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The International Monetary Fund stated earlier this fall that Vietnam’s foreign reserves, including gold, would grow to $15.4bn by the end of 2010–and $19.2bn next year–from $14.1bn year-end 2009, after a sustained drop since 2008 as foreign currency inflows lagged during the economic crisis and Vietnamese individuals and firms began hoarding dollars and gold (said sentiment persists, evidenced by the state’s rate of 19.500 Vnd/USD and the black market’s 21.000 Vnd/USD offer) against the backdrop of a burgeoning trade deficit (which more than doubled to $12.4bn in 2007, rose by roughly 40 percent in ’08 and has since retreated slightly to $10.66bn YTD 2010) and rampant inflation (spiking to 24.4% last year) from government-fuelled money supply growth and the absence of inflow sterilization through either debt issuance or reserve requirement hikes. In fact, it’s these two indicators (trade deficit, inflation) and where one thinks they’re headed in the next six months which likely underlies any investment thesis on whether or not Vietnam’s VN index is inherently underpriced at the moment. FT notes, for instance, that the market has fallen 14% YTD, trades on a 2010 forecasted P/E of 10.6 (see FT graphs) and is 63% below its 2007 historical peak despite the fact it remains one of Asia’s fastest growing countries in terms of output (over 7% forecasted next year). HSBC, in fact, has practically called the bottom.
The question about trade is something of a conundrum because ironically it speaks to Vietnam’s strength as an exporter (dominated by crude oil, textiles and garments, rice and coffee). But as Ayumi Konishi, Vietnam country director for the Asian Development Bank notes, “for Vietnam to export, first they have to import, because the foreign-invested manufacturers can’t source the equipment they need from inside the country.” Yet this paradigm may be shifting–and if it does, watch out. Dragon Capital noted to investors last month that the monthly trade gap deficit had dropped 20-30%yoy since July and that “on a 3m/3m basis (excluding oil and gold) exports are running well above imports, at a respective +35% versus +18%. If this trend continues into 2011, the market will begin to note a clearly declining trade deficit.” Per inflation, though, the matter may be more muddled. A recent WSJ piece spoke to the inefficiencies of “Hanoi’s aggressively pro-growth economic policies, such as low interest rates and state-subsidized lending” that laid the groundwork for current inflationary pressures and the dong devaluations that have hitherto played into a psychologically damaging, negative feedback loop in consumers’ minds (it also underscores just how politically ambiguous Vietnam remains from an ideological standpoint–a tension that does nothing for economic stability). Per Dragon, however, the country’s inflation rate was 9.66 percent in October, holding above 8 percent–the government’s target for the year–for the ninth consecutive month. But “the biggest contributors continue to be food and education,” Dragon wrote, and despite constituting roughly three-quarters of the rise, “they are one-offs that will not recur in coming months. Apart from them, the CPI basket was only up about 0.6%…[and] as inflation usually climbs a total 1.2-1.6% in Nov-Dec, we can expect it at 8.8-9.3% by year-end.” Nevertheless the dong could fall more than expected this time around given that the central bank, somewhat lacking tact, hinted earlier this month that it wouldn’t devlaue again “until at least the Lunar New Year festival” next February, creating no doubt an awkward limbo period. So in sum, Vietnam is either cheap, or markets in this case at least may be more efficient than we give them credit for.
In writing that “given the external demand, issuing [debt] overseas can be a cheaper option for African governments and corporations than their relatively small domestic debt markets, provided they can offer a bond big enough to whet foreign appetite,” a recent piece on rising Africa bond issues notes, for example, that “Ghana’s Eurobond was issued with a coupon of 8.5 percent, compared with the 13.95 percent on a three-year note issued locally the same year.” In whole, sub-Saharan debt issuance totaled $5.6 billion in the first nine months of 2010, down 30 percent year-over-year but well above the $1.6 billion in the first nine months of 2008, according to Thomson Reuters data.
Ghana’s bond is somewhat infamous in that it was the first dollar-denominated debt issued by a sub-Saharan government apart from South Africa and is labeled by some as a “benchmark” for African frontier debt; its yield spiked above 23 percent in 2008 but has consistently made new lows this year, falling to 5.746 earlier this month for instance. Moreover, a recent data overhaul revised 2009 output by 75 percent and allowed it to “leave the ranks of the World Bank’s low-income bracket of countries such as Liberia and Afghanistan [in order to] join the more affluent ranks of Thailand and the Ivory Coast.” This only a few months after S&P downgraded its credit rating to B, citing concerns about large fiscal deficits and a lack of clarity on oil-industry laws (the country is due to begin the production and export of 120,000 barrels of oil a day in 2011). Moreover, finance minister Kwabena Duffour noted last week that the cash budget deficit would narrow to 7.5 percent of GDP next year from roughly 9.7 percent in 2010, and proceed to drop to 4.7 percent in 2012 and 3 percent in 2013. The changes “should foster a rating upgrade,” per one analyst.
