Recent financial headlines may seem stuck on repeat. China! Market correction! Fed rate hike! China! Oil! China! As important as those happenings are, they aren’t the only events markets consider. Several other stories caught our eye this week, and while they may not make the front page, investors shouldn’t overlook them.
India Lays out the Welcome MAT
India announced it wouldn’t retroactively implement a minimum alternative tax (MAT) on foreign businesses—good news for investors. India’s minimum alternate tax, established more than two decades ago, requires firms whose effective tax rate is less than 18.5% to pay a minimum 20%, plus additional duties. Now, historically this only applied to firms with a permanent presence in India—not foreign institutional investors. That position was affirmed by Indian courts in 2010, seemingly clarifying matters. However, in 2012, a regulatory ruling in response to a Mauritius-based firm’s attempt to clarify the country’s position, changed this—suggesting even foreign firms are subject to the tax.
There the issue sat for a few years, with occasional court disputes, typically involving long running cases like Vodafone’s continuing quibbles with India over taxes due related to its 2007 acquisition of Hutchison. However, in February 2015’s budget announcement, Finance Minister Arun Jaitley said MAT wouldn’t apply to foreign companies from April 1, 2015 onward. (Onward being the key word.) Weeks later, news broke that over 100 fund managers received a bill for back taxes amounting to over $6 billion, sending investor sentiment reeling. Even though the confirmed number in back taxes ended up considerably lower ($9.6 million for 68 overseas funds)—and the government changed the law so the MAT wouldn’t apply to funds in the future—the uncertainty concerned investors.
An unexpected, retroactive grab of a company’s profits would scare off many from investing in that country, and the MAT’s return also reinforced the image of India’s unfriendly business environment, a reputation the country has struggled to shed. Confidence in Prime Minister Narendra Modi’s ability to enact reform also took a shot. Now, Finance Minister Arun Jaitley has officially stated the MAT won’t apply retroactively to foreign businesses.[i] While it didn’t happen in the last Parliamentary session, Modi has announced a controversial labor-reform package that would give Indian businesses much-needed flexibility. Couple these developments with one of the faster growing world economies—India recently announced GDP grew 7.0% y/y in Q2—and India’s future seems bright. This illustrates an underappreciated truth about Emerging Markets (EM) in general: You can’t make blanket judgments about the category. India runs counter to the notion all EMs are reform-challenged, commodity-heavy economies poised to weigh on the global economy. Non-commodity-heavy EMs exist too! And are growing just fine and seem poised to continue contributing positively to global demand.
The EIA Says Things About Oil Exports
A highly anticipated US government report found lifting the 1975 oil export ban wouldn’t have the dire consequences (i.e., higher gas prices) many fear. The US Energy Information Administration’s report stated, “Petroleum product prices in the United States, including gasoline prices, would be either unchanged or slightly reduced by the removal of current restrictions on crude oil exports.”
The reason: “Petroleum product prices throughout the United States have a much stronger relationship to North Sea Brent, an international crude oil benchmark price, than to West Texas Intermediate (WTI), a domestic benchmark price.” Why? Because US oil producers pump mostly very light crude. US refineries were built to handle heavier, imported oil, a product of the era when many thought US oil was a thing of the past. In other words, the global market sets US gasoline prices. US oil producers are banned from exporting crude oil, but that is just one input global energy markets consider—it alone doesn’t determine the price of refined petroleum products, like gasoline. Disallowing crude exports actually limits global gasoline supply, pushing prices upward. If the US lifted its oil export ban—a legacy of the 1970s oil shock—it may even lower gas prices, since it would allow shale producers to sell their oil at the global marketplace. Foreign refineries can then produce more petroleum products (including gasoline), and a higher supply of gas leads to lower prices (assuming equal demand, of course).
The export ban could be lifted by either presidential executive order or by passing a law, and while gridlock persists[ii], support to remove the antiquated ban is growing—House Speaker John Boehner has said lifting the ban would be a top priority this fall.[iii] Both parties have reasons to remove the ban for their constituents (Jobs! Lower gas prices! More exports!), especially now with the EIA’s support. Now, if this came to pass, it would add new markets for US oil, a plus for Energy firms. But that alone probably isn’t cause to bottom fish for Energy stocks today.
Greeks Will Vote ... Again
After now-former Greek Prime Minister Alexis Tsipras called snap elections to consolidate his power, polls show Syriza’s lead slipping, prompting speculation about a relapse to Greek political uncertainty. On August 20, Tsipras resigned after his Syriza party splintered. Tsipras set elections for September 20, an attempt to retain power with a solidified base. Most presumed it would be an easy win, based on earlier polls showing Syriza had a 15-point lead and Tsipras was the most popular man in Greece, sporting a 70% approval rating.
That was then, though. Now, polls show the leftist party’s support has taken some serious hits, with one showing center-right New Democracy ahead of Syriza. Even Tsipras has seen his popularity plummet—New Democracy’s Vangelis Meimarakis has pulled in front of the former premier per the latest numbers. This is triggering some worries that if Syriza doesn’t garner a majority in Parliament, it may result in a fractious coalition that can’t get anything done—and may put all of Greece’s reform “progress” in jeopardy. (The more things change, the more they stay the same!) However, several caveats accompany all this. About 25% of the electorate is undecided, and even though the election is just 16 days away, campaigning has barely begun. Candidates can rise and fall over night. Recent pre-election polling also has had a very spotty track record. Exhibit A: the unexpected Conservative sweep in the UK. Exhibit B: the recent Greek referendum. And even if election results are inconclusive or lead to a rag-tag coalition that can’t agree on anything, this isn’t necessarily a big negative, either: It’s more the status-quo for Greek politics, and while they grab headlines, markets have long priced in the country’s political antics. Regardless, unless you’re a fan of weird and wacky politics,[iv] the actual impact here on financial markets is still close to nil—Greek contagion risk remains minimal, and the country is too small to materially impact markets come default, grexit or continued bailout.
Following Q1’s -0.8% annualized contraction, Canada contracted -0.5% in Q2—officially entering recession by one widely accepted definition. However, its economic struggles aren’t a big surprise. Energy comprises a big slice of Canada’s economy, and with oil prices plummeting for more than a year, many of Canada’s oil and mining projects have become unprofitable. Canada’s oil benchmark—Western Canada Select—trades at a steep discount to global prices.[v] That said, don’t put Canada in the same boat as commodity-dependent nations like Russia and Brazil. Canada has healthy consumers, solid Financials and Health Care sectors and open borders (important given its proximity to one of the world’s biggest and strongest economies). So while Canada’s energy industry is big enough to push GDP slightly into the red, it is unlikely to drive a deep, dire downturn. And from a broader perspective, Canada comprises about 2% of global output—growth elsewhere should more than offset.
In Other News …
US manufacturers built stuff in July, especially cars. The stronger dollar didn’t ding US exports in July. Puerto Rico restructured some of its debt. They’re making lots of houses in the UK. Banks made money in Q2. Here are some nice charts. China!
[i] The Vodafone case is still unresolved.
[ii] As we’ve written often, gridlock doesn’t prohibit legislation from passing. It just lowers the likelihood big, sweeping change passes in its most onerous form.
[iii] Now as we always say, watch what folks do, not what they say. Still, it’s worth taking note.
[iv] And if you are, you’re in good company.
[v] WCS is currently at $C43.23, or about $32.56 USD, as of 9/3/2015. Global benchmarks like WTI and Brent are currently at $49.20 and $47.97, respectively, as of 9/3/2015.