Q+A: $14.3 trillion debt limit looms closer

WASHINGTON (Reuters) - The U.S. government is on track to hit its $14.294 trillion statutory debt limit as early as March 31, and newly emboldened Republican lawmakers intend to use the need to raise it as leverage for spending cuts.

Financial markets will listen closely to President Barack Obama's State of the Union address on Tuesday for any clues on whether he would be willing to strike a deal with Republicans to cut spending in exchange for a debt limit increase.

A lengthy standoff could lead to worries in markets about a potential U.S. default.

Following are key questions and answers on the debt limit and the politics and market forces surrounding it.

WHAT IS THE DEBT LIMIT?

Congress sets a ceiling that limits the amount of public debt that the Treasury can issue. This authority was first enacted in 1917 when United States began borrowing heavily to finance its entry into World War One. The limit was meant to allow the Treasury discretion to issue large amounts of bonds more efficiently, while maintaining Congress' broader control over the federal purse strings.

The debt limit applies to all debt held outside of the government and many intra-governmental holdings, such as internal debt owed to the Social Security and Medicare trust funds. It does not apply to certain categories of debt -- currently totaling $52.6 billion -- including unamortized discount adjustments on Treasury bills and zero-coupon bonds and federal agency debt held by the Federal Financing Bank.

HOW CLOSE ARE WE TO THE LIMIT?

As of January 20, the U.S. national debt stood at $14.004 trillion, just $290 billion below the limit.

The Treasury has estimated that based on recent spending and revenue trends, the government will hit the limit as early as March 31. This could stretch out until May 16, depending on the strength of government tax receipts and economic growth. Treasury Secretary Timothy Geithner has asked Congress to raise the limit before the end of March so the government can meet previous spending commitments.

WHAT IF CONGRESS FAILS TO ACT AND THE LIMIT IS HIT?

The government would have to stop issuing debt to fund its day-to-day operations. If it does not have sufficient cash on hand from other sources, such as tax receipts, it would have to curtail some activities, including closing government offices.

The government may have to halt payments of federal benefits, such as Social Security or Medicare, or default by halting interest payments on Treasury debt. It paid $148.2 billion in interest to bondholders from October through December 2010.

WHAT WOULD HAPPEN IF THE UNITED STATES DEFAULTED?

Treasury officials have said this would be "catastrophic." Financial markets could experience severe turmoil. The government would likely have to cut spending deeply, which would suck fiscal support away from a still-fragile recovery and hurt those who depend on federal benefits.

The Treasury, normally a safe haven for investors, may also be shut out of borrowing in public debt markets for a period, so it might have to turn to international institutions such as the International Monetary Fund for assistance.

After the United States is able to resume borrowing, analysts say it would be punished with sharply higher interest rates for years to come as a result of losing its top-tier credit rating. This would in turn cause mortgage rates to rise and further increase the U.S. debt burden.

ARE REPUBLICANS WILLING TO RISK A DEFAULT?

No. Although a number of Republicans have voiced opposition to raising the debt limit as a matter of principle, many also have stressed the importance of ensuring that the United States meets its financial obligations. House of Representatives Speaker John Boehner and other House Republican leaders have acknowledged that the limit will have to be raised.

But Boehner and House Budget Committee Chairman Paul Ryan have said any vote to increase the ceiling must be paired with a commitment to lower spending over the long-term. They will be looking at Obama's proposed budget, to be unveiled in February, for evidence of spending restraint.

HOW ARE MARKETS VIEWING THE DEBATE AT THE MOMENT?

So far, there has been little sign of worry among buyers of Treasury debt, with 10-year note yields a manageable 3.34 percent. Markets have been through this before, and are accustomed to a certain level of political rhetoric before a debt limit increase is approved.

Although yields on long-term debt have climbed a half percentage point over the last two months, analysts attribute this to an improved economic outlook, which has led investors to shift funds to riskier assets, like stocks. But some on Wall Street fear a prolonged debt limit standoff and failure to make tough choices to cut deficits could ultimately cause investors to sell Treasuries and push up yields.

CAN THE TREASURY DELAY REACHING THE DEBT LIMIT?

Yes. It has several tools to alter its cash flow, but these measures can only last about eight weeks or so, pushing back the day of reckoning to mid-July at the latest. Chief among these are drawing down a $200 billion fund at the Federal Reserve that was created to finance emergency lending measures and halting sales of securities to state and local governments. It can also dip into some government pension funds and the $50 billion Exchange Stabilization Fund.

(Reporting by David Lawder; Editing by Jackie Frank)