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

READING BETWEEN THE LINES: Interpreting Trump’s Not-So-Subtle Threat To India To Do More In Afghanistan

The India-US relationship has conventionally been undergirded by commonly shared democratic traditions, despite periodic upheavals. Thanks to president Donald Trump, this is likely to change soon and acquire a transactional shade based on quid pro quo, where acknowledgement is contingent on favours extended.

This was evident when Trump unveiled his long overdue strategy for Afghanistan, a nettlesome issue that’s remained unresolved through the last four presidencies to now bedevil a fifth one. Apart from his trademark bluster and rhetoric, Trump’s speech revealed two distinct strands: a deal-based approach to achieving strategic objectives, and, a marked candour that separates his speech from the studied diplomatese of past presidents.

Obviously, no speech on Afghanistan and South Asia can ignore India. But, Trump’s hat-tip to India and its critical role in maintaining regional stability has acquired a new binary, apart from a foreboding tenor: “We appreciate India’s important contributions to stability in Afghanistan, but India makes billions of dollars in trade with the United States, and we want them to help us more with Afghanistan, especially in the area of economic assistance and development.”

This is a curious statement, tethering Indo-US trade to India’s help in Afghanistan, and can be parsed in multiple ways.

One, this is a clear and overt threat: cooperate or else. President Trump has been waving the trade flag in all his perorations concerning India. He has been unequivocal about seeking enhanced market access for US goods and services. The joint press statement issued during prime minister Narendra Modi’s Washington DC visit has him saying: “It is important that barriers be removed to the export of US goods into your markets, and that we reduce our trade deficit with your country.” Indo-US trade touched $114.8 billion during 2016, with India enjoying a $30.8-billion trade surplus. It would seem Trump has made India’s trade with the US contingent upon cooperation in Afghanistan.

There is a second aspect. India’s port and associated connectivity projects in Chabahar, south-east Iran, have been delayed. The port, and its rail and road linkages, are expected to provide India an alternative trade route to Afghanistan and other central Asian republics, bypassing Pakistan. The highway linking that port with Hajigak mines in Afghanistan is expected to facilitate movement of iron ore for Indian steel plants. The Afghan Iron and Steel Consortium, a group of six companies led by public sector Steel Authority of India and brothers Naveen and Sajjan Jindal, has won concessions for three iron ore mines, including projects to set up steel and power generating companies in the Hajigak region. Connectivity is expected to help operationalise the $10 billion project, which is beneficial for both India and Afghanistan.

Many similar Indian projects are either in limbo or progressing slowly due to a combination of factors: concerns over security, changing domestic political configurations in Afghanistan, and the global economic slowdown rendering initial cost and revenue estimates awry. A lot will, therefore, depend now on how the US plays its cards with Iran and how additional US boots on Afghan soil affect India’s spectrum of projects in the war-ravaged economy.

There is a third angle, albeit an unspoken one. There has been speculation for some time now that Trump’s Afghan adventure is fuelled by a desire to help US companies access the nation’s vast mineral resources, still unexploited. The minerals range from iron ore, copper, and zinc to precious gems (lapis lazuli, emeralds, rubies) and even rare earth minerals like lithium. Many of these are being illegally mined by the Taliban and other militant rebel factions, largely as a funding source. While many estimates about the value of minerals trapped under Afghan soil have been thrown around, it is believed that the lure of access to these resources is what changed a reluctant president’s mind about continuing the US’s engagement in Afghanistan.

Trump’s exhortation to India on Afghanistan could, thus, also be viewed as an implicit inducement: cooperate and we will allow you to share in the mineral spoils.

Finally, the Indian reference could be an attempt to placate the US’s strategic and political community, which has as many India supporters as opposers. Hence, the attempt to pack both “for and against” sentiments into a short and contradictory statement.

On its part, the Indian ministry of external affairs (MEA) has welcomed Trump’s Afghan initiative, though the gamely and cryptic approval is conspicuously silent on the noisy undertones of the speech. Any shades of glee detectable in MEA’s response, can, of course, be attributed to schadenfreude.

Trump has thundered against Pakistan and held out direct threats to that country. “We can no longer be silent The MEA’s respo about Pakistan’s safe havens for terrorist organisations, the Taliban, and other groups that pose a threat to the region and beyond…We have been paying Pakistan billions and billions of dollars; at the same time, they are housing the very terrorists that we are fighting. But that will have to change, and that will change immediately.”

The MEA’s official reaction welcoming issues of safe havens and cross-border terrorism was predictably pointed.

To be fair, the MEA’s response has been circumscribed by the duality in Trump’s speech. His bluntness on Pakistan is a break from usual president-speak: This is the first time that a sitting US president has openly used such harsh words against traditional ally Pakistan. At the same time, the ambiguity arising from the odd pairing used in the India reference, which is open to multiple interpretations, is bewildering. But it does reveal a slice of Trump’s foreign policy bias: a calculus that will increasingly be based on give-and-take.

