US default probability low, but may impact Indian markets: Analysts

But if it does happen, it will be negative for all emerging markets as the US, simply put, would have run out of money

This week, Republican and Democrat lawmakers in the United States are likely to resume discussions with President Joe Biden to raise the country’s sovereign debt ceiling limit from the current $31.5 trillion.

June 1 is being seen as the date when the US will technically breach that ceiling, triggering a debt default by the world’s largest economy, unless the Biden administration comes up with a plan on budget priorities and on raising the debt limit.

While the probability of a default is still low, it cannot be discounted completely, and will impact all emerging economies, including debt, equity, and foreign exchange markets in India.

“If it does happen it can be quite negative for markets. The short-end rates can actually shoot up in the US, the long-end rates can come down. It can lead to tightening of financial conditions, which is negative for growth,” said A Prasanna, Chief Economist at ICICI Securities.

“Globally it can have a spillover across asset markets. Currency is expected to fall. It cannot be positive for bonds also. Such a development in the US will be negative for all emerging markets,” said Prasanna.

While there have been shutdowns in the US federal government before due to a lack of consensus on budget proposal, the breaching of the debt limit is seen as a more serious event. The US will, simply put, run out of money.

The US Treasury Secretary Janet Yellen has warned of dire consequences. "It is Congress's job to do this. If they fail to do it, we will have an economic and financial catastrophe that will be of our own making," she said earlier this month.

“For Indians in the fixed income markets, this event may be supportive, but you may find currency weakening. It could be negative for the currency markets, not necessarily for the bond markets, as the dollar might strengthen due to a risk-off,” said Rahul Bajoria, head of emerging Asia economics, Barclays.

Technically, the current debt limit was already breached in January 2023, but the Treasury Department used "extraordinary measures" to provide the government with more cash while it figured out what to do. Usually it's a formality for Congress to raise the limit as needed but this time the talks between Democrats and Republicans are taking longer.

“Most investors still think its a low-probability event, though the developments will be watched closely,” said Prasanna.

He added that in the last couple of months, Indian bond markets have been running on domestic variables as the Reserve Bank of India has gone for a rate hike pause before the United States Federal Reserve. “The market has become slightly immune to global developments, not reacting day-to-day to yields. But a default, however low the probability, is still big news.”

Barclays’ Bajoria agreed and said that the Indian markets seemed to have factored in a rate hike pause by the Fed as well.

However, both analysts said that the developments in Capitol Hill will be watched with interest over the coming days.