The Hindu Business Line : Rising protectionism in Europe

Rising protectionism in Europe is affecting both investment and trade. This is a challenging time economically and politically for Europe. What could be the impact for India and the rest of the developing world?

The export sector is dragging the entire European economy down with it, with orders and overseas sales plunging.

Mohan Murti

As I file this week’s column, the world’s 20 most important government leaders are about to meet in Washington D.C. to discuss an ostensibly new fundamental reform of the financial system. I am reminded of an anecdote my father related to me from the Gospel of Sri Ramakrishna. As the story goes, Ramkrishna Paramahansa one evening, walks out of his ashram, and sees a very drunk fellow searching about on the ground around a lamp post. Ramakrishna goes over and a sks what he’s doing. “I’m looking for my keys,” he says. “I lost them in the alley behind the bar.” “Then why are you looking for them all the way over here?” Ramakrishna asked. “Because the light is so much better,” answered the drunkard.

Unfortunately, few expect any major changes from the summit. Europe and the US have different visions for the future of finance. To defend Wall Street’s dominance, the US wants to remain the prevailing force on the capital markets. The Europeans are deeply divided, once again. And, even the so called ‘emerging markets’ such as India and China are only ‘sort of’ interested in all-embracing restructuring efforts.

Indeed, it already seems obvious that the new-fangled financial order will end up looking suspiciously like the existing one. What’s more, US President-elect Barack Obama will not be at the meeting, making it impossible to weigh the extent to which he might shore up the reforms.

In the words of Ramkrishna Paramahansa, “we don’t see things as they are. We see things as we are. I worry that the G-20 leaders are all wobbling around, where the light is better, searching for answers they will never ever find. And, it’s too dark, gloomy, sinister, mysterious, where the ‘key answers’ rest, to help us discern how we got into this mess. Let’s wait and see what emerges from the G-20 weekend rendezvous.

Meanwhile, the Organisation for Economic Cooperation and Development (OECD) has confirmed that the entire industrialised world is already in a state of recession. Indeed, a sense of general economic gloom has descended on the 15 countries that belong to the euro zone. The German economy — Europe’s largest — did shrink by 0.4 per cent in the second quarter. For years, Germany’s economy has been buoyed by strong exports.

Now that orders and sales overseas have plunged, the sector is dragging the entire economy down with it. This is a challenging time economically and politically for Europe. What could be the impact for India and rest of the developing world?

Protectionism up

Protectionism is rising — both in terms of oratory as well as action. It is affecting both investment and trade, and my expectation is that this will continue to get worse. My fear is confirmed by recent research, sponsored by CMS and international research firm Oxford Analytica.

Numerous innocuous activities are being hit by ham-fisted legislative swipes — both through direct prohibition and, indirectly, by creating a climate of uncertainty. That said, there is at least some optimism that the scope for protectionism is constrained by the international nature of trade and capital.

Free Movement of Capital

EU member states cannot enact national legislation that restricts the free movement of capital, whether within the EU or with non-EU members. However, some member-states want to enshrine greater protectionist measures in their national legislation.

Estimates place the current level of assets under management by Sovereign Wealth Funds at between 1.2 and 2 trillion euros. SWFs will be hit real hard, in Europe. Poor governance is a weakness of many large ones. Some of the major SWFs are held by States outside the EU that have become geostrategically very important.

If they do not change voluntarily, they will be likely to have more tedious restrictions imposed by Brussels, or national governments. Cash-rich national level pension funds may well also be adversely affected by legislation directed at SWFs.

Non-EU Investors

There is a minefield of legislation that non-EU investors need to take into account when buying stakes in European businesses. Except for the UK and the Netherlands, rules exist that openly discriminate against foreign investors.

For instance, a new law may come into effect from January 2009, whereby the German government could intervene in all acquisitions concerning at least 25 per cent of the shares of any German company by any entities from outside the EU. This law is certain to create uncertainty and put non-EU investors at a disadvantage in time-critical situations.

Implications for M&A

As a corollary of current developments, Indian investors must be particularly aware of political changes in the jurisdiction of the target company.

Experience has shown that enhanced awareness of national interest can create resistance to cross-border M&A transactions, in some cases causing national governments to intervene. This sentiment must not be underestimated.

I expect that the M&A regulatory minefield will get more complicated and restrictive for non-EU investors — certainly over the next few years and may be for much longer.

In the past five years, my frequent trips to Brussels have been drastically reduced as the EU use of anti-dumping and countervailing measures on imports had declined overall. But, in the current economic turmoil, I fear non-tariff barriers in EU could restart. Indian companies need to be prepared to counter this with a proactive plan.

For instance, the EU’s REACH — chemicals registration law — is not only draconian but also difficult to comprehend. There are already signs of a trend towards greater European ‘trade protectionism,’ specially so following the collapse of the Doha Round of the WTO.

In a worst case scenario, the European Union will completely turn away from further multilateral trade integration and simply negotiate bilateral agreements. Indian businesses need to be particularly wary of, and be prepared to lobby against, adverse trade restrictions introduced purportedly for environmental and other reasons.

Industry and trade associations such as the CII and FICCI will need to be prepared to challenge where the measure is unjustified or not proportionate.

(The author is former Europe Director, CII, and lives in Cologne, Germany. blfeedback@thehindu.co.in)

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