The Emerging Economies and Chinese Risk Capital
By: Amit Bhushan Date: 24th July 2014
The global ‘capital flows’ movement behaved much the same even with the growth of emerging economies in Asia or elsewhere. The rise of Japan or for that matter Taiwan or Korea only meant that much of the accumulated foreign currency was pour backed into the developed economies of the United States & Europe. The petro-dollars accumulated by oil-rich nation also largely behaved in the same manner. This was because of relatively smaller domestic appetite of the economies and relative abundance of raw materials or primary goods. Any return from investment was expected to be earned through participation in speculation in conjunction with sophisticated money managers operating out the developed world financial markets. There was little incentive to directly undertake risks in the other emerging economies and if any such risk was deemed to be worth taking it was undertaken via suitable vehicle in the United States (& Europe) so that element of protection is available and often in collaboration with the Transnational corporation operating from there. Such arrangement was deemed to be more secured and a degree of lower returns was deemed as acceptable price for risk mitigation. The ‘knowledge’ of the risk managers in the investment bank to mitigate risks and manage rewards for the investors was much appreciated & hugely rewarded. The practice ensured that ‘prized properties’ which once were centers of great economic activity continued their eminence in terms of valuations even after the economic activity had receded. Also during any crisis in any part of developing world, capital from the locality tended to fled ‘back’ to the developed world economies which witnessed an increase in currency value and lowering of the interest rates. Much of the developing world also got accustomed to receiving ‘capital’ payments (& also trade payments) in developed world currencies mainly USD and were able to commit servicing such capital in USD or other developed world currencies.
The rise & rise of China in the later years has begun to change the shape of the capital flows, a bit. With a large domestic market, China’s appetite for primary commodities was much more than anything in the past. Thus China began the chase for primary commodities by offering finance and technical support to develop mines in resource rich countries. Initially, its competitors (corporate) in the better developed world tried to compete, but soon realized that to compete with China they required to match the Chinese cost as well as offer similar terms to the beneficiary nations. The Chinese model of which consists of a mix mostly State owned companies combined with state supported tycoons taking direct exposure in the bad lands of emerging markets initially for the mineral resources and now increasingly for lucrative infrastructure deals especially where near monopoly is likely to exist for coming few years has taken off ground. The Chinese investors were also happy to make investments in USD take payments (for servicing investments) in ‘commodities’ provided it were suitably ‘priced’. The dizzy commodity markets with ever rising commodity price ensured that the reached their goals faster then many of them anticipated. We are thus almost continuing with the era of high commodity prices even with many new mines and new production sources being pressed to service the demand worldwide. This so because not many players were facing any shortage for needed commodity during the price build up but they only had an expectation built up for ever rising commodity prices with the markets/consumers also agreeing to play along. The synchronized action of the commodity markets also caught up with property markets in the developed world especially the US & Europe as well as in China which were witnessing sustained boom and ever rising employment & thus demand for housing properties.
However the balloon got pricked when it was realized that property loans in US were not backed by adequate cash flows or enough collateral (to cover for price risks) and some banks decided to move away from such financing. This cascaded soon into a fall in property prices across US & Europe and the central banks had to step in to print currency to recapitalize the banks. Ideally this action should have resulted in devaluation of the currencies of US and European nations but much of the emerging economies excluding China chose to devalue their own currencies almost in proportion so as not to loose on the demand for their produce with consumers in these countries and to be able to support paying back for the capital support received earlier. This also led countries such as Japan and other ‘emerged economies’ to get their act together and maintain their competitive profile and some of them went in for devaluation of their currencies. This act has continued to keep the commodities markets propped up. Many corporate in other countries also went ahead to adopt the model to their advantage. Also the citizens for the US & Europe escaped the like impact of inflation on them; however the citizens of the emerging markets faced inflation as well as impact of reduced demand and a bit lower price for the commodities. This has led to the clamour for rising economic nationalism and many of these economies have become candidates, ripe for political change.
What we are witness to is a backlash where people want much more transparency for the resources being exploited for especially exports and their fair share and participation in the economic activity. They want greater value addition in the home country with laws/policies to ensure support for the same. Also, the emerging countries have realized that many of them have now much lower wage rate than China and can pay for infrastructure required to develop manufacturing and services in ‘commodities’ of which they have surplus. So there is ever greater demand to raise the sophistication of their domestic economies by getting domestic players to partner with foreign players/technology providers and initiated domestic manufacturing & services. We are thus witnessing a shift in economic activities even as we continue to remain in the era of sustained ‘high commodity prices’ due to huge floating money back amply by risk taking appetite which has gone a bit bloated given the nature of economic activity in the near past. This continues even as we witness political disturbances in Ukraine or West bank which earlier could have had price impact on commodities and could have crippled some economies. The likely winding down of monetary expansion in the United States could be one event which may unshackle the markets but whether it will impact the high property prices in China or other markets or the Commodities or some other areas like equity markets in emerging economies, would be an interesting thing to watch. Whatever be the consequence, the chorus of rising economic nationalism in the emerging economies will continue to grow. The corporate, institutions and entrepreneurs in the emerging economies need to take position basis the given contours so that they can take advantage of the emerging situation. The push for higher value addition on commodity exports coupled with improvement in infra in emerging economies will ensure that they continue to imbibe newer technologies and grow their nascent capabilities, irrespective from which source they are getting technologies or funds. Even in scenario where commodity prices tend to fall and some of the existing operator try to disengage from the projects, newer players may be from other capital surplus locations may be ready to take direct exposure in these projects under suitable terms. This is so because most emerging markets currencies and asset valuation are at more sustained footing compared to developed world because of the political ‘need’ to raise economic activity in their markets is much more & this ensures continuity in valuations especially since the competitiveness of these economies have improved and many of the countries are making sustained improvement in stabilizing policies, processes and supporting infrastructure required.
