Outlook 2015

A small increase in World trade in 2015 | World trade grew at around 1.2% during 2014. This is still a forecast but is based on the actual data from the International Monetary Fund for the first three quarters of 2014 and the Delta Economics forecast for Q4 2014. The Delta Economics forecast aligns with the CPB Netherlands Bureau Trade Monitor for the first three quarters of 2014 but is divergent from the IMF and WTO’s trade forecast for 2014 by some margin (Figure 1).

Delta Economics is predicting that World trade will grow in value terms slightly during 2015 from 1.2% to just below 2% by the end of 2015. Because this is a forecast in constant values, it represents likely increases in World trade volumes during the course of the year.

Care should be taken in interpreting this growth, however. While it is the first forecast of slightly faster growth that we have made since 2011, it is still too slow to suggest that there is any major resurgence of trade as a driver of economic growth or, indeed, a return to the multiples of trade growth versus GDP that was evident in the immediate aftermath of the financial crisis.

 

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Figure 1  | Delta Economics, WTO forecasts versus actual trade growth, 2011-14
Source | Delta Economics, WTO and CPB Netherlands Bureau 2011-14

 

The growth in 2015 will be led by two regions, Asia and North America (Figure 2). Asia’s growth, to a large extent will be driven by:

  • China’s recovery from slow trade growth (at just 4%) in 2014 to above 7% in 2015, although this is still a long way below post-crisis peaks
  • Re-distribution of trade around the region away from China, we expect particularly rapid trade growth in Indonesia and Malaysia at over 10% and 7% respectively in 2015

North America’s growth is driven by exports which, following a sustained period of re-shoring, are forecast to grow by nearly 4.5% in 2015.

However, every other region’s trade is forecast to decline or grow at a slower rate in 2015 with Europe’s trade set to shrink in current prices by 3.5%. Much of this is due to declining intra-European trade: trade within the Eurozone is forecast to drop by 3.7% this year reflecting weak demand conditions within the Eurozone.

 

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Figure 2  | World and regional trade growth (% constant prices), 2014 and 2015 compared
Source | DeltaMetrics 2014

 

Disinflation, oil prices and the risks of contagion | MENA’s trade is forecast to drop to 1.9% in 2015 from an already disappointing 3.6% growth in 2014. At the beginning of 2014 the Delta Economics forecast was for above 4% growth. On paper at least, oil producing nations are net losers in export terms as the oil price drops while oil importers are net winners in that it reduces costs for producers and exporters.

A zero-sum game in trade terms as the oil price drops is over-simplistic, however. Trade and oil are 94% correlated. This means that trade can effectively be a mechanism through which disinflation is spread through the global economic system. Emerging markets are the largest oil producers and, as they lose export revenues, their aggregate demand falls back meaning that they demand less by way of imports from other countries. Lower oil prices reduce producer costs, but if there is little demand either within or outside of a region then export prices will also have to drop.

Against this backdrop the forecast for World trade becomes important as a predictor of when we might see oil prices increasing again (Figure 3).

The monthly predictions of trade growth suggest that there will not be any major pick-up in the oil price until the end of Q1 2015. Even then, any increase will be erratic and relatively small based on how we are predicting global trade will grow.

 

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Figure 3  | Monthly value of World trade vs. NYSE Arca oil spot, Last Price Monthly, June 2001-Nov 2011
Source | DeltaMetrics 2014, Bloomberg

 

Geopolitics, geoeconomics and “febrile stability” | 2014 was dominated by geo-political and geo-economic risks from the outset: starting with the Emerging Markets in January, Russia and Ukraine in late February, the Iraq crisis in June 2014 and subsequent crises in August to the end of tapering, with China and Japan’s economic slowdowns at the end of the year. Until the major fall in oil prices at the end of 2014, markets appeared to be pricing these in. Equity markets continue their bull run with the role of central banks increasingly seeming to be to provide reassurance to markets that nothing precipitous is likely to happen to interest rates in the immediate future.

This creates what Delta Economics terms, “febrile stability”: markets are behaving as if there are no underlying geo-political or geo-economic concerns, yet watching for one incident that will trigger a major sell-off.

