PERSPECTIVES · 2017. 3. 31. · facilities which could boost the US oil industry. Citi analysts remain positive on the energy sector but investors need to be selective as the sector

FEBRUARY – MARCH 2017

PERSPECTIVES

VIEWS

Thoughts on US

Border Tax

INSIGHT

Energy: Oil to lead the

way in 2017

ISSUE 2

MONTHLY PERSPECTIVES

PERSPECTIVES | 2

All forecasts are expressions of opinion, are not a guarantee of future results, are subject to change without notice and may not meet our

expectations due to a variety of economic, market and other factors. Likewise, past performance is no guarantee of future results.

Dear Clients,

Since the US Presidential Election in November, U.S.

equities have rallied 6% on expectations of deregulation and

tax reforms. The Trump administration’s proposed tax

reforms incorporate a Border Tax Adjustment (BTA) so that

companies will no longer be able to deduct the cost of their

imported goods, and the sales of their exports would no

longer be subject to U.S. tax. This radical reform potentially

pits U.S. exporters against importers and will have significant

impact on individual company performances as well as the

U.S. economy. In this edition of Perspective, we detail the

rationale behind the BTA proposal, its effects and the

likelihood of its implementation.

Policies from the new U.S. administration will also impact the

energy sector. President Trump indicated his intention to

reverse President Obama’s decision to veto the completion

of the Keystone pipeline bringing Canadian crude oil from tar

sands in Alberta to the US Gulf Coast. He also wants to

enhance US energy and economic security by facilitating

greater production of oil and natural gas. The likely result will

be more pipelines, processing plants, and storage and export

facilities which could boost the US oil industry. Citi analysts

remain positive on the energy sector but investors need to be

selective as the sector has already rallied 27% in 2016.

I hope you enjoy reading this edition of Perspectives. Please

talk to your Citibank relationship manager to discuss how the

developments in financial markets can impact your

investment portfolio.

Best regards,

Paul

Perspectives

Paul Hodes

Head of Wealth Management

Asia Pacific and EMEA

Citibank N.A.


PERSPECTIVES | 3



Thoughts on US Border Tax

Since President Trump’s inauguration in

January, there has been significant focus on

his proposed tax reforms, which incorporate

a Border Tax Adjustment (BTA). In a tax

system with border adjustment, U.S.

companies will no longer be able to deduct

the cost of their imported goods, and the

sales of their exports would no longer be

subject to U.S. tax. This radical reform

potentially pits U.S. exporters against

importers and will have significant impact on

companies and economies globally. In this

article, we explain the rationale behind the

BTA proposal, its effects and the likelihood

of its implementation.

What is a BTA?

A Border Tax Adjustment (BTA) is the policy

on U.S. government taxation for imports and

exports. In a tax system with border

adjustment, U.S. companies would no longer

be able to deduct the cost of their imported

goods and the sales of exports would no

longer be subject to U.S. tax.

Why does the US want a BTA?

Firstly, the primary motivation for including

BTAs in the tax reform proposals appears to

be to raise federal revenues. The U.S. trade

deficit (imports exceed exports, by roughly

US$500 billion annually – see Figure 1)

implies that revenues earned by taxing

imports would exceed those lost by

exempting exports under BTAs in the near

term.

Views

This is important given that other elements

of the tax reform would likely add to future

budget deficits (such as lowering personal

and corporate income tax rates and allowing

immediate expensing of capital

investments). Secondly, BTA appeals to

‘Bring Jobs Back’ supporters because they

may give the U.S. a competitive advantage,

as it is essentially equivalent to an export

subsidy-cum import-tariff.

What are the effects of BTAs?

A recent IMF study suggests that a 10%

permanent increase in U.S. tariffs on imports

(but no exports’ subsidy) would lead to an

8% real appreciation of the U.S. Dollar in the

first year after the tariff implementation and

raise U.S. inflation by 0.1%. At the same

time, the adjustment would lower U.S. and

global real gross domestic product (GDP) by

0.3% and 0.1% respectively as the much

stronger US Dollar would lower the foreign

demand for U.S. goods and lead to a decline

in business investment.

Sources: Census Bureau and Citi Research as of 20 Jan 2017

Chart 1: Trade Balance, Exports and Imports

(US$ billion, 12 month sum), 1992-2016


PERSPECTIVES | 4



Given that prices and currencies are unlikely

to adjust fully to offset the tax on imports

relative to exports, Citi analysts believe that

there could be real impact on profits and

trade, with BTA favouring US net exporters

versus importers. In Citi analysts’ view, the

spillover impact on trade and production will

depend on 1) the extent to which price and

currencies adjust to the new tax adjustment

2) the exposure to US trade adjusted for

how easily the goods can be substituted and

3) risks of retaliation by US trading partners.

