I published this column on Executive Magazine:
The spectacular rebound of emerging markets after the recent recession was driven in no small part by China’s emergency stimulus package in late 2008, arguably the timeliest and the largest in the world (relative to gross domestic product). The pull of Chinese demand was powerful enough to revitalize international trade — severely curtailed by the crunch in trade finance — and to drag out of the hole many of the economies well integrated in the Chinese supply chain, from Malaysia to Korea, and Australia to Germany.
The flip side of this stimulus has been a worrisome boom in real estate prices (which has led many to scream “Bubble!”) and persistent inflationary pressures which have extended across Asia (excluding Japan), complicating the macro picture at the national and global level. Asian central banks (and also Latin American ones) until late last year were reluctant to aggressively raise interest rates, lest they clip the green shoots of recovery. But with the upturn in emerging markets, food and commodities prices worldwide resumed their surge; since the beginning of this year this surge has been exacerbated by oil price reaction to the turmoil in North Africa. Amplifying this effect is the premature end, after Japan’s Fukushima disaster, of the much touted “nuclear renaissance” that was supposed to substantially curtail hydrocarbons in the world energy mix.
China remains to-date the epicenter of inflationary pressures, despite the fact that authorities were the first to react decisively by increasing reserve requirements up to 20 percent for top lenders, restricting credit to the real estate sector and hiking interest rates four times since October. Nevertheless, in March, Chinese inflation hit a three-year record of 5.4 percent per annum, while in India, which is also experiencing a generalized price surge, it reached almost 9 percent; across the emerging markets generally, from Korea to Brazil, price levels are overheated.
Conventional wisdom and mainstream policy advice suggests that the Chinese authorities should act even more aggressively to counter further price hikes, and indeed solemn pledges to this effect figure prominently in public statements by senior politicians. But China generally defies conventions and an alternative course of action appears to be gathering consensus within policy circles. The new five-year economic plan sets a 4 percent inflation target for this year, and Chinese authorities have signaled that in the medium term they would be comfortable with inflation between 4 percent and 5 percent, which represents a substantial increase compared to previous years.
Furthermore, national and local governments have enacted a spate of hefty salary increases: since the beginning of the year, 12 Chinese provinces and provincial-level municipal cities have raised their minimum wages. The average adjustment over the 12 provinces was 21 percent with the highest hike, 28 percent, being decreed in Chongqing, in central western China (outside the coastal belt where manufacturing is concentrated). Incidentally, thanks to a 20 percent rise, Shenzhen replaced Shanghai to become the city with the highest minimum monthly wage in China (approximately $203). If we consider a longer horizon, since last year 30 provinces raised the minimum wage, often by double digits.
These measures were justified by the need to attract labor from the inner regions and to improve living standards, an issue that had taken center stage in domestic politics after strikes and workers unrest spread across the country, threatening to become a widespread phenomenon.
Whether by happenstance or by design, it seems that an unorthodox policy recipe is emerging. One of the foremost issues confronting the Group of 20 countries is the rebalancing of the current-account surplus by China and Germany and other mercantilist oriented countries. The most vocal critique of China’s export-led strategy has been the United States, which (stirred by Congress) has used such criticism to push for a revaluation of the yuan.
The Chinese government and central bank are aware that an ever-increasing current-account surplus is not sustainable (the foreign exchange reserves have reached a walloping $3 trillion), but might be contemplating an alternative route; instead of revaluing the nominal exchange rate (as demanded by the US and others) they are increasing the real exchange rate.
By raising domestic wages they boost domestic inflation, thereby losing competitiveness, but Chinese workers feel the benefits more than foreign competitors. In essence, the Chinese government seems to be pursuing a redistributive policy in favor of the domestic population with the aim of boosting internal demand and reducing the current account surplus.
It is hard to say how this policy will turn out; it certainly carries risks, as once a price/wage spiral is triggered it becomes hard to control, but a few implications for the global economy and the Middle East are clear.
