Month: November 2018

What Caused Brazil’s Great Recession?

The debate continues on what caused Brazil’s most recent economic crisis, the deepest and longest the country has experienced since the Great Depression.

Nobel Laureate, Paul Krugman, gave his view in his New York Times column a few weeks ago (“What the Hell Happened to Brazil?”,  Link). Krugman points to “bad luck” in the form of a severe terms- of- trade shock caused by falling commodity prices, which in turn led to an unwinding of excessive household debt and a severe drop in domestic consumer spending. Brazil, according to Krugman, underwent a debt deflation process, not the typical “sudden stop” emerging market crisis where a build-up in foreign debt reverses when foreign capital abandons a country. The duration and depth of the recession, Krugman believes, were caused by bad policy mistakes: a combination of fiscal austerity and monetary tightening, at a time when Keynesian stimulus could have been effective.

Barron’s Magazine has also chimed into the debate with two articles by Mathew Klein (“Understanding Brazil’s Latest Depression” and “What Triggered Brazil’s Crisis,” Link).  Klein points to a massive increase in private debt between 2005-2015 which was accompanied by a large increase in foreign capital inflows, mainly into stocks and bonds. When the capital flows reversed in 2012-14 and the downturn began, the Brazilian authorities tightened both fiscal and monetary policies and deepened the fall, Klein writes echoing Krugman. Klein notes a fiscal adjustment of 5% between 2013 and 2016 (from a surplus of 2% to a deficit of 3%) but still agrees with Krugman that the authorities were too conservative on the fiscal front and focused largely on the tightening of monetary policy to stabilize financial markets.

Both the Krugman and Klein articles are insightful, but I take issue on several points. First, both Klein and Krugman make a glaring omission by not considering political factors. The reelection of President Dilma Rousseff  (October 2014) was a great disappointment for the business community and financial markets and probably triggered the start of the recession. At the same time, Brazil entered an enormous political crisis, with the explosion of the “Car Wash” graft probe (initiated in 2014, and still going on)) which implicated hundreds of businessmen and their political cronies.  This was soon followed by the impeachment of President Dilma (2015). These unsettling political events certainly played a big role in deepening and extending the downturn.

Second, both Klein and Krugman somewhat mischaracterize the crisis: Krugman, by arguing that Brazil’s woes were more akin to a developed market crisis and could have been alleviated through  stepped-up fiscal spending; and Klein, by stating that the commodity cycle (2003-2012) should be considered  largely irrelevant to the discussion.

I think the evidence does no support Krugman’s idea. In fact, the crisis should be seen as a garden-variety boom-to-bust emerging market crisis. This is clear if we put the event  in the context of the many EM crises of the past decades.  Ray Dalio’s book Principles for Navigating Big Debt Crises (Link) provides a good account of the record. Dalio’s “Economic Machine” concept is that financial crises are linked to debt cycles which evolve in predictable patterns and all go through three phases:  the bubble build-up, the depression  adjustment and the reflationary recovery.  Dalio looks at the specifics of 48 crises, 23 of which occured in major emerging markets and are summarized in the chart below. Brazil’s latest crisis is not included in Dalio’s book but I have added it for comparative purposes. The chart shows each country’s characteristics at the peak of the boom cycle in terms of the following criteria:

  • Expansion of the Debt to GDP Ratio of at least 5%
  • Foreign Debt to GDP of at Least 30%
  • Fiscal Deficit at least 2% of GDP
  • GDP Output Gap of at least 5% (GDP 5% over trend growth)
  • Currency at least 10% overvalued
  • Current Account Deficit over 3% of GDP

When a country meets most of these criteria its economy is considered very overheated and vulnerable to a serious downturn.

Not every crisis is the same. Every crisis has its own particularities, but by-and-large they follow the same pattern, meeting the criteria over 80% of the time. Russia, with its structural current account surplus, is the only anomaly, with both booms and busts dictated by oil-driven terms-of-trade shocks.

Brazil’s crisis fits like a glove, amply meeting all the criteria with the exception of “foreign debt to GDP.” But, even this exception is due only to nomenclature, because foreign capital inflows this time took the form of  direct investment in Brazil’s liquid bond markets instead of foreign debt. Brazil does in fact experience a pretty standard “sudden stop” when the end of the commodity boom leads to a reversal in capital flows.

