Guest Blog | Services trade should be a UK strategic priority

The release of UK balance of payments current account figures for 2014 was greeted by the usual shock horror headlines. The deficit in 2014 was close to £100bn, and reached the highest share of GDP recorded since 1948. Our current account deficit of 5.5% of GDP in 2014 exceeded the previous peaks of 4.4% in 1989 and 3.9% in 1974, after the first OPEC oil price shock.

These headline figures were a bit misleading, however. The underlying trade position for the UK has not deteriorated – for 2014 as a whole the deficit in goods and services was less than 2% of GDP and the figures were on an improving trend through the year. The current account figures reflect some unusually large net outflows of income which could turn out to be a temporary phase.

Digging down further into the trade figures we can find more good news. In 2014, the UK’s exports of services hit a new record – nearly £215bn. The value of UK exports of services is now very close to the total value of our manufactured exports (£225bn). In addition, we run a large trade surplus on services – totalling nearly £86bn last year, nearly 5% of GDP. This trade surplus on services more than offsets our deficit on trade in manufactures (£81bn). Both the level of services exports and the services trade surplus reached new highs in 2014.

Because services trade is less visible than goods trade, its importance tends to be underplayed. The UK is a remarkably successful exporter of services – second only behind the US in the world. Services exports account for around 12% of UK GDP, compared with around 8% in Germany and France, 4% in the US and 3% in Japan.

There are a number of myths about services trade which need to be dispelled. The first is that it is all about selling financial services, and therefore we are overly dependent on the City of London for our successful record of exporting services. In fact, the UK has a very diverse range of services exports. Banking, insurance and other financial services do contribute about a third of the total in the UK. But business and professional activities account for a quarter of our services exports. IT, travel and tourism, education and the creative industries – music, film, design, etc – also make a substantial contribution.

A second myth is that services trade does not add as much value to the economy as manufactures. In fact the reverse is true. Manufacturing industry is a big importer of components , energy and raw materials. So the value-added element of £1 of manufacturing exports is lower than the equivalent in the services industries. Work by the OECD suggests that UK services exports generate more value-added for the UK economy than manufacturing trade, not less.
A third myth is that we have exhausted the growth potential of our exporting services industries. Though services account for 70-80% of the output of major economies, their share of total world trade is just 20%. A concerted approach to breaking down barriers to trade in services – both within the European Union and more widely across the international economy – could support further rapid growth, as a recent report from the CityUK Independent Economists’ Group has argued. A PwC report in 2013 found that emerging market imports of services are now larger than the G7 economies – and were growing three times as fast.

Services trade is a big success story for the UK and services exports have significant growth potential. It is likely that within the next five years, UK services exports will exceed our overseas sales of manufactures. A strategic focus on breaking down barriers to trade in services, and maximising our export potential, should therefore be a priority for the next term of government – whichever party wins the forthcoming General Election.

 

 

Services trade should be a UK strategic priority | Guest Blog author | Andrew Sentance | Senior Economic Adviser PwC

UK exports show rates of improvements

With the UK’s general election rapidly approaching, it will have come as good news to all parties that Europe’s export orders to the UK were showing a marked increase. A quarterly survey by manufacturers’ organisation EEF and law firm DLA Piper reported findings that export orders were increasing and were moving out of negative territory for the first time in nine months.

Accordingly, Delta Economics forecasts that while the UK’s total exports to Europe are still falling, they will decrease at a slower rate from this year until 2018, when they will finally reach positive rates of growth. This is important and timely news for the major political parties vying for election success. Many parties have promoted ideas of policy refocus, particularly increasing the UK’s exports as a means of shifting the UK’s balance of trade further towards surplus.

However, the formation of effective policy to instigate this change will be tough. Delta Economics forecasts that the UK’s trade deficit is expected to decrease slightly over the next two years but will then continue to increase steadily for several years after that. Although this is worrying for the UK given efforts to address the deficit, investments into key sectors could help exports flourish.

For example, of its largest export sectors, the UK’s exports of meat are expected to grow by over 3% this year, suggesting that they are expanding international opportunities for the farming industry. Similarly, UK exports of clothing are also expected to be amongst the fastest growing sectors this year. This could also mark some significant opportunities for the British garment manufacturing sector.

What is becoming increasingly apparent in the policy structures that are emerging in the run up to the election is that the UK’s export industry has the potential to contribute significantly to the recovery and prosperity of the British economy. What remains to be seen is how well existing opportunities are nurtured and built into sustainable growth industries.

 

2015-03-09_CommentsAnalysis_014_fig01

 

Figure 1  |  UK exports show rates of improvements
Source  |  DeltaMetrics 2015

 

 

UK exports show rates of improvements  |  Author  |  Nayani Bandara  |  Analyst and Project Manager

What goes up…

Why markets should recover but uncertainty will remain |  For almost all of this year, Delta Economics has been arguing that global equities are long overdue a correction. The reason for this is simple: there is a high correlation between trade values and the global markets (68% for the FTSE and S&P 500 and 85% for the Dax). There is an even higher correlation between trade and emerging market equities at over 90% for the Kospi. If the Delta Economics forecast for trade growth is flat, then it should stand to reason that markets will also underperform.

But, as Figure 1 shows, what goes up appears to be going up forever. Since the bull-run began, trade has been relatively flat while markets have reached unprecedented heights. Even the putative crisis in emerging markets at the beginning of 2014 failed to have a lasting impact on equities generally despite ever-more negative news about trade.

