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What the debt ceiling deal mean and what it does not

29 May 2023 , 10:04 AM

For now, the uncertainty is over and the global markets can heave a sigh of relief. Had the deal not been inked, the US government would have defaulted on loans and regular payments. With the US dollar still the nucleus of the global financial markets, the outcome would have  been disastrous. 

Fortunately, that worst-case scenario is out of the way. It must be underlined that this is not a deal, but just an in-principle deal and the text of the deal still has to be reviewed and passed by the members of the Congress. However, with President Biden and House Speaker Kevin McCarthy giving the go-ahead, the actual approvals should just be a matter of academic formality.

Gist of the debt deal in the US

At the outset, this is not a deal to hike the debt ceiling but to suspend the debt ceiling for the next 7 quarters. Let us look at what the debt deal really entails.

  • The biggest aspect of the debt deal is that the debt ceiling is being suspended until the first quarter of 2025. That will be well beyond the next Presidential elections in 2024, so both the parties get enough time. Also, both the parties have effectively bought time till they are in a position to define a time period to address the debt limit. Obviously, a debt suspension cannot be unconditional, so this deal comes with strings attached.

     

  • The first string pertains to the spending caps. The Republicans (opposition) were demanding a 10-year cap on spending, which was anyways not feasible. What they have finally agreed upon is freezing of spending at 2023 levels for next 2 years. This will only pertain to non-defence spending. Also, non-defence spending will be allowed a 1% hike in 2025 and there will be no caps after that.

     

  • There seems to be consensus on the energy reforms front. For instance, Republicans wanted free access to government lands for prospecting while Democrats wanted strict curbs. Republicans want the easy shale policy of Trump and here the Democrats have an upper hand. The energy policy is veering towards being environment friendly. 

     

  • Another major aspect of the deal was on unpent COVID funds. Biden has accepted the proposal to claw back unspent COVID funds into the treasury. The total COVID outlay in the US was close to $4.5 trillion and the estimate of unspent funds vary, but is pegged in the vicinity of $30 billion. It would be come as a temporary relief.

     

  • Entitlements and benefits to Americans has been a major drag on the US budget. Here again, Joe Biden has gone out of his way to placate the Republicans. This applies to adding work requirements for able-bodied adults without minor dependents applying for entitlements and benefits. There are 3 major heads of assistance viz, Temporary Assistance for Needy Families (TANF), Supplemental Nutrition Assistance Program (SNAP) and Medicaid. To placate the Republicans, the eligible age for no work requirements under SNAP has been raised from 50 to 54. However, war veterans would be exempted as would the homeless. Medicaid will be free from work requirement.

     

  • Republicans and Democrats have agreed to fully fund medical care for veterans. This would include higher outlays to the Toxic Exposure Fund. Clearly, this has long been an emotive issue and neither party would want to be standing on the wrong side of this debate.

Apart from these, there are other IRS related cuts to ensure that the wealthy and the well-heeled do not get away by paying less tax. These are likely to be more populist in nature.

What the debt deal does not do?

It has been weeks and months of hard negotiations before the debt deal has agreed on key areas. However, there are a number of items that the parties could not agree upon. Here are 3 such specific areas that the debt deal does not cover.

  • The Republicans wanted rescinding climate-related provisions from the Inflation Reduction Act. The Inflation Reduction Act had some vivid clean energy and climate provisions, like clean energy projects in low-income communities. Republicans had wanted to repeal key provisions of the IRA, but Joe Biden prevailed on this issue. Climate protection liability will continue as part of inflation reduction plans.

     

  • Joe Biden had wanted the introduction of new taxes, especially on the wealthy and the well-heeled. That was something the Republicans had been flatly opposed to. In the final deal, there are no discussions about new taxes, so that stands rejected. 

     

  • Student debt relief was another major bone of contention in the debt deal. Republicans had been demanding for cancellation of Biden's student debt relief program and wanted that rescinded. However, that is not part of the deal, so the student debt relief stays.

It looks like a quick compromise hammered out by Biden and McCarthy, which buys time for now. However, it must be remembered that this is just an in-principle deal.

Just an in-principle deal; that’s all

The deal had to happen, even if there was no common ground. Neither Biden, nor McCarthy could be seen as precipitating a debt default by the US government. So, that is the sub-text. This is not a debt ceiling deal. It is not that the debt ceiling has been increased beyond $31.4 trillion. The debt ceiling has been suspended till the first quarter of 2025. That is something the ruling Democrats could have done under Constitutional powers, but this looks lot better. 

For now, the treasury can function up to 05th June and if the COVID fund clawback is also considered, the treasury can go on for longer. This is the first debt ceiling debate that went close to the wire. Both Republicans and Democrat governments have lived beyond their means in the last 25 years. What the debt deal could do is to ensure that the debt ceiling does not go through the roof. Keeping non-defence spending flat for 2 years would, at least, force the US government to cut its coat according to the cloth.

Global markets will heave a sigh of relief

Between now and June 05th, it should be more a case of stage management. Biden aptly described this debt ceiling suspension agreement as a compromise that was good for the United States and for the world. At least, this agreement prevents a catastrophic default that could have led to an economic recession, and left millions of Americans on the brink. However, the real struggle would be to pass this bill. Remember, the Republicans control the House (222 to 213), while Democrats control the Senate (51 to 49). The key would be to convince the die-hards on both sides, as it does look like too much of a compromise.

Emerging markets like India would surely heave a sigh of relief. In a worst case scenario, debt default by the US would have created chaos in global financial markets and thrown bond yields off tangent. As Biden put it, a debt default would have precipitated a recession in the US. For a country like India, which runs its largest trade surplus with the US, a default would have been bad news. India’s robust services exports in FY23 were dominated by IT sector exports. The US recession would have meant a sharp fall in tech spending, limiting the ability of IT companies to boost the export engine. Above all, it does not create chaos in the dollar markets, something India had always dreaded. For now, it is time to smoke the pipes of peace.

Related Tags

  • debt ceiling deal
  • US dollar
  • US government
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