The year gone by was eventful, both for the world and India. While the much-awaited Goods and Services Tax (GST) was passed by the Indian Parliament, United Kingdom voted to exit the European Union. While Donald Trump took the world by surprise, Indian Prime Minister Narendra Modi's sudden announcement of demonetisation left the whole country in a financial shock. The global commodity market too woke up from a slumber, though there is more recovery that can be made. While these and many other such events shook the world in 2016, their impact on global trade and policy environments will only likely be seen in 2017. Will 2017 be a year of change for the better? The Dollar Business takes a look at key elements and occurrences that could change world trade in 2017.
The Dollar Business Intelligence Unit | January 2017 Issue | The Dollar Business
Two events that shook the world in 2016 were Britain voting to exit the European Union and Donald Trump’s surprise (shocking?) win in the US presidential elections.
When it comes to India, the two major government decisions that created a stir in 2016 were the passage of the GST Bill and the demonetisation initiative of the government. We did predict, in January 2016 issue of The Dollar Business, that the GST Bill was likely to go through in 2016 and we have been proven right on that. Demonetisation though took us by surprise, just as it did the entire nation. We had also predicted that crude prices will be in the range of $40 to $60 and crude stayed within that range for the most part of 2016.
It was certainly a year of more hits than misses in terms of forecasts for us. And following tradition, this year again, we analyse the events of the past to come up with educated forecasts as to how 2017 will look for India and the world, in terms of trade and economy. Our take in general: 2017 will spring surprises too!
Love him or hate him, the world will now have to contend with President Donald Trump. His campaign rhetoric against China was something that many thought was just that, rhetoric. But his recent overtures towards Taiwan and his consistent remarks against China may mean that he will follow through on at the very least some of his campaign promises. He has already announced that US is walking away from Trans-Pacific Partnership (TPP), expressed a desire to work on a preferential trade agreement with UK, talked about imposing punitive taxes on US companies who outsource jobs abroad and has expressed a desire to revisit NAFTA.
So, even before Trump assumes the presidency, through his remarks on trade and key appointments he has made, Trump has cast an uncertain and his trademark unpredictable shadow on foreign trade. His promise of bringing down the corporate tax rate down to 15% from the present 35% may see investments flow out of India and other developing countries into US. Wall Street has reacted positively, and polls say that Americans believe Trump will be good for the US economy.
His disdain for the H1B visa regime however remains a matter of concern for India’s IT giants including TCS, Infosys and Wipro that depend on these visas for much of their revenues. His promise of incentivising job creation in US may also hurt the Indian outsourcing industry. Though it remains to be seen if cost benefit of the incentives can match low cost of labour in India.
Donald Trump. the maverick outsider, will assume US presidency on January 20,
2017. His isolationist policies may have a long-term impact on global trade.
What could have a large impact on both foreign policy and trade though is the mutual admiration society of Trump and Putin. Trump has made it clear that he wants closer relations with Russia – this may mean lifting sanctions on Russia. If it happens, it may usher in a fresh breeze of growth in Russia in 2017.
China and The World
While speaking of Trump, can China be far behind? China’s sluggish economy remains a major concern in 2017. Since the country is the world's largest consumer of major commodities, world trade is likely to remain subdued until China gets on its feet again. In fact, global trade grew just 0.8% year-on-year in the first ten months of 2016 – this was its worst performance since the Global Financial Crisis of 2009.
What could work in China's favour though is the Market Economy Status (MES) that the country claims it has gained in December 2016 under the terms of its accession to WTO in 2001. However, for most of the world (sans China), Market Economy and China do not go hand in hand. For, with MES in hand it would become difficult for trading partners to impose punitive anti-dumping duties on China, a country that is known for its penchant for dumping cheap products. Two of its biggest trading partners – EU and US – have refused to play ball, and China has promised to retaliate. The ball is now in WTO's court, and it remains to be seen who will win the biggest historical war fought over trade. As of now, the world can only hope that it's not the Dragon.
"Inward-Looking Policies of Some Countries are the Biggest Threat to Global Trade"
Also, issues such as protectionism and isolationism are increasingly disrupting the global economy. Brexit, which caught many across the world including those in UK by surprise, is an indicator of isolationism. Perhaps, if the trend continues, it will lead to a major breakdown in EU. For that record, International Monetary Fund (IMF) sketches a rough picture on how protectionism will impact the world going froward. In its October 2016 Global Financial Stability Report, IMF states that protectionist measures in Europe and US will "ultimately generate secular stagnation, given constrained macroeconomic policy responses." This will induce firms and households in Europe and US to postpone their expenditures, reducing private investment and consumption by 6% and 2%, respectively, over the next five years. In addition, higher trade barriers concentrated in these two regions will contribute to reductions in exports and imports in these regions by about 20% and by about 10% in the rest of the world over the next five years.
Protectionism and isolationism are patterns mostly common among advanced countries. But the injury it will inflict on the rest of the world is something that worries many. According to OECD, protectionism has been on the rise ever since the financial crisis of 2009. And G20 countries, the flag bearers of global trade, have been equally guilty of trade restrictive measures. The November 2016 Global Economic Outlook from OECD cited a 5.6% increase in trade restrictive measures over the June 2016 report. Amita Batra, Professor of Economics, Centre for South Asian Studies (School of International Studies, Jawaharlal Nehru University), says, “Inward-looking policies of some countries are the biggest threat to global trade, as they introduce uncertainty to the system.”
Speaking of that, the ‘exit’ movement in Europe is a concern. After Brexit, the worry is about Grexit, Frexit and more! Matteo Renzi, former Prime Minister of Italy (a country with $2.4 trillion debt), had proposed some changes to the constitution which would have had an impact on the level of governance and on the fiscal policy, bringing Italy in line with EU's policies. A referendum against the changes forced Renzi to resign and pushed Italy to consider a future outside EU. Meanwhile, right-wing political parties in France are busy mobilising public opinion in their favour with anti-immigrant and anti-Euro pitch – on top, there is the Grexit (Greek Exit).
While EU will be wary of some more exits, 2017 is likely to see more isolationist movements a-la-Brexit.
Meanwhile, the demonetisation move that pulled back 86% of India’s total currency in circulation on November 8, 2016, has had a negative impact on consumer spending and trade in the country. Many say that this will bring down Indian economy for a brief period, and reports from states suggest that the economy will indeed suffer.
A market watcher like India Ratings has already lowered India’s GDP growth prediction for FY2017 from 7.8% to 6.8%, while HDFC forecasts a year-on-year slowdown in Q3, FY2017 from 7.8% to 6.8%. Various sectors have already been hit and many will feel the impact going forward in 2017. For instance, JLL India predicts that demonetisation could impact luxury property price by 25-30%, which will also result in a short-term loss for cement and ceramic industries.
Officials at Nagpur ICD have also confirmed that demonetisation has had a devastating effect on exports of rice because more than 80% of transactions in procurement chain are in cash. Officials report that it will take about 4-5 months to stabilise and recover 60-70% of lost business.
Other than that, transport companies across the country have been hit hard, especially the smaller ones – some businesses are down by 50%. The only sector that seems to be enjoying the benefits of demonetisation is the bank. An HDFC report suggests that there will be an improvement in tax compliance and fiscal balance. C. S. Sudheer, MD & CEO of IndianMoney, a wealth advisory firm believes that bank FD rates will also go down in 2017, so would loans rates.
Agriculture, a labour intensive sector that runs on cash has been in a spot of trouble. There is also a worry that cash starved labourers will be unable to resume work during harvesting and tiling farmlands for Q4, 2016, and Q1, 2017. The impact on agriculture has spread to logistics players too. “Demonetisation is opposite from Jai Jawan, Jai Kisan. The local farmers here are dejected. The demand is feeble. Moreover, there is no remedy to cash when it comes to buying seeds, fertilisers and transport services. It will have a negative impact on our production in 2017,” says Insaram Ali, President of All India Mango Producers Association.
Further, post demonetisation, the Nikkei India Services Business Activity Index dropped from 54.5 to 46.7 (in November 2016) contracting for the first time in 17 months since June 2015, signifying a contraction in demand in the sector. However, Ashank Desai, CEO, Mastek Ltd., believes that the direct impact on services sector owing to demonetisation will be marginal. But then, the real impact of demonetisation on services can only be gauged in 2017.
"India's GDP Growth is Likely to Dip in 2017 Due to Demonetisation"
The Goods and Services Tax (GST), which was introduced in August 2016 to bring in uniformity in tax rates and procedures across the country, seems to be in troubled waters when it comes to its implementation. The April 1, 2017 deadline, which was the targeted roll out date, currently seems undoable with the Centre and states unable to agree on an acceptable formula for tax administration.
While Union Finance Minister Arun Jaitley has gone on record to say that the constitution requires the government to implement GST before September 2017, the central government will need the support of the states to push through the reform before the said deadline.
Further, as Ravneet Singh Khurana, Deputy Commissioner (GST), CBEC, puts it, “The entire economy will have to face the challenges that will be associated with GST. Challenge for manufacturers will be to streamline their entire supply chain. And for exporters, it would be to handle the working capital requirements.” This definitely will take time to happen as businesses have just started waking up to the tax reform.
And now demonetisation has also thrown a spanner in the works. Demonetisation decision, which united the Opposition and has already washed out the winter session of Parliament, is bound to impact the scheduled roll-out of GST.
All together, the new year may not be even upto the 2016 mark as far as India's GDP and foreign trade is concerned. The positive impact of the GST will only be seen in 2018 and the impact of demonetisation is likely to hold back exports of several products, particularly agri-commodities, in the short term.
World trade growth has been abysmal, registering a low 0.8% growth in the first 10 months
of 2016. China’s slowdown will continue to weigh on global economy in 2017.
On the brighter side, Worldsteel Short Range reports that global steel demand will grow by 0.5% and will reach 1,510 million metric tonne in CY2017, which will be driven by Brazil’s moderate recovery and the emerging ASEAN 5 i.e. Thailand, Malaysia, Vietnam, Indonesia and Philippines.
World Bank suggests that OPEC and non-OPEC’s decision to cut production will keep crude at $53-55 per barrel. And since Russia and Iran have too agreed to slash production in the same Vienna meeting, crude oil is very likely to sail out of trouble in 2017. Meanwhile, with the Trump administration in place, shale oil production in US should also add to the supply glut. But we expect that to have a minimal impact in 2017. The Dollar Business Intelligence Unit believes that crude oil in 2017 will trade above $60 level and may even touch $80. But moving beyond that seems to be difficult, nay, impossible in 2017.
Metals are something to watch out for in 2017 as Trump plans to focus on infrastructure development in US – this may fuel demand for metals. Even signs of recovery are visible in world's biggest market for metals - China. “Metals and minerals prices are expected to rise 4.1% in 2017, a 0.5% upward revision due to increasing supply tightness,” sums up a World Bank report on metals.
And speaking about certain commodities like copper, experts like Harry S. Dent Jr. Founder of Dent Research, feel that patience is the key to success. The rewards for the patient may start flowing in only by the end of 2017.
The seesaw relation between gold and dollar is another picture worth the study. According to Hareesh V., Research Head at Geofin Comtrade Ltd., a part of Geojit BNP Paribas, gold price will go down because the dollar is strengthening. “If the US Federal Reserve hikes the rate, it will crash the gold price,” he comments.We expect dollar to strengthen further as currencies like euro and pound sterling remain subdued, and that would mean that gold rates too remain subdued.
By all accounts most commodities will continue to perform better than 2016 levels, though a complete turnaround is not expected in 2017. Industry experts are of the opinion that the glut in commodities may still take more than a year or two to clear. Most of them have a less-than-rosy outlook for commodities in the near-term. But they do agree that the worst is over. And it's only a matter of time (say 2-3 years) before the growth engines start roaring again!
All in all, 2017 promises to be a year of change. We believe President Trump will fall-back on his experience of businessman Donald Trump, and while putting America first will take the fact that America is great because it took the lead in opening up the economy and boosting free trade. While Trans-Pacific Partnership (TPP) may fizzle out, we hope NAFTA (while undergoing some revisions in terms) will hold strong.
The US markets have responded positively to Trump's election and we believe Trump's first year will see increased economic activity in US. The Putin-Trump affair too has the potential to change the dynamics of international relations as well as global trade if sanctions on Russia are lifted.
When it comes to European Union, the bloc will experience more tremors going forward. The recent terrorist attack in Berlin has put Angela Merkel (who faces a re-election in 2017) on the back foot. France, which also has a general election in 2017, is also witnessing a right wing isolationist movement. And that does not bode well for EU's future.
As far as the Dragon is concerned, it is likely to register sluggish growth, though its foreign policy ambitions may lead to it taking the lead in trade initiatives with Latin American and African countries.
As for India, we believe that GST will be implemented before September 2017 and that we will see negative impact of demonetisation fade away by the second half of the year. Exports should however remain stable with little growth in 2017.
Overall, 2017 should be a year of economic revivals across the globe, bounce-back for commodities, return of protectionism and isolationism, re-negotiations on mega-FTAs, Brexit fallout and drama of the Trump administration.
What you've read thus far is a summary of issues that are far too significant to be discussed in a couple of paragraphs. A more detailed 'topic-by-topic' analyses of six factors that will shape world trade in 2017 have been discussed in the following pages of this cover story.
What's really in store for world trade in this brand new year? We urge you to flip through the pages and decide for yourself.
The current stalemate between the Centre and states on the much-debated issue of sharing of tax administration power could result in Goods & Services Tax (GST) missing its go-live date of April 1, 2017. And what will be the impact of the new regime on India's exports and economy?
Neha Dewan | January 2017 Issue | The Dollar Business
In August 2016, when the Goods and Services Tax (GST) Bill was finally given the nod by the Lok Sabha, it expectedly got everyone excited. After all, here was a bill that was expected to make taxation simpler with its revolutionary uniform tax regime. The GST in principle should simplify taxation in the country for goods and services, which should ultimately eradicate the cascading effect of multiple taxation. And, the fact that the government has assured to shield the common man from heavy tax shocks only added to its sheen.
In short, GST when implemented, is expected to perform wonders. But, can it really? Can it herald a new era for the Indian economy and foreign trade in 2017? Will the economy get a makeover – so to say? Industry experts are bullish on the impact that GST will ring in for the new year. The new tax regime is expected to give a leg up to exports as well as bolster the growth of the Indian economy.
The Task Ahead
Of course, what GST sets out to do is by no means an easy task! It will subsume a variety of central and state indirect taxes and foster efficiencies with its objective of ‘One Nation, One Tax.’ But there are hurdles already. The April 1, 2017 deadline, which was the targeted roll out date, currently seems bleak with the draft legislation not getting finalised yet by the Centre and states. What's more? As per industry insiders and reports, there doesn’t seem to be any showing up before September 2017 for it to be in place, primarily due to a lack of consensus between the Centre and state governments on the issues of tax administration.
However, this possible delay is being seen as good news by all and sundry. The reason is simple! Things have changed by dramatic proportions in the post-demonetisation days and implementing GST in such an economic scenario will by no means imply a smooth roll out. Optimistically, it is predicted that cash conditions will not normalise before March 2017. In fact, states like Bengal, which were once fervent supporters of the GST regime, are rethinking their position and believe that implementing GST at this time may be too much of a disruption. While FM Arun Jaitley has gone on record to say that the constitution requires the government to implement the GST before September 2017, the central government will need the support of the states to push through the reform before the said deadline.
