Geopolitics for Business
This week: India's second wave, US trade policy changes, and global tax deal within reach
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India’s second wave is principally a humanitarian disaster but also complicates its domestic economic recovery, delays global vaccination programs and risks prolonging the pandemic.
US trade policy has changed in some ways since Biden became president, but there are also important continuities, both of which provide clues to future policies and business impacts.
Geopolitics and tax do not often appear in the same sentence, but tax has become sexy and geopolitics taxy, with governments getting closer to clinching a deal on creating a global minimum rate to crack down on tax avoidance by the world’s biggest companies.
⏹️ India’s second wave
I. What happened:
India has become the global epicentre of the coronavirus pandemic. The country is experiencing record daily new cases and deaths, with the crisis spiralling out of control. Reuters.
II. The Bigger Picture:
Politically, India’s crisis hurts Prime Minister Modi and his reform efforts. His Bharatiya Janata Party has lost a major state election and Modi’s popularity has dipped on account of perceived mismanagement and prioritising politics over health. Increasing political pressure and a deepening crisis will stall reforms and could damage Modi’s business-friendly reputation and therefore India’s attractiveness to foreign investment.
Economically, India’s second wave hit after the economy shrunk by 7.7% in 2020-21. Even before the pandemic, the Indian economy was already slowing down – with weak consumption growth, shrinking capital formation, and record low growth rates in both industry and services in 2019. While the economy was recovering in Q1, now, renewed lockdowns are chilling investment activity, hurting jobs and dampening consumer demand.
Geopolitically, the crisis means India’s leadership in South Asia is under strain. The pause in India’s regional vaccine rollout is not only a health risk to neighbouring countries, but it opens further space to China – and Beijing has been quick in seeking to fill the void, particularly in key countries that have been open to Beijing’s overtures in the past, such as Sri Lanka. It’s no wonder that the countries rushing to India’s aid are the same Western countries concerned about China’s diplomatic practices.
III. Business Impacts:
India’s second wave will slow its economic recovery. So far, hospitality, tourism and entertainment sectors have been hit hardest. Barclays estimates the economy may contract by 7.6% in FY21 while S&P has warned of possible business disruptions and continued high level of systemic risk in the banking sector, which along with infrastructure, real estate and non-banking finance, faces a balance sheet crisis. Given India’s limited fiscal headroom, if Covid-19 is not controlled and government spending does not trigger growth, there is a real risk of a debt crisis down the road.
India’s Covid-19 crisis will set back global efforts to control the pandemic. The new Indian variant is already throughout South Asia and will spread further. India’s vaccine export bans will significantly reduce the ability of the 92 developing countries reliant on Indian goods to rollout successful vaccination programs, including via Covax. Companies in emerging markets will face slower vaccination rollouts and prolonged economic uncertainty. Further, with its enormous population, the longer Covid-19 runs rampant in India, the greater the risks of new variants emerging potentially resistant to existing vaccines.
However, the crisis in India has also triggered greater international cooperation. The US has diverted filters it ordered for vaccine production to India’s Serum Institute, the world’s largest vaccine manufacturer, and it will likely donate a large share of its roughly 60 million doses of the AstraZeneca vaccine. As its own vaccination program nears completion, it will likely start exporting vaccines on mass and remove more restrictions on components. Other governments have also provided assistance, including shipping oxygen, drugs, testing equipment, PPE and medical personnel. With any luck, history may view India’s second wave as a turning point in favour of effective cooperation in the global fight against Covid-19.
IV. What to do:
Investors should account for a prolonged pandemic and economic slowdown in India and emerging markets. Slower economic growth will affect expected cash flows of assets in India and Covax-recipient countries and increase risk premiums across asset classes.
Companies should update business plans and budgets to account for ongoing pandemic uncertainty – especially in India and emerging markets but also elsewhere. Above all, the India crisis shows that pandemic uncertainty will live on. This may require new approaches to creating enterprise resilience.
Business can support India, through direct donations and/or mobilising greater government assistance. The International Chamber of Commerce is calling for private sector contributions to help UNICEF raise $21 million to support the deployment of oxygen equipment and PCR testing machines.
⏹️ US trade policy changes
I. What happened:
Biden’s first 100 days in trade policy have been marked by both continuity with, and change from, the Trump administration. FT.
