Wednesday, June 09, 2010

An entrepreneur's journey to Brazil

"Theo's adventure capitalists" is arguably the first Reality TV show focused on entrepreneurship in emerging markets. Here you can watch the episode about doing business in Brazil.

Part 1

Part 2

Part 3

Part 4

An entrepreneur's journey to India

"Theo's adventure capitalists" is arguably the first Reality TV show focused on entrepreneurship in emerging markets. Here you can watch the episode about doing business in India.

Part 1

Part 2

Part 3

Part 4

An entrepreneur's journey to Vietnam

"Theo's adventure capitalists" is arguably the first Reality TV show focused on entrepreneurship in emerging markets. Here you can watch the episode about doing business in Vietnam.

Part 1

Part 2

Part 3

Part 4

Friday, May 28, 2010

South Africa as an emerging market

Here is a very interesting video interview of South Africa's Deputy President Kgalema Mothlante discussing the outlook for his country and more broadly offering insights on Africa as the last emerging frontier for investment and economic growth.

Also some very interesting insights on Chinese approach to doing business in Africa.

Monday, May 10, 2010

China's state capitalism and multinational corporations

Here is an interesting piece on China's state capitalism - I call it "red capitalism" - from Ian Bremmer, president of the political-risk consulting firm Eurasia Group.

Bremmer points out that although communism is dead the state still plays a very important role in China through its direct control (ownership) or indirect control (tight regulation) of a vast network of entreprises which are viewed as "national champions" and opposed to western multinationals which are increasingly having a hard time as the Google case signals.

At the end of the day, capitalism is all about politics and geopolitics as Bremmer argues.

Here is a short extract :

"So if you are a Western multinational, and your model is saying, “I’m going to be making lots and lots of money in state-capitalist countries,” you better have reasons to believe that, over the medium and long term, you will still be able to do business there. In other words, are there local competitors right now? Are they of scale? Will there be [competitors] in three or five years? What is it that you offer that is not only indispensable today but is going to be indispensable tomorrow that [the state] cannot compete with, rip off, or decide it doesn’t need because there are local, state-owned or stated-connected companies that will take you out? And I will tell you that Western multinational CEOs have not yet gotten this joke. This is of critical importance."

You can watch the whole piece (7 minutes), courtesy of McKinsey Quarterly.

Saturday, June 13, 2009

Brazil : time to loosen the brakes on growth ?

The Central Bank of Brazil trimmed the Selic benchmark rate by one percentage point, 25 basis points more than expected by market analysts, to a record low 9.25 percent on Wednesday, June 10. However, it also said that from now on further reductions would be carried out "more parsimoniously". Markets applauded this bold move with the Real continuing to appreciate against the Dollar

So far this year, the Central Bank slashed 450 basis points off the Selic benchmark rate, in an unusually aggressive move that is intended to support the ailing Brazilian economy, which is witnessing its first recession since 2003. As a matter of fact, the economy shrank 0.8 percent in January-March from the final three months of 2008, which saw a 3.6 percent decline from the previous quarter.

While this monetary easing is much wellcome, we believe that the Central Bank should go further, reducing the SELIC rate down to potentially as low as 6.5%. At a time of faltering inflation, the Central Bank has now a historical opportunity to turn its focus temporarily away from an orthodox inflation targeting policy to a pro-growth policy, while preserving the hard-won benefits of macroeconomic stabilization, that have been acquired since the early 2Ks.

Even at 9 percent, the benchmark interest rate is still the highest in the world among the major global economies. It is important to recall that this high interest rate was the price that Brazil had to pay for decades of economic mismanagement that resulted in skyrocketing inflation rates and brought down the country several times on the brink of collapse.

But with inflation expectations now robustly anchored below 5%, the largest Latin American Economy could not afford to keep this monetary burden on growth at a time when it mostly needs to support domestic demand.

One of the key arguments often pushed forward by Brazilian policymakers to justify such a high interest rate is the "confidence factor". According to this thesis, Brazilians still remember the decades of lost growth associated with hyper-inflation much in a similar way as Germans are almost anti-inflationist by nature with memories of the post WWI hyperinflation still deeply rooted in their minds.

This "confidence factor" is also related to foreign investors' appreciation of the Brazilian economy, which triggers the fear of so called "sudden stops"in foreign capital inflows. But this story also belongs to the past, and international investors are now more concerned by the huge US deficit than by the current state of the Brazilian economy, which has shown quite a remarkable resilience in the wake of the worst global economic crisis since the Great Depression.

In addition, one technical explanation behing high interest rates in the context of inflation targeting, is the alledgedly high pass-through from the exchange rate to domestic inflation, which is reinforced by the volatility of the exchange rate.

However, recent studies have shown that the pass-through from the exchange rate to inflation has been substantially reduced in Brazil over the last years. With commodity prices surging again, there should be no reason to keep confiscatory interest rates solely for a "self-insurance" purpose against a potential exchange rate crisis. Again, this is an obsolete story.

