Global Emerging Markets (GEMs)

African Risks and Opportunities

Chip Krakoff — Tue, 27 Oct 2009 19:21:00 GMT

I subscribe to the “Stock Gumshoe” blog, which specializes in ferreting out the truth behind those teaser ads for scores of investment newsletters and tipsheets that promise you 1,400% returns in six months, but only if you take advantage of this limited time subscription offer, a $1,000 value for only $695. In addition to debunking these extravagant claims, the blog’s publisher and author, Travis Johnson, analyzes various investment opportunities he finds interesting, some of them off the beaten track, and he doesn’t charge you hundreds of dollars to reveal the names and details. Recently he posted a lengthy article on Africa, with a particular focus on Lonrho, a U.K.-based company with a long history in Africa and a newly revitalized Afro-centric investment strategy. Here is my comment, posted on Travis’s blog:

I am a big fan of Africa, probably a function of my having worked and/or lived there for about a third of my adult life, and I thank you, Travis, for focusing on a much-maligned and -neglected part of the world. As a business consultant and sometime private equity/finance adviser and investment banker, I lived in South Africa for seven years, most of the time working in the financial sector. I have also lived for extended periods in DRC, Botswana, and Zambia, and I have worked or done business in about 30 countries on the continent.

I believe that African risk, more than almost any other region’s, is overpriced. Part of this is because most people, especially in the U.S., think Africa is one country, and can’t distinguish between Sudan and Senegal. Of course there are risks, but most of them can be managed, and there is certainly a risk premium for investing there, but I have come across far too many supposedly sophisticated investors who won’t touch any part of Africa with a barge pole.

There are a lot of ways to get African exposure, but apart from investing in various Africa-focused ETFs or buying the shares of African companies with ADR listings, there aren’t too many pure Africa plays. You could invest in big mining companies like BHP, RTZ, or Freeport McMoran, junior mining companies, mainly listed on the TSX, or in various energy companies both big and small that operate around the continent. But except for a few juniors, most of these companies have exposure all across the globe. The same goes for companies like Diageo (which owns Guinness), Heineken, and SAB Miller, which dominate brewing across Africa, and for telecoms firms like MTN, which have extended (some would say overextended) into Asia and the Middle East. The big companies listed in Johannesburg, many of which have primary or secondary listings in New York or London, are not pure African plays either. SASOL, Sappi, Old Mutual, Anglo American, and others, have their roots in South Africa, but operate all over the world.

Lonrho (LONR in London, LNAFF on the pink sheets) is an exciting company, resurrected from the ashes of Tiny Rowland’s old company, which operates in some of the most promising growth areas on the continent. They do mine for diamonds in South Africa (not too exciting), but the real excitement is in some of the areas Travis mentions: the Luba Freeport in Equatorial Guinea, the new Fly540 airline operating out of Kenya, and big agribusiness plans across Southern Africa. As the world, and especially the Gulf countries, look to secure their food supplies, they are turning to Africa, which presents huge opportunities for investment in the sector. Lonrho also offers one of the few Zimbabwe plays around, and if you think this is a bad joke, don’t. Zimbabwe is starting to come back, and sooner than you think it will once again be a huge agricultural exporter, manufacturing center, and tourism destination. I think Lonrho is a classic buy and hold opportunity. Buy it now, forget about it, and in several years you could be holding something pretty valuable.

Lonrho, and Southern Africa, are not the only play on the continent. I have said before (you can look it up on my blog - http://www.emergingmarketsoutlook.com) that in the next 20-40 years Nigeria will be a more important economic (and possibly political) force than Russia, and I still believe that. Nigeria has a long way to go, but it looks like following a similar path to Indonesia’s, which has gone from military dictatorship to genuine democracy and which has made a significant dent in corruption.

By all means do your own research. If you are looking to start living off your retirement funds in the next five years, Lonrho and other Africa plays may not be for you. But if you are looking at the longer term, take a close look at these.

Disclosure: T. Rowe Price Africa and Middle East Fund (NYSE: TRAMX). Market Vectors Africa ETF (NYSE: AFK).

I'll Take Sweden: Socialism, Free Markets, and the Nanny State

Chip Krakoff — Thu, 01 Oct 2009 20:36:00 GMT

In the eyes of many Americans, “Sweden” is shorthand for everything we don’t want America to become. It’s a tradition that goes back some way. In the 1965 movie I’ll Take Sweden, Bob Hope is an executive whose company sends him to Sweden, and he takes his teenage daughter, played by Tuesday Weld, largely to get her out of the clutches of her dead-end, guitar-playing boyfriend, played by Frankie Avalon, whom she wants to marry. Long story short, Tuesday falls in love with a suave Swede, only to find he has some strange ideas about premarital sex. Enter Frankie, who has traveled across the sea to try to win his girl back. He breaks his guitar over the degenerate Scandinavian’s head, and takes Tuesday back to America and married life in a trailer park, with Dad beaming proudly.

Opponents of President Obama’s proposed health care reform, massive deficit spending, takeover of the banking and automotive industries, and other “statist” excesses defend their position by saying those things are fine if you want America to become like Sweden, but we don’t, thank you.

John Stewart’s Daily Show ran a series a few months ago reporting on the horror that is modern day Sweden. The show’s ace investigative reporter went around interviewing people of all walks of life, from former members of ABBA to business executives, doctors, government officials, and factory workers, all of whom professed satisfaction with their lives and with the way Swedish society is organized. The reporter concluded that there had to be some kind of Invasion of the Body Snatchers thing going on, with most Swedes’ brains having been taken over by an alien life form that made them unaware how miserable they really are.

The only thing wrong with this picture is that it’s not really true. It is true that Sweden was an early adopter of the sexual revolution, the Swedes enjoy mixed saunas and sensible cars, and Sweden has colonized much of the world with Ikea, which for all its commercial success looks like something a state bureaucrat with fascist leanings might have invented.

Oh, and it is a welfare state. Sweden does provide benefits to the unemployed and it gives all its citizens free health care and education, and taxes them pretty highly in return. The combined income and social security tax for high earners is over 48% (including mandatory pension contributions), but that is not too far from the U.S. where earners in the top 5% can pay as much as 40%, depending on income taxes in their home state. And Sweden’s corporate tax rate is only 28%, compared to the 35% U.S. corporate tax rate and average effective combined Federal and state rate of 39.3%.

Sweden is far from being the statist, socialist nightmare that many Americans imagine. The government last week announced deep cuts in personal income taxes “to stimulate the economy,” together with planned reforms to improve the business climate and create incentives to start companies.

It may be their Lutheran heritage that has imparted to the Swedes some common sense and a work ethic. The maximum $1,650 after-tax monthly employment benefit is hardly lavish, and in most cases it expires after 300 days. The government offers retraining, employment subsidies and reduced employer social contributions to encourage companies to hire the unemployed, with additional enticements such as lower minimum wages and flexible contracts for hiring people under 25. Similar youth employment incentives proposed two years ago in France, drew hundreds of thousands of students into the streets in protest.

On health care, Sweden’s single-payer system came under intolerable stress in the 1980s, with rising costs and growing waiting lists for medical procedures. The government devolved substantial power to county councils, and gave them freedom to introduce market-based reforms, which most have done. Hospitals have been privatized and the market share of private medical practitioners is on the rise. Many kinks still need to be worked out, but Stockholm, which has been most aggressive in introducing market-oriented reforms, has shown impressive results.

Still and all, Sweden is socialist, isn’t it? And that has to be a bad thing, right?

In a word, no. Sweden is a leader in privatizing public pensions. Though mainly state-owned corporations historically accounted for about one fourth of the market capitalization of the Stockholm Stock Exchange, the government has privatized or plans to privatize most of its crown jewels, including the stock exchange itself, the Apoteket pharmaceutical distribution monopoly, the former alcohol manufacturing and distribution monopoly Vin & Sprit, and major state-owned telecoms, real estate, and financial firms. Industry itself has always been overwhelmingly in private hands, and Sweden has a lot of world-renowned companies for a country of only nine million people, including Volvo, SKF, Ericsson, Skanska, Electrolux, Sandvik, Atlas Copco, Ikea, and H&M.

In the 1990s Saab and Volvo sold their passenger car divisions to General Motors and Ford, respectively, while holding on to their lucrative truck, heavy equipment, and aerospace operations. This past spring, as GM teetered on the edge of bankruptcy, and the U.S. government started crafting its takeover of GM and Chrysler, the Swedish government firmly rejected the idea of a Saab bailout. “The Swedish state is not prepared to own car factories,” said Maud Olofsson, the Minister of Enterprise. The World Economic Forum ranks Sweden the fourth most competitive economy in the world, just behind Switzerland, the United States, and Singapore.

Sweden went through its own financial and banking crisis in the early 1990s when a real estate bubble collapsed, GDP dropped by 5%, total employment fell 10%, and the central bank briefly jacked up interest rates to 500% to prevent a run on the krona. The state took over a fourth of the country’s banking assets to save the banking system, at a cost of 4% of GDP. In 1994 the budget deficit stood at 15% of GDP. The government quickly restored the banks to private ownership, cut government spending, and introduced liberal economic reforms that enabled the economy to rebound quickly and to capitalize on the emerging IT and telecoms boom. From a 2008 budget surplus of 2.5% of GDP, this year’s expected budget deficit is 2.2% of GDP, and is forecast to widen to 3.4% in 2010 before returning to balance. Not bad for the worst global financial and economic crisis since the Great Depression, and an awful lot better than America’s projected deficit of 13.1% of GDP this year and 9.6% next year, not to mention the boom years of 2001 to 2008, when the Bush Administration ran average annual deficits of more than 4% of GDP.

Sweden is not perfect. The nanny state sticks its nose into too many corners of personal life. An eight-year-old boy in Lund had his birthday party invitations confiscated at school when he failed to invite two of his classmates. This violated rules on “inclusion.” Government has launched an investigation of parents who use the family computer to access porn sites, which their kids might then be able to access. In the 1970s Sweden, the home of former heavyweight champion Ingemar Johanssen, banned boxing as too violent for the pacific society it had become. TV advertising is banned from programs targeting under-12s, while movies with even a hint of violence get a rating that bans under-12s from watching, even if accompanied by their parents. Toy guns –even water pistols – were outlawed. Alcohol taxes are among the highest in the world, and you can see the unhealthy consequences on the overnight duty-free “booze cruises” from Stockholm to Helsinki, which end with bleary-eyed Swedes (and Finns), still drunk, stumbling onto the pier, their shoes encrusted with vomit. But e-commerce, home DVD players, the end of internal border controls in the EU, and a general feeling that things had gone too far have started to win some battles with the nanny state. You can buy toy tanks and bazookas now, and in 2007 the ban on boxing was repealed.

As the U.S. government, first under George W. Bush and now under Barack Obama, becomes ever more statist, and as Americans accept eavesdropping on telephone conversations, bans on trans fats ,and proposals to tax soft drinks as something governments have every right to do, Sweden – never anywhere near as socialist as popular imagination would have it – has steadily moved in the opposite direction. Our paths will cross, if they haven’t already done so. One can only be grateful that when Americans realize the limits of state intervention in our personal and economic affairs we will have the Swedish model as a guide to start putting ourselves back on the right track.

An End to Fuel Subsidies: Do as I Say, Not As I Do?

Chip Krakoff — Thu, 24 Sep 2009 22:22:00 GMT

President Obama, hosting the G20 meetings that kick off today in Pittsburgh, has asked Indonesian President Susilo Bambang Yudhoyono to deliver a presentation on his country’s elimination of fuel price subsidies, replacing them with needs-based grants to poor consumers. The U.S. estimates that if developing countries were to follow Indonesia’s example they could reduce fossil fuel emissions by 12%. The question is whether President Obama is willing to follow his own advice.

According to the International Energy Agency, the biggest developing countries spend over $300 billion a year to keep the price of gasoline, diesel, kerosene, and bottled gas artificially low. In developing countries, these subsidies matter a great deal to poor households that need kerosene and gas for lighting and cooking, and to taxi drivers and other small business operators who depend on affordable gasoline and diesel. In Nigeria, ordinary taxi and motorcycle deliver drivers will wait for hours – sometimes days – to buy gasoline at the official price, while those who have the means to pay the market price jump to the head of the queue. Threats to reduce or eliminate subsidies can bring tens of thousands of people into the streets and threaten to topple governments. One Indian energy expert, quoted in The Financial Times, says that phasing out fuel subsidies is “an extremely long shot. It’s politically absolutely non-feasible.”

The United States is just as addicted to fossil fuel subsidies as India or China, Iran, or South Africa, which are among the countries that offer the biggest subsidies. But in the United States, as much as motorists grumble about the pump price of gasoline, the main beneficiaries are in the energy industry itself. Much fanfare has been raised about the Obama Administration’s subsidies and grants for alternative energy, but according to a recent report by the Environmental Law Institute, from 2002 to 2008 the U.S. Government spent over $72 billion in subsidies for fossil fuels, mainly in the form of tax breaks and reduced lease payments – though cash grants amounted to more than $15 billion – versus only $29 billion for alternative energy. But more than half of that $29 billion – $16 billion – consists of grants and tax breaks for corn-based ethanol, not a fossil fuel but as big an emitter of greenhouse gases as gasoline.

Fuel subsidies are bad for the environment, it goes without saying, but they are bad fiscal policy as well. In the United States and other northern countries, it makes sense to help poor people buy heating oil or gas to get through the long, cold winters, but this can be done by means of cash grants, fuel vouchers, or tax credits. It doesn’t require that all consumers – and the producers too – also get subsidies.

I would love to see India, China and the rest agree to phase out blanket fuel subsidies in favor of targeted assistance to the poor. I would love to see the United States do the same. I wonder which, if any, of these countries will take the plunge. My money is not on the U.S.

