The Risk of Trade Wars Becomes A Reality

Trump’s trade actions and its contagion effects could theoretically lead to a slow erosion of the global rules-based trading system

Names can reveal a lot. The recurring cold waves buffeting Europe are called “beast from the east” because of their origin in Siberia. It is unlikely that the trade chill arising in the US and threatening to freeze global commerce will be given a similar sobriquet. US’ controversial decision to levy import duties—25% on steel and 10% on aluminium imports—has given rise to martial terms like trade war, with many countries threatening to retaliate. But truth be told, this is one winter that is unlikely to thaw any time soon.

But all credit to US President Donald Trump for not deviating from script. Multiple risk forecasts for 2018 had predicted a ratcheting up of trade protectionism. The tariff order—purportedly for national security purposes and to save jobs in the US steel industry—fulfils these prophesies. It now becomes necessary to see how the ripples left behind have an impact on India. Below the currents lies another trade development which is taking shape slowly but with potential to affect India.

As numerous reports show, US’ steel and aluminium import levies do not harm India grievously. India’s exports of steel (raw and finished) and aluminium into the US do not exceed $2 billion: it’s less than 5% of the $42 billion exported to the US in 2016-17. The effects will be felt elsewhere: Intermediate goods that originate in the US and form part of the global supply chain will become more expensive and could slow down wheels of trade. A study by Christine McDaniel, former senior economist with the White House council of economic advisers, has shown this is the US’ trade war with itself, given that industries consuming steel to manufacture other products (such as automobiles or washing machines) employ more workers than steel mills.

There will be some indirect consequences for India as well, with many countries threatening to erect their own protectionist walls. According to a Standard and Poor’s publication Global Trade At Crossroads, the strong undertow will be felt globally: “The retaliatory spiral could lead to a breakdown in the global rules-based trading system and raise the risk of an all-out trade war, eventually hurting exporters both in the US and globally.” At risk is India’s incipient export growth momentum: exports during April-February 2017-18 were $273.73 billion, 11% higher than the corresponding period of previous year.

Many commentators were critical of India’s higher import duty rates, presented during budget 2018-19, especially since they were introduced soon after Prime Minister Narendra Modi’s speech at Davos cautioned against growing protectionism. While the new tariffs do seem to contradict India’s stand on free trade, they are broadly consistent with its World Trade Organization (WTO) commitments and are within the bound rates fixed for India.

Trump’s trade actions and its contagion effects also do not violate WTO norms but, by bringing in a national security angle, could theoretically lead to a slow erosion of the global rules-based trading system. The WTO mini ministerial scheduled in Delhi from 19 March might provide a window into the future of the multilateral trading system.

As things stand, US has often been accused of subverting the WTO system when the going gets tough. It has been holding up the appointment of judges to WTO’s appellate body, actively preventing a satisfactory closure to the food security discussions and openly supporting bilateral deals over a multilateral solution. Its unilateral approach to trade—naming and shaming countries through Special 301 or its WTO-plus intellectual property laws—are regarded as openly contemptuous of multilateral systems.

On the sidelines, another global trade development is quietly challenging its predominance. On 8 March, 11 Asia-Pacific countries signed the Comprehensive and Progressive Agreement for Trans Pacific Partnership (CPTPP), an improved version of the earlier Trans Pacific Partnership (TPP) from which the US walked out. What makes the new agreement interesting, apart from 11 nations opting to go ahead without the US, is the relaxation of certain clauses specifically introduced by the US.

The new agreement puts on hold 20 provisions from the old draft, 11 of which relate to intellectual property rights (IPR) included at the US’ insistence. Among the changes introduced are a truncated patent protection phase for innovative medicines, or narrower data protection rules for new pharmaceutical products or biologics. Gone also are some of the onerous investor-state dispute settlement clauses.

India should be concerned about what remains on the books because some clauses could indirectly put pressure for an overhaul of its domestic policies: the chapter on state-owned enterprises is one example. By adopting these rules for trading within themselves, the 11 CPTPP members—Canada, Australia, New Zealand, Mexico, Japan, Singapore, Brunei, Malaysia, Peru, Chile and Vietnam—might demand other trade partners to follow some of these rules. They are unlikely to have one set of rules for TPP members and another set for other trade partners.

It is also quite likely, though not definite, that CPTPP will have a benign influence on other trade pacts involving India, such as the Regional Comprehensive Economic Partnership, which has many common members with CPTPP and is currently being negotiated. India will have to be prepared for this eventuality.