The article was originally published in qz.com and can also be read here

Reorienting India’s Trade Policy

It is vital that India’s trade policy, while taking cognizance of GST’s nitty-gritties, also realigns domestic trade infrastructure with the altering global trade landscape

India’s commerce ministry is conducting a mid-year review of its trade policy to closely align it with the roll-out of the goods and services tax (GST) on 1 July. Truth be told, GST is important but probably too narrow a peg to hang India’s trade policy from; it might make more sense to re-anchor the policy in the shifting framework for global trade and the rapidly evolving nature of globalization.

Deep resentment against globalization’s misaligned distribution effects, a widening wage gap and increasing inequality have given birth to an aggressive brand of nationalism. Strands of these have now found utterance in the economic and political policies of many countries. Brexit in the UK was sold as regaining economic independence from the European Union. US President Donald Trump’s executive decisions on trade (withdrawing from the Trans-Pacific Partnership, restricting H1B visas, threatening the North America Free Trade Agreement) or geopolitical moves (hectoring European leaders or abandoning the Paris climate change agreement) were custom-built to address localized grievances. The sharp pivot by both countries—main actors in constructing the post World War II global trade, financial and security architecture—has made globalization a guessing game, bereft of its earlier certainties and confidence. Both countries are now seen as flag-bearers of a neo-isolationist doctrine.

Australia, New Zealand and Singapore are also following in the US’ footsteps, complicating India’s traditional trade matrix. The picture is further muddied by two momentous shifts occurring in the subcontinent’s neighbourhood. One is the ambitious Belt-Road initiative, a vehicle designed to rejuvenate China’s surplus domestic capacity and to give expression to its expansionist aspirations. The second is the recent schism in the Gulf with Saudi Arabia, Egypt, Bahrain, the United Arab Emirates, Libya, Yemen and the Maldives collectively imposing informal sanctions against Qatar by shutting down transport links and choking essential supplies.

All these developments are bound to reorder the global trade system. Therefore, it is imperative that India’s trade policy, while taking due cognizance of GST’s nitty-gritties, also realigns domestic trade infrastructure with the altering global trade landscape. It is also perhaps the perfect opportunity for the policy to be more of a strategy document rather than a manual. The statement accompanying the 2015 Trade Policy states: “Change has been a constant in the global economy, not least in the international trading landscape.” Never was a truer word spoken, and never has there been a better time to factor this truism into the national trade policy.

Three areas demand trade policy’s attention.

One is to prepare for less reliance on traditional trade partners in the West while increasing India’s trade and investment footprint in alternative markets, such as the African continent. India started looking at Africa seriously after the launch of economic reforms in 1991 and then with renewed vigour after the 2008 crisis. However, promises to increase two-way trade between India and Africa to $90 billion by 2015 have remained largely unfulfilled. India’s trade with Africa touched $56.7 billion during 2015-16, down from $72 billion in 2014-15. The drop is largely due to the fall in oil prices, which contracted India’s import bill with Nigeria. Meanwhile, China-Africa two-way trade touched $215 billion during calendar 2014.

India has intensified its relationship with Africa, which includes initiating several high-level visits since 2015. Prime Minister Narendra Modi, President Pranab Mukherjee and vice-president Hamid Ansari have between them visited 16 countries, with senior cabinet ministers visiting the remaining countries on the continent. During May, the African Development Bank held its 52nd annual meeting in Ahmedabad.

More needs to be done, of course. Trade policy can examine how coordinated action between commerce, finance and external affairs ministries might help in expanding India’s trade efforts; for example, a larger presence of Indian banks outside the conventional East African theatre can help reduce export credit costs. This includes reducing delays in implementing projects under Lines of Credit, India’s flagship instrument for development diplomacy.

Second, there is a need for a clear link between India’s trade policy and Make In India, including strategic linkages through global value chains. Policy clarity will be required whether India desires domestic manufacturing platforms that double as supply hubs for a global market, or assembly units that can be folded up and relocated elsewhere when cost arbitrage dries up (Chinese mobile units are perhaps a good example). Trade policy may be able to play a role here.

Finally, there is trade in services. There seems to be a concerted move within the rich countries—through the Organisation for Economic Cooperation and Development—to open up trade in services, including movement of professionals. This has been India’s longstanding demand because trade in services has been asymmetric so far—high in capital flows, information and communication technology, but low in free movement of professionals. Rising unemployment, particularly in Europe, could be driving Western agencies to prise open employment markets elsewhere. India’s demand (and strategy) for trade facilitation in services should find some articulation in the revised trade policy.

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

Rising Trade Walls and Shrinking Standards

Country after country, especially free trade evangelists, are erecting walls to stop the flow of professionals and human capital

Indian professionals are finding doors across the world shutting, shrinking opportunities to ply their trade. Weaned on a diet of free markets and globalization, they are finding that promise now ringing hollow. Country after country, especially free trade evangelists, are erecting walls to stop the flow of professionals and human capital.

