US spending cuts: What`s in store for next seven months?

CARE Ratings has come out with its report on "impact of US Expenditure Cuts". According to the rating agency, the US accounts for nearly 22% of World GDP and moderation in the US economy is bound to impact global growth prospects. Estimates incorporating impact of sequestration are expected to be in line with the lower growth estimates presented by both World Bank and IMF for global economic growth, in the range of 2.4%-3.5% in 2013.

The US government on Friday (March 1, 2013) announced its programme of “sequestration”, thereby cutting back on $ 85 billion of federal funding over the next seven months (ending October 1, 2013). The significant aspect of this process is that it will not be a one shot affair, but will be sustained over a period of nearly a decade, up to 2021. Therefore, any implication of such a move has to be in the context of the next 8-9 years. Broadly speaking, defense and non-defense discretionary expenditures of the government would each see a cut of about $ 43 billion during this period; which in percentage terms translates to a 13% reduction in the defense expense bill and 9% of non-defense spending for the government.
Big picture: why the need for sequestration? President Obama first took to office facing a 10 year deficit of more than $ 8 trillion, which was only accentuated by the recession in the US economy. Simultaneously, spending programmes of the government were faced with problems of duplication and ineffective targeting that reinforced deficit concerns. To further aggravate fiscal issues for the US government, debt levels for the state have reached rather unsustainable levels. As is common knowledge, deficit gaps of governments are bridged through debt borrowings which have ballooned, a dilemma well recognised as the “fiscal cliff” for the US. As of August 2011, the Budget Control Act (BCA) established the need to put into effect $ 1 trillion of discretionary spending cuts budgeted to aid in deficit reduction by $ 1.2 trillion, also bringing a political debate on the fiscal cliff to a planned consensus. The BCA also included a provision for automatic trigger of sequester effective from January 2013 if no actions were taken. Budget plans presented by the President for the year 2013 chart out deficit reduction to the tune of $ 1.2 trillion over the next decade (2012-2021) in order to bring the deficits to more sustainable levels, in the range of 3% of GDP, from current levels of 8.5% in 2012 and budget estimates of 5.5% in 2013. The first step towards this considerable diminution of deficit was taken with the announcement of the sequestration programme effective for seven months. Economic growth: Estimates provided by the Congressional Budget Office, suggest that sequestration would result in US GDP dropping by 0.6%. It is also said that it could affect as many as 750,000 jobs. Budget 2013 is based on the underlying assumption of 3% real GDP growth and 1.7% inflation (GDP-chained price index) during the financial year. This would imply that the World Bank and IMF projections of 1.9%-2.0% growth in 2013 for the US appear likely in the face of pull-back in government expenditure. The unemployment scenario in the US undoubtedly would turn grimmer in the face of such spending cuts. It was estimated earlier that more than 700,000 fewer full time jobs would be created in the next few years. However, with lay-offs increasingly simultaneously, the unemployment rate could settle well above the current rate of 7.8%. Indeed, Budget 2013, excluding the impact of sequestration, has already set the estimated unemployment rate at a high of 8.6%. Impact on Global Economy: The US accounts for nearly 22% of World GDP and moderation in the US economy is bound to impact global growth prospects. Estimates incorporating impact of sequestration are expected to be in line with the lower growth estimates presented by both World Bank and IMF for global economic growth, in the range of 2.4%-3.5% in 2013 (and 3.1%-4.1% in 2014). In general, QE has not materially boosted growth and in the event of continuation of such a policy by the Fed, it is felt that growth prospects are not expected to change dramatically. Developments in the US and Euro economies would have significant impact on sentiments in capital markets and would hence, influence the direction of capital investment flows across countries. The USA has looked like one of the better performing economies prior to this announcement and was supposed to move up the curve gradually. Any negative development that restricts activity in the U.S. could have a magnified impact on the economic prospects for the rest of the world. As the euro market remains weak, export-oriented economies in Asia and Latin America have become progressively dependent on U.S. demand to lift their exports. Some of these countries such as China, Mexico, Canada, and UK could see a moderation in GDP growth if U.S. demand growth falters as a result of the government spending cuts. Disclaimer: This report is prepared by the Economics Division of Credit Analysis & Research Limited [CARE]. CARE has taken utmost care to ensure accuracy and objectivity while developing this report based on information available in public domain. However, neither the accuracy nor completeness of information contained in this report is guaranteed. CARE is not responsible for any errors or omissions in analysis/inferences/views or for results obtained from the use of information contained in this report and especially states that CARE (including all divisions) has no financial liability whatsoever to the user of this report. The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions. To read the full report click on the attachment

Read More