The real challenge for Brazil now is to accelerate its transformation from an economy that is still highly reliant on commodity exports, to a diversified industrial economy and further down the road to a knowledge-based post-industrial economy.

Lowering the interest rate to "decent" levels would be one important step in this direction.

Thursday, May 28, 2009

Can China lead the global recovery ?

There was much talk as of late on the potential for China to lead the global growth recovery that is forecast by many economists by the end of this year.

Although China has certainly much more weight in the global economy now than it used to have in the past, it would be rather naive to think that the Chinese growth can really lift, per se, the global economy. The reason for that is simple. In nominal GDP terms, the developed economies still account for nearly three quarters of the global economy.

At the present time, China is more dependent on the rest of the world than the world is dependent on China, although commodity exporting countries are directly or indirectly exposed to Chinese growth through its effects on commodity prices. Indeed, the price of oil for example is heavily dependent on marginal changes of demand coming from China, but for this relationship to hold strongly it is also important that oil demand recovers in the major developed economies. This is exactly the kind of circular causality effects that make it difficult to forecast any impact of Chinese growth on world growth.

What China can do, and effectively does, is to weather down the impact of the global recession on its economy by actively mobilizing its huge fiscal and monetary reserves. The cheer size of the stimulus package that the government has enacted is a much needed substitute for growth at times when the exports engine is havoc. China is like a plane that now runs on one reactor, putting much effort on investment in infrastructure and domestic demand. It is better than having no reactor at all, but this public-funded engine cannot support the economy for ever. Exports are still much needed for China, although in the long run the transition to a consumption-led, knowledge-based service economy is the real challenge.

I leave you with some chinese economists' views on China from this interesting panel brought together by McKinsey Quarterly.

Sunday, March 01, 2009

Is the BRIC concept still relevant ?

Here is an interesting view on the concept of BRIC (Brazil, Russia, India, China) by Milton Ezrati, senior economist at Lord Abett.

The whole concept behind the BRIC, that these four countries were leaders, is no longer the case today," said Ezrati, who published a report this week titled, "Broken BRIC."

You can watch Ezrati's interview with

It is true that the BRIC concept is as much a marketing invention, coined by Goldman Sachs economists for promoting emerging markets, , as it is a research concept.

However, contrary to Ezrati's view, and although BRICs may be suffering from the financial crisis at various levels of intensity, I still believe the BRIC concept holds much of its explanatory power as an easy way to describe the long term rise of these four large regional emerging powers. No other emerging country can challenge these 4 countries leadership in the "emerging markets universe".

Ezrati is right when he points out at the existence of other emerging countries that should not be excluded from an emerging markets investment strategy.

Wednesday, February 11, 2009

Chinalco's investment in Rio : the great leap forward ?

Chinalco Operations Map. Source : Chinalco

Chinalco, the Chinese state-owned metals and mining conglomerate, has made a decisive leap forward today by agreeing to invest $ 19.5 bn in troubled mining giant Rio Tinto. This move comes one year after Chinalco successfully acquired - jointly with the Alcoa group - a 12% stake in the UK listed arm of the Rio Tinto group, equivalent to a 9% stake in the group itself.

According to the Financial Times, "the deal, which will involve the sale of minority stakes in some of Rio’s best mining assets and the issue of convertible bonds, marks the biggest ever investment by China in a foreign company. Chinalco will buy $7.2bn in convertible bonds which will convert into Rio shares at a later date. That would increase its stake in Rio from 9 per cent to 18 per cent. The rest of the capital injection comes from the sale of the minority stakes."

As a matter of fact, Chinalco is pursuing an agressive growth strategy abroad, by taking advantage of the current slump in commodities prices, to buy strategic assets at a distressed price. This is consistent with a rising trend among state-backed Chinese companies, not only in the resource sector but in other sectors as well, to consolidate their dominant position at home and to expand abroad, as I wrote in a previous post three months ago.

Indeed, as Yan Janging, from Caijing Magazine reported, according to some experts the current uncertain environment could be a good opportunity for Chinese companies to continue their expansion overseas. He quotes Ian Sperling-Tyler, oil & gas director in Deloitte saying that China's state-owned oil companies may have an especially good chance to buy close to 19 independent oil firms, the market values of which are all lower than their net assets.

Although, the Chinalco Rio deal can still be hindered by regulatory authorities in Chile and Australia, or by angry shareholders in the UK, it is an important symbol of the structural shift in global capitalism. A shift that signals distinct features from the pre-crisis world.

All in all, if there is one more thing this deal tells us, it is that China's thirst for all kinds of commodities remains unquenchable, and that this thirst will be sustained through 2009-2010 by the huge amount of stimulus money flowing into the infrastructure and construction sector. Given the ongoing "supply destruction" and the CAPEX freeze at the global level that we are witnessing now, this will sooner or later push the price of commodities up and reignite the same kind of commodity-driven inflationnary cycle that the world has known over the 2003-2007 period.

