Flight to 'nowhere'

The flight to safety during the global financial meltdown of 2008 meant investment flows heading to the United States. Despite being the mother of the crisis, US was and remains a safe haven for investors.

But that status is on the verge of disappearing, with analysts predicting dire consequences for the US and global economies if the United States defaults. Credit rating agencies have threatened to downgrade the United States' triple-A (AAA) rating if Congress and the White House don't extend the debt ceiling and take steps to bring long-term deficits under control.

The rising uncertainties are deterring risk-taking and investment on one hand, and on the other hand currencies and commodities are on a swing. On the macro side, the current stalemate on the US debt ceiling enhancement has brought the US Dollar under pressure, which has a bearing on oil prices.

"Headwinds from fiscal tightening and sovereign credit worries are escalating rapidly," says a Citi report. Fiscal loosening was an important source of stimulus during the global recession, the report adds. "But many countries now face difficult challenges over how and when to return to sustainable fiscal paths."

Citi strategists expect that the US Fed will keep rates on hold until the second half of 2012. "If anything, the balance of risks over the next six months or so is tilted toward additional easing," the Citi report points out.

For India, additional easing in the US - a potential third round of quantitative easing (QE3) - would mean more trouble. As seen in previous rounds of US quantitative easing, commodity prices, including oil, went up. At a time when interest rates are rising in India, input cost shocks in the form of higher commodity and oil prices would expose India Inc.'s earnings to additional headwinds.

A rise in commodity prices, including oil, could cause issues for the Reserve Bank of India (RBI) in its ongoing attempts to combat inflation.  The US debt crisis has already made an appearance in the RBI's recent monetary policy review: "In the US, concerns over a sovereign default loom over financial markets, with potentially disruptive consequences for global capital flows."

While inflation remains RBI's most immediate concern, the consequences of the US resolving its debt ceiling debate could add to the Indian central bank's woes.