The case of Germany’s car trade with China and Russia illustrates the interplay between geo-politics and geo-economics and its dampening effect on trade (Figure 4). The DAX is 86% correlated with Germany’s trade overall, 73% correlated with its car trade to China and 84% correlated with its car trade to Russia. Figure 4 shows:

  • German car exports to China are forecast to grow during 2015 but it will not be until the end of Q2 that exports really pick up again, this suggests that China’s demand for luxury goods, while growing, is not growing at the pace that might be expected
  • German car exports to Russia are forecast to slow during 2015 and have dropped substantially since the beginning of the Russia-Ukraine crisis, this is partly a reflection of Russia’s weakening economy but in the first instance was the result of punitive reciprocal trade restrictions

The tipping point in 2015 is likely to be an increase in interest rates in the USA. If this is early in 2015 while oil prices are still falling, this will further strengthen the US Dollar, reducing further the export revenues for emerging economies in particular and placing at risk of default any sovereign debt or bonds denominated in US Dollars. As Russia, Argentina and Venezuela are close to default this could be the catalyst that sparks a global correction.

 

 

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Figure 4  | Monthly value of German car exports to Russia and China, USDm vs. DAX, Last Price Monthly (June 2001-Dec 2015)
Source | DeltaMetrics 2014, Bloomberg

Global equity markets long overdue a correction | Delta Economics modelling continues to suggest that equity markets are long overdue a correction. The correlation between World trade and the S&P 500 has weakened from 68% in January to 62% now and this reflects its long bull run that has extended to the end of 2014. It has become increasingly detached from real macroeconomic indicators and increasingly determined by central bank monetary policy and short-term sentiment indicators.

Delta Economics considers the bull run to be unsustainable given the pressures of disinflationary contagion and geo-political and geo-economic risk that spread through the global trade system. Economies do not operate in isolation in the same way as they did pre-crisis and a hike in interest rates in one country, particularly the USA, will impact others through trade and debt dependencies. Against this fragile backdrop, it is likely that a major correction in asset prices will take place during 2015.

 

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Figure 5  | Monthly value of World trade (USDbn) vs. S&P 500, Last Price Monthly, June 2001-Dec 2015
Source | DeltaMetrics 2014, Bloomberg

Outlook 2015: a small increase in World trade in 2015  |  Trade View Author  |  Rebecca Harding  |  CEO

Webcast 016 | Whisky and aspirin: is this the future of Europe?

In light of Delta Economics negative forecast for European growth, CEO Rebecca Harding and OMFIF Founder David Marsh explore the reasons behind the slowing in trade and how it is affected by, amongst other things, the recent slowing in Asian markets and uncompetitiveness. The discussion also examines the internal imbalances in the European economy, with particular emphasis on Germany and also looks at some of the fundamental differences between countries such as Greece and Spain with a view to understanding differences in trade growth patterns. This webcast also discusses the relatively positive trade growth in European periphery economies as well as they challenges they will face in the short and longer term.

 

Webcast 016 Author  |  Rebecca Harding  |  CEO

The invisible hand

Why Argentina needs free trade more than ever  |  There is little doubt that Argentina needs a miracle, or at least a helping hand. No, this is not another reference to football: just a simple statement of fact.

It has until the 30th July to find USD 1.3bn in order to avoid default. Argentina’s trade performance has suffered as a result of poor economic and trade tariff management since 2011. Trade declined in 2012 by over 4% and while it grew in 2013 and is expected to return to growth of around 7% this year, this will only take it back to the levels of exports last seen in the middle of 2011. Policy makers have focused instead on attracting inward investment to develop the large shale gas reserves, taking their eye of the trade ball. Yet even this policy has stalled: Delta Economics is forecasting that Foreign Direct Investment levels will increase in 2014 but this will again only take them just above the 2011 levels. Put simply: if Argentina is to stave off the permanent threat of default and encourage enduring FDI, it will have to bring the invisible hand back into its trade markets.

At first glance, it does not appear that trade matters unduly to the Argentinian economy. It still runs a trade surplus, although not as substantial as it was and this is reflected in its positive terms of trade (the value of exports in relation to the price of imports). Yet there appears to be very little correlation (-0.37) between its terms of trade and the value of the Argentinian Peso (ARS), as illustrated in Figure 1.

 

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Figure 1  |  Argentina’s terms of trade vs ARS per USD, Last Price Monthly, June 2001-June 2014

Source  |  DeltaMetrics 2014, Bloomberg

 

This matters in so far as countries with high correlations between trade and their currency values are less prone to speculative attacks on their currency. The Peso has weakened by around 50% since the financial crisis: the last time the deterioration in its value was as substantial, Argentina was gripped by its last sovereign debt crisis. While the decline in value has been over a longer period of time, it does suggest that traders are speculating against Argentina being able to re-pay its debt.

