Category Archives: Europe & Mideast

The ongoing challenge of assessing Frontier Markets political risk

2013.12 Frontier Markets Political RiskI’m generalizing it, but frontier markets political risk is my main takeaway after reading through Clear Path Analysis’ just-released Investing in Frontier Markets 2013.

And if that doesn’t get you excited, don’t let that deter you from looking further as there’s a lot of other stuff in there that I’m totally glossing over.

Some highlights:

Asked what kind of investors are mostly interested in frontier markets and how they’re using the exposure, Yvonne Bakkum of FMO Investment Management had this to say:

“We are talking about a diversified African private equity proposition to U.S. institutional investors, and it strikes me that we hardly have to explain the Africa story to them. They seem very well aware of the fundamental attractiveness of Africa as an investment destination but, are still studying the best way to access that opportunity. What type of asset class, should they go through public markets or private equity and if so should they select funds themselves or use a fund of funds vehicle? These are the types of questions being asked but in most cases the interest still needs to translate into actual commitments. Some African institutions haven’t decided as to whether they should invest and there we see an interesting discrepancy between the investment professionals and their boards of trustees. Trustees tend to be more cautious and want to start with BRICs because they are the more advanced emerging markets or the ones closer to home, such as Latin America. This means that you don’t always get everybody aligned simultaneously.”

Oliver Bell, portfolio manager of Africa and Middle East strategy for T. Rowe Price wound up having a lot to say about East Africa, among which was this nugget on the key risks in investing in African markets:

“The key risk still remains around the politics and the economics but the two are quite strongly linked. The first risk is when you get a change of government. 50 of these countries have had elections in the last three years so we are no longer talking about despotic dictators – this has become a relatively democratic continent. The key risk is that if the opposition wins an election does power get handed over peacefully? We’ve just seen a transition of power in Kenya for example which was peaceful but five years ago the election transition was very brutal. The more times you go through the peaceful transition, the more entrenched the democracy becomes. In Ghana we’ve seen the handover of power peacefully a few times so you get the sense that democracy is now deeply rooted in their society.

Related to the politics is the economic fallout that can occur in the run up to elections, because you tend to find that the incumbents spend aggressively to ingratiate themselves with the electorate. The targets go out of the window leading to a larger fiscal deficit, which can lead to currency weakness and hence inflation. This knock-on effect usually corrects itself the year after an election but it remains one of those things that you need to be very aware of when investing in Africa. One other risk at the stock level that we assess, when considering an investment in a company, is whether there are any political connections that the company is benefitting from, as this is not sustainable in the long term, given that the politics can change quickly.”

And finally, Richard Fox, Fitch’s Head of Middle East and Africa Sovereigns, had this to say about MENA political risk:

“Political risk is a fact of life but it varies from country to country. And it doesn’t necessarily mean a country is off limits to investors. Going back to where we started, the World Bank Governance Indicators would put a country like Nigeria or Lebanon very low down on the political risk spectrum. Nevertheless, these countries have a track record of foreign investment receiving very good returns. Just because political risk is high doesn’t mean that people will not put their money there…

… You can have volatile political developments but this does not mean that they automatically affect financial markets. Despite the political ups and downs of Lebanon, including war, there has never been a default and people are allowed to withdraw their money freely which has worked very much in Lebanon’s favour. Environments can be very risky but if you have investors aware of and happy to take those risks then it isn’t really an issue. In most cases, risks can be priced.”

The Ties That Bind Russia

2013.12.03.leninIn keeping with the just-released 2013 Transparency International Corruption Perceptions Index, I’m always in the market for new ways to describe the obstacles one encounters when trying to get things done in developing countries.

Enter this very enlightening piece from Peter Pomerantsev in the London Review of Books. The premise is what Russians refer to as the “Sistema”:

There are any number of paths and initiations into sistema, the liquid mass of networks, corruptions and evasions – elusive yet instantly recognisable to members – which has ordered the politics and social psychology of Russian civilisation since tsarist times.

And here’s the super gut punch:

This is the genius of sistema: even if you manage to avoid the draft, you, your mother and your family have become part of the network of bribery, fear, simulation and dissimulation. You have learned to become an actor playing different roles in relation to the state, the great intruder you wish to avoid or outwit or simply buy off. You are already semi-legal, a transgressor, but that’s fine for sistema: as long as you only simulate, you will never do anything real, you will always look for compromise and you will feel just the right amount of discomfort. You are now part of the system. If a year in the army is the overt process that binds young Russians to the nation, a far more powerful induction comes with the rituals of avoiding military service.

Read the rest here.

And if you read carefully, you’ll see a discussion of rules and laws that harks back to the very first thing I wrote on this blog, here.

