ISSUE ONE SUMMER 2007/2008 · 11/23/2007 · A copy of the PDS can be obtained by contacting...

ISSUE ONE | SUMMER 2007/2008

E x c l u s i v e i n s i g h t s i n t o g l o b a l e m e r g i n g m a r k e t s

PortfolioConstruction.com.au/BRIC+

ALSO IN THIS ISSUE

BEYOND BRICIMPLEMENTING

BRIC INTO PORTFOLIOS

BRIC+ IN BRIEFS

INSIDE THIS ISSUE

NOVEMBER 2007 BRIC+ DIGEST | 03

06

In the four years since Goldman Sachs first coined the term ‘BRIC’, the concept has taken the investment world by storm. The immense impact that the BRIC countries are expected to have on the global economy this century has sparked a worldwide debate on the investment and trade opportunities, and challenges of each. In this first BRIC+ Digest, we summarise the research that resulted in the BRIC concept, the key features of each market, and the challenges and opportunites that lie ahead.

COVER CHARTING THE BRIC GROWTH STORY

12

BEYOND BRIC

IMPLEMENTING BRIC

Non-BRIC emerging markets are faring better than their BRIC counterparts – on certain fronts. That the world needs to look beyond BRIC is corroborated by various studies showing that other emerging economies are faring better than BRIC in some areas....

The BRIC economies are potentially rich sources of investment returns. But research houses have traditionally shied away from providing asset allocation methodologies incorporating regional tilts. How then is it best to incorporate BRIC into investors’ portfolios?

FEATURES

24 CHINA

REGULARS

26 INDIA 28 RUSSIA 30 BRAZIL

04 PUBLISHER’S PERSPECTIVE

06 STUDY TOUR EXPERIENCES

34 LAST WORD

16

32 MEXICO+

CONTENTS

PUBLISHER’S PERSPECTIVE

TO MY MIND one of the greatest influences on portfolio construction over the coming years will be the emergence of the BRIC markets – Brazil, Russia, India and China. That’s why Think Global Consulting and PortfolioConstruction Forum established the BRIC+ Program (see page 15 for full details).

Just a few years ago, no one had heard the term BRIC, let alone appreciated that Brazil, Russia, India and China would be key influences on the world economy and investment markets this century. That changed dramatically in 2003 thanks to the landmark Goldman Sachs paper ‘Dreaming with BRICs: the path to 2050’ The paper maps out GDP growth, income per capita, and currency movements in the BRIC economies through to 2050. The results are startling. “By 2050, the list of the world’s ten largest economies may look quite different... If things go right, in less than 40 years, the BRIC economies together could be larger than the G6 in US dollar terms... India’s market will nearly equal that of the US, while China’s will be vastly bigger. Brazil and Russia will each be larger markets than Japan, UK, Germany, France or Italy. High growth may lead to higher returns and increased demand for capital. The weight of the BRICs in investment portfolios could rise sharply.”

While 2050 still seems forever away, the authors predict the changes will be most dramatic in the first 30 years – in our life times and careers. “As early as 2009, the annual increase in US dollar spending from the BRICs could be greater than that from the G6 and more than twice as much in dollar terms as it is now.”

In other words, the investment compass needle is swinging. Just as England grew to dominance in the 1800s and the US in the 1900s, the 2000s will see the BRIC economies emerge and dominant. Quite simply, our investment frame of reference – investment magnetic north, if you like – must move to to include the BRICs.

Plus there are a multitude of other emerging markets coming up fast behind BRIC and hence the “+” in BRIC+ Program. While the BRICs are the most significant of the global emerging markets, and China and India are the most well know to most of us living in Australia, we’ll also witness a host of other exciting investment markets emerge over the coming few decades, as explained in our “Beyond BRIC” article (page 8).

The international component of most investor portfolios remains firmly grounded in the traditional US/UK/Europe regions with at best a 5% to 10% allocation to Asia generally (rarely China or India specifically).

Please don’t mistake me – I AM NOT advocating that we all rush out and load up investor portfolios with BRIC allocations. For most, this would break the first rule of investment: if you don’t understand it, don’t invest in it.

However, I am a passionate advocate that those who are involved in building investor portfolios move down the path of becoming as familiar with the BRIC+ markets as they are the US/UK/Europe ones, so that any decision as to whether or not to to include BRIC+ investments in a portfolio – and if so, how and for whom – is well educated and researched (not a blind leap of faith!).