Tuesday, December 23, 2008

End of an annus horribilis : worse yet to come ?

Pieter Bruegel the Elder, The parable of the blind, 1568

Here we are at the end of this "annus horribilis" that brought down the world to its knees, marking the end of a global expansion cycle falsely described as the dawn of a new era of perpetual growth and enduring prosperity.

In a world that has gone madoff as this year's Nobel Prize winner Paul Krugman puts it, we are witnessing the return of the very notion of risk, whereby we start to recon that there is no such thing as "pure alpha" without some kind of "hidden beta". We haver learned that everything - including liquidity - eventually comes at a price. And we are now realizing that many of the Wall Street mavericks with six figures salaries and stratospheric bonuses are not the fascinating geniuses and "beautiful minds" that we were idolizing, but a mere bunch of rogue mercenaries devoid of any sense of ethics or collective responsability.

The emperor is naked and so are his knights, dark and white altogether. Ironically many hedge funds, which as their name purportedly indicates were supposed to hedge against risks, were actually engaged in the same race of blind yield generation and risk complacency that sealed the fate of some of the most reputable financial institutions down the Street.

The whole financial sector turned out to be a huge ponzi scheme set out by the few with the silent complicity of the many, including politicians from all parties, regulators from all public bodies, central bankers that printed money for free, rating agencies whose reputation is now tarnished by the conflict of interest at the heart of their business, and last but not least, corporate leaders, that were more worried about their stock option plans and golden parachutes than about the viability and long term growth prospects of their companies.

In a way, we are paying now the consequences of three decades of deregulation starting from the phasing out of Regulation Q in 1980 in the United States and going through to the subsequent endorsement of the Washington Consensus at the international level, which profundly altered the nature and scope of the Bretton Woods institutions (IMF, World Bank). The current financial system regulation could be described at best as "the parable of the blind guiding the blind" as illustrated in the eponymous painting of Pieter Bruegel the Elder.

Take the Basel Comittee which was set up in the nineties to avoid the accumulation of bad debt in OECD banks balance sheets. It was so successful that it led to the development of a whole new generation of financial products aiming at putting all the risks off-the-balance sheet, away from regulatory oversight. The same could be said with the development of the Credit Default Swaps (CDS) which transfered credit risk attached to junk bonds from specialized investors to "mainstreet" insurance companies, happy to earn more from this activity than from their traditional actuarial based business model. We know how the story ended, with the in extremis bailout of AIG and the fall of the so-called monoliners.

In a world of free capital flows, there is a need for a global regulation of these capital flows. The fact that this basic truth has been finally put on the global agenda at the G20 summit in Washington is an encouraging step in the right direction. But we are still far away from a comprehensive solution to the problem of regulatory loopholes and regulatory arbitrage as long as rules differ substantially depending on whether your are "legally" based in New York or in the Cayman Islands. Indeed, offshore finance is a second word for regulatory arbitrage.

Now, that the financial crisis has spread to the real economy, governments around the world are shifting their attention from the desperate calls of a handful of financiers to the much vocal ills and ires of their broad constituencies. However, it would be a dramatic mistake to let the financial reform momentum fade away. The stakes are high and yes, the time of half measures is definitively over. The world expects the new US administration to show determination and a real leadership on these pressing issues, even if it comes at the price of reigning in one's own perception of sovereignty and independence.

Yes, we can. Let us do it now.

Wednesday, December 17, 2008

Pump up the volume : ZIRP & QE

Here come the ZIRP little darling ...

As a former central banker, I cannot hold the pleasure of a short comment on that.

Yes, indeed the FED has gone as far as ZIRP (Zero Interest Rate Policy). It has also commited to QE (Quantitative Easing) which it has done already for some months by inflating its balance sheet in order to jump start the bankrupt US economy.

Let us be short. There are three questions that we can ask ourselves regarding the ZIRP/QE policy. I will try to bring my own answer to each question.

1. Did the FED has another choice ?
I would say Yes. Because once you committed to QE - which was arguably the case for the FED at least since the Lehman collapse - you are supposed to use every possible means to achieve that, including ZIRP.

2. Will it work ?
The answer is "it depends". Actually despite, a body of litterature on ZIRP/QE and a review of the Japanese experience, there is no evidence that QE works. It is a pure monetary - let's even say monetarist - bet. However, as we know since New Keynesian Economics became the mainstream of short term macroeconomic analysis, it "could work" precisely because it is based on an illusion, an artificially generated price increase that lifts supply and demand by avoiding deflation.

3. When will it produce any effects ?
Here comes the main issue. As Krugman and other economists pointed out, it can take years before ZIRP & QE produce their effects. It depends on the ability of the banking system to channel the extra liquidity to the economy. By all accounts, in 2009 banks will rather use the money to restructure their balance sheets and drop the remaining toxic waste they still hold.
To avoid these long delays, what is needed is a combination of ZIRP/QE with demand stimulation in the form of a massive fiscal package and a low dollar.