In regard to Klein’s discounting of the relevance of commodities as a major factor, I think this is very unlikely. Brazil, with its historical dearth of domestic savings, has always been very sensitive to terms-of-trade shocks. This latest boom-to-bust cycle for Brazil starts with the China-driven boost in commodity prices in 2003 and comes to an end with the collapse in prices that begins in 2012. A glance at any commodity chart confirms this.

Though Brazil is not nearly as sensitive to commodity prices as Russia, they still do matter a lot in that they drive the current account; and when they rise  a solvency effect occurs which lowers country-risk perceptions and attracts foreign capital flows.

I think we can safely say that Brazil experienced an entirely traditional boom-to-bust cycle triggered by an increase in commodity prices.

However, the duration and depth of the crisis are more difficult to explain. In the past, Brazil’s economy always proved to be resilient and bounced back quickly from downturns, but this decline  has lasted longer and caused more pain.   So, what happened?

Why Did Brazil’s Recession Dragged on for so Long?

Both Krugman and Klein blame Brazilian policy-makers for the economy’s extraordinary downturn. But, in arguing that traditional Keynesian fiscal stimulus would have worked, Krugman shows a lack of sensitivity for the “curse” of emerging markets, which is precisely the difficulty of implementing counter-cyclical policies. This “curse,”  which is arguably the defining characteristic of EM, exists mainly because of “hot” and fickle  foreign capital flows, and this is especially true for a savings-defficient  economy like Brazil’s facing a term-of-trade shock.

Klein is closer to the mark by stating that policy makers obsessed over meeting inflation targets because of Brazil’s recent experience with hyper-inflation.

Dalio’s data-base is useful to determine how the recent Brazilian crisis may be unique in terms of how policy makers responded. In Dalio’s framework, the bubble is followed by a “depression,” typically resulting in a deleveraging which sets the base for an eventual reflation period and the start of a new cycle. The chart below looks how during past EM crises emerging market policy makers have typically “engineered,” willfully or not, this depression phase. We focus on the three main levers of adjustment: currency devaluation, current account adjustment and inflation.

What we see clearly is that adjustment periods are all essentially the same, and Brazil in 2012-2017 is no exception. Countries devalue to smoothen the adjustment in the current account and they allow inflation to ramp up. Both devaluations and inflation are taxes on consumption, which drive the adjustment.

But, policy makers in Brazil opted to “cushion” the adjustment. We can see this in the following three charts.

Devaluation – The Brazilian real was allowed to fall, but slowly and not nearly as much as in previous downturns, and not enough to adjust the current account. Brazil’s authorities probably felt that the huge foreign currency reserves accumulated during the commodity boom gave them the luxury to soften the BRL’s decline, and this was orchestrated in the name of financial stability.

Current Account –  The current account adjusted, but only after commodity prices staged a rally in 2016-2017.  The lack of a strong current account adjustment in the face of a terms-of-trade shock is very unusual.

 

Inflation –  Inflation rose briefly, but was then squashed by extremely tight monetary policy. Brazilian real rates (after inflation) rose to as high as 7% at a time when U.S. and European real rates were negative.

Why did policy makers choose this path? First, politics interfered, as Rousseff primed the economy to ensure her reelection in 2013-14. This served to  worsen conditions and delay the adjustment. Also, I agree with Klein that the the Central Bank’s obsession with inflation-targeting was  rooted in historical experience. Policy makers understood that inflation is a direct and exclusive tax on the poor because the owners of capital in Brazil have safeguards. But, at the same time, the Central Bank in Brazil, like elsewhere, being a  captive of financial markets may have seen its mandate to be to preserve financial stability at any cost. By allowing greater changes  in both the value of the BRL and the level of inflation, authorities could have imposed a greater cost on foreign holders of domestic debt and domestic dollar-indebted corporates but they were very reluctant to do this.

Ironically, though financial stability was well maintained in Brazil and inflation was contained, it was still the poor that bore the burden of the crisis. This time it was not through the inflation tax but rather through a long and brutal decline in employment and wages.

Also, the policies had two highly perverse effects (shown in the charts below).

  • Very high interest rates dramatically increased public debt levels, causing a new source of potential stress. Brazil failed to take advantage of the crisis to engineer a deleveraging of the economy and set a new base for a new reflationary debt cycle.  The debt-to-GDP ratio actually increased by nearly 30 points since 2012, and now public debt sits at precariously high levels.  We can contrast this with the significant deleveraging that occured in the 2002 recession, setting a base for the economic boom starting in 2004.
  • The relatively strong and stable BRL encouraged Brazilian corporates to borrow in international markets, also creating a new source of stress. External debt to GDP has risen from 18% of GDP in 2012 to 27% in 2017 (World Bank data), now approaching dangerous levels.