Papua New Guinea: Democracy and Development in a Natural Resource Boom

Chip Krakoff — Wed, 16 Sep 2009 20:20:00 GMT

To anyone who has studied anthropology – it was my major in college – a visit to Papua New Guinea can’t fail to excite. PNG, a country with over 1,000 tribes and 700 languages – nearly half the world’s total – has almost certainly been the source of more anthropological monographs than any other place on earth. They include Bronislaw Malinowski’s classic “Argonauts of the Western Pacific,” about the Trobriand Islanders, and Margaret Mead’s “Sex and Temperament in Three Primitive Societies,” which became a basic text of the feminist movement for its depiction of three tribes in the Sepik River basin, one of which was determinedly pacifist, one female dominated, and one in which women and men were equally warlike. The body of Mead’s work tends to reflect her own sexual and political fantasies more than it does closely observed social behaviors, but never mind that.

I am here on a quick visit to negotiate a contract with the government, which has selected my firm, together with a local consulting firm, to prepare a strategy for the development of free trade zones and/or special economic zones throughout the country. I won’t get out of Port Moresby, the capital, on this trip, but once the project actually starts up I expect to visit several fairly out of the way places, including Daru near the mouth of the Fly River (another ethnographic mother lode) in Western Province near the border with Indonesia; Buka, on the island of Bougainville; Kerema, on the Gulf of Papua; and Manus, in the Admiralty Islands. I plan to fit in at least one visit to the Highlands, home to many of the country’s tribes and languages.

Even though the government has banned it in the National Capital District, the sidewalks in Port Moresby are stained red, not with blood, but with betel nut spittle. Betel, a mild stimulant that stains habitual users’ teeth red, is a national passion, and on every street you can find one or more vendors squatting on the sidewalk in front of a small pile of the nuts in their fleshy, green pods. Hotels, office buildings, and rental cars all post prominent signs “No Smoking. No Betel,” accompanied by the international sign for forbidden things, in this case a red circle with a dark rugby ball shape inside and a red diagonal slash through the middle.

Today the country celebrates the 34^th anniversary of its independence from Australia, which had ruled the former German colony under a League of Nations mandate since 1920. People everywhere are wearing shirts depicting the national flag, which depicts the Southern Cross (white on a black field) and the Bird of Paradise (yellow on a red field). The Independence Day festivities coincide with the annual Hiri Moale festival, which commemorates the epic voyages in outrigger canoes of the Motuan people from Central Province east of Port Moresby to trade and socialize with the Erema people of the Gulf of Papua. Yesterday the lobby of the Crowne Plaza Hotel was crowded with bare-breasted young girls wearing elaborate grass skirts and headdresses, their faces and bodies painted with black geometric designs, who are here to compete for the title of Hiri Moale Queen, who will be crowned and feted tonight in the Kambuingini Ballroom, an event to which I regrettably have not been invited.

India is frequently and justly praised for its ability to sustain a functional democracy in a land of staggering ethnic diversity, crushing poverty, and widespread illiteracy, but PNG’s achievement is even more impressive. Some tribes in remoter areas of the Highlands had no contact with the outside world until the 1990s, but they now vote in parliamentary elections even as they engage in more or less continuous warfare with neighboring villages.

A good part of the front page of the Papua New Guinea “Courier-Press” over the past week has been given over to a scandal in Yamine Village in the Tekadu area of Wau in the Morobe Province, where a new cult has surfaced, promising a tenfold increase in the banana crop for those who engage in public sex. The cult leader, it seems, has terrorized villagers into practicing public nudity and fornication, and kept the village magistrate, who objected to the practice, locked in a hut for four months until he managed to escape and walk 12 hours to the nearest police station. The police then mounted an expedition, which marched 12 hours back to Yamine to arrest the cult leader, only to find he had fled. According to the magistrate, the leader had launched the cult because the people had received no government services and needed to find other ways to improve their welfare.

What is most interesting is not the sex cult itself. We have had more than a few of those in the U.S., though many of them seek religious fulfillment or Maslovian self-actualization rather than more productive banana trees. No, what astonishes is that these villages are separated by 30 miles of jungle footpath from the nearest road or telephone or electric light. Making democracy function in that kind of environment cannot be easy.

Freedom House’s Index of Political Freedom classifies the country as “partly free” with a score of 3.5 (one being fully free), the same as Colombia and the Philippines and not too far behind India itself, noting that the most recent elections, in 2007, were marked by widespread irregularities. The Freedom House report also pointed to corruption scandals surrounding the Prime Minister and a sometimes-violent separatist movement in Bougainville, which the government has not always dealt with in the most sensitive fashion. Still, the press does not shy away from criticizing the government, the judiciary is widely recognized as independent, and the Prime Minister’s own party won only 27 out of 100 seats in the 2007 elections, so must rule in a coalition government.

PNG also scores pretty well in the Heritage Foundation’s Index of Economic Freedom, especially in areas like trade, taxation, business licensing, and labor, though its overall ranking is dragged down by a high level of corruption and a lack of secure property rights, the latter unsurprising in a country in which most land is under customary tribal tenure. Still, the challenges the country faces in trying to develop a modern economy are enormous. Far too many of the people I see on the streets of Port Moresby have the shell-shocked and blotto look, common among American Indians, Inuit, and Australian Aboriginals, of indigenous peoples forcibly uprooted from their traditions and cast into the lower reaches of the modern world, which has little time or use for them. Alcoholism, family violence, street crime, and HIV are rampant. People warn me not to take even a licensed taxi. “They will take you somewhere else and rob you.”

PNG, however, is about to come into great wealth, which may be the biggest challenge of all. The huge Ok Tedi copper mine in Western Province, which has been the source of most of the country’s export revenues and a significant chunk of total GDP for the past 20 years, is expected to shut down in 2013, its reserves exhausted. But a natural gas bonanza is in the offing. In 2008 the government signed a $10 billion agreement with a consortium led by Exxon Mobil to develop gas fields in the Southern Highlands and to build a pipeline to transport it to a new port and LNG terminal and refinery.The project is expected to export over 6 million metric tons of LNG annually and promises to double, or even quadruple, national GDP, transforming Papua New Guinea from a least-developed to a middle income country. PNG also has vast mineral resources, and the government in 2006 signed a $1 billion deal with state-owned China Metallurgical Construction Corp. to develop the Ramu nickel mine.

With corruption already endemic, PNG risks joining the legion of countries – think Nigeria, Congo – whose natural resource wealth has impoverished them through “Dutch Disease,” the sudden currency appreciation that can destroy a country’s agricultural and manufacturing base, and a shift from democratic governance to kleptocracy. To its credit, the government here seems to recognize the challenge and appears determined to use the country’s resource wealth to improve the lot of its people, 40 percent of whom live on a dollar a day or less. The free trade zone/special economic zone program is one small part of that, an effort to create a sustainable non-resource economy, and it goes together with other initiatives to build road, telecoms, and port facilities, and to build low-cost electricity generating capacity based on the gas and the county’s abundant hydroelectric potential, which can fuel development of energy-intensive industries like aluminum smelting. Its location on the Torres Strait, a major shipping route between China and Australia and New Zealand, gives Papua New Guinea a big location advantage too.

The ingredients for success are there, and the signs are positive. Macroeconomic management is good, and PNG is not highly indebted. Moody’s gives it a B+/Stable credit rating. It’s exciting to see a country poised for an economic transformation and to participate in some small way in trying to make things come right.

Tariffs on Tires Risk Igniting a U.S.-China Trade War

Chip Krakoff — Wed, 16 Sep 2009 19:58:00 GMT

The Cato Institute’s Daniel Ikenson has just posted this, a succinct summary of the winners and losers from President Obama’s decision to impose punitive tariffs on imports of tires from China. It was a short-sighted decision, pandering to Obama’s base of support in Big Labor (wasn’t giving the unions a huge share of both GM and Chrysler payback enough?). China already plans to retaliate with huge tariff increases on some American products, including frozen chicken. The move is similar to George Bush’s tariffs on imported steel enacted just before the 2002 midterm elections to try to get Republican votes in House and Senate contests seats in West Virginia, a steel-producing state. As short-sighted and nakedly political as that decision was, at least it didn’t come at a time of global economic crisis. With this year’s precipitous drop in global trade and heightened tensions with China, this move comes at the worst possible time. It risks igniting a trade war between two of the world’s largest economies when the world can least afford it, and stifling the recovery before it has even really begun.

President Obama Subsidizes President Obama with Tire Tariff

A View From Cairo: The Case for Investing in Egypt

Chip Krakoff — Tue, 08 Sep 2009 17:23:00 GMT

Crossing the Kasr el Nil Bridge that spans the Nile in central Cairo at eleven o’clock at night is like walking down 42^nd Street in New York at rush hour, only more crowded. Cairo is the real city that never sleeps, and never more so than the current month of Ramadan, when Muslims refrain from eating, drinking, and smoking from dawn to dusk and then pass the nighttime hours eating, smoking the shisha water pipe, and relaxing with friends and family. The streets are thronged: families having picnics on tiny patches of grass beside roaring four-lane roads; older men in serious conversation, smoking and playing backgammon in sidewalk cafes; groups of adolescent boys roaming around looking for adventure; and courting couples sitting chastely on park benches or standing together on bridges, whispering to each other and watching the lights of Cairo reflected on the water.

It’s not easy to get work done during Ramadan. People who may have snatched a couple of hours of sleep after the pre-dawn sohour meal roll into the office late. Government workers get off at two in the afternoon, and in the private sector everyone is gone well before five, in order to make it home in Cairo’s fiendish traffic in time for the iftar meal to break the fast at sundown. In Egypt, a land of heavy smokers, nicotine deprivation makes people absent-minded and forgetful, unable to focus on the task at hand.

Without meaning to, I have found myself on working visits to the Middle East at Ramadan three years running: last year in Cairo and the year before in Ramallah, on the West Bank. I’ve been coming to the region for more than 20 years, and first started visiting Egypt about eight years ago. The changes during that short time have been amazing.

Egypt has one of the world’s oldest bureaucracies, which dates back to the time of the Pharaohs. Only India and China can rival it for longevity. It has defeated the best efforts of the Greeks, the Romans, the Ottoman Turks, the French, the British, the Soviets, and the Americans to transform it, and instead has sucked in and Egyptianized them. The first time I visited Cairo, in 2001, I spent nearly an hour wandering around the downtown area looking for the offices of the investment promotion agency. I had the address, I was on the right street, but I had to go down a small alley into a courtyard surrounded by grimy buildings, where finally I saw a small sign to indicate the place. Up several flights of stone stairs worn down by the soles of a hundred years of bureaucrats and into the offices, where people lay sleeping at their desks or eating melon seeds and reading the newspaper. In order to get basic investment statistics, I was told, I would have to write a letter to the Chairman of the agency, who might respond within a week or so.

That was eight years ago. More recently, a Cabinet Minister told me that when his ministry moved from downtown into new quarters in Heliopolis, he took about a fifth of his staff with him and left the others in the old location, where they could while away their days drinking tea until they reached retirement, as long as they didn’t interfere with the real work at hand. It was a typical Egyptian solution. You can’t fire anybody, so you just keep them out of the way and get on with it. It’s impossible to fight or change the bureaucracy, at least in the short term, so people devise clever work-arounds. They’re not perfect, but generally they work.

This morning I visited a government client I had worked for last year, recommending changes to the procedures for getting factory building permits and industrial licenses. Since then, almost all of my recommendations have been implemented. I take no great credit for this – most of my suggestions were fairly obvious – but it says a lot about drive and initiative, qualities that not everyone associates with Egyptians. In typical fashion, they had proposed changes to legislation, but who knows how long that might take. So in the interim they have applied makeshift remedies, which are good enough for now.

To Westerners, this uncertainty and ambiguity can be maddening, though I believe it was an American who came up with the phrase “close enough for government work.” India has justly received a lot of praise for its liberal economic reforms, but to my mind Egypt’s achievements are even greater. India remains one of the most protectionist countries on earth. Egypt used to be in that same league, but since 2004 it has reduced its average import duty from more than 30% to less than 7%. Egypt has also removed most currency restrictions. In recent years the World Bank’s annual Doing Business report, which ranks 180 countries on ease of doing business, has named Egypt a top reformer, while the European Union recently ranked Egypt as the best country in the Arab world in which to do business.

Governments everywhere, especially in developing countries, talk about promoting the private sector, but few of them seem to have a clue what the private sector is all about and what businesses need for government to do and not do to allow them to flourish. The Egyptian government gets it. Technocrats have been appointed to high positions in key ministries and agencies, and there seem to be quite a few capable people at middle management level, on whom successful execution depends. The government is building roads and power plants and other core infrastructure, leaving private investors to get on with everything else.

Over the past week I have made several visits to 6^th October, a new city about 20 miles from downtown Cairo, established in 1979. For the first 15 years not much happened. But since the mid-90s the population has grown to more than half a million and the place has thousands of apartment blocks and houses under construction, which are almost certain to be occupied fast. It’s not hard to imagine that the government’s prediction of a population of more than three million will be fulfilled ahead of schedule. These people are attracted by the ability to buy more house for the money than in Cairo itself, but the huge industrial zones are also an attraction. Mercedes and GM, and scores of other multinationals have built factories there. The older industrial parks are already full, but five new ones, covering about five square miles, are being developed under a new, more liberal “investment zones” regime, and the zone developers have already sold 80% of the building sites. The Mayor of 6 October intends for the entire city eventually to become an “investment zone.”

The other night I was invited to a corporate iftar event in a luxury hotel in another new city development called New Cairo. Driving into town at dusk was a spooky experience: the streetlights had come on, and we drove along miles of empty streets past countless thousands of semi-finished houses and apartment buildings and empty bank buildings, and office centers, before coming across a massive hotel, all glass and gleaming light and shiny SUVs pulling up in front. I can’t imagine moving to New Cairo, but I wouldn’t bet against there being half a million people living here in the next 10 years or less. These developments strike me as more sustainable, and more soundly based on an underlying real economy, than the now-crashing Dubai property market. People are still investing, building, and buying here, which in the Emirates they are not.

