Interview of the Week: Surjit Mohapatra, Sr. Economist

 

It gives us immense pleasure in announcing another new feature on Businessviewsreviews.

In an exclusive interview with Businessviewsreviews, Surjit Mohapatra, Sr. Economist, discusses about the causes that led to the downgrading of the US credit rating by rating agency S&P, and its possible consequences. 

What triggered the US debt rating downgrade by S&P?

USA is the largest economy in the world with $14.56 trillion in 2010. The US Gross National Debt reached $14.58 trillion by August 2011. This is 100% of its GDP of 2010. The gross national debt has increased from 57% of GDP in 2000 to 100% of GDP in 2011 and does not seem to be decreasing in near future.

 

USA economy is still under recovery stage from the last economic slowdown. To improve the situation USA economy needs more government expenditure which will raise its total debt. USA is having a system of debt ceiling which was set after World War I to limit the government expenditure. Though the ceiling has increased several times, USA parliament increased the debt ceiling by $ 2.1 trillion on August 1, 2011 to raise it to $ 16.4 trillion approximately to avoid sovereign debt default. The parliament has cut the federal deficit by as much as $2.5 trillion over a decade. 

How will it impact the US Economy?

S&P, which has given the USA a top AAA ranking since 1941 has cut its grade to AA+ in 2011 after USA government striking the deal. The USA government may have to pay higher interest rate for its treasury bonds or public debt which will aggravate the debt situation. Mortgage rate will rise following higher Treasury bond rate which will impact real estate market. 

Do you think that the US will resort to third quantitative easing measures to combat the ongoing fiscal deficit crisis which has let it to lose its pristine triple-A rating?

 

With immediate effect, reduction in USA expenditure may further slowdown the USA economy. However, for fiscal 2012, there will be only $21 billion cut from expected spending of up to $3.7 trillion which is very small amount in a $15 trillion economy. Even the $2.5 trillion deficit cut in one decade is negligible for the US economy. In the next 10 years, if USA government does not raise revenue and reduce expenditure, the total debt may increase to 150 % of GDP which will be a big problem for the economy. The debt is accelerating in the present situation while the economy is moving slow. 

What impact do you foresee the unfolding US crisis on the rest of the global economy?

 

Looking at the exposure to USA Treasury bond, China holds largest USA bond worth $ 1.2 trillion followed by Japan with $ 0.9 trillion. In case of debt default by USA, these countries will have higher impact. Cutting of bond rating from AAA to AA+ will increase interest rate which will reduce the price of old bond. That will impact negatively on interest income of the above countries. On the other hand, government expenditure cut will directly impact on exporting countries. China is the largest exporter for USA, any cut in public expenditure will directly impact its GDP growth. This does affect Indian economy as well. However, the impact may not be so deep.  If the crisis persists, there may be problem in world currency market. However, with the debt crisis in European countries, USA Treasury bond is still an attractive option for investment.  

What are the options before the US Government to tide over the present crisis?

Being the largest economy and dollar being the major world reserve currency, USA is left with very few options in dealing with this situation. It will difficult to reduce its import significantly at the same time it has to maintain its dollar supremacy. The main option with USA right now is to reduce its expenditure and increase tax revenue. USA government can increase revenue in the future if it opts to allow tax cuts (enacted under George W. Bush) to expire as scheduled in 2013. 

What lessons it offers for India? 

India’s $229 billion external debt (22% of GDP), recorded at the end of March 2009, increased to US $297.5 billion by the end of December 2010, and went further up to US $305.9 billion (17.3 % of GDP) at end of March 2011, which is a sharp increase of 2.8% in three months. Total debt by March 2011 is approximately US $905.9, which is a sharp increase of 20.6% over the same period of 2010 (US $751.1). The gross public debt to GDP ratio is about 66.2% in 2011 which is highest in Asia region.

 

Looking at the debt structure, internal debt is higher in India than external debt and most part of the internal debt is held by banks. Hence India government does not have much problem in this area. However, taking higher risk in public debt may attract downgrading of its bonds by rating agencies. Being a developing country, where economy is growing at 8%+ per annum, India should not take the risk which will have significant impact on its economic growth.