If every crisis creates opportunities, in this case Brazil failed. On the other hand, the crisis led to the rise of Bolsonaro and the prospect of liberal reforms, so maybe it was not a total loss.

External Debt Metrics

 

Macro Watch:

  • A users guide to future QE (PIIE)
  • Economic brake-lights (Mauldin)

Trade Wars

  • The road to confrontation (NYT)
  • The real China challenge (NYT)
  • China and the uS are on a collission course (brookings)
  • How Trump and Xi got into a trade war (WSJ)

India Watch

  • Election uncertainty clouds Indian stock market (FT)
  • India electrification to impact copper demand (Gorozen
  • Can the rupee become a hard currency? (Livemint)

China Watch:

  • China picks tobacco taxes above public health (WIC)
  • How free is China’s internet? (MERICS)
  • China extends its global influence (NYT)
  • How cheap labor drives China AI (NYT)
  • China’s property barons (SCMP)

China Technology Watch

  • A profile of Bytedance, Chna’s short-video ap (The Info)
  • Sense-time’s smart cameras (Bloomberg)
  • China’s Electric Vehicle push (Bloomberg)

Brazil Watch

  • John Bolton’s Troika of Tyranny (The Hill)
  • The rise of evangelicals in Latin America (AQ)

EM Investor Watch

  • What drives the Russian state? (Carnegie)
  • Russia’s big infrastructure bet (WSJ)
  • Russia’s new pipeline (Business Week)
  • Indonesia’s elections (Lowy)
  • Chile’s renewable energy boom (Wiley

Tech Watch

  • Why have solar energy costs fallen so quickly (VOX
  • Asia leads in robot adoption (QZ)
  • The new industrial revolution (WSJ)

Investing

  • The top 100 asset managers in the world (Thinking Ahead)
  • An evolve or die momeent for the world’s great investors (Fortune)
  • Interview with William Eckhardt (Turtle Trader)
  • Why momentum inveting works (Anderson)

 

Billionaires in Emerging Markets

In April 2010 Brazil’s Eike Batista told the U.S. talk-show host Charlie Rose he would soon be the richest man in the world. As his vast oil discoveries came on stream, Batista said, his fortune would reach $100 billion, nearly double the $50 billion held by Bill Gates and Warren Buffet at the time. Three years later, after mostly dry wells, Batista’s oil company, OGX, filed for bankruptcy. Batista’s rise and fall is a good reminder of the ephemeral nature of great fortunes, particularly in the boom-to-bust conditions that characterize emerging markets. Huge wealth accumulation, particularly when it comes out of nowhere, is often a manifestation of extraordinary and temporary circumstances that have boosted asset prices to elevated levels. By looking at great wealth we can often identify where the greatest excesses are occurring in the markets. The chart below shows the ten-year evolution of the top ten richest individuals in the world, as compiled by Forbes magazine. Highlighted in red are the individuals who are based in emerging markets.

The first thing to note is the mercurial nature of the list. Only three names from 2008 remain on the list in 2018.

The changes in the list reflect economic and stock market cycles. Six out of the ten names in 2008 are from emerging markets, a consequence of the commodity-fueled liquidity boom that  greatly boosted asset prices in EM between 2002-2008.  India had an incredible four names on the list in 2008, the best possible indication of what has come to be known as the “billionaire Raj,” a process of enormous wealth accumulation and concentration based on “cozy” relations between business moguls and politicians.  Since 2012, India has disappeared from the top ten, as some of the excesses of the system have been curtailed.

Supported by the elevated commodity prices and global liquidity caused by China’s unprecedented credit-fueled construction boom, emerging markets remained active on the list until 2013. Eike Batista appears as the 8th name on the list in 2010, the year of the Charlie Rose interview, and peaks at seventh place in 2012.

After 2013, Carlos Slim has been the only representative of EM on the list, and his standing has been steadily declining because of the weakness of the Mexican peso and the very poor performance of his publicly-traded companies (since year-end 2012, Slim’s main asset, AMX, has lost 35% of its value while the S&P 500 has risen 110%.

Since 2012, the strength of the U.S. dollar, the remarkable outperformance of U.S. assets relative to the rest of the world and the surge of valuations for the FANG (Facebook, Amazon, Netflix and Alphabet-Google) and other tech stocks has led to the near-total domination of the top 10 ranking by Americans.  Bezos and Zuckerberg both appear on the list in 2016, and Bezos was crowned richest man in the world in 2018.