US President Donald Trump carried out his campaign promise on 18 April by signing an executive order overhauling the H-1B visa regime, a programme allowing foreign professionals to work in the US for six years. Indian infotech companies such as Infosys, Wipro and Tata Consultancy Services (TCS) are among the biggest beneficiaries of this programme.

In less than 24 hours, Australia followed suit by revamping the immigration law which allows entry of professionals, titled “Subclass 457 visa”. Australian Prime Minister Malcolm Turnbull’s abrupt about-turn was unexpected. He was in India less than a week earlier, waxing eloquent about India-Australia ties and dispensing homilies about trade between the nations. He even signed off on a joint declaration with Prime Minister Narendra Modi which, among other things, welcomed “…progress in the flourishing knowledge partnership…building on the strong links in higher education, skills development and science, technology and innovation”. The icing was a memorandum of understanding signed with TCS for opening a new innovation lab in Australia, the fate of which could now be uncertain.

What could have happened in less than a week to force such a transformation? Could it be a follow-up to the now-infamous Trump-Turnbull telephone call? Turnbull’s measure, ostensibly designed to undermine rising nationalist right-wing forces at home, has now jeopardized progress on the Comprehensive Economic Cooperation Agreement (Ceca) being negotiated between India and Australia. A Ceca is wider in scope than a free-trade agreement—apart from trade in goods and services, a comprehensive treaty also includes issues like investment, government procurement and competition policy.

Three other prosperous nations have erected barriers of varying degrees—New Zealand, Singapore and the UK. New Zealand’s new work visa rules came a day after neighbour Australia’s. The UK has been tightening its visa rules for some time now. UK Prime Minister Theresa May recently further tightened visa rules for professionals by mandating minimum salary thresholds and language requirements.

India has a Ceca with Singapore which provides for trade in services between the two nations; to avoid breaching the agreement, Singapore has not denied work permits outright but has kept them in extended limbo.

This pandemic of border and behind-the-border barriers to services trade has compelled even World Trade Organization (WTO) director general Roberto Azevêdo to undergird his 2017 cheery trade prognosis with a caveat: “At the domestic level, policies are needed to help support the workers of today and train the workers of tomorrow. Closing the borders to trade would only worsen the situation—it would not bring the jobs back, it would make more jobs disappear.” WTO estimates world trade in 2017 will grow between 1.8-3.6%, but might settle at around 2.4% if world gross domestic product (GDP) growth sticks to projections. WTO also recognizes existence of multiple downside risks, including the sort of knee-jerk protectionist measures implemented by the US and Australia.

There could be a charitable explanation for why these countries are banding together against professional Indian talent. Australia, New Zealand and Singapore may have responded reflexively to the US and UK’s restrictive immigration laws; apprehensive of a spillover from these countries, the three countries might have responded impulsively and hastily.

The more plausible justification is that these moves—particularly by Australia and the US—are perhaps designed to blunt India’s attempts to introduce trade facilitation in services (TFS) agreement, somewhat identical to the trade facilitation agreement (TFA) in goods which came into force in February. According to India’s concept note—introduced in the WTO on 27 September 2016—like the TFA is intended to “…expedite the movement, release and clearance of goods as well as cooperation on customs compliance issues…”, the TFS can result in “…reduction of transaction costs associated with unnecessary regulatory and administrative burden on trade in services”.

India followed up the concept note with an “element paper” in November 2016 and a draft legal text in February 2017. The TFS is also now pitted directly against TiSA, or Trade in Services Agreement, currently being negotiated outside the WTO by 23 members comprising mostly developed countries. It is aiming for an ambitious overhaul of the General Agreement on Trade in Services (GATS), which it hopes will attract more members and eventually be ratified in the WTO. Both India and China (as well as many other emerging nations) are not members. It is, therefore, safe to expect that trade politics and diplomacy will probably focus a lot on services trade in the immediate future, especially at the WTO’s December ministerial in Buenos Aires.

Coincidentally, TiSA was initiated by the US and Australia. Which brings the discussion full circle: Is Australia’s long-term destiny to remain cat’s paw of the US? Its desire to also be identified as an Asia-Pacific community member will call for some tough balancing act then.

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

Caught Between The Dragon And The Elephant

India’s trade diplomats will need some deft footwork to manage two trade partners—China and the US

Two large beasts cramp our geostrategic mindspace. One, China’s dragon refuses to vacate our imagination. The second one stirring about in the same space is expected to further cramp room for manoeuvrability. The current US administration, much like the Republican Party’s elephant symbol, is steamrollering global multilateral negotiations. Both these heavyweights present India with a difficult balancing act.

The first inkling of India’s expected high-wire act came from Chile last week when 11 members of the floundering Trans-Pacific Partnership (TPP), all founding nations barring the US, met to revive the plurilateral agreement. An added twist was China’s presence at the meeting.