Corruption is still rife, and political reform is drastically needed. President Mubarak, in power since 1981, is 81 years old, and no one quite knows who or what kind of system will replace him. There are high hopes for a shift to democracy, but no certainty this will happen. Regardless of what happens politically, I don’t see Egypt, which has been shedding more than 50 years of Soviet-inspired economic policies at a fast clip, reversing its reforms.

The fundamentals for the most part look right. These include a domestic market of 80 million people, expected to grow to 100 million by 2025, a stable currency and sound macroeconomic policies (moderate inflation and acceptable budget deficits), and . preferential market access agreements with the United States, the European Union, the Arab countries, and a large number of countries in sub-Saharan Africa. The Cairo and Alexandria Stock Exchange (CASE) is the second largest on the continent, after Johannesburg. Several times in recent years the CASE has been the star performer among world stock markets.

It’s not easy for Americans to gain direct investment exposure to Egypt. Egypt is one of 25 countries in the MSCI Emerging Markets Index, so its companies are part of most diversified and regional emerging markets funds, but there are no Egypt-focused funds traded on U.S. exchanges. The CASE has plans to launch an ETF based on the CASE 30 index, but this will not be directly available to individual investors in the U.S.

Though no U.S.-traded ETFs or mutual funds offer a pure Egypt play, several provide substantial exposure to the CASE, including: Claymore/BNY Mellon Frontier Markets (FRN), 15%; Market Vectors Africa Index (AFK), 14%; Powershares MENA Frontier Countries Portfolio (PRMNA). 22%; and T Rowe Price Africa and Middle East Mutual Fund (TRAMX), 10%.

Disclosure: AFK, TRAMX

Beer, Competition, and Emerging Markets

Chip Krakoff — Thu, 27 Aug 2009 22:05:00 GMT

Rarely does a news story address three of my biggest enthusiasms at once, so if I find one I pay close attention. Today’s New York Times reports that the U.S. Justice Department is considering antitrust action against Anheuser-Busch InBev and MillerCoors (itself a joint venture between SAB Miller and Molson Coors), which jointly control about 80% of the U.S. beer market (“Rising Beer Prices Hint at Oligopoly”). To be honest, the article itself only addresses beer and competition; the emerging markets angle is mine alone. It appears, in any case, that both brewing giants are raising their prices, even as the recession makes the average working man need a beer more than ever.

The Justice Department has not suggested that the brewers have colluded to raise prices, only that the concentration of the market gives them inordinate pricing power. Indeed, from 1947 to 1995 the number of brewing companies in the U.S. has dropped by about 90%. Anheuser Busch InBev, SAB Miller, and MillerCoors are themselves the products of decades of consolidation both in the U.S. and worldwide, as big brewers hoovered up smaller ones. InBev, which acquired Anheuser-Busch for $52 billion in 2008, was itself a product of a merger between Interbrew of Belgium and Brahma of Brazil. Interbrew, the long-time owner of such classic Belgian brands as Stella Artois, Hoegaarden, and Bellevue, itself began an acquisition spree in the early 1990s and snapped up Canada’s Labatt, Whitbread and Bass in the UK, Rolling Rock in the U.S., Mexico’s Dos Equis, and a slew of others in Eastern Europe and Asia.

Christine Varney, head of the Justice Department antitrust division, has even suggested the government might re-examine deals approved under the Bush Administration, such as last year’s SAB Miller and MolsonCoors joint venture. What I find puzzling in this is that big companies with dominant market share tend to use their economies of scale to drive prices down to levels at which smaller competitors can’t compete. But no one is accusing the big brewers of doing that.

Companies typically can use dominant market share to raise prices only in markets with high barriers to entry. Big airlines can sometimes get away with it because new competitors on a given route can’t get or have to pay through the nose for landing slots. Tight regulations and restrictions on foreign ownership of airlines in the U.S. and other countries also limit competition from new players. State regulations make it impossible for me, a Massachusetts resident, to buy medical insurance from a company in Texas, and force me to “choose” from among three or four approved insurers. My insurance premiums went up 23% this year, but so did those for every other insurer in the state.

Beer is not like that, at least not in the U.S. The craft or microbrewery industry has grown tremendously since the early 1980s, and the Brewers’ Association reckons that there are now over 1,500 brewing companies in the country, a level not seen since Prohibition was introduced in 1919. Go into almost any bar or pub in this country and you will find at least a half-dozen beers on tap, some of them local and independent brews and others imports. Pabst Blue Ribbon, in 1890 the most popular beer in the U.S., has seen its market share drop to 2.8%, but it has enjoyed a resurgence due to its cheap price, decent taste, and new-found cachet among urban hipsters. Narragansett, once the dominant beer in southern New England, ceased production in the late 1990s, but is now back, after a group of investors revived the brand. It too is a cheap, sturdy brand with a grand history. At the other end of the scale are the craft brewers, whose beers sell at a premium to the big brands. The beer market is completely open. Anyone with a marketing idea and a recipe can get a contract brewery to make the product. Pabst itself contracts out all its production to other breweries, and has become, in effect, a “virtual brewery.”

Emerging markets tend to be less open. Many of their brands have been acquired by the multinational giants, though some of them, like the Czech Pilsner Urquell now owned by SAB Miller, have kept their identities and been left to make their beer as they have done for the past 700 years or so. Developing and frontier economies have bad infrastructure, so the dominant national brewery, which tends often to own the national Coca Cola bottling plant as well, reinforces its dominance by controlling the entire distribution system. It owns the fleets of trucks that carry the beer to remote villages, and it provides financing, signage, and refrigerators (sometimes propane-powered in areas with unreliable electricity) to the shops that distribute the product.

Just four companies – SAB Miller (the SAB stands for South African breweries), Heineken, Diageo (owner of Guinness), and Castel (a French company that operates breweries throughout francophone Africa) control the bulk of beer production and distribution in, and the four companies have various joint production and marketing agreements in many companies (Heineken and Diageo, for example, own about a third of Namibian breweries, one of the few remaining independent brewers on the continent, and distribute its flagship Windhoek beer and other brands in South Africa). Castel and SAB Miller, in turn, have joint ventures in 32 African countries, including Algeria and Morocco. In some of the bigger African markets two, or sometimes three, of these companies will compete head to head. In smaller markets, such as Sierra Leone, there is only one game in town (Heineken, in this instance).

African governments don’t seem to mind this concentration in the brewing industry. Even when countries are engulfed in civil war or suffering famine, the breweries keep operating, and they are usually among the largest taxpayers, along with the mobile phone companies, providing something that everyone needs. The multiplier effect throughout the big breweries’ production and distribution chains has created jobs, increased incomes and wealth, and given countless small business people a start. Facilitating competition may not be a big priority in these places.

As for the United States, any beer drinker can find a beer to his or her tastes at almost any price point. The government already runs the car industry and will soon run the health industry. I can accept that, even if I don’t like it. But I would like the government to keep its hands off my beer.

I’m not in the business of recommending stocks. If you’re looking for emerging markets exposure in this industry, Castel is privately owned, SABMiller (SMBRY) generates 64% of its revenues from emerging markets in Latin America, Asia, and Africa, and jointly owns Snow, the Chinese brand said to be the best-selling beer in the world. Emerging markets, especially in Asia, look to be recovering much faster and more vigorously than the rest of the world, and breweries’ profits are higher in Africa than in other regions. A-B InBev (NYSE:AHBIY) is, of course, the biggest brewing company on the planet and owns the dominant brands in the U.S. (the biggest) and Brazil (big and growing fast) markets. Though less regionally diverse than SABMiller, it earns 45% of its revenues in emerging markets. Molson Coors (NYSE:TAP) is concentrated almost entirely in Canada, the U.S., and the U.K., mature markets with lower growth prospects, and its joint venture with SABMiller is only for the U.S. market. Diageo (NYSE: DEO) is a much more diversified drinks company, with big spirits and wine businesses in addition to the Guinness brewing operation, but Nigeria is Guiness’s second largest foreign market after the U.K. Heineken (OTC:HINKY) is especially strong in Africa and the Middle East, and owns the number one or number two brand in almost every market it is in, including Egypt and Nigeria. It also has a big presence in Eastern Europe and the former Soviet Union, Southeast Asia, and Latin America.

I leave on August 28 for a three-week business trip to Egypt and Papua New Guinea, where I expect to rely on Heineken product (Sakhara Gold in Egypt and South Pacific Lager in PNG). I will keep on posting from the road.

(Disclosure: No Positions)

Why African Manufacturers Can't Compete: It's the Roads, Stupid

Chip Krakoff — Thu, 13 Aug 2009 18:31:00 GMT

In Nairobi last week African officials and businessmen met with their U.S. counterparts for the eighth annual AGOA Forum. Hillary Clinton delivered the keynote speech. AGOA – the Africa Growth and Opportunity Act – is the U.S. law, passed in 2000 and set to remain in force until 2015, which grants preferential duty-free and largely quota-free access to the U.S. market for some 1,800 products from 41 sub-Saharan African countries. To what extent has AGOA helped Africa?

I did not make it to Nairobi last week, but did attend a forum several years ago in Washington. It’s hard not to feel inspired by the positive energy, vision, and hope on constant display at these events. In addition to plenary sessions with high profile speakers there were more specialized seminars discussing strategies to accelerate growth of the handicrafts and apparel and horticultural sectors or to increase regional trade integration within Africa. Plenty of African entrepreneurs were present, especially at the crowning event, a cocktail party at the Smithsonian, where scores of African craftsmen and their distributors displayed and sold their wares.

And yet…AGOA, according to almost any standard, has been a failure. The overall numbers impress. African countries in 2008 exported over $66 billion worth of products to the United States, an increase of almost 30% from the previous year. But more than $62 billion, or 94%, came from oil and gas and minerals, products that would have been exported with or without trade preferences. Economists use a term, “trade diversion,” which refers to a shift of current trade flows from one destination to another, usually as a result of changes in trade preferences or other market conditions. African countries would have exported the same quantities of oil and gold without AGOA, though those exports might have gone to China or France instead of the United States. This year’s trade figures have fallen off a cliff due to the recession and the fall in oil prices. Commerce Department figures show a 59% decline in first quarter AGOA exports as compared to the first quarter of 2008.

The funny thing is, no one talks about oil and minerals at these AGOA Forums. The focus is all on garment manufacturers and basket weavers. Part of this is due to the fiendish complexity of the global textile and apparel trade, which everywhere is hedged about with tariffs, “voluntary” quotas, rules of origin, and preferences. Women hand knitters from Kenya are also more appealing than your average oil company executive. The big issue since AGOA’s inception has been the “third country fabric provision,” which allows African apparel makers to source fabric from, say, China, instead of having to use American or African material. The U.S. textile industry of course does not care for this. But a growing number of African voices are also raised in opposition, claiming that use of third-country fabric prevents development of an integrated textile industry and keeps Africans trapped in low value cut-and-sew operations.

There is scant evidence, though, that removing the third-country fabric provision would release a flood of investment in new spinning and weaving plants across the continent, though it could easily cause the Asian companies that have set up apparel factories in Africa to pick up and move to other locations like Haiti or Central American countries, which enjoy similar U.S. market access preferences and are far more cost competitive than most of Africa.

Only a small number of African countries have textile industries that have really benefited from AGOA. Lesotho, a tiny country completely surrounded by South Africa, has created about 40,000 jobs as a direct result of AGOA, but a truck can reach the South African port of Durban, driving along South Africa’s excellent superhighways, in just a few hours. Lesotho is also part of a customs union with South Africa, so border delays are minimal. More typical is the case of Kenya. Not only is labor productivity half of what it is in Honduras – more than offsetting Kenya’s 30% labor costadvantage – but Kenya’s reject rate on garments is three times higher, and electricity costs nearly twice as much.

The real killer, though, is the cost of transport. It takes more than 30 days to get a container from Kenya to the U.S. and less than 15 days from Honduras. But it also takes much longer to ship a container to the U.S. from China than from Central America. When it comes to cost, Honduras can import a 20-ft. container of fabric for less than $700, while the cost for a similar cargo to Kenya is more than $2,300. Honduras can ship a 20-ft. container of T-shirts to the U.S. for $500; Kenyan exporters have to pay nearly $2,000 (Note: these figures come mainly from a 2007 World Bank report, Can Sub-Saharan Africa Leap into Global Network Trade?)

Kenya, at least, has a coast and a port. Countries like Uganda or Mali haven’t a prayer. Throughout much of Africa, inland transport accounts for about two-thirds of the total cost of shipment. It costs twice as much to send a container the 650 miles by road between the Port of Dakar in Senegal and Bamako, Mali’s capital, than to ship it the 8,300 miles between Dakar and Shanghai. It can cost $4,000 and take up to a month to carry a container between Kigali, Rwanda and Mombasa.

It is probably too late for the textile and apparel industries in most of Africa. But to develop any other industry that depends on making and moving things – and logistics nowadays accounts for more and more of a product’s value – better transport is essential. AGOA has failed mainly because no amount of trade preferences can compensate for Africa’s crushing cost disadvantages, especially in transport. My fellow blogger, Cecilia Brady, wrote on this site a couple of months ago about the tragicomedy of airlifting cement in Africa because the roads in certain parts of the continent range from bad to nonexistent.

Africa has so many problems – corruption, war, political instability, malaria, HIV, sanitation, and malnutrition to name a few – it is often hard to know which ones to address first. Many development experts have engaged in bitter public arguments over that very question. There may not be a single right answer, but you could do a lot worse than to make roads the top priority

Brazil - Investment Case

IIP Webmaster — Fri, 07 Aug 2009 15:03:00 GMT

EXECUTIVE SUMMARY

No longer the “Country of the Future”… Brazil emerges as the “Country of the Present”.

