The realization that foreigners are not so bad after all has dawned in India. However, foreign investors are aware that the economy lacks good governance, and unless this changes, the slowdowns could be greater and longer lasting than anyone expects
A little known measure of an emerging market economy’s health is its desire to attract foreign investment. Reforms meant to attract foreign capital, like other reforms, are usually not favoured by politicians. Any attempt to make the regulatory environment more economically efficient or, as some would have it, business friendly, hurts entrenched interests upon whose support politicians depend. These could include protected local interests, usually owned by cronies or party supporters. Politicians will not sell these constituents out unless things are so bad that there are few other choices. By few choices, I mean none. Either the reforms proceed or the economy tanks. Reforms do eventually result in economic growth, but this usually occurs after street protests, elections, or even armed revolts.
Recently many politicians have had the luxury of deferring the problems to compliant central bankers. But sometimes central bankers are either not helpful or have printed so much money that an inflationary melt down is a real possibility. In these instances politicians have to face the types of protests we are seeing in Greece and Spain in order to have any hope of economic recovery. When politicians have taken this fateful step, you have a pretty good idea that their country’s economy has real problems. If this assessment is correct, several emerging markets have some real economic issues.
Recently China, Brazil and, most of all, India, have announced incentives to attract foreign investment. In a way this is odd because just a few months ago, they were acting very differently. The Chinese especially were openly hostile. A prominent Chinese talk-show host encouraged his listeners to “throw out the foreign trash”.
Apparently now the Chinese have found that the foreign trash has value, at least when it comes to their stock market. Thanks to massive stimulus the Shanghai market recovered quickly from its October 2008 lows. But from August 2009 it was all downhill. The Shanghai Composite lost 40% of its value while the S&P 500 gained 45 \%. Shanghai has lost 17% since its most recent high in May.
Chinese corporate earnings are going south and retail investors, who make up three quarters of daily turnover, might feel that they have a better chance at the gambling tables of Macau. There have been almost 100 IPOs (initial public offers) on the Shanghai exchange with listing multiples of up to 60 times earnings. Now the Shanghai index trades at an average of 11 times earnings.
Since the Chinese are sceptical about investing in their own growth story, the government has decided to find someone who still believes in it: foreigners. The Chinese financial officials are on a road-show to encourage foreigners to buy Chinese stocks. Prior to April 2012, foreign direct investment was limited to a combined total of no more than $30 billion. The Chinese raised that quota to $80 billion, but there were few takers. The reason is that foreigners correctly view the market as lacking in good governance. For example, the IPO review process benefits vested interests by distorting share pricing and encouraging rent-seeking. This week the market expected an announcement of an overhaul. But it didn’t happen.
Surprisingly the Chinese search for foreign capital was not limited to shares. The Chinese are trying to encourage foreign private companies to share their expertise in exploring for shale gas. Foreign firms have been for the first time allowed access to upstream rights Chinese natural resources in oil and gas.
The realization that foreign companies are not so bad after all has dawned especially brightly in India. India’s growth has slowed dramatically from 8.5% two years ago to 5.5% in the latest quarter. Rating agencies are threatening to downgrade India’s sovereign debt to junk. Meanwhile the rupee has fallen to all-time lows against the dollar, quite a feat considering the US is doing everything to debase its currency.
In response the government has decided to open up more sectors to foreign investment. According to the proposal international retailing giants like Wal-Mart and Carrefour will be allowed to own a 51% interest in supermarkets and department stores. Also foreign companies will be allowed to own up to 49% in domestic airlines. The government approved partial privatization of four state-owned companies—Oil India, National Aluminium, Hindustan Copper and trading group MMTC. Even Brazil is encouraging private foreign investment in a proposed bullet train.
Over the past few years we have been treated to the emerging market growth story. A fiction, where demographics in emerging markets ensure sustainable growth for the foreseeable future at a rate faster than developed countries. What we are seeing instead is something quite different. Countries mired in government policies designed to protect vested interests rather than sustain growth. Unless this changes, the slowdowns in emerging markets could be greater and longer lasting than anyone expects.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected]).
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