If this is the case, then it is more than worrying. Argentina needs to default on its debt a bit like its football team needs the Netherlands to score 2 goals in the first fifteen minutes of the game on Wednesday. If it defaults, then it will find it very difficult to raise the external capital/inward investment that it needs to begin the process of extracting shale gas. But as Figure 2 shows, Argentina is no longer a net exporter of oil and gas, so, in order to restore its self-sufficiency urgently needs this inward investment.

 

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Figure 2  |  Value of Argentina’s oil and gas trade (USDm) versus ARS per USD, Last Price Monthly, June 2001-June 2014

Source  |  DeltaMetrics 2014, Bloomberg

 

The Peso is barely correlated with oil and gas exports (-0.42), although it is correlated with its imports (0.72) suggesting that as the currency weakens (values are in Peso per USD), it is more likely to import oil which is worrying because it suggests that oil imports are plugging a structural weakness in Argentina rather than a response to imported oil being proportionately cheaper. And as the correlation with exports is so weak, it reinforces the view that the currency is more closely correlated with its economic condition than with its trade position.

So what is the scale of the challenge ahead? What does the Argentinian government need to do if it is indeed to create substantial economic growth through the inward-investment associated with shale gas production? Figure 3 presents the specific six-digit subsectors within natural gas that represent shale.

 

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Figure 3  |  Value of Argentina’s natural gas imports and exports (USDm), 2001-2026 (forecast)

Source  |  DeltaMetrics 2014

 

Other things being equal, that is, if inward investment continues at the pace we are currently seeing it and if policy and the economic climate remain unchanged, then the picture is not rosy for Argentina’s shale gas revolution. Our model suggests that imports are already outstripping exports and that trend will continue to grow over time. The chance of a trade surplus is remote, as is the chance of self-sufficiency in gas.

It is not the intention to enter a debate on shale in Argentina, still less to suggest that this is the only way out of the current crisis. Instead, just take a look at where policy really can have an influence: trade. Argentina’s openness, in other words its trade as a proportion of GDP has grown from just under 30% in 2001 to over 60% now. The economy is more dependent on trade as a result since it is so important in relation to GDP.

Yet oil and gas is not the sector, arguably, where it should be focusing in the short term. There are two reasons for this. First, the normalised revealed comparative advantage of oil and gas has deteriorated from a position where it was competitive in 2001 (0.39) to a position where it is uncompetitive now (-0.51). We are expecting its position to deteriorate still further to -0.60 by 2020. In contrast, Automotives were uncompetitive in 2001 (-0.12) but are competitive now (0.32) and will be more so by 2020 (0.38).

Second, there appears to be a much stronger correlation between automotive trade and the value of the currency suggesting that some of the speculation may dissipate if the manufacturing side of the economy can be allowed to flourish as Figure 4 shows.

 

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Figure 4  |  Value of Argentina’s automotive exports overall and to Brazil (USDm) vs ARS per USD, June 2001-June 2014

Source  |  DeltaMetrics 2014, Bloomberg

 

If Argentina can grow its manufacturing sector then it stands a chance of creating real export-led growth, particularly if it focuses on the regional automotive supply chain to Brazil since the correlation between it and its currency is particularly high for that trade route. As the currency has weakened, this has strengthened the position of Argentina’s automotive sector in relation to Brazil and has provided a platform for growth.

This is where policy makers should focus to address the challenges of growth and currency stability in the long run and to provide a clear message to markets and arguably the US Supreme Court to stave off default in the short run. Trade suffered between 2001 and 2012 when tariffs were first imposed and Argentina can in no sense afford to make this mistake again. Free trade is as key – otherwise the “hand of God” may well start to look like an Argentina own goal.

 

 

Webcast 014 | Asia – is slower growth the new normal?

Delta Economics’ CEO, Rebecca Harding, and new Global Vice President, Tony Nash, discuss current opportunities in Asia and the risks facing Asian markets. In particular, there is focus on the high levels of indebtedness, dangers of deflation and the need for greater competitiveness. The discussion focuses on smaller emerging Asian economies like Myanmar and argues that even though growth is rapid, it is potentially still not enough to create ‘tiger’ like growth.