Over the past three decades China has become the world manufacturer and has been the most powerful force behind a relentless deflation in traded goods — reveled in by the rest of the world — thanks to an almost inexhaustible supply of cheap labor. This process is reverting, and with China’s inflation on the rise it is only a matter of time before a global reverberation is felt.
If one adds the effects of money printing in the US and the need to monetize at least in part public debts in mature countries, foremost in the Eurozone, the next few years will present serious challenges for monetary policy; the word ‘stagflation’ is likely to make a comeback in everyday parlance.
This change will not be a temporary adjustment, but will represent a structural shift in the global economic environment, affecting greatly the smaller economies in the Middle East and elsewhere. In particular, the Gulf Cooperation Council countries will find themselves again ensnared, like in 2006-2008, in a monetary policy determined by the US Federal Reserve to serve its domestic goals, but utterly inadequate for the conditions of GCC economies.
Furthermore, the central banks and the sovereign wealth funds that manage the accumulated export revenues are typically exposed to fixed income securities denominated in US dollars. At present, the safe haven status and the anemic credit conditions have held bond prices remarkably stable (excluding of course troubled countries such as Greece or Portugal). But when markets realize that higher inflation is not a blip, the adjustment could be traumatic for fixed income securities. There are no simple solutions to this kind of tectonic shift, but a revamping of the GCC’s common currency project could not be more timely. A degree of flexibility in monetary policy and a new strong international currency would be in the best interests of the oil exporters and also indirectly, those of other countries in the region.
The surge in Chinese wages will also lead domestic consumption to replace exports as an engine of growth. This swing has a long course to run as private consumption represents a remarkably low percentage of China’s GDP. The effects of the Chinese boom have thus far benefited countries and companies embedded in China’s supply chain, but from now on the effects of the stimulus could reach those countries and companies that cater to Chinese consumers, in particular in the provision of durable goods for the expanding middle class — washers, cars, furniture and high end services, such as tourism, healthcare and financials.
A benevolent interpretation posits that, far from being a serious worry, inflation spurred by the loose wage policy tolerated — and often encouraged — by the Chinese authorities could be another step in the long march toward better quality of life within China and the harbinger of a great leap forward for the world economy.
6 gen 2011
Executive - From hub to web
This article was published on Executive magazine January issue.
During the credit crisis triggered by the Lehman Brothers bankruptcy, a paradoxical consequence arose for the United Arab Emirates: the loans portfolio of its banking system was somewhat larger than its stock of deposits. Definitely not a large gap, more or less in the order of 10 percent, well within the internationally accepted norm of prudential parameters. Yet, as a result of the global money market convulsions and the extreme risk aversion which prevailed in the last tense months of 2008, the UAE banks had severe problems in funding this gap on the international market, which translated into a credit crunch for domestic businesses and consumers.
Hence the paradox: the UAE (and the other Gulf Cooperation Council countries) have been net exporters of capital for decades; they supplied a critical lifeline to the international banking system by supporting the recapitalization of major financial institutions in the United States and the United Kingdom when they were torpedoed by the sub-prime mortgage fiasco. But when, at a critical juncture, the need arose for the UAE banks — which were essentially sound and had only minimal exposure to toxic assets — to borrow, international financers deserted them.
This episode highlights a peculiar arrangement: emerging economies with large capital export use the financial services of heavily indebted countries where they are charged hefty fees for channeling this capital to borrowers. But if these emerging economies need finance during a crisis, largely provoked by the incompetence of Western bankers and regulators, these same bankers and regulators decide who is deemed creditworthy. This oddity was even more striking in the case of trade finance, on which depend virtually all exports from emerging markets. In the aftermath of the Lehman bankruptcy, loans to exporters, despite carrying very low risk, were drastically curtailed — leading to one of the most spectacular drops in international trade ever recorded.
Time for a system overhaul
This asymmetry is not acceptable anymore and has opened wide cracks in the “hub and spoke” model of international finance. Essentially, the main finance centers preside over all major financial relations in the world. A deal between, say, a Brazilian company and an Indian investor (the spokes) is likely to be mostly handled in London or New York (the hubs). While this was justified when the US was a net capital exporter, and therefore played a key role in the allocation of their own funds to the rest of the world, today it represents a vestige of the past. Worse, as the crisis has demonstrated, it is a fundamental element of financial fragility and therefore a threat to the stability of the world economy.
