Tag Archives: emerging market investment

Our Fragile Markets, or Why China’s Your Daddy

By Henry Teitelbaum, Editor, P3 Planet

There seems to be very little western investors, governments or central banks can do to stem the tide of contagion from China’s collapsing stock markets.

While it’s tempting to dismiss this selloff as merely a correction in equity markets after they hit sky-high valuations, it’s troubling to see how quickly the wealth of millions of people has evaporated. Of greater fundamental concern for markets is that as China’s export-driven juggernaut slows, there are no real economic growth engines in the world to replace it. The fact is that our economies remain weak and vulnerable, and for that we have ourselves to blame.

During the past 20 years, when China’s booming economy was busy exporting goods and importing western technology and capital, governments in the US and Europe did very little to mobilize investment in the essentials of future growth at home. In Europe, the focus was on futile efforts to rein-in social spending, reform labor markets and keep jobs from disappearing, while in the US little attention was paid to economic fundamentals. Instead, successive governments, Democratic and Republican alike, threw everything behind politically popular efforts to expand home ownership to the millions.

Critically, nothing much happened at either the federal or state level to develop the public infrastructure that would be needed to support a thriving and productive 21st century economy. Whether it was upgrading roads and bridges, rail networks and airports, or building schools and public healthcare facilities, investment utterly failed to keep up with society’s needs. What we got instead was the biggest housing bubble in US history.

US Labor Productivity

Wrong-Headed Crisis Response

Even after that bubble burst, western leaders ignored or were thwarted from making these investments. Across the Euro-zone, governments focused on a self-defeating exercise in fiscal austerity, while in the US, an initial investment in fixing public roads was followed by political gridlock. Despite the opportunity to borrow long-term at historically low cost,  governments in both the US and Europe continually failed to make these urgently needed growth-generating investments.

The private sector has also failed us. Businesses across the US and Europe — rather than make bold investments in their flat-lining economies — have been sitting on their expanding piles of cash for years. Dividends to investors reached record levels while companies waited for that elusive economic turnaround that never seemed to take hold. Predictably, when the investment-starved turnaround finally did come, it was weak and woefully inadequate.

So here we are. The US, Europe and Japan are all still drowning in debt, either outright, or as a percentage of GDP. And investment spending, such as it is, isn’t anywhere near where it needs to be to allow economies to grow their way out of debt. So western economies, markets and indeed their financial systems are all looking very fragile indeed.

Investment Opportunities Ignored

It didn’t have to come to this. Investments in infrastructure create enormous value for economies that fully justify their cost. In the short-term, they generate jobs, which helps to put money into circulation in the economy through increased spending on goods and services. Whether it is public money, or private sector investment through Public Private Partnerships, the multiplier effect that follows quickly generates economic activity and tax revenue for the government.

Longer term, the completed asset supports better services for both the public and private sectors, leading to a more productive economy and a more attractive investment destination for both domestic and foreign businesses. The debt generated from building these public assets can also make for a safe, long-term  investment that can contribute to the stability of domestic markets in the face of turbulence elsewhere in the world.

Studies have repeatedly shown that infrastructure investments, particularly during times of economic bust, generate a much higher fiscal multiplier than other types of government investment, (http://www.frbsf.org/economic-research/publications/economic-letter/2012/november/highway-grants/).

In effect, they provide a Keynesian lift to aggregate demand at precisely the time when it is most needed. Further out in time, according to the Federal Reserve Bank of San Francisco, there’s a medium term boost to the economy when the asset, in their example a public road, increases the economy’s productive capacity.

The SF Fed concludes that combining these multiplier effects can mean that every $1 of government spending produces “at least” $2 of economic output.

China’s Treasury Bond Option

The colossal failure of western developed economies to adopt growth-oriented investment policies means their markets will remain extremely vulnerable to exogenous shocks such as the one China has generated. And it’s not just equities. Treasury yields could be in for a similar shock if China, now the biggest holder of US Treasurys ($1.27 trillion as of June 2015), decides to start selling off its holdings to support its markets.