 

Webcast 014 Author  |  Rebecca Harding  |  CEO

Running out of energy

Why Europe needs Germany to sort out its energy policy  |  The last thing Europe needs right now is a crisis. With the ECB’s decision to take interest rates into negative territory last week, it rekindled the spectre of disinflation turning into deflation in the Eurozone. If this wasn’t enough, fears about Europe’s dependency on Russian oil as the crisis in Ukraine continues appeared to be abated slightly as Germany appeared to open up the potential for shale gas production and then shut it again saying that the exploratory work would stop well short of allowing fracking to resume.

This matters because Germany’s trade is 98% correlated with its imports of mineral fuels, including shale [Figure 1].

 

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Figure 1  |   USDm value of Germany total exports and its imports of mineral fuels June 2001-Dec 2014
Source  |  DeltaMetrics 2014

 

Germany is undeniable the export engine of Europe and its energy consumption (measured through imports) is so tightly related to the value of its exports that its energy policy becomes vital, not just to the country itself but also to the rest of Europe. Eight of Germany’s 17 reactors were closed after the Fukushima disaster and a commitment to close the remainder by 2022 was made, leaving Germany without a major source of internally generated energy and a need to rapidly find an alternative. In addition, much of Germany’s energy is produced in its own coal and lignite mines making it arguably increasingly dependent on one of the most polluting types of fossil fuel, despite its reputation for being at the leading edge of environmental technologies.

So are there signs in Germany’s trade that it is becoming either more green in terms of its energy production or consumption or that it is reducing its dependence on Russia for oil?

The short answer to this is not really as Figures 2a and 2b show.

 

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Figure 2a (top) and Figure 2b (bottom)  |
German imports or exports of mineral fuel products as a proportion of all mineral fuel imports or exports, 2014
Source  |  DeltaMetrics 2014

 

Although imports of crude oil are forecast to decline by 2014, imports of refined oil are set to increase by a similar amount. Imports of electrical energy, which is all energy produced from non fossil fuel sources and so includes nuclear and alternative sources of energy are forecast to increase slightly.

The picture for exports sheds some more light on why there is no real change in Germany’s energy consumption. Although imports of refined oil are set to increase, its exports are set to decrease suggesting that Germany will become more, not less, dependent on outside of its borders for refined oil. Even though exports of electrical energy are set to increase by nearly 3% between 2014 and 2020, suggesting greater production from non-nuclear and renewable sources, it is still insufficient to offset Germany’s greater demand for refined oil.

However, although the Netherlands is by far and away Germany’s largest import partner of refined oil, its oil comes from Belgium, the UK and Russia in almost equal proportions; Belgium gets its oil from the Netherlands, Russia and the UK. Figure 3 shows, the dependency of Germany on Russian oil is substantial.

 

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Figure 3  |  Running out of energy suppliers;
Why Germany is likely to be dependent on Russian oil for some time to come
Source  |  DeltaMetrics 2014

 

Countries like the UAE, Mexico, Angola and Iraq are all fast-growing suppliers of crude oil into Germany. However, adding up the total import values for each of the five fastest growing economies yields a total of USD 1.7 billion which is just one seventeenth of the total value of Russian imports of crude oil into Germany alone. More than this, Russian imports of both crude and refined oil are more highly correlated with German trade that imports from the UK, the Netherlands (refined) or Norway (crude). While oil imports from the UK are highly correlated with German trade, they are also forecast to remain static in the case of UK imports of refined oil and to fall by over 6% in the case of UK imports of crude oil.

There is still a long way to go; renewable energy alone will not reduce the dependency that Germany, and therefore Europe, has on Russia. Figure 4 shows how, despite a brief drop in imports into Germany during 2014, as a consequence of the current geopolitical uncertainty, Russia’s imports into Germany will continue to grow into 2015 and 2016 in current prices.

 

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Figure 4  |  USDm value of Germany’s crude oil imports from its top three import partners, June 2001-Dec 2015
Source  |  DeltaMetrics 2014

 

It is likely that the Netherlands will pick up the slack as imports drop from Russia during 2014 but as it is similarly reliant on Russian oil this simply shifts the fulcrum temporarily rather than generating a real change.

Over and above everything else this is important because Germany’s trade is 87% correlated with the value of the Euro against the dollar and 76% correlated with the value of the FTSE. Given the even higher correlation at the moment of Germany’s trade with oil, this renders the concerns over its energy security not just understandable but actually critical if Europe is to avoid an economic crisis caused by geo-political uncertainty.