Bottom line : Was ZIRP necessary ? yes, it was. Will ZIRP work ? it could work but nothing is certain. Will ZIRP alone work ? clearly not.

Wednesday, November 19, 2008

What next for the emerging economies after the G20 summit ?

For all its shortcomings, the G20 summit that was held in Washington on November 15 is already a historical event. Indeed, as the Financial Times writes in its November 16 editorial, this summit marks a shift of economic power and a recognition that the emerging economies will play a key role in reforming the global financial system that was shattered down by the worst financial crisis since the Great Depression.

"We are talking about the G20 because the G8 doesn’t have any more reason to exist,” said Luiz Inácio Lula da Silva, Brazil’s president.

The summit agreed to throw open to emerging economies the membership of all the key groups that frame the rules of global finance, including the Financial Stability Forum which was set up by the G7 countries following the Russian crisis and the collapse of LTCM in 1998. This summit also reinforces the case for a genuine refoundation of the Bretton Woods institutions, the IMF and the World Bank, far beyond the cosmetic reform of quota rights that has been enacted so far.

This recognition was unescapable for the "trillion plus" economies of China, India, Russia, Brazil, Mexico, Korea and the GCC which not only attract a substantial share of all the FDI and equity capital flowing from the developed countries, but also increasingly act as providers of capital for these same developed countries, as is demonstrated by their large holdings of US treasury bonds, and their participation in the bailout of distressed american and european financial institutions.

Altough the capitalisation of emerging equity markets has been savaged in the aftermath of the financial crisis, they still represent 20% of the world market capitalisation (down from 25% in January 2008). In the long term, the potential for these markets development remains important as their fast growing economies will continue to generate new companies in search of funding. China already records the biggest IPOs in human history with companies such as China Mobile, China Life or Industrial and Construction Bank of China raising billions of dollars in the last few years. And this is only the beginning. Many emerging countries market capitalisations are very low compared to their gross domestic product. As these countries adopt modern corporate practices they will move away from the family held private firm model to the more transparent public company model.

In fact, if there is one lesson to be learned from the financial crisis for emerging economies as well as for developed ones, it is the need to be less dependent on financial flows originating from one single country like the United States. This has always been true but while such a talk would have been played down as mere rethoric a few years ago, the structural shift of capital sources, from the North and West to the East and South, makes it more appealing and more feasible now.

Hence, as the emerging economies strenghten their economic and trade relations with one another, they also need to look at new ways to enhance their financial ties. Eventually, this would benefit the whole world as capital flows would be more balanced between different geographical areas. This would accompany the rise of a multipolar world order and put an end to the "core-periphery" model of globalization that has been in place for the last two hundred years.

At the official level, this could involve a generalization of permanent currency swap agreements between the largest emerging economies across the world, which would then in turn sign agreements with the smaller countries in their respective areas of influence. Such a move would lower the dependance of the world on the US dollar and constitute an adequate response to excessive currency volatility, while preserving the advantages of flexible exchange regimes.

Regional currency unions are also needed to stabilize the global financial system. The case for a currency union in the GCC is becoming more pressing as was illustrated by the recent difficulties of these countries to curb down inflation, because their peg to the US dollar prevented them of using monetary policy which is by far the most powerful instrument to fight inflation.

New emerging platforms should allow emerging markets companies to raise debt and equity capital, bypassing the old channels. Initiatives are flourishing here and there with local exchanges such as the Dubai International Financial Center (DIFC) ambitioning to become a capital hub for the Middle East North Africa and South Asia (MENASA) region. Delivering the key note address at the 'Leaders in Dubai Business Forum', HE Dr Omar Bin Sulaiman said:"DIFC is focusing on a project to develop a major node where companies from Egypt, India or Azerbaijan, could find capital from emerging markets through a listing or through private equity deals or any other convenient instrument." Also worth mentioning is the initiative of the Asian Development Bank (ADB) which aims at establishing a unified market for local currency bonds in East Asia. According to a new report by the ADB this market has shown great resilience to global credit turmoil and can be a key source of funds for Asian governments and corporates.

No doubt, for emerging economies these are challenging times, but what the G20 summit shows is that the old financial world is over. At this stage, nobody knows what the new financial order will look like, but what is sure is that the emerging economies will play a significant role in shaping this new order.

Tuesday, October 28, 2008

Looking beyond the crisis : a world of BRICs

The US financial crisis that started in July 2007 with the collapse of two Bear Sterns subprime hedge funds has now turned into a full-blown global economic crisis. Arguably, the climax of the financial crisis has been reached with the collapse of Lehman Brothers on September 15, and the subsequent fall of stock markets all around the world.