The above article was originally published in Mint newspaper and can also be read here

Why Banking Frauds Are So Frequent At PSU Banks

The terrain that is Indian banking turns tricky when government’s shareholder action in PSU banks starts impinging on RBI’s regulatory regime

It’s difficult not to detect a sense of déjà vu in the Nirav Modi scam, especially in all the hand-wringing and ex post facto zeal in setting up committees and investigations. Scams are a recurring motif in Indian banking, and the Punjab National Bank (PNB) case fits into the broad template of all previous stings.

In the search for solutions, a steady crescendo of drum-beats has been advocating whole-scale privatization of public sector (PSU) banks as a cure-all panacea. Implicit in the suggestion is the assumption that scams are the exclusive preserve of PSU banks. While it is true that the extent of scams and corruption is highest in PSU banks, data shows Indian private banks are not entirely immune.

The history of Indian banking over the past 50 years is littered with examples of failed private banks that were forcibly merged with stronger public sector banks (and with even stronger private banks recently—such as Bank of Rajasthan with ICICI Bank Ltd). This was done to safeguard depositors’ monies and to avoid systemic disruption. Here are a few random examples: Bank of Bihar was merged with State Bank of India in 1969; Hindustan Commercial Bank with PNB in 1986; Bari Doab Bank Ltd with Oriental Bank of Commerce in 1997; Kolkata-based United Industrial Bank merged with Allahabad Bank in 1989-90; Bank of Karad with Bank of India in 1994. The word merger has a volitional ring to it, but truth be told, there was nothing voluntary about these mergers.

Private banks have no special genes making them immune to scams and frauds. Global Trust Bank had to be merged with Oriental Bank of Commerce after its net worth was wiped out due to systemic fraud perpetrated by insiders. Even voluntary mergers in the post-reforms era are designed to escape distress and seek shelter with a stronger bank.

On balance, though, the larger proportion of scams in PSU banks does beg the question: why do they recur? One immediate reason could be the blurred lines of control and command. The government is the owner of PSU banks and exercises its shareholder rights capriciously: random appointments and transfers of chief executives, influencing appointment of board members, rationing out capital allocation in the name of fostering efficiency are some of the arbitrary control levers. The terrain turns tricky when government’s shareholder action starts impinging on Reserve Bank of India’s (RBI’s) regulatory regime. Bank senior executives, politically seasoned in picking up conflicting signals, reflexively align with the government even if it means contravening RBI’s regulatory framework.

For example, in the PNB fraud case, the bank’s core banking system (CBS) was not linked to its SWIFT system, thereby allowing officers to clandestinely issue letters of undertaking to Modi’s companies and confirming them with counter-party banks overseas through the SWIFT system.

This is despite RBI exhorting banks to link CBS with SWIFT; yet, PNB chose to violate these orders. It is, therefore, odd that none of the members of PNB’s governance troika—board, RBI or its all-powerful shareholder—pulled up the management or even sought an action taken report.

Former RBI governor Raghuram Rajan writes in his book, I Do What I Do: “Today, a variety of authorities…monitor the performance of public sector banks… It is important that we streamline and reduce the overlaps between the jurisdictions of the authorities, and specify clear triggers or situations where one authority’s oversight is invoked.”

RBI is tasked with detecting infirmities, but has no authority to enforce its own orders, administer remedial measures or even deliver swift punitive action. The central investigative agencies are tasked with following up on investigations and pursuing legal recourse. The political pulls and pressures on these agencies, as well as the Indian legal system’s long-drawn processes, provides swindlers with enough escape routes (pun intended), and is never a deterrent.

There is a likelihood that diminished incentives to regulate and supervise could be leading to weakened supervision and vigilance: most of it has become detection (after the event investigation) rather than prevention, which is to create systems and processes that raise alarms before the event or while transactions are taking place.

Flawed risk-mitigation design, which puts excessive focus on credit or market risks, has taken away attention from operation risk, leaving it susceptible to breaches. In addition, there is excessive dependence on manual supervision, at both external and internal levels. The sheer volume of transactions makes it impossible to manually control and supervise.

In the end, no matter what the design, somebody will always attempt to finesse the system. Blame corrupt politicians and bureaucrats, or the steadily disintegrating moral fibre of Indian businessmen, bankers and other white-collar professionals (as pointed out in this article), but scams are here to stay. The trick will be to construct a process design that prohibits anybody taking advantage of the system for sustained periods. And that will require dismantling some of the entitlement rights of the majority shareholder.

