Failure to reach deal on US debt limit to result in contraction: IMF

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International Monetary Fund (IMF) Managing Director Kristalina Georgieva said on Friday that failure to reach an agreement between the Biden administration and Republicans on raising the debt limit would lead to a contraction in the US and global economies. 

"Inevitably, we would be at the time of contraction in the US and in the world economy and that would come as a shock, upon shock upon shock," Georgieva said at a press conference on the 2023 United States Article IV Consultation.

While noting that the agency sees the necessity for the US to take more action to lower its public debt, Georgieva said that inflation in the nation is forecasted to remain above the Federal Reserve's target of 2 percent for the remainder of the year and the following year. 

"There is a need to do more to lower the public debt," Georgieva said, noting that "We see inflation remaining above the Fed's medium-term target throughout 2024."

In a press release on Friday, the agency said that raising the national debt ceiling is the only sound and viable solution to solve the recurring stand-off on the debt limit issue.

"Brinkmanship over the federal debt ceiling could create a further, entirely avoidable systemic risk to both the US and the global economy at a time when there are already visible strains," the release said.

"To avoid exacerbating downside risks, the debt ceiling should be immediately raised or suspended by Congress, allowing negotiations over the FY2024 budget to begin in earnest," the release said, noting that a more permanent solution is required to solve the recurring stand-off and ensure funds are readily made available to finance government programs. 

The International Monetary Fund (IMF) stated in its release that supervisors of the most susceptible banks in the United States have been "insufficiently assertive" and that their efforts have not appropriately addressed risks to financial stability.

The IMF supports holding mid-size banks to the same standard as large banks in order to tackle the identified systemic risks of smaller financial institutions, the announcement stated.

According to the so-called Basel framework, which establishes requirements for capital adequacy and stress testing, the IMF also advocates for annual stress testing of non-international banks.

Read more: Talks over debt limit made 'progress' yesterday: US House Speaker

On May 21, an analysis issued by fund flow and asset allocation data provider EPFR Global revealed that emerging market investors are incrementally moving away from dollar-denominated debt and assets and shifting towards local currency bonds as the safer options to park their assets.

According to results from the study, an estimated $2.65 billion has been withdrawn from primarily dollar-denominated assets between January and April of 2023. However, a net $5.23 billion was injected into local currency bond funds.

Observers say that the shift is attributed to attractive yields and falling inflation on local bond markets. Moreover, uncertainty surrounding the dollar and interest rate-related volatility has made it less attractive for investors. 

The recent collapse of SVB and other banks has further made the currency and treasury bonds less attractive for investors.

On Wednesday, US Treasury Secretary Janet Yellen warned that failure to reach a borrowing ceiling consensus before the June deadline would result in severe economic changes. 

US markets are accumulating losses every day as the debt default date of June 1st, also known as X-date, closes in. But the default impact would not be limited to the US as it would spill over to the global market. 

Moreover, in case this scenario happens, investors would lose trust in the US financial system, and thus won't be as motivated to invest in products and instruments backed by the US dollar.

Read more: Oil overshadows dollar in light of market turbulence