The current “hub and spoke” system needs to be replaced by a network of financial centers, a web of interrelation that would make it more flexible, efficient and resilient. In other words, if an Indian investor wishes to invest in a Brazilian company he will be able to bypass New York and arrange the operation directly in Mumbai, or maybe in Dubai, or through accessing expertise and resources in more than one location.
It is conceivable that even in the “web” system not all nodes will be equal, some will be specialized in certain areas, others will enjoy economies of scale in human capital and knowledge. But essentially, while each financial center will play a useful function, none will be indispensable for the stability of the global system.
A trend is already discernible. Sizeable deals between emerging markets — which until recently would have been arranged through a major financial center — now take place through direct links. China, with its huge current account surplus and accumulated net foreign assets, is at the forefront of this new wave, but other areas — including the GCC — are increasingly active outside the traditional financial perimeter. The foreign direct investments among emerging markets, which in the jargon of policy makers are called South-South flows, are booming, thereby dislocating the traditional capital flows.
With Asia’s emerging economies enjoying a quick rebound from the crisis — unlike the mature economies — this process is bound to intensify, but the speed at which it will develop depends on many factors. One of the most important is the creation of a liquid and deep debt market in the peripheral nodes.
A new market is born
Deep and liquid fixed income security markets represent the leading source of funds for governments, public companies, agencies and financial institutions. Their functioning is key for the efficiency and stability of financial intermediation, while providing a boost to economic growth. While some emerging countries have made notable progress in this area, the Middle East and the GCC still lag behind. According to data from the International Monetary Fund, capital markets in the Middle East are an anomaly when compared with other areas because they are dominated by bank assets and equities, which together make up 94.4 percent of finance; the corresponding figure for the world as a whole is approximately 60 percent.
Specifically, in the GCC, bond financing is out of favor, because it is deemed superfluous in a region flush with capital and hydrocarbon wealth. The swings in hot money flows, the drop in the region’s equity markets and the prohibitive cost of long-term borrowing have exposed the danger of relying on external capital markets. With a precarious financial lifeline in the face of the continued global liquidity crunch, GCC countries are now eagerly tapping the abundant domestic wealth and foreign capital looking for relatively safe investment.
This noteworthy trend was initiated this year with large sovereigns issuance (Qatar, for example, broke the record for the largest debt by an emerging market with a $7 billion issuance), to match governments’ commitment to maintain the infrastructure expenditure at pre-crisis levels. Now an embryo of a market has been created in the region with the appearance of a yield curve on which to price new securities and manage risk. But more is required to get on par with other emerging markets in terms of liquidity, depth, investors’ involvement, governance, debt management, etc. In particular, governments should take a leading role by committing to a plan of bond issuance across the maturities spectrum, conducted periodically over a number of years with appropriate pre-announcement of auction dates, size of the issue, characteristics of the securities, primary dealers and secondary market listings. Issuance must be large enough to attract active trading, while their features (coupons, legal obligations, transaction costs, custody fees, etc.) ought to maintain consistency across maturities. Equally crucial would be the legal and regulatory framework, which must enjoy the trust and confidence of lenders and borrowers, and hinge on transparency, timely information and solid governance.
The development of local currency debt markets is akin to any other public investment (e.g. in infrastructure, health, education, etc.), and has strategic significance. Once the debt markets in the GCC reach maturity, the peculiar arrangement described above — by which the wealth accumulated in the region has to be invested in traditional markets — will be reversed. In other words, international borrowers wishing to tap the enormous pool of liquidity will have to list their securities in the GCC, paying fees for the provision of financial intermediation. So there is a chance that in a few years we could be hearing the final notes of the requiem for the “hub and spoke” model.