Chart of the Day: The World as 100 People

From Jack Hagley:

World-as-100-People_3

 

Charts Of The Day: Economic Potential In MENA

The most recent Milken Global Conference in Los Angeles featured a panel entitled, “Two, Three, Many Middle Easts: A Region’s Economic Prospects”, whose commentary is really only for the hard core MENA geeks, but I thought these charts were worth drawing attention to:

This one was the leader, showing average real GDP per capita from 1980 to 2000:

MENA Economic Development Variation 1

Here we have slides showing variation in GDP per capita across the Middle East and North Africa since 2001. Notice the y-axis scale difference between the Gulf states in the rightmost chart versus North Africa and “core” Middle East:

MENA Economic Development Variation 2

An approximate comparison of just how miniscule FDI flows to the region relative to the world:

MENA Economic Development Variation 3

Of the FDI that does go to the region, we shouldn’t be surprised to find more of it going to the oil producers than to the non-oil producers:

MENA Economic Development Variation 4

And yet expected GDP growth for the coming few years is expected to be mostly uniform:

MENA Economic Development Variation 5

Finally, intra-regional FDI against total FDI to the region:

MENA Economic Development Variation 6

The link to the full hour panel discussion is here and embedded below. If MENA development is your gig, I guarantee there’s something in there for everyone, from diplomats to venture capitalists and anyone in between. For my time, by far the best bang for the buck commentary comes from Chris Schroeder, who starts speaking at approximately minute 36. This man talks way too fast for me to transcribe or bother quoting any of it, but suffice it to say he depicts in words far more illustrious than any of these charts the economic potential the Arab World possesses.

How Much More Can Emerging Markets Debt Grow?

EM versus US High Yield Bonds riskLondon-based Clear Path Analysis has an excellent report detailing investment considerations for Emerging Markets debt and FX investing. So good, actually, that it’s forcing me to second-guess my previously held view that Emerging Markets debt is in a bubble approaching crisis proportions. It’s a long-ish report (32 pages) and it’s all important, so let’s get straight to some of the notable commentary they’ve put together. I think these quotes really speak for themselves.

Gregoire Haenni, Chief Investment Officer, CERN Pension Fund, on why Asia has and will continue leading EMs:

One of the main reasons why investors are beginning to allocate into EM is because of the Asian sovereign credit re-rating trend. Asian sovereign credit fundamentals have generally been on the up for the last six years which is in contrast to other developed countries. The fiscal discipline and underlying economy growth has capped government debt to GDP without exceptions and trade surpluses over the past decade have resulted in a build up of foreign exchange reserves.
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Chart of the Day: Frontier Markets Correlations, Round 2

S&P Capital IQ slipped this press release out last week, which I’m glad I followed up on since it led me to the following correlation chart:

Frontier Markets Correlation vs Major Indices

Equally important, this comment which came alongside it:

From an asset allocation perspective, one of the biggest positive differentiators of frontier market equities is their relatively low correlation with both developed and emerging market equities as well as commodities (see table 2). The asset class’ ability to “zig” when others “zag” is a function of its aforementioned limited integration into the global economy and its more domestically driven fundamentals, in our view.

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Charts of the Day: The Future Of Emerging And Frontier Markets

CarnacTheMagnificentThanks to Ernst & Young, I’ve got my retirement destination all picked out: Turkey.

Because, you see, in 2040, when I’m 67 years old, forget the BRICs or Mexico or Dubai or South-South anything; Turkey’s gonna be an export boomtown. Or at least that’s one of the forecasts E&Y is touting in its new Rapid Growth Markets forecast. And if, come 2040, I’m not rolling G-style through the souks of Istanbul, I’m definitely suing the crap out of the 2040 incarnation of Ernst & Young,  which by then might be better known as ErnstPWCDeloitte-Slim/Gates LLC dot unit D sector. 

In all fairness E&Y does a dependable job of summarizing the main economic characteristics of developing markets for those who don’t plug into this stuff every day.

And they also have a nifty online interactive tool you  can play with here.

For the rest of us…the thing is I really just have a hard time taking seriously any forecast that goes out to 2040. But let’s try anyway. According to the charts, those of us lucky enough to still be alive in 2040, assuming there’s still a human race by then, should probably be doing something with exports. But definitely not anything between the Eurozone and the US:

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Map Of The Day: Global Shipping Routes

Thanks to CNI Group for this:

2013.04.16.Global Shipping Routes

I guess what strikes me the most about this map is the huge blank spaces among the world’s global shipping routes: the Bay of Bengal, southern Australia, the west coast of South America, and pretty much all of sub-Saharan Africa that isn’t connected to either South Africa or the Gulf of Guinea. Of these, Australia at least has a viable road network. Relative to the entirety of the world, these don’t look like large spaces, but the increased costs for closing these gaps via land are not insignificant.

Another thing that comes to mind here is imagining how the shifts in shipping patterns may have happened over the centuries. Never mind the obvious growth in gross number of journeys; what I’m thinking of here is the opening up of new routes.