In this vein, we’re pleased to introduce the BRIC+ Digest. Published three times a year, it combines thought-leading, analytical discussion about the BRIC+ economies, investment markets, business environments, societies, politics and histories. Our aim is to materially assist you down the path of increasing your understanding of the BRIC+ markets, and their role in portfolio construction. If you enjoy the BRIC+ Digest, we invite you to consider our Masterclass and Study Tours, which complete the Program.

Finally, we’re proud to say we practice what we preach. The BRIC+ Research Unit, a division of Evalueserve, which is a global firm with 2,000 analysts based in India, China, Chile and Eastern Europe!

GRAHAM RICH Publisher PortfolioConstruction Forum (Half of the BRIC+ team)

4 | BRIC+ DIGEST NOVEMBER 2007

BRIC+ Digest is published three times a year by Brillient Investment Publishing Pty Ltd and is part of the BRIC+ Program. Subscription is A$75.00+GST per annum or complimentary to selected financial services industry participants as determined by the Publisher.Address PO Box R923, Royal Exchange, NSW, 1225Email [email protected]

Director & Publisher Graham Rich + 61 2 9247 0496Director & Advertising David Thomas +61 2 9223 7867Director & Managing Editor Deirdre Keown +61 2 9247 0497BRIC+ Research Team EvalueserveOpinions expressed in the BRIC+ Digest are those of the authors. ©2007 BRIC+ Program. No material may be reproduced in part or whole without written consent from the Publisher.

COMMENT

Current Lonsec rating as at May 2007. Any Lonsec Limited (“Lonsec”) (ABN 56 061 751 102) rating presented in this document is limited to “General Advice” and based solely on consideration of the investment merits of the financial product(s)alone. It is not a recommendation to purchase, sell or hold any securities, and you should seek independent financial advice before investing in this product. The ratings contained in this document are reasonably held at the time of completion but are subject to change without notice and Lonsec assumes no obligation to update this document following publication.

Issued by Russell Investment Management Ltd ABN 53 068 338 974, AFS Licence 247185 (“RIM”). This document provides general information only and has not been prepared having regard to your objectives, financial situation or needs. Before making an investment decision, you need to consider whether this information is appropriate to your objectives, financial situation and needs. Any potential investor should consider the latest Product Disclosure Statement (“PDS ”) in deciding whether to acquire, or to continue to hold, an investment in any Russell product. The PDS can be obtained by visiting www.russell.com.au or by phoning (02) 9229 5111. RIM is part of the Russell Investment Group (“Russell”). Russell or its associates, officers or employees may have interests in the financial products referred to in this information by acting in various roles including broker or adviser, and may receive fees, brokerage or commissions for acting in these capacities. In addition, Russell or its associates, officers or employees may buy or sell the financial products as principal or agent.

A WORLD OF OPPORTUNITIESRussell’s Multi-Manager funds – the only Multi-Manager funds to receive the Lonsec Highly Recommended ratings of 2005, 2006 and 2007 – provide your clients diversification benefits & investment access across countries, currencies and companies.

For more information, contact Russell today 1800 616 022 or visit www.russell.com.au

STUDY TOUR

BRIC+ STUDY TOURS

THE MOST EFFECTIVE & REWARDING WAY TO LEARN

BRIC+ Study Tour India – April 2007

India delegate, Laura Menschik

India guru, Dr Anand SethiChina guru, Professor Xisu Wang

India delegates,Paul Hocking, Phil Ealy and Keith Jones

BRIC+ Study Tour China – September 2006

The Economist Research Unit, Shanghai

Site visit to Wuxi Pharmatech, Shanghai

Site visit to 3 Call Centre, Mumbai

Site visit to Shanghai Stock Exchange

Experiences

2008 Study Tours | India 27 Jan – 03 Feb | China 24 Feb – 02 Mar | Russia 21 Sep – 29 Sep | www.PortfolioConstruction.com.au/BRIC+

