IMPACT OF BREXIT ON EU

Author: TANUJ GUPTA

Love gone bad! No I am not referring to any Bollywood couple’s breakup but Britain’s exit from the European Union (EU). On 23rd June 2016, the people of Britain voted for the most important decision of their life which will impact not only them but also the future generations of Great Britain and EU. BREXIT will surely transform the economic, political and social landscape of EU.

ECONOMIC – Official trade statistics show that EU is the destination for half of British exports. But Britain’s share of intra-EU exports and imports is only 10.1% and 6.0% respectively. This number is also inflated because goods exported by Britain out of Europe are transited through Rotterdam port in The Netherlands. This phenomenon is termed as ROTTERDAM EFFECT.

Britain’s Total Export to EU 402.3 Billion Euro Britain’s share in total intra – EU exports Britain’s share in total intra – EU imports
Britain’s Total Import to EU 344.2 Billion Euro 10.1% 6.0%

Foreign investments in EU might dry up as companies use Britain as gateway to Europe because of Zero–tariff environment and free movement of labour and capital. Britain with 28% has the highest foreign investment in EU.

EU will have to find a replacement for London which has long served as the financial nerve centre of EU. Many investment banks having headquarters in London will have to move out of London so as to serve the European market. Germany which imports 14% of financial services will be the biggest loser in EU because of increase in cost of financial services.

POLITICAL – For starters, EU would lose an influential member which would have helped them to crack trade deals and have a say in World politics and economics. There will certainly be a shift in the power of decision-making in EU. Germany and France will want the decision-making power to shift towards them which might create further political frictions.

SOCIAL – Another pressing issue is immigration. The free movement of labour might be restricted in Britain due to BREXIT. This will result in the surge of low-wage migrant labourers from Africa and Middle East to EU. This might add fuel to the existing anti-immigration movements in EU and may lead to further political differences amongst EU members.

SECURITY – With the growing threat of ISIS, security is a key issue for EU. Britain is home to world-class intelligence agencies like MI5 and MI6. BREXIT will put EU at the back foot in counter terrorism and intelligence operations. The plans for building a unified European army will also be hit.

The EU after BREXIT will be an impaired regional and a geopolitical union as compared to the current EU, which already punches far below its economic weight in regards with  the global and regional diplomatic and strategic matters.

Importance of U.S. consumption in the revival of the world economy

By- Nayan Saraf

Since the global financial crisis of 2007-08, there has been a constant debate as to which economy would be the growth engine of the world, considering the complete slowdown of U.S. and the Eurozone. More often than or not, China and many other developing economies such as India, Brazil, Russia and Indonesia have appeared as the best alternatives. But regardless of all the optimism surrounding China and these developing economies, these countries have not been able to improve their performance in the absence of growth in U.S.

It’s not only because of the size of U.S. GDP, but also because of the contribution of consumption factor by U.S., which in itself is responsible for the prosperity of many leading economies. The table given below would give a clearer picture of the world’s two leading economies i.e. U.S. and China and the factors contributing to their GDP.

  Y     = C   + I        + G      + X(EX-IM)
U.S.  ($17.9 Tn) 100% 68.9% 16.3% 17.6% (3.3%)
China ($11.3Tn) 100% 38.1% 43.4% 13.8% 4.7%

It is quite clear that U.S. economy is mainly driven by consumption, whereas China’s is driven by investments (if we consider I + G). Hence, if U.S. economy slows down, it means less consumption, which could result in lower import which in turn may lead to closing off businesses and higher unemployment in exporting countries.

Since the global financial crisis, international weight of U.S. import share has shrunk from 17% to 12%, which is an alarming situation for countries like China, Canada, Mexico, Japan, Germany, U.K., France etc., which run huge trade surplus with U.S. Since U.S. is the largest trading partner of China, accounting for almost 1/5th of its import with a value of over $440 billion, it is very clear that even Chinese economy is worse off without U.S. consumption.

This is the reason that the economies around the world are anxiously waiting for U.S. to recover. And the key factor of reviving U.S. economy has always been consumption, which stands at nearly 70% of its GDP. That is why there have been constant efforts from the government and the FED to increase the consumption by means of lower interest rates, easy mortgage terms, Quantitative easing and easy credit card debt, in order to get the consumer to spend more and get the economy moving again.

TAX TREATY: BOON OR BANE?

By- Phani Kumar Ch

On May 10th, India’s 30 years love affair with Mauritius, with respect to their tax treaty, has finally come to an end. Investments routed, from financial year 2017, through Mauritius would attract taxes. Earlier, Mauritius was considered a tax haven for investors investing in India through this route. This could explain why in many years Mauritius was the largest source of FDI for India.

