Think Beyond Brexit

Steven Philip Warner | May 2016 Issue | The Dollar Business

The midlife crisis for Britain seems to be over. Temporarily perhaps. All doubts have now been put to rest with a small difference in opinion of the general Brit population. Ironical that a nation that for centuries had held many other nations chained to hoisting their flag should get a peaceful voting system within their border to decide on whether they break free from a ‘designed to fail chastity belt’ called EU. [How else would you describe an integration of 28 nations with financial but no fiscal integration?] For months, debates over whether the Brits would defy bipartisan opposition to Brexit (British exit from EU) were doing the rounds. So much that even current and former Presidential candidates of US were caught getting vocally liberal with their views on the dos and don’ts for the British populace when it came to the referendum on the single-largest geo-political question that has stared at Westminster for decades. And with UK walking out of EU and David Cameroon 'officially' out of 10 Downing Street on June 23, history was made. To a great extent. But UK’s departure from one of the least envied institutions of Western solidarity today hardly has the dust surrounding this macroeconomic heavyweight of a political-economic debate settled.

Truth is, the UK territories in recent years were living in grudging compromise with the eurozone. That being the case, by construct or complacence, EU playing the jacket of comfort – in geopolitics and foreign trade – for the Brits, had become a necessary evil. How much will the Brexit impact world politics and trade? That’s a question many in the policymaking and foreign trade circles ask today. Many fear that the Brexit will cause an erosion in value of the pound and euro, which in turn will push the dollar northwards and endanger America’s exports. Could be. The other question is clearly more political. With UK walking out of EU, similar demands may be tabled across nations like the Netherlands, France and Germany, where elections are happening next year. And if the EU starts disintegrating geographically, what will happen to the yet-not-improved Greek crisis, refugee issue, instability in Eastern Europe, etc.?

As for India, I think the impact will be mixed. While on the one hand, UK walking out of EU could mean that the two nations (India and UK) would now have an independent chance to create closer trade and political ties, on the other, it could be unsettling for hundreds of Indian companies who have operations in UK primarily to use it as a gateway to Europe. Talking of currency volatility, fears persist that given India’s substantial trading corridors with both UK and EU, if considerable depreciation occurs in both the pound and euro following the Brexit, India’s exports to the region could witness a bigger fall in 2016. At the same time however, an appreciated dollar could mean a more pleasant experience for India when it comes to exports. There are a few concerns like capital flight (my guess is that capital will be shifted to near-dated US Treasuries in the short term and long term futures of select commodities or other dollar assets in the mid-to-long term), potential alterations in import guidelines that UK may impose on some products (that means Indian exporters will have to possibly create separate products for the two markets of UK and EU), fall in inward FDI (UK is the third largest source of FDI for India), etc., but the bigger truth is, what results from Brexit does not really bother India’s export community as a matter of great urgency.

In time, other nations may walk down the path that Greece avoided and Britain didn’t in the past year, but speculation on all such matters for India’s foreign trade community will end up as “time will tell” moments-in-the-making. And to talk of the present and clear uncertainty to our exporters, I assume that our policymakers in the process of concentrating too hard on one nation, may have missed an entire continent.
Imagine the world map with India placed right in the centre of the part of the sphere visible to you. Sitting where you do, Africa seems to be separated from India by just a tiny lake. That’s perception. In reality, that small patch of blue is a combination of two water bodies, a stretch of about 2,400 nautical miles (4450 km – as the crow flies). That’s reality.

And that’s where we’re headed in our discussion of present and clear uncertainty to our exporters. Looks like the Dark Continent just got a shade darker.

Africa – its rising commercial defaults has already started taking a significant toll on India’s exporters. Cash crunch due to falling commodity prices – especially oil – and tumbling currencies have resulted in many markets shutting down as potential export destinations for India. In combination, these two factors have led to non-payment or delayed payments for shipments from India, with exports across sectors like auto & auto components, pharmaceuticals, capital goods, electrical and electronic equipment, etc., being the most affected. Heads across a few of India’s Export Promotion Councils and other industry associations have also been quite frank about this matter – and their expressions make me believe that, in general, the African continent as a whole is undergoing a crisis of “trust”. The past half-a-year has perhaps been the worst in this matter after those years that saw civil wars barrelling through its lands.