Last month Moody’s noted in regards to Lebanon that “deep structural challenges” (namely high public debt which hampers the scope for productive, public spending; see graph) continue to limit the economy’s longer term potential, though it riterated that a “robust level of external liquidity, a resilient bank deposit base, the government’s strong track record of debt servicing, and the country’s proven ability to mobilize donor support” underpinned its B1 rating for foreign and local currency government debt (raised from B2 last April). To that first point, The Economist recently underscored the strength of Lebanese remittances, which comprised a fifth of GDP in 2009 and remained buoyant during the global recession and after “not only because the war prompted generosity but also because of solid banks that offer 7% interest on the dollar and property prices that have doubled or tripled in four years.” And last week the World Bank revised its estimate of remittances into Lebanon for 2009 upward, setting their value at $7.6 billion, and estimated they would reach $8.2 billion in 2010, the equivalent of 22 percent of total remittances to the Middle East and North Africa (MENA) region. This means that while Lebanon has less than 1% of the MENA population, it receives 22% of all remittances destined for that region. In regards to investing, banks (our favorite remains Blom Bank) remain a prudent way to capture Lebanese growth. Historically quite liquid (due somewhat to pragmatism in the face of ever-turbulent geopolitics), Lebanese banks have been very profitable over the last two years, emerging relatively unscathed from the financial crisis due to conservative fiscal policies by the central bank, which prohibited exposure to risky instruments.
The lower effective cost of imports has hitherto helped to tame inflation in Chile, although further dollar appreciation can be expected (two, three and five year swap rates all climbed to relatively new highs after the decision) as the $164bn economy expanded 7 percent in the third quarter year over year, its fastest pace since 2Q2005. Despite the fact that core CPI numbers came in below consensus (down 0.1 percent in October after rising 0.4 percent in September), and the country’s trade surplus hit a 22-month low, falling 88 percent to $214.9 million in October from $1.785 billion the month before, the central bank raised benchmark rates by a quarter-point (to 3 percent) for the sixth straight month this past week. Interestingly, though the peso has been the region’s strongest performer–up 14 percent since late June against the dollar–Chile has no plans to implement capital controls (such as Brazil’s 2 percent tax on inflows) to curb gains, per Finance Minister Felipe Larrain. “Capital is very smart,” he said. “You can say this short-term capital I don’t want, so they disguise it as long-term capital and they are really playing with the interest rate differential.” As an investment, the Chilean ETF (ECH) remains strongly correlated with the price of copper, which in turn follows the lead of the Shanghai index (China is the top consumer), argues trader Moise Levi. Using technical indicators (inverse head and shoulders; see graph left), he cites a close above 3150 on the Shanghai as a strong buy indicator on the metal.
To a contrarian investor, articles like this one–documenting the fact that frontier market equity funds so far this year have received more than $1 billion in inflows, easily eclipsing their hitherto record in 2007 of $442 million–signal that–in Chuck Prince lingo–the music may have indeed stopped. This would run contrary to the conventional feeling following the confirmation of QE2 that the yield-seeking ‘risk trade’ was still ‘on’, though the natural rebuttal to that would be that markets have essentially been pricing in QE2 to their risky asset valuations ever since Ben Bernanke all but revealed his hand in Jackson Hole on August 27th. That said, as the true ‘tail end’ of the risk curve, frontier markets have historically lagged their emerging brethren in terms of timing and breadth (their higher volatility also suggest that even core ‘believers’ are somewhat fickle). The MSCI BRIC index, for instance, has risen nearly 150 percent since March 2009, while the MSCI frontiers index has ‘only’ returned 65 percent over that same period (see chart, left). This suggests that the claustrophobia felt by some emerging market investors could naturally be a boon for less crowded, frontier trades, per Nouriel Roubini’s latest musing.
Additionally, for at least one fund manager, QE2 is a curse given its inflationary implications. “I would view the impact of QE2 as being mostly negative,” argued Ahmed Heikal, chairman of Cairo-based private equity firm Citadel Capital. “QE1 has caused a substantial rise in food prices, QE2 is a continuation of that. There is no sign of food prices abating anytime soon, and that is going to put inflationary pressures on many parts of Africa.” This echoes our argument that inflation in countries like Nigeria, where food is such a relatively large portion of headline CPI compared with developing nations–will be especially rampant all else equal going forward. This effect would be muted to a large degree if frontier currencies also rose. To Razia Khan, head of Africa research at Standard Chartered, the rub is in the timing of it all. “The danger for African countries is if you see oil prices going a lot higher–or food prices–before you see African currencies rising,” Khan said.