Since then, governments have been hastily working out massive bailout plans for their banking systems, in the United States, the European Union, Russia, South Korea, and elsewhere. This was a long awaited recognition that radical measures were needed to avoid a global collapse given the huge amount of outstanding derivatives and other off-the-balance-sheet liabilities threatening the stability of the global financial system.

Despite this massive effort, it is clear that the large developed economies will undergo one of the most difficult periods since many decades. The deleveraging process will be long and painful because the liquidity crisis has translated in a permanent increase in the cost of capital which makes the current downturn much more pronounced than previous ones.

It is also clear that some medium-sized emerging economies such as Hungary, Turkey or Ukraine, that relied heavily on foreign capital to fuel their domestic growth are feeling the heat as foreign investors start to repatriate capital to safer places. Hungary and Ukraine are in the process of being bailed-out by the IMF and will have to sacrifice growth for some years. Turkey has also seen large outflows of capital, but it is in a better shape now than at the start of the decade when the country had to devalue its currency and drastically restructure its economy.

The key question however is the impact of the crisis on the "trillion plus" emerging economies of China, India, Brazil, Russia, Mexico, and Korea, and the extent to which it could jeopardize their long term growth potential.

In this regard, China and India have been relatively spared thanks to their lack of financial integration with the world. By contrast, there are sobering news coming from Russia, Mexico and Brazil, where healthy companies now struggle to roll over debt due to foreign investors. As a matter of fact, in the past few weeks the yield on corporate bonds of leading Mexican companies such as Cemex and Telmex have skyrocketted. Mexican and Brazilian companies are facing billions of losses because of the sharp depreciation of their domestic currencies against the US dollar. Finally, Russian oligarchs are desperately asking and getting - at a heavy price - the support of the Kremlin to pay back foreign creditors who threatened to seize large shares of Russian companies, which were pledged as a collateral for loans.

Nevertheless, the situation is in no way comparable to the nineties where one big emerging country defaulted after the other. The liquidity problems faced today by Russian, Brazilian, or Mexican companies are much more manageable than the solvency problems faced by their governments a decade ago. With huge foreign exchange reserves of over half a trillion US dollars, Russia has made it clear that it can deal with the crisis without external help. Mexico, Brazil, and South Korea, also have reasonable foreign exchange reserves. Besides, they are supported by the Federal Reserve which has commited USD 50 billions to each of these countries in currency swap agreements, as a recognition of their "systemic importance". In addition, all these countries have actioned comprehensive bailout plans for their financial sectors and for their blue chip companies through state-guaranteed liquidity lines, injections of capital, tax exemptions and the like.

Most importantly, when the dust will settle down, and the world economy will gradually recover from the crisis, the new expansion cycle will be, by all accounts, dominated by the BRIC economies. China will get out almost unaffected by the crisis. The likely slowdown of the chinese economy in 2009 will probably be very moderate because it will be cushioned by the massive spending plan announced by the Government to boost the construction sector and support falling house prices. The slowdown will result in a much welcome consolidation across a wide spectrum of industries ranging from mining, power generation, automotive, and white label manufacturing, to real estate development and financial services.

In a year or two from now, Chinese large banks and manufacturing companies backed by the state could take over some iconic brandnames in the western world. Take the automotive industry. While the "big three" US carmakers, GM, Chrysler and Ford are on the brink of bankruptcy, the booming Chinese car industry is moving forward thanks to a rapidly growing domestic market and to the ever improving quality of local brands which benefited from partnerships with western carmakers. The Obama administration will likely wellcome any foreign investments in this distressed sector rather than running the risk of losing hundreds of thousands of jobs. No doubt, China has the will and the financial resources to become a superpower, but it still has to transform itself and achieve its democratic transition, under the pressure of a growing urban middle class.

The Russian economy will escape a 1998 style collapse and consolidate its influence in regional and world affairs as a global supplier of energy and military technology. No matter how untrustful Russia's political elites may appear to the West, there is no choice but to cooperate with them and include them in the game, in order to concentrate on the weak spot of the planet, namely the Middle East. On the other hand, Russia's renaissance as a global power is far from granted, as it will depend critically on the government's ability to move to a knowledge based economy from its current over reliance on natural resources.

Finally, among the BRIC countries, India and Brazil are probably going to make the most important breakthrough in the coming years. They have unleashed their growth potential only in the nineties (in 1991 for India and 1994 for Brazil) and much of their growth acceleration still lies ahead. Contrary to China and Russia, India and Brazil will continue to benefit from the "demographic dividend" with a growing working-age population.

Brazil is not only one of the world's biggest and most diversified commodity producers, it is also becoming a major competitor in high-end technologies, with a competitive edge in cleantechs and renewable energies. Brazil's most accute problem, the low average level of education of its 190 million population is being addressed by comprehensive social programs such as Bolsa Familia which encourages poor families to send their children to school. As a result the gap between the poor and the rich, deemed to be the highest in the world, will gradually narrow in the next decade, paving the way for a growth potential closer to the 10% magical threshold.