This brings us back to the opening statement. What Europe needs least is another crisis. There is evidence of growth in demand and the Delta Economics forecast for trade, although flat, is a considerable improvement on the negative outlook of six months ago. Yet a closer examination of Figure 1 shows something worrying: in current prices, Germany’s trade growth is relatively flat too. In other words, the slow growth in value terms of trade over the past few years and into the next two years, is not just because of slow global demand conditions, especially in Asia. It is also because there is downward, disinflationary pressure on prices which is flattening the real value of trade as shown in Figure 5 which looks at German exports against gold prices.

 

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Figure 5  |  German exports, USDm value June 2001-May 2015 versus Gold Spot, Last Price Monthly, June 2001-May 2014
Source  |  DeltaMetrics 2014, Bloomberg

 

The correlation between German exports and the Gold Spot price is high at 0.79 (compared to 0.78 and 0.77 for the EU 28 and the Eurozone exports respectively). Gold is a hedge against deflation and we are beginning to see strong disinflationary tendencies if not deflation itself. At present that correlation remains positive because deflation has been on the horizon for a while, so markets are pricing it in at present.

However, if the Ukraine crisis deepens and Russian oil to Europe is shut off, then this will have a profound effect on German trade, pushing its real current value down and, hence, adding to deflationary tendencies. There is a real danger that the European recovery may be threatened by Germany’s trade, quite literally, running out of energy.

 

 

Be wary what you wish for

Why the anti-European protest movement is missing the point | As the dust settles from last week’s European Elections one thing will be quite clear: there is a real momentum behind anti-establishment and Euro-sceptic protest parties across the continent.  From the “Alternative für Deutschland” (AfD) party promoting Germany’s exit from the Euro, through the Front Nationale in France, to UKIP (UK Independence Party) advocating the UK’s exit from Europe altogether, the mistrust in established politicians is manifest.  Beyond the clear fact that voters are frustrated with national politicians, the core of Euro-sceptic sentiment is rooted in anger, indeed frustration, at the failure of Europe’s politicians to create economic security for its voters because of the tortured recovery from the financial and sovereign debt crisis, perceived threats to job security from immigration and a failure of European institutions more generally.

As Europe and the UK’s mainstream politicians start to re-calibrate their dialogue with the electorate about Europe, they would do well to focus on trade, not least because one of the two founding principles of the European Union was free trade between Member States.

Trade is central to understanding why European Union is important.  First, take the country with the most vocal advocates of European exit, the UK.  Trade with Europe was worth an estimated £301bn to the UK economy in 2013 and the Centre for European Reform (CER) estimates that some 30% of the UK’s total trade is reliant on membership with the EU.  Second, there are signs that economic conditions in Europe are improving: our forecast for European trade has risen from a negative forecast for 2014 three months ago to a flat growth forecast (-0.08%) now reflecting an improvement in underlying drivers of trade included in Delta’s model, including lower market volatility, improved GDP and greater migration which improves the downward pressure on trade of aging populations.

Europe remains a long way from sustained growth, still less rapid growth, but there are positive signs of internal rebalancing since Mario Draghi’s commitment to “do whatever it takes” to ensure that the Euro did not collapse.  But while Mr Draghi concentrated on the need for the ECB to shore up the Euro as required, the Delta Economics view is that Europe’s longer-term solutions lie in its international competitiveness represented through its external trade balance.  Figure 1 shows why we see this as the case.

 

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Figure 1 | The Value of EU 28 and Eurozone trade (USDm) versus the USD per Euro exchange rate, Lat Price Monthly, June 2001-April 2014

 

What is remarkable about the relationship between the value of Europe’s and the Eurozone’s exports and the USD-Euro currency spot price is the strength of the correlations: 0.86 NS 0.87 respectively.  In itself, this helps to explain why, even at the depth of the sovereign-debt crisis there was never a serious or sustained run on the Euro.  The currency is a trade currency and this means that it is less vulnerable to speculative volatility.

Similarly, European markets are also highly correlated with EU28 and Eurozone trade.  Taking the DAX as a proxy, the correlations are 0.76 and 0.75 respectively, as illustrated in Figure 2.

 

 

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Figure 2 | The value of EU 28 and Eurozone Exports (USDm), June 2001-Dec 2016 versus the DAX Last Price Monthly, June 2001-April 2014

 

Figure 2 shows a weaker correlation with the value of the Euro since mid 2011 for the Eurozone reflecting the sovereign debt crisis, the relationship between  EU 28 trade and the value of the Euro has remained strong, suggesting that the DAX reflects the economic fundamentals of trade to a greater extent than does, say, the FTSE 100.

