A new model for emerging markets

Growth 'survivors' like the Philippines now define rising economies, says Natsuko Waki of Reuters

Headline growth numbers are no longer enough to attract foreign capital to emerging markets, as discriminating investors home in on countries with the most sustainable economic models.

Mexico and the Philippines are among those trying to ensure growth can be maintained long term by encouraging domestic saving that can be used to fund infrastructure projects.

This transition to a new model is already underway, with equity and bond funds in both countries attracting net inflows in the past six months despite a sharp emerging market sell-off.

The Federal Reserve's plan to withdraw its massive monetary stimulus is dividing emerging markets fortunes, with capital draining rapidly out of countries with large financing needs.

To make themselves less vulnerable to the ebb and flow of foreign short-term money, some countries are beginning to invest in their economies, backed by a more stable financing base.

The Philippines, where remittances from overseas workers provide a steady flow of income, is channeling a pool of domestic money to build airports and roads in a project costing 3 percent of gross domestic product.

Mexico plans to spend almost a third of its GDP on improving its infrastructure in the next six years, and is among Latin American countries that have reformed their pension systems to encourage workers to save regularly.

That creates a base to finance infrastructure spending, which should boost domestic demand and potential growth.

"In emerging markets, you are no longer trying to find a winner but you're trying to find a survivor," says Salman Ahmed, global fixed income and FX strategist at Lombard Odier Investment Managers.

"We still think Mexico and Philippines are well placed ... Winners of yesterday, Brazil and Turkey, are looking trickier."

According to estimates by Lipper, dedicated Mexico equity and bond funds saw combined inflows of $3.7 billion (2.4 billion pounds) in the six months to June-end, while Philippine equity and bond funds attracted combined net inflows of $2.56 billion.

Mexico's stock market has risen 1.6 percent since May 22, while the broader index has lost nearly 7 percent.

The Philippines' stock market has risen more than 14 percent in 2013, and its sovereign credit rating is on review for an upgrade by Moody's.

The ratings firm has cited stable and favourable government funding conditions and a strengthened government policy mandate among triggers for the rating review.

How to spend it

Latin America is a step ahead in building up an institutional domestic savings base, having reformed its pension systems following the debt crisis of the 1980s. Mexico, Chile, Peru, and Columbia all have relatively high savings rates of above 20 percent of GDP, according to the World Bank.

Chile is the highest-ranked emerging economy after Singapore and Taiwan in BlackRock's Sovereign Risk Index, which measures credit risk through a broad list of fiscal, financial and institutional metrics.

"It's interesting to know that a considerable number of emerging markets get very high ratings in that index because of domestic finance savings institutions," says Ewen Cameron Watt, BlackRock Investment Institute's chief investment strategist.

"Countries that are tending to find their financing of currencies more resilient are those who have deepened their domestic financial system, usually with the development of the domestic contractual financing and savings industry."

Mexico is beginning to channel domestic savings to building projects via its state pension funds, which have about 1.919 trillion Mexican peso ($150.76 billion) in assets, representing about 23 percent of private savings. They hold 1.5 percent of assets in domestic debt specifically labelled as infrastructure.

State funds may be key to its plans to spend $300 billion in the next six years to build highways, rail lines and communications infrastructure, and upgrade the country's ports.

After two decades without a passenger rail service, Mexico has earmarked 95 million pesos for three routes, including a 300-kilometre line across the Yucatan peninsula, home to its famous Cancun beach resort and the ancient Maya pyramids.

The government has also promised to consider a second airport in Mexico City to ease pressure on the current sole hub, which is Latin America's second largest by traffic.

The Philippines government has offered private sector firms contracts to modernise at least five airports in two of its three main regions, and will soon accept bids for a $814 million toll road contract in two provinces just south of the capital.

For both economies, Japan could be a model. Much of its post-war growth kick-started with foreign capital, was driven by private savings that were channeled by banks to finance massive infrastructure and reconstruction projects.

By the time it passed West Germany to become the world's No. 2 economy in the 1960s, Japan no longer relied on foreign capital to grow.

"Infrastructure in the long term is a positive factor. It makes you more competitive, and improves the supply side of the economy," Ahmed of Lombard Odier says.

Long hard road

Myanmar's quest for foreign investment will not be as easy as most think, says Jared Ferrie of Reuters

In a cramped auditorium in Myanmar's capital, pro-democracy champion Aung San Suu Kyi had a message for the world's business elite: Her country is teeming with foreign investors scouting for opportunities in one of Asia's final frontier markets, but not many are actually investing.

Interviews with foreign and local business leaders on the sidelines of June's World Economic Forum in the Myanmar capital Naypyitaw show why.

