Qatar  | عربي

 

Download the PDF version of this weekly commentary in  عربي or  English 

The US Congress approved a two–year budget deal last week, further avoiding the specter of another government shutdown. While this marks a positive step by lifting a cloud hanging over the world’s largest economy, it does not tackle the challenges of the US long-term fiscal outlook. The budget deal in fact only increases discretionary spending marginally in 2014-15 without addressing the long-term rise in nondiscretionary spending, like Medicaid, Medicare, Social Security and interest payments. According to QNB Group, this budget deal is unlikely to change the overall long-term fiscal outlook and does not alter QNB Group’s forecast for US economic growth of 1.5% in 2014.

Following the collapse of a bipartisan commission in 2011 to tackle the large fiscal deficit, a large reduction in government spending (the so-called “sequestration”) became mandatory on March 1, 2013. This led to a significant fall in government spending, which has negatively impacted US economic growth this year. Democrats and Republicans failed to reach an agreement on the 2014 US budget last September, which led to a partial government shutdown for 16 days in October. A further mandatory sequestration of government spending would have taken place on January 1, 2014.

The budget deal reached last week between Democrats and Republicans restores a small amount of government spending that would have been cut under the sequestration. The deal marginally increases discretionary spending—the part of federal spending that is not subject to health and social security entitlements or interest payments. According to the US Housing Budget Committee, the budget deal restores USD45bn of discretionary spending in 2014 and USD18bn in 2015 that would otherwise have been cut from the US budget. This USD63bn cumulative rise in discretionary spending levels only represents 0.3% of GDP, which is unlikely to make a significant difference to the already weak US economic outlook. Most of this increase will be funded through higher airline passenger fees and other taxes.

US Federal Spending (2011-23)

(% of GDP)

 

Budget Deal Does Not Change Long-Term US Fiscal Outlook

 

Sources: US Housing Budget Committee, Congressional Budget Office, International Monetary Fund (IMF) and QNB Group analysis and forecasts

The main benefit of this budget deal is that it avoids another government shutdown over the next two years. The deal will increase discretionary spending in the short-term, easing the pain of sequestration. However, the budget deal keeps government spending lower than envisaged before the sequestration, which will lead to an additional drag on US economic growth of about 0.5% of GDP in 2014. QNB Group therefore forecasts the US economy to grow by only 1.5% next year.

Critically, the budget deal does not eliminate the potential for a renewed fiscal crisis. The deal does not include an increase in the US debt ceiling, which will again become binding on February 7, 2014. Unless this ceiling is raised, the US government will not be able to fund its operations, which would raise again the risk of an unprecedented default on US government debt.

Over the medium term, the problem of containing health and social security entitlements has not been addressed by this budget deal. According to the Congressional Budget Office, these entitlements are expected to rise significantly to about 15.0% of GDP by 2023 as a large portion of the US population, the so-called baby boomers, retire. This represents a significant challenge to keep the fiscal deficit under control while having sufficient room to address the growing infrastructure needs of the US economy. The current budget deal leaves it to a subsequent Congress to address this challenge.

Overall, the budget deal does not change the US long-term fiscal outlook, according to QNB Group. While it avoids another government shutdown, it does not address the challenge of reducing entitlements over the medium term. Moreover, it does not address the risk of a possible government default once the US debt ceiling becomes binding again early next year. As a result, QNB Group keeps to its current forecast of 1.5% US growth in 2014.

 

Follow Us