II. The Bigger Picture:
What’s new in Biden’s trade policy? The Biden administration has a greater focus on Buy American, climate and environmental issues, supply chains, and inclusivity. Allies matter more, with the US now preferring to work with partners to deal with China compared to Trump’s go-it-alone approach. Rhetorically, Biden is much more committed to the “rules-based multilateral trading system” (the WTO and regional deals). And of course the style.
But much has stayed the same. Like Trump, Biden is focused on building a middle class and is very pro-worker. US concerns about China as a growing economic rival and security threat have not gone away; if anything, they have increased. Trade will keep being used principally as an instrument of leverage rather than a method of commercial policy. And the US will continue to prefer negotiating bilaterally with allies (EU, UK, Japan) than with competitors.
Most importantly, Biden’s America will not return to its former role as the guarantor of the international economic system. This matters because the world has only had relatively open markets during periods of “hegemonic” leadership - under the British Empire then during the US-led post-WWII period. Obama and Trump abandoned that role. It’s now clear Biden will not take it up. If history is any guide, the broader international system will drift towards protectionism, discrimination and weakened international institutions.
III. Business Impacts
Most immediately, Biden’s focus on supply chains and Buy American will create business threats and opportunities. Importers will likely face tightened restrictions, requiring more US or allied sourced components, which could in turn mean higher prices. Similarly, the US will create tougher laws to ensure supply chains do not use forced labour or undermine human- or workers’ rights. Buy American policies will lead to a greater focus on enforcement of domestic content rules and, possibly, the creation of new thresholds for determining rules of origin. All of which will add costs and complexity in international commerce.
Over the next four years, US policies will make it harder to do business with China. The new administration has indicated it will continue to enforce s 301 tariffs and honour the Phase One Deal. With concerns over intellectual property theft, human rights, forced labour and Taiwan unlikely to abate, the government will keep using sanctions, export controls and tariffs to attempt to contain China. How far the US will go will depend on how foreign powers (especially the EU and China) react. Each of these tools may serve foreign policy interests but come at the expense of US commercial interests.
Longer-term, the world may be drifting into a bloc system. With the US abandoning its role as guarantor of the multilateral trading system, all major economies largely pursuing bilateral deals, and the potential for the US to insist its partners shun China, we could see the emergence of two distinct economic blocs. If so, the global economy would become less efficient and countries and companies alike may be forced to choose which economic systems they would prefer to operate in.
IV. What to do:
Understand your supply chain. Importers should ensure raw materials and manufacturing come from credible sources, and possibly avoid Xinjiang as a supplier. Proactively review supply chains for red flags and keep an eye on future supply chain regulations.
Explore opportunities and reduce risks from Buy American laws. Huge spending programs present government procurement opportunities. But be aware that potential changes to origin rules will require existing and expiring contracts to comply with new rules, including on thresholds.
Conduct scenario planning on what the emergence of competing economic blocs and continued stagnation in the multilateral trading system would mean for your company.
⏹️ Taxing negotiations
I. What happened:
Governments got closer to reaching agreement on the creation of a global corporate minimum tax last week, when the US proposed a 21% rate for the world’s 100-150 most profitable companies. Reuters.
II. The Bigger Picture:
Over the last few years, Europe and the US have been going head-to-head on digital taxation. Many European governments (see map below) have proposed or implemented laws that make Big Tech pay taxes in Europe for digital services. Deeply frustrated that Big Tech makes money from European citizens but does not pay taxes on the continent, Europeans governments have argued companies should be taxed where value is created, not where companies are created. Trump saw this as an attack on America and threatened retaliatory tariffs. It all got very heated, very quickly, and has been a major source of tension between Europe and America.
Meanwhile, the OECD has been coordinating negotiations for several years to find common ground. There are actually two sets of talks going on - one to specifically create rules for taxing cross-border digital services, and another to curb tax avoidance. As part of these second talks, governments are discussing creating a global minimum tax rate. Negotiations are complex as finding a solution that suits more than 130 countries requires balancing different interests. Not just European and American, but also those of tax havens (like Ireland) who want to remain competitive and developing countries.
The US proposal of a 21% rate for the world’s 100-150 most profitable companies was a breakthrough and has created considerable momentum. Many Europeans are on board and there is political pressure to seal the deal by the middle of the year. Doing so would ease US-European tensions, boost multilateral cooperation, and offset the risks of countries adopting different and inconsistent approaches. The major test now is whether the OECD can bring on board the whole world and especially developing countries, many of which have viewed the talks as driven by advanced economies and without clear benefits for them.