STUDY TOURExperiences

1. IMF World Economic Outlook October 2007. Fidelity Investments Australia Limited (“Fidelity Australia”) ABN 34 006 773 575, AFSL No. 237865, Level 8, 167 Macquarie Street, Sydney, NSW 2000. Fidelity means Fidelity International Limited (“FIL”), a company established in Bermuda, and its subsidiary companies and affi liates. Fidelity Australia is a subsidiary company of FIL. The Fidelity group of companies also comprises FIL’s US affi liate, FMR Corp., and its subsidiary companies and affi liates. This document has been prepared without taking into account your objectives, fi nancial situation or needs. You should consider whether the information contained in this document is appropriate to your objectives, fi nancial situation and needs. You should consider the Product Disclosure Statement (PDS) relating to this fi nancial product before making any decision about whether to acquire or hold the product. A copy of the PDS can be obtained by contacting Fidelity’s Investor Services on 1800 119 270 or downloading from our website at www.fi delity.com.au The issuer of the managed investment scheme(s) referred to in this document is Perpetual Trust Services Limited (ABN 48 000 142 049). Fidelity Australia provides investment management and marketing and sales services in relation to the managed investment scheme(s). Details about Fidelity Australia’s provision of fi nancial services to retail clients are set out in our Financial Services Guide, a copy of which can be downloaded from our website at www.fi delity.com.au None of Fidelity Australia or any other member of the Fidelity group of companies makes any guarantee as to investment performance, distributions or the return of capital. Unless otherwise stated, all fi gures are in Australian dollars. This document may not be reproduced or transmitted without the prior written permission of Fidelity Australia. Copyright 2007. FID0455

Over the past 25 years, India’s economy has contracted

just once many times

OVER10 YEARS

EXPERIENCEIN INDIA

You might be surprised to learn that over the past 25

years, India’s economy has only once headed south and

that over the last decade the economy grew at an annual

average rate of 6.5%, one of the fastest in the world.1

Facts like these explain why many regard this ‘new’ India

as an excellent long-term investment. However, there are

various economic and political risks.

To fi nd out more about investing in India and about

Fidelity’s India Fund, call us on 1800 119 270 or visit

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THE CRITERIA adopted by the authors of the 2003 Goldman Sachs report ‘Dreaming with BRICs: The Path to 2050’ focused on two main factors – economy and demographics – “in an attempt to highlight those economies that could provide a challenge to the major developed economies in terms of their weight.” In the process, important economies were ommited from the final four because they may never attain the scale to challenge the hegemony of the developed nations. However, these economies offer possible avenues for future growth. In a 2005 update, Goldman Sachs confirmed, “In our initial report, we did exclude several other large developing countries that have the potential to be much bigger economies in the coming decades.”

That the world needs to look beyond BRIC is corroborated by various studies showing that other emerging economies are faring better than BRIC in some areas. [That’s why we call them BRIC+ - Ed]

Manufacturing and services According to a July 2007 PricewaterhouseCoopers (PwC) report ‘Emerging Markets: Balancing Risks and Rewards’, there are economies beyond BRIC that have significant potential for the manufacturing and services sectors. The PricewaterhouseCoopers EM20 Index ranks 20 emerging markets according to their attractiveness for foreign investment. The various factors taken into account include GDP per capita, economic growth forecasts, corporate taxes, transportation costs, tariffs, and the risk premium that the country commands in the global bond market.

PwC notes that manufacturing companies look for low production costs investing overseas and that Vietnam leads the emerging economies in terms of attractiveness in the manufacturing segment, followed by China, Poland, Chile, and Malaysia. Vietnam is very cost competitive and offers the potential for high manufacturing returns, although PwC ranks it fourth in terms of associated risks.

The report also suggests that a country’s services sector can be one key factor contributing to its overall economic development. “For businesses in the services sector, markets with relatively high per capita incomes are likely to be most attractive as services

are typically delivered locally.” Hence a country that serves as a good opportunity for investment in the services sector may fare poorly when it comes to manufacturing. The UAE, Saudi Arabia, South Korea, the Czech Republic, and Hungary lead the list the PWC EM20 Index of the most attractive emerging markets for the services sector.

Outsourcing Although India remains the world’s preferred outsourcing destination, globalisation has facilitated the entry of other economies including Mexico, China, Egypt, Poland, and Singapore, into what was once India’s sole domain. Central and Eastern European countries are also emerging as other outsourcing destinations. The integration of a number of these countries with the EU will facilitate the further flow of business to these emerging economies.