Which countries are likely to be most

affected?

In assessing the vulnerability to a US BTA,

Citi analysts first looked at both the relative

size of domestic value added of exports to

US versus total imports from the US (Figure

3). Next they examined industries where the

US has a relative comparative advantage

and thus could pose a competitive challenge

for countries with similar industry exposure.

The exercise revealed the following:

• With Trump targeting the auto industry for

domestic production and investments, a

BTA could affect countries where auto

trade with the US is large e.g. Mexico and

Canada. If export prices of US autos

become more competitive globally, this

could pose greater competition for Japan,

Korea and Germany.

• Emerging Asia does not have many

overlapping industries with the US where

the US has a high comparative

advantage.

• Even among the economies that have

large trade exposure to the US via

manufactured goods including China,

Korea, Malaysia, Singapore, Taiwan and

Vietnam the relative overlap appears

more limited relative to the developed

economies. Within Asia, India appears

most insulated, followed by Indonesia.

Potential risks

BTA for corporate income taxes is unlikely to

be compliant with WTO rules: WTO rules

only allow border adjustments for indirect

taxes (such as VAT), but not direct taxes

(such as personal and corporate income

taxes).

In Citi’s view, U.S. trading partners would

likely retaliate against U.S. BTAs in

corporate income taxes if implemented.

Examples include countervailing duties on

imports from the U.S. in line with WTO

policies, as well as less transparent

measures such as delays in customs

processing or in providing licenses or more

intrusive regulatory inspections.

Sources: US Trade data from CEIC, Haver, Citi Research as of 17 Jan 2017

Chart 2: Domestic value added of exports to US and imports

from US (% of GDP)


PERSPECTIVES | 5



Key Takeaways

• In a tax system with border adjustment, companies would no longer be able to deduct the

cost of their imported goods and the sales of their exports would no longer be subject to

U.S. tax.

• The BTA is expected to lead to a stronger U.S. Dollar and higher U.S. inflation, while

having ambiguous effects on the U.S. trade balance and U.S. activity. The BTA may also

have negative effects on activity in the rest of the world.

• Within US equities, big importers such as retailers, tech hardware and autos are

particularly vulnerable. On the other hand, exporters such as aerospace, defense and

mining equipment could benefit.

Citi analysts also believe that the retaliation

may not be specifically against the U.S., but

could usher in a less open international

trading environment. Citi analysts suspect

that U.S. BTAs would raise the risk of a

significant further increase in global

protectionism and the risk of a trade war,

which is among the major risks Citi identified

in our 2017 outlook.

Will the BTA be implemented?

It is uncertain whether a BTA will be

included in any U.S. tax reform passed in

the coming years. Citi suspects that BTA will

be part of the House budget bill but will not

be passed by the Senate. However, Citi

analysts stress that the risk of some form of

BTAs being included in tax reform is

material. Indeed, we expect some form of

BTAs will be part of the House budget

proposal that will likely be presented in

Spring 2017.

It is possible that the perceived appeal of

BTAs (competitive benefits, some fiscal

revenues) will likely allow it to survive the tax

reform negotiations.

Market Implications

Citi analysts see a potential US border tax

as having important implications for markets

and companies across the world. Within US

equities, big importers such as retailers, tech

hardware and autos are particularly

vulnerable. However, exporters such as

aerospace, defense and mining equipment

could benefit.

Companies which export to the US look

most exposed to a border tax, especially in

the auto and tech sectors. As such, Korean,

Taiwanese and Mexican equities may be

vulnerable.


PERSPECTIVES | 6



Energy: Oil to lead the way in 2017

OPEC’s production cut in January,

coordinated with Russian and other non-

OPEC producers have helped tighten supply

and provide support to oil prices. Citi

analysts expect Brent crude prices to edge

higher and reach mid-$60s by year-end.

President Trump has talked about achieving

American energy independence and

eliminating excessive regulatory burdens on

the industry, setting a positive outlook for the

energy sector.

Oil market re-balancing picks up pace

In 2017, supply is again expected to be the

key driver for oil as oil demand grows 1.1

million barrels per day (m b/d), down from

1.3 m b/d in 2016 (Chart 1).

Since the start of 2017, Saudi, Kuwait and

the U.A.E appear to have cut production

more than expected.

.

Insights

It is estimated that Saudi has cut output by

1m b/d, more than the 750 k b/d combined

reduction agreed by the three producers in

2016. While some analysts are concerned

the Saudis and the Gulf Cooperation Council

(GCC) could resume supply in 2H17, above

4Q16 production levels, Citi analysts believe

that production is likely to resume slowly

given that producers are keen to maintain

prices around the $60/bbl mark.