Ravneet Singh Khurana, Deputy Commissioner (GST), Central Board of Excise and Customs (CBEC), GoI, says, “It is too early to measure the kind of impact demonetisation will have on the implementation of GST. But, if you look at the broader perspective, both demonetisation and GST are two sides of the same coin in the strategy of the government towards combating corruption and black money.” So, despite the veil that currently cloaks its implementation, GST is being largely seen as a reform that has the wherewithal to turnaround the competitiveness of our economy.
Sample this. According to a Care Ratings report, the logistics industry is pipped to grow at a CAGR of 15-20% between FY2016 and FY2020 and is expected to get a further boost after the GST roll out, slashing costs by 20%. The report highlighted how costs could get trimmed significantly as such a tax structure would reduce the long queues at border check points as well as other entry points within and between the states.
Ramesh Agarwal, CMD, Agarwal Movers Group, says, “I think, once GST is implemented logistics cost in India, which is currently about 1.8 times higher than that of developed countries, will become quite competitive. And my assumption is that the sector will grow at 10-12% year-on-year post GST. At present, the slew of trade barriers that include the entry tax, local body tax, octroi to name a few, keep trucks idle for a good 30-40% of the day, resulting in loss of man hours and fuel."
Dhruvil Sanghvi, CEO and Co-founder LogiNext highlights that global logistics spending is expected to be $10.6 trillion in 2020 – with transportation accounting for most of the spending, at 70%. “GST will prove to be the best thing that has ever happened to Indian economy. Imagine India with no state-wise octroi check posts, the very basic barriers to intercity logistics and trade. Trade barriers such as VAT, CST, service tax, etc., will diminish, which in return will positively affect the overall foreign trade position. Post GST implementation, we can expect increased foreign trade with better exim policies,” says Sanghvi.
A major change involving GST implementation is its compliance,
which will necessitate robust systems and tracking of information.
Other than logistics, industry experts predict that sectors such as FMCG, automobiles and consumer durables will be big beneficiaries of GST. And that is because the multiple direct taxes levied differently in different states will be scrapped and a single tax structure will come in place. The reduced tax rate would also mean an increase in the consumption rate of goods.
Pankaj Dubey, CEO & Managing Director, Eicher Polaris and Polaris India, respectively, offering a perspective, says, “The current tax rate in the automobile industry is believed to be in the range of 30-40%, which on the implementation of GST would fall in the range of 20-50%, depending on the vehicle’s category, capacity and classification. So, even a 10% reduction is a reason to rejoice as it will benefit the end users. In the long run, the automotive sector is expected to see a high rate of growth.”
The telecom sector is also expected to see an upward trend with handset prices possibly taking a dip across states. A greater ease of business could be in the offing for handset makers as they will not have to set up state specific entities or invest in logistics just to take advantage of tax breaks doled out by different states. In addition, cement and other construction related businesses will witness a turnaround because savings will come from lower transportation making products more competitive across the world.
Because of lower transportation and compliance costs, the GST, most agree, will be a positive for the foreign trade fraternity. At least in principle, think tanks feel that GST will be a win-win game for importers and exporters in the long-term. Veeresh Hiremath, Head,
Commodity Research, Karvy Comtrade, says, “With the implementation of GST, India is likely to become more competitive in global trade. Under GST, importers would be taxed at the same rate as products produced and consumed in the domestic market, while exporters would be taxed at zero rate and will be eligible to claim the refund of input tax credit. Since imports would be fully taxed it will protect domestic players.”
Tarun Arora, Director at IG International, a fresh produce import-export company, holds similar views. “Under the GST regime, customs duty would prevail and CVD, SAD, cess, etc., shall be replaced by IGST, which would be fully refundable. This may benefit most of our importers,” says Arora.
Besides being applauded as a healthy reform within the country, foreign investors might also find GST to be more transparent regime. As per a Feedback Business Consulting Services survey, 72% of respondents are positive about the influx of FDI into India – especially in automotive and engineering sectors. So far, some foreign investors have been reluctant to invest in India, primarily because of the country’s regulatory and bureaucratic complexities. A successful enactment of GST could have a transformative effect on FDI inflows.
Agarwal also feels the logistics sector will be able to attract FDI, as MNCs will take an active interest in the Indian market. Nikal Kothari, Chairman of National Council on Indirect Taxes, ASSOCHAM, too believes that, “The commencement of a unified tax system from an earlier complex one with multiple sources will make indirect tax processing simpler and even foreign investors will find the system easier to fathom.”
Despite the positive sentiment around the bill, one thing that worries exporters is the refund structure. Just like the present system, even though exports are zero rated, the GST retains the refund system at the final stage. Industry reports allege that the provision of no exemption and only refund will block at least Rs.1,85,500 crore annually for the manufactured goods exporters.
Vibhash H. Trivedi, MD at Kanoovi Foods, says that not much is expected to change as far as claiming of refunds is concerned under GST. “In the current structure, the refund timeline is around 60-70 days. So, the only difference with GST will be a single window, unlike today. However, we do expect that documentation processes for refund claims, etc., will be easier once GST is in place.”
"FDI inflows may grow post-gst, on the back of a uniform tax regime"
France, in 1954, was the first country to introduce GST. Slowly, other countries implemented the tax system. While positive sentiments are good, if there is a learning to be taken from countries like Australia, Canada, Japan and Singapore, the GDP growth has almost always slowed down accompanied by a rise in inflation in the year of implementation of an unified tax regime.
And not surprisingly, GDP growth is expected to drop in the initial years in India too. “There would be very minimal impact of GST on inflation and the impact, whatsoever, would be for short term. Countries that implemented GST witnessed a one-time increase in inflation for a very short period after GST implementation,” shares Anshul Rai, CEO & Co-Founder, Happay, a cash management company.
Further, the Malaysia experience shows that manufacturers also take time to adapt to GST. Traders in Malaysia had demanded the postponement of the implementation as they found the new system to be cumbersome. Agrees Khurana as he tells The Dollar Business, “The entire economy will have to face the challenges that will be associated with GST. Challenge for manufacturers will be to streamline their entire supply chain. And for exporters it would be to handle the working capital requirements.”
With GST, the ubiquitous state and city check posts will be a thing of the past,
thus improving the speed of cargo movement. But how soon? That only time can tell.
Although the draft GST bill is already in public domain, manufacturers will have to wait and watch till it assumes a final shape. Some believe that the exemptions, levies, and the four-tier structure may make the tax regime complex again.
So far, so good! But the question remains: Will GST be able to meet the September 2017 deadline? While most legal experts sound optimistic that the system will be operational by the end of 2017, industry and technology experts opine that building a system from legacy could have potential barriers. Further, other than hardware and software required to transform the country's tax regime, the government will also have to train about 60,000 tax officials. The good news though is that about 45,000 of them had already received training till December 15, 2016. But then, it's still a long way to go.
The other worry is that would the industry be able to make the changes required at their end within the stipulated time? Much of this change will occur on the systems that organisations use for compliance. “Entire ERP systems will need to be re-configured, and staff will have to be trained on GST aspects. The onboarding of vendors could result in a big change. There is need of support from finance, procurement, legal, IT, and other departments for positive outcome of GST, else the holistic picture may not be possible,” says Pratik Shah, Partner, SKP Business Consulting LLP.
And now demonetisation has also thrown a spanner in the works. Demonetisation decision, which united the Opposition and has already washed out the winter session of Parliament, is bound to impact the scheduled roll-out of GST. [West Bengal has already expressed concerns about timely implementation of GST due to demonetisation.]
Considering all this, we believe that while GST may be implemented before September 2017, its roll-out is likely to be postponed until July 2017. This means that we will have to wait until 2018 to see its real impact on the Indian economy.
Patience is a virtue. And that, of Indians will be well-tested with the go-live date of GST still being largely debated. But that's not the Big Q here. The more important question is – how simple will taxes really look after GST comes alive. And how will exporters benefit from the so-called progressive tax regime?
Patience, Dear Exporter, Patience!
Ravneet Siggh Khurana, Deputy Commissioner (GST), CBEC, Government of India
TDB: In 2017, what kind of an impact do you think GST will have on Indian economy and foreign trade?
Ravneet Singh Khurana (RSK): GST has been proclaimed as the game changer that will reshape the economic landscape of the country. The shift from origin-based taxation to destination-based consumption taxation, free flow of goods and services throughout the country, and an unbroken input tax credit string throughout the supply chain will make a huge impact on the Indian economy. GST is looking at efficient neutralisation of taxes so that our exporters do not export taxes embedded in the inputs. This will not only make our exports competitive but will provide an opportunity to the Indian exports sector to grow. On the imports side, it is going to provide effective protection to the domestic industry by the imposition of IGST (Integrated Goods and Service Tax) equal to domestic levies on goods being imported and thereby enhance the potential of our domestic manufacturing. Of course, all these expectations are based on the assumptions that other factors that impact the economy or international trade remain the same.
TDB: How do you think GST will help India secure a position among the big league in the global supply chain?
RSK: To start with, I don’t see GST as a mere indirect tax reform but a reform that would re-engineer the business process, right from procurement of raw materials to delivery of final product to the consumer. GST has the potential to transform the Indian economy and revolutionise the way business is conducted in India. GST would create a common national market by opening the inter-state trade.
Also, efficient neutralisation of taxes, especially for exports, will make our products more competitive in the international market and give a boost to Indian exports.
Another crucial aspect that needs to be highlighted here is the elimination of central sales tax (CST) in the GST regime, which in my eyes is the biggest obstacle to the transformation of India into an economic union. The non-VATable character of this tax not only adds to the cost of production of a particular product but also forces the businesses to base their decisions on taxation rationale rather than on business considerations. The advent of VATable IGST on inter-state trade or commerce will open the horizons of the inter-state trade like never before. So, I have no doubt in my mind that if GST does not have the potential to launch India into the big league of global supply chain, nothing else will.
TDB: How will GST change the ease of doing business impression about India?
RSK: Well, the answer to this question lies in the objective of GST, i.e. “One Nation, One Tax”. The ease of doing business is not merely a cliché but a set of parameters that define the way the taxpayer interacts with the tax administration. Some of these parameters are like obtaining registration, filing of the returns, making payment of taxes, etc. And, if you look at all these parameters, GST is going to score high compared to our present day indirect tax regime. GST would have a single registration, single return and single payment, which would make the life of the taxpayer much easier – all these will be done electronically. This will not only result in the reduction in compliance costs, but it will also bring down human interface between the taxpayer and the tax administration. Another aspect that I would like to highlight is uniformity, which is the buzzword in GST. GST is expected to ensure homogeneity in the indirect tax laws and procedures along with tax rates throughout the country. So, one just needs to consider the business aspect of the supply, rather than the tax component.
TDB: It is being feared by many that the refund structure in GST could create more blockages. What’s your opinion?
RSK: GST is expected to be beneficial for the export sector as exports are going to be zero rated. There are various ways to ensure that the exports are zero rated. However, we have put forth two options. One option is that the exporters would pay taxes on inputs and input services that are being utilised for the exports and then claim refund of the same. The other option is that the exporter will pay taxes on inputs, use the input tax credit for paying tax on exports and then claim refund of the same – colloquially known as rebate of taxes and the most popular one also. This we understand may lead to increased working capital requirements. Therefore, to alleviate this burden, the draft model GST law provides for provisional refund to the exporter to the tune of 90% of the refund claimed within seven days of filing of refund application. Further, with the refund process becoming electronic, the delays and challenges associated with the claiming of refund will be things of the past.
TDB: How will GST change our supply chain dynamics? Will it help us achieve international benchmarks?
RSK: That isn’t a simple task because of many variables involved such as infrastructural constraints, regulatory and taxation framework, etc. For instance, the check posts that act as non-tariff barriers create impediments to the free flow of the goods. Also, the imposition of CST on inter-state trade or commerce forced many companies to adopt complex supply chains, resulting in multiple warehouses and supply centres throughout the country. It also resulted in higher investment and inventory cost for businesses and created infructuous small-sized warehouses, thus making businesses unable to realise the benefits of economies of scale.
However, with GST, the supply chain is going to emerge as the biggest benefactor, besides the manufacturing sector, as business decisions will no longer be guided by taxation considerations. The introduction of IGST, instead of CST, will lead to consolidation of warehouses and shrinkage of the supply chain thereby making it more efficient and cost effective. Removal of check posts or at least streamlining of its working will go a long way in reducing the on-road time of the vehicles and make their movement faster. Also, the supply chain will witness consolidation as the dynamics of the economies of scale come into the picture and result in the emergence of investment opportunities in this sector. I firmly believe that introduction of GST will have a positive impact on our supply chain and make it more efficient, dynamic and lucid and bring it closer to international benchmarks.
TDB: Do you think Indian products will become more competitive in the global market post GST?
RSK: There is no doubt about that! With GST, there will be seamless flow of Input Tax Credit, right through the entire supply chain and thereby have a positive impact on the cost of our products. Further, with exports being zero rated and more efficient neutralisation of tax component in the export products, Indian products will acquire greater competitiveness in the international market. Also, the gains from the logistics will further reduce the costs and make the supply chain more efficient, thereby ensure timely availability of our products in international market.
TDB: Do you foresee GST initiating any challenges for exporters and manufacturers in 2017?
RSK: The answer to this question is not easy. However, the first thought that comes to my mind is the challenges that will be associated with the successful implementation of GST, which the entire economy will have to face. But with the objective to have a smooth transit between the old and the new system, the GST law, rules and processes have been put up in the public domain to not only seek the comments of trade and industry, but also to make them aware of the challenges ahead and enable them to prepare their transition plans accordingly.
The biggest challenge for the manufacturers will be to streamline their entire supply chain from the cradle to the grave – as they say. They need to look at their vendors from whom they are sourcing their inputs and try to consolidate their input procurements because the input tax credit will be available only on matching the invoices. Further, the logistics part and selling and distribution network need to be aligned with the consumer demands and key areas of growth.
Also, the fact that GST is going to be IT driven, the shoring up of the technological capacities to handle the electronic processes is going to be one of the key concerns of the manufacturing sector. Besides, decisions about pricing of the products will be important as it will be based on equalisation of all India cost, taking into account uniform tax rates in various states as well as the decision to pass on the benefits of the GST to the final consumer.
As for the exporters, the biggest challenge would be to handle the working capital requirements which will arise because of weaning away of the option of duty free procurement of goods and services as inputs for exports, both domestically and imported. The need to re-align the working capital cycle with the flow of funds will be crucial.
Veeresh Hiremath, Head, Commodity Research, Karvy Comtrade
TDB: How do you think GST will impact the Indian economy and foreign trade in 2017?
Veeresh Hiremath (VH): GST is the biggest reform since 1991, when the country opened the economy. However, after implementation, there will be a negative impact in the first year because tax payers will have to adjust to the new tax regime and understand the process. So, the environment for trade and industry isn’t very promising and will slow down the growth of the economy in the short run. State governments will lose their share of revenues, which the Centre has to compensate – an additional burden on the central government’s budget. However, in the long-term, GST will bring a positive change.
TDB: What sectors do you think will benefit the most from GST? Do you see any late gainers in the chain?
VH: GST is expected to have a both positive and negative impacts on the economy. Sectors such as FMCG, automobile, cement, electrical, retail, multiplexes and logistics will benefit from the reform. However, from the lot, I think the FMCG sector will emerge as the biggest beneficiary. It is because the multiple indirect taxes levied differently across the country will be scrapped and a single tax structure will be implemented.