For a number of years, Brazil has been considered the “Country of the Future” due to its geographical size, growing population and abundant resources. Historically Brazil continued to live up to this long standing reputation as the “Country of Future”, as it remained plagued by poor economic conditions, political instability, poverty as well as immense socioeconomical and bureaucratic challenges. In 1994, the governmental and business leaders launched a set of measures to stabilize the economy which, have resulted in Brazil securing a position as one of the top 10 largest economies in the world, an investment grade credit rating on its sovereign debt, and has set the stage for sustainable long-term growth for years ahead. Today, Brazil is now positioned as the “Country of the Future” and is rapidly becoming one of the world’s economic powerhouses.

Unique Access to Natural Resources

The idea of Brazil as the “country of the future” stems from the large geographical area of the country and the abundance of resources that is possesses. As the fifth largest country in the world, Brazil’s territorial extension is bigger than all of Western Europe and larger than the continental United States. It shares common boundaries with every South American country except Chile and Ecuador.

Brazil controls a great deal of the world’s most basic resources. It has the largest farmable area in the world (22% of the territory), 33% of the planet’s forests, and 15% of the world’s potable water. It is the world’s largest producer of coffee, oranges, and sugar-cane; 2nd largest of manioc, beans, soy, beef and chicken; 3rd largest of refined sugar and corn; and ranks in the top ten in the production of grains,cocoa, eggs, pork,cotton and rice.

In addition, it is one of the few countries in the world that is self-sufficient in oil and is the world’s leader in alternative energy sources. It is responsible for 33% of the world’s ethanol production., Brazil enjoys an advantageous climate that is primarily free from major natural disasters, and enjoys a temperate climate that extends the growing season beyond that of many other countries.

In summary, Brazil has more food, forest, water, minerals, and energy than it needs. These are unique luxuries that many countries do not enjoy, contributing to the rationale that Brazil has historically has been viewed as the “Country of the Future”. Considering the wealth of Brazil’s attributes, what are the factors that have contributed to Brazil not reaching its full economic potential to date?

Young and Strong Democracy

While Brazil is currently the third largest democracy in the world, the democratic form of government in the Country is only 24 years old, which makes it 38 years younger than India’s democratic regime and 200 years younger than that of the United States. Brazil’s democratic regime began in 1985, after a 21 year military dictatorship. The military regime that preceded it severely hampered the Country’s development by poor economic policies and rampant corruption, destroyed its credibility by defaulting on its external obligations, and drove the economy into hyperinflation while simultaneously accruing enormous foreign debt.

In addition to having to deal with carnage left behind due to the dictatorship, the first seven years of the democratic regime also had unique challenges to overcome, creating more hurdles for the fledgling society. The first President elected, Tranquedo Neves, died from natural causes before even taking office and was replaced by his Vice-President, Jose Sarney, who was not successful or equipped to solve the country’s massive economic problems. The second President, Fernando Collor, took office in 1990 and was impeached, after a crowd of 10,000 peacefully gathered in the nation’s capital to protest against a massive corruption scandal. When his Vice-President, Itamar Franco, took office in 1992 the Brazilian economy was still unstable and the problems inherited from the dictatorship continued to drag and weigh on the country.

Finally, in 1993, President Franco appointed Fernando Henrique Cardoso (“FHC”) as his Minister of Finance. One year later, FHC launched the “Real Plan” which introduced the “Real” as the Brazilian national currency and marked the beginning of Brazil’s economic and political stability. FHC was later elected President in 1994 and served two terms until 2003making him the first elected President since the dictatorship to serve a complete term.

Brazil has made great progress since the dictatorship. Today, it has an exemplary democratic process supported by one of the most advanced voting systems in the world (expedient and fraud free) and an increasingly transparent regulatory environment. It has introduced several new market-friendly policies favorable both to domestic and foreign investors. Its governmental and financial system levels of accountability have also improved significantly.

All of these factors demonstrate that the Brazilian democracy is maturing and becoming increasingly efficient. The problems that have held Brazil back as just the “country of the future” are now fading behind and the improvements seen over the past several years have set up the basis for an optimistic view of what lies ahead.

Investment Grade Rating Backed by 15 Years of Sound Fiscal Policies

One of Brazil’s major accomplishments over the past 15 years has been the stabilization of its economy. Since the Real Plan was introduced in 1994, regulators have been focused on controlling inflation, managing the country’s balance of payments, restoring its credibility in the global financial community, and laying down building blocks for a sustainable long-term economic model.

This focus is agreed to by policy makers of all political parties and has been continuous since the plan’s inception. As a consequence, inflation rates have dropped from an annual rate of nearly 640% in 1994 to an average of 5.4% over the past five years; the country’s net external debt has shrunk from approximately 15% of GDP to negative levels over the same period, and per capita GDP growth (PPP) has soared at an average of 6.2% annually over the past three years.

What makes these achievements even more impressive is that they were sustained and enhanced by the current leftist President, Luis Inacio da Silva (Lula), who followed through with the conservative policies of his predecessor despite their ideological differences. Therefore, supporting the idea that commitment to sound fiscal policy is a consensus among policymakers from all spectrums of the political environment.

The maturing political environment and the commitment to sound fiscal policy have rendered Brazil two consecutive investment rating upgrades in 2008. Today, the country is far different from what it was under the dictatorship regime in the early 80’s when it defaulted on its debt. The upgrades granted by Fitch and Standard & Poors are a reflection of what is becoming a consensus in the world investment community, that Brazil offers one of the best long-term, risk/reward alternatives in the world.

Strong Growth, Stability, and Market Friendly Policies Attract FDI

Foreign Direct Investment (FDI) going into Brazil has increased 437% from approximately US$4.4 B in 1995 to an average of around US$23.6 B over the past 5 years. Bradesco, one of Brazil’s major banks, expects FDI to remain above the past 5 year average in 2009, at around US$25 B, despite the global economic crisis. The surge in FDI is the result of the high risk/return ratio the country offers, driven not only by its stable economy but also by existing market/investor friendly legislation that has recently been enacted.

Brazilian law gives the same protection and guarantees to foreign capital investments that it gives to investments made by Brazilian nationals. The Brazilian government is actively encouraging foreign investment to enhance and stimulate economic growth. Historically, Brazil has been an important destination for prospective investors as the government permits registered capital and earnings to be repatriated on a tax free basis. The liberal FDI policies have led Brazil to be a preferred destination for global investors.

Currently there are attractive tax incentives for foreign direct investments, including mechanisms that can be utilized to reduce or eliminate taxes for foreign investors, including private equity. For example, Law 2689 allows for capital gains and financial transaction tax exemptions on stock market investing for foreign investors. The investment vehicle know as “FIP” (Fundo de Investimento em Participacoes) is similar to a limited partnership in that it allows for investors to make investments in private entities on a capital gains tax-exempt basis. The federal government has also granted tax benefits to certain free trade zones. The Manaus Free Trade zone is the most prominent of all such trade centers to have attracted significant foreign investments, including those from noted US companies.

This combination of favorable policies, economic stability, and credit rating upgrades has increased the country’s access to capital while decreasing such capital cost. A higher inflow of cheaper capital is crucial for the country’s future, as it gives room for domestic investments that will ensure sustainable long-term growth.

Income Growth in All Economic Classes to Add New Consumers

The prosperous economic cycle taking place in Brazil is also driven by the increased purchasing power of the middle and lower class. Poverty reduction and income distribution indicators have dramatically improved over the past several years. According to the World Bank, the country’s full poverty rate dropped from 41% in the early 1990’s to 25.6% percent in 2006, with an estimated 6 million people moving out of poverty in 2006 alone. Fueling this substantial improvement has been low inflation and economic growth, targeted transfer programs (including “Bolsa Familia,” a conditional cash transfer program to lower income families), improvements in labor productivity due to gains in schooling, and a reduction in the geographic segmentation of labor markets.

The improvement of poverty conditions has added new consumers to the market. Over the next decade, these new consumers will play a vital role in taking Brazil into the next level of economic prosperity. GDP per capita is expected to double by 2018. As massive wealth creation in the lower income class is realized over the next decade.

The rise in income levels across all economic classes, and the rising demand that it is forecasted to generate, is likely to take Brazil’s growth story outside the main metropolitan areas to smaller towns across the country. All this activity is expected to create a cycle of growth that starts with higher purchasing power, leading to increased demand that will stimulate infrastructure investment, thus creating additional jobs and again adding to consumer’s income. Ultimately leading to a sustainable economic growth model equipped for the long term

Economic Crisis May Favor Brazil in the Long-Run

Brazil will undoubtedly be affected by the Global Economic crisis. Signs of a decelerating economy have already started to surface, as industrial output and retail sales figures have begun to trend downwards. The ongoing financial crisis will continue to push confidence levels down (both consumer and economic), suggesting that the borrowing appetite in Brazil this year will be kept to a minimum. Disappearing investor appetite and the lack of global liquidity will have severe implications for fixed investment and capital flows in 2009. Overall, Brazil has braced itself for one of its biggest economic slowdown since the Russian default and the Asia financial crisis of 1998, when Brazilian GDP growth fell to 0.1%

Although Brazil will have to face difficult challenges in 2009, it is actually better positioned to weather the storm than the majority of nations around the globe. While a change in GDP growth from 5.7% in 2008 to an estimated 0.8% in 2009 is a significant setback to the economy, it is not as bad as what other countries are experiencing. In fact, Brazil is expected to rank among the top 5 highest growth economies in the world in 2009, coming in fourth place behind China, India, and Indonesia.

Brazilian banks are well capitalized and in better shape than their peers around the world. The Bovespa has continued to outperform the great majority of global equity indexes and has been recovering well from the sharp drop of 2008. The reduced foreign debt levels have prevented any major adverse impacts derived from the sharp drop of the real. In fact, opposite to what has happened in prior recessions, the devaluation of the real versus other currencies may actually help spur exports once global demand starts to pick up. For the first time Brazil is showing signs that it is becoming a more independent economy able to deal with a major global crisis without running a major risk of default.

The conservative fiscal policies followed by the Brazilian Central Bank (BCB) have placed Brazil in an unprecedented position in this global crisis. In the past, when there was a sharp drop in the Real, the country was forced to tighten its spending in order to prevent a default. The BCB has also had to maintain high interest rates in order to control inflation. This strategy prevented the government from being able to provide any type of stimulus to spark the economy, thus, exposing the country to the full extent of international economic crisis. Currently the Brazilian government continues to keep a tight budget in order to ensure its ability to support its debt, however, because the current global economic crisis has nullified prior inflationary forces, the BCB is finally in a position to cut interest rates and use them as a tool to spur economic activity.

As of December 2008, the Brazilian Selic rate (A Brazilian Central Bank's system for performing open market operations in execution of monetary policy) was approximately 13.75%. Economists predict that the Selic rate will fall close to 400 BP over the course of this year to levels near 9.75%. Such a large cut in interest rates would reduce the government’s interest rate expense from 5.6% of GDP in 2008 to 4.7% in 2009. Thus, increasing its ability to invest in the economy and thus preparing Brazil for a strong recovery relative to other nations.

Ultimately, Brazil averted the major issues currently affecting other nations in the current financial climate. Brazilian banks have relatively low leverage and were not exposed to significant levels of sub-prime lending. The BCB has the ability to lower interest rates, which may well put Brazilian rates at a permanently lower level moving forward, thus, freeing up resources for investments and added economic activity. Most importantly, the Brazilian economy is, for the first time in decades, in a position to make decisions more focused on the country’s internal needs, as opposed to decisions based mainly on debt management. The global crisis comes with significant risks and setbacks - the way Brazil handles these difficult times may define the trajectory it will follow in the years ahead. The country is well positioned to manage the challenges that will be presented as the crisis plays out. All variables indicate that Brazil will come out stronger and will finally settle into a meaningful growth pattern.

Brazil Remains a Top Choice for Investors

Aside from the current headwinds afflicting the Brazilian economy, its long term outlook remains bullish. Brazil’s economic growth will continue to be fueled by the emergence of a rapidly growing middle class in the years ahead. Despite the lower growth rates estimated for 2009, economists predict that real GDP growth rates will pick up in 2010 and should remain at a rate of 3.4% over the next decade. Credible monetary and fiscal policies will help to keep long-term investor interest in vital sectors of the economy anchored.

The Brazilian growth story will be written by the rise of new consumers as income levels increase. The new middle class will set a foundation for Brazil to remain stable and to guarantee its place as one of the leading global economies. Massive wealth creation is expected to take place over the next decade and this added demand will lead to growth both within and outside major metropolitan areas. This shifting socio-economic dynamic is likely to attract FDI, which will unlock capital investments. This additional inflow of investments combined with government lead initiatives, such as the Growth Acceleration Program 2007-2010 (GAP), will likely pave the way for elaborate upgrades of Brazil’s infrastructure.

The Growth Acceleration Program promotes investment opportunities in infrastructure. The main areas of focus are the following sectors: Logistics, receiving a total of US$ 56.3B; Power, receiving a total of US$322.9 B; Social and Urban Projects, receiving US$ 109.4B. Therefore, by the end of 2010 a total of US$ 488.6B will be invested in infrastructure projects throughout the entire country. In the Logistical arena, investments will be made in roads, railroads, and ports. Investments in roads will be made in the South-Central region, where most of the industrial and agricultural production is located, representing 54% of the Brazilian GDP. The railroad concession program will allow companies to participate in bidding processes for the North-South railroad, East-West railroad, and high-speed train. The Southern section represents 33% of the Brazilian agricultural production, 72% of land available for agriculture, a high concentration of mineral resources, and a distribution of agricultural and industrial production through 4 ports. The East-West railroad investment will be US$ 1.9B to maximize the distribution of agricultural and mineral production, and interconnection with waterways. The high speed train between Rio and Sao Paulo will include an area of 650 km that can reach up to 36 million inhabitants, and represents 45% of the Brazilian GDP. The high speed train will connect Sao Paulo (the largest business center in Latin America - 70% of the stock market) with Rio de Janeiro (the biggest tourist center in Brazil.) The estimated investment is US$ 11B. Exports through the sea in 2008 reached a total of US$ 162 B with an annual average growth of exports of 22% of US$ per annum from 2003 to 2008, and 8% in tons per annum at the same time period. Investment opportunities will also exist in the energy sector, including generation and transmission of electric power, oil and gas, and bids to procure rigs, supply vessels, and tug boats, long-term contracts with service providers.