During the credit crisis triggered by the Lehman Brothers bankruptcy, a paradoxical consequence arose for the United Arab Emirates: the loans portfolio of its banking system was somewhat larger than its stock of deposits. Definitely not a large gap, more or less in the order of 10 percent, well within the internationally accepted norm of prudential parameters. Yet, as a result of the global money market convulsions and the extreme risk aversion which prevailed in the last tense months of 2008, the UAE banks had severe problems in funding this gap on the international market, which translated into a credit crunch for domestic businesses and consumers.
Hence the paradox: the UAE (and the other Gulf Cooperation Council countries) have been net exporters of capital for decades; they supplied a critical lifeline to the international banking system by supporting the recapitalization of major financial institutions in the United States and the United Kingdom when they were torpedoed by the sub-prime mortgage fiasco. But when, at a critical juncture, the need arose for the UAE banks — which were essentially sound and had only minimal exposure to toxic assets — to borrow, international financers deserted them.
This episode highlights a peculiar arrangement: emerging economies with large capital export use the financial services of heavily indebted countries where they are charged hefty fees for channeling this capital to borrowers. But if these emerging economies need finance during a crisis, largely provoked by the incompetence of Western bankers and regulators, these same bankers and regulators decide who is deemed creditworthy. This oddity was even more striking in the case of trade finance, on which depend virtually all exports from emerging markets. In the aftermath of the Lehman bankruptcy, loans to exporters, despite carrying very low risk, were drastically curtailed — leading to one of the most spectacular drops in international trade ever recorded.
Time for a system overhaul
This asymmetry is not acceptable anymore and has opened wide cracks in the “hub and spoke” model of international finance. Essentially, the main finance centers preside over all major financial relations in the world. A deal between, say, a Brazilian company and an Indian investor (the spokes) is likely to be mostly handled in London or New York (the hubs). While this was justified when the US was a net capital exporter, and therefore played a key role in the allocation of their own funds to the rest of the world, today it represents a vestige of the past. Worse, as the crisis has demonstrated, it is a fundamental element of financial fragility and therefore a threat to the stability of the world economy.
The current “hub and spoke” system needs to be replaced by a network of financial centers, a web of interrelation that would make it more flexible, efficient and resilient. In other words, if an Indian investor wishes to invest in a Brazilian company he will be able to bypass New York and arrange the operation directly in Mumbai, or maybe in Dubai, or through accessing expertise and resources in more than one location.
It is conceivable that even in the “web” system not all nodes will be equal, some will be specialized in certain areas, others will enjoy economies of scale in human capital and knowledge. But essentially, while each financial center will play a useful function, none will be indispensable for the stability of the global system.
A trend is already discernible. Sizeable deals between emerging markets — which until recently would have been arranged through a major financial center — now take place through direct links. China, with its huge current account surplus and accumulated net foreign assets, is at the forefront of this new wave, but other areas — including the GCC — are increasingly active outside the traditional financial perimeter. The foreign direct investments among emerging markets, which in the jargon of policy makers are called South-South flows, are booming, thereby dislocating the traditional capital flows.
With Asia’s emerging economies enjoying a quick rebound from the crisis — unlike the mature economies — this process is bound to intensify, but the speed at which it will develop depends on many factors. One of the most important is the creation of a liquid and deep debt market in the peripheral nodes.
A new market is born
Deep and liquid fixed income security markets represent the leading source of funds for governments, public companies, agencies and financial institutions. Their functioning is key for the efficiency and stability of financial intermediation, while providing a boost to economic growth. While some emerging countries have made notable progress in this area, the Middle East and the GCC still lag behind. According to data from the International Monetary Fund, capital markets in the Middle East are an anomaly when compared with other areas because they are dominated by bank assets and equities, which together make up 94.4 percent of finance; the corresponding figure for the world as a whole is approximately 60 percent.
Specifically, in the GCC, bond financing is out of favor, because it is deemed superfluous in a region flush with capital and hydrocarbon wealth. The swings in hot money flows, the drop in the region’s equity markets and the prohibitive cost of long-term borrowing have exposed the danger of relying on external capital markets. With a precarious financial lifeline in the face of the continued global liquidity crunch, GCC countries are now eagerly tapping the abundant domestic wealth and foreign capital looking for relatively safe investment.