At present, complaints of non-payment are flowing in from Nigeria, Libya, Egypt, Angola, Ethiopia, Sudan, Ghana, Angola, Zimbabwe, Algeria, Kenya and South Africa. What’s shocking, eight of these eleven names are amongst Africa’s ten largest nations by GDP!
Surprisingly, some of these names were until recently being cited as the most trusted of destinations for Indian exports, rather, an antidote to India’s falling exports to many First World economies. Now, exporters have to be more careful about shipping their goods to them in the short term. That would be wise.

How real and present the payment default trouble is for Indian exporters is also depicted by the manner in which some nations in Africa have blocked the repatriation of airline profits outside the country. As per IATA, Nigeria – the posterboy of Africa – has for 7 months held back $591 million of foreign airline funds, Sudan $360 million for 4 months, Egypt $291 million for 4 months and Angola $237 million for 7 months. “Blocked funds are a problem in a diverse group of countries [in Africa], some of them undergoing significant economic challenges particularly with a fall-off in oil revenues. Repatriation issues arose in the second half of 2015 when demand for foreign currency in the country [Nigeria] outpaced supply and the country’s banks were not able to service currency repatriations,” states IATA. [Two foreign carriers – United Airlines and Iberia have already announced their exit from Nigeria citing uncertainties and financial challenges.] So beyond how much has been blocked, here is the most important line – that these funds have been blocked for First World powers proves that the ongoing trouble will not spare Indian exporters as well!

Quite frankly, an assessment of conditions in a region’s largest and most talked about nation is an indicator of the prevailing state of affairs in neighbouring states. And that ironically is more true if the leading nation is in a rough patch. We’re talking about Nigeria here – Africa’s largest crude producer and exporter. Falling crude prices have taken a toll on this nation and it is now very near a recession. Its GDP contracted 13.7% in the first quarter of 2016 over the previous quarter. Nigeria has two big problems which are leading to bigger problems. First, oil is currently finding it hard to stay comfortably above the $45-50 a barrel mark; often moving southwards – a situation expected to prevail until late 2017 or even 2018. And Nigeria needs oil prices to remain in the $80-plus levels for fiscal breakeven. Second, spoiling the half-lost battle are supply disruptions in the Niger Delta; crude production in May was the lowest in over ten years! Bad times for a commodity that accounts for over 70% of the government’s revenues and about 91% of its total merchandise exports don’t translate into happy times for Nigeria.

Let’s take a quick look at other popular nations in the African continent that are undergoing hard times.

Zimbabwe. Forget being able to pay foreign exporters for imports, they’re finding it hard to withdraw US dollars from their own banks for local consumption. Now, its government is preparing to launch dollar-equivalent bond notes (in denominations of $2, $5, $10 and $20) if the currency crunch doesn’t improve. Which it will not and the bond notes currently being designed will hit the market soon. So here’s a rather ridiculous fact that proves the lack of funds amongst Zimbabwean government and public. The country’s government-run Parks and Wildlife Management Authority made an appeal last month to its public "with the capacity to acquire and manage wildlife" to come forward and adopt its animals, which include elephants, lions, rhinos, leopards and buffaloes. Perhaps they should export them in lieu of the dues they owe to Indian exporters.

Egypt. The continent’s second largest economy is fighting equally hard to sustain in an environment characterised by a shortage of US dollars. Despite frequent government controls on withdrawals of USDs in recent months and interventions in the form of strict currency and trade controls (from import restrictions to higher tariffs), Egyptian importers are today struggling to access hard currency to pay for their purchases. In fact, early this year, Egypt’s central bank was forced to inject over $14 billion dollars into local banks to facilitate import activity. Despite such measures, the nation has been experiencing an acute dollar shortage that has handicapped importers and limited manufacturing activity. It is important to note here that the 2011 Arab Spring movement struck lethal blows to inward FDI and count of foreign tourists in Egypt (two obviously big sources of USDs for Egypt for years). Apparently, importers have now started tapping into the black market where large amounts of USDs are more readily available. Continued fall in tourism, low oil prices, overvalued local currency and unwanted capital controls have hit Egypt’s export revenues hard. And where imports continue to rise, the mismatch is bound to create a smaller-by-the-day dollar reserves [which is today half of what it was during the pre-Arab Spring days] that makes for an inefficient system of coughing-up of USDs to pay foreign sellers!

South Africa – the third-largest in Africa by GDP – is currently in a political, financial and structural mess. Lack of political leadership after Mandela, reliance on commodity exports, habit of being a net borrower of capital, poor manufacturing numbers, poor infrastructure and a weak economy that is growing weaker under a weak political leadership, etc. – the nation is fast turning into a welfare state.