In the absence of western leadership, what’s likely to happen in our fragile markets going forward will depend on how quickly and successfully China re-positions its economy towards domestic consumption. Let’s hope they decide they don’t need to sell their Treasury holdings to get there.

This blog has appeared in Medium and Business Daily.

Henry is available for freelance commissions and long-term assignments and is reachable at hthq@hotmail.com.

Global Climate May Be Biggest Loser In India’s Growth Budget

By Henry Teitelbaum
Editor, P3 Planet

A lot of positive press has been directed at Indian Prime Minister Narendra Modi for a budget that promotes long-term economic growth by investing in infrastructure and reforming the way it is delivered. But insufficient attention is being given to the disastrous long-term climate change implications of its heavy reliance on coal.

Supporters of sustainable growth inside and outside the country need to do a lot more than cheer-lead for Modi’s agenda if they want to prevent a potentially catastrophic rise in carbon emissions from what is already the world’s third largest CO2 producing country.

Modi’s 2015-2016 budget focus is geared heavily towards spending and investment to develop the country’s transportation infrastructure. High on the agenda is ensuring that regulatory and land acquisition issues that have hobbled the completion of rail and road links are corrected. For years, these issues have prevented India from making effective use of its existing Public Private Partnership (PPP) model for transportation infrastructure, particularly highways. An estimated $10 billion of such projects are uncompleted due to the inability to secure the land that is needed to finish them.

PPPs allow governments in developing countries such as India to get the infrastructure they need without adding massively to public debt by allowing private investment capital to pay for much of the upfront development costs. In return, the private sector project delivery businesses that are selected receive the right to design and build the asset. Once the project is operational, they get paid to operate and maintain it over the long-term through a share of the tolls collected or from dedicated government tax revenue streams.

To give an idea of how much of this infrastructure is needed, the International Monetary Fund (IMF) estimates that India, with the world’s second largest population, needs an additional $1 trillion in investment in the medium term.

Infrastructure’s Multiplier Effect

The experience in neighboring China over the past 20 years suggests the Modi government is right to view investment in infrastructure as central to India achieving its potential as a global manufacturing hub. With its stable democracy and vast pool of young, highly skilled workers, India has drawn interest from around the world, including from China, as a future export manufacturing center because wages are so low. But until now, the poor state of the country’s infrastructure has held India back.

Modi’s program for investment in infrastructure promises to do a lot to turn that around. His  pro-growth policies, which include business tax cuts and measures to promote bank lending, are likely to support continued strong GDP growth, currently estimated to be over 7%. According to the OECD, India is already on course to become the fastest growing large economy in the world by next year.

A focus on domestic infrastructure investment is particularly appropriate for India because it quickly puts money in the pockets of working people. According to a recent study by Standard & Poor’s Corp., the “multiplier effect”, that is the increase in final income arising from any new injection of spending, is particularly strong in developing countries. It estimates that in India, any increase in infrastructure investment would result in a boost to GDP of at least double that increase. So a little investment in India’s infrastructure can go a long way towards addressing wealth inequalities in one of the world’s most economically polarized societies.

Elephant in the Room

But Modi’s strategy also brings big environmental challenges that few seem to want to discuss. These derive mainly from the fact that the government intends to rely on domestic energy resources, chiefly coal, to power its economic expansion. Considering the size of India, unchecked expansion of India’s use of coal at a time when other coal consuming countries are either cutting back or have plans to do so could soon turn India into the world’s largest carbon emitting nation.

According to the International Energy Agency (IEA), more than 80% of electricity generation in India comes from fossil fuels, with the power generation sector alone consuming about 70% of the domestically produced coal. Developing modern economic infrastructure is very energy-intensive by definition, requiring vast amounts of cement, bricks, lime, steel and aluminum. Heavy industry in India is already heavily reliant on coal, which is also the only fossil fuel for which domestic reserves are still plentiful. So it’s not hard to to see where the energy for the vast majority of India’s growth agenda is going to come from, or why.

Worse yet, coal-fired energy production in India is currently very inefficient by global standards, running at around 31% at a time when efficient rates of 45% have been achieved, according to the IEA Clean Coal Centre.