The Double Taxation Avoidance Agreement (DTAA), which was signed between India and Mauritius in the year 1983, has been amended in such a way that in the initial two years, 2017-2019, investments would be taxed at a rate of 15 – 20 %, which is half of the domestic tax rate in India. The treaty has been amended because of significant round tripping, and in the backdrop of the recent leak of Panama Papers that has prompted Governments to reconsider their tax laws. In this context, round-tripping means that money goes overseas through various channels like Hawala and payments to shell companies, and comes back to India through Global depository receipts and Participatory notes. Analysts are of the view that the treaties with Singapore and Cyprus will also get amended in the same way.

Will the FDI flows into India be impacted? We don’t think so. There might be a short-term pressure but in the longer term, everything boils down to fundamentals. And right now, India is one of the fastest growing nations in the world. Eventually fund flows will be dependent on the economic strength of the nation. Hence, the tax treaty amendment is definitely a boon.

WHAT DOES CHINESE SLOWDOWN MEAN FOR INDIA?

By Priyanka Modi

Edited by Sachit Modi

Executive Summary

The purpose of this paper is to analyze the impact of the slowdown in the economic growth of China on India. I will analyze the repercussions of Chinese economic crisis on the global economy. India being well-integrated with the global economy cannot be alienated from the effects of the slowdown. I will discuss both the benefits and the negative implications for the Indian economy. In the midst of this crisis, there is also an opportunity for India. I will consider the steps that can be taken by the Indian government to reduce the degree of the negative impacts of the weakening Chinese economy and leverage the opportunities at hand.

Ever since the economic growth of China, India’s largest trading partner in goods started slowing down, concerns have been raised over its possible impact on the Indian economy. The steep fall in value of the Chinese currency, Yuan, in recent times has once again emboldened the naysayers. While it will be erroneous to argue that India will not be impacted by the economic churning happening in China, it will be equally irresponsible to suggest that India will be completely doomed if China falters. In value terms, China accounts for approximately one-tenth of India’s merchandise trade, and bulk of it comes from imports of goods to India. India’s trade deficit with China stood at $51.86 billion, with a bilateral trade of $71.22 billion in 2015. During this period, India’s exports to China came in at $9.68 billion while imports stood at $61.54 billion. With respect to 12 major product groups largely manufactured by MSMEs, imports from China grew at a higher rate than respective imports from all other countries combined during the period negative impact of a Chinese slowdown as trade flows slow down. At the same time, it should also explore the positive side and leverage the opportunities it has.

Implications of Chinese slowdown on the Global Economy

China used to have the fastest growing economy with growth rates averaging 10% over the past 30 years, according to the International Monetary Fund. They account for close to half of the global consumption of copper, aluminium and steel, and more than 10% of the crude oil. China has driven global growth, which has averaged a paltry 3% a year since 2008. So, the Chinese economy slowdown would impact different regions of the world in different ways depending on their exposure. In countries like Australia, Brazil, Canada and Indonesia, which are dependent on the commodity exports, the slowdown could have a negative impact on their GDP. However, the inevitable fall in the commodity prices could be beneficial for the countries that consume the commodities, such as the United States. Either way, the slowdown will require some adjustment on the part of the global economy. As per IMF, the country was the single largest contributor to the global economic growth, contributing 31% on average between 2010 and 2014. In this scenario, slower Chinese GDP growth would definitely have global repercussions. A fall in exports to China will impact countries such as South Korea, Japan, Brazil and Australia as exports to China are ~20-30% of total exports for these countries. India too won’t be spared as the overall global growth falters.

Positive Impact on India

Lower commodity prices: The first and an overwhelmingly positive impact of a slowdown in China’s commodities demand on India would be through lower commodity prices. India imported $139 billion worth crude and petroleum products in the FY 2015, and as a rough rule of thumb, every $1 drop in crude prices results in a $1 billion drop in the country’s oil import bill.

Attract foreign capital: Though India cannot do much about the currency, the rupee is expected to remain strong as oil prices tumble and markets remain flush with foreign money. While the impact of China is negative for exports, it may provide a good opportunity for Indian debt and equity markets. The Chinese devaluation has scared foreign investors who may flock to India to look for better returns. A depreciated currency shrinks the dollar value of investments at the time of repatriation. Given that other large emerging markets such as Brazil, Russia and South Africa are going through their own economic issues, India currently is the best-placed country among the top developing nations to attract these flocking investors.