Although poverty levels have been considerably reduced, Brazil still has high social discrepancies, thus indicating that there is an entire population of consumers that have not been playing a major part in country’s demand. Economic growth will continue to raise these consumers out of poverty, which in turn, will increase demand, further spur economic growth, promote added capital investments, and cement a sustainable growth model for the country.

GENERAL COUNTRY OVERVIEW

History, Geography, and Population

History

Brazil was discovered in 1500 by the Portuguese explorer Pedro Álvares Cabral and was ruled from Lisbon as a colony until 1808. Brazil is the only Portuguese speaking Latin American country, and its Luso influence differs from the Hispanic heritage of its neighbors. Its economy was based on slave labor and the exportation of Brazilian wood from 1500 to 1550. The wealth of the colony was based on commodities, principally sugar, in the Seventeenth century, gold in the Eighteenth century and coffee in the early Nineteenth century.

The Brazilian population became even more diverse when, during the late Nineteenth and early Twentieth century, millions of Germans, Italians, Japanese, Arabs, and other immigrants entered Brazil and left their mark on the social system while their descendents became Brazilians.

Following three centuries under the rule of Portugal, Brazil became an Independent Nation in 1822 and a Republic in 1889. Brazil overcame more than half a century of military intervention in the governance of the country when in 1985 the military regime turned over power to civilian rulers. A constitutional congressional convention drafted and approved a new Federal Constitution in 1988, and in November 1989 the first direct presidential elections of the post-military era were held.

Even though inflation was controlled by the 1990s, more than one out of four Brazilians continued to survive on less than a dollar per day. In 2002, these socio-economic contradictions helped lead the election of Luiz Inacio Lula da Silva, a former lathe operator and union leader. Lula was re-elected President in the general elections of October, 2006. The current government has been successful in consolidating macroeconomic stability, while stepping up social spending.

Today, Brazil is the largest and most populous country is South America. The country continues to pursue industrial and agricultural growth and development of its interior. Exploiting vast natural resources and a large labor pool, Brazil's economy outweighs that of all other South American countries with large and well developed agricultural, mining, manufacturing and services sectors. Highly unequal income distribution and crime remain pressing problems.

Geography

Brazil is the fifth largest country in the world and the largest one in South America with a total area of 8.5 million square kilometers covering approximately two-thirds of the continent’s entire Atlantic coast. The country is of continental scope with a size of 4,420 km from North to South; 4,328 km from East to West, an Atlantic coastline of 7,367 km and a total border of 23,103 km. Brazil neighbors every country in South America, except Chile and Ecuador. More than half of the country is 200 meters or more above sea level but only a small part rises above 1,000 meters, with the highest peaks reaching an altitude of around 3,000 meters.

Brazil has an extensive river system. The Amazon and its tributaries, which are great rivers in themselves, drain over half of Brazil. Other large rivers include the São Francisco in the northeast and the Paraná and the Paraguay River system, which flow south to empty into the Rio de La Plata. The considerable hydroelectric potential of Brazil’s rivers has been increasingly exploited over the last 35 years.

Forests still cover vast expanses and farmland is found mainly in the South, Southeast and Central West with large areas suitable or adaptable for pasture. Brazil has some of the largest iron ore deposits in the world and mines significant quantities of many other metals, minerals and precious stones.

Population

Brazil has a population of more than 196 million people. The majority of Brazil’s population is located near the coast, where there is the highest concentration of metropolitan centers. Brazil’s annual population growth has decreased continuously since the 1980’s, and this trend is expected to continue going forward, changing from an annual growth rate of 0.98% forecasted for 2009 to 0.30% forecasted for 2030. The country’s population is expected to grow to 216 million by 2019.

Although the average age of its population increased significantly over the past 30 years, Brazil is still a young country with an average age of approximately 28 years. This young profile is expected to change moving forward, as Brazilians increase their life expectancy and families become smaller in size. The country average age is forecasted to change at a compounded annual growth of 3% per year up to nearly 38 year of age by 2030, in other words, the Brazilian population will become 10 years older on average in the next 30 years.

Macro-Economic Overview

Brazil is one of the top countries in the world in natural resources, providing the country with a comparative advantage in terms of natural products, agriculture, wood, livestock, and minerals. With a population of over 196 million people and a per capita income of around US$ 7.6 thousand per year, Brazil has the largest domestic market in Latin America.

Brazil is the largest economy in Latin America. With a nominal GDP currently around US$ 1.3 trillion it represents 36% of the region’s GDP. Irrespective of the tools employed in measuring the size of national economies, Brazil's is always ranked among the ten largest economics in the world.

Services comprise 64 % of the GDP, followed by industry and agriculture with 31 % and 5%, respectively. Tourism, IT, and banking are the chief sub-sectors of services. The industry sector, the second most important sector to GDP, includes such subsets as motor vehicles, industrial equipment, chemicals, and aircraft. The south-eastern region of the country contains the majority of these industries and is responsible for the largest workforce in the region. Appendix III provides further detail on Brazil’s supply and demand components of GDP.

During 2006 and 2007, Brazil’s GDP grew at rates of 3.8% and 5.2%, respectively. According to the International Monetary Fund's World Economic Outlook, Brazil’s GDP growth in 2008 was 5.1%, and predicts a decline by only 1.3% this year compared to an expected decline of 3.3% in the IMF’s January report, with inflation at 4.8% this year compared to the 5.7% realized in 2008. Brazil's growing urban centers account for 75 percent of the GDP. These growth rates are expected to slow significantly over the next two years, with estimates of 1.3% and 3.5% in 2009 and 2010 respectively.

As we can see in Appendix V, the slower growth rates are expected to be driven mainly by a drop in internal demand growth, expected to fall from 8% to 1% from 2008 and 2009, driven mainly by lower household consumption rates. Reduced household consumption is expected as a consequence of diminished accessibility to capital, lower salary growth, and uncertainty affecting consumer confidence.

Total Brazilian international reserves (US$196bn) now exceed the total foreign debt (US$163bn) by more than US$30bn, a fact that has allowed Brazil to achieve a risk classification of “investment grade”.

In 2008, Brazil received a total of approximately $US40B of Foreign Direct Investments, 67% in the form of equity capital and 13% in intercompany loans. This number is expected to decrease significantly over the next two years due to the global economic crisis. Credit Suisse forecasts a total of $US20B and $US25Bof Foreign Direct Investments for 2009 and 2010.

Brazil’s disciplined fiscal policies have allowed it to considerably reduce its external debt, which has decreased from 26.5% of GDP in 1998 to an estimated 13.5% in 2008. Although debt levels are expected to increase slightly over the next two years it is expected to remain close to current levels.

General Public Markets Information

Size & Scope

The Brazilian Central Bank measures the countries Financial Investments as the total balance of five key investment vehicles: Funds, Stock Funds, Savings Deposits, Time Deposits, and Investment Funds. As of February 20th, 2009 the combined balance of these vehicles add up to R$1,936 B, the equivalent to US$826B. Although this number provides a good indicator of Brazil’s public markets, it does not include the country’s Derivatives market value, which historically has accounted to approximately 32% of the Brazilian Financial Markets.

As of March 09 2009, Brazil’s equity market size totals approximately R$1,351B or nearly US$577B. This value represents the market cap of the 393 companies traded in the country’s most important stock exchange, the Bovespa.

Number of Offerings

In 2008 there were a total of 4 Initial Public Offerings (IPO) on the Bovespa, which together raised a total of $US300 MM. A significant drop when compared to the $US5 B generated from the 25 IPO’s that took place in 2007. Secondary and mixed offerings dropped to zero in 2008, while in 2007 these totaled $7.2 B from 39 offerings.

Over the past 4 years, the Bovespa has averaged US$16.5 B of IPO’s , with an average of US$400 MM raised per firm. Secondary and mixed offerings have raised an average of US$5.3 B per year at a ratio of US$200 MM raised per firm.

Top Growth Sectors

Agriculture

Driven by increases in both productivity and in cultivated areas for two decades, the agricultural sector has kept Brazil amongst the most highly productive countries in areas related to the rural sector. The total agricultural productivity is subject to variations in rainfall. The majority of the population residing in the north-eastern part of the country is dependent on this sector. The growth in the agriculture sector is variable because it is dependent upon the weather. Moreover, a lack of automation in farming is equally responsible for low productivity.

Currently the country has 152 million acres being cultivated, but the government claims that this can easily be more than doubled. According to the US Department of Agriculture, the country has 668 million acres of available agricultural land. Brazil produces 40 % of the sugar traded on world markets and output is increasing by nearly 20 % per year.

Investors also plan to spend more than US$12 B over the next five years to create new and expand existing ethanol plants. The government believes it can increase ethanol production from the annual level of about 18 billion liters today to close to 200 billion liters by 2025. Producers have invested substantially in expanding ethanol capacity.

Brazil is also the world's top producer of orange juice and coffee and ranks second in world production of soy beans and meat (beef and poultry) and third for fruits and corn. The agricultural sector and the mining sector also support trade surpluses which allowed for impressive currency gains (rebound) and reduction of external debt.

Industry

Brazil has the second most advanced industrial sector in the Americas. Most of the heavy industries are located in the South and South-Eastern parts of the country. The rapid growth in the industrial sector, particularly after 2002, stands testimony to the success of privatization. The Plano Real provided an increase in economic stability that contributed to the overall industrial growth through the transfer of managerial and technical expertise in heavy industries like aircraft, steel, petrochemicals, computers, automobiles, and consumer durables. There were also heavy investment in new equipment and technology, a large proportion of which has been purchased from U.S. firms. (Foreign participation through the transfer of technical and managerial expertise in heavy industries like aircraft, automobiles, chemicals and heavy industrial equipment—contributed to the overall industrial growth.)

Services

The services sector comprises the majority portion of the GDP, but needs considerable support from the government. Since 1994, the banking and finance sub-sector has achieved laudable success due to the large scale participation of foreign banking and non-banking financial institutions accounting for as much as 16% of the GDP. The information and communication technology (ICT) sector had also experienced a similar trend but has further room for growth. The ICT sector faces a shortage of highly-skilled workers as the country’s educational set up has failed to provide this kind of trained manpower. On the other hand, the tourism industry has surged significantly in recent years, giving a boost to the overall service-sector performance. The services sector has come to play an increasingly dominant role in the economy accounting for 68 % of the overall average growth in GDP in the last five years between 2002 and 2007. It increased 4.7 % in 2007, achieving a positive performance of all subsectors, especially in the financial sector with a 13 % increase. Commerce registered a 7.6 % increase, transportation, mail, and warehouses a 4.8 %, information technology an 8%; real estate services 3.5 %, and other services 2.3 %.

Total Foreign Direct Investment and Major Sectors Receiving Funds

One of the basic characteristics of the Brazilian economy is a high level of internationalization, with foreign corporations playing a leading role in many sectors. This is not a new phenomenon since historically Brazil has been an important destination for prospective investors as the government permits registered capital and earnings to be repatriated on a tax free basis.

In the 1980’s, however, the external debt crisis ended the Brazilian economy’s long growth cycle. Brazil started to experience highly volatile GDP growth rates, as well as chronic inflation which stagnated FDI inflows stagnated at low levels.

During the 1990’s, motivated by changes in the economic policy and conditions, with liberalization, privatization, and macroeconomic stability, followed by an increase in demand for consumer durables, international investors began to expand their presence in the Brazilian economy again.

As a result of more favorable economic environment, FDI inflow increased to an average level of US$24B billion annually between 1995 and 2000. Despite the Asian crisis of 1997, the Russian crisis of 1998, and even the Brazilian crisis of 1999, it is interesting to notice that inflows continued to grow through the year 2000. After being at low levels for a few years due to a world economic slowdown, the FDI inflow into Brazil declined reaching a nadir of US$ 10 MM in 2003. In 2004, FDI rose again to US$18.3 B. Since then the FDI inflows into Brazil have continued to increase and an acme of US$ 45.1 B in 2008.

Being a major destination for foreign direct investment, in this decade, the country attracted US$ 218.1 Bof FDI Inflows.

Main Sectors

Until 1995, the manufacturing sector accounted for more than 67% of all foreign direct investment in Brazil. Foreign direct investment in the service sector had a notable resurgence in the second half of the decade because of the privatization of electricity, gas, water, postal services, telecommunications, wholesale, and financial services. By the year 2000, the manufacturing sector only accounted for approximately 34% of FDI and the service sector was responsible for 64% of FDI. On the other hand, many manufacturing industries such as food and beverages, automotive, chemicals, and metallurgy continued to attract significant amounts of foreign investment. The retail and consumer goods sector, more specifically the food and beverages segment, was the most attractive sector and has accounted for more than US$ 5 B in investments since 2000.

Since last decade, the service sector has been the largest recipient of FDI inflows, accounting for more than half of total inflows although it has dropped compared to previous years. In particular the ICT sector has received the principal share of total FDI inflows. Other areas that have attracted considerable foreign investments are financial, insurance and business services sector as well as the manufacturing sector that accounted for 38.5% of the total inflows during the same period. Agriculture and mining also grew accounting for 7.1% of total FDI.

The high FDI inflows have meant an increase in the foreign share in the Brazilian economy. According to the census of foreign capital made by the Brazilian Central Bank in 1995 and 2000, total sales of foreign majority-owned companies reached 14.4% of Brazil’s total output in 1995. In 2000, this ratio increased to 19.7%. Foreign corporations also increased their share of the country’s foreign trade, reaching 41.3% of exports and 49.3% of imports.

Large companies are responsible for a strong role in the foreign capital. Among the largest 500 private Brazilian companies, those under foreign control accounted for 41.2% of sales in 1989, 49% in 1997, and by 2003, reached 51.7%. These data show the progress of internationalization of the Brazilian economy. Financial investors have also increased their investment in the Brazilian market, particularly through Initial Public Offering (IPO).