Figure 3, which shows the relationship between the value of the UK’s exports to the EU and shows that, although the relationship is weaker (correlation of 0.69) the UK’s trade relationship with Europe is an important driver of market sentiment.

 

 

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Figure 3 | Value of UK exports to the EU (USDm), June 2001-Dec 2016 vs FTSE 100 Last Price Monthly, June 2001-April 2014

 

What all this suggests is that the value of the Euro and key European stock markets are highly linked with European trade generally and UK trade with Europe in particular.  The UK’s trade with Europe is even reasonably correlated with the value of the DAX at 0.64.  In other words, markets can use trade statistics as a proxy for underlying fundamentals and react accordingly. Indeed, unlike the S&P 500, which appears to have gone in the opposite direction to trade recently, European markets seem to reflect European trade quite closely.  The conclusion? That Euro-sceptic political parties do not need to worry as much as they thought about economic mismanagement if a focus on long term growth, competitiveness and trade can supersede the shorter-term focus on austerity and rebalancing over time.

During the course of the next year, however, Europe’s politicians need to worry about the consequences of a potential UK exit from Europe, following the proposed referendum should the Conservatives win the next election.  The debate will focus around the benefits to the UK of European membership and a cursory look at the correlations between the USD-Euro, Sterling-Euro and Sterling-Dollar spot prices confirms that the value that the UK extracts from its EU in currency terms is far less than the value that the EU gets from its trade with the UK.

 

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Figure 4 | Why Europe matters to the UK
Source | Delta Economics (Estimated proportion of trade dependant on EU – Centre for European Reform)

 

The correlations are much stronger between UK trade with Europe and the value of the Euro than they are for the value of Sterling, particularly against the Euro where the correlation is minimal.

This is hardly likely to have an impact on the average British voter, however, and, far from suggesting that the UK’s trade with Europe is valueless in currency terms, the fact that the correlations are weaker simply illustrates how the value of Sterling is more volatile in response to market sentiment rather than economic fundamentals.  Actually, as Figure 4 suggests, the value to the UK economy of trade with Europe is significant and, if the UK were to exit from the EU then the country would lose some £425bn, or over £6,000 per head of population in lost export trade value by 2022.

More than this: our forecasting model suggests that trade is highly correlated with skills, at some 0.98 across key countries in the European Union, the US and India.  In other words, across the developed and the emerging world, higher skills lead to more trade.  Here the UK has a gap with its European competitors: the skills component of trade is actually mildly negatively correlated with trade itself at -0.30 where it is 0.98 in other European countries.  In other words, the bulk of UK trade is currently not skills dependent and on the face of it may actually benefit from having lower skills (and hence lower costs) associated with it. Similarly innovation is only mildly positively correlated with UK trade at 0.35.

Two other countries with skills and innovation correlations like this are Brazil and China suggesting that the UK could easily lose out to lower cost nations if the bulk of its trade remains at this lower value end unless it can find cheaper ways of producing the same goods. Reports in May suggested that migration may actually have a positive effect on trade by reducing costs.

But there are two significant issues with assuming a low cost-low skill trade base for the UK is adequate. The first is one of principle: the UK should remain competitive at the higher value end of goods trade where innovation and skills are highly correlated with trade and where cost is less important. It is imperative that it increases the innovation component of its trade and recruits people with the skills to work in an innovative and international environment.  The second is one of practicality: if the UK is to find the people to take these roles, then it will have to compete with the rest of Europe as well as emerging economies like India which have high correlations of trade with skills and innovation. Accessing wider skills and innovative capacity through immigration is a central pillar of a strategy to build high-end competitive.  For example, Germany, having identified skills shortages in its productive and exporting base a decade or longer ago, now has its highest net-migration since 1993.

If Europe’s economy is improving, the benefits of trade to individual member states so great and the benefits of migration in skills and innovation terms so clear, Eurosceptics would do well to remember to be wary what they wish for.