Shoddy infrastructure, opaque regulations, red tape, recent bouts of sectarian violence and lingering uncertainty over U.S. sanctions are hampering large-scale foreign investment in the country, strategically nestled between India and China.

"Actually, there isn't that much investment coming in," Nobel Peace laureate and opposition leader Suu Kyi told reporters.

The figures support her analysis.

In June, reformist President Thein Sein said Myanmar attracted only $1.4 billion in foreign investment in fiscal 2012-13 - a decent figure for a country that only recently emerged from 49 years of military misrule and isolation, but far from the amounts needed to jump-start its broken economy.

The country has clearly made a start: Anglo-Dutch consumer goods giant Unilever plans to open two factories this year - part of a plan to invest 500 million euros ($661 million) there over the next decade - and The Coca-Cola Co has began bottling there for the first time in more than 60 years.

Ford Motor Co has opened a showroom in the largest city, Yangon. And hosting the World Economic Forum was itself was a coup for the Myanmar government's investment drive.

"When was the last time a market of 60 million people fell out of the sky?" asks Martin Sorrell, head of advertising and marketing giant WPP Plc, which has invested in media agencies in Myanmar. "This is one of the last frontiers."

Sorrell says major WPP clients such as Nestlé SA, the world's biggest food maker, would soon invest as well.

But there is a long way to go, with global consulting firm McKinsey estimating Myanmar needs $170 billion in foreign capital in the first stage of its economic transition.

And like many frontier markets, the investment climate is still anything but sunny, despite the enormous changes.

Sorrell's optimism is tinged with an awareness of the risks, including growing ethnic and communal violence in Myanmar where unrest between majority Buddhists and minority Muslims have killed hundreds of people in the past year and displaced more than 140,000, mostly Muslims.

"Ethnic issues are a problem," he says.

Other executives and analysts interviewed at the forum spoke of a range of major investment barriers, including Myanmar's poor infrastructure and unclear regulatory environment.

Speculative fervour

McKinsey has pointed at manufacturing as a key sector that could generate six million jobs and eventually account for a third of the economy. But Serge Pun, who heads Serge Pun & Associates, which has interests in real estate among other sectors, says a lack of zoning laws was holding back growth in manufacturing.

"Today, they go out and speculate [on] industrial land with the same fervour and enthusiasm as if it was prime residential land," he says.

Serge Pun says the government should set aside industrial land for investors to build factories and employ people. "I always advocate that if there's a factory operator that's willing to come in, the price should be very cheap," he adds.

For Christopher Fossick, regional managing director for real estate consultancy Jones Lang LaSalle, the problem is Myanmar's foreign investment law. It was passed by parliament in November last year, but the government has yet to put it into effect, leaving foreign developers waiting for certainty before moving in.

"From there, you need to develop a land ownership structure," he says. "Anybody coming in here and investing will need the confidence and the understanding that there's a certain level of transparency in the market, and that they can have title over the real estate that they're investing into."

A similar lack of transparency is holding back growth in agriculture, according to Don Lam, head of VinaCapital, a Vietnam-based investment management and real estate development company. His company is looking at investing in agricultural processing and technology, but it will stay away from production in a sector vulnerable to contentious land disputes.

"Agricultural reform means the rules for investors have to be completely clear," he says.

Lam says he is also looking into hospitality and financial services in Myanmar, but has encountered another challenge: Decades of mismanagement have left the country with a limited educated workforce. Lam says VinaCapital has so far been unable to find a local CEO to head its operations there.

"We have funds allocated to Myanmar, we have investors ready to launch a Myanmar fund," he says. "So capital is not the issue - the issue is finding the right talent."

Doan Nguyen Hansen, a senior partner with McKinsey, says people in Myanmar have an average of only four years of education, contributing to the country's weak productivity rate which was 70 percent below that of benchmark Asian countries, including China, Thailand and Indonesia.

But there is no way to build enough schools and train workers fast enough, she says. Technology could fill the gap with remote learning, but telecommunications infrastructure needs an overhaul: Myanmar has among the lowest mobile telecommunications penetration rates in the world, with only 4 to 8 percent of the population connected. Internet and mobile phone services are not available in much of the country.

Arvind Sodhani, president of Intel Capital, the venture capital arm of chipmaker Intel Corp, says he is looking at Myanmar but is waiting for the right "ecosystem" to develop - better and faster broadband access, clearer regulations, and a labour market with adequate legal and financial expertise.

"The number one thing that matters to us is Internet access - high speed, readily available, affordable relative to the incomes of the population," he says. Those factors have not been achieved "judging from the fact that none of my devices work.”

