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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%.”
Despite the fact that its benchmark Merval index is up over 50% this year–making it the world’s fifth-best performer according to Bloomberg–Argentina lost its position in the benchmark emerging-market stock index this past week and joined MSCI Inc.’s “frontier” category, a classification based on a given market’s size, liquidity and economic development. Analysts told Bloomberg that the change “may lure funds to the nation and extend a three-month equity rally,” especially those portfolio managers who are feeling the start of a new secular bull market in commodities–crude, for instance–and those who are betting that the government’s days of defaulting on debt are fin.
“‘You’re getting fresh eyes with frontier investors taking a look at Argentina,’ said Paul Herber, who helps manage $5 billion at Forward Management LLC in Seattle, including the Accessor Frontier Markets Fund, and plans to buy Argentine shares. ‘We’re not looking to take any heroic bets in Argentina but we’re certainly comfortable with a market weight.’”
Index rally aside, there is still plenty in Argentina to be weary of. Economist noted last month, for example, that “amid 17-19% inflation, the government of President Cristina Fernández de Kirchner is trying to control the prices of some locally consumed foodstuffs by sporadically preventing their export. But agriculture earns Argentina much of its sorely needed foreign currency, so for produce that is allowed to leave the country Ms. Kirchner has hiked export taxes as high as 35%.” Such policy is hardly assuring.
Drought in Brazil and Argentina, and a dispute over an export tax in the latter may cause the price of May soybeans to rise even further. Bloomberg reported yesterday that world inventories on Sept. 30 will fall to a five-year low of 45.8 million metric tons, down 11% from the March forecast and 14 % from a year earlier, according to the U.S. Department of Agriculture. And Financial Times wrote that soybeans continued to draw support from strong demand from China and from concerns about production prospects in Latin America. In fact, Oil World, a consultancy, opined that the risk was high that Argentina’s crop will shrink to 39m tons, down 16.5% from last year’s 46.7m.
According to the Financial Times, pressure is intensifying on Argentina to settle with holders of defaulted debt, who are now owed $29bn including interest. In 2001 the country defaulted on $95bn worth of debt. Ever since, the country has been effectively barred from capital markets, despite a 2005 debt swap accepted by the majority of bondholders, since those holding out would be able to seize any funds raised. A plan to settle with the hold-outs fell through last September after the Lehman collapse, and consequently Argentina’s continuing financial isolation is making it hard for it to meet its debt obligations. Some economists fear it could be heading for a new default next year.
That said, some kind of settlement could be drawing near. Five-year credit-default swaps based on Argentina’s bonds have taken a beating of late, and have soared nearly 10 percentage points in the past month, the worst performer among credit-default swaps tied to government debt. Traders eyeing a convergence could be rewarded.
A fascinating article in this week’s Economist details the phenomenon whereby Argentina’s seemingly secular instability is this time paying dividends to its vastly smaller neighbor, which the newspaper predicts will better weather the global downturn despite having a “small, open economy dependent on banking, beach tourism and beef exports.”
Why? The primary reason provided is that Uruguay will better be able to finance stimulus, an ability it owes to its decision back in 2001-2 to enter into a rescheduling agreement with its creditors, while Argentina defaulted on its debt, nationalized foreign businesses and imposed price controls:
“Argentina may struggle to roll over the $23 billion in debt maturing this year and next because of investors’ distrust: its bonds yield 15 percentage points more than American Treasury bonds. Uruguay is charged a premium of only five percentage points, and can thus more easily afford a fiscal stimulus.”
Fundamental research by IIR Group indicates a 25% upside in Telecom Argentina’s Class B common stock in a 6 – 24 month perspective. The target price for the company’s ADR (NYSE: TEO) is set at US$10.10, reflecting a 18.82% upside. IIR’s outlook for TEO is broadly positive based on the healthy top-line growth reported for 2008, and expectations of higher future revenues from wireless services. The wireless market is expected to grow on basis of higher usage as a result of lower tarriffs. According to consultancy firm Frost & Sullivan, the WiMax customer base is expected to grow at a CAGR 97.7% from 2006 to 2012.
The competitive situation, with only two major telecom players present in Argentina, puts TEO in a position to capitalize on the opportunities in the WiMax market.
Moreover, IIR reports TEO is planning to form an agreement with regulators to offer licenses for for triple-play services (internet, TV and phone). On the downside, increased expenses for promotional activity, promotion and branding, is expected to put margins under pressure.
