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

The Budget Sidesteps Geostrategic Risks

Arun Jaitley’s budget seems to contain very little—by way of either allocations or strategic intent—to mitigate risks that endanger the Indian economy

Both the budget document and the Economic Survey have painstakingly detailed risks that endanger the Indian economy and can disrupt growth and employment impulses. Yet, the budget seems to contain very little—by way of either allocations or strategic intent—to mitigate these risks. The focus seems to be on surmounting immediate electoral challenges and neutralizing near-term policy distortions like demonetization.

Both Union finance minister Arun Jaitley and his chief economic adviser Arvind Subramanian see major risks emanating from the external sector. Jaitley’s budget lists multiple Fed rate hikes likely in 2017, commodity price uncertainty (especially crude prices) and “…signs of increasing retreat from globalization of goods, services and people, as pressures for protectionism are building up”. The Economic Survey also underlines the last two risks.

Given these clear and visible risks, it would be fair to expect defensive action, especially in areas of India’s strengths. The budget small print belies that belief.

Start with this year’s Economic Survey, which identifies clothes and shoes as ideal candidates for low-skill, high-employment manufacturing potential and for occupying crucial trade space being vacated by China. The survey also finds India has competitive advantage in these two items despite myriad challenges—such as domestic labour laws and tax structure, or the duty preferences enjoyed by competing countries in key buyer markets.

Given the Survey’s clear strategic direction, check out allocations for the commerce and industry ministry under the expenditure budget. Jaitley and his team have allocated only Rs0.01 crore to the Footwear Design and Development Institute, compared with Rs109.99 crore in 2015-16 and Rs25 crore in 2016-17. The institute provides skilled human resources and technology development to the leather and footwear industry. The Indian leather development programme (ILDP) gets a higher allotment of Rs500 crore, compared with Rs235 crore in 2015-16 and Rs400 crore in 2016-17. But then the ILDP focuses on improving the raw material base for leather units and the Survey actually shows non-leather footwear has achieved higher exports than leather footwear.

This is not the only mismatched allocation in the commerce ministry. There’s a token entry of Rs0.50 crore against the project development fund, which the ministry created with the Exim Bank to promote Indian private sector investments in Cambodia, Laos, Myanmar and Vietnam (commonly referred as CLMV nations) as part of Prime Minister Narendra Modi’s “Act East” policy. The creation of the fund was announced by Jaitley in his second budget in February 2015. There are, of course, no follow-up remarks in subsequent budgets.

The budget documents are littered with such examples. The geo-economic strategy, drawing from Modi’s repurposed foreign policy, betrays an excessive strategic reliance on select developed countries which could be a risk. The readout from the White House after US President Donald Trump’s brief telephone conversation with Modi reiterates that the US “…considers India a true friend and partner in addressing challenges around the world.” While these “challenges” remain undefined, Trump’s recent trade policy announcements now renders this alliance vulnerable. While it might be too early to declare doomsday, India needs a hedging strategy which includes exploring alternative markets.

And, yet, the budget sidesteps this obvious alternative. Take the example of Chabahar port in Iran, to which India has attached great geostrategic significance. The port offers India a land bridge to Afghanistan and Central Asian markets that bypasses Pakistan, and can become an alternative route to north Europe via Russia. Unfortunately, India continues to drag its feet on Chabahar, even though India and Iran started discussing it in 1997 and signed the first agreement in 2003 as part of the Delhi Declaration. This was further consolidated through a Trilateral Transit and Transport Corridor agreement signed during Modi’s visit to Iran in 2016.

Chabahar port has been allotted only Rs150 crore under the ministry of external affairs, compared with Rs100 crore in 2016-17. One could argue that since the project is being executed by special purpose vehicle Indian Ports Global Pvt. Ltd, a joint venture between Jawaharlal Nehru Port Trust (JNPT) and Kandla Trust, it might make sense to identify capital allocation to these two ports. The two ports have been allotted Rs1,850.30 crore and Rs393.90 crore for 2017-18, against Rs562.38 crore and Rs130.18 crore, respectively, during 2016-17. But there’s a catch: Both amounts have been listed under the head “IEBR”, or internal and extra budgetary resources, which means the government will not contribute any money and the two ports will have to generate these amounts from profits, loans and equity. Importantly, both ports are also implementing significant expansion plans (the JNPT’s plans include two new container terminals, two dry ports in Wardha and Jalna, and a special economic zone, among other things) and it is moot how much funds they can spare for Chabahar.

Is India going deliberately slow on Chabahar, given the Trump administration’s recent statements and executive order against Iran? India’s on-now, off-now engagement with Iran may have pushed the country closer to China through a joint military cooperation agreement and possible One Belt, One Road connectivity. The budget lost an opportunity to make some critical course corrections.

The article originally appeared in Mint newspaper on February 8, 2017, and can also be read here