With the slowing of the emerging market economies it is possible that 2013 default rate could achieve a new record. As the business cycle moves into an inevitable contraction, one success of the central banks may result in a dismal failure
It wasn’t supposed to be this way. Emerging markets, especially the BRICS countries, were reputed to grow far faster than developed countries. Investments in emerging equities markets were a one way bet. With expanding young populations, cheap labour and growing consumer demand, emerging markets were supposed to routinely turn in annual GDP (gross domestic product) growth of over 5%. It has not happened. The US S&P 500 has witnessed record highs and an impressive 11% return in the first quarter, while emerging markets have had generally disappointing results. Europe, perennially on the verge of crises, managed a 12% rise. The Japanese market, often written off, has achieved an astonishing 28% return.
In contrast many emerging markets have lost ground this year. The worst is Brazil, which is off 7.8%. India is next, where the BSE has dropped 3%. Russia is off 2.6%. The Chinese market appeared to be showing signs of life, after a 20% rise from December lows—it has again experienced an 8% decline and is off 1.66% for the year. As a whole, emerging market stocks have experienced their biggest first quarter drop since 2008. In theory, emerging markets should attract buyers because of their valuations which are 11 times 12-month projected earnings, compared with 14 for the MSCI World Index.
In a way it is a bit unfair. The boom in developed country markets is primarily based on a flood of free money. Emerging stock prices don’t jump upon the happy pronouncement of ever more easing by American or Japanese central bankers. On the contrary. The Chinese government has made it clear that rising inflation at 3.2% is too high. But their problem is far less than other emerging markets. Russia, Brazil, Turkey and South Africa all are coping with inflation rates above 6%, while India’s inflation rate has remained stubbornly above 8% for over a year.
In fact without the illusion provided by monetary policy, the emerging markets may more accurately reflect the reality of the world economy. After four years of expansion, it is rather late in the business cycle. Global growth forecasts are being cut from 3.3% to 3.1% and emerging market forecasts declined from 5.5% to 5.3%.
Brazil is particularly troubled. For many years it appeared to be on the path of sustainable growth. Between 2004 and 2008 it averaged an annual growth rate of almost 5%. Now that growth has declined. The average growth between 2011 and 2012 was only 1.8% less than the growth of the United States. Falls in commodity prices and lower exports to China and Europe haven’t helped, but the real problem has been a fall in labour productivity, various bottlenecks like inadequate infrastructure, a bureaucracy with an insatiable taste for red tape and weak investment.
The economy of Poland was one of the few economies in Europe that never experienced a recession. But its proximity has limited its immunity to the problems of the Eurozone. When the numbers out of Europe and especially Germany, Poland’s primary market, fall, Poland’s statistics follow suit. Its unemployment rate increased to a six-year high of 14.4% and increased from 14.2% in January. Retail sales have fallen by 0.8% and the forecasts of GDP growth of 1.5% look out of the question.
Another country that has been affected by Eurozone issues is Turkey. A recent economic tiger with growth of more than 8% in 2010 and 2011, it has shrunk to more of a house cat with growth last year of 2.2% slowing to 1.4% in the fourth quarter. The year-end bounce that was supposed to have been stimulated by monetary easing never materialized. Exports have slowed. Foreign direct investment has cooled from over $40 billion to $8 billion.
Falling oil prices due to falling demand has impacted Russia. The numbers for February showed a miniscule amount of growth at 0.1% down sharply from the 1.6% growth recorded in January, but consistent with the trend. The Russian economy has been slowing for five consecutive quarters.
The tables have been turned on what was to become the S in BRICS. South Africa used to make up 40% of the total GDP of the 48 countries in Africa south of the Sahara. Its closest rival was Nigeria in second place at 14%. Today, while the South African economy can only manage 2% growth, the rest of Africa’s average rate has risen to 6%. Peripheral Europe is not the only place to experience a downgrade of its sovereign debt. The rating agencies have not only downgraded the South African sovereign credit rating, but also five major metropolitan areas and two state-owned companies.
