Trade tariffs bothering you?

I've usually used the phrase 'stay the course' as one of the great rules of investment success. -John C. Bogle

Reform by crisis – An Indian tale

It was the year 1991. Indian sovereign debt had been downgraded by Moody’s as a response to the twin deficits that the country was facing leading to a sharp deterioration in the exchange rate vis-à-vis the US dollar. Further, a weakening Russia and consequently the Indo-Russia rupee trade slowdown, sharply rising crude oil prices following the gulf war and severe balance of payments crisis with hardly enough foreign exchange reserves to fund 3 months of imports led to the union budget not being passed in the Parliament. At that time India had to do several actions to counter the situation including pledging of a significant amount of its gold reserves, agreeing to a host of conditions imposed by the World Bank and IMF.

Cut to the present. This trade crisis is not a patch on what happened then. However, there are some parallels that can emerge as positives from the current situation. In response to the crisis in ’91, India undertook major economic reforms now enshrined as the great reset for the Indian economy. Among the many reforms undertaken the major ones were: Doing away with licensing requirements for manufacturing (facetiously referred to as the “license Raj”); No Pre-approval of foreign investment up to 51% in equity bringing in technology and industrial development, allowing for equity participation in public sector companies and for greater autonomy in their management and finally the abolition of the MRTP act that ensured government scrutiny for all companies exceeding a certain size.

Such reform could not have been imagined prior to the crisis and the significant foreign borrowings leading to the crisis were almost a catalyst for the government to change in a decisive fashion thereafter. The current crisis highlights a legacy of the past. High trade barriers to ensure protection of Indian manufacturing and to a certain extent, almost an embargo in the agriculture and dairy sectors. While the agriculture and dairy sectors remain protected in western countries as well, the real focus may turn on what can be a reasonable trade tariff on the remaining manufacturing sectors in the Indian economy.

Remember, reducing trade barriers signal lower priced goods albeit from abroad for local consumers and vice versa. While in effect this may benefit domestic consumers the high trade barriers in the US consequently can only damage domestic demand and could signal a slowdown in that economy several quarters later. So, who wins the trade war?

What can investors expect from the situation?

Understand that the longer-term benefits are stacked in India’s favour

• Volatility is inherent in markets. If not a trade spat, it would be something else. Focusing on the longer term always helps.

• Lower trade tariffs in India are demand positive for the domestic economy and disinflationary

• Higher trade tariffs impact for Indian producers is marginal at best on the overall economy level and even more limited for listed universe.

• Market action is more sentiment driven and will subside over time. Not an opportunity to time the market or expect a quick bounce back

• Stay with long term asset allocation

One can only hope for the best in the interim. Longer term allocations to the equity asset class need not change and institutional investors may increase tactical allocations to equities in the interim.

Time is your friend; impulse is your enemy. -John C. Bogle

How long can this volatility continue?

The way the trade issue has taken centre stage in the US, it appears unlikely that the storm will pass anytime soon. The markets can remain volatile for a considerable amount of time. Expect strong earnings growth and fundamental strength to eventually overshadow current volatility in the next two quarters. This could be an attractive opportunity for tactical allocations for institutional investors.

Happy investing!