Warehouse rationalisation and reduction in overall tax rates would generate savings for the logistics and supply chain sector. And with the reduced tax rate, the consumption rate of the FMCG goods will surge. Also, the benefit for automobile sector will be larger than other sectors as the prices of most vehicles will come down because of lower tax rates. Some sectors, including cement and electrical, are seen as late gainers because they are dependent on housing market and infrastructure projects, and will enjoy the benefits in a trickle down effect.
TDB: How soon will GST help boost exports ?
VH: When GST starts to benefit the domestic industries, it will eventually make Indian goods and services more competitive in the international market. India is one of the key players in the global trade of goods and services, and, it is expected to grow bigger after GST.
TDB: Do you think demonetisation will have an impact on implementation of GST?
VH: Demonetisation cannot be linked with GST because of the differences in their purpose. But with that said, the two put together will smoothen the economic progress of the nation. India is in the process of adopting a single tax formula, which requires state-of-the-art technology to make payments online. Hence, demonetisation will have a positive impact on the implementation of GST.
TDB: How do you compare India’s supply chain dynamics against other countries? Will ‘Made in India’ products become more competitive?
VH: Supply chain is mostly dependent on logistics and warehousing. And, as GST is expected to smoothen the inter-state movement of goods and services, logistical and warehousing services will be automatically strengthened. GST will reduce the logistical and warehousing charges, so it will be a money saving tool for stakeholders in the supply chain. And in return, the system will make India more competitive in the global market. As for the second question, GST will have a mixed impact on the economy. But the fact that GST will scrap taxes levied at various levels, the ‘Made in India’ products will be more cost competitive in the international market.
While a large segment of the Indian population supports the post-Diwali demonetisation drive, that its impact on India's economy will be negative in the short term is a given. The Dollar Business analyses how the move could well prove a headwind for India's manufacturing, foreign trade and economic growth.
Sairaj Iyer | January 2017 Issue | The Dollar Business
The Government of India, in a sudden and shocking move, implemented demonetisation on November 8, 2016. The move rendered Rs.500 and Rs.1,000 bank notes illegal tender. According to the government, it's an attempt to reduce corruption in the country and clamp down down black money, smuggling, drugs, counterfeit money, etc. Banning 86% of the country’s money in circulation by value is surely a bold move, but will it turn out to be a good move as well? Or, is demonetisation a policy that has gone too far? Above all, can the move really benefit India's growing economy?
While the people of India are split on the decision, economists are unanimous that the move will not benefit the economy in the short run. Considering its impact on the Indian economy, Reserve Bank of India (RBI) itself has lowered the GDP growth forecast for FY2017 from 7.6% to 7.1%.
In fact, several market watchers like Mumbai-based Ambit Capital have brutally lowered India’s GDP growth forecast for the current fiscal from 6.8% to 3.5%. "The demonetisation-driven cash crunch that is playing out in India will paralyse economic activity in the short term. We expect a strong 'formalisation effect' to play out as nearly half of the non-tax paying businesses in the informal sector (40% share in GDP) will become unviable and cede market share to their organised sector counterparts," states a report from Ambit Capital.
Demonetisation has made Rs.500 and Rs.1,000 currency notes illegal tender.
The denominations account for about 86% of the total cash in circulation in Indian economy.
While Dr. Narendra Jadhav, a noted economist who formerly donned the RBI’s Chief Economist hat, labels demonetisation as “constructive disruption”, former Prime Minister Manmohan Singh, a venerated economist himself, terms demonetisation as “organised loot, legalised plunder”. Certainly there are fierce supporters and naysayers on opposite sides of the aisle! Who is right and who isn't, that, only time will tell. But for now, the economy has to live with it.
India isn’t the only country that has gone this far to curb black money! In the last few decades, countries like Nigeria (in 1984), North Korea (in 2010), and the erstwhile Soviet Union (in 1991) have demonetised their currencies. The circumstances post demonetisation though were very different in these countries and none mirror the circumstances that were prevalent in India when the initiative was launched.
While in North Korea people had no food to eat, in Myanmar there was a phase of economic stagnation. As in Soviet Union, the policy didn’t go down well with the public (leaving states like Ukraine and Kazakhstan severely affected and bringing down the Union's per capita income about 20%). So, what level of damage are we talking about when it comes to India?
Many perceive that demonetisation will have a short-term impact on the economy – they believe the negative effect will only last for the first two quarters of CY2017. "The fall in economic activity due to demonetisation could last for two to three quarters. As a result, GDP and GVA growth in the quarters from September to December 2016 and January to March 2017 could be significantly lower than previous years," states a report from New York-based investment research and analytics firm Market Realist. While Fitch cuts down India's growth forecast for FY2017 by 50 basis points to 6.9%, a report from Care Ratings estimates that overall GDP growth would be affected by 0.3-0.5% in FY2017.
Real estate, automobile and consumer goods sectors have emerged as the top losers as
customers have adopted discretionary spending behaviour post demonetisation.
Real estate, automobiles, retail have emerged as the top losers in most of these predictions as customers have suddenly adopted discretionary spending behaviour. JLL India predicts that demonetisation could impact luxury property price by 25-30%, which will also result in a short-term loss for the cement and ceramic industry that are diectly connected to real estate demand.
However, almost all experts believe that in the long run, demonetisation has the potential to lift India's growth through a more transparent economy.
"Fall in economic activity due to demonetisation could last for two to three quarters"
The foreign trade sector has so far seen mixed fortunes and the trend will continue for some time in the near future. India had an excellent monsoon in 2016 and experts have forecasted an above average harvest. Thus, ports and ICDs were expecting to see and incredible surge in business, particularly exports of agri-commodities. However, officials at Nagpur ICD tell The Dollar Business that demonetisation is having a devastating effect on exports of rice because more than 80% of the total domestic transactions are in cash. Almost the whole chain involved in procurement favours cash, which is being reflected in the exim business at the ICD. Officials report that it will take about 4-5 months to stabilise and recover 60-70% of lost business.
Interestingly, on the contrary, Dr. Anup Dayanand Sadhu, Group General Manager of CONCOR Bangalore, says that in November 2016, ICD Whitefield witnessed one of the best exim businesses in the last few years. Both exports and imports from ICD went up by 30% y-o-y each. He says, “Ports or any other establishments that rely on cash transaction will face the brunt. But a cashless set up like ICD Whitefield will stand through the tough days,” says Sadhu.
V. J. Kurian, Managing Director of Cochin International Airport, also shares a similar story. “Passengers are travelling as usual and we have not seen any impact on exim cargo business so far. Hopefully, this will continue through the remaining phase,” he tells The Dollar Business.
Maersk Line too reports that while business in Q4, 2016, was slower than usual, in 2017 India will be amongst the few countries where the company will witness a quadruple increase in its topline (over 2016). The only players in the logistics chain that seem to have taken a hit are the small transport companies – bigger players with a strong establishment seem to be on safe shores. Santosh Kumar of Green India Transport, a Tamil Nadu-based logistics company, says, “Business has gone done by 90% since demonetisation. And we aren’t the only company in troubled waters. But, hopefully, business will bloom because there are many pending cargoes that need to reach their destinations. It’s a matter of another couple of months.”
Equities & Inflation
Demonetisation's positive effects are expected to pay out only in the second half of 2017. An HDFC report suggests that there would be an improvement in tax compliance and fiscal balance. Alongside, it will reduce corruption and eliminate counterfeit money in the long term. "This move is likely to lead to better tax compliance, increased tax to GDP ratio and improved tax collection. This could lead to lower borrowing and better fiscal management. Also with lower cash transactions in the near term, inflation may see downtrend in the near term," states the report titled 'Demonetisation and its impact'.
Even a Morgan Stanley report predicts that 2017 could very well turn out to be the year for equities. The report points that low return environment could get a respite due to better equity valuations, resulting in a bottoming of the growth cycle and higher correlations with global equities markets. Morgan Stanley expects personal consumption, which accounts for 60% of the GDP, to pick up from the second quarter of CY2017. "We maintain our overall constructive outlook on India. We expect growth to be back on the recovery track from Q2, 2017 after a short period of slowdown between November 2016 and March 2017, due to the currency replacement programme," states the research note.
C. S. Sudheer, MD & CEO of IndianMoney, a wealth advisory firm, believes that bank FD rates will go down in 2017, so would car and housing loans. “When interest rates are falling in the economy, debt mutual funds do well. Many debt mutual fund schemes have given more than 2% returns in a week. This will continue in 2017,” says Sudheer.
This should also mean a higher inflow of FDI into India on the back of a more transparent investment climate, and that should bode well for the manufacturing and foreign trade fraternity.
Sectors such as textile, weaving, seafood, handicrafts, beedi-rolling, metal-ware, etc., which are largely labour-driven, remain in the informal economy and the impact of demonetisation on these sectors will be largely negative in the first half of CY2017. However, industry experts believe a major part of these industries will come into the formal sector post-demonetisation in the long run and that should add significantly to the GDP.
Also, border trade through land entry points, where cash is widely preferred, is expected to decline. For instance, India’s trade with Bangladesh and Nepal through land entry points involve a lot of cash and there is a probability that a major part of this trade will now move into the formal economy, which is definitely good for the economy.
Interestingly, demonetisation has been a mixed bag for our neighbours too. Indian rupee is a quasi-legal currency in some of these countries – Nepal and Bhutan. And not to say, the surprise move flummoxed both local businesses and governments in these neighbouring nations. According to reports, the price of agricultural commodities in Bhutan have fallen by 12% (as on December 24, 2016) since the first week of November.
Demonetisation has had a devastating effect on exports of rice because
more than 80% of the transactions in the procurement chain are in cash.
Foreign institutional investors (FIIs) have been moving money out of the country since demonetisation. In November 2016 alone $5 billion worth of funds moved out of the country's capital markets fearing a slow down in the economy. More funds are expected to flow out in the near future. In fact, the yield of the benchmark 10-year government bond has already hit a seven-year low of 6.19% on November 30, 2016, and is expected to remain somewhere around the number for some time. However, market players argue that domestic institutional buying have helped arrest the slip.
What comes as a double whammy is that another Fed rate hike is on the cards in January 2017. If that happens, more FIIs will begin marking their exit from India starting that month for better prospects in the US market.
Ready For The Future
The most positive impact of demonetisation would be that the money that normally remains idle will come into the banking system. This will give banks the required liquidity to fund infrastructure projects. Historically in India, even when the government and the RBI have instilled rate-cuts, banks have done little to pass on the benefits to customers. This could change now with more liquidity in bank coffers.
It is important that some of this liquidity goes into creating infrastructure to make Indian manufacturing competitive. The Industrial and Commercial Bank of China (ICBC) offers loans in the range of 4.9% for 5 years to Chinese companies, whereas Indian banks have maintained a 12-20% rate. Once interest rates fall, the infrastructure sector should see a renewed interest from private players as gestation and break-even periods are expected to shorten.
The government will also be prompted to utilise these funds in creating infrastructure and developing ports. Investing in projects outside of India could also be an option. “Chabahar Port development will perhaps move in the right direction after demonetisation,” says Huned Gandhi, CEO, Express Logistics India.
Agriculture sector, which contributes nearly 15% to India’s GDP, will be highly impacted due to unavailability of credit and labour in the short term. Co-operative banks and micro-finance institutions, the leading credit providers to farmers, have been forced to shut shops in the face of demonetisation and that has already had a dampening impact on seeds offtake during the sowing season. There is also a worry that cash starved labourers will not be able to resume work, at the very least, till the first half of 2017.
Besides seeds and labour, availability of fertilisers is also a worry. A stronger dollar will result in higher prices of crude and raw materials in the production of fertilisers. All this will hit India’s top agri-exports like cotton, cereals, coffee, tea, spices, etc., really hard. Prices of cotton have already soared by over 9%. So, by the time Q1, 2017 is over, there could be an impact on acreage sown and yields. Even plantation crops such as fruits, rubber, tea, jute and cardamom are observing tough times as owners have no cash to pay the labourers.
Ports or any other establishments that rely on cash transaction will see the impact.
But a cashless set up like ICD Whitefield will stand through the tough days.
What's more worrying is that the impact of demonetisation on agriculture is expected to last long as a large number of farmers are financially illiterate and do not have bank accounts. “Demonetisation is opposite from Jai Jawan, Jai Kisan. The local farmers here are dejected. The demand is feeble. Moreover, there is no remedy to cash when it comes to buying seeds, fertilisers and transport services. It will have a negative impact on our production in 2017,” says Insaram Ali, President of All India Mango Producers Association. This also means India's exports of some agri-commodites might go down in 2017, while imports of some will rise to fulfil the domestic demand.
Will Services Shine?
India's services sector has always been a front-runner – be it exports or attracting investments. The sector attracted the highest amount of FDI inflows during April 2000-March 2016 period – to the tune of $50.79 billion, which is about 17.6% of the total FDI inflows into India during the period (DIPP data). However, post demonetisation, the Nikkei India Services Business Activity Index dropped from 54.5 to 46.7 (in November 2016) contracting for the first time in 17 months since June 2015, signifying a contraction in demand in the sector.
However, Ashank Desai, CEO, Mastek Ltd., believes that the direct impact on services sector owing to demonetisation will be marginal. “The sector has been a key driver of India’s economic growth, contributing nearly 66% of gross value added (GVA) growth in FY2016 and has emerged as an important net foreign exchange earner and the most attractive sector for FDI inflows. With demonetisation, the currency has depreciated against the dollar and the volatility has dwindled. A stronger dollar will help exports. However, when it comes to FDI, I believe, inflow be lower in 2017 than what we saw in 2016,” says Desai.
Case-Study In Making
The initial impact of demonetisation is slowly taking effect, but it will take another six months or so to realise its total impact on foreign trade. A stronger dollar will mean that exports will get a boost, but the rise may be negated by supply side problems. "As a response to the slowing GDP growth, we expect RBI to consider rate cut of 20-50 bps in the first half of 2017," states a report from Ambit Capital.
The other factor that needs to be considered is GST. If the acrimonious political fallout of demonetisation results in a delay in its implementation, that will have serious implications for both manufacturers as well as the merchant community of India.
Will demonetisation bring in acche aayat-niryat din for India? Only 2017 will tell. What we forecast though is that the impact of demonatisation will fade away by the second half of 2017. And despite demonetisation we expect 2017 to be 'the' year when India's exports stage a slow, steady turnaround.
Ravi Bhagchandani, Managig Director, Jr Financial
TDB: What sectors, in your opinion, have borne the brunt of demonetisation? What will be the impact on the country's GDP in the long term?
Ravi Bhagchandani (RB): The key segments of the economy where cash transactions play a vital role are real estate, construction, gold and informal sectors. Rural economies, agriculture, small traders, services sectors, households, professionals such as doctors, carpenters and utility service providers will also be significantly impacted.
The role of cash transactions in the case of real estate and gold is mostly dubious. However, in the case of informal sectors, it is the lifeline. The sudden move by the government is a jolt for dabba trading (proxy market) which thrived in equity markets. Satta Bazaar, the illegal betting market, including trades done outside bourses, will die a natural death.
The nature, frequency and amounts of the commercial transactions involved within these sections of the economy necessitate cash transactions on a more frequent basis. For example, small and marginal farmers in the fruits and vegetables category, typically off-load their produce in the local mandi in cash. So, with this move, they will now face challenges.