China’s government reversed its tightening last year, just in time for the leadership change in October. The reversal allowed a revival of the real estate boom. Both housing prices and inflation began to rise helped by an explosion in lending through the shadow banking system. With the worries over a political hand off out of the way, the Chinese government is again trying to slow out of control financial and real estate markets. New regulations limiting the sale of Wealth Management Products have been created. Taxes of up to 20% on sales of houses are supposed to come into effect along with real estate taxes which have previously been unknown.
The general assumption is that emerging market problems are due to issues in the developed world—slow growth in the US and a recession in Europe. The reality is that emerging markets have been slowing for quite some time. If you look at the GDP growth charts for China, India, Brazil and Turkey they all reveal the same thing. They all recovered very rapidly from deep downturns in 2009. Their growth sprung back quickly and hit highs in early 2010. But then the increase in growth rates stopped. The trend in growth has been downward ever since. Until today when in many emerging markets there is barely any growth at all, certainly not the advertised vibrant growth of 5% or more.
The promise of their markets has also been an illusion. While the US equity markets have made a slow but steady progress from March 2009 to their recent new highs, many emerging markets have moved in a trading range. Russia, India and Brazil reached post crash highs in 2010 and have not moved any higher. The Chinese market peaked in 2009 and has been on a slow but steady decline ever since. The exceptions are Indonesia and Turkey whose markets have progressed upward over the entire four years.
Unlike their stock markets, emerging market bonds have done well. Much of the capital flows into emerging markets have been due to the largesse of developed countries’ central banks. The suppression of interest rates has stimulated an international hunt for yield and a higher tolerance for risk. However, the steady decline of emerging markets does not bode well. Much of the demand in the world economy and the source of record corporate earnings came from emerging markets. As they begin to contract, we will see the effects.
Already the default rate from emerging market corporate issuers has begun to rise. Emerging market corporations defaulted on $22 billion of their obligations last year, a massive jump from the $182m of defaults recorded in 2011. In percentage terms, this translates into an emerging market corporate default rate of 1.43% in 2012, compared to 0.33% in 2011. The problem was especially acute for junk bonds. Last year was the fourth worst year on record for junk bond defaults in emerging markets. One would think that 2009 took the prize, but that is not true. Defaults in emerging markets were especially bad in—1998, 1999 and 2001—and years of the Asian financial crisis, the sovereign crisis in Russia and the 2001 default of Argentina respectively. With the slowing of the emerging market economies it is possible that 2013 default rate could achieve a new record.
Central bankers have shown themselves particularly adept at inflating certain asset markets. They have not been as successful in creating real growth. As the business cycle moves into an inevitable contraction, their one success may result in a dismal failure.
(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.)
DoT last Friday asked Bharti Airtel to end its 3G roaming pact with Idea Cellular and Vodafone under which the three firms on quid pro quo basis have been selling 3G services in telecom circles where they hold spectrum for the same
The Department of Telecom (DoT) is seeking to invoke bank guarantees given by mobile telecom service provider Bharti Airtel and has written to banks in this regard as the company has not paid the Rs350 crore penalty imposed on it for providing 3G services outside permitted areas in violation of rules.
“The communication was made by the finance wing of DoT to various banks where they (Bharti Airtel) have provided bank guarantees,” a DoT official told the media.
Bharti Airtel in statement said it has always maintained the highest standards of compliance. “We believe the 3G ICR arrangements are in compliance with all applicable laws and licensing conditions. These arrangements are also hugely beneficial to customers and discontinuing these will cause grave inconvenience to them,” the statement added.
The fine was imposed on 15th March for providing 3G services in areas where Bharti Airtel did not have 3G spectrum by entering into a pact with other service providers.
Bharti Airtel, one of the largest telecom operators in the country, was directed to deposit the penalty amount within 15 days.