The most fascinating change of the past decade, the rise of China, is not done justice by the chart above. For this, we have to look at the top 100 names, as shown in the charts below.

 

There are many striking changes shown by these two charts, mainly driven by the end of the commodity/EM boom, the continued rise of China and the great rise of the QE-fueled U.S. bull market.

In 2018, China becomes the second largest contingent on the list with 19 names, compared to zero in 2008.

In 2018, 18 out of the top 30 are Americans and five are Chinese, compared to eight and zero, respectively, in 2008. Russia had seven names in the top 30  in 2008 but zero in 2018, and India goes from four to one.

The full list is shown below.

Macro Watch:

  • A users guide to future QE (PIIE)
  • Economic brake-lights (Mauldin)

Trade Wars

  • Henry Paulsen gets negative on China (WSJ)
  • U.S. accuses Cina firm of stealing Micron secrets (Wired)
  • Asia’s next trade agreement (Brookings

India Watch

  • India electrification to impact copper demand (Gorozen
  • Can the rupee become a hard currency? (Livemint)
  • Can India become the next $10 trillion economy ?(Wharton)
  • Apple is losing share in India to Chinese (Reuters)

China Watch:

  • China’s infrastructure investments in Latin America (The Dialogue)
  • China’s art-factory  town is evolving (Artsy)
  • China’s global infrastructure push (NYT)
  • Kevin Rudd on China reforms (Caixing)
  • 50 million empty homes in China (SCMP)
  • China and Myanmar approve port project (Caixing)
  • Four reasons to manage China’s rise  (Lowy)

China Technology Watch

  • China’s Electric Vehicle push (Bloomberg)
  • The rise of Asia’s research universities (The Economist)
  • China’s tech slowdown (Reuters)
  • China fights back on IP theft accusations (scmp
  • A graphic view on China’s tech progress (NYT)

Brazil Watch

  • The rise of evangelicals in Latin America (AQ)
  • Brazil’s new foreign minister says climate change is a marxist plot (The Guardian)
  • Brazil’s new finance tsar (Bloomberg)

EM Investor Watch

  • Russia’s new pipeline (Business Week)
  • Indonesia’s elections (Lowy)
  • Chile’s renewable energy boom (Wiley

Tech Watch

  • The new industrial revolution (WSJ)
  • Pathways for inclusive growth (BSG)
  • Paraguay is a bitcoin powerhouse (The Guardian)

Investing

  • The top 100 asset managers in the world (Thinking Ahead)
  • Interview with William Eckhardt (Turtle Trader)
  • Why momentum inveting works (Anderson)
  • Learning from investment history (Forbes)
  • The rise of “quantamentals” (FT
  • Monish Pabrai’s ten commandments (Youtube)
  • A profile of Paul Singer (New Yorker)

 

 

 

 

 

 

Brazil’s Low-hanging Fruit

 

Brazil’s newly elected president, Jair Bolsonaro, campaigned on a platform of liberal economics and deregulation to unleash the repressed spirit of the Brazilian entrepreneur. As I discussed last week(Link ), it is well documented that Brazil is an exceptionally difficult place to do business   compared to  other countries. The very high cost of regulation and bureaucracy forces small firms into the underground economy and gives a formidable advantage to larger firms with the scale and resources to deal with the regulatory burden. The good news for the incoming administration is that Brazil is  currently at such a low level of governance that any serious and concerted effort to deregulate should produce very high benefits over the short term.

In the World Bank’s ease of Doing Business Index, Brazil is by far the worst ranked of the major economies in emerging markets. The chart below shows how Brazil ranks compared to several emerging market peers and also compared to New Zealand, the country with the highest ranking in the World Bank’s Index. The data is collected from each country’s most important business center. In the case of large countries ,such as Brazil, the World Bank looks at two cities; Sao Paulo and Rio de Janeiro are used as the reference cities for Brazil with a weighting of 61% and 39%, respectively. What this means is that conditions for doing business are certainly significantly worse in other regions of the country.

The World Bank ranks 190 countries on ten different measures; starting a business, dealing with construction permits, getting electricity, registering property, protecting minority investors, paying taxes, trading across border, enforcing contracts and insolvency resolution. Brazil has the lowest ranking in this group in six of the ten categories. For paying taxes, a firm in Brazil needs 1,958 man-hours for the task, which is 6.6 times the second-worse, Chile, and 14 times more than New Zealand (57 times the 34 man-hours required in Hong Kong).