“Recent nationalization of ten pension funds in Argentina will increase liquidity risk and dampen investor perception of Argentina due to increased funding cost,” IIR reports. This could present a significant risk.
The planet is facing a topsoil crisis, meaning that the greatest commodity of them all one day could be farmland. That potentially makes Cresud Inc. (NASDAQ: CRESY), which owns large swathes of farmland in Argentina and also has a growing presence in both Paraguay and Brazil, a sound long for punters. Additionally, the firm is currently involved in a variety of other projects including crop production, cattle raising and milk production, not to mention real estate accumulation (several shopping centers in Buenos Aires, for instance). In fact, while it is estimated that the firm owns about a million acres of farmland and 50,000 head of cattle, Guy Bennett of Q1 Publishing, an investment research firm, mentioned that Cresud’s executives consider themselves to be primarily a real estate development company. But all this diversity may not necessarily be a positive. Per one commentator:
“A significant component of Cresud’s net asset value lies in its stake in IRSA, owner of commercial real estate in Argentina and stakes in a few other affiliated real estate companies. IRSA has a lot of debt which poses a risk of a dilutive debt refinancing or potentially even bankruptcy, either of which would erase a significant portion of Cresud’s NAV. If Cresud were only a farmland owner, it would be much more attractive.”
On Thursday, the expansion of operations continued. The company reported to the Argentine Comision Nacional de Valores and to the Buenos Aires Stock Exchange that it agreed the purchase of approximately 7,600 ha of farmland in Bolivia at USD 17,501,359.99. The company has paid 43% of total amount while the rest remain to be paid in two annual consecutive payments, the first one to be paid during calendar year 2009. These transactions were made according to what was stipulated in the Company plans made public upon the Equity Follow on of last March, regarding international expansion.
One way to think about Cresud could simply be the Asia factor. The company produces many of the food staples that China, for example, will need more and more of as income per head rises. Corn, soybeans, sunflower (oil), and beef are some of the firm’s major products. Of course, there’s always that pesky problem of export taxes, but if you listen to insiders, a more business friendly government could be in store for the country in the coming years.
Bloomberg reports today that the cost of protecting corporate bonds from default surged to a record on concern Argentina and Pakistan may default, worsening global economic turmoil. Swaps on the benchmark Markit iTraxx Crossover Index surged above 800 basis points for the first time, and they rose 9 points on the CDX North America Investment Grade Index of contracts that is linked to 125 companies in the U.S. and Canada.
In Argentina, President Cristina Kirchner’s planned takeover of pension funds heightened concern the government is headed for its second default this decade. The probability the country will fail to meet its commitments has soared to 94 percent. And in Pakistan, even the possible bailout by the IMF (a meeting was scheduled for today in Dubai) may not be enough to save it from [another] credit-rating cut according to Standard & Poor’s, which already cut the nation’s debt rating on Oct. 6 to CCC+, seven levels below investment grade. Bloomberg notes as well that “Pakistan is also expected to seek financial support from the ‘Friends of Pakistan’ group, which is due to meet next month in the United Arab Emirates. The group, which was established last month to help Pakistan stabilize its economy, includes the U.S., U.K., China and Saudi Arabia.” Meanwhile, the country suffers from increased political instability due to omnipresent volatility in its lawless [FATA] tribal region which provides cover to legions of Islamic militants including Taliban from both Pakistan and Afghanistan, as well as al-Qaeda fighters.
Frontier markets are smaller, more undeveloped and riskier than emerging markets, and Friday index provider MSCI Barra announced that not only will it consider upgrading Kuwait, Qatar and the United Arab Emirates to emerging markets from frontier markets (expect a final decision by June 2009), but that it will further consider downgrading Argentina and Colombia to frontier markets from emerging markets “unless significant improvements in the relevant capital flow restrictions are observed” by December (despite Moody’s announcement that Colombia’s debt rating will be raised just one notch below investment grade). As far as definite downgrades, MSCI said that it will reclassify Jordan to a frontier market from its current designation as an emerging market starting this November, because of the small size of the nation’s market and the lack of liquidity.
More than $3 trillion is benchmarked to the MSCI International Equity Indices, and the MSCI Emerging Markets Index is one of the most widely used indices to gauge the performance of emerging equity markets. The iShares MSCI Emerging Markets ETF tracks the performance of the index.