Stephen Groff, vice-president of the Asian Development Bank, says he is impressed by the government's commitment to reform and its efforts to attract investment. But he adds that the government can do more to manage the expectations of investors and Myanmar's people who are eager for the fruits of change.

"That patience runs out," he says. "How much time are people willing to give the government to see this process through?"

Myanmar poised for six-fold rise in multimillionaires

By Stella Dawson of Thomson Reuters Foundation

The ranks of Myanmar’s super rich will increase at least six-fold in the coming decade as one of East Asia’s poorest countries emerges from military dictatorship and embraces a market-oriented economy, according to a new report.

Wealth-X, a firm which gathers intelligence on wealth, estimates in its World Ultra Wealth Report that there are 40 individuals in Myanmar currently who have assets worth $30 million or more. It sees that number growing by 687 percent to 307 by 2022, the fastest pace of growth anywhere in the world. 

Myanmar’s hotel industry, commodities especially lumber and finance, and banking sectors are growing very rapidly and this will expand the ranks of the country’s ultra wealthy over the coming decade, says Mykolas Rambus, CEO of Wealth-X.

“When a market opens up to this degree as we are seeing in Myanmar, when there is a change in leadership, where there is a large population and it is located in Asia, there is immense new opportunity,” Rambus says.

Myanmar also has significant problems of inequality. Twenty six percent of its population live in poverty, 75 percent lack access to electricity and the average per capita national income is $800 to $1,000 a year, according to the World Bank. The United Nations lists Myanmar in the bottom ranks for quality of life at 149 out of 186 countries in its 2013 Human Development Report, which measures factors such as inequality, education, healthcare, income and social opportunities.

However, the country is one of the most dynamic in Asia. Foreign investors are flocking there to take advantage of its immense natural resource wealth in oil and gas reserves, precious gems, timber, and water and farmland as the former military dictatorship begins to privatise assets. The economy is expected to grow by 7 to 8 percent a year over the decade, and the Asia Development Bank estimates Myanmar could triple its per capita income by 2030.

The question is whether this growth will benefit the majority of the population, Rambus asks. “There is a question:  Will this wealth stay in the hands of a few, or will Myanmar provide opportunities for the wealth to trickle down?”

Indonesia, for example, saw rapid economic growth as it democratised but wealth has remained relatively concentrated in a few hands. Russia, since the collapse of communism, has seen a large wealthy class emerge, but its middle class has not developed as rapidly.

Most of Myanmar’s richest people hold their assets in the form of private residences and ownership of private companies, Rambus says.

Reaching a limit

In July, Singapore’s DBS Group dropped its $7.2 billion bid for Indonesia’s Bank Danamon, scuppering talks for what would have been Southeast Asia’s largest bank M&A deal ever. The deal’s collapse came in the wake of a new rule imposed by Indonesia’s central bank, capping foreign ownership of its banks at 40 percent. As a result, Indonesia’s attractiveness for foreign investment has been dealt a hefty blow. Some foreign investors can still acquire up to 99 percent ownership by fulfilling certain criteria, but a proposed banking law for next year may change things altogether. Kanishk Verghese reports

After 16 months of discussion, Singapore’s DBS Group withdrew its $7.2 billion bid for Indonesia’s Bank Danamon, shattering the prospect of sealing what would have been Southeast Asia’s biggest bank M&A deal ever. The deal collapsed after Indonesia in May capped foreign ownership in domestic banks at 40 percent, which analysts say will hurt Indonesia’s attractiveness as a hub for foreign investment. Some foreign banks, however, can still own up to 99 percent in an Indonesian bank after passing financial soundness tests. But a proposed new banking law may scrap this regulation altogether and implement a new, lower ownership limit. Market observers stress that the new law needs to introduce much needed sweeping reforms to improve financial diversification and enhanced bank services, and to make its domestic banks more competitive in international markets.

A failed bid

In April last year, Singapore’s DBS Bank launched a $7.2 billion bid to acquire Indonesia’s Bank Danamon. DBS had sought to buy a controlling stake in Indonesia’s sixth-largest lender from Temasek, which owns about 67 percent in Bank Danamon and a 29 percent stake in DBS. The stage was set. But in May this year, Bank Indonesia, Indonesia’s central bank, limited single ownership in domestic banks to 40 percent from 99 percent. The government had introduced legislation allowing 99 percent ownership in the wake of the 1998-99 Asian financial crisis in an effort to attract investment. DBS could eventually own more than 40 percent of Bank Danamon, but would need to pass several financial soundness tests, which could take up to another 18 months. The new rule would have made it difficult for DBS to integrate Bank Danamon with its existing business in Indonesia, and in July, the Singaporean bank pulled the plug on the deal.