The fact the China led BRICS have decided to continue to support their domestic financing needs as well as needs of other emerging economies by forming a multilateral bank is an important step. Going forward as the institution shapes up, we will get signals as to how activity of emerging economies will be molded and guided under the new dispensation. The formation of the bank is an unmistakable signal that rising ‘south-south’ capital flows will be sustained. The rise of such banks will definitely encourage other players like petro-dollar countries to venture out and co-mingle with market participants on their own or they may seek guidance with other non-euro/US institutions for ‘better’ deals though this may not be possible for the immediate few years till the BRICS manage to gain the confidence of the markets and ensure some degree of sanity/order. The rise of Reminbi as a trade currency and its growing acceptance is already a signal for waning GBP/Euro/CHF era. Although the energy rich nations have not embraced this as of yet, however a sustained growth in Reminbi is definitely going to impact the demand for Euro & others and impact their potential as ‘a store of value’ in times to come. Growing conflict in Europe coupled with continuance of a mild decline in economic activity may start the unshackling sooner than later. Any escalations are in fact likely to be even more counterproductive although the political impact over the longer term on global economy remains rather unpredictable at this juncture. We also continue to see resource hungry emerging economies like India and also countries like Bangladesh, Ethiopia etc. continue to make sustained pitch to attract ‘growth capital’ by promising to develop markets for the manpower intensive businesses in their quest to come out of economic and political turmoil. The continuance political shakeup in emerging economies is likely to keep the pressure up on global markets to readjust economic activities for some time to come. What is material is the point when the growth of emerging economies become self sustainable (and how) without causing concerns outside, is a point to watch for.
By: Amit Bhushan Date: 24th July 2014
The global ‘capital flows’ movement behaved much the same even with the growth of emerging economies in Asia or elsewhere. The rise of Japan or for that matter Taiwan or Korea only meant that much of the accumulated foreign currency was pour backed into the developed economies of the United States & Europe. The petro-dollars accumulated by oil-rich nation also largely behaved in the same manner. This was because of relatively smaller domestic appetite of the economies and relative abundance of raw materials or primary goods. Any return from investment was expected to be earned through participation in speculation in conjunction with sophisticated money managers operating out the developed world financial markets. There was little incentive to directly undertake risks in the other emerging economies and if any such risk was deemed to be worth taking it was undertaken via suitable vehicle in the United States (& Europe) so that element of protection is available and often in collaboration with the Transnational corporation operating from there. Such arrangement was deemed to be more secured and a degree of lower returns was deemed as acceptable price for risk mitigation. The ‘knowledge’ of the risk managers in the investment bank to mitigate risks and manage rewards for the investors was much appreciated & hugely rewarded. The practice ensured that ‘prized properties’ which once were centers of great economic activity continued their eminence in terms of valuations even after the economic activity had receded. Also during any crisis in any part of developing world, capital from the locality tended to fled ‘back’ to the developed world economies which witnessed an increase in currency value and lowering of the interest rates. Much of the developing world also got accustomed to receiving ‘capital’ payments (& also trade payments) in developed world currencies mainly USD and were able to commit servicing such capital in USD or other developed world currencies.
The rise & rise of China in the later years has begun to change the shape of the capital flows, a bit. With a large domestic market, China’s appetite for primary commodities was much more than anything in the past. Thus China began the chase for primary commodities by offering finance and technical support to develop mines in resource rich countries. Initially, its competitors (corporate) in the better developed world tried to compete, but soon realized that to compete with China they required to match the Chinese cost as well as offer similar terms to the beneficiary nations. The Chinese model of which consists of a mix mostly State owned companies combined with state supported tycoons taking direct exposure in the bad lands of emerging markets initially for the mineral resources and now increasingly for lucrative infrastructure deals especially where near monopoly is likely to exist for coming few years has taken off ground. The Chinese investors were also happy to make investments in USD take payments (for servicing investments) in ‘commodities’ provided it were suitably ‘priced’. The dizzy commodity markets with ever rising commodity price ensured that the reached their goals faster then many of them anticipated. We are thus almost continuing with the era of high commodity prices even with many new mines and new production sources being pressed to service the demand worldwide. This so because not many players were facing any shortage for needed commodity during the price build up but they only had an expectation built up for ever rising commodity prices with the markets/consumers also agreeing to play along. The synchronized action of the commodity markets also caught up with property markets in the developed world especially the US & Europe as well as in China which were witnessing sustained boom and ever rising employment & thus demand for housing properties.