Lower cost of infrastructure: China is the world’s largest copper consumer, accounting for 40% of the global consumption. The Chinese slowdown has resulted in the fall in prices of the hard commodities, especially copper and aluminum. These commodities constitute the largest portion of the infrastructure bills. Thus, the fall in prices could be beneficial for India, whose major focus at this time is building a strong infrastructure network for the country. This fall would help India to reduce the cost of constructing new infrastructure and would act as a supporting element to initiatives such as the Smart City Mission.

Control deficit and inflation: Oil prices were already tumbling down because of the global slowdown and the possible US-Iran deal. The Chinese economic slowdown further plummeted the prices. Low oil prices help India to control its deficit and keeps inflation under check.

Higher profits for Indian corporates: Over the past few years, due to the depressed domestic demand, many of the Indian corporates had been struggling with their pricing power and were unable to pass on the increased cost to the end consumer. Cheap global crude and commodity prices mean lower input costs, translating into higher profit margins for them. This will act as a major respite for them.

Negative Impact on India

India’s export growth: India’s exporters will lose out on currency competitiveness in the segments where it competes directly with China, particularly textiles, apparels, chemicals and project exports. If the Chinese demand slows down, its raw material requirement will go down, and India’s exports to that country may decrease to such an extent that it may not be able to take advantage of the Yuan devaluation to earn more dollars. The fact that India’s exports to China declined 19.5 percent to $11.9 billion in 2014-15 from $14.8 billion a year ago illustrates this. India’s trade deficit with China has almost doubled from $25 billion in 2008-09 to $50 billion in 2014-15. And China’s share of India’s total trade deficit is up from just under 20% in 2009-10 to 35% in 2014-15. Thus, there is a chance that India may lose out in the race.

Indian metal producers: China accounts for nearly half of the world’s steel production and as construction and investment slows down, the decline in demand for commodities will hurt the Indian metal producers. Steel companies and Aluminium manufacturers may start facing losses. Hindalco and Balco, for instance, are increasingly relying on costlier captive coal. Steel manufacturers like JSW Steel and Tata Steel were forced to lower their prices and face the fear of dumping from across the border. Also, companies like Tata Steel and SAIL, which have their own mines, will suffer the most as they will not be able to benefit from the lower iron ore and coal prices. Metal producers like JSW, who buy coal and iron ore from the open market, would be the least affected.

Tyre industry: As demand slows down in their home market, Chinese tyre makers might start exporting tyres at very competitive rates to the rest of the world. A Chinese tyre is around 30-40 per cent cheaper as compared to the domestic prices. Thus, the commercial vehicle tyre segment will be negatively impacted as most of the consumers are more concerned about the value rather than the brand.

Automobile industry: China had the potential of becoming the fastest growing market for the automobile exporters and manufacturers. As the demand in their market goes down, companies like JLR, who were investing in that market, will have to look for alternate options.

How should India react?

India’s GDP has expanded by 7.3 percent in the last quarter of 2015 whereas China’s GDP slipped to 6.8 percent in the same period. India will be the fastest-growing major economy in 2016-17 growing at 7.5%, ahead of China, at a time when global growth is facing increasing downside risks, as per the World Economic Outlook released by the IMF in April 2016.

Since we are already growing, now is the right time to leverage the Chinese slowdown to our advantage. India can surely benefit from the opportunities it has by focusing on the following-

Make in India: With the government of India giving a lot of weight to the ‘Make in India’ campaign, this may be the time to provide impetus to manufacturing and invite Chinese companies to set up a manufacturing base in India.

Growth center to invest: A slowdown in the Chinese economy would also mean that the global finance and capital market would look for new growth centers to invest in. The government should invest in infrastructure like roads, railways etc. and introduce reforms to improve business conditions in India. By providing an attractive alternative to China, India can have a much bigger pie of the global capital, which in any case it needs to fund its huge infrastructure capital requirement.

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Stem the rupee’s fall: A bigger concern that arises from the Chinese devaluation is for the Reserve Bank. RBI governor, Raghuram Rajan, who had been giving warning against the “beggar thy neighbor” policies, may have to alter rate decisions in order to keep up with the global environment. The Reserve Bank of India could sell dollars in the market to increase the rupee’s value. There are several other measures possible that range from floating a sovereign bond to raise money from NRIs to making the import of luxury goods costlier by imposing duties on them.

Anti-dumping duty: The steel industry and the government, both are worried over dumping from China. So far, there have been 322 anti-dumping cases in 2015, of which 177 cases involve China. The Finance Ministry has imposed antidumping duties on the import of hot-rolled stainless steel (HR SS) flats of grade 304 originating from China, Malaysia and South Korea. The anti-dumping duties will be effective for a period of five years starting 2015. India consumes about 1 million ton of this type of stainless steel and more than 40 percent of that is imported, mainly from China. The anti-dumping duty can also be extended to the 200 grade stainless steel as it commands a market share of more than 50 percent in India.