 

A dose of its own medicine

Why India has a clear way of boosting its economy through exports  |  When Mr. Modi takes office on the 21st May, his first thoughts will almost certainly not turn to US pharmaceutical imports, but maybe they should. India has been plagued by a trade deficit since 2006 which is likely to grow in double digits this year and next. Alongside this, its terms of trade (the value of its exports in relation to the value of its imports) have deteriorated substantially and although its share of world trade increased to above 2.5% in 2013 and is forecast to reach 3% by 2015, this is as much because of increases in imports as it is about increases in exports. The Rupee’s value against the US Dollar has slipped by over a third in the three years since May 2011 when confidence in emerging markets generally and India in particular was so strong but if Mr. Modi is to address some of the broader challenges he faces, then it is the link between trade, real economy and key indicators such as the value of the Rupee that he needs to tackle first.

This will not be a simple job because, at the moment, the speculative element in Indian markets and the dominance of its trade by imports means that the correlation between the currency and exports is relatively weak at 0.50. The correlation is slightly stronger between its imports and the value of its currency at 0.53, as shown in Figure 1, which illustrates something unusual about the relationship: as the currency becomes weaker, imports drop.

 

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Figure 1  |  Indian imports (USDm value, June 2001-April 2015)
against Rupees per USD, Last Price Monthly, June 2001- April 2014
Source  |  DeltaMetrics 2014, Bloomberg

 

India imports predominantly crude oil, which, with an estimated value of USD 175bn in 2014, is nearly three times higher than the next largest import – gold. If the currency devalues, then exports should become more competitive and imports less competitive since they are more expensive. India has increased its imports of oil over the time since 2006 by over 350% against a backdrop of a depreciating currency making it inflation-prone.

But this relationship also demonstrates the fact that India’s currency is prone to speculation. The correlation is weak against commodity exports and this suggests that it is not so much measuring the economic development and growth of the Indian economy as it is measuring the capacity of the economy to soak up imports from overseas. The Indian stock market is a measure of the investment potential of the Indian economy and it too is more strongly correlated with imports (0.91) than it is with exports (0.90), as illustrated in Figure 2.

 

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Figure 2  |  Indian imports (USDm value, June 2001-April 2015) vs IndiaBSE, Last Price Monthly, June 2001-April 2014
Source  |  DeltaMetrics 2014, Bloomberg

 

While the difference in the correlation between the BSE and exports and imports is marginal, it points to the fact that investors are, arguably, measuring the success of the economy against their own capacity to invest in it. The post-dotcom hubris that surrounded India’s development in the early 2000’s spawned an excitement about India’s potential growth that fuelled inward investments in biotechnology, pharmaceuticals and electronics from developed world economies, particularly the United States. And yet, paradoxically perhaps, India’s trade itself has shifted markedly away from the developed world economies and towards economies in the Middle East and Asia.

 

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Figure 3  |  Moving focus – how India’s trade is shifting from Europe to Asia and the Middle East
Source  |  DeltaMetrics 2014

 

For example, China was India’s twelfth largest export destination in 2001 but is its third largest now and Singapore was its eleventh but fourth largest now. The UK was India’s fourth largest export destination but is now 7th and Germany its fifth, but is now 8th. India’s fastest growing export destinations are Indonesia, Vietnam and Brazil and while the UAE has risen from second to first, much of this is because of exports of diamonds, jewellery and gold.

Its import structure has changed as well, reflecting India’s insatiable demand for oil, diamonds, gold and jewellery. In 2001 the UAE was ranked 14th and Saudia Arabia are nexus pheromones any good 18th. They are now 2nd and 3rd respectively. China is the number one importer and with import values into India of USD 71.9bn anticipated in 2014, its imports are worth more than twice those from Switzerland and the United States which ranked first and second in 2001.

Trade is normally glacial in the pace at which it changes so these shifts in the structure of India’s trade partners are worth dwelling on. The pattern that is being reflected is a shift away from the developed world towards the emerging world and while this is, in itself, not a bad thing, it pushes India’s trade structure increasingly towards that of an emerging economy. Its trade is heavily concentrated in refined oil (nearly 19% of its exports) and pearls, precious stones, precious metals and jewellery (16%). Pharmaceuticals overall account for around 3% and while this is more than its concentration ratio of 2.5% in 2001, it is modest in comparison to its commodity exports.

Exports to the emerging economies are largely commodity-based: for example, exports to Vietnam are dominated by beef and soyabean cakes, maize and fish while exports to Brazil are oil, synthetic filament thread (used to stitch car seats), carbon and coke and insecticides. Yet to Germany, its top five export sectors include aircraft parts and cars, while to the US they include medicines.

