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Investment manager Vietnam Holding offered words of encouragement in its May investor newsletter regarding the dong:
“Fears that a return to trend-line economic growth and the side-effects of last year’s economic stimulus package would result in a return of high inflation have proven to be premature. The consumer price index figure for May was just 0.3% month-on-month and 9.1% year-on-year. Crucially, food prices actually dropped in May, by 1.3% month-on-month, following an even steeper drop in April. So far this year, the consumer price index has risen by 4.6%, which includes the inflationary effect of the ‘Tet’ (lunar new year) holiday. The Government recently revised its inflation target for 2010 from 7% to 8%. Although much depends on the summer harvest and the impact of recent drought conditions, a 2010 inflation figure of 10% seems more likely.”
Vietnam’s persistent dong devaluation policy (February’s was its fourth since June 2008), while theoretically long-run inflation inducing, proceeds under the guise of shoring up the country’s trade deficit (its export market is founded upon an ever larger import one) while also tempting dollar hoarders to return cash into circulation and thus slow down the vicious circle whereby the central bank (SBV) sells dong to fund its hard currency needs. The IMF noted in early June that Vietnam’s foreign-exchange reserves had declined to the equivalent of about seven weeks of imports from less than 11 weeks in December. Inflation has dogged the country this entire decade, when market reforms unleashed a torrent of growth (GDP grew from 2000 to 2007 at an average of 7.5%) as well as a steady flow of foreign capital. And while the credit crisis eased inflation by depressing oil and food prices, exports slumped and FDI plummeted, causing the trade deficit to balloon, reaching $10.2 billion in the first 11 months of the year, while dollar sales aimed at stabilizing the dong shrunk foreign reserves.
Yet a ‘mixed signals’ policy may ultimately doom the dong. While the World Bank recently opined that confidence in the currency was “gradually returning,” for example, and that dong deposit rates were becoming more attractive, tempting local investors to shift their portfolios out of gold and foreign-currency assets, officials seem particularly keen to loosen monetary policy as soon as possible. The SBV, which has held its benchmark interest rate at 8 percent since December, stated in early June that it would try to ‘encourage’ commercial banks to reduce their lending costs because current interest rates were at a level that ‘hurts corporate profits,’ per its Deputy Governor Nguyen Van Binh. Analysts in general are bewildered. “Premature easing is the key risk to unraveling dong confidence, leading to another round of reserve deterioration,” warned Johanna Chua, the Hong Kong-based head of Asian economic research at Citigroup days later.
Back in late April the Financial Times noted that “Southeast Asia’s insurance sector [would] likely see an uptick in M&A as major foreign players clamor[ed] to make acquisitions in the region.” Vietnam and Cambodia, the piece argues, stand out as especially attractive targets:
“Vietnam, the most vibrant economy in the Indochina region, has already attracted lots of international insurers’ capital, thanks largely to its big youth population and government policy to encourage people to buy insurances, continued the Indochina source. Vietnam has a life insurance penetration rate of just 0.7%, and a population of 88.1 million.”
Although the market share of Vietnam for life insurance is dominated by three main players–Prudential (40 percent), Bao Viet (34 percent) and Manulife (10 percent) per the Vietnam Insurance Association– smaller sized insurers are becoming increasingly relevant: ACE Life, AIA Life, Dai-ichi Life Vietnam, Previor, Cathay Life, Great Eastern, and Korea Life, for example, all showed marked growth in 2009.
Per Cambodia, FT wrote that “there is no foreign ownership cap in the country’s financial services sector, and thus “banking and insurance businesses are combined into one license, meaning that if an entity secures a license, it can provide both services at the same time.” Cambodia’s non-life insurance market is more developed than its life one, as the majority of its citizens still cannot afford the personal life insurance products. While Cambodia’s economy has grown between 6%-10% in recent years, the increases have been driven by construction, garment and tourism rather than the agriculture sector–the defacto foundation for roughly 85% of the population’s livelihood which nonetheless suffers from habitually shoddy infrastructure, low productivity, a lack of access to markets and poorly developed rural financial services. The results in tow have been persistent rural poverty and food shortages. Cambodia’s government claims to be aggressively targeting the situation, and points to international backed schemes to alleviate its chronic, urban-rural income disparity. Last December, for instance, the Asian Development Bank’s (ADB) Board of Directors approved a loan and grant totaling $30.7 million (joining the International Fund for Agricultural Development (IFAD) and the Government of Finland’s combined $19.1 million) targeted to increase crop productivity and output, improve post-harvest management, increase market access and price transparency, offer greater access to rural financial services, and foster knowledge of agriculture technologies.