Investment potential Each BRIC country has areas of concern from a foreign direct investment perspective. Brazil has a delicate political situation, the Russian government interferes in business operations, the Chinese market is not sufficiently open, and India has a fluctuating equity market. At the same time, other emerging markets such as Egypt, Mexico, Poland, South Africa, South Korea, and Turkey also offer investment opportunities. These economies may not have billion-plus-populations, but their growth has been impressive over the past few years and their sharemarkets have, in some cases, delivered better returns than some of the BRIC sharemarkets. These countries also have strong growth profiles, fast-track reform agendas, and investor-friendly environments.

Ease of doing business The World Bank undertakes an annual study in which it ranks countries according to the ease of carrying out business in them. A ranking is given to each country on the basis of on 10 parameters. In the latest study, Singapore ranked first, followed by New Zealand and the US in second and third places respectively. Emerging economies such as Mexico, South Africa, Saudi Arabia, and Korea in fact ranked higher than the BRIC economies – the rankings for Brazil, Russia, India, and China were 122, 106, 120, and 83, respectively.


NON-BRIC EMERGING MARKETS ARE FARING BETTER THAN THEIR BRIC COUNTERPARTS – ON CERTAIN FRONTS BRIC+ RESEARCH UNIT

FEATURE

BEYOND

BRIC

Beyond BRIC

Next11 Next11 or N11 is a list of countries proposed by Goldman Sachs in its 2005 update. On this list are Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, South Korea, Turkey, and Vietnam. Macroeconomic stability, political maturity, openness of trade and investment policies, and quality of education were taken into consideration in drawing up the list. Figure 1 shows Goldman Sach’s GDP projections for each of the N-11 for the year 2050. Interestingly, the projected combined N-11 GDP in 2050 (USD35,542 billion) remains considerably lower than the G7 (USD 64,211 billion) and BRIC (USD89,995 biliion).

VISTA VISTA stands for Vietnam, Indonesia, South Africa, Turkey, and Argentina. On the basis of the PwC EM20 Index, Vietnam takes the top spot as the most promising emerging market for manufacturing companies. It’s been making long strides in economic development since its accession to the WTO in 2007.

South Africa was recognised as a prominent emerging economy by Goldman Sachs in its earlier 2003 report. “Our longer-term projections show South Africa growing at an average rate of around 3.5% per year over the next 50 years, comparable to our predictions for Russia and Brazil. With declining population growth rates, per capita incomes under these projections would rise signifi cantly more rapidly.” However, the impact that AIDS is expected to have on the labor force in South Africa is likely to be a major hindrance to its growth.

NIE NIE, or Newly Industrialized Economy, is a socio-economic classifi cation devised by economists and political scientists. The current NIE list includes South Africa, Mexico, Brazil, China, India, Malaysia, the Philippines, Thailand, Indonesia, and Turkey. Each has experienced rapid economic growth over the past few years. However, they have a long way to go before they catch up the developed nations.

CHIME CHIME stands for China, India, and the Middle East, refers to the bilateral and regional cooperation between the Middle East and Asia. The Gulf Cooperation Council (GCC) countries, comprising Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and UAE, have economic growth rates comparable to those of the BRIC countries and each has a lot of wealth at its disposal.

PwC’s recent July 2007 EM20 Index report ranks UAE top of its list of services sector investment destinations. This is a dramatic contrast with its last place position in the manufacturing index. “UAE’s extremely high GDP per capita means it enjoys a signifi cant lead over its nearest EM20 Services rival, Saudi Arabia,” the report notes.

Comparing BRIC and other emerging economiesFigure 2 presents the 2006 GDP of the BRIC and other emerging countries. It highlights that the Mexican and South Korean economies are now comparable with Brazil in size. India and China are in a distinctly advantageous position as a result of their large working populations, a positive indicator for growth.

Figure 3 depicts GDP growth rates in 2006 for the BRIC and other emerging countries. Mexico, Vietnam, and South Korea each had a better GDP growth rate than Brazil, while Vietnam achieved a better growth rate than both Brazil and Russia. Furthermore, 2006 per capita incomes of Mexico, South Africa, and South Korea are signifi cantly higher than the corresponding fi gures for each of the BRIC countries.