It is expected that China will step into the US’ large shoes. America’s withdrawal from the TPP was seen as a parting kiss of death since its stewardship had kept negotiations alive. Having invested time, resources and political capital—especially on beyond-the-border issues like labour standards, environment rules and intellectual property laws—many developing countries are loath to let all that work go to waste.

These developments point to the likelihood of an alternative Asia-Pacific trade agreement, perhaps without the trademark TPP markers. Importantly, China was not part of the TPP, which was seen as an instrument and extension of the US’ strategic power. While it is still early to predict how it will all shape up, hopes are the new pact will be built on the back of Latin America’s four-country Pacific Alliance and South-East Asia’s Regional Comprehensive Economic Partnership (RCEP).

India is part of the RCEP trade and investment initiative being negotiated between 16 countries—10 countries from the Association of South-East Asian Nations (Singapore, Malaysia, Thailand, Indonesia, Cambodia, Vietnam, Laos, Myanmar, Brunei and the Philippines) and six others with which the regional grouping has a free trade agreement (India, China, Japan, South Korea, Australia and New Zealand). Many of these nations are also TPP members. The RCEP provides India an opportunity to stamp its strategic and economic presence across the Asia-Pacific. It also provides India an opportunity to bring multilateralism back to centre stage.

But here’s the thing. With China assuming leadership of the RCEP and the putative Asia-Pacific alliance, the world will be keenly watching the shape of the new trade and investment agreement, especially who gets to set standards and the nature of standards finalized. The TPP’s insistence on standardized labour, environment and intellectual property right (IPR) regulations (apart from a host of other issues) conflicted with notions of sovereignty.

The question now is: Will China impose similar standards?

While China has publicly endorsed World Trade Organization (WTO)-compatible trade agreements, will it cherrypick rules? India and China share an uneasy geostrategic relationship, especially in trade. India’s three-tiered tariff proposal for the RCEP has already met with disapproval and India’s push for inclusion of trade in services faces multiple headwinds.

In the other corner, the US’ browbeating at the recently concluded G20 meeting in Germany provides a glimpse of forthcoming challenges to the existing world trade order and globalization. During the drafting of the final communiqué, the US bullied all members to drop pro forma references to free trade and protectionism. Not surprisingly, all members complied, though they did grumble in private.

US President Donald Trump’s administration has repeatedly emphasized that it prefers bilateral agreements over multilateral compacts. The 2017 Trade Policy Agenda makes it official: “The overarching purpose of our trade policy…will be to expand trade in a way that is freer and fairer for all Americans…these goals can be best accomplished by focusing on bilateral negotiations rather than multilateral negotiations—and by renegotiating and revising trade agreements when our goals are not being met.”

India does not have a free trade agreement with the US and negotiations over a bilateral investment treaty between the two countries is stuck over, among other things, the investor-state dispute system. IPR laws are the other thorn in the relationship: India claims its IPR regime is compliant with the WTO’s Agreement on Trade-Related Aspects of Intellectual Property Rights while the US insists on a WTO-plus framework. This has prompted the US to unilaterally include India in its “Priority Watch List” under Special 301.

The trade agenda outlines the future course of the bilateral: “Although existing Indian trade and regulatory policies have inhibited an even more robust trade and investment relationship, India’s economic growth and development could support significantly more US exports…In 2017, the United States will press India to make meaningful progress…on intellectual property rights, promoting investment in manufacturing, agriculture, and trade in goods and services.”

This, in short, is the dilemma. India’s geostrategic ambitions include RCEP membership but it will have to contend with China’s growing heft and increasing pressures to further reduce tariffs. India’s trade deficit with China is growing every year and shows no signs of reversing. On the other hand, India’s support for multilateralism will have to contend with the US’ insistence on bilateral treaties and a re-examination of all existing trade relations. Ironically, India enjoys a trade surplus with the US—in 2015, it touched $30 billion. India’s trade diplomats will need some deft footwork to manage these two trade partners and contradictions.

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

The world’s strongmen are eroding the autonomy of central banks. Exhibit A: India

Whatever the differences over the demonetisation fallout, there is near consensus over one collateral damage: the reputation of the country’s central bank, the Reserve Bank of India (RBI), has taken a severe beating after 86% of the country’s currency (by value) was withdrawn and not replaced on time. But, worse, there is a growing perception that the central bank buckled under government pressure and rubber-stamped demonetisation. Fingers are pointing at governor Urjit Patel for readily agreeing; this may be jumping to conclusions but governor Patel’s non-communicative mien has not helped matters.

Three former RBI governors have publicly lamented the erosion of the central bank’s relative autonomy. Former governor Y V Reddy expressed concern about the knocks the RBI is taking: “For the RBI, for a central bank, reputational risk is the worst risk…And if this is happening in the international opinion, I would say that it is a national problem now and it is not just a political issue.” Even Reddy’s predecessor, Bimal Jalan, chimed in with his concerns over threats to the RBI’s autonomy. The opening line of former deputy governor Usha Thorat’s recent op-ed was anguish-laden: “It is indeed a sad day to see one of the most respected public institutions in India becoming an object of ridicule and scorn.”