According to Youk Chamroeunrith, general manager and director of Forte, the largest domestic insurer in terms of premium revenues, the fundamental issue holding back life insurance growth in Cambodia is the lack of both a proper regulatory framework as well as overall general awareness of the products, despite the fact that the World Bank identified life insurance as a vital sector to encourage public savings and drive productive investment. Moreover, foreign investment schemes, he says, are crucial to the industry’s growth. To that extent, the World Bank noted in April that foreign direct investment in Cambodia would reach $725 million this year, up from an estimated $515 million in 2009.
Non-life is already a rapidly growing sector and is driven chiefly by property, fire, motor and medical business lines. Premium revenue for the entire industry grew 19 percent in the first two months of 2010 and is still forecast to grow approximately 20 percent for the year, per figures released from the General Insurance Association of Cambodia (GIAC) in the spring. This coincides with 1Q results from Forte which reported premium-derived income growth of nearly 20 percent.
Boston Consulting Group’s recent piece on Africa’s economic expansion over the past decade highlights forty companies in particular that it calls its “African Challengers”, chosen following a vetting process that included minimum annual revenue, growth rates, cash flow, leverage ratios, exports and foreign-based employees, assets, acquisitions and partnerships. While admittedly “top-heavy” (the five largest firms represent over half of the list’s sales), smaller companies earned recognition based in part on their degree of international presence. Tunisia’s Groupe Elloumi, for instance, owns Coficab, mentioned in this space earlier in the week and the second largest supplier of automotive wires in the Euro-Mediterranean region (as well as one of the top five globally). Coficab has operations in Morocco, Portugal, Romania and Turkey, and a subsidiary is planning further expansion in Germany.
In a recent interview with The Wall Street Transcript, fund manager Larry Seruma, founder of New York City-based Nile Capital Management, LLC, extolled four reasons for investing in Africa:
“First, let’s talk about an objective that motivates almost all investors – potential returns. Over the last five years, African markets as a whole have returned about 12% annualized. This is comparable to the return of the broader index of emerging markets (MSCI Emerging Markets), which has been about 13% annualized over the same period. So Africa has performed about as well as emerging markets on the whole. But when you compare that performance with developed markets, it looks even more attractive.
Most major developed market indices have produced flat to negative total returns over the last five years. Over a 10-year horizon, the performance gap between Africa and developed markets is even greater. Second, African markets have produced low correlation with other emerging markets as well as developed markets. This means that adding Africa to a core portfolio has the potential to increase portfolio diversification. The third reason is Africa’s growth story. Increasingly, global GDP growth is being driven by emerging and frontier markets, and Africa’s GDP is projected to grow by 6% annually over the next few years. This matches the average annual increase in Africa’s GDP over the last decade. The fourth reason is a surge in money flows to emerging investment markets.”
Following on the heels of Bank Indonesia, which set a one-month minimum holding period for investors, South Korean regulators recently set limits on banks’ currency-derivative positions. The Economist points out that far from making the country’s currency market less stable, however, South Korea’s introduction of capital controls may not only ease pressure on the Bank of Korea to keep benchmark rates low, but also could help tame a historically volatile currency. Volatility has stemmed not only from the relentless, accommodative monetary policy from the world’s largest central banks in the U.S., Japan and Europe, but also from fervent de-leveraging from local and foreign banks during the Lehman debacle and, more recently, the European debt crisis, as overseas investors pulled money en masse.