The FT noted this week that according to many analysts Dubai’s “core model, built on finance and trade and infrastructure, still puts it far ahead of its rivals as competition heats up to be the region’s hub.” However, the city-state and its government-related companies still have a total of $110.6bn of outstanding public debt according to Bank of America-Merrill Lynch figures, of which a significant portion ($48.5bn) comes due in the next two years. Last month Dubai World, the government-owned conglomerate, confirmed that creditors had indeed agreed to restructuring proposals regarding the $20bn of debt whose repayments the group announced a moratorium on last November, a move that analysts theorized could spur similar deveopments at other state-linked firms. Simon Williams, chief economist for the MENA region at HSBC Bank in Dubai, thinks that the emirate has a whole has “shifted into recovery mode,” citing the fact that his firm’s UAE Purchasing Managers’ Index (PMI), which measures the performance of the OPEC member’s manufacturing and services sectors, rose to 53.8 points in October–a 15 month high. And last month the IMF upgraded its GDP forecast for the UAE to 2.4 percent, faster than the 1.3 percent it previously forecast, based largely on robust demand for UAE services, “particularly in light of Asia’s rebound and the agreement on debt restructuring, which will resolve uncertainties and contribute to boosting real estate-related sectors.” Yet worrisome news over this past weekend should give bulls some pause, as five-year credit default swaps (CDS) for Dubai spiked 30 basis points from the previous close to 440 basis points (a two-month high) on news that Dubai Group, a financial services firm, missed two payments on separate loans in recent weeks, including one arranged by Citibank.
Yesterday we relayed Imara Asset Management CEO John Legat’s theory that a flat tax rate would be a boon for Zimbabwe and ultimately erode corruption while underpinning the country’s competitiveness (against the likes of South Africa, for instance) and moreover augment its moribund tax base. The Economist’s latest piece on business and bureacracy (“Snipping of the shackles”) touches upon some of these same themes, noting [in regards to the World Bank’s latest “(Ease of) Doing Business Survey 2011”] that “wherever the red tape is thickest, the result is widespread informality. Many small firms operate under the radar of officialdom, dodging taxes and ignoring rules [in order] to survive. But they have to stay small, and thus contribute much less than they might otherwise do to a country’s prosperity.” Cutting said tape, the theory goes, propels a positive feedback loop that–given how low a base some countries are coming from–can quickly translate into fairly remarkable results. The state of Lagos for example, home of Nigeria’s business capital by the same name, “has been improving its tax collection . . . encouraging formerly chaotic companies to keep proper accounts, which in turn makes it easier for them to do business with each other. The extra tax revenue is being used to improve services such as public transport, which among other benefits makes it a better place to do business.” Among other countries making recent gains in the rankings, Mexico (“the most straightforward country in Latin America”) and Kazakhstan (year’s most improved economy) were frontier stand outs.
Another, Saudi Arabia, is ranked higher than both Germany and Japan, which might cause some cynics to question the data’s veracity. On a similar note we switch gears to a project recently published by two MIT economists which used the internet to provide a daily gauge of consumer price inflation (see graph, inset) among various countries and which also calls into question the rosey conclusions offered up by some governments–namely Argentina’s:
“In countries where the apparatus for collecting prices is limited, or where officials have manipulated inflation data, the economists’ indexes might give a clearer view. In Argentina, for example, the government has been widely accused of massaging price figures to let it pay less interest to holders of inflation-indexed bonds. President Cristina Fernández has defended the government data. For September, the government’s measure of prices rose 11.1% from a year earlier. The economists’ measure in that period: up 19.7%.”
The plight and root cause of surging physical rubber prices in Thailand (the world’s largest producer with 31% of global natural rubber output), Malaysia and Indonesia, as well as rubber futures across various exchanges, somewhat echo that of the cocoa industry in the Ivory Coast: persistent underinvestment in the past and thus a continual dependence on aging infrastructure (i.e., rubber-yielding trees planted in the 1980s and thus just beginning to enter the stage of declining yields, per Macquarie, an investment bank) and a stable-to-shrinking supply of agricultural land–is finally translating into increased volatility in quality and yield. Coupled with ever-changing weather patterns and voracious demand from emerging markets for tires, condoms and gloves–led by China, whose tire consumption according to the FT grew 57% y-o-y for 1H2010 per Pirelli–and prices are likely to stay trending upward. The cash price in Thailand gained 1.6 percent to 130 baht ($4.40) per kilogram this week, just shy of the record 130.55 baht on April 27th. Yet “prices may surge above 150 baht by the end of this year as demand remains robust while supply is limited,” said Supachai Phosu, the country’s deputy minister of agriculture and cooperatives. Chinese demand, by the way, is likely to increase its upward rate of acceleration, if for other reason than the continuation of a government subsidy for fuel-efficient cars and also the enduring prospect of further surprise rate hikes underpinning current consumption.