The sudden nature of this exercise has adversely impacted this segment of the economy and it will witness immediate contraction, though we should hope that this impact will diminish over time. There will be a short-term deflation followed with a short-term inflation. But, in the long-term, these sectors will resume their work as a formal sector. This will mean that these will be calculated within the GDP. It should be about a positive 1-1.5% impact on the GDP in the long term.
TDB: Do you think because of demonetisation the industrial outlook for 2017 could be gloomy?
RB: I don’t think that the industrial outlook should be negative for 2017. It is because if you look at the formal sectors, the problems are basically labour, working capital and discretionary spending pattern of customers. Sectors such as offshoring, outsourcing and largely services such as B2B have been the least impacted, though short-term traders have been.
The industrial outlook for 2017 does look scary from a labour perspective. But, that will again mean employers will be forced to open bank accounts or utilise e-wallets to remit or transfer wages. This will eradicate many cash-related challenges. The first half of 2017 therefore is laborious, but the second half looks promising.
The sudden decline in money supply and simultaneous increase in bank deposits is adversely going to impact consumption demand in the economy in the short-term. This, coupled with the adverse impact on real estate and informal sectors may lead to lowering of GDP growth. Many think tanks, including economists, have in fact gone to assume that Q3 and Q4 growth for FY2017 will be 5-6% on the GDP numbers. The GDP formation could be impacted by this measure, with a reduction in consumption demand. Moreover, this expected impact on GDP may not be significant as some of this demand will only be deferred and will re-enter the stream once the cash situation becomes normal.
TDB: Now that PSU banks will be re-infused with new deposits, what are your thoughts on the banking sector?
RB: We can expect a large amount of cash in circulation to be brought within the purview of the formal banking system by way of deposits. Within a month and a half, about Rs.14 lakh crore was brought back into the banking system. This is structurally positive for banks because a part of this cash gets deposited as current account and savings account (CASA) deposits, reducing banks dependence on high cost borrowing.
Deposit deployment remains a challenge in the short to medium term, due to the current tepid demand for credit, subsequently pushing deposit rates lower. With cash transactions facing a reduction, alternative forms of payment will see a surge in demand in the long term.
Digital transaction systems, e-wallets and apps, online transactions using e-banking, use of plastic money (debit and credit cards) etc., will definitely see substantial increase in demand. This should eventually lead to strengthening of such systems and development of the infrastructure required.
TDB: Do you agree that demonetisation has proven to be a major threat for the real estate business?
RB: It’s not only real estate. Since the sector has strong linkages with cement and steel industries, they will also turn credit negative in the short-run. A significant impact in the short-run will be on contractual labourers in the informal sector. The construction sector has one of the highest employment multipliers. So, from a production perspective, construction and real estate will be impacted by nearly 20-30% in the short-term.
With more money coming into the banking ambit, deposit growth is likely to improve and positively impact the savings rate. Investors will be keen to invest in financial products and therefore real estate's relevance as an investment option will diminish in the short to medium term. The only silver lining is for the working class, who will be motivated to buy their first property on the basic premise that loans have suddenly become reasonable.
Dr. Jeffery A. Frankel, Professor, Hrvard Kennedy School, Harvard University
TDB: What do you think would be the direct impact of demonetisation?
Dr. Jeffrey A. Frankel (JAF): This was a bold act by Prime Minister Modi, which I think many western leaders won’t be brave to follow. With that said, the effects could be with respect to the exchange rate, disruptions in international trade, international investments and even migration.
TDB: How do you view demonetisation as a reform remedy?
JAF: I can think of three categories of demonetisation. One common category is when one note is replaced with another for technical reasons, giving the public plenty of time to cash in all their old notes in exchange for the new. Nobody needs to lose out. One reason why the authorities might make the switch is to improve the security features of the bills. Another might be if the old note proves so unpopular that it is not widely used. We could also consider in this category such peaceful transitions as the discontinuation of 11 of Europe’s national currencies after January 1, 1999, and their replacement with the euro.
TDB: Then what, according to you, is PM Modi’s motive?
JAF: His motive was closer to the third category. It includes what America did in 1969, when it announced the phasing out of $500 bills and higher denominations and what the European Central Bank decided in May 2016 to do with its €500 notes (and what some economists think US should do with its $100 bill). These high-denomination notes are mostly used in illegal activities, ranging from tax evasion to corruption to drug trafficking and terrorism.
So, the government stops issuing the big bills to avoid facilitating these illegal activities. In these cases, the phase-out period is generally very long – in some cases, indefinitely long, until all the paper notes wear out. If the government is brave, it could set a relatively short time-period, of less than a year, after which the note in question is no longer valid, and could ask tough questions to anyone trying to cash in a large quantity of the large-denomination notes.
The goal would be to go beyond merely phasing out the facilitation of illegal activities and strike a strong blow against those who have been engaging in them.
TDB: Has the demonetisation initiative lived up to its hype?
JAF: Discouraging illegal activities is a motive to be applauded, but the implementation in the case of India has obviously fallen short. I don’t understand why it had to be so sudden and secretive. Especially when the notes were relatively small and widely used by all Indians, not just in illegal activities. The government should have allowed enough time to print plenty of the new notes and even allowed businesses to accomplish some of the desired switchover to non-cash means of payment.
Even with the advanced warning time, those who had accumulated large wealth stashes in the form of the bills would still have lost some value – in effect a tax – if they had been unable to demonstrate to a bank that they had valid reasons for owing the bills. Yes, they would still have been able to take recourse to an unofficial market in the phased-out bills, but they would have had to sell the bills at a discount.
Most importantly, more time would have avoided the serious inconveniencing of ordinary people and disruption to the economy that India has experienced.
With the Electoral College in US voting in favour of Donald Trump, questions of who will be the most powerful man in the world after Obama have been put to rest. What would a President Trump, who won on an isolationist platform, mean for the future of world trade? Will a US withdrawal from TPP signal the beginning of the end for the mega trade pact? Will China eventually benefit? The Dollar Business finds out.
Indranil Das | January 2017 Issue | The Dollar Business
It was a long shot. Some fervent liberals had hoped that Donald Trump would fail to garner the requisite number of votes from the Electoral College. But with the electoral votes cast and counted, the last effort to stop a Trump presidency was exhausted. Love him or hate him, the world will now have to contend with President Donald Trump. His campaign rhetoric against China was something that many thought was just that, rhetoric. But his recent overtures towards Taiwan and his consistent remarks against China may mean that he will follow through on – at the least – some of his campaign promises.
He has already announced that US is walking away from the Trans-Pacific Partnership (TPP), expressed a desire to work on a preferential trade agreement with UK, talked about imposing punitive taxes on US companies who outsource jobs abroad and made clear a desire to revisit the North American Free Trade Agreement (NAFTA).
Even before he assumes office, through his remarks on trade and key appointments he has made, Trump has cast his trademark unpredictable shadow on global trade.
Claims Versus Facts
Since Trump had made 'Making America Great' his campaign plank, let us first see how a Trump presidency may fare in terms of growing the US GDP. The economy and how to improve it was in focus during the presidential election. While the Republican Party and President-elect Trump has said that Obama and his liberal policies have failed to boost the economy and it is time to revert to fiscal conservatism to revive the economy, history suggests that economy has typically fared better under a Democrat president. Yes, you heard it right!
US Congress Joint Economic Committee data shows that, since World War II, GDP growth has been substantially better under Democrat presidents. And each Democrat president since the time of John F. Kennedy has performed better in terms of GDP growth than the preceding Republican president. Unemployment and job growth was the other factor that voters were concerned about. Interestingly, a study titled, ‘Presidents and the US Economy: An Econometric Exploration’, by Professor Alan S. Blinder and Professor Mark W. Watson, both from Princeton University, suggests that “During Democratic presidential terms, the unemployment rate fell by 0.8 percentage points, on average, while it rose by 1.1 percentage points, on average, during Republican terms – yielding a large D-R gap of 1.9 percentage points.”
Trump sure has built a reputation as a maverick, but if one has to go by past numbers (and Trump depends on fiscal conservatism) Trump may find it difficult to deliver on his promise of growing the economy and bringing jobs back to America. Trump's promise to cut corporate tax rate from 35% to 15% though should improve the investment climate and we may actually see job growth. But then, the rate cut and America's present level of debt (estimated at nearly $19 trillion) will mean there is less money to spend on the social sector. It will also mean there will be less to spend on infrastructure. Less spending on the social sector, including education and student loans, may mean that America's workforce will not be competitive. Trump has himself said many-a-time that America's infrastructure is in a shambles and needs immediate attention. Without infrastructure and an efficient workforce, it is difficult to boost the economy.
"US has historically seen better gdp and job growth under democrats"
Trading with Trump
World trade was not in the best of shapes even before Trump was elected President. It continues to remain that way. The WTO trade monitoring report, released on December 9, 2016, states: “The WTO is projecting a 1.7% increase in world merchandise trade volume in 2016, down from its earlier forecast of 2.8%. If this revised forecast is realised, it would mark the slowest pace of trade and output growth since the financial crisis of 2009.” Organisation for Economic Co-operation and Development (OECD) researchers in September 2016 found that annual growth in global trade has fallen dramatically from 3.4%, a rate that existed prior to the Global Financial Crisis. According to the OECD report, since 2011, global trade growth has averaged just 1.3%. “This is well below past norms and implies that globalisation as measured by trade intensity may have stalled,” it adds. What is interesting is these are all pre-Trump numbers.
Trump has already made his anti-free trade stance clear. Opposition to trade agreements is not just restricted to politics in US, the anti-globalisation sentiment is also on the rise in Europe. It also taps into legitimate concerns about the continued relevance of free trade and the idea of an international trading system exclusively designed to promote economic liberalism. Brexit was the fall out of this sentiment and it seems there are more European countries like Italy and France that might venture on this route. Ironically, US that has been one of economic liberalism’s biggest proponents seems to be turning away from the agenda. All thanks to Trump!
If Trump follows up on his rhetoric of relooking NAFTA, cancelling TPP and reviewing all other trade pacts, US may one fine day wake up to find itself without a single major partner. How will that work for the US economy? Not well. Trump may not realise but the axis of trade has moved eastwards and US is no longer the economic power that it once used to be. With US backing away, TPP may no longer be the trade bloc that it promised to be. Vietnam has already withdrawn from the agreement and Japan is rethinking its stance.
Many European leaders have been open about their dislike for Trump. And Trump has wholeheartedly reciprocated such emotions. While EU continues to be one of America’s most important trade partners, it remains to be seen how EU-US trade performs under the new regime, and of course with TPP no longer on the table. Trump though was a supporter of Brexit and we may see a closer bond between UK and US. But a US-UK FTA is not on the cards in 2017 as UK is not in a position to negotiate any FTA till the time its exit negotiations from the EU are over.
Bringing back manufacturing jobs to US will be a difficult task for Trump. Interestingly, according to the Bureau of
Labour Statistics, since 2000, American manufacturing companies have wiped over 5 million people off their payrolls.
Who Hates China? TR...
Trump was openly anti-China in his campaign speeches, and has promised to bring back manufacturing jobs to US. Trump has also threatened to impose an unrealistically high 45% tariff on Chinese imports, prompting US companies operating in the Asian country to fear retribution. He has further annoyed China by making friendly overtures to Taiwan, and may relook the 'One China Policy'. China has certainly not taken kindly to these signals and has vowed to keep the status quo in place.
During the election campaign it certainly made sense to flay China. The US-China trade imbalance has been a cause of concern and that manufacturing jobs have moved from US to China and other countries is a fact. But will businessman Trump allow politician Trump to forego a low-cost manufacturing location? Nobel Laureate Joseph Stiglitz has said that the US economy would be a big loser if Donald Trump imposes new tariffs on imports from China.
He forecasts a possible trade war, a correction in US living standards and job loss. Can such outcomes be ignored?
With US taking an isolationist stance, China has started projecting itself as the trading partner of choice to all major economies. China has made overtures to Latin American countries during the Asia Pacific Economic Cooperation (APEC) Summit in Peru held in the middle of November. During the Summit, Chinese President Xi Jinping laid out the agenda for the LatAm nations saying "come join us and let’s move forward." Chinese officials also recently (in December) visited Mexico to strengthen ties with the LatAm manufacturing giant, a country which has also frequently found itself caught in Trump’s political crosshairs. Both countries have expressed interest in lessening their dependency on US. China is also trying to push through the Regional Comprehensive Economic Partnership (RCEP) and is taking pains to show that it is a reliable trade partner for fast-growing economies across the globe. Will US’ loss be China’s gain? [Do we need to even answer that?]
Middle East Quagmire
Trump drew flak from the Islamic world after he said that he would impose a ban on Muslims entering US. Trump has also vowed to be ‘neutral’ in negotiations between Israelis and Palestinians, which is considered to be a major break from long-standing US foreign policy favouring Israel. And that could make Trump’s rise bittersweet to the Muslims. Will it also bring a semblance of stability to trade in the Middle East? With the recent strife in Syria, Turkey, Iraq and rising threat from ISIS, this seems to be an unlikely occurrence in the near future. Trump had talked about bombing ISIS to pieces. But America has had a less than enviable record when it comes to interference in the Middle-East, and the present state of disarray in Iraq is a testimony to that. If Trump does take an aggressive stance, it would mean he does not believe in learning from history.
President-elect Trump has announced that US will be walking away from the Trans-Pacific Partnership (TPP). He has also gone on record
stating that US will also look at renegotiating NAFTA. Going forward, such isolationist stance from Trump could adversely impact world trade.
The Putin Affair
Trump's love for Russian President Putin had made the headlines during the campaign. And for Russia it seems a Trump presidency is a blessing as he has talked about normalisation of relationships. Will Trump remove the sanctions on Russia? If that happens it could see the emergence of Russia as a major trading partner for US. It would also mean a shift in foreign policy for US, and could help matters in the Middle-East. But the US government has accused Russia of interfering in US elections and Obama has promised that US will hit back at a time and place of its choice. Will the two governments be able to bury that mistrust that has been created over many years? Not so soon. At least not in 2017.
Time To Change
The world economy in 2017 will be grappling with many issues; the fallout of Brexit, the dilution of TPP and the emergence of the unpredictable Donald Trump as the leader of the free world. Trump the 'outsider' may change the notion of business as usual when it comes to foreign policy and foreign trade for times to come. For good or for bad is anybody's guess, but 2017 will surely be a time to change.
Geethanjali Nataraj, Trade Economist and Researcher, Brookings India
TDB: Donald Trump’s victory in US election has sparked many talks on isolationisms and protectionisms. Do you see this impacting global trade policies?
Geethanjali Nataraj (GN): Earlier, it was just the proliferation of FTAs, but now it is all about the mega FTAs like Trans-Pacific Partnership (TPP) and Transatlantic Trade and Investment Partnership (TTIP). And with the Trump administration going against trade, America will be affected. Other countries may also follow suit. Protectionism will rise and, I think, mega FTAs will be dropped. I think more countries will sign bilateral deals with countries that they have some interest in and India is also going to do the same. Since TPP has not gone through as of now, India has more time to prepare for more internal reforms such as Goods and Services Tax (GST).
TDB: Do you think India must join Regional Comprehensive Economic Partnership (RCEP) despite what is happening with the TPP?
GN: Even if RCEP goes through, its significance has declined. But then, RCEP is the only big regional trade deal that India is a part of. So, it is more or less beneficial for India to be a part of RCEP than to be in isolation. But, in the long-run, I don’t think it will serve any purpose. It would be better for India to sign bilateral deals with countries that it has specific interests in.
