Investors fret over US debt ceiling crisis

The Sensex falls 347.5 points to close at 19,379.77, while the Nifty drops 97.90 points to close at 5,735.3 on Monday

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In the coming days, a political face-off in the US over its government’s proposal to raise the country’s debt ceiling is expected to keep stock investors worldwide, including in India, on the edge. Economists and analysts said failure to increase the debt limit by October 17 would result in the US defaulting on its loans, which could potentially damage the sentiment in global financial markets.

If the Congress does not clear the budget before Tuesday, the immediate consequence would be a possible government shutdown in the US. This, coupled with concern over the debt ceiling, partly contributed to the sell-off in global markets on Monday: The Sensex fell 347.5 points to close at 19,379.77, while the Nifty dropped 97.90 points to 5,735.3.

In 2011, a political showdown between Democrats and Republicans over raising the debt limit had gone down to the wire. Though it was resolved through last-minute negotiations on August 2, it had led to ratings agency Standard and Poor’s stripping the US of its top-notch credit rating on August 5, 2011, sparking a sharp sell-off across global markets. After the downgrade, the MSCI Emerging Market Index fell seven per cent through the next two days, while the Nifty declined three per cent in the same period.

This time, too, investors are expecting markets to fall if neither party is willing to budge. “The US debt ceiling issue is certainly a potential time-bomb and can cause a lot of anxiety in the market,” said U R Bhat, managing director, Dalton Capital Markets.

Signs of nervousness over the issue are already visible on Dalal Street, with the volatility index—a gauge of traders’ expectations of near-term market risks based on Nifty options—jumping 10.8 per cent to 26.65 on Monday. Brokers said concern over the outcome of the debt limit negotiations was reflected in the Nifty options position build-up in the October series on expiry of the September contracts on Thursday.

“There was no concentration of positions in the Nifty October option strikes on Friday, which shows traders have no clue where the markets are headed,” said the derivatives head of an institutional brokerage. “Also, (option) premiums were subdued, showing (option) writers expected premia to rise further,” he added.

“Investors are quite jittery because the political battle has only escalated. The Republicans may not want Democrats to score another win after Obama managed to diffuse the Syria crisis,” said Tirthankar Patnaik, director and strategist-institutional research, Religare Capital Markets. “Indian markets will react negatively to such negative news from the US.”

According to US law, a government can spend only if it has enough money coming from taxes or is within the borrowing limits. The debt ceiling limits the treasury’s ability to borrow for government programmes in the absence of adequate revenues. The increase in the debt cap requires the approval of both Houses. While Democrats, including US President Barack Obama, are favouring tax increases and lower spending cuts, Republicans want a cut in social programmes, including the Affordable Care Act (known as Obamacare). Obama has said any move to delay his healthcare programme would be vetoed; Republicans argue the healthcare law would damage the economy.

Some, however, are hopeful the issue would be resolved before there is a default. “One can take comfort that these things are part of a democratic set-up and hope these would be resolved soon, without causing too much damage to the markets,” said Bhat.