The rising tendency of protectionism across the world, especially involving the G20 countries (together account for ~84 per cent of world GDP and 79 per cent of world trade) is incongruous in the backdrop of the recent cyclical recovery in the global economy and trade, led especially by major economies like the U S and Europe.
Concerns about global trade hostilities getting prolonged have escalated lately in the context of the recent measures taken by the US. The Donald Trump administration has imposed tariff hikes on Steel and aluminium, triggering retaliatory actions by China, besides also kicking off renegotiations over NAFTA.
Backtracking from trade liberalisation in not new. While the US is leading on trade protectionist actions, there is abundant evidence that it is pervasive across many countries. Global Trade Alert (GTA) data reveals a significant reversal in trade liberalisation since the global financial crisis 2008, and especially since 2011.
Since 2008 countries topping the list of trade protectionism are the US (initiating over 1200 measures), India (~730), Russia (~610) and Argentina (~480). Also, the UK and Germany figure in top seven. G7 + Australia have contributed ~50 per cent to the global trade protectionist measures undertaken by G20 economies.
The number of anti-dumping initiations rose to a high of 360 in 2017, nearly double the count seen in 2011. The number of regional trade agreements, which saw a continuous rise post the Asian financial crisis in 1997-89 to a peak of 34 in 2008, declined sharply to a modest 8-9 in 2017.
Importantly, the major chunk of protectionist measures comprises not tariff measures. Over 60 per cent of the G20 restrictive measures are in the form of export measures, mostly tax-based, followed by trade finance, import tariffs, subsidies (17 per cent, including export subsidies) etc.
Indications are that the US administration could get even more aggressive in 2018, initiating tariff measures to provide a beneficial backdrop for the US companies in both, domestic and global markets. The US slogan of “free but fair” trade resonates with its protectionist stance of the 1980s.
Dissection of recent trade protectionist measures in terms of sectors reveals that most of them are aimed at metals (especially products of iron & steel). Also, China is bearing the brunt of such actions, with the US implementing most of these measures. However, with the high frequency of G20 countries taking harmful trade actions impacting fellow members is sufficient evidence to suggest dissipating commitment to shun protectionism.
There has been increasing pressure on India also to cut tariffs and dilute export incentives. Notwithstanding the reduction in average import tariffs for the most favoured nation (MFN) category to 8 per cent, there has been a steady increase from the 20-year low of 6.8 per cent in 2010 and it ranks very high against the developed countries; the US is at 1.8 per cent effective rate and an average rate of 3.2 per cent.
The big picture is that rising protectionism could be a prolonged battle. The structural catalyst behind the growing support to protectionism is the attempt by developed economies, let by the US, to reverse the shift of economic power from the advanced nations to the developing economies, especially emerging Asia.
The short-term manifestation can be seen in the rising skepticism about the benefits of trade, especially in the advanced economies. This theme formed the bulwark of President Trumps election campaign, which espoused the thesis that trade protections will lead to greater domestic prosperity.
While the liberalisation of trade barriers over the past 70 years resulted in considerable opening of global trade, the initial phase benefitted only the advanced economies. Exports/GDP for the advanced economies increased from 60 per cent in 1950 to 75 per cent by mid-1970, indicating that the advanced economies were the early gainers of trade liberalisation.
However, during the 1990s and the subsequent decade, the equilibrium shifted considerably towards the developing markets, with their contribution to external trade and global economic growth rising sharply.
The share of developing Asian economies in global exports increased to 21 per cent by 1999 from 15 per cent in late 1980s. It ascended even further to 37 per cent by 2013.
The share of GDP coming from developing Asia has doubled to 29 per cent by 2017 from 2003; for the advanced economies, it has declined precipitously to 58 per cent from a steady level of 76-78 per cent during 1990-2004.
The US, which has been aggressively moving towards protectionism since GFC, has seen its contribution to global exports decline from 12 per cent in 2001 to 8 per cent in 2013. The share of the US GDP to global GDP has also declined from 32 per cent in 2002 to 22 per cent in 2014.