There’s no reason to doubt Modi’s word when he expressed  the hope that India will become the “renewable energy capital of the world” through its focus on solar and wind deployments. But the government has released few details about how its renewable energy plan can be made to meet the country’s energy needs. In the meantime, its stated goal remains to double coal production to one billion tons annually within five years.

The Deafening Silence From Abroad

Perhaps the absence of a roadmap to sustainability in energy wouldn’t matter so much if there was at least a blueprint for eventually reducing India’s reliance on coal.

Unlike China, which concluded a bilateral deal with the US last November committing both countries to begin reducing carbon emissions, no such deal was struck with India when US President Barack Obama visited the country in January. And while China aims to start lowering carbon emissions by 2030, the best Obama could come away from India with was an agreement in which the US will financially support India in five clean energy programs.

It’s not just the US that’s been willing to overlook the potential for environmental degradation and global warming that will accompany India’s head-long rush for growth. IMF chief Christine Lagarde said nothing about the issue during her recent visit to India, where she instead heaped praise on the government for its pro-growth policies.

For the record, India’s latest budget does present some practical measures to fund renewable energy projects, notably a doubling of the coal tax for a second consecutive year. That represents about 10% of the price of coal and should bring in about $2 billion a year in revenue. This at least should start to encourage greater efficiency and lower CO2 emissions. But that revenue estimate will still bring in far less that the $100 billion commitment that Modi has made toward reaching India’s renewable energy targets of 100GW of solar and 175GW of total renewables by 2022.

Promoting Private Sector Involvement 

So it would seem likely that a great deal of private sector participation, particularly from foreign investors, will be required if there is to be any chance of achieving these targets. In other countries where PPP is in use, the need to mobilize vast quantities of private capital to deliver such improvements would present an excellent opportunity for using this model. But India’s poor record of project delivery through PPP, particularly in road transportation projects, is likely to cause a great deal of hesitation among foreign investors.

The modal unit for PPPs in new and renewable Energy at India’s Ministry of Finance didn’t respond to numerous efforts seeking to discuss specific plans for encouraging private investment in renewables.

In all likelihood, India’s government will need to find other ways to encourage private investment in public infrastructure, particularly for frontier technologies in wind and solar energy. This could be done through the issuance of low-interest projects loans, guarantees, or some form of credit enhancement facility.

India’s increasing reliance on coal could also make it an attractive proving ground for carbon capture and storage technologies, particularly as carbon taxes continue to rise. The retrofitting of existing coal-powered energy facilities, as well as the design and construction of new ones, could prove more attractive and perhaps less risky for foreign  private investors than PPP infrastructure, at least in the near term.

Ultimately, the best guarantee of performance for the energy and transportation infrastructure that India needs to reach  its potential in a globalized economy will be for the government to ensure that its PPP reforms are effective. That means doing what needs to be done to make sure projects achieve completion and deliver value for money.

 

Mexico’s Infrastructure Plan Makes Compelling Case For Foreign Investment

by Henry Teitelbaum, Editor, P3 Planet

It probably comes as no surprise to investors that great diversity exists among the countries that make up the world’s emerging markets. Yet, when a financial crisis strikes them, it’s often because the foreign portfolio managers that run giant global investment funds indiscriminately dump their holdings of emerging market debt and equity at more or less the same time.

This behavior has often been triggered by country-specific credit issues or by changes in interest rate expectations in the US or elsewhere. But the impact on many of these countries is both immediate and far-reaching, often dramatically raising the cost of financing for governments and businesses in those countries that rely on foreign borrowings to service their debt. Typically, this leads to liquidity shortages as buyers disappear, steep losses for investors, bank runs, government and private sector defaults, and catastrophic job losses.

It doesn’t end there either. The contagion that follows reaches across borders to engulf whole economic regions. Of course, this domino effect is rarely justified by the underlying economic reality, and many western institutional investors have become adept at exploiting such short-term selloffs to pick up stocks for their portfolios on the cheap or to lock-in high yields on bonds that have been beaten down by panic selling.