Last but not least, India, the world's largest democracy, has recently decided to tackle the infrastructure problem with a massive investment program over the next 20 years. It has set up one of the most investor-friendly PPP legislation and is attracting foreign capital from all over the world to help it, litterally, bridge the gap. Education is still a daunting issue for hundreds of millions of peasants relinquishly kept out of the "shining India" picture. However, the liberalization of the economy has unleashed the energy of millions of entrepreneurs and has considerably improved social mobility, leading to a widening of the middle class. There are opportunities in almost every sector and the so-called "licence raj" has substantially decreased over the last years. True, India has still a long way to go before it joins the club of advanced nations, but it already has serious credentials in information sciences, nuclear engineering or space technology.

All in all, retreating now from emerging markets, and from the BRIC countries in particular, although seeming rational in an environment of high risk aversion and liquidity dearth, would be a serious mistake in the long run, given the almost intact growth potential of these economies and given their importance in shaping tomorrow's world, far beyond the current crisis.

Friday, October 17, 2008

The outlook for China's big four banks

The Empire state building dressed up in red and yellow to celebrate the official opening of ICBC's branch in New York on October 15, 2008

Record profits for Chinese banks

China's "big four" commercial banks have posted record profits in H1 08 reflecting the resilience of the Chinese economy which grew by 10.4% in the first half of the year. َ

As a matter of fact, the operating profit of Industrial and Construction Bank of China (ICBC, HKG:1398), China Construction Bank (CCB, HKG:0939), Bank of China (BOC, HKG:3988) and Bank of Communications (BOCOM, HKG:3328) grew on average by 35% in H1 08 from the same period a year ago. After-tax profit jumped on average by 62% , BOCOM leading the way with an 81% increase and BOC lagging behind with a mere 38% . In addition, the return on equity of the four largest chinese commercial banks reached a stunning 23% up from 19% a year ago.

With an after-tax profit of RMB 64.9 billion yuan ($9.57 billion) in H1 08, ICBC, which is already the bank with the biggest market capitalization in the world, became the world's most profitable bank, largely ahead of follower HSBC which posted a profit of $7,7 billion.

At a time when the United States face their worst financial crisis since the Great Depression, these figures signal a shift of financial power to China and reward the prudent policies put in place by the Chinese authorities over the last expansion cycle to reign in credit and avoid the accumulation of bad loans that clogged the banking system in the late nineties.

In a context of increased competition from both domestic and foreign players, China's "big four" banks have achieved a dramatic transformation over the last five years moving from an administrative culture to a customer-centered culture, extensively diversifying their offering of products and services, and opening up their capital to global financial institutions such as Citigroup, HSBC, and Bank of America.

Preparing for the downturn

Ironically the exceptionnal H1 profit figures have been permitted to a large extent by the PBOC's six consecutive hikes of interest rates in 2007/2008 which boosted the commercial banks interest margin, before the central bank reversed its policy in September, amid growing concerns over the economy. In fact, interest income still contributes between 75% and 85% to the operating profit of the big four, although the contribution of net fee and commission income has steadily increased over the last few years. If the PBOC lowers by 100 bp its benchmark rate in the coming months, this could cut off roughly 20% to 30% of the banks operating income.

In addition, the fee and commission income comes in part from wealth management services can be significantly impaired if the stock market does not stabilize in the coming months.

Finally, although there should be no hard landing of the chinese economy in 2009 if domestic demand remains strong enough to compensate for reduced external demand, any slowdown will impact heavily the most exposed sectors of the economy : small private export firms mostly based in the Pearl River delta, and property developers which will be hurt by the falling property prices in some of the country's major urban hubs (Shenzen, Shanghai, Hanzhou,...). Hence, credit losses are likely to rise over the next few quarters, therefore negatively impacting the commercial banks operating income.

All in all, H2 profits figures are likely to bring more sobering news than the skyrocketing H1 figures. However, with an average capital adequacy ratio of 13, with a geographically diversified business across all the major provinces of China, with a stable funding made up mostly of corporate and individual deposits, the Big Four are relatively well prepared for the downturn. Besides, the valuation of their shares is now exceptionnally attractive given their high return on assets, their low cost-to-income ratio (around 35%) and their long term growth potential.

Bottom line : if you want to make a bet on China's long term growth story then make a bet on China's big four banks !

Thursday, October 09, 2008

An insider's view on emerging markets

I recommend this interview of indian private equity fund manager, Mr. Partha Gandhi, managing director of Vision Investments, published today by The Economic Times. Here are some excerpts from this interview. Mr. Gandhi conforts our long secular view on emerging equities while aknowledging that there could be still a lot of volatility and downside pressure in the next 6 to 12 months.
With the liquidity crunch accelerating, how do you map the emerging market universe in the next 3-6 months?