There is no denying the BRIC countries have shown a signifi cant pace of development, notably faster than predicted by Goldman Sachs in its 2003 report. However, their rise does not negate the importance of other emerging economies which are also taking signifi cant leaps in terms of economic development and represent potential key investment destinations beyond BRIC.


Figure 1: Projected GDP of N11 in 2050

Proj

ecte

d GD

P (U

SD b

illio

n)

8,000

7,000

6,000

5,000

4,000

3,000

2,000

1,000

0

Bang

lade

sh

Egyp

t

Indo

nesi

a

Iran

Kore

a

Mex

ico

Nig

eria

Pack

ista

n

Phili

ppin

es

Turk

ey

Viet

nam

Source: Goldman Sachs Report 2007

Figure 2: 2006 GDP of emerging economies

GDP

(USD

trill

ion)

12.00

10.00

8.00

6.00

4.00

2.00

0.00

Braz

il

Russ

ia

Indi

a

Chin

a

Mex

ico

Viet

nam

Sth

Kore

a

Sth

Afric

aSource: CIA Factbook

Figure 3: 2006 GDP growth rates

GDP

Grow

th R

ate

2006

(%)

12.00

10.00

8.00

6.00

4.00

2.00

0.00

Braz

il

Russ

ia

Indi

a

Chin

a

Mex

ico

Viet

nam

Sth

Kore

a

Sth

Afric

a

Source: CIA Factbook

3.7

6.7

9.4

11.1

4.8

8.2

5.0 5.0

FEATURE


IMPLEMENTING

BRICTHE BRIC ECONOMIES ARE POTENTIALLY RICH SOURCES OF INVESTMENT RETURNS. HOW THEN IS IT BEST TO INCORPORATE THEM INTO INVESTOR’S PORTFOLIOS? DEIRDRE KEOWN

FEATURE

THERE ARE ccurrently three main schools of thought amongst those building investor’s portfolios, as to how best to incorporate an exposure to the BRIC economies and other emerging markets into an investor’s portfolio.

In 2006, PortfolioConstruction Forum conducted a survey of delegates’ views on allocating to BRIC and other emerging markets as part of the annual PortfolioConstruction Conference. Given the nature of the conference, the vast majority of Conference delegates each year are members of investment committees within their dealer group or research firm, or are crafting portfolios for investors on a day-to-day basis. We asked them how they were currently going about the task of allocating to BRIC.

The good news was that only 3% of delegates believed that the BRIC issue was “irrelevant” to how they built portfolios. Some 44% believed it was “central and of such significance” that they needed to understand the full impact, followed by 40% who felt BRIC decisions were “very important” however could be delegated to their fund managers. The remaining 13% said BRIC was “interesting but not central to what I do.”

Of the 97% who agreed that BRIC was not an irrelevant issue in building investor portfolios, around 40% said they look to add BRIC via an emerging markets allocation – that is, select an emerging markets fund or funds and leave the BRIC decision to the manager(s) of the fund(s).

They were not alone. Many fund managers argue that a BRIC-specific mandate acts as an obstacle to generating risk-adjusted returns and that investors are better served by adopting a global emerging market investment mandate rather than constraining a fund manager’s opportunity set.

Another 40% said they believe it’s best to take that philosophy one step further and leave any decisions about emerging markets allocations, including BRIC allocations, up to their global equity fund manager(s).

Only 7% said they were comfortable adding a specific BRIC allocation to an investor’s portfolio.

The right tools for the job

However, on further analysis, it appears that many of those leaving the BRIC decision to either their emerging markets manager(s) or global equity manager(s) may be doing so as a default in the absence of tools that would allow them to do otherwise.

When we asked delegates how they currently build their international equity portfolios, about one third were already using regional funds – however, 44% were not, but said they would like to be able to. In other words, 75% of delegates said they would like to or were already implementing regional allocations in investor’s portfolios.

A robust methodology It’s no secret that many of those building investor’s portfolios are dissatisfied by the fact that their research houses have shied away from providing methodologies and asset allocation models encorporating regional tilts. Specialist asset allocation research house, farrelly’s, did exactly that for the PortfolioConstruction Conference delegates at our request.

Principal Tim Farrelly began by explaining that the strategy is designed to help advisers build portfolios for private investors, and in doing so, three principles have been adopted:

• Turnover and transaction costs should be kept low (and were assumed to be 0.7% for buying and 0.7% for selling);

• The process should not rely on signals and market timing; and,

• The process must be implementable by investment advisers in retail client’s portfolios.