TDB: Leaving aside India, do you think China will emerge as a strong leader with RCEP and develop trade ties with African and Latin American countries?
GN: Yes! Since TPP does not have US in the equation anymore, countries like Australia and Japan may ask China to become a part of it. Japan can lead TPP without US, but now, if Australia wants China to be a part, China can take the lead in all of this – including China’s own initiatives like the 'One Belt, One Road' initiative. So, you really cannot do much without China!
TDB: Do you think the North American Free Trade Agreement (NAFTA) is in trouble?
GN: Obviously, NAFTA is in trouble. These countries – Canada and Mexico – will obviously look at other agreements that US is not a part of. Everybody will try and frame their own trade policies according to the changing situation. And now that all know exports to US are not going to be so easy, US firms are not going to invest in Mexico.
TDB: How do you look at India-US trade development under Trump’s administration?
GN: There was a time when US was India’s largest trade partner – not anymore though. India’s trade no longer depends on just US – anyways our exports to US are declining. But, I think, the large-scale investments from US into India might get affected. Also, India’s service exports will get affected, not only because of Trump, but also because of Brexit. The sentiment of nationalism is growing strong in these countries and India’s services sector is really going to be hit with anti-immigration policies.
TDB: What is your take on the long-pending India-EU FTA and the potential of an India-UK FTA?
GN: India-EU FTA has been on the back burner for almost three years. Negotiations have sretarted, but EU is not giving data security status to India and India is not ready to give entry to their wine and automobile industry, so there is a problem. Of late, India is trying to negotiate something with UK – there are a lot of permutations and combinations that are being worked out, but it’s too early to comment. So, I don’t think anything is going to happen in the global trade for the next few months. I think people will allow Trump to settle down and see if he is ready to give a second look to TPP – if TPP goes through then the scenario will be very different. So, it’s wait and watch time and nothing drastic will happen in the coming months.
TDB: How would you explain the Trump phenomena?
GN: I am not an expert in this, but I think there is very little that he can do by himself. I don’t think US's relationship with India will be affected in any way because US needs India more than India needs US. This is also because of the geopolitical situation developing in Asia and US’s deteriorating relationship with China. US is aware that India has a role to play and, I think, India will get more concessions than other countries.
TDB: FTAs have been opposed in India, especially with developed countries. What are your views on this?
GN: Many industry chambers have raised an objection to most of the FTAs. They include even the Comprehensive Economic Partnership Agreement (CEPA) between India and Japan, India-Korea CEPA, India-Malaysia CECA, etc., because India’s exports declined after signing them. So, the government has set up an expert committee under the chairmanship of Arvind Subramanian, Chief Economic Advisor, GoI, who has taken out a report on what India should be doing with these FTAs. We don’t know the recommendations, but I think India should continue to do its bilateral deals and FTAs with other countries. We can set right our policy in the domestic sector and look for new avenues outside to export our goods.
Dr. Amitendu Palit, Senior Research Fellow, ISAS, National University of Singapore
TDB: How do you explain the Donald Trump phenomenon?
Dr. Amitendu Palit (AP): The election of Donald Trump is to be seen as a part of a series of major global developments that mark the anger of a sizeable part of the working class over the loss of jobs and those who feel socially neglected. The combination has been a preference for anti-establishment, non-elite candidates like Donald Trump.
TDB: Can Trump bring back manufacturing jobs to US?
AP: Very doubtful! The jobs that Trump refers to as having left from US to Mexico are unlikely to come back as many of them don’t exist anymore due to automation. The best that he can try to do is to protect the existing jobs. But, even these would be vulnerable to digitalisation and automation.
TDB: Is this the end of the road for TPP?
AP: Vietnam has pulled back and I understand it has deferred ratification of TPP. Trump has announced US withdrawal, but the remaining TPP members might go ahead with the deal, although it won’t be the same without US.
TDB: What is your take on the future of NAFTA?
AP: Trump is unlikely to live up to his electoral rhetoric – at the same time, he will certainly take some action. Renegotiation of some aspects of NAFTA is very likely, particularly tariffs, rules of origin and some investment rules. At another level, Trump might try to live up to his promise on tackling immigration by reducing some segments of labour inflows from US to Mexico.
TDB: Do you think the uncertainty on TPP will push RCEP?
AP: RCEP is now the main economic framework for trade integration in the Asia-Pacific. China will lead the progress of RCEP supported by Australia, Japan and some of the other TPP members. ASEAN and India should also look forward to the conclusion of RCEP, and I think RCEP has the potential to grow into Free Trade Area of the Asia-Pacific (FTAAP).
TDB: Do you think Trump’s isolationism will benefit China?
AP: It is difficult to comment on this at the moment. Trump will probably not be as active an ‘Asian’ president as Obama, but he may not be entirely hands-off. He is likely to focus more on bilateral engagements with Asian countries taking the relationship of each country with US as a stand-alone feature. How this affects the US-China relations will be important to watch.
TDB: In the future, do you see China taking the lead in forming regional trade blocs with Latin American countries?
AP: Yes, this is possible. Also, the BRICS might enlarge into a trading bloc, and EU and Japan will also take trade initiatives. EU’s economic partnership agreements will be interesting to watch as well as efforts within African and Latin American countries to organise themselves into trading blocs.
TDB: Do you think services exports from India to US will be effected because of change in government?
AP: Again, I don’t think there is an immediate cause for concern. It is important to note that H1-B visa numbers have already come down during the Obama Presidency and the fees have been increased. India has also taken the US to dispute at the WTO on this. I’m not sure if matters would be very different from what they are right now.
TDB: Do you see India benefitting from RCEP?
AP: Now that RCEP is being integrated as a single undertaking, India’s chances of getting greater market access in services is more. Strategically, the growth of RCEP into FTAPP can give India the opportunity of becoming a part of the Asia-Pacific without being a formal member of the APEC.
Volatile currencies, protectionist measures in EU and US, cyberterrorism, China being granted an ME status, disintegration of free trade blocs and economic unions, tension in South China Sea and augmented militarisation moves and many such recent occurrences have made 2017 an unpredictable season for world and India's exports. The Dollar Business analyses.
Niladri S Nath | January 2017 Issue | The Dollar Business
Future of the global economy is unpredictable. And in today's world, you don’t need an economist to tell you that. China’s infectious sluggish economy, rising cases of protectionism across global supply chains, dilution of some mega trading blocs, cyber terrorism, and the long-drawn drought in Africa, are some of the several concerns that world trade faces today. Many analysts expect a lacklustre global trade performance in the near term. For instance, the International Monetary Fund (IMF) has already reviewed its World Economic Outlook in July 2016 – global growth projection for 2017 in IMF's January 2016 report was 3.6%, which was lowered to 3.4% in July. So, what are the factors that would have the biggest impact globally in 2017 and result in a slower world?
The dragon running out of fire is a concern! In fact, economists say that it’s the biggest worry. IMF’s former Chief Economist, Ken Rogoff, labels the situation as “the greatest threat to the global economy.” And considering the current sluggish Chinese growth rate (China's GDP growth rate has stayed at 6.7% in the past three quarters), the road to recovery looks like an uphill climb.
Policy-induced shifts in China’s exchange rate have in the past raised questions on China’s foreign trade objectives. More recently,
China being granted the Market Economy Status (MES) by WTO in 2017 has made foreign trade matters more mysterious.
So, what does the future look like for the country whose exploits in exports have been envied by peers across the globe? Well, the World Bank’s Global Economic Prospect reports are continuously pruning GDP growth forecasts for China. Growth projections for CY2017 and CY2018 have been cut down to 6.5% and 6.3%, respectively. [Though these figures are better than those predicted for other economies around the world, they aren't a representation of the China of the last two decades, one for which an 8-10% annual GDP growth was easier than winning an Olympic bronze (for the Chinese national team, we mean)!] Further, as per a World Economic Forum report, the Chinese debt rose from 148% in Q4, 2007, to 237% in Q1, 2016. Some causes for concern we reckon.
Srikanth Kondapalli, Professor in Chinese Studies at Centre for East Asian Studies, School of International Studies, Jawaharlal Nehru University (JNU), is however not amongst the worried lot. “I can foresee some structural problems in the Chinese economy, but there won’t be a collapse of any kind. We can expect a mid-course correction,” assures Kondapalli. The good news is that China is trying to claw back by seeking newer markets and investment opportunities. “As many as 30,000 companies from China are now operating across the globe and have made investments worth $128 billion (in CY 2015). The ambitious OBOR (One Belt, One Road) project can also help China revive its economy,” he adds. However, one thing China needs to worry about is Trump and his 'Make America Great Again' policy. During his campaign, Trump swore to impose a 45% tax on Chinese goods and bring millions of jobs back to America. As ambitious as that sounds, if he works to keep his promise, China will continue to be in trouble for some more time. And, all in the name of protectionism!
"Protectionist policies adopted by us and eu will hurt exports across the globe"
To Protech, or Not?
“Protectionism and inevitable trade retaliations would offset much of the effects of the fiscal initiatives on domestic and global growth, raise prices, harm living standards, and leave countries in a worsened fiscal position,” says Catherine L. Mann, Chief Economist, Organisation for Economic Co-operation and Development (OECD). And she is right!
According to IMF, the impact of protectionism in the next few years would be huge, not only on countries that are resorting to such tactics but on the world as a whole. IMF's Global Financial Stability Report, for October 2016, states that protectionist measures in Europe and US will "ultimately generate secular stagnation, given constrained macroeconomic policy responses." Result: Confidence losses concentrated in Europe and US will induce firms and households to postpone their expenditures, reducing private investment and consumption by 6% and 2% there, and by 3% and 1%, respectively, in the rest of the world over the next five years. In addition, higher trade barriers concentrated in these two regions will contribute to reductions in exports and imports in these regions by about 20% and by about 10% in the rest of the world, over the next five years.
Higher trade barriers concentrated in EU and US are expected
to contribute to reductions in exports and imports of these regions.
Protectionism would not only hurt world trade and economic recovery, it will also widen the gap between developed and developing countries. Agrees Deepanshu Mohan, Executive Director, Centre for International Economic Studies, Jindal School of International Affairs, O.P. Jindal Global University, as he tells The Dollar Business, “Protectionism limits the ability of emerging markets to financially integrate themselves at trade level with other countries. This in turn reates a deep chasm between the developed and the developing countries.”
Think tanks, across the globe anticipate a rise in isolationism in the name of protectionism in 2017 – thanks to an increasing number of non-tariff barriers to trade around the world. While mainstream economists are essentially looking at trade barriers in terms of higher tariff levels and quotas, over the last few years there has been a tendency to restrict trade flow by imposing environmental and labour restrictions. In fact, the sanitary and phytosanitary restrictions imposed on developing countries like India, by various developed and industrially-progressive nations, is a perfect example of protectionism – a reason why the negotiation process of India-EU trade deal has been pending since 2007.
Sectors like services will bear the major brunt. “Information and communication sector heavily depends on the short-term movement of skilled labour, data and technology. Hence, going froward, protectionism would hit services sector the most,” says R. Chandrashekhar, President, NASSCOM.
One of many consequences of protectionism would be disintegration of free trade blocs and economic unions. Brexit has shown the way and Donald Trump is a lurking threat. That being said, elections in Netherlands, Austria and Germany are also likely to impact the future of EU’s politics and economy. Some solvent members such as Germany, Netherlands and Finland are fast losing the financial wherewithal and political will to support their weak EU partners.
While Matteo Renzi, Prime Minister of Italy, a country with $2.4 trillion debt (140% of its GDP), had recently proposed some changes to Italy's constitution (which however were rejected by Italian voters), right-wing political parties in France are busy mobilising public opinion in their favour with anti-immigrant and anti-Euro pitch. “2017 has answers to whether the fractures in EU could be cemented or the fissures are going to widen,” comments Mohan.
The year 2017 will also decide fates of Trans-Pacific Partnership (TPP) and Regional Comprehensive Economic Partnership (RCEP), whether they can be construed as mega regional trade agreements! “If you delve into internal dynamics of these agreements, you will find that RCEP is a counterfoil to TPP. In my opinion, if TPP doesn’t take place, it can impact RCEP as well. TPP was envisaged by US and excludes China, while China is a part of RCEP. But, for RCEP to achieve tangible progress, competitors like India and China need to come together, which in itself is a big challenge,” says James Nedumpara, Associate Professor, Centre for International Trade and Economics Laws, Jindal Global Law School. Hence, the question remains: Are bilateral trade agreements the only option? Yes, at least in 2017, we would say!
It's said that currency volatility can bring down an economy like a house of cards. And we can perhaps expect a few such cases in 2017. In fact, a case in point could be Turkey – Turkish lira has lost nearly 20% against US dollar (USD) this year, a drop large enough to be termed as crisis. Even British pound (GBP) is down about 20% against dollar since the referendum (though the fall seems to have been arrested as of now).
In 2016, many currencies were devalued to stay alive, except for US dollar. And it seems to be a landscape that will probably persist in 2017 as well. "Currency markets are likely to remain vulnerable on the back of shifting policy risks as market participants assess the outlook for the newly elected US administration," points out a recently released report titled 'Global Economics and Foreign Exchange Strategy' by Scotiabank. Well, the reasons are simple. While pound sterling is vulnerable to a yet-to-be-defined Brexit process, euro (EUR) is responding to a scenario shaped by growth and interest rate differentials that will result in a decline in EURUSD. Similar is the case with Japanese yen (JPY) – yen has weakened by about 10% against the greenback since the election of Donald Trump in November. "Growth and monetary policy divergence will leave EUR, GBP and JPY at a clear disadvantage to the USD in 2017. National elections in the Eurozone and the ongoing focus on the UK’s Brexit process represent significant, additional risks for the EUR and GBP respectively," states the report.
This certainly poses a threat to global financial stability and countries with higher level of debt will find themselves in a difficult situation. For instance, China has been tapping into its foreign currency reserves to fend off pressure on its currency. And, China is not alone. “We might witness some sort of currency crisis in Latin American countries such as Brazil, Columbia, Mexico, etc. We may also see a major issue in South East Asian markets including India. Any country which is managing its float with USD will face a major challenge,” says Mohan.
Then there is cyber terrorism, a threat that has just started attracting global attention due to its potential to destroy an entire economy. What's more? UK-based online digital market research company Juniper Research predicts that the cost of data breaches due to proliferation of digital communication will rise to $2.1 trillion globally by 2019, which is four times the cost of breaches in 2015. A 2016 PwC Global Economic Crime Survey also reveals that cybercrime has become the second most reported economic crime in the world. And not to say, as such, cyber security breaches will cost the global economy more in 2017.
Cyberterrorism has become the second-most reported economic
crimes in the world. And will continue to haunt the world in future.
With digital currency fast becoming an acceptable legal tender across the globe, cyber terrorism is bound to have a bigger impact on global trade going forward. The 2007 cyberattacks on Estonia, and Stuxnet, a computer worm that attacked a nuclear power station in Iran in 2012 are a few prominent examples from the recent past of what cyber terrorism can do to the world. In fact, going forward, the credibility of a digital currency will be determined by the level of cyber security support it comes with. While in US, cyber terrorism has already been identified as one of the biggest threats to the country in the near future, countries like India are slowly waking up to the issue.
And Many More...
Another emerging threat that remains unaddressed is climate change. Countries around the globe have realised the weight of this issue and the impact it will have on global agriculture yields. For instance, in Africa, El Nino has worsened the drought, effecting 40 million people who are now exposed to food insecurity.