PRIVATE EQUITY INVESTMENT OVERVIEW

Fund Raising

According to a new study from “Fundacao Getulio Vargas” (FGV), The Brazilian Industry of Private Equity and Venture Capital has evolved significantly in the last few years, propelled by the world environment of financial liquidity and by the strong expansion of the national economic indicators. The total committed capital grew at an impressive average annual rate of 53.4%, since 2004, reaching US$26.65 B in June of 2008. In the last 12 months (June 2007 to June 2008), the industry committed capital increased from US$15.91 B to US$2,65 B (+68%). In June 2008, the committed capital of the Brazilian Industry of Private Equity and Venture Capital represented 1.7% of the GDP (Gross Domestic Product), against 0,6% in 2004. Nonetheless, this number is still less than half of the world average range of 3.7 %. In the United States and England, two countries with decades of tradition in Private Equity and Venture Capital, the proportion of this industry in relation to the GDP is equivalent to 3.7 % and 4.7 %, respectively.

The Internationalization of the Brazilian Private Equity and Venture Capital Industry

The maturiation and consolidation of the Brazilian Industry of Private Equity and Venture Capital are evidenced by the fact that 21 managing organizations have at least 10 years of activity. They are responsible for the administration of around 30 % of the whole committed capital of the industry.

As per FGV study, out of the 67 managing organizations that began their activities between the beginning of 2005 and June of 2008, 46 are from Brazil. In June of 2008, out of 127 managing organizations operating in Brazil, 107 (79 %) were independent – 7 of which became listed, 15 (12 %) affiliated with financial institutions, 3 (2 %) were from the public sector (2 %) and two (2 %) were from industrial groups or corporate ventures (2 %). While there was a reduction in the quantity of managing organizations affiliated with financial institutions from 20 to 15, the number of independent managing organizations presented a significant growth, from 50 in 2004 to 107 organizations.

However, from the distribution of the committed capital, it is possible to observe a bigger participation of the independent organizations (both private and public listed) followed by the ones affiliated with financial institutions. The public sector is not much expressive as managing organization and therefore, as committed capital, though it has an important participation as investor in investment vehicles managed by private managing organizations (see item 3.7. for further information).

The 91 managing organizations from Brazil were the majority in the industry in 2008 and corresponded to 72% of the total against 53 in 2004 (75 % of the total). The managing organizations from the US are the second biggest contingent (17) followed by the Europeans (9) and the ones with head offices in Bermuda (3).

It is important to notice the substantial increase in the operations of the international managing organizations in Brazil through their Global and Regional investment vehicles. Furthermore, the participation of the Brazilian managing organizations in the total committed capital of the industry corresponds to 50 %. There was an expressive increase in the relative participation of the European organizations and of structures with head offices offshore, from 1.6 % and 3.4% in 2004, respectively, to 13 % and 16 % in 2008.

The Private Equity and Venture Capital Impact in the Capital Market

The IPO’s (Initial Public Offerings) constitutes one of the natural outlets for investments in PE/VC in the whole world and for many years was not a viable alternative in Brazil due to the volatile macroeconomic environment and high interest rates in the country during the decades of 1980 and 1990. Thus, few companies choose the stock market as a long term investment option in Brazil and, consequently, the IPOs market went through a period of very low activity.

With the improvement of the macroeconomic scenario, increased in global liquidity and reduction of interest rates, the stock market has gained prominence as a long term investment alternative. In fact, from the year 2004, the Brazilian capital market was taken on a new momentum with a wave of IPOs triggered by the divestments of companies from the portfolios of some PE/VC managing organizations. Between 2004 and June 2008 there were 110 IPOs which raised US$ 88.5 billion, of which 39 companies had received PE / VC investments before the public offering according to the Center of Studies in Private Equity and Venture Capital of Sao Paulo School of Business.

The Computer Science and Electronics sector remains the largest portion of companies in the portfolio of the managing organizations (22% of the total), although in the past four years there was a reduction in its relative participation (it was 33% in 2004) and the considerable number of divestments that occurred in this sector between 2005 and 06/30/2008.

One of the sectors that stood out the most in recent years was the Civil Construction / Real Estate sector: it increased its relative participation in the total portfolio of the industry (from 3 % to 12 %) stimulated by the reduction of the interest rate, facilitation of government credit to the sector and heating up of the economy. Today this sector has the 3rd largest relative participation in the total portfolio of the industry.

Although still representing a small portion of the total portfolio, the investments in companies shares in the education sector were also among the fastest growing between 2004 and 2008 (+200%), together with the Energy and Agricultural Business sectors (+314% and +133 %, respectively) and Communication / Media (+357%).

In the last four years, the number of companies of the industry portfolio based in the Southeast increased significantly from 66% in 2004 to 80% in 2008. Companies form the South region reduced their relative participation from 26% to 12% and other regions, all together, maintained their relative participation of 8% of the total number of companies in the portfolio.

The total volume of funds raised by companies that received PE / VC investments reached R $ 27.2 B, being equivalent to 31% of the total volume of IPOs issued in the period, between primary and secondary offerings. Between May 2004 and May 2008, investments in shares of companies disinvested by PE / VC had an average annual return of 17.3% against 1.5% of companies that have did not received PE / VC investments. On 67% of the observations, the returns of the companies invested through PE / VC were positive against 40% of the ones not invested through PE/VC.

HOW FOREIGNERS CAN INVEST IN BRAZIL

The current financial crisis has made many investors take a look around the globe in order to diversify their investments. Many of the emerging markets have been turning in impressive returns in the recent months. Brazil is one such location that has been somewhat insulated from the global economic woes. Brazil’s economy continues to boom and Brazilians are still consuming goods. Banks are sound and profitable, leverage is low, and fiscal policies are conservative. Brazil is also a large producer of iron ore, steel, paper, oil, ethanol and food, providing the resources that the world will always need. If you are not a Brazilian, but are interested in investing in Brazil, there are several options. Since foreigners are not allowed to open a bank account in Brazil, you won’t be able to open a brokerage account at a Brazilian bank, however, several options do exist that will allow you to use accounts in the United States to facilitate Brazilian investing.

Option 1 – Investing in Individual Companies: Depository Receipts

Currently, there are 35 share certificates of Brazilian companies listed and traded on the New York Stock Exchange (and 1 on NASDAQ). Brazilian certificates are known as “Depository Receipts” (DRs) and can be bought like any other share listed on the NYSE by using your existing brokerage account in the US. Depository Receipts are quoted in U.S. dollars. Other companies that operate in Brazil but that usually have headquarters outside of Brazil have shares listed directly in the US (not as DRs, but as shares) which can be bought like any other share. These companies often have operating companies in Brazil but holding companies outside of the country. Here are some examples: Vale (RIO & RIO-P, top 3 mining company in the world), Petrobras (PBR & PBR/A, top 10 oil company in the world), Embraer (ERJ, top 4 aircraft manufacturer in the world) and many other companies involved in natural resources (VCP, ARA), steel (SID, GGB), food (PDA, SDA), financial services (BBD, ITU, UBB), utilities (ELP, CIG, CPL, SBS), telecom (BRP, TSP, TSU, TNE), airlines (GOL, TAM), real estate (GFA), consumer and retail (ABV, CBD), etc.

Option 2 – Investing in Mutual Funds

If you would rather invest if a group of companies, there are two easy options for an investor to take. The first option is to look for a mutual fund that invests in Brazil. Many of the largest banks and asset management companies offer Brazil-specific funds in the U.S. and Europe, like ABNAmro, HSBC and others. However, many institutions will only offer Latin American funds because they offer more “diversification.” It should be known that a Latin American fund will usually have a significant percentage of investments in Mexico, which is an economy much more dependent on the United States. It depends on what your objective are, but if you already have a large portion of your assets in the U.S. or other industrial countries and are seeking global diversification, you may want to target more country-specific funds that target Brazil directly.

Option 3 – Investing in Exchange Traded Funds

iShares MSCI Brazil Index (EWZ) is an Exchange Traded Fund (ETF) which mirrors the Morgan Stanley Capital International Brazil index. Currently, if buy a share of EWZ, then you are investing in the equivalent of 24% Petrobras, 21% Vale, 13% Brazilian Banks, 6% steel companies, and 36% in various other companies. This option may be the easiest for you to invest in Brazil if you already have a brokerage account. You can find the updated holdings of this fund online. In order to purchase this ETF, you simply put the symbol “EWZ” in your broker’s online system and purchase it like you would any other stock.

Option 4 – Foreign investment in Brazilian Financial and Capital Markets

Brazil has actively sought direct foreign investments for many years. Therefore, Brazil has issued a resolution (CMN Resolution 289/2000) that allows non-resident investors to have the same access to Brazilian financial and capital markets in order to allow non-residents to invest in commodities, futures markets, and investment funds. Listed below is an excerpt from a website portaldoinvestidor.gov.br that indicates the rules and regulations for international investors to gain access to the financial and capital markets of Brazil.

According to the website portaldoinvestidor.gov.br: “the Securities and Exchange Commission, through its Rule 419/2005, created the simplified registration of the non-resident investor. Generally, based on this Rule, the brokerage firms (and the custodians) may perform the simplified registration of its non-resident clients given that the following prerequisites are complied with:

the non-resident investor must be a client of a foreign intermediary institution, before which he is duly registered under the applicable country of origin legislation;
the referred intermediary institution would take before the brokerage firm the obligation to present, whenever requested, all the information required by the CVM Rules that deal with investor registration within the ambit of the securities market, duly authorized, as well as other information required by Brazilian public bodies with inspection powers; and
the capital market regulating body of the foreign intermediary institution's country of origin would have signed with the CVM a mutual cooperation agreement that would allow the exchange of investors' financial information.

Furthermore, the country in which the foreign intermediary institution is located should not be considered high risk as regards money laundering and terrorism financing, and should not be classified as non-cooperative by international organs, in relation to the fight against illicit actions of that nature.”

CONCLUSION

ENABLING ENVIRONMENT

Since being named in the BRIC group of emerging economies in a 2003 report by Goldman Sachs- along with Russia, India, and China- Brazil has grown at an average rate of 3.8 %, reaching 5.4 % last year. The country’s GDP per capita has risen 120 %to US $6,951 in 2007, and local consumer demand has continued to expand at an impressive pace. The recent consecutive upgrades to investment grade in early 2008 have quelled the long-standing worries about government insolvency. Several vital developments have led to a resurgence of investments and have made Brazil the most lucrative private equity market in the region. Recent institutional changes have led to a number of improvements in the macroeconomics, institutional and regulatory landscape, capital markets, and corporate governance that have allowed for the sustainability of the private equity and venture capital market in Brazil. In fact, PricewaterhouseCoopers recently declared in its annual report, “One thing is clear: within the BRICs, Brazil is the cou
ntry that has the most developed capitalist system, in terms of its institutions, its market economy, the flexibility of its economic policy and democracy.” Several key developments will play a fundamental role in continuing to drive the economy over the next ten years. Domestic demand will ultimately remain the key driver of the economy, and rising disposable income levels will attract greater investments into Brazil. Over the next decade, it is the rise of the Brazilian consumer that will lure foreign direct investors and turn the economy into a regional powerhouse.

EFFETIVE MACROECONOMICS POLICIES

Since the introduction of the plan “Real Plan” in 1994, Brazil has managed to suppress the inflation that once plagued at rates as high as 2,400 % per year. The economic stability plan was based on the super-indexation of its economy, a change in its currency, and a rise in interest rates. The towering interest rates constrained aggregate demand and led to a sharp appreciation of the nominal exchange rate. This introduced an era where the country was able to start using traditional instruments of economic policy and was able to align relative prices correctly, especially salaries. Market mechanisms began operating more efficiently and prices were no longer a reflection of an exchange rate correction or inflationary inertia and Brazilian corporations were again able to accurately assess their viability and predict their need for resources. Controlling inflation however caused an escalation of the public debt and a deficit in the balance of payments which fueled foreign debt and increased external vulnerability. This culminated in another currency crisis in 1999 and a loss of a substantial amount of foreign reserves. In 1999, the government introduced an economic policy that combined a floating exchange rate system, inflation targeting, and a primary fiscal adjustment in combination with various tax reforms to address the costs associated with the monetary stability plan of ’94. This new combination of economic policy based on a tri-pod system allowed Brazil to reduce real interest rates to below ten percentage points, to reduce external vulnerability, and to contain the growth of the public debt. Brazil’s macro-economic performance from 2004-2008 was the best in the last thirty years largely because it has recorded consecutive current account surpluses for the last five years. Brazil’s gross national debt has declined dramatically since President Luiz Inacio Lula da Silva (Lula) was elected president in 2002 while Brazilian exports have tripled largely due to rising world demand for soybeans, iron-ore, beef, and cars. In 2007, Brazil had a trade surplus of $40 B. Net currency inflows reached a record $87.5 B thanks to rising foreign investment coupled with high domestic interest rates. In February 2008, Brazil emerged as a net foreign creditor for the first time and was able to pay off its debt to the International Monetary Fund. Foreign currency assets exceeded liabilities by more than $4 B in contrast to the net debt of $165 billion at the end of 2003, Lula’s first year in office. The latest figures estimate Brazil’s foreign reserves at $205 B, four times higher than in 2004. Brazil has also been gaining international market share in its exports, from 0.83 % in 1999 to 1.12 %t in 2007. Approximately 55% of Brazilian exports are manufactured goods and not raw materials (25%) as many people believe.

