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Expect fiscal cuts in the US

A significant cutback in the bond purchase programme will probably have to wait till the end of 2014 or thereabouts

We talked to leading economists and fund managers to help you make sense of what is happening in the US and how it could impact emerging economies like India. This is what Saugata Bhattacharya, SVP & Head-Business and Economic Research, Axis Bank, had to say:

Is there any chance the US might get away without tapering?
Eventually tapering will have to happen because no central bank can afford to go on increasing its balance sheet to the size that we are already seeing. When this happens will depend on how the US growth prospects, particularly the housing markets, look. The unfortunate convergence of the Federal Government shutdown and the impending debt ceiling limit got resolved; but with some compensatory cutback in fiscal spending. The Fed will be worried about the effects of a fiscal contraction.

Could we see a shock in markets globally when that happens?
It will probably be not as severe as we were expecting in June and July. The cutback might be to the order of 5 billion to 10 billion a month. A significant cutback in the bond purchase programme will probably have to wait till the end of 2014 or thereabouts. Second, there hasn't been a very major drop in the yield of the benchmark US 10-year paper. So I think some part of this is already probably priced in.

Why has there been no inflation in spite of the US printing money every month?
The Federal Reserve's balance sheet would have grown by about $2.4 trillion from $0.8 trillion when they started the asset purchase program. But a lot of this money--around 70 per cent-- promptly went back into the Federal excess. So it's not as if a lot of money is sloshing around in the system. On top of that, given low consumer confidence, demand is expected to be moderate. Remember consumers are also de-leveraging. They had racked up huge amount of leverage. They're trying to reduce the size of their debt and then not buying as much.

The latest headache indicates a possible US debt default. How realistic is it?
The US cannot afford a default, the implications for not just the US, but other developed and emerging markets will be very significant. The debt ceiling will be extended. The trigger is going to be other factors like lower growth, fiscal drag, and so on. That will probably be the larger threat, larger trigger.

Could you elaborate on these triggers?
Interest rates will go up, mortgages more expensive, payments have been disrupted, important services like medical facilities have been closed, and other business opportunities are getting degraded. This can't carry on. The US administration and the Houses of Congress are probably both sensitive to negative perceptions. So my guess is that there will be some compromise at the last moment. How much this compromise will be in terms of fiscal cuts, I don't know.