Conclusion

The impact of China’s slowdown on India would depend on many factors such as lower input prices, intensity of competition from cheaper imports and the pace of global growth. The speed at which we go ahead with the reforms is very important. It is not a matter of global economy slowing down, but how India speeds up its reforms. India will have to come to grips with the fact that in an integrated world, much is beyond its control and it needs to focus on the things it can change – boosting investments and generating jobs.

References

http://www.crisil.com/pdf/research/CRISIL-Research-Opinion-China-Slow-
down-16Jul2015.pdf. (n.d.). Retrieved April, 2016, from http://www.crisil.com/pdf/research/CRISIL-Research-Opinion-China-Slowdown-16Jul2015.pdf

•How China’s Slowdown Is Having Ripple Effects All Over The World. (n.d.).
Retrieved May 17, 2016, from http://www.businessinsider.in/How-Chinas-Slowdown-Is-Having-Ripple-Effects-All-Over-The-World/articleshow/29918501.cms

•China economy slowdown: India should focus on mitigating impact. (2016,
January 11). Retrieved April 20, 2016, from http://www.hindustantimes.com/editorials/
china-economy-slowdown-india-should-focus-on-mitigating-impact/story vMRWd6CcBdkVFTr0whrGkL.html

•India imposes anti-dumping duty on some steel from China. (n.d.). Retrieved
April 22, 2016, from http://www.moneycontrol.com/news/current-affairs/india-imposes-anti-dumping-dutysome-steelchina_1401378.html

•How the Chinese Yuan devaluation will impact India? Read more at: Http://
http://www.vccircle.com/news/economy/2015/08/11/how-chinese-yuan-devaluation-will-
impact-india. (2015, August 11). Retrieved April 22, 2016, from http://www.vccircle.com/news/economy/2015/08/11/how-chinese-yuan-devaluation-will-impact-india

•Steel producers to benefit from import curb: India Rating. (2015, June 22). Retrieved April 23, 2016, from http://www.dnaindia.com/money/report-steel-produc-
ers-to-benefit-from-import-curb-india-rating-2097936

•The impact of a China slowdown. (2014, November 29). Retrieved from http://www.economist.com/news/economic-and-financial-indicators/21635039-impact-china-slowdown

• India Could Edge Out China From Top Growth Spot in 2016. (2016, January 13). Retrieved April, 2016, from http://www.bloomberg.com/news/articles/2016-01-
12/india-seen-edging-out-china-from-top-growth-spot-in-2016#media-4

•India’s trade deficit with China swells to $51.9 billion in 2015. (2016, March
14). Retrieved April, 2016, from http://articles.economictimes.indiatimes.com/2016-03-14/news/71509794_1_trade-deficit-trade-imbalance-chinese-exports


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About the author:

She is a PGDM finance student of batch 2015-17 at TAPMI. Her area of interest includes economic research and risk management. You can contact her at priyankam.17@tapmi.edu.in

REGRESSIVE EXCHANGE RATE POLICY OF CHINA

By Nayan Saraf

Edited by Shulin V K Satoskar

 Introduction

There have been many dramatic events in the history of the financial world which have subsequently changed the structure and practices across the world. These practices were mainly intended at getting ahead in the competitive world of trade. And when it comes to trade, all we can talk about is China. Perhaps, China is one of those countries which has tried every possible trade practice to be ahead of other countries. Some of these are unfair. These unfair practices are: Currency manipulation and currency devaluation. But before we go ahead and discuss the impacts of these unfair and regressive trade policies, we first need to understand currency manipulation.

What is Currency Manipulation?

Currency manipulation, also known as foreign exchange market intervention, or currency intervention, occurs when a government buys or sells foreign currency to push the exchange rate of its own currency away from equilibrium value or to prevent the exchange rate from moving towards its equilibrium value. This is basically an act of artificially inflating or deflating the fair value of the currency. In most cases, manipulation is illegal. Usually, the fair value is decided by the demand and supply of that currency in the market. But when a country manipulates its currency, the free market does not remain any free. In that case, the country with trade surplus doesn’t allow its currency to get appreciated, which in self-correcting phenomenon should do. Due to this process, the goods from that country would still cost less than those of other countries whose currencies would be wrongly inflated. This way, the country using currency manipulation attracts more exports and disturbs the free market.

How does China do Currency Manipulation?

