World Risk Developments - May 2014


India — Narendra Modi’s election victory

Markets have rallied following the historic landslide election of the Bharatiya Janata Party (BJP), led by Narendra Modi, but politics will challenge implementation of his reform agenda.

The business-friendly leader’s election has driven stocks to record highs and the rupee to an 11 month high. The emphatic nature of the switch from the National Congress Party — which ruled India for most of its modern history — gives Modi a clear mandate to address voter frustration over a stagnant economy hindered by corruption and fractious politics.

High personal approval ratings and a broad support base will embolden him to pursue his ambitious agenda for market-oriented reforms. But he will face formidable challenges. To meet election promises, he must overcome the same political obstacles that stifled economic growth under the Congress Party. These include: state government land policies that prevent infrastructure development, institutionalised corruption, and opposition to privatisation from powerful trade unions and other political power brokers.

Modi may also struggle to satisfy the cultural agenda of his Hindu nationalist supporter base without inflaming communal tensions.

Vietnam — Anti-Chinese protests

The fury and randomness of the mid-May anti-Chinese riots are causing direct investors to reconsider Vietnam as a destination for their capital.

More than 3,000 Chinese nationals have been evacuated from Vietnam amid riots that killed four and injured 100, and another 4,000 are expected to follow. According to preliminary estimates, around 300 foreign businesses have been damaged or destroyed. Apparently the protesters struggled to identify Chinese businesses, because the majority of firms attacked were actually Taiwanese and 24 Korean. The riots were triggered by China’s dispatch of an oil rig to contested waters in the South China Sea.

In response, many Chinese and non-Chinese companies alike have halted production and are reconsidering their involvement in the low-cost county.

The financial markets took the events in their stride. So the issue seems to be more one of whether Hanoi can restore confidence enough to head off incipient plans by direct investors to pull out, rather than a risk of capital flight and balance of payments crisis. Even so, the economy is crisis-prone because of relatively low foreign exchange reserves, weak banks, and a recent history of capital flight. So the risk of fresh financial instability can’t be ruled out.

Russia/China — Gas deal

Last week’s mammoth gas deal between Russia and China continues the efforts of both countries to diversify their international commercial ties and gives a further boost to burgeoning ‘South-South’ trade.

Russia’s gas monopolist Gazprom and the China National Petroleum Corporation signed an MOU on deliveries of Russian gas during President Putin’s visit to Shanghai last week. The agreement covers a 30-year term and calls for supplies of up to 38b cubic metres of gas a year, about the same as Russia supplies to Germany. Its total value is US$400b, according to Gazprom. The price is undisclosed, but the Russians will reportedly receive 25% less than they get from European customers. The agreement ends a decade of negotiations.

Deliveries are planned to start in 2018. They cannot start before because Gazprom has yet to build the pipelines in what will probably be the world’s largest infrastructure project, costing US$55b.

The Kremlin will no doubt look upon the 25% discount as the price it has to pay to lessen its dependence upon European customers, who themselves are seeking to lower their dependence upon Russian gas in the context of the rift over Ukraine. Better still, the deal will promote development of backward Eastern Siberia by harnessing gas
from that region.

For its part, Beijing reportedly sees the deal as a way to supply gas to eastern China and to reduce its dependence on seaborne shipments. At present, Central Asia supplies piped gas to western China, and Australia and Indonesia LNG to southern and eastern China.

The deal looks as if it will have a marked, if uncertain, effect upon the geography of the world gas trade. Obviously, the deal will inject a new supply into the East Asian market. It is also likely to promote the development of Russian and hence worldwide gas supplies. Then again, it may discourage potential gas suppliers to East Asia from North America.

Another aspect of the deal is that it provides for settlement in renminbi or roubles — the first major commodity contract to do so. As such, it advances the goal of both countries to reduce their dependence upon US dollars and euros in international trade.

PNG — LNG project

Because the LNG project is so large and the PNG economy so small, the project’s various mutations are leaving a considerable macroeconomic imprint.

ExxonMobil announced on 29 April that it had started production at the $19b project — ahead of schedule.

During the construction phase over 2010-13, annual GDP growth soared to nearly 9%. But now that construction is ending, growth is expected to fall to 5½–6½%. Until, that is, production peaks in 2015, which should boost growth to more than 20%. Thereafter growth should slow to around 3½% as the non-resource sector moves towards its more normal growth rate of 4½% and production at mature mines dwindles.

Indonesia — Bilateral investment treaties

The Indonesian government seems determined to end up to 67 bilateral investment treaties (BITs) on concern that they are favouring foreign investors over Indonesia.

Existing investors will receive some protection as sunset clauses will continue after the BITs expire. But prospective investors will view new investment with fresh caution because the existing BITs were seen as important protection, and proposed successor treaties have yet to be spelt out.

Roger Donnelly, Chief Economist

Cassandra Winzenried, Senior Economist

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