Correlations In Emerging Markets Declining

Lately, this pattern has started to break down. Individual country performances seem to be reflecting a more diverse range of economic and business conditions across emerging markets better than they have in the last 20 years, and investors appear to be standing by their convictions. This is a good thing, and the surest evidence yet that emerging markets have grown up in a very short period of time. Emerging markets have not only grown dramatically just in the past five years, they now offer more ways to diversify risk across credit and equity markets.

Naturally, investors will look at broader macro-economic factors affecting individual economies such as external debt, current account, domestic deposits and foreign currency reserves. But they are also looking more closely at the policy priorities within individual countries that affect long-term stability, including progress in political and economic reform, and at the choices governments make when investing for the long-term prosperity of their people.

The selloff in January 2014 was a case in point. Emerging market countries where reforms have been implemented, where governments have limited their borrowing and where domestic savings are growing, proved resilient to the selloff. Many of these mostly Asian and Southeast Asian markets have more than recovered the steep losses that followed the change in dollar interest rate expectations.

Investors are also drawing distinctions among emerging market countries based on major programs and policy initiatives. One good example of how this is playing out can be found in Mexico. The country, which has historically been a target for foreign investment due to its oil and gas resources and proximity to the US, has lately been garnering attention for its open, progressive and highly credible approach to developing public infrastructure.

Making Mexico Investment-Friendly

And it should be. Mexico’s 2014-2018 national infrastructure plan outlined earlier this year by President Enrique Peña Nieto is an excellent example of how to structure a large-scale investment program to make it attractive to private investors. Not only  has the government incentivized domestic institutions such as pension funds to invest in early stage Public-Private Partnership projects, it has created the structures that will ensure that financing is available to get them off the ground.

The plan is nothing if not ambitious, envisioning some 7.75 trillion pesos ($590 billion) in public and private investment in infrastructure. There are 743 projects outlined for investment, and these focus heavily on energy, communications and transport. But the plan also includes new projects in housing and urban development, health and tourism.

To support investment, Mexico’s government-run infrastructure bank and fund trustee, Banobras (Banco Nacional de Obras y Servicios Publicos) has been given the capacity and the legal and structural mechanisms to make public private partnerships (PPP) “bankable” for a broad range of long-term investors, including foreign institutions.

What that means is that Banobras and Fonadin, the infrastructure trust fund that it runs, may help to catalyze private investment in infrastructure investment by taking the financial risks that private investors are unwilling to take. This is especially important in the early stages of construction, when risks are at their highest. They are also willing to provide long-term financing for projects, including PPPs that have low yields but high social impact.

Mexico, which has the world’s 14th largest economy, could really benefit from the investment, as its infrastructure places it only 64th of 148 countries in the World Economic Forum’s global competitiveness index. This was recognized as a key driver in the government’s decision to dramatically boost infrastructure investment. It also provides any and all potential investors with clarity on the value that the government places on the success of these projects.

A Helping Hand For The Poor 

Mexico’s government has gone further than most in trying to ensure that the investment capital is channeled to infrastructure development in parts of the country where it can make a big difference. Finance Minister Luis Videgaray indicated early this year that the plan places special emphasis on Mexico’s poorest states in the south and southeastern regions of the country.

By targeting these regions for infrastructure investment, there’s a good chance the investment will do “double duty”, and have an outsized impact on the economy of these regions. That’s because in addition to creating public assets that boost local productivity and competitiveness over the long-term, the investment will bring a near-term boost to regional economies through the jobs it creates.  Taken as a whole,  the program amounts to a powerful instrument for  addressing income inequality and increasing social stability throughout the country.

Foreign investors seem to have taken notice. The country’s equity market has been a strong performer in 2014, and currently stands out for both its emerging market-leading forward price/earnings ratio, and for its performance in relation to historical averages.

Could Mexico’s model for infrastructure development also be giving the country a leg up on the other emerging market countries with which it competes for  stable, long-term foreign investment?

I wouldn’t want to generalize about individual investment decisions. But for any investor comparing long-term prospects in emerging markets around the world, Mexico’s PPP-driven infrastructure push sure seems to tick a lot of boxes.

full disclosure: the author holds listed shares in the iShares MSCI Mexico Capped ETF

This article has also been published in The Conde Report on U.S.-Mexico Relations