If there is a slowdown in the US, you are going to see a fallout across every major country in the world. If you go back and look at some of the financial crises that you have had over the past century, there are quite a few. If you start mapping these out, this is one of the worst we have seen in a long, long time. In the emerging market universe, markets like India, Brazil or China are showing signs of decline. Markets are typically going to look to future and based on that, there will be issues. ICICI Bank is a case in point.

They have issued a statement saying they have not been affected in a big way, and I tend to agree. You will find that Indian banks have some exposure, but not tremendous exposure. We are looking at tough times ahead, at least for the next 6 months.

I believe that the entire emerging market sector, whether China or India, is going to start looking better around June next year. By which time, you will see more clarity, more visibility in the market. What I would look for in emerging markets is equities, where one can find quality through strong fundamentals and good cash flow.


What is your sense of where the Indian market is headed and how do we compare vis-à-vis other emerging markets now?

Indian markets have been hit by the recent global shakeout, but not as badly as others. That’s primarily because we have a strong domestic internal market. We are looking at global pressure, but the internal consumption story is very strong.

If you look at liquidity, we have a relatively well-regulated banking environment. In fact, it is the regulatory environment that has served as a cushion for India. We could have been completely open and in a lot more trouble.

That said, hedge funds have a lot of performance pressure compared to, say, private equity funds which can afford to take a 5-year view. So, short-term performance is a tough call right now.

Saturday, October 04, 2008

Why this could be the right time to buy emerging markets equities

In these times of high volatility and risk aversion, some people may find it foolish to buy emerging equities which are traditionnally considered as "high beta" risky investments.

It may seem a bit contrarian indeed, but I am not the only one to hold this view. Seasoned investors like Mark Moebius who manages 34 billions USD of assets at Templeton Asset Management are more bullish than ever on emerging markets (see video above).

Emerging markets have performed poorly this year

So far, it is true that emerging markets have suffered more than developed markets from the general flight to safety away from risky assets. As a matter of fact, on a year-to-date basis, the iShares MSCI Emerging markets ETF index (NYSE:EEM) dropped a whopping 39% compared with a drop of "only" 25% for the iShares S&P 500 ETF Index (NYSE:IVV) !

In addition, there is now a widespread feeling that the worst is yet to come for the global economy, as economic data clearly shows the United States, Europe and Japan have either entered into recession or are on the brink of it.

As investors around the world try to find out where are the next victims of the global credit crunch, one big question mark lies on the so-called BRIC countries (Brazil, Russia, India, China) which have alltoghether accounted for two thirds of global growth over the last five years (on a PPP basis).

So, is it just a matter of time before these economies falter and fall into recession ? For me, the answer is NO.

Why emerging economies will not fall into recession

With all the gloom and doom coming from Wall Street it is very difficult to keep one's nerves. If stock markets were a good predictor of developments in the real economy than we should really worry, as stock markets in the BRIC countries lost between 40% and 50% of their market capitalization in just a few months.

Actually, stock markets are NOT a good predictor of the real economy as far as emerging markets are concerned. At short time horizons, these markets are in fact much more influenced by the US stock market than by developments in their domestic economy. Call it financial integration or call it contagion it does not matter. This owes simply to the hegemonic nature of the United States which still account for 26% of the world GDP and 34% of the world market capitalization as of september 2008 (down from more than 50% five years ago).

The true story is that of a gradual decoupling between developed and emerging economies. The former are now going through a painful deleveraging cycle after having lived for many years"beyond their means". In sharp constrast, the latter are witnessing an unprecedented boom with domestic demand soaring thanks to massive investments in infrastructure, a construction boom, and an incredible consumption frenzy .

Don't mistake me, I am not saying that everything is rosy for emerging markets. Many export-led emerging economies will be impacted in a way or another by a recession in the developed countries. However, this impact should be cushioned by the growing South-South trade between emerging countries themselves. Hence, Russia and Brazil will continue to import manufacturing goods from Сhina and India which will in turn continue to buy commodities from the former to satisfy their huge thirst for energy and basic resources.

Some good reasons for investing now in emerging markets

Although the earning prospects of some companies based in emerging markets may be negatively impacted in the short term by slowing orders from the US and Europe, this provides them with an incentive to increase their productivity and to move up the value scale. As an example, Wen Jiabao, the Chinese Premier urged last week chinese manufacturing companies to invest more in innovation and to export more products under their own name, rather than just being low cost contractors for western companies. The same is happening in India, as the battle for Axon illustrates it, with indian outsourcing companies increasingly looking to expand beyond their borders, and to deliver high value-added services.

Another good reason for being bullish on emerging countries comes from the fact that they have been relatively well preserved from the global credit crunch. Indeed, most emerging economies are awash with cash, with large foreign exchange reserves and well capitalized banks which have developed overstretched investment banking departments, and have not invested in the kind of toxic securities that brought down to its knees the entire US financial system.