DoT had slapped Rs350 crore penalty for violation of UAS licence conditions in Haryana, Maharashtra, UP (East), Kolkata, Gujarat, Kerala and Madhya Pradesh service areas where company is providing 3G services to customers without having 3G spectrum and license amendment for right to use 3G spectrum for provisioning of 3G services.
The Delhi High Court on last Thursday set aside a single-judge order which allowed the telecom operator to continue providing 3G intra-circle roaming facilities with other service providers.
Bharti Airtel’s statement said that the company has filed an SLP against the order of the division bench of the Delhi High Court. “Our SLP (special leave petition) is listed before the Supreme Court on Monday,” it added.
DoT last Friday asked Bharti Airtel to end its 3G roaming pact with Idea Cellular and Vodafone under which the three firms on quid pro quo basis have been selling 3G services in telecom circles where they hold spectrum for the same.
The Department had also slapped Rs550 crore penalty on Vodafone and Rs300 crore on Idea Cellular for violating 3G service roaming norms and had asked them to end the pact by 8th April.
Bharti Airtel, it is learnt, has been asked to stop providing 3G services by Saturday. This, however, could not be independently verified.
In this final part of the four-part series PS Deodhar talks about how both, the DoT and the nationalised banks used a commercial trick to disqualify APLAB from even offering a price. What happened in both these cases still haunts the author and makes him wonder about the role corruption played in the denial of these businesses
In my engineering career of 60 years, I have come across innumerable smart technical entrepreneurs who, in spite of their handicap of limited means and resources, have developed very innovative products and processes with unique features and performance. They have established credible technological businesses but struggle to grow. The government has not shown any interest in identifying and giving them special attention even though any developing nation, in its own interest, must do so.
In my early years, I was lucky to get such recognition in BEL, ISRO and many others. Unfortunately, there is no formal mechanism to utilize such innovators in our country as it exists in the US, Israel and even China. If our government is not interested or sensitive to the processes of assisting SMEs then our country loses its chance to advance technologically. We have the Science Congress for our scientists to announce their work, but no "Technology Congress" where our technical entrepreneurs can present their work.
Studies carried out by the government have shown that very few technological contributions are made by the large-scale sector. Most of them invest negligibly in research and development. Even those who sell high-tech IT man-hours have software products such as Windows or mobile OS like Android to their credit! They have the resources and the talents to identify and develop software products which can make them far richer, like Steve Jobs or Bill Gates.
Interestingly, it is the small and medium sector that does some important application in R&D and develops unique processes and products. In the US and Israel, for instance, such SMEs get a 'pioneer' status and preference over imports in the government's purchasing program. I feel that those who govern this country do not know how to make use of technical entrepreneurs in strengthening the technological progress of the nation.
Let me illustrate with APLAB’s experiences in two niche areas—Smartcard-based public payphones and automated teller machines (ATMs). Both products were needed in huge numbers by India. Initially, the Tata Group tried to build ATMs, but soon gave up. What happened in both these cases still haunts me and makes me wonder about the role corruption played in the denial of these businesses.
Both, the DoT and the nationalised banks, used a commercial trick to disqualify APLAB from even offering a price. In fact, a large and enterprising private bank even accepted our competitive tender for ATMs! It still did not end up buying from us, but the chairman of the bank was honest enough to tell me that he found APLAB's quote useful in getting competitors NCR and Diebold to drop their prices drastically!
Let me explain both the events more elaborately.
APLAB was quick in understanding the importance of smart cards in late 1989. I left the government after Rajiv Gandhi lost the election in December 1989 and the first thing that excited me was the card-operated pay phone that I saw in Paris. I knew that Semiconductor Complex (SCL) in Chandigarh had the technology to make Electrically Erasable Programmable Read Only Memory (EEPROM) chips. I knew that we could redesign this chip to work as a stored value telephone card. APLAB paid a big fee to SCL and got such a programmable chip made. Then we developed the technology to embed this chip on to a credit-card sized plastic card. APLAB also developed a public payphone with micro-controller-based system control. A unique communication protocol was developed to debit the card depending on the rate applicable to the destination called. It was then put on trial by the DoT in Mumbai for over six months. It established that our smartcard public telephone worked fine. MTNL then allowed us to install hundreds of them all over Delhi, including several in the Parliament House. All this happened without a single bribe. MTNL did not buy our phones, but we put them on the basis of a revenue share formula. The International Conference on Smartcards held in India even honoured me as "Smartcard Industry Pioneer".