The return of Shale is critical to the

medium term outlook

After nearly two years of falling production,

the recent rally in oil prices has spurred a

surge in drilling in the US shale patch. US

rig count rose by 15 to 566 in the week

ending 20 January 2017, the highest since

November 2015. US shale production is

expected to resume its growth trajectory in

2017 and maintain the uptrend as long as

prices stay above $50/bbl (Chart 2).


Chart 1: Global Oil Supply vs. Demand Growth (million

barrels per day)


Chart 2: Shale Production Trajectories Under Various Prices


PERSPECTIVES | 7



Citi analysts expect Brent to trade in the

mid-$60s/bbl by end-2017. By 2018, Citi

estimates that US shale oil production could

return to the previous peak of 5.5 m b/d

reached in early 2015, which may cap Brent

prices in the mid $50/bbl range (Chart 3).

Policies will be key

Policies from the Trump Administration can

also impact volume, capacity and prices of

the energy sector. President Trump has

indicated his intention to reverse President

Obama’s decision to veto the completion of

the Keystone pipeline bringing Canadian

crude oil from tar sands in Alberta to the US

Gulf Coast. He also wants to enhance US

energy and economic security by facilitating

greater production of oil and natural gas.

More pipelines, processing plants, storage

and export facilities can boost the US oil

industry.

Energy Sector likely to outperform

The energy sector rallied 28% in 2016 and

Citi analysts remain positive. Among the

large oil and gas companies, known as

supermajors, Citi analysts favour companies

that can deliver sustainable, low-cost growth

with a business model that has adjusted to

the reality of lower oil prices.

Citi analysts are also positive on companies

that offer integrated services. These

companies are exposed to both shale and

the Middle East, which Citi analysts believe

are areas of growth.

In contrast, offshore driller fundamentals

remain weak. Demand continues to face

headwinds as large numbers of rigs get

completed and operators remain reluctant to

sanction new work at low oil prices. Citi

analysts are concerned about companies

that have too much debt on their balance

sheets.

Finally, there is more to the US energy story

than just oil. Natural gas producers are

expected to grow production volumes and to

respond to rising domestic as well as

international demand for cheap US natural

gas. Citi expects prices to average $3.3 in

2017 as infrastructure bottlenecks could

potentially lead to a supply shortage.

Source: Citi Research. As of 4 December 2016.

Chart 3: Citi Brent Price Forecast ($/barrel)


PERSPECTIVES | 8



Key Takeaways

• Citi analysts expect Brent to trade in the mid-$60s/bbl by end-2017 as the oil market re-

balancing picks up pace. The sector may also benefit from new policies from the Trump

Administration.

• Citi analysts remain positive on the energy sector but investors need to be selective. Citi

analysts favour companies that offer integrated oil services. These companies are

exposed to the shale industry as well as the Middle East, which Citi analysts believe are

areas of growth.

• There is more to the US energy story than just oil. Natural gas producers are expected to

grow production volumes and to respond to rising domestic as well as international

demand for cheap US natural gas.


PERSPECTIVES | 9



World Market At Glance

Source: Bloomberg as of 17 February 2017.

