Dollar- Uncle Sam's worry

Those who react to last week’s fall in the dollar’s exchange rate and predict that the US currency is set for a further dip, would be well advised to read some of the forecasts made a couple of years ago, when the dollar had suffered a similar decline. Currency experts, bankers and economists were predicting then that the dollar would drop to as low as $1.50 against the euro, even $1.80 and $2.20. None of that happened, the dollar recovered, and life went on as usual. Now there is another round of nervousness, with the dollar dipping noticeably last week and having fallen by about 15 per cent this calendar year (though by barely 2-3 per cent against the rupee).

Is the long-predicted decline of the dollar about to happen at last, or is this another false alarm? That there is reason for worry, if not alarm, is easy to see. US housing has dipped for seven months in a row, US manufacturing has dipped for the first time in two or three years, and if the Federal Reserve drops interest rates (after a five-month hiatus) to try and revive the economy, capital could flow out of the US and further weaken the currency. If the Asian economies that hold foreign currency reserves of between $1.5 trillion and $2 trillion, decide that the dollar is not a safe store of value and look for alternatives, that will put still more pressure on the currency. ( Iran has decided to Euro against USD, thought it’s a different question why???) If, on the other hand, the Fed leaves interest rates untouched (for it is also worried about continuing inflation), it could slow down the US economy even more—and add to problems from another direction.

Surveying the flurry of comment on the subject, the most noteworthy is what has been said by The Economist. In a leading article it argues that, contrary to popular opinion, US productivity levels have not been improving faster than European levels, and that it is Europe which has greater room for productivity improvement. If true, that would argue in favour of a further weakening of the dollar as it argues in favour of switching to the euro as the currency of choice. With the dollar already close to its all-time low against the euro, some new currency benchmarks might well be set in the coming weeks. The other point worth noting is that the dollar has not really gained much ground this year against either the yuan or the rupee. Trade with India is not significant for the US, but that with China is—and if the yuan does not appreciate, much of the gains to be achieved from a cheaper dollar (through a reduced trade deficit) get nullified. From India’s perspective, the economy’s undoubted gains in productivity should help the rupee climb against the dollar, but the continuing weaknesses in the physical and financial infrastructure prevent that from happening, and the Reserve Bank is left with the task of pursuing an otherwise illogical currency policy and continuing to accumulate foreign exchange reserves in order to make up for the failures of the reform programme. There is no gainsaying that the US needs to do quite a lot of course correction in order to tackle its twin deficits (fiscal and trade), but if the dollar does fall further, it will test the quality of response from the other major economies—which now include India. If they fail the test, then global growth will be the casualty

Biocides- Making a killing

According to a new report by Kline & Company, Specialty Biocides 2004-2005, the West European market for speciality biocides is currently the second largest on a global basis behind that of the US. Valued at around €485 million for a volume of around 125,000 tonnes on a 100% active basis, the West European market will continue to exhibit only modest growth (averaging 2-3% overall) over the five years from 2004 to 2009. The US market, by contrast, is worth about €1,175 million, Japan's is worth €185 million and China's €92 million, though growing rapidly.
As Figure 1 shows, Western Europe's speciality biocides market is less driven by water treatment applications than the US market, and more by industrial preservation.

Figure 1 - Main global markets for speciality biocides

However, the latter is far more important in terms of relative market share in Japan and China than it is in either Western Europe or the US, where 'other' applications, notably wood preservation, leather tanning and household and industrial and institutional (HI&I) cleaning products, loom larger.The most significant driver for future biocide consumption in Western Europe is changes in legislation that is currently uncertain and difficult to predict. Such legislation includes the Biocidal Products Directive (BPD) and the potential reclassification of, and increased labelling burden for, selected biocidal actives.
Suppliers of speciality biocides have already invested significant time and resources into generating the data required for the BPD approval process. In many cases, this process has been slow and drawn-out because active ingredients for each application have been reviewed in a stepwise fashion.
Concurrently, companies from China and India have been flooding the market with generic products, driving prices down, further suppressing profitability and generally adding insult to injury for West European suppliers of biocidal actives. However, manufacturers with a smart BPD strategy and strong products could see a healthy long-term return on their investment.
The product and application mix in Western Europe differs in terms of volume and value. Organosulphur biocides, including isothiazolines, dithiocarbamates, pyrithiones and thiocyanates, lead on a value basis, with a 25% market share. Nitrogen-based products rank second with a 23% share; this category include quats, triazines, THPS, oxazolidines among many others (Figure 2).