Indeed, since GFC, the trade limiting policies implemented by G20 countries have quadrupled, resulting in stagnant global trade volume following a quick recovery from the initial shock from GFC. The narrowing growth differential of EMs vis-à-vis the global economy is symptomatic of the de-globalisation trend that is already underway.
The rising trend of protectionism is an extension of growing US concerns about global economic imbalance since 2006 and the intense pressure on China to abandon the currency peg. The undervalued yuan was seen to be aimed at enabling Chinese manufacturers to feed on the US demand, resulting in a widening US external deficit. While the US current account deficit (CAD) has declined from 6.5 per cent to 2.2 per cent in 2013, the recent cyclical growth revival has resulted in some retraction to 3.4 per cent in 2017.
In comparison, Chinas current account surplus has declined from a high of 9 per cent in 2007 to 1.5 per cent in 2017. But, with China spreading its base of manufacturing across the world, reflected in the consistent rise in outward Chinese FDI, the decline in Chinese trade surplus and current account surplus is seen as deceptive.
Empirical experience from the 1970s and 1980s indicates that the inflection point for a complete global rebalancing was achieved in 1992-93, following ~10-13 years of adjustments and protective dispensations in the advanced economies, led by the US. At the inflection point in 1992, the trade in the advanced economies was completely balanced. On the other hand the trade surplus of the developing economies declined from a high of 4 per cent of GDP in 1979 to a deficit of 1.5 per cent in 1992.
In the current context, the global rebalancing still incomplete and the inflexion point is yet to be reached.
Unlike the other phases of slow growth when global trade protectionism rises, the post GFC recovery looks fairly tentative. Importantly, while the US economy is seen by the Federal Reserve to be on a solid footing with an improving job market, compensation growth, strong consumption & investment demand, it appears to be mainly dependent on monetary as well as fiscal support. Also, the fiscal burden remains high, with total public debt/GDP at 104 per cent in 2017 – almost double the level it was prior to GFC at 60-62 per cent. Hence, the counter-cyclical buffer in major economies to fend off another economic crisis is inadequate. It therefore appears that the US is also trying to ring-fence its current growth recovery.
For India, further tightening in the global trade policy, slower growth in trade volume and decline in growth elasticity with respect to global trade are emerging as major challenges. The second and third order effects of resurgence in external trade through its multiplier effects on savings, investments, productivity, corporate performance, banking sector and employment generation make India highly dependent on a conducive global trade environment.
Decline in trade openness has seen India responding with protectionism coupled with inward-looking policies, including increasing role of government in driving demand, supporting farm & rural sectors, job creation, housing for all and prioritising MSME lending for public sector banks (PSBs). This trend is expected to continue. Hence, it will also imply higher fiscal commitment.
Generally speaking, every 100bps decline in trade openness will lead to 100-120bps drop in sales growth of Indian companies. While trade openness benefits Indian companies, reduction in import tariff hurts them on the demand front because of competition from imports. Hence, increase in tariff rate can lead to improvement in the performance of select sectors.
Earnings performance of Indian companies will depend on the strength of demand impetus from higher government spending, relative to rising cost of inputs in a trade protectionist environment.
Our estimates indicate that an environment of restrictive global trade has an adverse impact on profit growth of Indian companies. Higher import tariffs can have a negative impact on earnings, by increasing the cost of inputs. Every 100bps decline in trade openness leads to 200bps impact on earnings growth and 100bps increase in average import duty can compress it by 130bps.
The impact of higher government spending is less significant and contrastingly it is negative. This is probably because of its counter-cyclical nature; higher spending is initiated during slowdown and vice versa. Alternately, higher public spending is also associated with higher tax on profits
From the equity markets standpoint, the contrasting combination of accommodative monetary and restrictive trade policy of advanced economies (AEs) since 2008, led by the US, possibly fuelled the paradox of declining earnings growth and all-time high equity market valuations. While the strengthening growth in the US and advanced economies has a positive implication for emerging market equities, a steeper rise in US inflation, hastened by trade protectionism, can prompt faster-than-anticipated normalisation of Feds monetary policy, thereby tightening financial market conditions for emerging markets.