The above article was originally published in Mint newspaper and can also be read here

One Local and Three Global Risks Facing India

As India lurches towards the 2019 general elections, it might be appropriate to list some of the risks that confront the country

The beginning of a new year usually sees think tanks and insurance companies list their version of perceived global risks over the next 12 months. As India lurches towards the 2019 general elections, it might be appropriate to list some of the risks that confront the country.

India’s numerous direct and indirect geopolitical challenges are well known. Some of these are: problems with a mendacious neighbour on the western border; China’s aggressive expansionism and its belligerent posturing in the South China Sea; smouldering conflicts between Saudi Arabia and Iran and Qatar aggravating; the proxy war in Syria coming to a boil; and tensions further escalating in the Korean peninsula.

War and geopolitical conflicts have persisted throughout modern history and 2018 is unlikely to be an exception. But, India’s primary concerns spring from geo-economics, traditionally neglected in future risk scenarios and risk mitigation frameworks.

Three large risks dominate the landscape and they all impinge on both the fiscal and current account deficits.

The first one is uncertainty over oil prices and India, a large net importer, is directly exposed to this volatility. Slow but certain recovery in the global economy has pushed oil prices from the 2015 lows of $30 per barrel to over $60 now. The future direction of oil prices will be decided in a power play between USA-based shale producers and the informal alliance between the Organization of Petroleum Exporting Countries (Opec) and Russia.

The unofficial Opec-plus arrangement has been successful in cutting oil production and slashing overstocked inventories. As oil prices have risen, record volumes have gushed from the US, threatening to eclipse production from the world’s two largest producers—Russia and Saudi Arabia. There are apprehensions that as prices further appreciate, some other South American oil producers might add to the US flood. This might force the Opec-plus grouping to push for further production cuts which could eventually threaten the agreement. Added to the mix is the risk that energy prices and flows might become the next weapon in the renewed US-Russia conflict.

As things stand, the Opec-plus agreement is scheduled to be reviewed soon and is likely to be extended. Even if they agree to wind down the arrangement, it has to be done in an orderly fashion, without disrupting markets. India is exposed to these volatilities through its reliance on oil imports, and its recent agreement with the United Arab Emirates to construct strategic oil reserves might be a bit too late.

India’s second geo-economic risk emanates from the wave of protectionism that threatens the global economy, particularly the ongoing trade war between the US and China. Apart from real and threatened tariff measures affecting India’s exports to the US, there are indirect consequences also.

The Economist Intelligence Unit notes in a recent publication, Cause for Concern: “Any ramp-up in protectionism would certainly have repercussions beyond North America and China. Prices and availability for US and Chinese products in the supply chains of companies from other nations would be badly affected. Consequently, global growth would be notably curtailed as investment and consumer spending fall back.”

India’s third geo-economic risk originates from a person: Jerome H. Powell, the Federal Reserve chairman. Based on his recent testimony to Congress, markets are sensing greater aggression compared with his immediate predecessor (Janet Yellen) and, consequently, expecting three to four interest rate increases during 2018. This could inject a new degree of turmoil in the markets, especially in the face of what many find unsustainable asset markets. The Reserve Bank of India’s sixth bi-monthly monetary policy statement noted: “Financial markets have become volatile in recent days due to uncertainty over the pace of normalisation of the US Fed monetary policy…The volatility index (VIX) has climbed to its highest level since Brexit.“

India, like many other emerging markets, is particularly vulnerable, given that recent asset market developments are predicated on global capital flows. Any reversal of these flows could spell trouble for not only asset valuations but also future capital raising. The World Economic Forum’s The Global Risks Report 2018 states: “…economic and financial risks are becoming a blind spot: business leaders and policy-makers are less prepared than they might be for serious economic or financial turmoil.”

It would be negligent not to account for risks on home terrain: various state assembly elections in 2018 and general elections in 2019. Governments, on the eve of elections, are tempted to loosen policy restraints, succumb to populist forces and spend more. Another election-related threat looms. Risk Map 2018 from specialist risk consultancy Control Risk states: “A political environment in which parties leverage emotive and controversial social issues for electoral support could foster the spread of adverse nationalist rhetoric, potentially posing risks for foreign businesses in 2018.”

That said, with 16 general elections already under India’s belt, the next one also falls in the business-as-usual category. Therefore, in the balance of risks confronting India, the beyond-border challenges remain trickiest as they run the risk of derailing India’s twin deficits and, as a consequence, critical macro variables like inflation and growth.

The above article was originally published in Mint newspaper and can also be read here