Low-Hanging Fruit

The good news is that things are so bad in Brazil that a concerted effort could bring rapid improvements. Brazil has a great amount of low-hanging fruit to harvest. Three years ago India’s incoming Prime Minister Narendra Modi specifically committed himself to a deregulation agenda to improve India’s ranking in the ”Doing Business” Index. In this short period of time India was able to bring its ranking from 130th to 77th, a remarkable achievement. Modi has set a target of reaching a top 50 ranking over the short term, which would place India in the global elite in terms of this measure. Modi correctly understands that the main beneficiaries of deregulation are small businesses. He said last week:

“The biggest benefit of Ease of Doing Business goes to the MSME (Micro, Small and Medium Enterprises) sector. Whether it is permissions for constructions, availability of electricity or other clearances, these have always been major challenges for our small industries.”

The chart below shows the evolution of both Brazil and India in the “Doing Business” rankings for the past three years. India has improved a remarkable 53 spots, improving its ranking in nine of ten categories. The most remarkable improvements have been with construction permits and access to credit, two areas of fundamental concern for small businesses. Brazil has improved 14 spots over the period, but remains at an extremely poor level. Brazil improved its ranking in five categories, but also worsened in five.  In the cases of securing construction permits and paying taxes Brazil’s ranking is among the worst in the world and got worse over the period. One area of some progress is for starting a business where the ranking has improved from 175 to 140 (from extremely poor to only very poor) because of improvements brought about by the launching of online systems for company registrations, licensing and employment notifications.

 

Macro Watch:

  • A users guide to future QE (PIIE)
  • Economic brake-lights (Mauldin)

Trade Wars

  • Henry Paulsen gets negative on China (WSJ)
  • U.S. accuses Cina firm of stealing Micron secrets (Wired)
  • Asia’s next trade agreement (Brookings

India Watch

  • Can the rupee become a hard currency? (Livemint)
  • Can India become the next $10 trillion economy ?(Wharton)
  • Apple is losing share in India to Chinese (Reuters)

China Watch:

  • Kevin Rudd on China reforms (Caixing)
  • 50 million empty homes in China (SCMP)
  • China and Myanmar approve port project (Caixing)
  • Four reasons to manage China’s rise  (Lowy)
  • The reforms China needs (Project Syndicate)
  • China’s Eastern Europe push (WSJ)

China Technology Watch

  • Tencent’s social responsibility drive (WSJ) (SCMP)
  • China’s giant transmission grid (Tech Review)
  • AI will develop under two separate spheres of influence (SCMP

Brazil Watch

  • The rise of evangelicals in Latin America (AQ)
  • Brazil’s new foreign minister says climate chnage is a marxist plot (The Guardian)
  • Brazil’s new finance tsar (Bloomberg)
  • President Cardoso’s speech at the Wilson Institute (Wilson Center)
  • Brazil may move embassy to Jerusalem (WSJ

EM Investor Watch

  • Mexico’s challenge with investors (FT)
  • Russia’s de-dollarization strategy (WSJ)
  • Africa’s overlooked business revolution (McKinsey)
  • Timing the EM cycle (Seeking Alpha)
  • The age of disruption, Latin America;s challenges (Wilson Center)
  • Rwanda, poster child for development (WSJ)

Tech Watch

  • Pathways for inclusive growth (BSG)
  • Paraguay is a bitcoin powerhouse (The Guardian)

Investing

 

 

 

Promoting Business Initiative in Emerging Markets

 

The World Bank has conducted its “Doing Business” survey since 2006, ranking countries according to the ease of conducting business. The rankings provide a useful comparison between countries, and the survey has enough history to show which countries are implementing the reforms needed to allow entrepreneurs of all sizes to thrive.

The chart below looks at the evolution of the rankings for those countries  that are important for emerging market investors. This data covers 10 years, which is, more or less, two full business or electoral cycles and enough time for government policy reforms to have an impact. What we see are dramatic changes, both on the positive and negative sides. On the positive side, Russia, India, Indonesia, China, Poland, Taiwan and Turkey have achieved transformational results. On the negative side, we see a very concerning collapse occurring in South Africa, and significant declines in Colombia, Nigeria, Thailand and Peru.

