correction in the fiscal balances by the US government has implications for the revival of the global economy. Today, the Federal Reserve is working towards tapering its QE programme based on the premise that growth is picking up as unemployment numbers become more acceptable. If it were so, then the equilibrium gets distorted if the US government stops spending. The only real option for the US government is to give up on healthcare. But that would mean political defeat. Alternatively if any other expenditure is compromised, it would mean a setback for growth. Either way, the world economy will continue to be wobbly as the search for a solution lingers.

Clearly, there are lessons to be learnt from this episode, considering that it will happen again. The way in which things work in the US are definitely laudable where even the government cannot take things for granted. However, keeping the credit rating unchanged poses a dilemma for analysts given that any default can rock the financial markets all over with a large volume of transactions being reckoned in dollars. Surprisingly, even the CDS rate did not show confidence as it jumped from 22 cents per $100 in September to 38 cents just before October 17. Markets do not spare even the biggest.

The author is chief economist, CARE Ratings