He then divided the world into five regions – the US, Japan, UK, Europe (ex-UK) and the Pacific (ex-Japan) and used the relevant MSCI Index (USD) to represent the performance of each region over the period December 1969 to December 2005, the longest period for which MSCI data was available.

Farrelly was at pains to say that “there is nothing magical about the choice of countries and regions… Advisers can choose their strategies based on regions that make sense to them and have readily accessible avenues for investment” – including, he noted, emerging markets and specific BRIC countries.

In explaining why he’d chosen the regions he had, he noted that the MSCI World index has been a long-standing benchmark for international equities and is representative of the performance benchmarks that managers generally try to exceed. In addition, all the regions are components of the MSCI World index. That is, no outside assets (that is, emerging markets, BRIC) were included and hence, if we can beat this Index without using outside markets, it is a fair test of the strategy.

However, he again emphasised that this did not mean that in practice the strategy needed to be confined to the five regions he’d chosen.

And, while Farrelly based his analysis on indices, “the use of active managers to implement at a country or regional level should enhance returns – if, of course, the managers can produce index outperformance,” he noted.

And the four strategies?

• Equal weights – the sample portfolio was divided into five equally-weighted regions;


FEATURE

• GDP weights – the portfolio was divided up according to the relative GDP weights of the countries that made up the region;

• Earnings weighted – the portfolio was divided up according to the value of the earnings generated by each region (as measured by market capitalisation divided by the PE ratio); and,

• Smooth earnings weight – the portfolio was divided up according to the smoothed earnings generated by each region.

A three-yearly rebalance period was used for each strategy initially, however the impact of different rebalance periods (1, 2, 3, 5 and 7 years) was assessed subsequently and it was found that the best results were achieved by rebalancing every two years, although a three-year rebalance period producing almost as good results.

“From there on, return enhancement starts to fall away, but useful gains are still achieved,” Farrelly noted. “These results do not conclusively point to two years being the optimal rebalancing period, however they do clearly suggest that advisers wanting to adopt two- or three-year rebalancing cycles will not be severely disadvantaged compared to those who rebalance each year, and in fact may even do better.

And the results? Each of the strategies outperformed MSCI World index over the 35-year test period, as shown in the table below. Most also outperformed the MSCI World index in most of the sub-periods reviewed. The first two strategies produced much higher value-adds. In looking for the drivers of this result, one of the keys is bet size, defined as the average departure from the index over time. This was calculated by each

year summing the absolute difference between the weights in a particular strategy and the MSCI market capitalised weights and then averaging that difference over the full 35-year review period. It is analogous to tracking error, Farrelly explained. For a three-year rebalancing approach, the following was observed:

Equal GDP Earnings Smoothed

Avg bet (%) 35.3 19.7 10.5 9.1Avg ER (%pa) 1.98 1.45 0.95 0.75 Avg TC (%pa) -0.05 -0.04 -0.05 -0.04Avg NER (%pa) 1.93 1.42 0.90 0.72

where ER is the average excess return over the index, TC is the average transaction cost, and NER is the average excess return post costs.

From this, Farrelly explained, we see that, while all four strategies had different bet sizes and results, the level of turnover and therefore transaction costs were similar in each strategy, at 0.05% pa (that is, annual turnover of around 4% of the portfolio).

However, the icing on the cake is that the simplest strategy – the equal-weights approach – had the most consistent outperformance, beating the MSCI World Index by 1.93% per annum on average after transaction costs.

Farrelly adds a caution. “When considering if and when to add new regions, great care is needed to ensure that if the new region has come to the investor’s attention after a period of hot returns, it is not added prior to a period of likely underperformance.”

“Also, take care that the weighting process is not such that new regions automatically get a substantial weight, particularly if they have been strong recent performers.”

Finally, he warned, “this strategy is unlikely to work if it is subject to regular change.”


