Fifth of India’s forex reserves at risk if US does not up debt ceiling

India held $59.1 b of US treasury securities as of July 2013

One-fifth of India’s foreign exchange reserves are at risk if the US is unable to raise the debt ceiling and actually defaults on its debt obligations.

According to US Treasury, at the end of July 2013, India held $59.1 billion of US treasury securities. This accounts for 21 per cent of India’s foreign exchange reserves of $276 billion.

The debt ceiling is the total amount of money the US government is authorised to borrow to meet its various legal obligations, including interest payment on the national debt. Many countries, including India, have lent money to the US Government by investing in US Treasury securities.

Holding $1.27 trillion of US treasury securities, China is the largest lender to the US. Among other emerging markets, Brazil with $256 billion, and Taiwan with $178 billion, are others with high exposure.

The fallout

The wealth of all US government security holders will shrink if the US fails to raise debt ceiling, resulting in a default of the interest or even the principal on these obligations. The ramifications for global financial markets are enormous.

In May 2011, when the world faced a similar situation, the US Treasury had issued a warning saying, “If Congress fails to increase the debt limit, it would cause investors here and around the world to doubt, for the first time, whether the US will meet its commitments. That would precipitate a self-inflicted financial crisis potentially more severe than the one from which we are now recovering.”

This year, too, the US Treasury has been issuing dire warnings that “Failure to raise the debt ceiling has the potential to be catastrophic with credit market freezing, dollar plummeting and US interest rates skyrocketing with the negative spillovers reverberating around the world.”

Indranil Sengupta, in a Bank of America Merrill Lynch report, writes that if the US finally defaults, it would lead to a Lehman-type global collapse that will likely slash about 80 basis points from India’s GDP forecast for 2013-14.

Congress MAY move IN

Most economists, however, believe that US Congress will not let the situation get out of hand.

Indranil Pan, Chief Economist, Kotak Mahindra Bank, says, “Since the dollar is the reserve currency of the world, it is unlikely that this issue will be allowed to escalate. Even if the US Senate fails to raise the ceiling, the President can exercise his veto power to do so.”

Advanced/emerging

According to the IMF, as of end June 2013, a third of the global foreign exchange reserves were held in dollar-denominated assets (including bank notes, bank deposits and government securities). These assets have grown 41 per cent from the first quarter of 2009 and currently stand at $3.7 trillion.

Advanced economies appear more vulnerable as their dollar denominated holding, as a proportion of total foreign exchange reserves, stands at 56 per cent. This is double the exposure of emerging economies.

(This article was published in the Business Line print edition dated October 8, 2013)