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FACTBOX-Key political risks in the United States

Source: Thomson Reuters Foundation - Tue, 5 Mar 2013 11:59 GMT
Author: Reuters
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By Alistair Bell

WASHINGTON, March 5 (Reuters) - Partisan fights in Congress over the budget and tension with Iran over its nuclear ambitions are among the main political risks at the start of U.S. President Barack Obama's second term.

FISCAL BATTLES

Fights in Congress over the budget have dominated U.S. politics since Republicans gained majority control of the U.S. House of Representatives at the beginning of 2011.

At the heart of Washington's persistent fiscal crises is disagreement over how to slash the budget deficit and gain control of the ${esc.dollar}16.7 trillion national debt, bloated by wars in Iraq and Afghanistan and government stimulus for the ailing economy.

Government red ink also rose over the last decade after the enactment of tax cuts in 2001 and 2003 secured by President George W. Bush.

The crisis took a serious turn last week when ${esc.dollar}85 billion in automatic spending cuts known as "sequestration" began after both parties failed to reach a deal on how to stop them.

Both sides of the aisle agree that sequestration is bad for the economy but they disagree on how to replace the cuts. Republicans seek more targeted spending reductions while Obama and his Democrats want a mixture of cuts and tax increases.

The Obama administration is warning of dire consequences for the public - from long delays at airports to fewer food safety inspections - and an economic slowdown. Many of the predictions are based on the full sequestration cuts taking place over the next seven months until the fiscal year finishes at the end of September. A more likely scenario is that the United States will see only a few weeks of belt tightening before lawmakers come to an agreement toward the end of March to put off the cuts or replace them with more targeted reductions.

So far, the stock market has shrugged off sequestration, which is likely to only shave around 0.5 of a percentage point off gross domestic product this year in the worst case.

But if any companies are to be hit as the cuts bite and consumers rein in spending, they would likely be retailers such as Wal-Mart Stores Inc and Costco Wholesale Corp .

Defense companies such as Raytheon Co, Lockheed Martin Corp and Northrop Grumman Corp might also be exposed because half of the cuts are to come from the Pentagon's budget.

From a long-term perspective the worry for U.S. government bonds is that debt and deficit levels will undermine the world's opinion of the United States as a safe haven, and attendant credit downgrades would eventually cause U.S. borrowing costs to rise as investors demand more for what is seen as greater risk. Corporate borrowing costs could also rise in addition if yields on safer government debt move higher. In addition, talk that municipal debt may lose its tax-exempt status during budget negotiations would hit those bonds as part of their appeal comes from their tax-advantaged status.

But in the short term, U.S. government bonds could actually see a rally as a result of investor desire for safety if the budget crisis begins to spiral out of control.

What to watch :

- A deal between with White House, and the two parties in Congress, perhaps in late March, to replace sequestration with gentler spending cuts. Ideally, Democrats want any such agreement to also include closing tax loopholes on major oil and gas companies and eliminating the "carried interest" provision that reduces taxes for investment managers. But the two parties might agree on ways to soften the sequestration cuts by giving individual government agencies flexibility on how to implement them.

- The "continuing resolution." At the end of March, the financing of government operations expires, raising the possibility of a government shutdown. Known as the "continuing resolution," the appropriations legislation runs out on March 27 although lawmakers will be in recess that week so they might try to find a way by the end of the previous week to fund government operations.

- Entitlement reform. Obama this week raised anew the issue of cutting programs such as Medicare and Social Security to try to bring Republicans to the negotiating table and end sequestration. Some Republicans are open to dropping their opposition to raising hundreds of billions of dollars in new tax revenue if Democrats accept significant changes to Medicare and Medicaid as part of a long-term budget deal. One way to reform entitlements is changing the way the government calculates increases in the cost of living that would slow down gains in monthly Social Security payments to seniors. The White House considered this change - using an index known as chained CPI - but dropped it in December partly due to opposition from Obama's left wing.

- The debt ceiling. The federal government's authority to borrow new money runs out on May 19, although the Treasury Department is likely to take extraordinary measures that would push that deadline back to late July or early August. Fitch Ratings has warned it might downgrade the U.S. sovereign rating if Congress fails to increase the debt limit in a timely way.

ENERGY

Energy policy is shifting as newfound supplies push the United States from fuel scarcity to abundance. The Obama administration is considering whether to allow more exports of natural gas and a decision could come later this year.

Opponents of exports, such as Dow Chemical Co, say the shipments could spike fuel prices for manufactures and for home heating. But drillers, including Exxon Mobil Corp and Sempra Energy, would like access to new markets, especially with low prices domestically for the fuel.