However, some key players such as US, Russia and China are still not quite sure about pursuing the ratifications agreed upon at the United Nations Conference on Climate Change – COP21 – in Paris. There is a lack of political will to mobilise international cooperation. “The Paris resolution has made it compulsory for countries to invest a certain parentage share of the annual budget in green projects. And, it is going to hurt the country’s GDP, no doubt,” elucidates Kondapalli.
The need for political will among the participating countries becomes even more significant given the rise of Donald Trump to US presidency. He, and many like him, still refuse to wake up to the reality of climate change, and we can only hope that nations will unify to deal with this threat in 2017.
Further, the tension in South China Sea has been a global concern in 2016, especially with militarisation moves by China, Vietnam, Philippines, Malaysia, Japan and US. Although some experts don’t perceive this as a big threat, the issue will continue to impact (to an extent) global trade in 2017.
What could also be a threat to many economies is China receiving the Market Economy Status (MES). China was supposed to get the status in December 2016, and it would have made it much more difficult to levy anti-dumping duties on China. Many countries including US and India have imposed anti-dumping duties against unfair trade practices by China. Japan, US and EU have refused to acknowledge China's MES status. But China has promised to retaliate and it is bad news for those like India, Bangladesh, Vietnam, US, etc.
The sluggish growth projection of the world GDP in 2017 by IMF is a testament to the fact that the trade sentiment across the globe will remain muted even in 2017. Developing countries, which constitute 40% of the global trade, are expected to find it even harder to achieve targeted growth.
The silver lining though is that India is expected to show a healthy GDP growth. Despite demonetisation, some economists believe the economy will start picking up pace in the second half of 2017. India's exports have already started showing growth over the last few months, after a steady decline for over a year and a half, and that should bring the country some cheer. The key here is to enhance the production competitiveness in terms of quality and pricing. We can only hope that a Black Swan event does not upset our cart. But in this year of change, we will not bet on that!
Biswajit Nag, Associate Processor, India Institute of Foreign Trade (IIFT)
TDB: How do you see growing trend of protectionism affecting global trade in 2017?
Biswajit Nag (BN): It’s a big concern. I think, it’s a knee-jerk reaction from the developed nations in the West to regain their supremacy in global trade. Going forward, in 2017, I can foresee product and manpower mobility, especially from the developing nations to the developed nations, to be severely affected by some non-tariff barriers.
TDB: And how do you think the sluggish Chinese economy will impact the global economic outlook?
BN: As China boasts of a large share in global trade, the economic slowdown in China is a worrying symbol for the world economy. It underlines the fact that the recessionary period is getting extended. But, I think, in the next few years, the rest of the world will come together to help China maintain its economic buoyancy.
China’s export-strategy is two dimensional. On the one hand, it exports finished goods in low-technology, innovation-led categories such as mobile phones, televisions, etc. On the other, Chinese have made significant penetration into the global supply chain of high-end, technology-driven categories such as high-speed trains, aeroplanes, solar energy generation systems, etc. This supply chain is primarily controlled by developed nations such as Germany, US, etc. But, they have outsourced a part of the manufacturing process to China. So, for their own good, these nations have to support China.
Meanwhile, China’s economy has been pre-dominantly export-oriented. Hence, their domestic growth pattern was extremely distorted. Initially, they started incentivising domestic production. But, being an oriental economy, it didn’t grow as expected and consumption stood at 37.4% of the GDP in 2014. So, they are once again shifting the focus to exports. They are working on a two-pronged strategy – driving domestic consumption and increasing exports.
But, there is another angle to it as well. China is the biggest buyer of US treasury bond. In a way, US fiscal deficit is financed by China. And, China is using that money in manufacturing and exports. So, it’s a symbiotic relationship.
TDB: What’s your take on the future of European Union (EU) as well as emergence of regional trading blocs?
BN: I don’t think EU will breakdown. Instead, it will find a middle way. However, you can expect some disconcerted voices from its members as the profitability of some capitalist nations has taken a hit due to a burgeoning business of some developing countries. I think, some countries are finding it difficult to strike a balance between their fiscal policy and monetary policy after the introduction of the common currency. Losing individual monetary policy was a setback to some countries. So, I expect EU assuming a different shape in the coming years. Mega trade pacts like RCEP will also find roadblocks, as most countries are waiting for others to make the first move, in terms of opening up the trade. All in all, it’s a delicate situation.
TDB: What kind of progress can we expect on the climate change front in 2017?
BN: Producing clean energy requires a lot of investment. As of now, no country is ready to invest, except for private players carrying out experiments. But, they will pressurise the governments when these become commercially viable. In this time of recession, it’s extremely difficult to change the framework. So, everyone is trying to maintain the status quo. I am not expecting any significant development on this front.
Dr. Rafiq Dossant, Director Center For Asia Pacific Policy, Rand Corporation
TDB: With regards to global trade and economy, how do you envision 2017 shaping up?
Rafiq Dossani (RD): The major economic challenge will be on issues to do with climate change and trade. Climate change is going to be very costly to address and requires a commitment by every large polluting country to make the necessary sacrifices. If any of the large polluters – US, China, India, Germany, etc. – pulls out from the recent climate change agreement at COP21, then the deal will collapse. There is a similar situation with the trade. For instance, US pulling out of TPP, which itself was faulty by excluding key countries like China and India, will lead to a collapse. And it isn’t clear as to what will replace TPP because blocs such as Regional Comprehensive Economic Partnership (RCEP) are poorly designed.
TDB: How do you see the slowdown in Chinese economy?
RD: The latest economic figures from China suggest that its economy will avoid a hard landing, though with some cost – such as higher levels of debt. However, debt levels in China are not exorbitant. Government debt is about 45% of GDP, which is lower than India’s government debt, which is at 66% of GDP. Total debt, including personal and corporate debts, is 240% of the GDP in China, which is lower than the US rate of 260% and the Japanese rate of 300%. So, at China’s growth rate of 6.5%, the debt is quite sustainable.
TDB: Do you envision another exit among EU nations?
RD: I think EU nations were shocked by the Brexit vote. So, there will be much more effective campaigning against exits from other EU countries. As long as France and Germany stay in EU, there is little chance of any more exits. I think Brexit is an isolated case.
TDB: Do you see an emergence of an isolationist trend with Donald Trump assuming office of the US President?
RD: I think the situation in the world trade has been skewed by FTAs. The idea behind FTAs was to improve on WTO arrangements. Instead, countries have misused FTAs to build large tariff and non-tariff barriers. For instance, agricultural tariffs between US and Korea remain very high, with an average of over 40%, even though the two have an FTA. So, I think it is time for some politician to say, ‘this does not make sense’ and to renegotiate such agreements towards a fairer trade for both sides.
If such arrangements can be made, then I think, nationalism would be worthwhile. Another aspect of nationalism is that it has the potential to reject globalisation. I don’t think Trump is an instinctive anti-globalist. After all, he runs businesses that have investments in many countries. Instead, I think he is fixated on unfair trade, which is a more reasonable position to have.
TDB: It is said that demographic change will transform some countries' economy. What’s your thought?
RD: Population aging is going to dramatically affect some countries in the next few decades. For instance, Singapore has one of the lowest fertility rates in the world. However, there is some protection from aging in Asian countries, which is because the female participation rate in the workforce is low and retirement ages are relatively low. For instance, in China, the retirement age in practice is 55 years for women and 60 years for men.
Also, for its demographic composition, the share of women in the workforce is relatively low. As a result, there is plenty of scope to offset the economic effects of aging by raising retirement ages and women’s participation. So, aging is a long-term problem, but not one we need to worry about now.
What does 2017 hold for the global commodity market? Numbers suggest that after a rather dull 2015, commodities experienced a modest recovery in 2016. Expectations are that 2017 may see them ride out of the slump. But given global geopolitical and economic uncertainties, 2017 could well mean a return to 2015!
TDB Intelligence unit | January 2017 Issue | The Dollar Business
In its January 2016 cover feature titled 'What 2016 will mean for global trade', The Dollar Business had foretold that the year 2016 won't be a very promising one for commodities. Price and demand growth in commodities such as steel, oil, copper and gold were anticipated to be slow. Nevertheless, the year turned out better than anticipated. After all, the commodity market managed to stage a comeback after five sluggish years. As per International Monetary Fund (IMF) data, commodity prices climbed 19% in the first 10 months of 2016 – thanks to a 30% surge in crude oil prices, followed by an increase in metal and agricultural commodity prices by 15% and 6%, respectively. To give you an overall idea of the improvement in moods in the commodity market, the Thomson Reuters (Core Commodity) CRB Index (a commodity futures price index) rose 2.12% y-o-y as on December 28, 2016. Comparatively, the London Metal Exchange (LME) Index rose 18% and the S&P GSCI Commodity Index rose 10.13%. To speak of individual industrial commodities, copper, cobalt, lead, aluminum, tin, zinc, nickel, steel, iron ore, coal fared well in 2016. Amongst agricultural commodities, those that made the cut in 2016 were items like soybeans, canola, cotton, corn, etc. Overall, unlike 2015, the past year was a year of revival for exporters and manufacturers of commodities around the world.
Crude oil price, which hit its lowest (since 2003) in January 2016, reaching $27.88 per barrel, has made a remarkable comeback to $55.70 per barrel (as on December 21, 2016) – and is amongst the merriest stories of the year as far as the global commodity market is concerned. Gold prices lagged commodities that displayed a double-digit revival, but still rose 6.43% y-o-y to average $1,339.95 per troy ounce (oz t) as on December 28, 2016. (Silver on the other hand, rose 13.52% in value during the same period.)
Overall, 2016 was a year of recovery for commodities. But the ‘decent’ upswings were not too remarkable to celebrate. What the world needs 2017 to be is an awesome year to recover from what it has been through for almost a decade now. Will 2017 mean a shimmer of hope for the global economy? If one goes by the modest growth forecasts for 2017 and turmoil in the global economy, no miracle should be expected. Matters though, could marginally improve.
Crude, which had a seesaw ride in 2016, may remain under pressure in 2017 – say market trackers. The Vienna meeting (held in November 2016) is expected to lift the price yoke, provided Organization of the Petroleum Exporting Countries (OPEC) and some non-OPEC countries' (11 non-members) joint decision to cut oil production works out. OPEC has agreed to cut production by 1.2 million barrel per day (mbpd) while non-OPECs decided to slash by 0.6 mbpd. This decision was made for the first time in eight years to stabilise global oil prices.
Gold prices lagged commodities that displayed a double-digit revival in 2016. Still, it rose
modestly by 6.43% y-o-y in end-December 2016. 2017 should see a modest price movement
for the yellow metal (in the single digit percentage range).
However, there is a school of thought that feels the whole situation could turn turtle if US fast-tracks its shale oil production. President-elect Donald Trump wants US to produce more oil and get into the "drill, baby, drill!" mode (a Republican campaign slogan first used at the 2008 Republican National Convention). And if Trump goes by his campaign pledge, oil prices may once again slump. Meanwhile, it has been reported that shale firms have started deploying employees at rig sites. Now, that's news!
Nevertheless, the World Bank suggests that OPEC and non-OPEC countries’ decision to cut production will keep crude prices at $53-55 per barrel in 2017 – that’s way up from 2016. And since Russia and Iran too have agreed to slash production in the same Vienna meeting, crude oil is very likely to sail out of trouble in 2017. Furthermore, US Energy Information Administration (EIA) reports that the unconventional shale oil production may remain low throughout 2017. Shale production is expected to grow only in 2018.
Understanding a cut-down in oil production in the light of factors like the unstable equilibrium in the oil market, Iran's natural inclination to pump as much oil as possible, Indonesia's temporarily withdrawal from OPEC, etc., we believe, crude could quite possibly break through the $60/bbl benchmark in 2017 and oscillate in the $60 to $80/bbl range.
"In 2017, global steel demand will grow by 0.5% and will reach 1,510 MMT"
Factors at Play
So far so good! However, the iffy recovery of China’s economy will continue to keep the global base metals market subdued. Russia’s structural issue and Brazil’s political instability did ruin the situation in 2016, while the Dragon got the biggest share of the blame (it still is, as China’s economic slowdown is playing a major role in slackening the demand for base metals). And now, with India also going through a demonetisation phase, many speculate that most industrial metals will not appreciate by double digits in 2017.
Then there are several other factors fuelling the commodity crisis. “For instance, Brexit has further raised uncertainty on the long-awaited recovery of steel in EU,” says T. V. Narendran, Chairman, Worldsteel Economics Committee. However, there are think tanks that feel Brexit’s long-term impact on the commodity market will be negligible. As per them, what one needs to be worried about is the firming of US dollar that has impacted the US steel market in 2016, which is likely to continue in 2017. Copper and aluminium, as a Scotiabank’s report observes, look flat, and steel profitability slips under pressure, and mines in North America and Australia have been idle and yet to commence operations.
Brexit has further raised uncertainties on the long-awaited recovery in steel prices.
The outlook for gold is similar. Agrees Hareesh V., Research Head at Geofin Comtrade Ltd., as he tells The Dollar Business, “I don’t think gold prices will go up because the dollar is strengthening. If the US Federal Reserve hikes the rate, gold prices will crash.” However, if the dollar goes up, there will be inflationary pressure and demand from India will reduce on the back of demonetisation and gold could get victimised again.
Harry S. Dent Jr., Founder, Dent Research, believes that gold is up for correction, and that's going to last for a while. "I have been predicting the demise of gold since early 2011 and see gold going down to at least $700 in the next year or so, and more likely down to $400 or lower before it sees its greatest bull market," he tells The Dollar Business.
On the contrary, Peter Schiff, President & CEO, Euro Pacific Capital Inc. believes the future path of gold is upwards. "In the long-term, there is no direction for gold but upwards," says Schiff adding that "investor sentiment for precious metals will improve significantly once the ridiculous 'higher inflation is bad for gold' narrative ends, and investors once again correctly view gold as a hedge against rising inflation."
Considering this, and various other research reports and, of course, the past trend, we see the yellow metal mostly staying below the $1,200 mark in 2017. The precious metal will take some more time before it shines bright.
When it comes to agri-commodities, prices are anticipated to recover modestly in 2017 but with wide variations in the outlook for different commodities depending on supply conditions. "A small increase of 1.5% in the Food Price Index largely reflects an anticipated 2.9% rebound in grains prices, a 2% increase in oils and meals prices, and a 3% gain in raw materials prices in 2017," states the World Bank Commodity Markets Outlook report.
The Troublesome Duo
So, will it be smooth sailing for commodities in 2017? Or, are there headwinds? Well, the troublesome duo in 2017 could be a stronger dollar and China’s doubtful economic recovery.
Experts feel that the strengthening dollar could at worst lead to another global economic collapse in 2017 because it will have an impact on the overall commodity trading. The dollar is already at its highest since 2003, which according to experts, is a threat to global financial stability. "The US dollar is in a bubble. It is extremely overvalued based on a misunderstanding of the true state of the US economy and the Fed’s ability to raise rates without pushing it into recession or creating another financial crisis," adds Schiff.
Then you have China. According to many, its exports and various developmental indices may dip further in 2017. MarketWatch reports, “Now, a nationwide debt crisis looms at Beijing’s doorstep amid business defaults and bankruptcies, low industrial profits, winnowing returns on investment and the very real prospect of yet another slowdown in the real estate sector.” Fuelling woes, Trump, who has never been a supporter of trade with China, might just impose a 45% tax on all Chinese products imported to US. And if these forecasts are anything to go by, copper and iron ore may crash because production will come to a halt in China, the world's biggest importer of base metal!