Analysts have criticised Bank Indonesia on its decision, arguing that foreign investors are being treated unfairly amid a rising tide of economic nationalistic sentiment in Indonesia. The collapse of the DBS-Danamon deal suggests that Indonesia’s appeal as a destination for foreign investment has been tarnished. For foreign investors keen to tap Southeast Asia’s booming economies, gaining a controlling stake is vital to make their investments worthwhile. Some lenders, however, may be willing to settle for a minority stake just to get their foot in the door, Melissa Ng, an M&A partner at Clifford Chance in Singapore, told Reuters. However, Basel III capital rules make it expensive for banks to hold minority stakes in other lenders.

When asked about the rumour that BI introduced this rule to scuttle the DBS-Danamon deal, Erwandi Hendarta, a Jakarta-based partner at Hadiputranto, Hadinoto & Partners, a member firm of Baker & McKenzie, mentioned that Darmin Nasution, the Bank Indonesia governor who presided over the issuance of the 40 percent rule, stated in his memoir that the rule was not at all targeted at stopping the DBS-Danamon deal from taking place.

Erwandi says that there may be a general misconception that the rule itself has been changed to cap foreign investment in domestic banks at 40 percent.  While Bank Indonesia introduced the 40 percent rule (for the first stage), government regulation, which is higher than Bank Indonesia’s rule, still allows foreign banks to own up to 99 percent of a domestic bank, he says. “It has just become a two stage process. In the first stage, banks are allowed to buy a maximum of 40 percent in an Indonesian bank. But, if certain criteria are fulfilled – for example, if the bank acquirer is a listed company – they may apply to buy up to 99 percent of its target,” says Erwandi.

However, the two-stage system certainly presents potential buyers with a new set of challenges. “One criterion [of the rule] is that the acquired bank must reach a certain soundness level in 18 months. So if you buy 40 percent of an Indonesian bank, you now have to enter a temporary joint venture with the seller for 18 months, which makes things more complicated in a way. Potential buyers now need to change their mindset,” says Erwandi.

A new law

But things are likely to change soon. Indonesia’s Financial Services Authority (OJK), which will take over supervision of the banking sector from Bank Indonesia next January, has stated that a new banking law was certain to come into force in 2014. “It will definitely come out next year,” Muliaman Hadad, head of the OJK, told Reuters. Legislators are working on a draft proposal, but there has been no decision on whether the foreign ownership cap on banks will be changed. Senior MPs told Reuters they expected to include a maximum 51 percent limit on the amount a foreign investor can own of a local bank. “We have not seen a final draft. There was a very preliminary draft issued earlier this year, but we have not seen any strong development or discussion on the banking law yet,” says Indri Guritno, another partner at Hadiputranto, Hadinoto & Partners.

Nonetheless, analysts say that the new banking law will need to address much-needed structural reforms. Indonesia needs to improve market competition, financial diversification, and enhance its bank services. One of the major changes being discussed would force foreign bank branches already in Indonesia to change their status to a local operation with limited liability.

Furthermore, Indonesia wants to make its domestic banks more competitive in international markets. Bank Indonesia’s new governor, Agus Martowardojo, told reporters in May shortly after his swearing-in ceremony that he would respect the country’s current regulations on banking reciprocity and negotiate with his foreign counterparts to open their domestic markets to Indonesian companies. Indeed, market observers have noted a distinct rise in economic nationalism in Indonesia, adding that this may deter foreign investors. In the case of the DBS-Danamon deal, Bank Indonesia gave the Singaporean bank’s bid its consent in May to buy a 40 percent stake in Bank Danamon. But as part of its approval, Bank Indonesia said for DBS to acquire more of Bank Danamon, Singapore would have to allow Indonesia’s banks greater access to its financial services industry.

The draft law would need to be approved by the parliament and then by the president. It is unclear whether the new law will be introduced next year, especially due to the presidential election in 2014, says Guritno. “Also, since the Financial Services Authority will have only just begun its rule over the banking sector next January, we do not know how realistic 2014 sounds,” says Guritno.

Bank Indonesia’s new 40 percent rule, coupled with its push for banking reciprocity, has certainly dissuaded some foreign investors. However, the 40 percent rule may still be more favourable than that of other Southeast Asian countries, says Erwandi. Given Indonesia’s size, burgeoning middle class and growing consumer market, foreign investors may not be able to pass up on conducting business in Southeast Asia’s largest economy. Nonetheless, Bank Indonesia will need to oversee large-reaching reforms in its new banking law. Potential buyers and existing stakeholders will be keeping a close eye on the new law and what changes to foreign ownership limits it will bring. But with Indonesia’s presidential election less than 12 months away, an immediate change in policy is highly unlikely.