Free money creates bad government and bad government is the root cause for most of the continent’s anaemic economic growth
There is a great debate why Africa has not enjoyed greater economic growth. For me, the answer is simple: free money. Free money creates bad government and bad government is the root cause for most of anaemic economic growth.
The free money comes from two places, natural resources and aid. Africa has been blessed with vast mineral wealth. The small country of Guinea with a population of only 10 million holds up to half the world's reserves of bauxite.
It also has more than 4 billion tonnes of high-grade iron ore, significant amounts of diamond, gold deposits, uranium and even rare earths. Yet its per capita GDP of $991 is one of the lowest in the world. It ranks only 145th.
Even the relatively rich, democratic South Africa has problems. It ranks as the 26th wealthiest nation in the world. It has extraordinary mineral wealth, with 90% of the world's known platinum reserves, 80% of its manganese, 70% of its chrome and 40% of its gold, as well as a large amount of coal. Yet 50% of its citizens live below the poverty line. Its GINI coefficient (a measure of the relative equality of wealth) is the second highest in the world signifying that few of its people benefit from the geologic bonanza.
The free money from mineral reserves is known generally as the curse of oil. The paradox is that instead of generating wealth for the country often income from exploitation of commodities is squandered or stolen and the country ends up poorer. Perhaps the poster child for the curse of oil is Nigeria.
Nigeria has the 10th largest oil reserves in the world. Nigeria produces almost two million barrels of oil a day, and could potentially increase that by over 35%. It could refine the oil. Nigeria has four refineries that could produce around 500,000 barrels of oil a day, but only one is operational. Like Iran, Nigeria produces immense quantities of crude, but must rely on imports for much of its refined products.
Despite the vast flow of oil income, Nigeria has one of the lowest life expectancies in the world. It ranks near the bottom of the list in education spending (177th) and 70% of its citizens are below the poverty line. It ranks at 130 on the corruption index, which is at least above Guinea at 168.
Why does this happen? Why is such wealth wasted? Simple, the money belongs to the people. The people are represented by the government. So the money goes to the government and gives politicians colossal economic incentives to take it. This is not a question of national morality or culture. Politicians everywhere are caught with their hands in the public treasury.
The best method to stop them is a free press which has financial incentives to expose them. Scandals sell newspapers, television shows and websites. It is also good if the information unearthed by journalists is backed up by prosecutors with strong incentives to enforce the law. Government without a free press is like a football game without a referee. Without the red cards of legal disincentives, investment is impossible.
Sadly these disincentives rarely exist in Africa. On the contrary, the politicians often use the funds from natural resources to insure that any legal disincentives are suppressed either by building and paying for security forces to intimidate dissenters or by buying off the opposition. These problems are exacerbated especially in post-socialist countries where bureaucrats have economic incentives to maintain a discretionary regulatory infrastructure that serves their ambitions to become permanent rent-seekers.
The result is the same whether the money comes from mineral wealth or in the form of aid provided by well meaning, but foolish developed countries. Over $1 trillion of development aid has been given by rich countries to Africa in the past 60 years. Presently the gifts amount to about $50 billion a year. This free money has the same effect on governments as does the income from natural resources. It corrupts.
Of course if you can win using the Paradinha, you have a large incentive to keep doing it. The politicians who create weak legal infrastructures have enormous strong incentives to keep them in place. In addition, countries with poor legal systems tend to be more relationship-based than rule-based. So politicians need extremely large amounts of patronage to reward friends, family, party members, security forces and anyone else who keeps them in power.
The investment climate is changing, but at a cost. President Johnson-Sirleaf of Liberia forced her own brother to step down because of corruption and President Jakaya Kikwete of Tanzania is at least trying to curb corruption. But the really successful players are those most familiar with the pitch. The best ways to invest in Africa are through home grown companies, many from South Africa, who are aware of how the game is played on the continent and can navigate its problem successfully.
Bears aim for ‘top kill’, bulls hope for a durable bottom
The short-term top I had called, when the recent market decline started on 15th April, is still in place and looks likely to stay for quite some time. And there are only vague signs that we are about to get a short-term rally. Two weeks ago, as I was writing this column, the Sensex did stage a strong rally—650 points. I had mentioned that the market is not headed anywhere, despite this rally, and despite the fact that global markets had all rebounded nicely. Indeed, the Sensex is at the same level after two weeks of trading. I had marked that rally of two weeks ago as a short-term uptrend. This uptrend fizzled out at the Sensex level of 17,150 the following Friday; the index has given up 600 points thereafter and is trying to rally again.
There is absolutely no conviction among investors. Foreign institutional investors are continuing with their alternative bouts of buying and selling; but, over the past few days, their investment volumes have shrunk. Are they keeping their shrinking powder dry or are they waiting to bolt at every rally? The way the bulls have been ambushed by fierce selling at every rise, especially on the days when the global markets were down, should now make them fearful of the market taking away the gains of last year.
After all, the bulk of ‘smart investors’ has invested after mid-May 2009, when the Sensex was already around 15,000. As the fear of losing their gains spreads, bulls will have one thought uppermost in their minds: who bags the gains first? At every fall, real losses start kicking in. When fearful bulls make an exit in the same direction as confident bears, we know how low the market can go. It’s mob psychology, pure and simple, that happens in the market again and again. On the other hand, for the bears to gleefully enjoy a waterfall decline, they must find ways to break 16,500 and then 16,000—the lines on the sand that separate hope from chaos for the bulls. We have sailed dangerously close to those levels but since the market has so far turned higher, we have no prediction—just a probable scenario to keep in mind.