III. Business Impacts:
If passed, the world’s biggest 100-150 companies would have to pay more tax, no matter where they are headquartered. There will be fewer incentives to avoid taxes via profit shifting or headquartering decisions, which could reduce the appeal of countries like Ireland as major employment hubs. That said, it is still unclear which companies the rules will apply to (after all, maybe the US proposal will fail) or what the tax rate will be (the US’s proposal of 21% may ultimately be lowered to get tax havens on board). Either way, while the biggest winners will have to pay more tax, they will also benefit from lower political heat.
In theory, an agreement on corporate minimum taxation should reduce complexity and create more consistent tax rules across jurisdictions. In turn, this should reduce the administrative burden of compliance and the risk of double taxation. But the devil will be in the detail, and much will hinge on implementation. Assuming the OECD can birth an agreement, every country would then need to implement new tax rules. During this time, there will be considerable uncertainty as governments adjust their laws at different paces. And any new regime could still carry risks of double taxation.
If, on the other hand, no agreement is reached, big corporates would continue to face different tax rates in different jurisdictions. The Caymans would remain appealing not only for its beaches. More importantly, there would likely be a proliferation of digital services taxes and other rules to clamp down on avoidance, which could easily prompt the US to restore retaliatory tariffs on European industry. European and American businesses alike would face a more uncertain policy outlook.
IV. What to do:
Monitor progress in the OECD global minimum tax discussions and, if affected, prepare a comprehensive compliance plan across more than 130 jurisdictions.
Pay greater attention to the increasing regulation of the digital economy. The Global Trade Alert’s new Digital Policy Alert provides a useful method of tracking policy changes by G20 nations.
Consider how US-EU cooperation and tensions on digital issues can affect your business and whether encouraging cooperation should be included in your government relations strategy.
⏭️ ISSUES TO WATCH
South Korea President to meet Biden. Moon Jae-in will travel to Washington on 21 May to meet Joe Biden and discuss trade, North Korea and climate change. This second in-person meeting of a foreign leader, once again from the Asia-Pacific region, underscores how strategic the area has become for Biden’s foreign policy and the importance of strengthening cooperation with South Korea, an essential ally to balance the rise of China in the region.
EU-India trade talks. The EU and India will begin talks on a free trade deal and separate investment agreement on 8 May. Previous negotiations were suspended in 2013 over disagreements about car part tariffs and easing work rights for professionals. But, geopolitically, times have changed. Both are grappling with the increasing economic power of China - the main driver behind the EU’s new Indo-Pacific strategy. India’s generally protectionist stance means whatever agreement is ultimately reached will not be very “deep”.
🔂 UPDATES
Brexit deal. The EU Parliament overwhelmingly voted to ratify the EU-UK trade and cooperation agreement, officially putting an end to the tumultuous Brexit process and paving a way for a new chapter of the Cross-Channel relationship.
WTO TRIPS waiver. Yesterday, the US announced its support for waiving IP protections for Covid-19 vaccines and said it would “actively participate” in WTO talks. This is a potential gamechanger. But the US joining means the text will get watered down, continued EU opposition means it may not even pass, and even if it does it won’t happen for several months. More important: patent waivers do not address the real problems of production and distribution. So hardly a breakthrough for rapidly ending the pandemic.
🎦 UPCOMING EVENTS
Friday 7 May: The Think20 (the official “ideas bank” of the G20) will host a series of roundtables on “EU, US & China: the impossible triangle? Global economic governance after the pandemic”. Register here.
Thursday 13 May: Teneo will host a webinar with former US Senator Christopher J. Dodd to reflect on the first 100 days of the Biden presidency. Register here.
Thursday 20 May: The Financial Times and the Indian Express will host a virtual debate on “India, China and the US: A new geopolitical landscape?”. Register here.
⤵️ DIG DEEPER
Why the world should worry about India, The Atlantic, 26 April 2021.
Trade after Trump: Can the Biden Administration Shore up the Eroding Foundations of American Leadership?, EUI Working Papers.
The world is closer than ever to make corporations pay up, Foreign Policy, 27 April 2021.