 

 

2014-10-20_whatsGoesUp_fig01

Figure 1  |  Value of World Trade (USDbn) vs S&P 500, Last Price Monthly, June 2001-Dec 2014
Source  |  DeltaMetrics, 2014, Bloomberg

 

As markets do not consider trade data as market-leading, this should not be a surprise. What appeared to happen during the second week of October was that market analysts reacted to suspicions that interest rates might rise and that Quantitative Easing might stop in October. Simultaneously they realised that the Ebola crisis in Africa could have an economic impact while tumbling oil prices raised a spectre of disinflation and poor German data put the Eurozone crisis back in the spotlight.

So is this the moment where Delta Economics steps back and says, “We told you so”? The short answer is no, not yet. We are expecting markets to continue to recover their lost ground in October, but for volatility to remain high. We are forecasting a seasonal pick-up in trade, which means that Purchasing Managers’ Indices may well show some sign of recovery at the end of the month. This could spur equities if not to new heights, then at least to reverse the correction earlier this month (Figure 2).

 

2014-10-20_whatsGoesUp_fig02

Figure 2  |  Eurozone PMI (normalised value) versus Eurozone Delta Trade Corridor Index (Sentiment) change (June 2001-Dec 2014)
Source  |  Delta Economics analysis

 

The Delta Trade Corridor Index-Sentiment (TCI-S) measures the change in a country’s or region’s trade against its PMI. For the Eurozone, the correlation is 86% thus the slight pick-up we expect to see in trade this month is likely to be accompanied by a similar increase in the value of the Eurozone’s PMI. Similarly, we expect the PMI to improve for China and the US as well.

This is nothing more than a seasonal fluctuation and it is always a mistake to react to one month of data. Instead, it is more useful to look at the macroeconomic momentum. This is precisely what the TCI-S measures: the way in which trade is changing over time. What is clear from Figure 2 is that the Eurozone trend is downwards; the same is the case for the Global Manufacturing PMI, as measured in Figure 3.

 

2014-10-20_whatsGoesUp_fig03

Figure 3  |  Global manufacturing PMI normalised values vs Global Delta TCI-S change
Source  |  Delta Economics analysis

 

Figure 3 presents a more worrying picture of momentum: that well into Q2 next year will be the earliest we see any pick-up in our TCI-S or trade more generally. After an increase this month, the next five are likely to be weaker with the TCI-S turning negative.

The reason for this has as much to do the uncertainty caused by geopolitical risks as it does with macroeconomics; these risks will affect emerging markets in particular. While conditions remain uncertain, investment will be held back and it is likely that Africa will suffer first. Since March 2014 we have seen a year-on-year decline of 8% in West Africa’s trade. Further, we are expecting Chinese imports from West Africa to halve (from over 16% to 8% growth) in 2014. With falling oil and commodity prices generally, this represents a perfect storm for investment in Africa.

 

2014-10-20_whatsGoesUp_infographic_v01c

 

Second, Turkey is likely to suffer substantial economic fallout from the Iraq crisis. Turkey’s trade with Iraq alone is worth some USD11.6bn. Much of this trade is in oil and, although Iraq’s oil reserves are largely in the South rather than the ISIS-controlled North, we are still forecasting a 21% reduction in its imports from Iraq to January 2015. We also expect a 23% reduction in its trade with Syria over the same period.

Finally, oil prices have not risen as a result of the crises in the Middle East or in Ukraine although this may have been expected. Instead, prices have fallen as Saudi Arabia has increased its oil supply and as the USA, now the world’s largest oil producer has loosened its restrictions on exports. Trade values and oil prices are 94% correlated and our forecast of 0.56% trade growth in 2014 suggests that oil prices are set to fall further (Figure 4).

 

2014-10-20_whatsGoesUp_fig04

Figure 4  |  Value of world trade (USDbn) vs NYSE ARCA oil spot, Last Price Monthly, June 2001-Dec 2014
Source  |  DeltaMetrics, 2014, Bloomberg

 

The falling price of oil is a double-edged sword: while it lowers costs, it also raises the spectre of deflation, which is increasingly causing concern amongst analysts. If prices turn negative then it threatens global economic growth – as witnessed in the latest downgrading of IMF economic and trade forecasts.

Delta Economics is of the view that the IMF and WTO forecasts for trade growth, at over 3.1%, have still not sufficiently factored in the effects of falling oil prices. Based on data produced by the CPB Netherlands Bureau’s World Trade Monitor, the Delta Economics forecast still appears to be closer to actual trade than that of either the IMF or the WTO (Figure 5).

 

2014-10-20_whatsGoesUp_fig05

Figure 5  |  World Trade Organisation and Delta Economics World Trade Forecasts versus actual
Source  |  Delta Economics analysis

 

We are expecting a temporary increase in world trade in October that could well boost markets for the remainder of the month. However, we are also expecting trade to drop back considerably into the first quarter of 2015. The immediate reaction to the return of volatility in the early part of August must surely have been, “What goes up must come down” and over the longer term, we expect continued uncertainty to fuel volatility in markets. The potential for a major correction before the year end cannot be discounted. However, in the very short term, the reverse might well be the case: what goes down must surely come up again.

 

 

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.

 

2014-07-07_the InvisibleHand_fig01

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.

 

2014-07-07_the InvisibleHand_fig02

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.

 

2014-07-07_the InvisibleHand_fig03

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.

 

2014-07-07_the InvisibleHand_fig04

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