India is only playing catch-up

On closer scrutiny, though, this shouldn’t come as a surprise. India is only following a global trend. The world over, in countries with right-wing governments headed by perceived “strongmen,” the executive has locked horns with serving central bank governors, and in some cases even abrogated the relative autonomy of the central bank. India is only playing catch-up: the refusal to extend former governor Raghuram Rajan’s term, and the growing public perception of Patel’s inability to dissent, further reinforces the notion of India tacking on to a global trend.

Two recent examples testify to the global pattern’s prevalence. President-elect Donald Trump denounced US Federal Reserve chief Janet Yellen on his campaign trail, claiming she was playing politics with interest rates (translation: she was keeping interest rates deliberately low to help Hillary Clinton) and should be replaced. Whether he will follow through on that promise will be known only after Jan. 18.

In England, soon after securing the referendum supporting Brexit, Conservative Party grandees—notably Michael Gove and former foreign secretary William Hague—tore into Bank of England (BoE) governor Mark Carney. They were taking their cue from prime minister Theresa May who, at an earlier party conference, had slammed the BoE for the low interest rates and quantitative easing since it short-changed savers. Carney has since dropped dark hints of resigning.

The relationship between elected politicians and central bankers has always been fraught. The 2008 trans-Atlantic financial crisis has deepened the chasm with central banks being increasingly asked to take on quasi-fiscal responsibilities. This has resulted in increasing institutional friction.

In Japan, soon after prime minister Shinzo Abe assumed office in December 2012, he leaned on the Bank of Japan (BoJ) to print more money and to bump up its inflation target from 1% to 2%; both measures would require the BoJ to pursue an expansionary monetary policy. This, the government hoped, would provide the necessary growth stimulus to the economy and finally help Japan escape the pernicious deflationary trap that’s plagued the economy for over 10 years. BoJ governor Masaaki Shirakawa was initially reluctant and when the pressure continued to pile on, he resigned in February 2013, two months before he was due to retire.

The Hungarian president and head of the right-wing party Fidesz, Viktor Orban (who recently built barbed wire fences to keep out immigrants), used his majority powers in parliament to browbeat the central bank into submission. He even went to the extent of replacing the sitting governor with long-time Fidesz politician Gyorgy Matolcsy. Interestingly, Matolcsy currently faces myriad allegations of cronyism and misuse of public funds, including those of the central bank to window-dress the government’s fiscal health.

Closer home, Sri Lanka has been witnessing heightened tensions between central bank governor Indrajit Coomaraswamy and finance minister Ravi Karunanayake.

More than just monetary policy

Bank of Israel governor Stanley Fischer resigned ahead of his retirement date, sparking off rumours of differences with prime minister Benjamin Netanyahu. Fischer subsequently joined the Federal Reserve as vice-chairman. A year ago, he had delivered a speech on central bank independence, in which he made an interesting point, one that resonates with the Indian situation. He said: “…there is a distinction between the terms monetary policy independence and central bank independence. In the literature that developed before the global financial crisis, central bank independence referred to independence from political influences in the setting of monetary policy. But many central banks have roles outside monetary policy—in particular, bank regulation and supervision. These roles are in certain cases granted their own level of independence…”

This point has also been made by former governor Y V Reddy: “There are two types of confusion… my own suspicion is that the institutional identity of the RBI has been damaged… the RBI is the monetary authority, yes. But it is also a full-service central bank. It is in charge of many other things. The recent emphasis appeared as though monetary policy is the main function. The governor is accountable to monetary policy. Then he is not accountable to regulation, he is not accountable to currency coins? There is a confusion about relative importance. That relative importance is being decided more outside than within.”

Successive governments have found ways of corroding each of these different independent roles. For instance, under the previous Congress-led government, former finance minister Pranab Mukherjee (currently the country’s president) set up in 2013 a new financial sector monitoring body, called Financial Stability and Development Council, to be chaired by the finance minister. This was a clear intrusion; the central bank’s mandate includes financial stability. The RBI governor was put on par with other regulators, which betrays a flawed understanding of a central bank’s role and remit.

The Australian example is instructive. The governor of the Reserve Bank of Australia chairs the single integrated prudential regulator, the Australian Prudential Regulation Authority, as well as the Council of Financial Regulators.

Rule by fiat

The process of emasculating the RBI seems to have accelerated now. The surgical changes to RBI’s governance structure are telling: The government’s unwillingness to fill up vacant posts of independent directors is believed to have accelerated the passage of the demonetisation proposal and helped obtain the central bank’s acquiescence overnight. Ordinarily, the central bank would have debated and dissented, after assessing the logistical nightmare of not only distributing fresh cash to the wide network of bank branches across the country but also recalibrating and replenishing over 200,000 ATMs across the country.

Subsequent RBI submissions to parliament’s committee on finance disclosed that the central bank had acted on government advice.