Low Country Risk

The post-‘99 external adjustment resulted in the reduction of the country risk and the appreciation of the currency. Brazil’s long-term foreign currency sovereign debt was upgraded to investment grade by Standard & Poor’s on April 30th 2008 and by Fitch ratings on May 29th 2008. The promotion to investment grade causes Brazil to be more attractive to international investors especially for funds earmarked for long-term projects. Brazil’s inflation is the lowest among the BRICs and ended 2006 at 3.14 % the lowest in a decade. In 2007, because of increasing food prices, inflation rose to 4.46 %. Accumulated inflation is currently standing at 5.23 % below the government’s target of 6%. The external adjustment of ’99 is perceived as long lasting given the gain in market share, higher trade balance, diversity of exports and destinations. As such, Brazilian inflation is expected to be systematically lower and less volatile from now on. Only thirty percent of bank assets are foreign-owned, compared to over eighty percent in Mexico. To the extent that Brazilian banks also have very low foreign liabilities, the economy is somewhat protected from a major credit contraction in international financial markets. Brazil is likely to withstand any external liquidity shock given that its non-financial public sector external debt / FX-Reserves ratio fell from 292 % in December 2002 to 32.7 % in September 2008.

Aggressive Fiscal Policies

Brazil is among the best positioned economies in Latin America to weather the current fiscal financial storm and a rapidly deteriorating global macroeconomic outlook. Certainly the global outlook continues to deteriorate and the Brazilian economy will be impacted by tighter liquidity conditions and more expensive domestic credit. In order to mitigate the liquidity constraints policymakers and central bankers are acting to pre-empt a credit crisis by issuing short term loans to the banking system, spending international reserves to offer funding to the export sector, relaxing the reserve requirements for the banking system and delaying the introduction of higher reserve requirements on cash deposits for two months (to 1/16/09), and increasing financial resources of BNDES to be used in exports financing. In total, these measures are expected to add $7.2 B to Brazil’s financial system and to prevent a sharp decline in the private sector credit growth next year. The nominal interest rate is expected to remain at 13.75 %, given the growing focus on liquidity

INVESTOR FRIENDLY INSTITUTIONAL & REGULATORY LANDSCAPE

Brazilian economy has significantly benefited from prudent fiscal, social, and monetary policies. Existing legislation that has recently been enacted is though to be both market and investor friendly. Brazilian law gives the same protection and guarantees to foreign capital investments that it gives to investments made by Brazilian nationals. The Brazilian government is actively encouraging foreign investment to enhance and stimulate economic growth. Historically, Brazil has been an important destination for prospective investors as the government permits registered capital and earnings to be repatriated on a tax free basis. After being at low levels for a few years, foreign direct investment (FDI) has recorded an upswing. The liberal FDI policies have led Brazil to be a preferred destination for global investors. The retail and consumer goods sector and more specifically the food and beverages segment was the most attractive sector for FDI in Brazil, and has accounted for more than $5 B worth of investments since 2000. The Brazilian property market is highly attractive to both domestic and foreign investors. To step up motivation among investors, the government has created a level-playing field for both local and foreign investors. Very few restrictions are imposed on foreigners to own local property, with the exception of areas that are used for defense and communication.

Tax Incentives

Currently there are attractive tax incentives for foreign direct investments, including vehicles that can be utilized to reduce or eliminate taxes for foreign investors, including private equity. For example, Law 2689 allows for capital gains and financial transaction tax exemptions on stock market investing for foreign investors. The investment vehicle- FIP (Fundo de Investimento em Participacoes) is similar to limited partnership in that it allows for investors to make investments in private entities on a capital gains tax-exempt basis. The federal government has also granted tax benefits to certain free trade zones. The Manaus Free Trade zone is the most prominent of all such trade centers to have attracted significant foreign investments, including those from noted US companies.

Improving Efficiencies

Since 1991, the government has been streamlining its existing policies exhaustively. The capital flows have become more fluid because the arcane registration processes to get money flows approved have now been streamlined so that it is no different than any other developed country. The government has now also disregarded old policies which discriminated between foreign and domestic investors. Foreign investors are now permitted to venture into most economic sectors, with the exception of some sectors on the grounds of strategic significance. Finally, the relatively new bankruptcy law in Brazil has essentially removed the arbitrary judge-ruled bankruptcy/liquidation proceeding and has replaced it with a chance to have a controlled recovery process

WORLD CLASS GOVERNANCE

The main corporate governance agents include the stock exchange, Brazilian Securities and Exchange Commission, and the Brazilian Institute for Corporate Governance.

In the sphere of corporate governance, Brazil is not just ahead of other Latin American countries but also surpasses other major emerging economies like India, China and Russia. Moreover, the Brazilian corporate governance practices are far more advanced than that of other developed countries. In Brazil, corporate governance was promoted in a much more didactic manner than in the US, with the primary focus being on how a company should protect minority shareholders from the controllers. However, corporate governance in the US was based on corporate scandals. The Brazilian corporate governance laws aim at formulating strict internal controls. The law has provisions that control self concession of salaries, bonuses and stock options. Moreover, they prohibit close relations between company executives and Board of Directors.

THE TIME IS NOW

For investors looking for dynamic returns from a rapidly growing economy while still being able to invest in companies and management teams culturally similar to the US, Brazil is the place to go. Many believe that over the next several years the real growth will be in the emerging markets, especially the so called “BRIC” countries of Brazil, Russia, India and China. However, across this group there is great disparity in language, business practices, political systems, and cultural norms. As the only Western Hemispheric BRIC, Brazil and Brazilian companies can seem very familiar to US investors. This becomes particularly important when investors seek to learn more about a company and its plans. Whereas visiting and speaking with business owners from some countries can be particularly challenging due to language and cultural issues, working with Brazilian companies provides investors the ability to interact with management teams schooled and familiar with western business practices and, quite often, fluent in
English.

For US investors seeking access to the Brazilian growth machine, there are several options including the ADR’s (America Deposit of Receipt) of Brazilian companies trading in the US, index and Exchange Traded Funds (“ETF’s”) tracking either the BOVESPA or synthetic indexes composed of a basket of stocks of Brazilian companies, or the stocks of Brazilian companies directly listed on a US exchange. This last category, directly listed US stocks, has the potential to offer US based investors the best of all worlds; namely, the ability to participate in the growth of engine of Brazil while being offered the transparency and liquidity of the US capital markets. Although there are currently only a handful of such Brazilian companies listed directly in the United States, more companies are coming to the market as more investors become aware of the potential of the Brazilian boom.

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Don't Rush to Invest in Jordan

Chip Krakoff — Wed, 05 Aug 2009 20:59:00 GMT

Andy Serwer writes today on the Fortune magazine website an article entitled “Can Jordan Build on its Relative Success?” Even the title is a give-away of modest expectations: “relative success”? The article lists some of Jordan’s undeniable achievements over the past seven or eight years: free trade agreements with the U.S. and the European Union that have caused exports to soar, some measure of macroeconomic stability, continued GDP growth even in the current economic crisis, improvements in education and health care, and reform and liberalization of several key areas of the economy. Having spent quite a lot of time working in Jordan, I agree with Mr. Serwer’s assessment of Jordan as the most secure and pleasant place to live in the neighborhood – in which he includes Egypt, Saudi Arabia, Iraq, Syria, Lebanon, and Israel – though Beirut’s nightlife and the topless sunbathers in Tel Aviv outshine any of Jordan’s more sedate attractions. But it is easy to overstate the case.

I have reservations about the World Bank’s “Doing Business” rankings and the methodology they use, but it’s worth noting that the 2009 “Doing Business” report ranked Jordan 101^st out of 181 countries surveyed in overall ease of doing business, compared with 94^th the previous year, just behind Zambia (100^th) and ahead of Sri Lanka (102^nd). Compared to its neighbors, Jordan beats out Egypt and Syria, but lags behind Lebanon, Kuwait, Israel, the United Arab Emirates, and Saudi Arabia. Some of the more problematic indicators for Jordan are: “starting a business,” “protecting investors,” and “enforcing contracts,” none of which augur well for the country’s prospects of attracting international investment. If you’re not too bothered by not being able to drink or wear shorts in public, Saudi Arabia (ranked 16^th) is a far better place to do business.

The World Economic Forum’s 2008-2009 Global Competitiveness Index highlights Jordan’s “inefficient government bureaucracy,” “tax regulations,” “inadequately educated work force,” “restrictive labor regulations,” “inadequate supply of infrastructure,” and “poor work ethic in the national labor force,” as the most damning factors – inflation formerly headed the list, but Jordan this year has brought the official rate down from 21% to 0.5%, for which it does deserve accolades.

Andy Serwer himself highlights the big infrastructure problems: lack of water – Jordan is the fourth poorest country in the world in water resources – and lack of energy – Jordan imports 965 of its energy needs – but sees the answer in a couple of multi-billion dollar water projects and in uranium, of which the country apparently has a lot. Enough, at least, to build its own nuclear reactor with French assistance and sell some yellowcake to pay for at least a portion of the cost of the water projects. Of course, if it were that simple, Yemen and Niger would be among the world’s most prosperous countries.

Jordan is certainly better governed than those unfortunate countries, but its relative stability and prosperity mask some worrying undercurrents. Jordan, like most of its neighbors, is a tribal country. As a foreigner with limited knowledge of Arabic, I couldn’t begin to explain the tribal dynamics, but suffice to say that the tensions are so great that the Cabinet tends to be reshuffled every twelve months or so to make sure no group feels slighted. This makes coherent and consistent policy hard to achieve. On top of that, nearly half the population is Palestinian, which makes for divided loyalties. Then there are the Iraqis. Jordanians will tell you a million Iraqis now live in Jordan, though the real figure is closer to half that, but it’s still a lot in a country with only six million inhabitants.

The numbers themselves mislead. Most of the surge in foreign direct investment and exports occurred in the early part of this decade, mainly as a result of the U.S.-Jordan-Israel Qualifying Industrial Zones program, which provided quota-free and duty-free access for garments and textiles made in Jordan with at least 11% Israeli content. The high GDP growth rates in recent years (9.6% in 2008) seem largely unrelated to Jordan’s prowess in developing the competitiveness of its economy and are more likely the result of an influx of people and dollars tied to America’s war in Iraq. How soon this bubble deflates depends far more on the speed of America’s disengagement from Iraq than on anything – positive or negative – Jordan’s government may do.

Investing in Jordan is hard for individual American investors. Of the Middle East funds available in the U.S., Wisdom Tree Middle east Dividend Fund (NASDAQ:GULF) has a 6.7% Jordan weighting. T. Rowe Price's Africa and Middle East mutual fund (TRAMX) allocates a little over 4% to Jordan. Other funds, including SPDR S&P Emerging Middle East & Africa ETF (NYSE:GAF) and Power Shares MENA Frontier Countries ETF (NASDAQ:PMNA) have unspecified and variable Jordan weightings.

Disclosure: Long TRAMX

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Will South Africa Survive? Jacob Zuma's Mrs. Thatcher Moment

Chip Krakoff — Mon, 27 Jul 2009 19:41:00 GMT

Jacob Zuma faces a growing threat as strikes and violent protests continue. Can he defuse the situation and satisfy some of the demands of the poor without destroying the economy? Will he?

...(read more)

How to Make Nothing out of Everything: Argentina's Road to Ruin

Chip Krakoff — Mon, 20 Jul 2009 20:01:00 GMT

In P.J. O’Rourke’s book Eat the Rich a chapter entitled “How to Make Nothing from Everything” seeks to explain how Tanzania, a country endowed with beautiful beaches, plentiful forests, rich agricultural land, and magnificent wildlife, had contrived by the mid-1990s to become one of the world’s poorest countries in the world in spite – or, perhaps, because – of more than a billion dollars of development assistance. An even better example might have been Argentina.

The Financial Times a few weeks ago reported that Argentina, one of the world’s largest agricultural producers and until recently its fifth-largest wheat exporter, may have to import wheat this year (“Prospect of Wheat Imports Looms,” July 29). Farmers are expected to plant about 2.9 million hectares of wheat this year, down from 4.2 million last year, the smallest amount since records started over 100 years ago. The government has blamed a drought, which has caused the worst planting season on record, and the financial crisis, which has made it hard for farmers to raise capital to buy fertilizer and seed. These problems are no doubt real, but I don’t recall severe droughts in the Great Plains (and we have had them) turning the U.S. or Canada into wheat importers.

In 1913, Argentina was the 10^th (some say the 7^th) richest country in the world. Per capita income and wages were higher than in almost every country in Europe, one reason that more than half of all Argentines are of Italian descent. Since then, things have gone badly. The IMF now ranks Argentina 58^th in the world in per capita GDP based on purchasing power parity (PPP). In 1913 Argentina’s per capita GDP was about 85% of that of the United States. Today it’s around 30%. What happened?

This year’s drop in wheat production can be directly attributed to several years of direct government intervention in wheat trading, which included a 2007 ban on exports followed by a 23% export tariff. These measures correlate directly with a drop in acreage harvested from 5.8 million ha. in 2007 to 4.2 million in 2008, a drop in production from 16.8 to 8.4 million metric tons, and a fall in exports from 11.2 million to 4.5 million tons. Incentives – and disincentives – do work.

Governments make this kind of mistake all the time, responding hastily and without sufficient consideration to a current crisis. What is disheartening is that the wheat cock-up is only one incident in a century of policy disasters. Even when the economy has spiked in response to sensible policy reforms (such as privatization and economic liberalization under the Menem government), nothing seems to break the long-term trend of decline, which by now seems to be deeply embedded in the politico-economic culture.

One can certainly blame Juan Peron for a great deal. Peron, a member of a military junta that overthrew the government in 1943 and was then elected President in 1946, was an enthusiastic admirer of fascist economics. In 1938, the Army sent him with several other officers on a study tour of Italy and Germany. Though the trip’s purpose was to study those countries’ military organizations, Peron was highly impressed by Italy’s corporatist system in which, in Mussolini’s words, “balance is achieved between interests and forces of the economic world… [This] is only possible within the sphere of the state, because the state alone transcends the contrasting interests of groups and individuals, in view of co-coordinating them to achieve higher aims.” Ideas do matter, and these ideas wrecked Argentina’s economy and civil society in ways still felt today. For some reason, Peron remains popular and Argentina’s leaders still wrap themselves in his mantle. Carlos Menem and Nestor Kirchner – as well as Kirchner’s wife and current President Cristina Fernandez –call themselves Peronists.