Change in Ease of Doing Business Rankings.  Best to worst over 10 years
Russia 89
India 56
Indonesia 49
China 43
Poland 38
Taiwan 33
Turkey 30
Vietnam 24
Brazil 20
Philippines 20
S Korea 14
Malaysia 8
Argentina -1
Mexico -3
Chile -7
Peru -12
Thailand -15
Nigeria -21
Colombia -28
South Africa -48

 

The criteria that the World Bank uses in its Doing Business methodology are shown in the chart below.

The full rankings for the 18 countries that make up the core of our EM universe for investors are shown below. The chart shows the rankings from 2006-2019. The World Bank currently ranks 190 countries, and the full ranking can be found on the World Bank website (Link). 

We can consider the top 25 to be the global elite, the absolute easiest places to start and run a business. The top 50 can be considered good; 50-100, mediocre;  and 100-130, bad.  Any ranking above 130 indicates a very hostile environment for entrepreneurs.  Countries above 100 are highly dominated by inefficient bureaucracies and by extractive entrenched interests such as oligarchies and politically connected rent-seeking agents.  Typically, in these countries you have to be big and politically connected to be successful, and most entrepreneurs are  forced into the underground economy. Four important markets – Brazil, Philippines, Nigeria and Argentina –  persistently rank very poorly and show little sign of progress. India, Indonesia and Vietnam in recent years have moved out of this group of “dysfunctionals,” showing clear signs of improvement.

 

We can dig deeper into the survey by looking at the rankings on a regional basis.

Asia

The evolution of the rankings for Asian countries is shown below.  This is the world’s most dynamic economic region and also where we see both the best and the most improving business conditions. We can separate this group into two cohorts: the “Asian Tigers” and the Asian laggards. Of the Asian Tigers, South Korea, Malaysia, Thailand are in the elite and have been so throughout the period. Korea, Malaysia and Taiwan have continued to improve over the period, while Thailand has shown some moderate slippage. China is between the Asian Tigers and the laggards, but appears to be moving rapidly towards the former. We also see in recent years that the laggards are making significant progress. India, Indonesia and Vietnam all have made large leaps forward. The case of India is noteworthy; Prime Minister Modi publicly committed to improving India’s ranking when he took office, and he is delivering through a major deregulation push.  (The tweet below from Modi shows the focus that he has on this measure.) The main exception in Asia is the Philippines where we see very little progress. It appears that the all-powerful oligarchs in the Philippines are not being challenged.

Latin America

The evolution of the rankings for Latin America are shown in the chart below. This region is characterized by the “middle-income-trap” malady: after reaching middle-income status, these countries fail to both invest in public goods (human capital and infrastructure) and to implement pro-business reforms. Like Asia, the region is divided into the good (Chile, Mexico, Colombia and Peru) and the laggards (Argentina and Brazil).  Of the better-ranked countries, none has made progress over the period. Worse, Chile has seen a worrisome decline from its former elite status, and Peru, after showing signs of improvement, has regressed. On the side of the laggards, Argentina has deteriorated significantly while Brazil is stable.

Europe, Middle East and Africa

This region is diverse and shows great divergence in results. Both Nigeria and South Africa are cause for concern. Nigeria has joined the camp of highly dysfunctional economies, and South Africa has gone from elite status to mediocrity and it shows no signs of halting this trend downward. Fortunately, all the other countries in this group show positive trends. Turkey and Russia, both run by nationalistic, pro-business “law-and-order” autocrats, have made remarkable progress. Poland, in line with most countries in Eastern Europe, has also risen sharply in the rankings and now borders “elite” status.

Macro Watch:

Trade Wars

  • Henry Paulsen gets negative on China (WSJ)
  • U.S. accuses Cina firm of stealing Micron secrets (Wired)
  • Asia’s next trade agreement (Brookings
  • Wisconsin has econd thoughts about Foxconn deal (New Yorker)
  • Australia blocks China pipeline takeover (SCMP
  • Firms shifting plants to ASEAN (SCMP)

India Watch

  • Can the rupee become a hard currency? (Livemint)
  • Can India become the next $10 trillion economy ?(Wharton)
  • Apple is losing share in India to Chinese (Reuters)
  • India’s central bank under pressure (NIKKEI)
  • India-sponsored Iranian port is a problem for th U.S. (WSJ)

China Watch:

  • China and Myanmar approve port project (Caixing)
  • Four reasons to manage China’s rise  (Lowy)
  • The reforms China needs (Project Syndicate)
  • China’s Eastern Europe push (WSJ)
  • Self-reliance is the new mantra in Beijing (Washington Post)
  • China’s southern Europe strategy (Carnegie)
  • The big story in China; no talk of autumn policy meet (SCMP)
  • The world is awash in waste after China ban (FT)
  • Trump’s decoupling with China will hurt Asian allies (Lowy)
  • Cruise companies rethink China bet (WIC)

China Technology Watch

  • Tencent’s social responsibility drive (WSJ) (SCMP)
  • China’s giant transmission grid (Tech Review)
  • AI will develop under two separate spheres of influence (SCMP
  • BAIDU and Volvo team up 0n self-driving cars (SCMP)
  • An AI war would be a huge mistake (Wired)
  • China robotic firm seeks to buy German competitor (Caixing)

Brazil Watch

  • President Cardoso’s speech at the Wilson Institute (Wilson Center)
  • Brazil may move embassy to Jerusalem (WSJ
  • Brazil’s new president (Wharton)
  • Brazil’s economy boss looks to Chile (FT)
  • A european view on Brazil’s new foreign policy (GGPI)
  • Trumpism comes to Brazil (Foreign affairs)
  • How will Bolsonaro deal with China (Caixing)
  • Brazil’s new foreign policy (Brookings)

EM Investor Watch

  • The age of disruption, Latin America;s challenges (Wilson Center)
  • Rwanda, poster child for development (WSJ)
  • The passing of the conscience of Venezuela’s left (NYT)
  • Poland moving back to the center (NYT)
  • Why Mexico and the U.S are getting closer (Wharton)
  • The short term case for EM (Disciplined investing)
  • China’s inroads in the Andean amazonian basin (Asia Dialogue)
  • Are developing countries converging (PIIE)

Tech Watch

  • Pathways for inclusive growth (BSG)
  • Paraguay is a bitcoin powerhouse (The Guardian)

Investing

  • Learning from investment history (Forbes)
  • Interview with Doug Kaas (RIA)
  • Investment value in an age of booms and busts:
    A reassessment (Edelweiss)
  • Monish Pabrai’s ten commandments (Youtube)
  • A profile of Paul Singer (New Yorker)

 

 

 

 

 

AMLO Shoots Himself in the Foot

 

The ability to invest in fundamental public goods – human and physical capital — is a primary characteristic that differentiates one emerging market country from another. The process of building-out infrastructure is particularly fraught with risks because of the complexity and flexibility of contracts, so countries also differentiate themselves in their ability to conduct business ethically and complete projects at reasonable costs.

Over the past weeks, we have seen this process at work, with very different outcomes. On the one hand, in China two enormous infrastructure projects were inaugurated – 1. The Hong-Kong Macau Seabridge;2. The Hong-Kong to the Mainland Bullet-Train link. On the other hand, in Mexico the incoming president canceled the new Mexico City Airport, the country’s largest and most needed project.

The decision this week by Mexico’s President-Elect, Andres Manuel Lopez Obrador (AMLO), to scuttle the new $13.3 billion airport being built on the outskirts of Mexico City is emblematic of the political obstacles face by many developing countries to provide basic public goods.

No one disagrees that Mexico City needs a new airport. The city’s main  airport has been saturated since the 1990s, which is very problematic for a country with a growing tourisn industry. Nevertheless,  over the past two decades multiple proposals for a new airport have been abandoned after fierce opposition from indigenous communities and environmentalists.

AMLO’s opposition to the current project, which is about one third completed, has been known for over two years, and he expressed it many times during the presidential campaign. He decried the complexity and cost of the project, as well as environmental considerations. But his main objection has been a belief that the contracts were awarded without transparency to political cronies of the outgoing party.  During the campaign AMLO had said: “It has been proven that this airport is going to be very costly for the country… It’s a bottomless pit… This isn’t a good deal for the country, for Mexicans. It is for a small group of contractors, they are going to make a lot.”

In an essentially symbolic process aimed at justifying his decision, AMLO hastily organized a “popular referendum,”  to “let the people decide.” This occured this past Sunday and resulted in 70% of the one million votes counted agreeing with the candidate to cancel the project.

The following day, a visibly delighted AMLO held a press conference praising the exercise in direct democracy: “The citizens took a rational, democratic and efficient decision. The people decided. And we have to keep on creating the democratic habit. Where there is democracy, corruption does not exist.”