Truth be told, the RBI Act does not empower the central bank with absolute autonomy, but the RBI does have relative autonomy allowing it to pursue certain monetary and regulatory functions with some degree of independence, free from political pressure. Saying “no” in the interest of avoiding short-term volatility and ensuring the economy’s long-term health is part of the job. Tinkering with this fine balance will have massive repercussions, including undermining investor confidence in various asset markets.

The article first appeared in www.qz.com on January 15, 2017, and can also be read read here

Rex-T: Sharp Edge of Donald Trump’s Foreign Policy

Donald Trump’s choice for secretary of state, Rex Tillerson, is an old oil hand; do not be surprised if his statecraft leads to fresh geo-strategic conflagrations

A small spark can light up an entire forest and leave it wreathed in smoke and ashes for days. They say the flapping of a butterfly’s wings translates into weather changes halfway across the world. Nassim Nicholas Taleb pulled out a black swan from his risk bucket to explain hard-to-predict catastrophic events.

Will there be one careless spark, a languid butterfly or a black swan to distinguish 2017? Some events of 2016—Brexit, Donald Trump’s surprise election victory, oil prices creeping up, boardroom brawls at Bombay House and demonetization—will continue to influence developments in 2017. But this being the merry season for compulsive crystal gazing, here’s hazarding a wild guess about one risk element that might set 2017 apart.

It’s called Rex-T: US president-elect Trump’s choice for secretary of state, Rex Tillerson. He’s not to be mistaken for the Jurassic carnivorous dinosaur; but he’s also not quite the cardboard character from a Steven Spielberg movie set. An Exxon lifer and chief executive officer, Rex-T has been described, variously, as a deal-maker, a hard-boiled negotiator, an inveterate networker. In selecting Rex-T for the position, Trump is bringing the oleaginous mix of history and politics back to centre stage after almost a century.

Exxon Mobil CEO Rex Tillerson, Donald's Trump's choice for secretary of state. Photo credit: Reuters

Anthony Sampson’s classic The Seven Sisters: The Great Oil Companies And The World They Shaped describes how oil multinational corporations exercised inordinate heft in shaping early 20th century geopolitics: “The (US) government…preferred to use the oil companies, at a discreet distance, as the instruments of national security and foreign policy.” Texaco, Exxon, Standard Oil, BP, Shell, Gulf Oil and Mobil carved up vast territories in the Middle East, left behind by a retreating Ottoman empire, between themselves for oil concessions; occasionally, they even helped the US state department or British foreign office redraw political boundaries to suit business interests. Rex-T’s appointment rekindles suspicions of close links between oil and US statecraft.

The first risk arises when the US Senate foreign relations committee meets to confirm Rex-T’s appointment, which will then have to be endorsed by the entire Senate. It is speculated that this could be in jeopardy, given Rex-T’s Exxon background, the company’s business interests in Russia and the man’s proximity to Russian President Vladimir Putin. Many Republican senators have voiced their discomfort with Trump’s choice of the US’ future foreign policy architect: too compromised, too close to the enemy. If the confirmation falls through, events can take a different turn. That’s a risk in the unknown-unknown category because Trump’s backup choice is not known.

Assuming Rex-T obtains the confirmation, the state department can be expected to follow a certain policy trajectory. At this point, it might be safe to assume that part of Rex-T’s foreign policy design will be influenced by three chief factors: his oil background (having worked in Exxon all his life), his company’s Russian assets, rendered uneconomic by US-imposed economic sanctions, and his close friendship with Putin.

It might also be realistic to expect that Rex-T will bring two economic sanctions back into play: Russia and Iran. The US will probably relax economic sanctions against Russia, as Trump has hinted several times. The noose regrettably tightens in Iran’s case. A huge question mark looms over how Trump will follow through with the US’ recent extension of the Iran Sanction Act, which was expected to lapse at December-end. The renewal provides Trump with a window to reimpose punitive sanctions if he is convinced that Iran is violating the Joint Comprehensive Plan of Action signed with the US, France, Germany, China, Russia and the UK. Incensed by the renewal, Iran is already threatening to build a nuclear submarine.

Will Rex-T be the spark that ignites this risk? Consider this: The Organization of the Petroleum Exporting Countries’ (Opec’s) members and non-members (primarily Russia) recently agreed to cut oil output. This had an immediate impact: Oil prices moved up sharply. Also consider this: Trump has promised to revive the US’ shale oil and gas industry, asserting during his campaign that this will create two million jobs. This additional output could potentially depress prices again.

The only way to keep prices up is to take out a large producer from the equation. And that could be Iran. The country’s oil exports, which dropped to a low of almost 1.1 million barrels per day (mbd) in 2013, is now back to almost 2.5 mbd on the back of almost 4 mbd of production. However, low oil prices have deterred revenue from reaching pre-2011 levels. Iran, which has so far refused to heed any Opec call for production cuts, seems to have finally agreed during November’s 171st ministerial conference in Vienna to reduce production marginally.