A review of most countries in the African continent reveals similarities to the above four nations. And of all the ongoing events that matter to a foreign exporter, the eventual inability of their banks to tender payments is what Indian exporters have to consider until the situation improves.

Commercial payment (between buyers and the sellers) defaults is therefore a big problem with the African market at present. Oil prices and falling dollar piles in their financial systems have led to their currencies losing charm to the extent of almost 25-50% in the past 18 months. So be it Nigeria or Egypt, South Africa or Sudan, Algeria or Morocco – they’ve all been significantly roughed up by forex volatility. When the currency depreciates so swiftly and deeply, it becomes very difficult for their importers and India's exporters. This also puts tremendous pressure on commodity prices.
That was Africa.
A similar situation may be brewing in Latin America, where Venezuela, which is India’s largest trading partner in the region, has already turned out a big defaulter when it comes to paying millions of dollars to merchandise and services exporters from around the world. What else can you expect from a country that has a currency that’s lost half its value in a matter of five months and is battling monthly inflation levels that are now closing in on 200%! [Imagine having to cough up Rs.250 for a loaf of bread that you could have afforded for just Rs.50 a month ago!] Unlike in Africa, the problem with Venezuela is more at the sovereign level and less at the commercial (buyer-seller) level. [The nation is the number one defaulter for blocking repatriation of funds of foreign airlines on IATA’s list (total blocked sum equals $3.8 billion!).] Amongst Indian exporters, apparently those in the pharmaceutical business have been hit the hardest. [Expected as bulk drugs and formulations account for almost 60% of India’s exports to the country.] Brazil, Argentina, Mexico… given the political, financial and inflationary situation across these markets, they may be the next Latinos on the list of defaulters.  

The government is currently working to negotiate barter deals with some countries. For example, with Venezuela, the oil-for-drugs deal has been proposed by India. Similar arrangement can be thought of to protect interests of exporters to other nations, especially in Africa, where the problem is more pronounced, and of a nature where government intervention can get complicated. But the bigger question is – what about defaults that will occur in the future? There are export insurance tools available, but in a market like India, where SMEs contribute to 40% of exports directly and a larger proportion indirectly, total knowledge and wholehearted acceptability of such insurance products are things of the far future. So what does the government do?

As a first step, the Ministry of External Affairs is discussing the possibility of opening escrow accounts with countries in Africa. The first rights on proceeds for payment of oil and other import dues in the said account will be given to distressed Indian exporters. So how will that actually work? Under the proposed payment mechanism, when Indian importers pay for oil and other imports from Nigeria, a substantial pie of the amount (say 20-40%) will be kept aside by an Indian PSB in Nigeria. So if SBI Delhi has to transfer $500 million to its account in SBI Nigeria to be paid in lieu of imported crude oil, it will put aside $100 million converted in Indian rupees in SBI Nigeria’s account in SBI Delhi. Once the Nigerian importer has confirmed receipt of goods, he can instruct his Nigerian bank to release the payment in favour of the Indian exporter, who will thereafter get paid via the SBI Nigeria-SBI Delhi route. The final debit of course will be made from SBI Nigeria’s account in SBI Delhi. The arrangement sounds safe. But it’s hardly fool-proof. And it’s easier said than done. If the other parties (i.e. African nations) agree to that, it will mean that the importing countries that were earlier getting 100% payments in dollars will get less dollars. This happened very successfully in case of Iran in the past [because then, Iran's foreign trade and banking industry was handicapped due to sanctions]. But the case with Africa is different. Hard to believe that their governments will agree to this arrangement, which will further restrict flow of the dollars into their country at the initial stage of arrangement and put more pressure on their currency. A stalemate looks likely.

Talking of a fool-proof plan, can there actually be any if the importing nation itself is facing a dollar crunch for whatever reasons and its banks are unable to process payments to exporters overseas?

Precisely the reason why it is most important for Indian exporters to measure and weigh the right focus markets (which also means avoiding troubled exports markets to the extent that they can) and deal only with ‘verified’ buyers before they take the big leap. Today it’s the African nations in trouble (and Latin American to an extent). Tomorrow it could be other OPEC and non-OPEC nations outside these regions, and possibly even those from East and West Europe.

Look before you leap. That’s a lesson taught in school. And it applies well to foreign trade.