As U.S. oil output hits the highest level in 19 years, pressure to export crude is also rising, though a nearly 100- year-old law requires companies to get special licenses to do so.

The oil boom is also giving Obama plenty of time to decide whether the United States should build a ${esc.dollar}5.3 billion pipeline to transport more crude from Canada. The project has been stalled for years due to concerns about its impact on the environment.

But it is uncertain whether the executive actions Obama says he could take on emissions would go beyond tougher standards on coal-fired power plants. Climate regulations on coal could hit miners and power companies.

What to watch:

- Environmental Protection Agency and Gina McCarthy, who Obama nominated to be its next head. Since Congress cannot agree to tackle climate change, Obama has signaled he will use the EPA to set stricter rules. Air quality expert McCarthy would likely push for putting emissions limits for existing power plants. After a long career in public service including work for two Republican governors, McCarthy is expected to win confirmation in Congress thanks to her reputation as a practical regulator.

- A decision by mid-year by the administration on whether to approve TransCanada Corp's Keystone XL oil pipeline that would bring oil sands crude from Alberta to refineries in Texas. The chance of approval rose when the U.S. State Department, in an environmental impact statement, said last week that the proposed ${esc.dollar}5.3 billion pipeline would not likely accelerate Canadian oil sands production, and by extension, fuel a spike in greenhouse gas emissions.

IRAN

- Dispute over Iran's nuclear capacity might come to a head this year. Israel has suggested it might attack its neighbor to curb what it says is Tehran's ambition to build a nuclear bomb. Oil prices would likely soar and the United States would be exposed to revenge attacks by Iran and its allies in the region.

What to watch:

- The red line. Israeli Prime Minister Benjamin Netanyahu has set a mid-2013 "red line" for denying the Islamic republic the fuel needed for a first bomb. The red line was dramatically illustrated by Netanyahu at the United Nations last year with a drawing of a bomb. Israel says it will not allow Iran to have enough uranium enriched to a fissile concentration of 20 percent. Even then, Iran would need to enrich the fuel further to have the basis for a bomb, a step Netanyahu said could be taken rapidly. While scientists differ about how much uranium is needed to have the ability quickly to make a bomb, analysts say the Israeli limit figure is believed to be 240 kg of uranium enriched to 20 percent.

- Talks. The United States and five other world powers will hold expert-level talks with Iran in Istanbul on March 18 and to return to Almaty for political discussions on April 5-6. The March meeting will be a chance for experts to explain in detail what an offer to slightly ease sanctions in return for Iran curbing its most sensitive nuclear work.

CHINA

Disruption to U.S. relations with China can move bonds, currencies, stocks and commodities globally. Beijing is the biggest single foreign holder of U.S. Treasuries, with around ${esc.dollar}1.1 trillion at the end of 2012. China has complained about U.S. fiscal policies and political gridlock in budget and tax debates and moved to diversify its foreign exchange portfolio. But fears that China could dump the bonds because of a political dispute have never materialized - largely because that would hurt China. U.S. pressure, including threats by lawmakers of punitive legislation, over China's currency policies has abated as the Chinese yuan has gained in value.

What to watch:

- Tensions between China and Japan intensified in 2012 over a long-standing dispute about sovereignty over a set of tiny islets in the East China Sea controlled by Japan but claimed by China. China grew more assertive in sending official but non-military maritime surveillance into waters surrounding those islands to challenge Japan's control and some in Beijing have accused Washington of goading its treaty ally Tokyo to confront China. The United States says it is neutral on actual sovereignty over the islets but that its 1960 security treaty with Japan covers all territories under Japanese administration. China is also locked in a territorial spat with another U.S. treaty ally, the Philippines, over islands in the South China Sea.

- The United States and China have been engaged in war of words over hacking and cyber espionage after a U.S. computer security company said that a secretive Chinese military unit was likely behind a series of hacking attacks mostly targeting American government agencies, think tanks, businesses and leading media outlets. China rejected the accusations and its Defense Ministry issued a claim that its websites were attacked by sources within the United States. Both countries are beefing up their cyber warfare capabilities, and U.S. industry has grown increasingly wary of Chinese efforts to pilfer industrial and business secrets through hacking.

- Political and military crises in the Koreas after North Korea's third nuclear test in February. Can Washington and Beijing can work together to defuse tensions? Taiwan lingers as a potential flashpoint in China's relations with Washington, but trade ties between the island and Beijing have dramatically expanded in the past several years. (Additional reporting by Tim Gardner, David Gaffen, Richard Cowan and Paul Eckert; Editing by Lisa Shumaker)

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