Keep The Fith Keep
When we said the world is riding out of the slump, here is why. World Steel Association's Short Range Outlook suggests that global steel demand will grow by 0.5% and will reach 1,510 million metric tonne (MMT) in 2017. The report also suggests that Brazil’s moderate recovery and the emerging ASEAN 5 (Thailand, Malaysia, Vietnam, Indonesia & Philippines) will drive global demand for steel and other metals going forward. India, despite demonetisation, may also be back on the fast growth track in the second half of 2017.
In fact, the metals sector is also something to watch out for in 2017 because Trump plans to focus on infrastructure development, which may fuel the demand for base metals. “Infrastructure development in US will mostly involve government funds supporting private designated investments. It will gradually support growth and demand for materials,” says Rachel Ziemba, MD, Emerging Markets & Global Research, Roubini Global Economics. In addition, China’s short-term recovery in its construction sector is likely to renew demand for copper. “Metals and minerals prices are expected to rise 4.1% in 2017, a 0.5% upward revision due to increasing supply tightness. Zinc prices are likely to rise more than 20%, following the closure of some large zinc mines and production cuts in earlier years,” sums a World Bank report.
World Bank Non-energy Commodity Index, which dropped by 3% in 2016, is also expected to recover by 2% in 2017.
Praying for a Miracle
Having said that, the demand for commodities and their prices in 2017 will largely depend on how India, China, US and EU perform. Further, industry experts are of the opinion that the glut in commodities may still take more than a year or two to clear. Most of them have a less-than-rosy outlook for commodities in the near-term. But they do agree that the worst is over. And it's only a matter of time (say 2-3 years) before the growth engines start roaring again!
Uncertainties and low non-agricultural commodity prices resulted in a stronger global
economic slowdown in 2016 than expected; the situation is anticipated to improve in 2017.
We too expect a modest recovery in 2017. It should be another year of single-to-double digit recovery on average for industrial, agricultural and precious metals. Don't expect a full-recovery though. Remarkable highs are still some three to seven years away for the commodity market.
Peter Schiff, President & CEO, Euro Pacific Capital Inc...
TDB: What’s your take on US dollar? Do you expect Federal Reserve to raise its key interest rate in near future?
Peter Schiff (PS): The US dollar is in a bubble. It is extremely overvalued based on a misunderstanding of the true state of the US economy and the Fed’s ability to raise rates without pushing it into recession or creating another financial crisis. For those reasons, the Fed will raise rates much less than the markets anticipate, and will likely reverse course and lower rates early in the Trump presidency. Also, the Fed is likely to launch another quantitative easing (QE) programme, much larger than the last one to keep a lid on the rising long-term interest rates and monetise exploding budget deficits.
TDB: What about gold? How do you the yellow metal performing in the global market in 2017, and beyond?
PS: I am certain that the future path of gold is upward. In the long-term, there is no direction for gold but upwards. In the short-term, the anticipation of higher inflation is creating a headwind for gold because the markets incorrectly perceive that higher interest rates, which will result from higher inflation, will be a negative for gold. However, any actual rate hikes will be insufficient to restrain rising inflation as the Fed will always be behind the curve. As a result, real interest rates will be falling even if nominal interest rates are rising. This will be extremely bullish for gold, and it’s only a matter of time before the markets figure this out. Also, investor sentiment for precious metals will improve significantly once the ridiculous ‘higher inflation is bad for gold’ narrative ends, and investors once again correctly view gold as a hedge against rising inflation.
TDB: It is believed that the cycle times – duration of the upward and downward movements of price – are lengthening. How do you foresee the situation?
PS: It does seem the cycles have expanded, likely because monetary policy is more reckless than ever. As a result, the artificial booms last long, as do the necessary corrective busts. I think the greater problem is that while the booms last longer in asset markets, the economic recoveries associated with those bubbles are far less robust and the corresponding recessions when they burst are much deeper.
Harry S. Dent Jr., Founder, Dent Research
TDB: According to some experts, prices of some commodities will be on a recovery path. Your opinion?
Harry S. Dent Jr. (HSD): The slowing global demand for commodities will only accelerate with the inevitable collapse of the over-stimulated developed countries and the continued decline of China’s massive export machine and demand for commodities to feed it. The only good sign is that commodity prices have already collapsed near 70% and don’t have as much to fall as do global stocks and real estate. Supply will continue to contract and commodity prices could start to rebound somewhere between late 2017 and early 2020, but not significantly near term.
TDB: Copper price is expected to remain flat till 2018 mainly due to the supply glut and moderate demand. Do you agree?
HSD: Copper has seen one of the strongest rebounds recently, but will decline again, especially with my forecast for the US dollar rising another 20% plus in the next year or so as it becomes the safe haven in another global financial crisis that becomes more of a depression than a great recession.
TDB: While infrastructure development is a key element of US President-elect Trump's domestic agenda, economic recovery seems to be in the works in China. How will these affect global demand for commodities?
HSD: The economic recovery based on Trump’s infrastructure plan is a fantasy... period. US economy is due to weaken dramatically in the next three years from demographic trends and debt burdens. China is likely be the last major economy to see a bubble burst broadly. But, it will be the greatest burst as China has overbuilt its economy more than 10 years+ forward and is the only emerging country to have falling demographic trends from 2011 forward and more so after 2025. India is the next big thing in the world. It has seen underinvestment until recently. Indian Prime Minister Modi is heading in the right direction and the slowing developed world will see India as a prime place to invest in the coming decades, as China crashes and then grows much slower in the decades ahead.
Having said that, there are other emerging countries (other than China) that have strong demographic trends in the decades ahead and they are the biggest producers and consumers of commodities. Hence, I see a major commodity boom from somewhere between 2020 and 2023 forward – perhaps the greatest in history as emerging countries, led by India, not China, largely drive the next global economic boom.
TDB: Some experts believe that gold prices will remain uncertain due to political uncertainty arising out of the US election. What’s your view on this? What will be your projection as far as the price of the yellow metal is concerned?
HSD: Gold was expected to rise if Trump was elected as he would create more uncertainty. Instead, it fell, only partly, as investors expect Trump to revive the US economy. But even that would tend to create higher inflation and gold would like that as it correlates short and long term only with inflation. The real reason is Modi’s war on the cash and illegal economy in India. Many in that realm launder their underground profits into gold and with larger bills. Hence, the evaporation of such larger bills means less gold buying. Modi is rumoured to even consider banning gold imports for a period-of-time to clamp down on this illegal and underground sector. I have been predicting the demise of gold since early 2011 and see gold going down to at least $700 in the next year or so, and more likely down to $400 or lower before it sees its greatest bull market yet into the next 30-year commodity cycle peak around 2038-2040 – like the last peak between mid-2008 and early 2011 and before that 1980 and before that 1949-1951 and before that 1920. Yes, markets move in cycles!
TDB: What are the key political issues and developments that are likely to create headwinds for the bullion prices in 2017?
HSD: Again, Modi’s war on the cash economy is the largest trend currently against gold. A declining US and global economy despite worn-out stimulus policies will see a further slowing and deflationary trends globally – that is what will propel gold down to $700 or lower in the years ahead, most likely to at least $400 to erase the seven times bubble from 2001 to 2011. And yes, after all such bubbles burst, they tend to go back to at least where they started. That would have been in 2005 at $400 by my calculations for when gold prices diverged from the fundamental trends and started bubbling – as most commodity prices did.
TDB: What’s your outlook on agri-commodities?
HSD: Agri-commodities are harder to predict due to weather and that is harder with climate change. But agri-commodities still have tended to follow the broader commodity cycles down and should continue down into at least late 2017 and likely into early 2020 or so. I see emerging countries, due to their strong demographics, coming out of this global depression the soonest and commodities to also follow in the wake of their demand. I am looking for a commodity bottom generally somewhere between late 2017 and early 2020, earlier than most other financial sectors like stocks more around 2020-2022 and real estate more around 2023+
Rachel Ziemba, Md, Emerging Markets & Global Research, Roubini Global Economics
TDB: Crude oil prices, as many expect, will rise to $55 per barrel in 2017 due to OPEC’s cap on production and geopolitical unrests in parts of Africa and Iraq. What is your take? Will US shale oil price also impact the crude price, as feared?
Rachel Ziemba (RZ): The oil market is slowly rebalancing. Modest global growth and emerging market investment in 2017 imply continued oil demand growth (1.5 million barrels per day), led by US, India and China. However, ample supply is likely to keep oil range-bound around $45-50 per barrel until (at least) late 2017, when inventory drawdowns become more meaningful. The recent OPEC production agreement increases the risk of an earlier rebalancing, which will eventually be offset by increased production in US. So, we see oil prices moving up slowly in the medium-term.
Although the most vulnerable producers have finally allowed their currencies to adjust, rising external debt burdens and the lasting liquidity crunch means fiscal policy could choke off domestic demand. Investors should be prepared for credit events and privatisations. On our radar is Saudi Arabia, where economic policies do not look sustainable in the medium-term despite ample funds.
We see oil prices moving up slowly in the medium-term as increased production from US, where producers have benefited from cost compression, offsets cuts elsewhere. In the medium-term, cuts to investment by international oil companies (IOCs) will tighten the market, returning prices to a plus $60 range. Outages are more likely in Russia.
TDB: Will the rising crude oil price impact the recovery process of developed and developing economies?
RZ: The moderate increase in crude oil prices is unlikely to have much of a negative impact on consumers as it will move up gradually and be driven by global demand. Should it rise sharply by $10-20 per barrel in a year, this would add inflationary pressures, limiting central bank space and hit consumers. Emerging markets like Turkey and India are most exposed!
TDB: How do you see China and US determining the price and demand trends of copper and aluminium?
RZ: China’s economy is now based on investment rather than exports. The recent credit fuelled boom in property is likely to support construction in early 2017, providing some benefit to copper. However, we think both Chinese construction and US infrastructure-led demand will be modest. Infrastructure development in US will mostly involve government funds supporting private designated investments. It will gradually support growth and demand for materials, but this will come at the same time as Chinese demand softens.
Sanjeev Ranjan, MD, International Copper Association India
TDB: What is your take on global demand for copper in 2017? Do you see the demand for the base metal scaling up in the next few years?
Sanjeev Ranjan (SR): Copper is the barometer of the economy. The demand for copper is good in countries with encouraging economic growth rate. India is recording an encouraging GDP growth rate of over 7%. Meanwhile, China is recovering and US President-elect Donald Trump is focusing on infrastructure, which will further boost demand for copper.
Coming to India, the five new ultra-mega power projects of 4,000 MW each, entailing investments of Rs.1 lakh crore, is a big boost to the copper industry. The National Democratic Alliance (NDA) government’s ‘Housing for All by 2022' mission will further increase demand for copper. Under the mission, the Centre will build 60 million houses – 40 million in rural areas and 20 million in urban areas.
TDB: Unpredictable mining operations and rising imports seem to be a worrisome factor for the Indian copper industry. What measures would you suggest to tackle this?
SR: Indian copper industry is facing issues such as inverted duties due to existing FTAs and hence the rising imports. The Centre should ensure sufficient working capital availability for the copper units. International Copper Association India is closely working with several industry players by promoting new technology, knowledge sharing and best practices.
Some of our initiatives include encouraging practices that will further boost the domestic demand. For instance, encouraging safe house wiring practices, increasing awareness on power quality through Asia Power Quality Initiative Platform and energy efficient motors and pumps in the industry and agricultural sectors.
TDB: What are your thoughts on copper demand in India? Where does India stand against global standards?
SR: From 2006 till the first half of 2016, India’s copper usage has increased at a CAGR of 6.4%. This growth rate is second only to Chinese demand for copper, which grew at a CAGR of 8.7% during the same period. Overall, the copper usage globally has grown at a CAGR of 1.4% during the same period. Copper demand has surged in recent years due to urbanisation in the emerging markets, mostly led by China and India.
Refined copper usage in India was 540,000 metric tonne in FY2015, which is about 3% of the world’s total refined copper consumption. Overall, copper usage in India in FY2014 was around 1 million tonne. In terms of copper usage per capita, India’s per capita copper usage stands at 0.46 kg, as compared to world average per capita of 3.3 kg.
The European Union (EU) was expected to strengthen European trade. But 45 years later, Brexit and concerns of further EU disintegration are threatening its core ideal. The Dollar Business, looks at the implications on EU-UK trade and how trade for India and the rest of the world could be impacted in 2017.
Anishaa Kumar | January 2017 Issue | The Dollar Business
The UK-EU journey has come a full circle, from the discussion on ‘Will UK join the European community and who benefits from this union’?, in 1961, to a ‘Will UK leave the EU and who will lose by UK leaving the EU?’, in 2016. On June 23, 2016, in results that created ripples both within EU and globally, a decision was made – with a 52% majority – for UK to exit the EU.
Brexit, as it's popularly known, is expected to bring about major socio-economic changes not only for EU and UK, but also for their trade partners – from US to India. And not only that, Brexit also calls for an introspection for all countries that were looking to form common-markets a-la-EU. Has the EU model failed, or is it too big to fail?
Bracing for Impact
For UK, clarity on a post-EU future will evolve over time. But several impacts are apparent. One of the biggest post-Brexit concerns was among the younger generation. Till now, the ease of travel across EU had made UK a favourable location for foreign students who brought in revenue and became an important part of the UK workforce. Euromonitor reports that in 2015 foreign students made up nearly 57% of total graduates in UK.
UK is also at risk to lose its financial centre status to European countries like France, Austria and Germany. But, Dr. Thomas Sampson, Assistant Professor, Department of Economics and Political Science, London School of Economics, while talking to The Dollar Business, says that the possibility of this happening is unlikely unless UK-based banks lose passporting rights to operate throughout EU. In that case, he says that some financial activity will relocate from London to other EU countries.
While within EU, UK’s position as a financial centre may not be impacted much, another possible concern being discussed is that till now both London and New York were considered as important global financial centres. With Europe’s growing instability, some reports express concerns about the possibility of a shift from London towards other countries, especially financial hotspots in Asia like Hong Kong.
A large section of UK's younger generation had voted in favour of staying in EU. They believed that their future would be brighter in a
common market. It was the older generation that had favoured a Brexit. And, it turned out, the older generation got the better of the younger!
But before looking at the future, it is important to understand the EU-UK relationship. For proponents of the leave movement, EU was unwieldy and restrictive. For the others, it has been aiding UK’s development. Lest we forget, it wasn’t easy for UK to join the trade bloc. It took UK 12 years before it finally became a member in 1973. So, was all the years of effort actually worth it?
To give you some insight, Office of National Statistics mentions that between 1972 and 2015, UK’s GDP grew by 149.77% – from £733.77 billion to £1,832.80 billion. Many argue that EU has helped UK stabilise its GDP and achieve growth. Centre for Economic Policy Research (CEPR) research also states that EU has saved UK from its economic decline, because in 1973, when UK joined EU, its per capita GDP was 7% lower than EU-6’s average. But in 2016, when it left, it was 7% higher!