After successfully running them for 18 months, MTNL announced its plans to float a tender for 10,000 card-operated telephones. Everyone at APLAB was excited since APLAB had the pioneer's edge with a field proven product. It was at least a Rs200 crore business. Then I was called by our Delhi office to meet the telecom minister. I introduced myself to Mr Sukharam. He never knew that APLAB belonged to me. He treated me well and I told our Smartcard story. The next week, I learnt that our European competitors raised the question of APLAB's capability in handling a large order. DoT knew from my reputation that APLAB would not be their “milking cow”. So when the tender was released, DoT put in one qualifying condition in the tender that the vendor must have at least 50,000 smartcard payphones functioning anywhere in the world. With one stroke, APLAB was thrown out! The Government of India gave its first reward for our pioneering work. Fortunately, I too had my admirers in Delhi. They probably ensured that DoT would never buy any smart card payphone from anyone either. Ten years later, cellular phones came in and consigned the smartcard payphones to the junkyard. Interestingly, APLAB's smartcard payphone was approved in Europe by Belgium Telephones, but they wanted international credit from India which I did not know how to organize or arrange for.
Then in 1996, I got excited by bank automation solutions. The ATM that I saw in HSBC made me wonder why APLAB shouldn't make ATMs. By then APLAB had a good grip over computing techniques and our team headed by BN Pal showed a lot of excitement to have a go. The heart of the ATM machine is the cash handling mechanism. I had a good friendship with a Mr Bond of De La Rue through APLAB UK. De La Rue was the prime source of bank note dispensers to global ATM manufacturers like NCR and Diebold, but they lost both these customers since both started making their own dispensers. So De La Rue readily agreed to support us with its field proven cash handling dispensers. The rest was designing a customer-friendly interface with a CRT screen, secure handling of ATM card and secure writing networking software.
Around 18 months later, APLAB had the ATM machines ready. Again, it was a pioneering effort on the part of our design group. We sold over hundred machines over the next 12 months. We also had two unique design features. At first, our machines were interactive with the user and provided his/her native language to be displayed onscreen. The second feature was taking a picture of the person withdrawing cash from the machine. Both were not provided by our competitors, NCR and Diebold. APLAB created a new Electronic Transaction Control, ELTRAC Division. With over 200 ATMs in field, we were looking forward to our banks to buy them.
When the nationalised banks started floating tenders for ATMs, all of them put a condition that the supplier must have at least 2,000 ATMs installed and functional. In one clean sweep, APLAB was debarred by Indian banks from the ATM business. I met two cabinet ministers at the Centre who I thought would understand the merit of supporting an Indian company's pioneering effort. All I got was a cup of tea.
There are many more instances for me to quote, but these are the two instances could have made APLAB at least a Rs2,000 crore enterprise, if not more. Well, this is the cost one pays for being upright, honest and technologically savvy.
I must, however, conclude by saying that I consider the loss was India’s, and feel very proud that we in India, can pull off what others in the world are accomplishing, and that too with a small Rs150 crore set up.
I have no regrets today as I have a good reputation and enough money to live with pride and contentment.
(PS Deodhar is founder and former chairman of the Aplab Group of companies. He is also the former chairman of the Electronics Commission of the Government of India and was an advisor to late Prime Minister Rajiv Gandhi on electronics. He also was the chairman of the Broadcast Council in 1992-93 that set in motion the privatisation of the electronic media with metro channels.)