Per Businessweek, Indonesia’s rupiah and South Korea’s won were Asia’s top two performers last year, rallying 16 percent and 8 percent respectively against the dollar, but this year, the won has been the region’s biggest loser, dropping 4.9 percent to 1,216.40 per dollar as of a week ago (the rupiah had risen 2.4 percent this year to 9,167). But with the recent yuan decision coming from China (which likely had far more to do with combating inflation than any kind of Geithner-inspired capitulation), analysts are bullish won going forward, and have a further arrow in their quiver if volatility indeed proves lessened (the currency rose on the day of the news). Barclays, for instance, predicted a 2.5% appreciation in the KRW earlier this week. And to the extent that it can keep some form of its hitherto ‘highest beta in EM Asia’ status, capital controls aside, that number may ultimately prove to be on the conservative end.
Jim O’Neill, the global economist at Goldman Sachs widely credited with coining the “BRIC” label, continues to tout the “N-11” (a term he first introduced in 2005) as the next 11 emerging economies, after the BRICs, that have the potential to rival the G7 as a source of global demand and sustained growth.” In addition to constructing trends in income per capita, O’Neill and his team monitor “a simple ‘financial development’ score, made up of seven financial indicators, which suggests a positive relation with income per capita,” in their ongoing evaluation “whether [a given country’s] domestic financial architecture provides adequate support to [its] macro fundamentals.” Vietnam and Egypt (jump to page 6 of the linked PDF; countries to the right of the trend line are seen as ‘outperforming’ in terms of financial development, whereas those to the left are underperforming given their relative wealth) show “high levels of financial development given their income per capita,” he notes, “whereas Mexico and Turkey (although financially more developed than the smaller N-11 economies) have the potential to become even stronger in terms of the size, depth and efficiency of their financial markets.” O’Neill notes, however, that “country-specific” factors likely play varying roles in the degree of reliability of the study’s determination.
O’Neill also deconstructs a given country’s financing growth, mindful of “recent studies triggered by the issue of global current account imbalances [which] suggest that developing countries that are more open to certain types of financial flows yet less reliant on foreign capital (financing the lion’s share of their investment through domestic savings) have on average experienced better growth performance.” Additionally, he studies the size an strength of bank-based finance, since “the assumption across the finance-growth literature is that the size of the financial sector is positively correlated with the provision and quality of services, and therefore with growth and development. Therefore, those countries that score consistently highly across a broad range of indicators should on average grow faster.”
The conclusion? As stated here on myriad occasions, not all “frontier” markets are created equal.
“The N-11 are a diverse group of economies, bound together by population size, resource-wealth and sub-regional dominance. The countries within this group have huge potential, both collectively and individually, and most are growing strongly relative to the advanced economies in spite of the global slowdown. Although much of this represents a continuation of a catch-up process for some, the pace of development in financial markets in these countries, combined with the scope of expertise and experience that national regulators and policymakers can draw on from past experience, mean that these countries are in a strong position to capitalise on both market-based and bankbased systems of finance. As these systems improve, strong growth should continue apace, and the poorest of the N-11 should be able to climb the income ladder to join the ranks of the BRICs and their own N-3.”
Paul Collier, professor of economics at Oxford University, pens an interesting piece in this month’s McKinsey Quarterly (“The case for investing in Africa”) that touches upon the continent’s untapped resource potential:
“Africa is the last major region on Earth that remains largely unexplored. In the long-explored countries of the OECD, the average square kilometer of territory still has beneath it around $114,000 of known subsoil assets, despite two centuries of intense extraction. In contrast, the average square kilometer of sub-Saharan Africa has a mere $23,000 of known sub-soil assets. It is highly unlikely that this massive difference is due to a corresponding difference in what is actually there. Rather, the difference in known assets is likely to indicate an offsetting difference in what is awaiting discovery.”
For those who buy the commodity super cycle theory–namely that we are in the midst of another secular bull market in commodities, confirmation of which can be seen in the strong upward trajectory of demand for home wares and autos in emerging markets where ever-expanding middle class populations perpetually strive for a better standard of living–then Africa’s commodity export markets, which Collier opines can grow five-fold, may be one important factor behind impending, per capita income growth.