Still stumping for the thesis that Zimbabwe’s stock market is undervalued, John Legat, CEO of Imara Asset Management, “noted that in the third quarter of 2010 foreign buying jumped to 63 percent of all activity on the stock market compared to 29 percent the previous period, a sign of attitudes changing among those running frontier Africa investment funds.”
Legat made headlines earlier this month when he announced his support for a flat tax regime in lieu of the current proposed revisions (supported by KPMG tax director, Steve Matoushaya) which would incorporate a residence-based system meant to tax all Zimbabweans for income earned outside the country, as well as that earned locally. “The net result of low tax rates, if successful, will be immigration and a rising population which will immediately add to consumer demand, investment in new businesses and a boost for the construction industry as housing investment rises. That in itself will lead to a growing tax base,” argued Legat. “In Russia, the tax system was too complicated and tax rates were high. In 2001 President Vladimir Putin introduced a flat tax of 13 percent, that rate being applicable to all personal income. He reduced corporation tax from 35 percent to 24 percent. In just three years, his tax reforms had resulted in a significant increase in government revenues and a reduction in the informal economy.”
In sum, Legat concluded, a flat tax would not only encourage a return migration, but it would incentivize the current informal sector. The net result, he opines, is less bureaucracy and higher after-tax incomes–which in turn would further fuel P/E ratios and larger receipts.
“For a country like Zimbabwe, which is starting with a clean [post hyperinflation] slate, rising global taxation provides a great opportunity to attract skills back to the country. In very simple terms, if Zimbabweans living in South Africa are paying 40 percent in income tax at the top band, 15 percent provides an attractive incentive to relocate back to Zimbabwe. Furthermore the informal sector will slowly be encouraged to join the formal sector, especially where good policing can discourage underhand/illegal dealings . . . a lower tax rate [will] also result in higher after-tax income and hence higher disposable incomes, encouraging greater consumption that would translate into higher value added tax receipts.”
Deloitte’s recent projection that “the number of mergers and acquisitions in the Middle East [should] double in 2011 as regional economies expand and governments spend on infrastructure” may mean that merger arbitrage–in which a given target company’s stock price should eventually rise to reflect the agreed per-share acquisition price, while the acquirer’s price should fall to reflect what it is paying for the deal–could become an effective short-term, regional and/or sector-based strategy in the coming years. “Merge-arb” may also seek to capitalize on the spread at a moment in time based on a perceived probability of a given deal being approved, and/or how long it will take the deal to close, versus market perceptions.
As always, the devil is in the timing of it all. The Saudi insurance market, for instance, is “ripe for M&A” but “awaits a nod from the central bank,” according to Ali Al-Subaihin, chief executive of the kingdom’s biggest insurance firm, Tawuniya. “Consolidation is bound to happen, if it does not happen this year, it will happen next year or the year after. The catalyst would be for the regulator to intervene and suggest that some firms merge or for some firms to seek the regulator’s approval to merge,” he told a recent summit. Takeovers would be a welcome market response to the government’s overly aggressive push to license new firms amidst surging demand for protection & savings and health insurance (with the country’s population projected to reach 45 million by 2020, analysts opine that the demand for insurance products, especially medical and motor insurance, will only escalate further; to that end, per capita expenditure on insurance is rose 31 percent last year). Per a Reuters piece, “the pace of licensing may have been too abrupt to allow the new players to become quickly profitable, industry analysts say, forcing many to consider mergers or become acquisition targets.”
Health insurance accounts for over 40% of the overall market and is expected to grow, according to a report by RNCOS, an industry researcher, “as the increasing involvement of private companies develops the scope for insurance cover, and as foreign nationals and foreign pilgrims are obliged to take out insurance. In addition to this, the most recent introduction of compulsory health insurance for private employees, irrespective of the size of the company they are working with, will further boost the health insurance market in the country.” General insurance, which accounts for the majority of insurance premiums, is expected to grow at 13 percent annually until 2013 on the back of rising motor, property, engineering, energy, liability and aviation insurance.
Looking broadly across the entire region, premiums in the GCC rose by 28 percent in 2009 to $10.6 bn, though penetration rates still have room to converge. “Insurance penetration–aggregate insurance premiums over GDP–stands at 1 percent for the GCC countries. In contrast, the developed insurance markets in the US and Europe register penetration rates in the range of 5-15 percent,” per one consultant. “[And] Saudi Arabia’s penetration rate is a tiny 0.6 percent, which is dwarfed by that of the UAE at two percent.”
JGW
Frontier Markets 