Argentina’s decline, however, started well before Peron came to power. Following World War I, the country entered an era of negative or anemic growth which, with a few interruptions, has continued to this day, and which has provided more than a few thesis topics for students of economics. The explanations have included a resurgence of colonial-era mercantilism, militarism, and political absolutism starting early in the 20th century, as well as more recondite theories of insufficient capital, relative declines in total factor productivity, and the effect of insecurity of property rights on growth of the money supply. There is truth to all of these arguments, but they all seem to distill into one, which I find most persuasive: the “systematic creation of barriers to competition.” According to a 2006 article that examines the causes of stagnation in Latin America in general, high import tariffs and quotas kept Latin American growth rates low for much of the 20^th century, and it is no coincidence that those countries that have liberalized the most completely – Chile is a stellar example – have grown the fastest.

It’s not just about foreign trade, though. Argentina’s economic reform has been a history of half-measures, which negate many of the benefits liberalization is supposed to bring. As an example, privatization of Brazil’s iron ore industry increased productivity by 140%. Most of Argentina’s state-owned industries privatized in the 1990s were allowed to retain the same monopoly status they had enjoyed as state enterprises, and productivity increased by an average of 46%. The 2006 paper’s authors state that: “policy changes that substantially affect the amount of competition faced by Latin American producers significantly and systematically change productivity… [which] suggests that Latin America indeed can achieve Western productivity levels when competitive barriers are removed.”

This is hardly a surprise. Those of us who still believe in free markets would have had to search desperately for explanations if the data did not support this conclusion. The more interesting question, though, is how Argentina, with a similar colonial experience to that of other Latin American countries, has taken such a different path. It’s worth asking why Argentina became so prosperous a century ago, when its neighbors did not. And now it’s worth asking why, since the 1990s when so many Latin American countries emerged from military dictatorship, Argentina has failed to implement the same kinds of reform that has transformed the economies of Chile and Brazil.

Disclosure: I own shares of iShares MSCI Brazil Index (NYSE: EWZ) and of Sadia (NYSE: SDA)

The World's Worst Job?

Chip Krakoff — Fri, 17 Jul 2009 17:21:00 GMT

The day after the U.S. Presidential election last November, the satirical weekly The Onion led with the headline “Black Man Gets Nation’s Worst Job”. The July 12 lead article in the South African non-satirical weekly, The Mail & Guardian, makes it clear that Barack Obama has no reason to envy South African President Jacob Zuma.

A senior member of President Zuma’s Executive Council recently threw cold water on demands to nationalize the country’s mining industry. “Our key strategic agenda at the moment is to maintain the infrastructure development and grow the economy to create decent jobs,” the executive member said. “Nationalization is definitely not on the agenda.”

This came less than a week after ANC Youth League President Julius Malema called on President Zuma to fast-track implementation of the so-called Freedom Charter, which calls for transfer of the nation’s mineral wealth to the people. Mr. Malema, famous for his incendiary comments, is perhaps best known for having said: “We are ready to die for Zuma…Not only that, we are prepared to take up arms and kill for Zuma.” Since then, he has criticized the Zuma administration incessantly for failing to enact the radical agenda embraced by many ANC rank and file members.

Mzolisi Diliza, boss of the South African Chamber of Mines, which represents the mining companies, has said that in the current economic crisis the government is unlikely to consider calls to nationalize key economic assets, pointing out that the mining industry alone is worth more than R2-trillion ($250 billion). Though Mr. Diliza represents powerful economic interests, and happens to be right, his statement may not reflect majority opinion.

David Masonda, Chairman of the Young Communist League (the Communists are part of the ruling ANC coalition, along with COSATU, the Congress of South African Trade Unions), has attacked the ANC’s approach to nationalization of the mining industry, saying: “The Mineral and Petroleum Resources Development Act is not nationalization. It is essentially a tool to transfer mining equity from the white elite to the black elite by the state elite.” There is a lot of truth to this statement. The ANC’s Black Empowerment policies have enriched a small number of well-connected black businessmen and political figures, while doing little to improve the lot of poor, mainly black, South Africans.

But Mr. Masonda then veers sharply leftward: “This is the most appropriate time to nationalize the mines and banks. This will ensure that the state does not depend solely on the whims of private individuals to generate funds for its industrial strategy and social programs such as free education…Our mines must be transferred back to us without any compensation. Business has no moral authority whatsoever to claim a cent for transferring what belongs to the people. And if they refuse to hand over these mines, they must be forced to do so.” When asked if calls for nationalization would chase investors away, Chairman Masonda said, “Investment for what and for whom? Investors must invest on our own terms and we must have control over the dividends of our work and resources.”

These criticisms must sting Mr. Zuma, whose campaign theme song was “Bring Me my Machine Gun,” and who initially based his presidential campaign on opposition to the previous ANC government’s accommodation of business interests and failure to provide jobs and housing for the masses. But Jacob Zuma, for all his legal problems, corruption allegations, and populist rhetoric, is nothing if not a shrewd politician. Later in his campaign he sounded much more conciliatory towards the business community, and after his election he named a Cabinet that promised no radical shift from existing economic and social policies. There is no saying what Mr. Zuma truly believes, but he seems to have realized it would be both political and economic suicide to follow the prescriptions of his communist and syndicalist allies.

The real question is whether – and for how long – the center can hold. I don’t see South Africa following Zimbabwe’s path to self-destruction. A lot can change in the next 10 years, but I would be astounded if Mr. Zuma, even if he serves two full terms as President, trying to amend the Constitution to allow himself a third term, and even more astonished if he were able to muster enough votes to do so. Nationalization of mines, banks, or any other important sector is highly unlikely. Government introduced a bill in 2002, proposing to impose mineral royalties for the first time, but seven years later royalties legislation is still being debated in Parliament and discussed with the Chamber of Mines. It is almost certain that any law ultimately passed will be something both sides can live with.

South Africa, which has an open and dynamic financial sector and a diversified industrial and service economy far less dependent on mining than 20 years ago, saw GDP growth fall from over 5% in 2007 to 3.1% in 2008. This year’s forecast growth is 1.1%, but the economy is expected to rebound to around 3.5% in 2010. Not great, and not enough to turn South Africa from a middling-poor country into a nearly rich one, but not bad in the current circumstances. My best guess is that South Africa will continue to be the financial and economic hub for most of Africa that rule of law will prevail, and that business and government will continue to work things out in a reasonably amicable and satisfactory way. Much like Obama’s America, come to think of it. It may be far from optimal, but it’s probably not bad enough to scare away investors in any significant way. (Disclosure: I don’t directly own shares in any South African companies but I do own shares in the T. Rowe Price Africa and Middle East Fund – TRAMX and in Market Vectors Africa Index ETF – AFK).

Can Dubai Come Back?

Chip Krakoff — Thu, 16 Jul 2009 20:13:00 GMT

It’s official: the recession has hit the United Arab Emirates, especially Dubai, hard. Well, maybe not official official, but I'm convinced. It's not always easy to tell what's happening in that part of the world. With rampant intermingling of public and private funds and little transparency over who owns and owes what, appearances can be deceiving.

Most of the economic and business numbers have been pretty grim, but losses can easily be moved around, as in a game of three-card monte. For every big real estate project mothballed or scrubbed during the past six months, other highly visible projects like the Dubai Metro have continued apace, and new ones are still being announced. Even as property values started to spiral downwards and huge property companies began to look distinctly wobbly towards the end of last year, there was still so much cash sloshing around and so many big projects still being announced and built the picture was pretty unclear.

Dubai, which has built a gleaming 21^st-century economy based on real estate, trade, and services literally on a patch of desert sand, has for so long defied common logic and perhaps even the laws of physics, and has produced such contradictory news since the onset of the financial crisis and recession, we might as well have tried to figure things out by reading our coffee grounds.

When the UAE government in February announced a new $100-billion project to build 80,000 new housing units in Dubai and Abu Dhabi to accommodate rising demand, there was at least a temptation to suspend disbelief. When the chairman of a large industrial group in Sharjah was quoted as saying that industrial investment was booming: “Recently, investors have been keen to invest in new areas. A lot of these investors have chosen the industrial sector, increasing the number of licenses, industrial facilities, workers, and types of industrial facilities. This clearly shows that the UAE is not exclusive to real estate investment, but is also active in all sectors,” I thought maybe there was something to his argument.

Turns out, there was not. A recent UAE-wide poll revealed that one in ten people in the country have lost their jobs over the past six months. Half of those polled said their companies have cut their workforce and a quarter say some of their co-workers have been required to take unpaid leave.

The real scale of job losses may be even higher. The UAE economy is built on an expatriate work force, ranging from Bengali and Pakistani laborers to highly-paid American and European investment bankers. Only 20 per cent of the total population of around three million are citizens; most of the rest are there on temporary work permits. If you are a non-citizen the law requires you to leave within a month if you lose your job. This gives the UAE economy a safety valve of sorts by reducing unemployment compensation claims, but it can also have a devastating ripple effect as the job losses in the hardest-hit sectors – construction and property – produce more losses in a whole range of other industries. At the beginning of this year some analysts feared that the UAE population might drop by as much as eight per cent. Now this seems optimistic.

In what may be the most telling sign, the expected completion date of the Burj Dubai, the world’s tallest building, has been pushed back from September to December. The developer, Emaar, has been close-mouthed about the details, and is trying to get itself acquired by Dubai Holdings, though the financial situation of Dubai Holdings is hard to read, given the proportion of its assets held in land, most of which has probably not been marked to market. Other property companies are also said to be trying to merge. And Nakheel, another huge property company, which two years ago acquired the QE2 for £50 million, has temporarily abandoned plans to refurbish and reopen it as a luxury floating hotel moored to Palm Island, and now intends to send it back out on the high seas.

True, it’s not all about property. The overall UAE economy, of which oil still accounts for a third, is expected to contract by only 1% this year, and could well rebound in 2010. This may, however, signal a shift in the economic center of gravity back to Abu Dhabi, which produces about 85% of the Emirates’ oil and which has always dominated politically. But even if oil keeps the UAE economy from sinking, the boom times are unlikely to return soon. Until then, I would give investments there a fairly wide berth. Given the interlocking nature of UAE companies, when you buy a share of one it’s hard to know who else’s hidden risks and liabilities you’re buying too.

Still, if Dubai's recent history tells us anything it's that anything is possible. If you can get British tourists to fly halfway around the world to lie on a beach in 120-degree heat this is literally true. So I wouldn't entirely write off Dubai. Certainly not yet.

Is the Rest of the World Ready for a Unified BRIC?

Chip Krakoff — Fri, 10 Jul 2009 20:37:00 GMT

"The Vital Wave Consulting" blog has an interesting post from June 26 - "Is the Rest of the World Ready for a Unified BRIC?" - about the previous week's summit in Moscow of the four "BRIC" countries: Brazil, Russia, India, and China. The article points out that trade among the four countries is too small to justify talk of a new trading bloc, but remarks that they have some common interests with respect to world trade, notably reducing reliance on the U.S. dollar. The BRIC countries are hard to overlook. Together they comprise about 43% of the world's population and 15% of its GDP, and hold over 40% of the world's gold and foreign exchange reserves. Their economies are growing at more than double the pace of developed economies. That they are holding a summit at all indicates that they are looking for ways to throw their combined weight around for mutual benefit.

Talk of unification, however, is premature and largely misplaced. Though their interests may coincide and overlap in some cases - as happens within any grouping of countries - they also diverge in many important respects. Brazil, of which Charles de Gaulle once said"It is the country of the future. And it always will be," finally seems to be realizing its potential. Its huge and productive agriculture sector, sophisticated manufacturing base, liberal market-oriented reforms, and new discoveries of big offshore oil deposits all but guarantee Brazil an important place in any new economic and geopolitical landscape. Russia is past its peak. Its economy depends on primary resources no less than Saudi Arabia's. Strip out the oil and gas and minerals - as well as the nuclear weapons - and Russia is of no more consequence than Saudi Arabia. I am willing to bet that within 50 years, and possibly much sooner, Russia will be less of a player on the international stage than Nigeria. India has undertaken profound economic reforms and has escaped from what used to be called the "Hindu rate of growth." Its sixty years of nearly-unbroken democratic governance are an inspiration. But its bureaucracy stubbornly resists change, ethnic tensions and conflict with Pakistan remain close to the boiling point, and for all its reforms India still maintains one of the most protectionist trade regimes on the planet. China's potential seems limitless, provided the rest of the world can provide the raw materials it needs to grow.

How much do these countries really have in common? True, they have issued joint statements calling for increased representation in international organizations and institutions like the World Bank and the IMF, though it is hard to see China and Russia, with their permanent seats on the U.N Security Council, agreeing to admit Brazil and India to the club. India's farmers are inefficient and highly regulated and subsidized, hence its then- Trade Minister's insistence on wrecking the 2008 Doha Round trade talks in order to keep the right to impose swingeing tariffs on agricultural imports. In this it was supported by China, which has a hugely inefficient agriculture sector of its own, and resolutely opposed by Brazil and other big agricultural exporters in the "Cairns Group," which includes Australia, Argentina, Canada, Chile, New Zealand, South Africa, and Thailand. Russia, which was close to final WTO accession talks, has just shelved its application, promising to re-submit a joint application with Belarus and Kazakhstan.

Vital Wave is half right when it says that for global businesses the BRIC countries "are an essential factor - as a group and individually - when setting growth strategies." They are an essential factor, but individually rather than as a group, and there is little to suggest that this will change in the near to medium term.

(Disclosure: I own shares in ING Russia Fund: LETRX; IShares MSCI Thailand Fund, NYSE: THD; Sadia S.A., NYSE:SDA; IShares MSCI Brazil Fund, NYSE: EWZ; and Market Vectors Indonesia Fund, NYSE: IDX)

Originally published on the Emerging Markets Outlook blog by Chip Krakoff