It would be a mistake for policy makers to ignore the importance of traditional areas of export strength. Precious metal, pearl and jewellery exports to the UAE, for example are strongly correlated with the value of the currency at 0.61, as shown in Figure 4.

 

2014-05-19_aDoseOfItsOwnMedicine_fig04
Figure 4  |  Exports of pearls, precious stones, precious metals and jewellery (USDm) to the UAE,
June 2001-April 2015 against Rupees per USD, June 2001-April 2014, Last Price Monthly

Source  |  DeltaMetrics 2014, Bloomberg

 

It would also be misguided to ignore the importance of emerging markets in Asia. As Figure 5 shows, there is a very strong correlation (0.91) between the value of India’s Iron Ore exports to China and the Indian Stock Exchange.

 

2014-05-19_aDoseOfItsOwnMedicine_fig05
Figure 5  |  Indian exports of ores, slag and ash to China (USDm value, June 2001-April 2015)
vs IndiaBSE, Last Price Monthly, June 2001-April 2014
Source  |  DeltaMetrics 2014, Bloomberg

 

Indian pharmaceutical exports to the United States, however, are almost as highly correlated with the BSE at 0.88 and this is important for policy makers. Over the period since 2001, the comparative advantage of Indian pharmaceuticals has gone from positive to negative and while the comparative disadvantage of Indian electronics exports (measured through revealed comparative advantage) has gone from -0.66 to -0.46, given the powerhouse that is India’s innovation economy, this should be reflected in its electronics exports as well. Yet the correlation between India’s trade and proxies for its innovation (the amount the government spends on R&D and business expenditure on R&D) are very high at over 0.93 as are skills, wages and foreign direct investment. More than this, the currency elasticity of trade is 0.99 correlated with trade.

All of this gives Mr. Modi’s team a clear lever to stimulate the economy. First, in the short term, the currency should be kept weak – this will have the effect of closing the trade deficit simply because the responsiveness of trade to changes in the currency is so high. This will promote exports in areas where price competitiveness is key, such as oil or iron ore, or even beef, which is a fast growing export product.

Second, India’s new government needs to think about its long term growth which will only come from extending education into rural communities, building on its high level skills base in cities and innovation – building on its successes in software and business services as well as in pharmaceuticals. South-South trade between emerging economies is commodity and infrastructure focuses and Delta Economics is not positive about its pace of growth in the immediate future. Accordingly, as the developed world begins to emerge from the financial crisis, India needs to take a dose of its own medicine to re-connect with these markets as they will help it to restore its competitive advantage in the innovative sectors that were so vibrant ten years ago.

Webcast 012 | Is Mexico the new China?

Rebecca Harding presents Carlos Sanchez Pavan and Shannon Manders to uncover the key trade drivers behind Mexico€™s strengthening supply chains. Mexico has been a strong beneficiary of re-shoring in manufacturing and the country’s strong economic and political structural changes have facilitated trade growth in automobiles, auto parts, oil and alternative energies. Delta Economics’ view is that Mexico and increasingly, the Latin American region, have growing competitive advantages over emerging markets in Asia and that China is becoming less competitive in wage and productivity terms, relative to Mexico.

 

Webcast 012 Author  |  Rebecca Harding  |  CEO

World

Delta Economics is forecasting that world merchandise trade will grow by just over 1% in 2014. This is lower than its previous forecast, released in December 2013 of 1.7% and substantially lower than the World Trade Organisation’s forecast of 4.5% world trade growth for 2014. While at a country level, there are some positive growth stories, trade in 2014 is likely to be lower than trade in 2013 and this is dampening our global growth forecast.

The lower global forecast also reflects several things:

  • The effects of geo-political crises (specifically Russia’s annexation of the Ukraine which has created market uncertainty and raised the threat of sanctions, higher oil prices and slower economic growth because of constrained investment.
  • The effects of deflationary pressures in Europe and Asia which have already evident in the nominal values of trade for 2012 and 2013.
  • Lower actual trade growth in 2013 than was anticipated.
  • Forecast South-South trade growth of 5% during 2014

Sub-Saharan Africa

Africa remains one of the regions that is full of potential but difficult to capture accurately. Trade data is one way of demonstrating how the economies of the region are growing. Nigeria and South Africa are relatively well integrated into the global trading system: Nigeria’€™s exports of oil are fueling rapid import growth to develop infrastructures and to fuel growing consumer demand while South Africa’€™s exports of iron ore are forecast to grow in 2014 by over 15% and of cars by over 10%.