On the stump, Trump repeatedly railed against Iran and carped about the nuclear deal; vice-president-elect Mike Pence even threatened to “rip” it up. Will Rex-T be the sharp edge of this machete, to keep oil prices high and revive his old company’s sunk investments in Russia? Closer home, high oil prices further compromise India’s fiscal fragility. 

There is an even chance that Rex-T will baulk and this risk won’t play out. But, then, Trump has introduced another known-unknown to the equation: Peter Navarro, a well-documented China-baiter, as head of the White House National Trade Council. If Trump’s administration does initiate the promised trade war with China, that’s another future wrinkle for the global economy.

On that note, wish you all a happy 2017!

The above article was first published in Mint newspaper on December 28, 2016. It can also be read here.

After Shock Within, Comes External Shock Wave

Apart from demonetisation worries, Donald Trump’s victory in the US has added new risk variables for equity, bond and currency markets

The government’s demonetization contretemps has focused attention on the short-term havoc it will inflict on the domestic economy. There’s another worrisome front opening up which could exert additional pressure on the stressed economy: the external sector.

Donald Trump’s unanticipated election victory in the US and his scattergun statements on trade, visa control and general economic policymaking have added new risk variables for equity, bond and currency markets.

In addition, markets sense that the Federal Reserve might be on track to increasing interest rates in December. Consequently, investors are headed for dollar-denominated assets which, in turn, has adversely affected emerging market assets.

In India, foreign portfolio investors sold close to Rs32,000 crore of securities in November (till 25 November) alone. Predictably, the Indian rupee also depreciated by over 2% in November.

It also raises questions about the Reserve Bank of India’s (RBI) surgical strike: There’s speculation that the sudden and inexplicable 100% incremental cash reserve ratio announcement is aimed at stopping the deposits deluge from bringing down bond yields further and staunching outflow of foreign exchange.

But, that’s not the main problem; it only adds to the underlying weakness. The problem lies on the current account front.

The mainstay of India’s export basket— services—is slowing down. According to RBI data, services exports between April-September 2016 increased only 2% over the same period in 2015, while services imports are up 7%. And, though India enjoys a positive trade balance in services exports, slowing export growth has shrunk the surplus trade balance by 50%.

There’s more. The performance of software and IT-related services exports, the largest contributor to services exports, is expected to deteriorate progressively. Leading infotech companies are revising their FY2017 estimates downwards.

For example, Infosys has marked down its top-line growth expectation to 8-9% for FY17; the lowered guidance comes a second time this year.

Nasscom, the industry association for the information technology and business process management companies, expects IT industry’s exports to grow at 8-10% for the financial year ending March 2017, against its earlier estimate of 10-12%: from $119-121 billion estimated earlier to $116-118 billion now.

The drop in the IT sector’s revenue generation is a direct fallout from US-based companies holding back, or deferring, their spending till the political drift becomes clearer. Trump is expected to take over in January; meanwhile he has revealed his business agenda which, if followed through, is likely to spell trouble for India’s IT sector.

For example, he has promised to review the US visa programme and reform “abuses of visa programmes that undercut the American worker”. Read that as targeting the H1B visa programme, a non-immigrant visa that allows US companies to hire foreign workers in specialized roles for short periods. In IT-speak, it’s a special window which allows Indian software coders to work on client sites in the US.

Trump seems to be following through on his promise: his pick for advocate general, Alabama senator Jeff Sessions, is a long-time H1B opponent who has tried to legislate a reduction in H1B annual quotas and sought federal investigations into alleged H1B visa frauds.

So, till the picture gets clearer, most US companies have put their IT spends on hold. This hurts because the US accounts for about 60% of India’s software exports. Add to this Brexit and the uncertainty caused earlier in year, and that’s another negative mark against the rupee. Expect further changes over the next few months as the picture becomes clearer.

There’s additional pressure on the horizon. Goods exports have been in steady decline, affected by a mix of cyclical and structural factors. Merchandise exports between April-October 2016, in dollar terms, were stagnant (actually marginally down by 0.17%) over the same period in 2015.

The trade balance might look redeeming, with the negative spread between imports and exports having narrowed but hides another source of worry: goods imports during April-October contracted 10.85% in dollar terms.

Apart from the impact of lower oil prices, this reflects two trends: waning global demand squeezes items imported for re-export (such as precious stones, or other jewellery inputs), and decline in domestic demand affects imports of raw materials or intermediate goods.

The bad news doesn’t end there. One of the pillars of India’s current account— remittances sent by Indian workers overseas—has also been steadily coming down. Net remittances during April-June 2016 amounted to $8.82 billion, down 3% from $9.1 billion in the same period of 2015.

It can be argued that the external economy has been under stress for a while. What’s changed is the effect of demonetization on the economy.

The sudden liquidity withdrawal will have a shock effect on the economy, disrupting supply chains, dampening an imminent consumer-led economic revival, deterring capex impulses and lowering overall GDP growth.