I’m not a shipping person, but I try to be as much of a history person as I can. Off the top of my head, I would venture that China’s periodic bouts with isolationism over the centuries have had material effects on the Asia routes, the most recent probably being a massive dropoff during the 1950s through sometime in the 1970s as China re-opened and Japan started coming online. And transatlantic development from the Industrial Revolution forward has kind of been done to death.

There’s also this book, which I’ve yet to read but has been on my to-do list since it came out. I suppose where this all leads is, what’s the future of this map? More specifically, how much of south-south trade development will any of us live to see?

A Diplomatic Way Of Saying A BRICS Development Bank Is A Stupid Idea

Dani Rodrik has this in Project Syndicate today:

It can be cause only for celebration that the world’s largest developing economies are regularly talking to each other and establishing common initiatives. Nonetheless, it is disappointing that they have chosen to focus on infrastructure finance as their first major area of collaboration.

This approach represents a 1950’s view of economic development, which has long been superseded by a more variegated perspective that recognizes a multiplicity of constraints – everything from poor governance to market failures – of varying importance in different countries. One might even say that today’s global economy suffers from too much, rather than too little, cross-border finance.

What the world needs from the BRICS is not another development bank, but greater leadership on today’s great global issues. The BRICS countries are home to around half of the world’s population and the bulk of unexploited economic potential. If the international community fails to confront its most serious challenges – from the need for a sound global economic architecture to addressing climate change – they are the ones that will pay the highest price.

Yet these countries have so far played a rather unimaginative and timid role in international forums such as the G-20 or the World Trade Organization. When they have asserted themselves, it has been largely in pursuit of narrow national interests. Do they really have nothing new to offer?

Read the rest here.

What Central Bank FX Reserves Really Tell Us

The New York Fed has just published what is absolutely mandatory reading for anyone with a stake in the foreign exchange market. It’s a 10-page pdf entitled, “Do Industrialized Countries Hold the Right Foreign Exchange Reserves?” and is one of those rare documents whose entire text is quotable, making excerpting rather difficult, but I’ll try to keep it short. The abstract provides a pretty good summary:

That central banks should hold foreign currency reserves is a key tenet of the post–Bretton Woods international financial order. But recent growth in the reserve balances of industrialized countries raises questions about what level and composition of reserves are “right” for these countries. A look at the rationale for reserves and the reserve practices of select countries suggests that large balances may not be needed to maintain an effective exchange rate policy over the medium and long term. Moreover, countries may incur an opportunity cost by holding funds in currency and asset portfolios that, while highly liquid, produce relatively low rates of return.

And this, from the opening paragraph, is also worth drawing attention to:

To date, the foreign exchange reserves of major industrialized economies have received relatively little attention in public policy circles, with few questions posed regarding their optimal size, composition, and use. Instead, discussion of foreign exchange reserves tends to center on the large holdings of emerging market countries—including China, whose reserves reached about $3 trillion in mid-2012. Foreign currency reserves are also overshadowed in public discussion by the much larger external imbalances that countries amass in the form of trade deficits and surpluses.

The key element here is that this paper only looks at the US, the UK, Switzerland, Japan, Canada, and the euro area, and rightly so as these are the big fish of the global FX market. The brief mention of emerging market countries’ holdings highlights what’s implied in the debate but rarely stated explicitly, so allow me to do so now:

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Video Of The Day: A Real Journalist Questions A Real Banker

This has become such a rarity, you really need to just put aside five minutes to watch this:

What The BRICS Really Have In Common

2013.03.28.BRICS as The_Breakfast_ClubSometimes news editors exercise such brain-dead judgment that it’s a wonder journalism as a practice even survives.

That sentence was one of a few I conjured up as a possible lead-off thought. Well, technically, it was the only sentence, since the rest are thoughts posed as questions. Here they are:

Is the BRICS Durban conference officially the acronym’s 14th minute of fame?

When will the country grouping of France, Uganda, Chad, Kenya, Oman, Fiji and Finland finally supplant the BRICS as the political economy cadre du jour? What about Bulgaria, Uganda, Lithuania, Latvia, Spain, Haiti, Italy and Thailand?

2013.03.28.bric_summit_durbanDoes anyone honestly still believe in the BRICS as an investment theme?

Am I the only one seeing that Brazil, Russia, India, China and South Africa may actually have less in common than a brain, an athlete, a basket case, a princess and a criminal?

What drives this apparently human need to shrink everything down into bite-sized archetypal infonuggets?

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Chart of the Day: World Gold Production in 2012

World gold production last year, sourced from here. Kind of speaks for itself I think.