This noteworthy trend was initiated this year with large sovereigns issuance (Qatar, for example, broke the record for the largest debt by an emerging market with a $7 billion issuance), to match governments’ commitment to maintain the infrastructure expenditure at pre-crisis levels. Now an embryo of a market has been created in the region with the appearance of a yield curve on which to price new securities and manage risk. But more is required to get on par with other emerging markets in terms of liquidity, depth, investors’ involvement, governance, debt management, etc. In particular, governments should take a leading role by committing to a plan of bond issuance across the maturities spectrum, conducted periodically over a number of years with appropriate pre-announcement of auction dates, size of the issue, characteristics of the securities, primary dealers and secondary market listings. Issuance must be large enough to attract active trading, while their features (coupons, legal obligations, transaction costs, custody fees, etc.) ought to maintain consistency across maturities. Equally crucial would be the legal and regulatory framework, which must enjoy the trust and confidence of lenders and borrowers, and hinge on transparency, timely information and solid governance.
The development of local currency debt markets is akin to any other public investment (e.g. in infrastructure, health, education, etc.), and has strategic significance. Once the debt markets in the GCC reach maturity, the peculiar arrangement described above — by which the wealth accumulated in the region has to be invested in traditional markets — will be reversed. In other words, international borrowers wishing to tap the enormous pool of liquidity will have to list their securities in the GCC, paying fees for the provision of financial intermediation. So there is a chance that in a few years we could be hearing the final notes of the requiem for the “hub and spoke” model.
30 dic 2010
Forced Labor
A new provision by the UAE Minister of Labor stipulates that from January 1 2011 a new employment permit will be granted immediately after a work contract expires eliminating (if the contract ends amicably) the six-month period mandated so far to get a new contract in the country. It is a measure that makes the labor market more efficient and alleviates the many constraints and imposition on employees in the UAE. In any case it is simple common sense.
Not so for the employers. Their representatives gathered at the Ministry of Labour to protest against this reform that merely removes anachronistic provisions that have few analogies in market economies. This is an example of the arguments brought about by the protesters, taken from the local press: "After this news came out, our employees started threatening that they can leave as soon as their contracts are finished and not worry about the six-month ban," said Naima, an engagement administrator from an audit company in Abu Dhabi who did not want to give her last name. "We used to have control over them, and we knew it wasn't easy for them to go, now we will lose this control."
That is right! Some employers demand control over their employees. It is intolerable that they might decide to leave! Who do they think they are?
Others were upset that dropping a year on the duration of labor contracts has the practical consequence that companies have actually to pay end-of-service payments. According to Mohamed, a manager at an airline, who joined the protesters but preferred to remain anonymous when interviewed by a journalist: "This is really bad news; this means we will have to pay our employees their end of service payments at the end of their contracts after two years. We didn't have to pay much before because they always left before the three years. This means we will lose a lot."
These remarks shed some light on business that have made a habit (and a lucrative one) of making life tough for their employees in various guises so to force them to resign and deprive them of their end of service compensation. Unfortunately it will take more than a palliative to enforce contractual obligation in a fair way but the changes from January 1st are a small step in the right direction.
Not so for the employers. Their representatives gathered at the Ministry of Labour to protest against this reform that merely removes anachronistic provisions that have few analogies in market economies. This is an example of the arguments brought about by the protesters, taken from the local press: "After this news came out, our employees started threatening that they can leave as soon as their contracts are finished and not worry about the six-month ban," said Naima, an engagement administrator from an audit company in Abu Dhabi who did not want to give her last name. "We used to have control over them, and we knew it wasn't easy for them to go, now we will lose this control."
That is right! Some employers demand control over their employees. It is intolerable that they might decide to leave! Who do they think they are?
Others were upset that dropping a year on the duration of labor contracts has the practical consequence that companies have actually to pay end-of-service payments. According to Mohamed, a manager at an airline, who joined the protesters but preferred to remain anonymous when interviewed by a journalist: "This is really bad news; this means we will have to pay our employees their end of service payments at the end of their contracts after two years. We didn't have to pay much before because they always left before the three years. This means we will lose a lot."