Another pillar supporting an inevitable increase in global wealth transfer to Africa, Collier writes, will be labor related:
“Per capita GDP in China is already above the global average, so its days as the low-wage factory of the world are limited. Africa will soon be the last remaining major low-wage region. It has an enormous coastline, more proximate to both European and North American markets than Asia is. Over the past three decades, offshoring shifted labor-intensive manufacturing from the OECD countries to Asia. In the next decade, expect the same process to begin shifting these activities from Asia to Africa.”
McKinsey Quarterly has a slew of great articles under the header “Doing Business in Africa” that really deserve attention. I’ll try to mix in some of the main points in subsequent posts over the next week or so, but in the meantime, registration there is free so go ahead and peruse at will if you’re so inclined.
Some nuggets for now, gleaned from this week’s Economist:
- The natural-resource sector accounts for only about a third of the continent’s growth. Africa is producing a growing number of world-class companies outside the resource industry, from South African giants such as SABMiller, the world’s second-largest brewer, and Aspen Pharmacare, the largest generic-drugmaker in the southern hemisphere, to niche players such as Tunisia’s Coficab, one of the world’s most successful suppliers of wiring for cars.
- As to the poor, thanks to rising living standards, some 200m Africans will enter the market for consumer goods in the next five years. Moreover, the continent’s working-age population will double from 500m today to 1.1 billion in 2040. Consumer-goods companies ranging from Western giants such as Procter & Gamble to emerging-market car companies such as China’s Great Wall and India’s Tata Motors are pouring into Africa. Foreign firms are likely to start using Africa as a base for manufacturing as well, as Europe’s population shrinks and labour costs in India and China rise.
Bloomberg reports that Hungary today sold 45 billion forint ($196 million) of three-month Treasury bills at an average yield of 5.28 percent, up from 5.26 percent at the previous auction on June 8, and “almost double the planned amount, signalling a return of investor confidence after the government’s failure to raise the full amount offered at an auction last week.” Moreover, the forint has now gained 3.2 percent since June 4 when it hit its weakest level this year after local politicians compared the country’s fiscal strength to that of Greece asserted that the previous administration had lied about finances.
Not so fast, a piece in this week’s Economist warns. Hungary prime minister Viktor Orban’s 29-point economic plan, introduced June 8th and which temporarily stalled a fall in the forint and a spike in borrowing costs, may yet wreak havoc. The country, it writes, “is the most debt-ridden country in eastern Europe: its public-sector debts exceed 80% of GDP. Cuts in public spending will have to go far beyond the gimmicky blitz on top salaries, official cars and mobile phones mentioned so far. As in other ex-communist countries that have tried it, the flat tax will doubtless have a splendid effect, raising revenues and shrinking the black economy. But that takes time. The banks are already staggering under the weight of bad debts. Hitting them with an extra tax—apparently amounting to 200 billion forints ($860m), or 0.6% of GDP—will do little to encourage lending.”
Yet many observers still scoff at the notion that Hungary and Greece belong in the same breath, owing the flippant remarks on finances more to opportunistic political manuevering than to any bona fide, lurking ailment. Per the FT last week, for instance, “analysts say Fidesz party officials have been overly gloomy about Hungary’s finances in an effort to prepare the public for further spending cuts.” Added an emerging markets strategist: “There is no real financial reason that Hungary should struggle to raise money.”
I’ll try to get back into a more semi-regular posting routine by sharing this YTD price chart (below) from Silk Invest. Per Baldwin Berges, its Managing Director, in the firm’s latest investor geared commentary:
Africa proved to be mixed bag ranging from Egypt’s -12.11% to Ghana’s +9.37%. The markets of the Middle East seemed to have imported a deal of negative global sentiment. In our view, it only make this cash rich and ideally located part of world even more attractive for investors. The same goes for fixed income, while the credit scores across the region remain very solid, the market can’t seem to help but sprinkle a pinch of globalised risk aversion all over it.
If nothing else, the broad array of returns suggests that there may be more nuance to the frontier economies than some investors might think, and that simple assumptions about their broad, return correlations with the BRICs and other ‘risk’ trades quickly break down. Here, I propose, is where nimble managers are truly capturing alpha, across both equities and debt.
JGW
Frontier Markets 