How long that will last is still uncertain. But what is certain is that the added burden of a shrinking external economy—gripped by a decade-long slowdown and buffeted by systemic shocks like Brexit or unexpected sharp turns in US economic policy—will only aggravate the systemic shock.

This article originally appeared in Mint newspaper on November 30, 2016, and can be also be read here

The Two-Step Trump Dance

It seems India-US ties will primarily be a two-track exercise: with one track chugging along smoothly and the other full of bumps and speed breakers

India has witnessed 16 years of progressively intensifying partnership with the US under the George W. Bush and Barack Obama presidencies. With Donald Trump moving into the White House soon, predictions about future India-US ties swing between hope and trepidation. Indeed, both sides may have to reset many existing markers in ongoing negotiations.

Everybody is trying to figure out Donald Trump the president versus Donald Trump the candidate. On the campaign trail he confused observers with his wildly oscillating undertakings. The scope for speculation is greater in his ramblings about India; he waxed effusive about India’s business opportunities but issued grim warnings about Indian software engineers in the next breath.

The question uppermost then is: Where does India figure in his plans? For one, Trump’s campaign arc has seen many flip-flops and this may well continue till he finds his feet in the Oval Office in January 2017; the post-victory phase has seen policy reversals, such as second thoughts on completely discarding Obamacare and scrapping the nuclear deal with Iran.

The clue to Trump’s India policy may lie in the document ‘Republican Platform 2016’: “India is our geopolitical ally and a strategic trading partner… We encourage the Indian government to permit expanded foreign investment and trade, the key to rising living standards for those left out of their country’s energetic economy. For all of India’s religious communities, we urge protection against violence and discrimination.”

Parsing the paragraph, it seems the India-US relationship will primarily be a two-track exercise, with one track chugging along smoothly and the other full of bumps and speed breakers. For instance, as the first sentence suggests, security and strategic ties will remain cordial. The second sentence points to the craters: unfulfilled trade and investment demands. In short, it’s business as usual.

The first reset button, though, will have to be pressed by Prime Minister Narendra Modi. He assiduously built a close working relationship with Obama: They had three bilateral meetings and numerous one-on-one engagements in the past 30 months. Modi will now have to figure out the unknown quantity called Trump and see if they can share a working relationship.

So, while there are no safe bets, hopefully the institutional architecture of the current bilateral framework—especially ministerial negotiations under the Strategic and Commercial Dialogue (S&CD)—will hold under the new leadership.

For instance, the civil nuclear partnership and defence acquisitions will be pursued as aggressively by the incoming administration as the outgoing one. Security, strategic affairs, defence cooperation are likely to be smooth sailing because both countries have some convergence of interest here.

To be sure, there’s still uncertainty about Trump’s outlook towards Pakistan, Russia and China and their knock-on effects on India, but it is clear that the India-US geo-strategic alliance will persevere in some form.

The problem area, as in the past, will be trade and investment. Both sides have painted themselves into intractable corners with numerous trade barriers. While Trump’s trade-related campaign tirade was largely restricted to the Trans-Pacific Partnership (TPP) and US-China trade relations, the new administration might train the arc lights on India’s $30 billion trade surplus with the US. India-US trade in goods and services touched $108 billion during the 2015 calendar year.

Interestingly, during Modi’s first state visit to the US, the joint statement set a $500 billion trade target without mentioning any end date. And while under the S&CD and its predecessor, the India-US Trade Policy Forum has held 10 ministerials so far, progress has been at a glacial pace.

Large parts of each year’s communiqué read like the one from the previous year. There are many pain points developing. For instance, in agriculture market access, India wants to export grapes, rice and honey while the US wants market access for cherries, alfalfa hay and pork.

The US has issues with subsidies in the Indian textile sector. India and the US have dithered over signing a bilateral investment deal, the main trip-wire being the contentious investor-state dispute settlement mechanism.

The other sensitive area is intellectual property rights; both sides have been gingerly circling each other with communiqué politesse masking the underlying stress. There are serious differences of opinion in services trade.

There is one redeeming feature though. Under the Obama regime, India was left out of the three large trade arrangements being shepherded by the US: the TPP, the Transatlantic Trade and Investment Partnership (TTIP) and Trade in Services Agreement (Tisa). While Trump has publicly expressed his distaste for TPP (with TTIP presumably falling in the same category), Tisa remains the odd one out.

This is one area where India will have to be vigilant, given India’s strategic advantage in services. India should also use this opportunity and leverage its relationship with the US to prise open the Asia-Pacific Economic Cooperation for a membership. This is a grouping that works well for India, given its flexibility, advantages and non-binding commitments.

It is unlikely that the Trump administration will roll over on trade any time soon; neither should India, because strategic autonomy will continue to be an asset. While the love-hate relationship can continue, both sides must endeavour to find some middle ground in the meantime.

This article originally appeared as part of my column, General Disequilibrium, in Mint on November 16, 2016. It can also be read here.