Figure 2 - West European market for speciality biocides by product chemistry

Figure 3 - West European market for speciality biocides for industrial preservation by application

Looking at the market from an applications standpoint, industrial preservation ranks first, with a 35% share by value of the overall West European market for speciality biocides, excluding formulations. Figure 3 shows the market segmentation for industrial preservation by application
Three key drivers are impacting such industrial preservation applications as marine anti-foulants, paints and coatings, adhesives and sealants, synthetic latex polymers, metalworking fluids, plastics and resins and mineral slurries. These are:

* the BPD
* increased competition from generics suppliers in India and China
* the potential reclassification and/or increased labeling of formaldehyde-releasing biocides and carbendazim

To date, none of the industrial preservation applications has been reviewed under the BPD. However, small-volume biocidal actives that are unlikely to make it through the review process have already been dropped and huge uncertainty exists regarding the final outcome, because biocidal actives will be authorised by individual application. Manufacturers have evaluated the risks and rewards of supporting their actives.
Currently, actives that are not patent-protected, such as bronopol, CIT/MIT and BIT, continue to face increased pricing pressure from Asia On the completion of individual BPD application reviews, foreign generic competitors will not be able to import freely unless they register or cooperate with a current European supplier of the active. This means that traditional European suppliers of these actives will have a level of competitive protection.Overall, speciality biocide consumption in industrial preservation applications is forecast to grow at an average volume rate of 1.25%/year. Similar to other global regions, the bright spot in the Western European market is the plastics and resins end-use segment, particularly for silver-based biocides.

These biocides are more environmentally friendly, protect the integrity of plastics, and offer surface antimicrobial protection. European sales of biocidal actives to the plastics and resins market are expected to grow by 4.5%/year from 2004 to 2009, with silver-based actives growing by 10%/year.
By contrast, consumption of speciality biocides overall will grow by only 1.25%/year and annual growth rates in other market sectors over that period will be 3.0% in synthetic latex polymers, 2.3% in adhesives and sealants, 2% in minerals and slurries, 1.7% in marine anti-foulants and 1.2% in paints and coatings. In metalworking fluids, consumption is forecast to decline by 0.35%/year.

Overall, the growth of organosulphur biocides is relatively flat, at 0.7%/year on a volume basis through to 2009. However, within this category, isothiazolinines and pyrithiones will exhibit above average volume growth, driven by the displacement of older chemistries. Thiocyanates will decline, due to legislation concerns.
Biocide formulations are an important aspect of the West European paints and coatings, synthetic latex polymers, and adhesives and sealants markets. Kline estimates the market for formulated biocides at more than €200 million, with paints and coatings accounting for more than half the market.
The competitive landscape in formulations is relatively fragmented, with Thor (which pioneered the business model), Lanxess, Rohm and Haas and Troy among the leaders. Many suppliers of straight biocidal actives to industrial preservation applications have adopted the formulations business model in order to extract more value from clients.
In most cases, biocidal actives firms have acquired formulations expertise. For example, Clariant acquired Bactria, ISP acquired both Biochemica Schwaben and Progiven and Troy acquired the biocides activities of the former Riedel-de Ha‘n.Overall, the supplier base for speciality biocides for all applications is highly fragmented both from a product and from an application standpoint. More than 30 companies are active. Kline estimates that the top five suppliers of biocidal actives (Arch Chemicals, BASF, Lanxess, Lonza and Rohm and Haas) combined account for only 34% of the market value.
However, selected product and applications are much more consolidated. For example, the top five suppliers of organosulphur biocides in Western Europe (Arch Chemicals, Clariant, Lanxess, Rohm and Haas and Thor) account for 87% of the market. From an application standpoint, water treatment is relatively fragmented, with the top five suppliers accounting for around 40% of the market on a value basis. In contrast, for industrial preservation, the top five suppliers account for 65% of the market.

OIL PRICES - How vulnerable is India to high oil prices?

Higher global crude oil prices will adversely impact GDP growth rates, inflation, the fiscal deficit and the current account deficit, but the country's macroeconomic stability is unlikely to be threatened.

Rising oil prices since 1999, initially as a result of OPEC supply-management policies, and later due to geopolitical uncertainties, had driven the international crude oil prices to an unprecedented level. Though oil prices have fallen recently from their peak levels, a sudden spike, which could be caused as much by a disruption in oil supplies as by demand increases, cannot be ruled out. The geopolitical situation in west Asia may well change abruptly. Also, the International Energy Agency in its recent World Energy Outlook (2006) has stated that over 70 per cent of global primary energy demand in the future will come from developing countries, led by China and India. This means prices of oil and gas will have a crucial bearing on the prospects of these economies.

How much of a threat do high oil prices pose to the Indian economy? If we go by the performance over the last few years, then it is quite evident that high oil prices have had very little impact on the growth in the Indian economy. Is this indicative of the Indian economy’s resilience to withstand high oil prices? Perhaps, yes, so far. However, the prospect of the economy withstanding the impact of persistently high oil prices will depend how they behave in the future.