These remarks shed some light on business that have made a habit (and a lucrative one) of making life tough for their employees in various guises so to force them to resign and deprive them of their end of service compensation. Unfortunately it will take more than a palliative to enforce contractual obligation in a fair way but the changes from January 1st are a small step in the right direction.
27 dic 2010
Kafka in the Gulf
It looked simple enough. My bank required a copy of my passport, certified by a Notary Public or by a government official. I know that there is a Notary Publich in Barsha near the Courts Building. I passed by several times, so I felt relieved that the task would not be a jumble of procedures and trips to various offices. Best of all the Notary Public, I learn, closes at 8:00 pm. So after work I will have time to drive there. But when I arrive at 7:30 the door is already locked. The Pakistani attendant insists that I come the following day, because it is too late. I point at the sign with the closing time but he shrugs. There are too many people inside. The next day I go early enough. I explain at the information desk that I need a certified copy of the first page of my passport. The blank expression on his face sets off an alarm bell in my mind. He has no idea.
After I explain three times the matter he suggests that I speak to a supervisor. I go to an office where a lady is kind enough to listen, but confirms that the Notary Public does not attest the copy of identity documents. It can attest the copy of a contract but not a passport. I am naive enough to ask what is the difference. There is no difference. That's the way it is. I can try at the Ministry of Justice somewhere between Dubai and Sharjah. In which department or office it not for anybody to know. I resolve to ask a friend who is a lawyer in Dubai. The response is hardly reassuring. Every time she goes to an office the rules have changed. One day you need the traslation in Arabic of a document the next you do not. One day the contract must be verified by a Consulate a week later it must be verified by a Court. One day an English translation is deemed acceptable, then once you go back with the document translated another official decides that an Arabic translation is a must. And so on. So everytime she needs an interaction withe the authorities she prays that the harassment will not go on indefinitely. She has to bear the clients' rage, their suspicion that she is an incompetent or worse, their frustration with the waste of time (for whoich they refuse to pay) and the whole story definitely does not contribute to make the business and legal environment attractive for anybody with a grain of mental stability.
23 dic 2010
Common Currency
It came out of the blue. For months the monetary union in the Gulf had been forgotten. It had disappeared from the media and those few who still remembered its existence were given the glances usyally reserved for lunatics.
Then a few day ago the Secretary General of the GCC, Al Attiya stated that the common currency "is around the corner".
This morning the Arabic press is reporting that at its fourth meeting, the GCC Monetary Council yesterday has approved an institutional framework for the Gulf Central Bank. Almost nobody was expecting such an accelleration in the process and details have not been disclosed, but this is a major breakthorugh. Also the announcement that the Monetary Council will start to recruit staff ia another signal that the project is gaining momentum.
Then a few day ago the Secretary General of the GCC, Al Attiya stated that the common currency "is around the corner".
This morning the Arabic press is reporting that at its fourth meeting, the GCC Monetary Council yesterday has approved an institutional framework for the Gulf Central Bank. Almost nobody was expecting such an accelleration in the process and details have not been disclosed, but this is a major breakthorugh. Also the announcement that the Monetary Council will start to recruit staff ia another signal that the project is gaining momentum.
15 feb 2010
Schizo Roads
They did it again! Since I moved in my current apartment the roads to my place have changed at least a dozen times. Some were cancelled, others were temporarily closed, others were blocked to allow construction, new were created, some were enlarged, some were connected, others disconnected. Every time without notice, often without a justification, in some cases without a logic.
Now they have closed off a roundabout. Drivers are forced into a right turn. If you need to go straight or left that's tough luck. You can't. Nor you can make a turn into the neighborhood anymore. There is only one way of access and it can be taken only from one direction. Which means that you have to go down a couple of kilometrs and pass two traffic lights before you can make a U-turn.
It is true that Dubai is a work in progress, but it is hard to dispel the notion that bad planning predominates. And that this habit is not limited to roads. Because when a work is in progress, it is of paramount importance to understand where the plan is leading. Otherwise one is bound to get lost on a raod to nowhere.
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