Last price 52-Week 52-Week

17-Feb-17 High Low 1 week 1 month 1 year Year-to-date

US / Global

Dow Jones Industrial Average 20624.05 20639.87 16165.86 1.75% 4.02% 25.34% 4.36%

S&P 500 2351.16 2351.31 1891.00 1.51% 3.67% 22.02% 5.02%

NASDAQ 5838.58 5838.58 4425.72 1.82% 5.41% 28.77% 8.46%

Europe

MSCI Europe 412.38 415.10 353.59 0.76% 1.44% 8.54% 3.08%

Stoxx Europe 600 370.22 372.09 307.81 0.77% 2.15% 12.61% 2.43%

FTSE100 7299.96 7354.14 5788.74 0.57% 1.10% 21.05% 2.20%

CAC40 4867.58 4932.35 3955.98 0.81% 0.16% 14.98% 0.11%

DAX 11757.02 11893.08 9125.19 0.77% 1.88% 25.38% 2.40%

Japan

NIKKEI225 19234.62 19615.40 14864.01 -0.74% 2.24% 21.46% 0.63%

Topix 1544.54 1559.22 1192.80 -0.13% 2.35% 20.44% 1.71%

Emerging Markets

MSCI Emerging Market 939.03 947.27 732.69 0.95% 4.93% 27.62% 8.90%

MSCI Latin America 2624.85 2683.59 1735.59 0.98% 7.58% 48.28% 12.14%

MSCI Emerging Europe 149.91 153.21 105.51 -0.75% 0.98% 38.84% 2.17%

MSCI EM Middle East & Africa 255.78 259.12 200.24 1.05% 1.96% 24.80% 4.50%

Brazil Bovespa 67748.42 68455.85 41070.88 2.46% 5.27% 62.74% 12.49%

Russia RTS 1152.21 1196.99 725.40 -1.03% -0.37% 56.59% -0.01%

Asia

MSCI Asia ex-Japan 562.24 564.37 453.62 0.92% 4.86% 24.08% 9.31%

Australia S&P/ASX 200 5805.82 5833.20 4838.30 1.49% 1.87% 18.92% 2.47%

China HSCEI (H-shares) 10360.13 10544.10 7837.65 2.32% 6.78% 30.67% 10.27%

China Shanghai Composite 3202.08 3301.21 2638.96 0.17% 3.00% 11.67% 3.17%

Hong Kong Hang Seng 24033.74 24364.00 18867.70 1.95% 5.22% 27.00% 9.24%

India Sensex30 28468.75 29077.28 22494.61 0.47% 4.53% 21.76% 6.92%

Indonesia JCI 5350.93 5491.70 4627.64 -0.39% 1.59% 12.28% 1.02%

Malaysia KLCI 1707.68 1729.13 1611.88 0.51% 2.68% 2.61% 4.02%

Korea KOSPI 2080.58 2092.59 1892.75 0.27% 0.42% 10.44% 2.67%

Philippines PSE 7244.79 8118.44 6499.00 0.13% 1.71% 7.22% 5.91%

Singapore STI 3107.65 3118.30 2588.83 0.23% 3.15% 18.89% 7.88%

Taiwan TAIEX 9759.76 9869.59 7999.98 0.97% 4.33% 18.81% 5.47%

Thailand SET 1577.84 1600.79 1293.48 -0.47% 0.70% 22.46% 2.26%

Commodity

Oil 53.40 55.24 28.73 -0.85% 1.75% 74.17% -0.60%

Gold spot 1234.95 1375.45 1121.03 0.11% 1.47% 2.18% 7.18%

Historical Returns (%)


PERSPECTIVES | 10



Currencies Forecasts

Source: Bloomberg and Citi Forecasts as of 17 February 2017.

Last price

Currency 17-Feb-17 Mar-17 Jun-17 Sep-17 Dec-17

G10-US Dollar

Euro EURUSD 1.06 1.05 1.02 0.99 0.99

Japanese yen USDJPY 113 116 119 123 125

British Pound GBPUSD 1.24 1.23 1.20 1.17 1.15

Swiss Franc USDCHF 1.00 1.00 1.02 1.04 1.05

Australian Dollar AUDUSD 0.77 0.79 0.77 0.76 0.75

New Zealand NZDUSD 0.72 0.73 0.71 0.70 0.69

Canadian Dollar USDCAD 1.31 1.32 1.33 1.34 1.35

EM Asia

Chinese Renminbi USDCNY 6.87 6.91 7.01 7.10 7.12

Hong Kong USDHKD 7.76 7.77 7.77 7.78 7.78

Indonesian Rupiah USDIDR 13,333 13,594 13,557 13,520 13,500

Indian Rupee USDINR 67.02 67.9 68.3 68.8 69.1

Korean Won USDKRW 1,146 1,172 1,187 1,202 1,204

Malaysian Ringgit USDMYR 4.45 4.53 4.56 4.59 4.57

Philippine Peso USDPHP 50.05 50.4 50.6 50.7 50.5

Singapore Dollar USDSGD 1.42 1.45 1.46 1.47 1.47

Thai Baht USDTHB 35.01 35.6 35.8 36.0 35.9

Taiwan Dollar USDTWD 30.78 31.4 31.5 31.7 31.8

EM Europe

Czech Koruna USDCZK 25.46 25.92 26.04 26.16 26

Hungarian Forint USDHUF 290.52 296 304 313 317

Polish Zloty USDPLN 4.08 4.17 4.21 4.26 4.25

Israeli Shekel USDILS 3.70 3.80 3.82 3.84 3.86

Russian Ruble USDRUB 58.29 57.7 59.0 60.3 61.3

Turkish Lira USDTRY 3.63 3.76 3.81 3.85 3.90

South African Rand USDZAR 13.04 12.98 13.48 13.99 14.32

EM Latam

Brazilian Real USDBRL 3.10 3.11 3.19 3.26 3.31

Chilean Peso USDCLP 644.82 663.00 667 672 675

Mexican Peso USDMXN 20.43 21.1 21.4 21.7 21.8

Colombian Peso USDCOP 2891.56 2944 2994 3045 3045

Forecasts


11



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