In order to test the vulnerability of the Indian economy to higher oil prices, we carried out a combination of statistical and simulation exercises to look at how different oil price outcomes (average price during the year) will impact the four macroeconomic indicators — growth rate, inflation rate, the fiscal deficit and the current account deficit. Taking a baseline scenario as an average annual price of $64 per barrel, we look at an optimistic scenario with $55 per barrel and pessimistic ones with $80 and $100 per barrel.

The statistical estimate of GDP with respect to the price of oil is a useful summary measure of the sensitivity of the economy to an increase in oil price. The estimates of the relationship between GDP and oil prices, however, depend to a degree on what oil price measure we use. Many studies simply use the international price of oil assuming full pass-through to the domestic economy — a method we know is not really applicable to the Indian economy. Therefore, in the four scenarios presented, we have not taken the international price of oil as such, but the pass-through of international oil prices to the domestic economy, which is reflected in the Wholesale Price Index (WPI) for mineral oil. Based on the mineral oil component of the WPI, we have estimated GDP growth under alternate oil price scenarios.

A hike in oil prices increases the production cost of goods and commodities as well as transportation costs. This increase in input costs is passed on to the consumers, who ultimately end up paying higher prices. In our exercise, we used elasticity measures to quantify the impact of higher oil prices on general WPI, and hence on inflation.

We have also simulated fiscal deficit scenarios using a model that takes into account the international oil prices and their impact on the government’s payment of subsidies, and tax collections through impacted GDP. The gap between international and domestic prices of cooking fuels is increasing due to stagnant domestic cooking fuel prices coupled with higher international oil prices. Therefore, it would adversely impact the government’s overall subsidy bill and hence the fiscal deficit. Beyond this, however, economic activity in general tends to slow down due to higher oil prices, and this will lead to a lower tax collection and hence a higher fiscal deficit. Thus, we see the fiscal deficit of the government impacted via two channels.

For a country like India, which is heavily dependent on imported oil, ceteris paribus, a substantial increase in the international crude oil price will also lead to an increase in the oil-import bill. However, the slowing down of GDP growth due to higher oil prices will have an offsetting impact on non-oil imports. Both these factors will determine the net effect on the current account balance. We have treated oil and non-oil imports separately to find out the impacts of higher international oil prices. For oil imports, an algebraic decomposition of oil import intensity of GDP has been made. Non-oil imports have been linked to the activity in the economy captured through impacted GDP following a change in international oil prices. These specifications allow us to generate potential current account scenarios.

Our analysis of the impact of high oil prices on the Indian economy reveals some interesting results. Under the most likely scenario (average basket price of around $64 per barrel during 2006-2007), our results show that GDP growth would be 8.3 per cent and inflation would be 5.0 per cent. The fiscal deficit as a percentage of GDP would settle at 3.9 per cent and the current account deficit is estimated to be around 1.0 per cent of potential GDP.

At the basket price of $55, the Indian economy is expected to experience GDP growth of 8.7 per cent. Our simulation shows that inflation would be around 4.2 per cent, and the fiscal deficit would become 3.9 per cent of the potential GDP. The current account deficit would come down to 0.2 per cent of India’s potential GDP.

If the price touches $80, GDP growth would drop to 7.8 per cent and the inflation would cross the 6.0 per cent mark. The fiscal deficit as a percentage of potential GDP would become 4.0 per cent. Thus, our analysis indicates that if the Indian basket touches $80/barrel, it is unlikely that the fiscal deficit target for 2006-2007 would be met. The current account deficit would rise to 2.6 per cent of potential GDP.

While $100/barrel now appears increasingly improbable, it does serve as a reasonable limiting case in the simulation exercise. Under this scenario, while the GDP growth would further shrink to 7.1 per cent, inflation would inch up to 7.7 per cent. The fiscal deficit/GDP ratio would further increase to 4.2 per cent due to both a reduction in tax revenues and the government’s additional expenditure to fund increase in subsidies. The current account deficit would bloat to 4.5 per cent of potential GDP. The significant deterioration in the current account deficit, combined with declining capital inflows because of slower growth, might push the economy to the brink of a balance of payments problem. But, as we have said, the probabilities are rather remote and within the bounds of realism, macroeconomic stability does not appear to be threatened by high or rising oil prices.

To sum up, higher global crude oil prices will adversely impact all parameters included in our analysis, but the economy appears remarkably resilient. On average, a $10/barrel price rise reduces GDP growth by around 35 basis points, increases inflation by 75 basis points and fiscal deficit/GDP and current account deficit/GDP ratio by around 7 and 97 basis points, respectively.

BS