2013.02.26.world-gold-production

Chart Of The Day: Emerging Markets Currency Wars Landscape

This is interesting:

2013.03.06.Swan FX Diagram

2013.03.06.Swan FX Table

And here’s an explanation of what we’re looking at:

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Map Of The Day: Emerging and Frontier Markets Dominate Global Reserves of Key Commodities

Why does it not surprise me that a map showing commodities reserves of emerging and frontier markets would have come from a Glencore report?

2013.02.20.Map of the day EM FM dominate global resereves of key commodities 2

Looking at it in these terms kind of raises an obvious question: how is it that these countries aren’t in more dominant positions of setting the global agenda, policymaking, or development? Chalking it up to corruption is a bit too easy,  and I’m honestly coming around to the opinion that nobody is totally free from corruption. It’s partly corruption, sure, but it’s also just simple logistics.

The Problem With Trying To Rank Emerging And Frontier Markets

“Only the most bullish should even think about putting up to 5% of their equity portfolio in frontier markets. And even that might be too much.” — Ben Levisohn

The March issue of Bloomberg Markets magazine apparently attempts to rank the “most promising” Emerging and Frontier Markets for investors according to relative economic performance across a variety of areas. And because we simply cannot resist rankings and lists, I’ve been spending some time digging through some of this which is currently available online (the methodology is described here).

So this is the EM table (go here if you prefer a slideshow format…I personally do not):

2013.02.19.Bloomberg Emerging Markets ranking

And here’s the FM table: Continue reading

Chart of the Day: Investment Banks’ share of Emerging Markets

Is this really the best way to communicate this?

2013.02.14.IB market share in EMs

Sourced from Bloomberg.

Central Banking Today: Game Theory Now More Than Ever

Take a look at this recent column from PIMCO’s Mohamed El-Erian and try to tell me otherwise:

With many other policy makers essentially missing in action, central banks find themselves in leadership roles not out of choice but necessity. Given imperfect tools, their involvement entails, to use the US Federal Reserve chairman Ben Bernanke’s phrase, “benefits, costs and risks”. They believe that macroeconomic benefits will outweigh the collateral damage; and they hope that they will buy sufficient time for others to respond properly and for economies to heal endogenously.

The dilemma of modern central banking was captured well last week by incoming BoE governor Mark Carney in his testimony to the UK House of Commons Treasury committee. While recognising the risks of further QE, the current Bank of Canada chief argued that central banks should act to avoid sluggish growth raising the natural unemployment rate via hysteresis.

The fundamental problem is that central banks are pursuing too many objectives with too few instruments. That is why outcomes consistently fall short of their expectations; and also why talk of exit is repeatedly shelved.

Absent better support from other policy makers, central banks will be dragged deeper into policy experimentation. Meanwhile, with incentive structures failing to align properly, perverse reactions are clear – from persistent (and, in Europe’s case, increasing) policy complacency elsewhere to distorted market functioning leading to potentially harmful resource allocations.

Then there is the biggest issue of all: the effects of unconventional monetary measures are likely to become volatile and highly binary if a growing number of central banks around the world feel they have no choice but to join the current western policy stance.

A larger global shift to expansionary monetary policy would enhance the probability of triggering “wealth effects” and “animal spirits”: the two channels through which policy-bolstered asset prices translate into better economic fundamentals. With that, the greater the likelihood of a pivot from “supported growth” to “genuine growth”.

However, relative pricing channels, including currency relationship, would be crippled if too many central banks were to opt for the same policy. Harmful beggar-thy-neighbour effects would amplify damage from artificial surges in asset prices that encourage irresponsible risk taking, fuel “bad inflation” and worsen the risk of disorderly economic and financial deleveraging.

Chart of the Day: What the Big Mac says about Eurozone prices

Borrowed Bruegel (source link here):

“…the Big Mac tells us that Italy is the most expensive place in the euro area. A Big Mac costs €3.85, while it costs only €3.6 in France and 3.64 in Germany. Or to put it in percentages, in July 2011, Italy was overvalued by 2.9% while in January 2013, it was overvalued by 5.7% relative to Germany. Of course, you may just as well say that Germany was undervalued… but then, the adjustment in Germany seems to go in the right direction but not in Italy in these last one and a half years.”

2013.02.11.Big Mac Euro 1

2013.02.11.Big Mac Euro 2

Frontier Markets! These Prices are IN-SANE!

Sometimes when I read mainstream financial media coverage of how frontier and emerging markets are booming-heaving-climbing-winning-advancing-accelerating-faster-bigger-better-more, I get this weird sensation in my gut. It’s like I’m listening to some combination of carnival barker and auctioneer and used car salesman all rolled into one.

Actually, I know what it reminds me of. This is exactly what it reminds me of:

Take a look at this opening from this Bloomberg article last week and see if you don’t feel it too. It starts with the headline, “Best Stock Pickers Trawl Frontier Markets as U.S. Funds Lose” and continues as such. Try reading this aloud in as few breaths as possible:

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