However the balloon got pricked when it was realized that property loans in US were not backed by adequate cash flows or enough collateral (to cover for price risks) and some banks decided to move away from such financing. This cascaded soon into a fall in property prices across US & Europe and the central banks had to step in to print currency to recapitalize the banks. Ideally this action should have resulted in devaluation of the currencies of US and European nations but much of the emerging economies excluding China chose to devalue their own currencies almost in proportion so as not to loose on the demand for their produce with consumers in these countries and to be able to support paying back for the capital support received earlier. This also led countries such as Japan and other ‘emerged economies’ to get their act together and maintain their competitive profile and some of them went in for devaluation of their currencies. This act has continued to keep the commodities markets propped up. Many corporate in other countries also went ahead to adopt the model to their advantage. Also the citizens for the US & Europe escaped the like impact of inflation on them; however the citizens of the emerging markets faced inflation as well as impact of reduced demand and a bit lower price for the commodities. This has led to the clamour for rising economic nationalism and many of these economies have become candidates, ripe for political change.
What we are witness to is a backlash where people want much more transparency for the resources being exploited for especially exports and their fair share and participation in the economic activity. They want greater value addition in the home country with laws/policies to ensure support for the same. Also, the emerging countries have realized that many of them have now much lower wage rate than China and can pay for infrastructure required to develop manufacturing and services in ‘commodities’ of which they have surplus. So there is ever greater demand to raise the sophistication of their domestic economies by getting domestic players to partner with foreign players/technology providers and initiated domestic manufacturing & services. We are thus witnessing a shift in economic activities even as we continue to remain in the era of sustained ‘high commodity prices’ due to huge floating money back amply by risk taking appetite which has gone a bit bloated given the nature of economic activity in the near past. This continues even as we witness political disturbances in Ukraine or West bank which earlier could have had price impact on commodities and could have crippled some economies. The likely winding down of monetary expansion in the United States could be one event which may unshackle the markets but whether it will impact the high property prices in China or other markets or the Commodities or some other areas like equity markets in emerging economies, would be an interesting thing to watch. Whatever be the consequence, the chorus of rising economic nationalism in the emerging economies will continue to grow. The corporate, institutions and entrepreneurs in the emerging economies need to take position basis the given contours so that they can take advantage of the emerging situation. The push for higher value addition on commodity exports coupled with improvement in infra in emerging economies will ensure that they continue to imbibe newer technologies and grow their nascent capabilities, irrespective from which source they are getting technologies or funds. Even in scenario where commodity prices tend to fall and some of the existing operator try to disengage from the projects, newer players may be from other capital surplus locations may be ready to take direct exposure in these projects under suitable terms. This is so because most emerging markets currencies and asset valuation are at more sustained footing compared to developed world because of the political ‘need’ to raise economic activity in their markets is much more & this ensures continuity in valuations especially since the competitiveness of these economies have improved and many of the countries are making sustained improvement in stabilizing policies, processes and supporting infrastructure required.
The fact the China led BRICS have decided to continue to support their domestic financing needs as well as needs of other emerging economies by forming a multilateral bank is an important step. Going forward as the institution shapes up, we will get signals as to how activity of emerging economies will be molded and guided under the new dispensation. The formation of the bank is an unmistakable signal that rising ‘south-south’ capital flows will be sustained. The rise of such banks will definitely encourage other players like petro-dollar countries to venture out and co-mingle with market participants on their own or they may seek guidance with other non-euro/US institutions for ‘better’ deals though this may not be possible for the immediate few years till the BRICS manage to gain the confidence of the markets and ensure some degree of sanity/order. The rise of Reminbi as a trade currency and its growing acceptance is already a signal for waning GBP/Euro/CHF era. Although the energy rich nations have not embraced this as of yet, however a sustained growth in Reminbi is definitely going to impact the demand for Euro & others and impact their potential as ‘a store of value’ in times to come. Growing conflict in Europe coupled with continuance of a mild decline in economic activity may start the unshackling sooner than later. Any escalations are in fact likely to be even more counterproductive although the political impact over the longer term on global economy remains rather unpredictable at this juncture. We also continue to see resource hungry emerging economies like India and also countries like Bangladesh, Ethiopia etc. continue to make sustained pitch to attract ‘growth capital’ by promising to develop markets for the manpower intensive businesses in their quest to come out of economic and political turmoil. The continuance political shakeup in emerging economies is likely to keep the pressure up on global markets to readjust economic activities for some time to come. What is material is the point when the growth of emerging economies become self sustainable (and how) without causing concerns outside, is a point to watch for.