      Now suppose, a trade occurs between a US importer A and a Chinese exporter B. After the trade, importer A would transfer its money to the account of Chinese exporter B in dollars. Now, after receiving money in dollars, exporter B would go exchange the dollars in local currency Yuan. But instead of exchanging from its reserves, People’s Bank of China (Central Bank) exchanges it with newly created Yuan. This is equivalent to printing money. The Central Bank thus supplies more Yuan in the market. The Central Bank constantly prints new currency and uses it to buy U.S. dollars and U.S. government debt, thereby flooding the market with Chinese currency and increasing demand for American dollar. This way the supply of Yuan would be more than its demand and would result in lower prices of Yuan. On the other hand, the demand for dollar would be more than its supply and would result in an inflated dollar value.

Proof of China’s Currency Manipulation

We can observe it from the Figure 1 that from 2005-14, China’s export has grown by more than 300% which is 30% growth annually (on average). The monetary value of exports from 2005-14 has grown from $500 billion to $2.3 trillion. But in the same decade yuan depreciated by only 25%, i.e. from 8.26 CNY to 6.37 CNY for a unit dollar.

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How is it possible?

It is only possible by manipulating the currency. In the same decade, the Central Bank has increased its Forex Reserve by more than 600% i.e. from $500 billion to $3.7 trillion (Figure 3). This is a clear sign of manipulating yuan by buying more dollars and supplying more Yuan. Figure 4 clearly indicates the increased money supply of Yuan, which is more than 700% in the same decade.

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Why is China Devaluing its Currency?

The question which everybody is asking: why did the Chinese government devalue its currency in 2015? The answer is an interplay of many reasons. First, the global economic slowdown in US and Eurozone: The U.S. is slowly recovering from the global financial crisis of 2007-08, but the Eurozone is still in the vicious circle of recession. The export of Chinese goods has reduced due to low demand in US and Eurozone. Inflation in the second quarter of 2015 remained at 2% in the U.S., and abysmally low at 0.2% in Eurozone.

Second, the declining growth rate in China: It also resulted in this devaluation. China has realized that the currency manipulation is not yielding benefits as it did five years back. The exports are declining, which is also resulting in lower demand in the domestic market.

Third, the adoption of quantitative easing by Eurozone: Since the adoption of QE in March 2015, Euro has drastically depreciated against dollar. Now, Chinese government is worried that if this depreciation continues, then their goods would be less desirable in the Eurozone.

At the same time, Japanese government also adopted QE, which resulted in depreciation of yen. The fear of losing this competitive advantage over other countries has forced China to get into this currency war.

Impact on Chinese economy

The recent devaluation resulted in a crash of the Chinese stock markets. Despite the massive stimulus the government unleashed to prop them up the situation remains unchanged. The Shanghai index has fallen by nearly 40% from its mid-June peak. So is this the hour of China’s crisis? Not so likely. Stocks and economic fundamentals have little in common. When share prices nearly tripled in the year till June, it was not a sign of stunning improvement for Chinese growth prospects. China’s growth has been slow for a while but their stock market kept rising.

Furthermore, the property market of China is far larger than the equity market. Housing land accounts for a major chunk of the financial system and thus plays a much bigger role in spurring growth. House prices have risen up nationwide but this crisis has stopped overvaluing the property market. This stabilization has reduced the risk of property market crash – an event equivalent to that of a stock market crash in America.

Conclusion

This is not the first time that any country has devalued its currency. In 2010, the Japanese government moved to depress the value of yen. South Korea also has a habit of intervening in the valuation of its currency. Switzerland pegged its franc to the euro in the beginning of 2011. But a lesson that these countries have not learnt is that the fluctuation in currencies have global impacts.

Earlier this year, when Swiss Central Bank had unpegged their currency, the currency rose from pegged level of 1.12 Euro to 0.82 Euro in just one day. This is the highest appreciation of a currency in the history of the financial world in one day. The corresponding impact was that the Swiss market went down by 12% the same day. Many big hedge funds went bankrupt. And now, when China has devalued its currency, again, there is a market crash. This market crash is far bigger than the Swiss market crash. It eroded nearly $1 trillion of wealth in just one day.

China has always used these unfair practices just to get ahead in the world. But now, it should realize that this world is interconnected, and any volatility would cause global crisis. When China last devalued its currency in 1994, there was a financial crisis in Asian economies just after 3 years. Now again, we are at the verge of another financial crisis as the RBI governor, Raghuram Rajan, predicts. And its consequences would be far more fatal than 2007-08 global financial crisis.

References:


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About the author:

The author is a Banking and Financial Service student at TAPMI. His area of interest is mainly economics, banking, and risk management. He is on the editorial board of TJEF and also the member of Literary and Media Committee of TAPMI. You can contact him at nayan.bkfs17@tapmi.edu.in