Finally, if you look at equity valuations, given the tremendous growth potential of these economies that still lies ahead, the current valuation of hundreds of blue chips companies from Turkey, Russia, China, or Brazil have never looked as attractive as now ! And although the MSCI Emerging Markets is down 39% this year it is still up by more than 93% from its level five years ago !

For all these reasons, this is the right moment to buy excellent assets at bargain prices, with the intention of holding them for 5 to 10 years.

Alex Kateb

This article has been published on Seeking Alpha, a leading investment website, at the URL

Wednesday, October 01, 2008

The battle for AXON and its implications for the Indian I.T. sector

As Ramit GUHA writes in the WSJ, the battle is raging between Indian firms INFOSYS (BOM:500209) and HCL (BOM:532281) for the takeover of AXON Group (LON:AXO), a British I.T. software company with strong value-added SAP implementation capabilities and with a foothold in the UK and in continental Europe.

This battle epitomizes the new creed among indian I.T. outsourcing companies as they try to diversify their clients base away from the ailing US market (that still represents 60% of their overseas turnover with the bulk in financial services), and as they seek to move up the value scale, away from low margin outsourcing into high margin services.

So far, indian outsourcing companies like INFOSYS, WIPRO, TCL, and HCL have done relatively well both in terms of revenue generation and margin expansion, with INFOSYS being unchallenged as the industry leader both in terms of revenue growth and profitability.

But the financial meltdown in the United States is forcing Indian outsourcing companies to reinvent themselves if they want to survive. As a matter of fact, wage inflation in India has reached double digit levels this year putting a strong pressure on costs amid a shortage of skilled labour, and international competition has increased in the low end of the business from сountries such as Vietnam, Ukraine, and the Philippines.

If as we expect, the cash-rich INFOSYS succeeds in this takover battle over AXON, it will strenghten its revenue generation potential and preserve its advantage over its local and international competitors. However, it will take more time and more substantial acquisitions for INFOSYS to compete with global consulting giants such as IBM and ACCENTURE.

In this regard, the dismissed rumour that had been circulating a year ago about a potential acquisition of Paris-based CAPGEMINI, a heavyweight in the European I.T. consulting industry with a workforce of 75000 equivalent in number to that of INFOSYS, looked much more like the perfect strategic move for the Indian company ! But at that time CAPGEMINI was probably considered "too big to swallow" by the Bangalore-based conservative management. Watch out for further developments this year !

Alex Kateb

This article was also published on Seeking Alpha, the leading provider of stock market opinion and analysis, at the following URL

Monday, September 29, 2008

What is an emerging market ? What is a frontier market ?

Starting a blog on investment in emerging and frontier markets supposes some clarification on the nature and scope of the aforementioned concepts regardless of the confusion surrounding them.

The term "emerging markets" was coined in the early 80s by an economist at the world bank called Antoine Van Agtmael arguably as a substitute for "developing markets" in order to attract investors from developed countries by insisting on the growth opportunities offered by developing markets. Hence, in its broadest sense, the term "emerging markets" may include such diverse countries as China, Tunisia, Peru or Croatia.

Further, the term "frontier markets" was coined in the late 90s to designate the developing countries that were not included in the first wave of "emerging markets" because of various economic, institutional, or political factors. One of these factors is the under-development or the lack of openess of their capital markets, and more generally the lack of institutional development sustaining growth as compared to other more mature emerging economies.

As an illustration, the MSCI Barra Emerging Markets Index, an established asset management industry benchmark, is composed of company stocks from the 25 following countries : Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, Turkey.

In addition, MSCI Barra also provides a Frontier Markets Index which includes 19 countries : Bahrain, Bulgaria, Croatia, Estonia, Kazakhstan, Kenya, Kuwait, Lebanon, Mauritius, Nigeria, Oman, Qatar, Romania, Slovenia, Sri Lanka, Tunisia, Ukraine, United Arab Emirates, Vietnam.

The case of countries like South Korea, Taiwan, or Israel is controversial as they already reached the status of developed countries but are still sometimes considered as emerging markets because of their historical belonging to that class and/or the prevailing political uncertainties and risks.

There are some common caracteristics to the countries viewed as emerging or frontier markets.

On the positive side, these countries are generally growing faster than developed economies and their domestic markets present huge opportunities both for local and for foreign companies.

On the negative side, their economic growth is more volatile with sometimes large cyclical swings and violent boom & bust episodes. These countries are also more prone to go through episodes of political instability, violence, and war.

All in all, the definition and scope of emerging and frontier markets should not be taken for granted for ever but rather viewed as a convenient mental scheme which needs to be renovated and cleansed every now and then.

Our focus will be on equity investment in large emerging markets such as the BRIC (Brazil, Russia, India, China) and a handful of other key emerging economies : Mexico, Indonesia, South Africa, Egypt, Ukraine, etc.

In order to identify investment opportunities in these markets we will adopt an approach combining top-down macroeconomic and political analysis with bottom-up sector and company analysis.