Markets pin hopes on rise in US debt cap

Reaching upon a consensus on the debt deal is crucial for emerging markets including India

How the stock market behaves in the near term would depend a lot on the outcome of political negotiations in America over the increase in its debt limit before Thursday’s deadline.

US stocks gained on Wednesday on hopes that the debt cap would be raised, helping the country avert default. Ratings agency Fitch placed US debt on watch for a downgrade, which threatens the country's top credit rating. US indices — Dow Jones Industrial, S&P 500 and Nasdaq — were up one per cent at the time of going to print on Wednesday. Reaching a consensus on the debt deal is crucial for emerging markets, including India.

European shares had erased most of the early losses at the time of going to print, on expectations that the political differences would be sorted. The FTSE 100 Index down 0.3 per cent. The markets in Asia were mixed, with Japan and Australia gaining, while Hong Kong and South Korea ended weak. Indian markets were closed on account of Bakrid.

“In case the deadlock is not resolved, there could be a cascading impact on the rupee, and on stocks and foreign exchange reserves of several emerging market economies. Those fears could then hit the markets,” said Dilip Bhat, joint managing director, Prabhudas Lilladher. “Further, there could be a downgrade of the US, which will cause withdrawal of investments. That fear is still very much on the radar.”

Analysts said Indian equities were vulnerable to shocks in the US because foreign institutional investors (FIIs) own a sizable chunk of stocks here. FIIs have pumped in close to Rs 4.2 lakh crore or $85 billion since January 2009. An FII pullout will result in a slide in the markets and also drag down the rupee, which has stabilised after falling to as low as 70 a dollar. Politicians and bankers have warned of global economic consequences unless the rival political parties, Democrats and Republicans, are able to sort their differences by Wednesday night

A similar political showdown between Democrats and Republicans in 2011 over raising the debt limit had gone down to the wire. Though it was resolved on August 2, 2011, through some last minute negotiations, it led to ratings agency Standard and Poor’s stripping the US of its top-notch credit rating on August 5, sparking a sharp selloff across global markets. The MSI Emerging Markets Index fell seven per cent over the two days after the downgrade, while the Nifty declined three per cent.

US laws say a government can spend only if it has enough money coming from taxes or is within the borrowing limit. The debt ceiling limits the Treasury’s ability to borrow for the government’s programmes, in the absence of adequate revenues. The increase in the debt cap requires the approval of both Houses of the US legislature. While Democrats, including US President Barack Obama, are favouring tax increases and lower spending cuts, Republicans want a cut in social programmes including the new health insurance access law.