In 1973, roughly 30% of UK’s total exports went to EU, which increased to 50% in 2015. Reports also show that nearly 40% of UK’s service exports goes to EU. While these may seem daunting numbers, some expect the impact to be of a lower order. “In the worst case, UK will lose 2.2% of its GDP by 2030, but concerns can be negated if UK can successfully negotiate free trade deals with the remaining EU countries,” reports Open Europe, a UK-based political think tank. The quantum of impact of Brexit on UK is up for debates, but then there seems to be unanimity that UK will suffer in the short term. For instance, PwC has revised its main scenario projections for UK real GDP growth to 1.6% and 0.6% in 2016 and 2017, respectively, down from 1.9% and 2.3%
A view of Canary Wharf, a major business district located in East London. It houses global and
European headquarters of most of the biggest banks and financial institutions in the world.
Now that UK has decided to leave, what are its options? Case 1: Become a member of European Economic Area (EEA) and continue to enjoy free trade. However, this would cost UK in terms of both a membership fee and concessions on the free movement of people. Case 2: Opt for total separation, end the budgetary contribution and face all tariff and non-tariff barriers. Case 3: Become a member of European Free Trade Agreement (EFTA) – but this will be of little benefit to UK as the FTA covers only trade for some fish and agricultural products, and no services at all.
As a bloc member, UK annually pays nearly £8 billion as a compulsory budgetary contribution. So, total exit means, some savings. But, in case we’re forgetting, the sterling pound has already faced devaluation and is at its lowest in the last 31 years. And that will surely have an impact. Sampson adds, “Through 2017, the devaluation is likely to raise the cost of living in UK leading to lower living standards.” That isn’t good news, except for hospitality and tourism sectors which may see increase in foreign visitors.
No separation is easy and the biggest challenge for both EU and UK will be to negotiate a new trading relationship. EU cannot go too easy on UK as that might trigger more exits. Being too harsh may alieneate an important trading partner.
EU is also facing concerns related to debt crises, migrant crises and terrorism threats. Last year, Grexit (an abbreviation for Greek exit from EU) almost happened and in France, Marine Le Pen, leader of the French National Front, has sworn that if her party wins the 2017 election, she would push for a French exit referendum – Frexit. Another shocking referendum, in December 2016, has added a concern of Italy being the next EU nation to part ways. Could 2017 see the domino effect play out in EU?
The status of London as the financial capital of Europe is at stake after Brexit. Many fear that
a substantial part of activity would move away from this historical financial centre.
Adding to its woes, many EU nations have expressed dissatisfaction with the policies of the Union, which makes us mull over how will EU behave during UK’s exit process? German Chancellor Angela Merkel has hardened her stance on allowing UK a soft exit and has said, “If we don’t insist that full access to the single market is tied to complete acceptance of the four basic freedoms (i.e. freedom of movement of goods, people, services and capital across borders), then a process will spread across Europe whereby everyone does and is allowed what they want.”
An Irish daily broadsheet newspaper recently reported that EU is pushing for a hard Brexit. It quoted Donald Tusk, President of the European Council, “That is pure illusion; that one can have the EU cake and eat it too.” Also, David McAllister, Vice President of the centre-right European People’s Party, and a Member of the European Parliament (MEP), has been quoted by the British media, “The British are testing us, we all know that. So, what is important is that Europe stays together. No bilateral negotiations with the British. No cherry picking. We are doing this as a bloc.” Well, an amicable separation does not seem to be on the cards!
Two of the world's largest trading economies are at the brink of economic and political changes – for EU, it’s the Brexit and for US, it’s the surprise victory of Republican Candidate Donald Trump. While President Obama had announced that US will not be looking at “fast tracking” a trade deal with a post-Brexit UK, President-elect Trump during his campaign had expressed his support for a UK not bound by EU regulations. But as President, will he be able to fast track an US-UK FTA? Now that’s something we have to wait and watch.
When it comes to trade, UK has been an important trading partner for US for both goods and services. As per US Census Bureau statistics, in CY2010, total imports from UK were worth $49.81 billion against $57.96 billion in CY2015. Exports were up to $57.96 billion in CY2015 from $48.41 billion in CY2010.
The volume of services trade between the two is also growing. Exports of services from US to UK has grown 4.42% between CY2014 and CY2015, while services imports from UK to US rose by 1.15% during the period.
Brexit is also expected to play a role in the valuation of the dollar. According to Bain Insights, the ongoing conflict could move capital away from UK and EU towards markets like US resulting in a rise in the value of dollar. This is expected to put further pressure on the US manufacturing industry by making exports uncompetitive. Similarly, Japan could also face a threat in form of higher valuation of yen which in turn could put pressure on Japan, a country that has been struggling to revive its economy.
Where does the combat between EU and UK leave India? Post-Brexit, UK will need to renegotiate its trade relationships across the world and, of course, with EU. UK will also be looking to strengthen its ties with US, India, China, Japan and Commonwealth nations. But this would require considerable diplomatic effort, partiularly in case of countries like India where the deal is stuck given concerns over mode IV services and migration.
In the early part of the decade, trade figures backed EU as a growing market for India and vice versa. India's exports to EU grew from $48.6 billion in CY2012 to $56.3 billion in CY2013. The last couple of years though has not been too kind to India's exports – exports to EU fell by 9.84%, from $51.6 billion in CY2014 to $44.7 billion in CY2015. Now, with UK exiting the equation and having contributed $8.9 billion to India's exports in CY2015, EU’s importance as a trading partner is bound to reduce.
While India has developed various individual treaties with EU countries, a major point of discussion has been a possible EU-India BTIA (Broad-Based Trade and Investment Agreement). When India and EU began talks on June 28, 2007, the aim was to develop an agreement that would grow trade between the two. Since then, they have reached a sort of impasse on the structure of the agreement. As the name suggests, the agreement aims to encompass all aspects of business. Research by the University of Sussex suggests that EU-India FTA could increase FDI inflows from EU into India by 27%.
Over 14 rounds of discussion, the EU-India FTA has faced setbacks due to differences on issues of IPR protection, data security, business and work visas as well as relaxation of tariffs for European products like wine and automobiles in India. So, will the structure of FTA change post-Brexit? Is the FTA still a valuable proposition for India – without UK? The questions are many.
According to Dr. Rajiv Kumar, Senior Fellow at New Delhi-based Centre For Policy Research, EU-India FTA now has much less relevance for India than it would have had earlier as it loses out on an English-speaking audience. He says, “The idea would have been for India to use UK as a platform for gaining entry into Europe. But that has changed. Therefore, I cannot see the EU-India FTA moving ahead at all. On the other hand, a UK-India FTA is (also) hugely premature because until UK completes its exit from EU, it is in no position to negotiate any trade agreements.”
Despite the decline in imports-exports numbers and a stalemate in reaching a conclusion, both EU and India continue to stress upon the need to keep a discussion on FTA active. But some experts like Dr. Kumar consider talk about both EU-India and UK-India as premature. “Right now, I think it would be better to improve our export competitiveness and exports to Europe under the Most Favourable Nation (MFN) route because we do not really need a preferential treatment. We can do a lot with the MFN regime as that provides a lot of scope given Europe’s relatively lower tariffs and ease of access to the market,” he says.
Who will be next?
So, what is next? Scotland has already warned that a hard Brexit could mean that Scotland would seek a new refrendum. And that could mean the end of the 'United' Kingdom.
What is of even greater importance is the future of EU as a common market. While the future of EU and UK will gain clarity only towards the latter half of 2017, Brexit has without a doubt shown that the concept of EU as a common market has built-in inefficiencies. Many other regional blocs in Latin America and Africa have been encouraged by initial success of EU to formulate a similar common market. Will Brexit mark the end of the common market concept and move the world towards isolationist policies? As we deliberate these issues we will keep any eye on who leaves EU next. Italy? Greece? France? Well, our guess is, Italy. What's yours?
Kent Hughes, Public Policy Fellow, Wilson Centre, Washington, D.C.
TDB: In 2017, EU and US will experience important changes because of Brexit and a new president. Where do you see EU-US and US-UK trade and political relations today?
Kent Hughes (KH): EU and US continue to consider the Transatlantic Trade and Investment Partnership (TTIP) – though negotiations are now on a slower track. Donald Trump did not focus on TTIP during his campaign; rather he was actively opposing the Trans-Pacific Partnership (TPP) and raising questions about the North American Free Trade Agreement (NAFTA). Meanwhile, in Europe, there is now visible opposition to elements of the TTIP and a growing reassertion of national identities. The continued concern about some major EU banks and the underlying question of how to retain the value of euro and still balance intra-EU trade are added challenges. Elections will complicate the picture as well! In particular, the decision of Germany’s Angela Merkel, to seek another term, will complicate economic decision making in Germany and the EU.
The question of US-UK relations is even more uncertain. Prior to Brexit, President Obama had said that UK would have to go to the end of the line in seeking a free trade agreement (FTA) with US. President-elect Trump and several influential members of the US Congress have expressed a different view. If UK does trigger negotiations, it would be difficult, but not impossible, for a second track of negotiations with US.
In both cases, the major unifying force will be the shared concern about national and global security. The recent decision of Russia to install a family of ballistic missiles in Kaliningrad should be a powerful force to encourage US-European unity.
TDB: Speaking about trade with Asia, what are the expected changes once President-elect Trump assumes office?
KH: As Asia continues to emerge as a major source of economic growth, there are compelling economic as well as national security reasons to seek closer economic ties with Asia. But what he might seek on a new US-Asia trade agreement remains to be seen. Given his focus on jobs and manufacturing, my guess is that he would favour agreements that would be a clear economic plus for the manufacturing sector, generate employment, and ideally, raise wages.
TDB: Do you think US has the market space to welcome UK and EU as separate entities?
KH: Yes, there is room. But, one major hurdle will be the timing because separation may take up to two years. It would be difficult for UK to be conducting parallel negotiations with US, while bargaining with EU. Also, EU and UK will want to get a clear sense of the Trump administration's general approach to trade agreements. The challenge here is the reaction against trade agreements in EU and the uncertainty of how a Trump administration might change the current position of US in the agreements.
TDB: Lest we forget, EU is juggling with many issues other than Brexit. How do you look at the whole continent?
KH: Yes, European Union (EU) has its own internal challenges. In my view, the adoption of euro, as common currency, was premature. There is no common fiscal policy to complement the European Central Bank’s control of monetary policy. Bank regulation is left to the individual countries. Labour mobility is slowed, not by law, but by language and customs. The earlier difficulties with the European Monetary System should have been a warning that Europe was not ready to be tied to a single currency.
The act of welcoming immigrants from warn-torn countries was a great humanitarian gesture, but it also has its impact. There was no effective EU policy to control its borders or plans to provide language skill, cultural education and jobs. At the same time, many EU countries themselves were already suffering record unemployment among youth.
Before Brexit, there was talk of Grexit – some may ask if Italy might be a candidate or even Netherlands. The question of disintegration will haunt the expected negotiations with UK. If EU is too demanding, it will incur costs for economies closely tied to UK. But, if it’s too accommodating, some EU leaders appear to fear that it could lead to other exits.
TDB: Talking about FTAs between developed and developing countries, do you think the developed economies get an upper hand, defeating the purpose of the agreements?
KH: A good trade agreement must work for both parties. But, trade relations between the developed and developing economies have become ever more complicated. Though most developed countries have opened much of their market to duty free entry for developing countries' goods, I would say, that the developed country does have greater bargaining leverage in negotiations. At times, the leverage can show up not in tariffs but in new rules of the road, rules that could be more demanding than those currently required by WTO. With that being said, individual FTAs can affect developing countries in at least two positive ways. First, with assured access to developed country markets, the developing country can attract inward FDI. Second, the agreements often push developing countries to improve administrative and judicial functions.
Harshavardhan Neotia, Chairman, Ambuja Neotia and President, FICCI
TDB: What are your thoughts on the current business relationship between EU and India?
Harshavardhan Neotia (HN): There has been a gradual reduction in demand and relatively fewer avenues for Indian companies to expand business footprints in European markets. As per FICCI’s assessments, several Indian business entities have been re-aligning their operational focus to stay put on a long-term basis. The aim is also to diversify and cultivate newer markets in Central Europe and Africa.
TDB: How have Indian companies reacted to the unstable EU and UK markets, especially after Brexit?
HN: Preliminary feedback from Indian companies suggest that they have some concerns regarding a dip in export realisations, additional compliance requirements, and a possible rise in operating costs of doing business in UK as an immediate impact. However, given the strengths of the economy, it may be worthwhile to look at a bilateral FTA with UK, focused on goods, services and investments. It is felt by experts that UK may now take a less rigid stand compared to EU and it may be worth pursuing a broad-based bilateral agreement.
TDB: Brexit triggered the talks about reviving the stalled EU-India BTIA. Do you think India leaning towards EU will have an impact on its trade with UK or vice versa?
HN: India’s trade with EU accounts for 14% of India’s total trade in goods, out of which UK constitutes 16%. UK accounts for 17% of India’s total IT exports and around a third of the Indian investment in UK is in IT and telecom sector. So, from the Indian industry's point of view, both EU and UK will continue to remain important trading partners for India.
Brexit could lead to some implications for certain sectors of the Indian industry that have relatively greater exposure to the UK market, but change in UK-EU dynamic wouldn’t lead to alienation of any of the existing trading partners.
Indian businesses are keen to deepen their trade ties with both EU & UK, and India has expressed its interest in reviving the stalled EU-India Broad-based Bilateral Trade and Investment Agreement (BTIA), as well as initiating talks on a free trade agreement between India and UK.
TDB: How important is it for India to start negotiating a trade agreement with UK. What are the challenges and opportunities you see ahead?
HN: UK is an important market for India. FICCI is in favour of negotiating a comprehensive India-UK FTA post-Brexit that would cover trade in goods, services and investments. In terms of potential opportunities, we may expect, UK – now no longer encumbered by EU – would be in a position to conclude an FTA with India within a shorter timeline. The sectors that have a strong competitive advantage stand to benefit from the FTA with UK. However, India’s commercial benefits from FTA will be significantly determined by the actual terms of Britain’s withdrawal from EU. Such uncertainties, possible contraction in UK-demand and volatile currency movement may pose some challenges for Indian companies.
TDB: What are your views with regards to Brexit and its impact on Indian exporters?
HN: FICCI conducted a survey post Brexit to assess the near-term impact of Brexit on Indian businesses and bring to fore the concerns of India Inc. Some of the companies surveyed, share deep trade and investment linkages with UK.
Respondents felt that the Brexit transition may lead to moderation in investments flows to UK from India.
However, India is expected to get continued attention from investors, including investments from UK. The country is the third largest investor in India and accounts for about 8% of the total FDI inflows into India. In the last two years, FDI inflow has increased in India due to a considerably liberalised FDI regime – and this trend is expected to continue. If the growth moderates in UK and EU, in the aftermath of Brexit, our IT companies may face some difficulties in the short-term.
And when it comes to Indian students studying in UK, Brexit might result in a more level playing field compared with other EU students who hitherto had an informal edge over the rest of the students in the job market.
There is confidence that UK will make renewed efforts to strengthen its ties with Commonwealth nations and India stands to gain given its own growth performance and a much improved regulatory and business environment. Also, the Indian industry is hopeful that this can be an opportunity for India and UK to make renewed efforts to strengthen ties.
TDB: For an importer or exporter dealing with the European markets, what are the policies and announcements they need to keep track of in the coming days?
HN: According to FICCI’s evaluation, rules regulating issuance of visas for professionals travelling to EU need to be regularly watched by Indian companies. Overemphasis on sanitary and phyto-sanitary issues by EU could impact exports of agricultural products from the country to EU. Future restrictive non-tariff barriers are also some of the ongoing issues that also require proper surveillance by companies.