AMLO’s decision to cancel the project, the biggest infrastructure project of the administration of President Enrique Peña Nieto, will result in very large losses (estimated by the WSJ at $5 billion) for bondholders, suppliers and contractors, including Mexican magnate Carlos Slim, one the biggest supporters of the project.

What has just happened in Mexico is not unusual at all in emerging markets. Ironically, as many countries have become more democratic, they have also lost the capacity to invest in public goods. This is particularly true in Latin America where democratization since the 1980s has implied a more free and inquisitive press, a more activist judiciary and independent regulatory agencies captured by special interests. In a country like Brazil where this has been accompanied by a dramatic expansion of the welfare state aimed at providing “social justice,” the state has found itself handcuffed, without funds and facing an incredibly laborious process to get anything done.

Ironically, in many emerging markets when the “grease” of corruption is not allowed to work things come to a complete stop. One of the companies involved in the Mexico City airport project, Grupo Hermes, is related to Carlos Hank Gonzalez, a well known Mexican politician linked Pena Nieto’s party, who famously quipped “a poor politician is a poor politician.” In a similar vein, it used to be said about a former governor of Sao Paulo, “he may steal, but he gets things done.”

The case of China is interesting. China’s unprecedented build-out of public infrastructure since the 1980s is a truly remarkable achievement which has brought the quality of infrastructure from one of the worst in the world to a very high level. However, it is no secret that the construction sector is ridden with corruption and that many of the great fortunes of China have been created by the unethical ties between contractors and municipalities. Not surprisingly, when President Xi Xinping came to power several years ago promising a total crackdown on corruption, for a while, activity came to a stop.

The same goes for India, where kickbacks in construction contracts essentially finance all political campaigns. Politicians and construction contractors in India have long worked under the assumption that the relationship is mutually beneficial and sustainable as long as contractors deliver the promised service. This has resulted in a certain risk aversion, where politicians will only work with the most efficient and technically competent contractors.

A similar approach goes in Turkey, where construction firms have worked closely with the Erdogan regime. As in India, Erdogan has been a tough task-master, demanding competency from contractors.

It is interesting to look at the connection between infrastructure and corruption. We can do this by looking at both the World Economic Forum’s 2019 infrastructure ranking (WEF) and Transparency International’s Corruption Index (Link).The first chart below shows the top 100 of WEF’s infrastructure ranking of 142 countries. The next chart shows the top 90 of the 154 countries covered by the corruption index. A final chart looks at where the primary EM countries fall in this infrastructure-corruption matrix.

Transparency International, Corruption Ranking

 

We can draw some interesting insights from these charts. Basically, there are three distinct groups of countries:

Group 1 – Good Infrastructure with low cost of corruption.

  • This includes all developed countries. We can venture to say that the ability to provide public goods at a low corruption cost is an intrinsic characteristic of development.
  • In EM, only Chile, Taiwan and Poland make the cut, and, in this sense, these countries can really be considered developed. Korea is borderline. Corruption has become a major political and social-media issue in recent years, and it may well fall rapidly from the current high levels.

Group 2 – Relatively Good Infrastructure with High Corruption.

  • These are the “He may steal, but he gets things done” countries. Corruption is high and costly, but politician and contractors have worked it out so that both sides benefit and infrastructure gets built.
  • In EM, China is the master of this group; Mexico, Malaysia, Turkey, Thailand, India and South Africa also qualify.
  • The direction that Mexico will take under AMLO will be interesting to see.

Group 3 – Bad Infrastructure with High Corruption.

  • In these countries, politics have become so dysfunctional that the “return” on corruption is near zero. Included in this list are: Brazil, Argentina, Indonesia, Vietnam, Columbia, Peru and the Philippines. At the extreme of this category and in a class of their own are semi-failed states: for example, Venezuela and Nigeria.
  • Most emblematic of this condition has been Venezuela under its Bolivarian regime. Thirty years ago, Venezuela had one of the best infrastructures of any developing country; today it ranks 118th in the WEF report. Venezuela now has zero capacity to invest in public goods, all of its fiscal resources either dedicated to welfare programs or syphoned-off to the offshore accounts of regime cronies.
  • Brazil faces an interesting situation today. It currently has the worst-of-all worlds, with very high corruption and close to zero capacity to carry out infrastructure public works. The election of Jair Bolsonaro was a repudiation of the kickback-driven political system, so going back to that model is impossible. To a considerable degree, the success of the new government will depend on quickly finding a new way to do business.

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Interview with Doug Kaas (RIA)