The only silver lining is that pessimism about the global economy is running deep. This always sets the stage for a snapback rally that seems to have started. The rally may take the Sensex all the way to 17,300. And beyond that?
India Infoline had issued two different recommendations on Punj Lloyd to its clients on the same day
Have you ever come in contact with someone who advises you to buy and sell the same thing at the same time? No, then welcome to the world of Indian retail brokerages. One such brokerage, India Infoline, has come out with two different reports on Punj Lloyd Ltd on the same day but with opposite recommendations.
Both the reports, whose copies are with Moneylife, were published on 31 May 2010. In one report, India Infoline wanted institutional investors to 'sell' (which according to its recommendation structure meant, "Absolute-stock expected to fall by more than 10% over a 1-year horizon") shares of Punj Lloyd. It also gave a 12-month target price of Rs97 or 29% lower than the current trading price of Rs137 as on 28th May.
On the other hand, India Infoline's second report, issued on the same date and on the same company for its private client group recommended to 'buy' Punj Lloyd shares with a target price of Rs158 as against the closing price at the end of 28th May of Rs137. There was no time frame or limit mentioned for the target price in this report. According to India Infoline's recommendations parameters mentioned in this report, a 'buy' meant absolute return of over +10% (no time frame or limit mentioned).
For its private client group, the brokerage advised: "With a robust order book, the company is well covered for the next couple of years. The company does not have any legacy orders remaining to be executed and Punj Lloyd is shifting projects from Simon Carves to the parent entity. We expect the company's PBT to witness 74% CAGR over FY09-12E. We reduce our target price to Rs158 per share from Rs198 per share earlier to reflect concerns on extended period of non-billing its client and slow execution rate. However the recent correction in the price provides room for upside, hence we recommend high-risk investors to take exposure in the stock."
When contacted, Harshad Apte, India Infoline's vice president for corporate communications, said, "Both these reports are in fact, targeted and sent to two separate set of customers and also both these recommendations are for differing time horizons. One of the recommendations (IIFL Private Client Group) is for the retail clients and carries a shorter time horizon while the other one is meant for institutional clients and is for a longer time horizon."
There is no period mentioned in the report for the private client group. However, it is assumed that all brokerages use 12 months as standard period for target price.
So, the question still remains as to why the brokerage wants one group of its clients to sell and other to buy Punj Lloyd shares? Maybe the brokerage-and its clients-knew better.
After Moneylife wrote about this case and also brought it to the attention of the Securities and Exchange Board of India (SEBI), the brokerage firm has come out with a press release clarifying the research calls made by different teams of the IIFL group. However, the company's stand does nothing to comfort the investors; in fact it should raise eyebrows higher.
India Infoline had published two reports on 31 May 2010. In one report, the firm wanted institutional investors to 'sell' shares of Punj Lloyd, with a 12-month target price of Rs97 or 29% lower than the then trading price of Rs137 as on 28th May. On the other hand, the second report issued on the same date recommended its private client group to 'buy' Punj Lloyd shares with a target price of Rs158. No time horizon was mentioned for the private client group report.
The company, in its response, has very conveniently stated that the IIFL group has two separate and distinct retail and institutional research teams that are separated by 'Chinese walls'. In today's world of finance, it isn't too difficult to see the irony in this idea. The Chinese wall concept is most commonly utilised in financial institutions with interests in both investment banking and brokerage operations. Its purpose is to provide a separation between the two, while allowing the company to engage in both activities without creating a conflict of interest. This wall is not a physical boundary, but rather an ethical one that financial institutions are expected to observe.
While this was widely practised until a few years ago, wide cracks have become increasingly evident in the Chinese wall model over the years. The porous nature of this so-called wall was in full display during the recent debacle in Wall Street, when investment banks tumbled one after the other. These institutions are supposed to have internal policies that necessitate impartiality on the part of analysts. But very often, these policies are based on flimsy structures, open to being twisted and violated in the process. These institutions compensate the very same 'impartial' analysts based on some investment banking deals they might have participated in. The end result is there for all to see.
The case is no different in India where insider trading and market manipulation are rampant. Fancy portfolio management services (PMS) products offered by various brokerages show that there are, in effect, no Chinese walls. Moneylife has written about cases where PMS money has dramatically shrunk because the broking arm took the money heavily traded in and out of stocks that not only meant huge costs but also huge losses. These products are designed in such a way as to entice high net-worth individuals (HNIs), but are usually based on shoddy strategies that end up creating havoc on the client's portfolio. Very often, the advice to HNIs is diametrically opposite to that given to retail investors.
India Infoline's press release also states, "The respective research teams conduct independent research and reports are made by separate research analysts considering the various factors including client group to which they are providing the services, risk profile, investment goals, horizon of investment etc. Since the different sets of investors, institutional and non-institutional customers, have different time horizons and different investment philosophy, they need to be serviced differently." This looks good only on paper. Besides, we are not even sure if this is what the reality is. Indeed, SEBI is now thinking of actually removing Chinese walls inside asset management companies because they actually serve no purpose.