VALUE ADD OF THE FOUR REGIONAL ALLOCATION STRATEGIES EXCESS RETURNS (%PA) OF THE STRATEGY VS THE MSCI WORLD INDEX RETURNPERIOD EQUAL GDP EARNINGS SMOOTHED WEIGHTS WEIGHTS WEIGHTS EARNINGS

35 years 1.9% 1.4% 0.9% 0.7%

30 years 2.3% 1.6% 0.9% 0.7%

20 years 1.4% 1.0% 0.7% 0.6%

10 years 1.4% 1.4% 1.3% 0.9%

10 years 0.8% 1.5% 1.7% 0.8%

10 years 0.0% 2.2% 2.1% 1.7%

10 years 1.9% 1.4% 0.8% 1.0%

10 years 0.1% 0.9% -0.5% -0.3%

10 years 1.3% 0.2% -0.3% -0.2%

Source: farrelly’s

FEATURE

For more information, visit: www. PortfolioConstruction.com.au/BRIC+ or phone +61 2 9247 0496

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- PRESENTED BY-

- IN ASSOCIATION WITH -

IN THE FOUR years since Goldman Sachs first coined the term ‘BRIC’, the concept has taken the investment world by storm. The immense impact that the BRIC countries are expected to have on the global economy this century has sparked a worldwide debate on the investment and trade opportunities, and challenges of each.

In this first BRIC+ Digest, we summarise the research that resulted in the BRIC concept, the key features of each market, and the challenges and opportunites that lie ahead.

Future cover stories will focus in more depth on key opportunities and challenges within the BRIC markets and the implications for portfolio construction.

A star is born

The term BRIC – Brazil, Russia, India and China – first appeared just four years ago in ‘Dreaming with BRICs: The Path to 2050’, a research paper penned by Goldman Sachs in the wake of the September 11 attacks. It focused on two main factors – economic

growth and demographics – “in an attempt to highlight those economies that could provide a challenge to the major developed economies” and found that Brazil, Russia, India and China would, collectively and individually, emerge as the major economic powers of this century, eclipsing most of today’s dominant economic powers.

Of course, Brazil, Russia, India and China had, for some time, been showing individual signs of economic resurgence, along with growing activeness in the world economy resulting from globalisation.

What the Goldman Sachs paper did was focus the world’s attention for the first time on the combined force that these economies could possess in the not-so-distant future. It predicted that by 2050 the four BRIC economies could collectively become larger (in US dollar terms) than the combined economies of the G6 nations. It estimated that in 2050, the US and Japan would be the only countries among the current G7 left in the list of the top six global economies by size. All going well, India’s market will be nearly equal that of the US, while China’s will be vastly bigger.

THE BRIC ECONOMIES HAVE WELL AND TRULY CAPTURED THE WORLD’S ATTENTION. THIS FIRST ISSUE OF THE DIGEST EXAMINES WHY.DEIRDRE KEOWN & GRAHAM RICH

CHARTING THE

GROWTH STORY BRIC


Brazil and Russia will each be larger markets than Japan, UK, Germany, France or Italy. In fact, Goldman Sachs’ 2003 estimates have to date proved conservative. Figure 1 compares Goldman Sachs’ forecast GDP figures from the 2003 report against the actual GDP results that have transpired over the last four years. In every year, each of the BRIC economies have exceeded the forecasts, with the difference increasing exponentially. The contribution of the BRIC countries to global output is now almost 50%, well on the way to Goldman Sachs’ estimated 78% by 2050.

GDP Figure 2 lists the GDP growth rates for the

BRIC countries over the first half of this century. The estimates decline over time – but keep in mind that as the BRIC economies become larger, grow is off an increasingly larger base and therefore higher rates are increasingly harder to achieve. For instance, the estimated annual growth rates for 2005 to 2010 for China and India of 7.6% and 6.2% respectively compare to 10% and 5.9% per annum in the period 1995 to 2005. Although growth is expected to decrease by 2050, high GDP growth rates over the next few decades are more than enough to sustain healthy economic development in these nations.

Hence, while the GDP of each BRIC country is currently much lower than those of the developed nations, these growth rates are higher than the developed nations. The result is shown in Figure 3. The cumulative GDP of the BRIC countries is expected to nearly equal that of the G7 countries during 2035 to 2045, and to surpass the G7 by 2045. By 2050, the cumulative GDP of the BRIC countries is expected to be around USD90 trillion as compared to the USD64 trillion GDP for the G7 countries.

However, Brazil, Russia, India and China have had their fair share of economic ups and downs and there are many challenges ahead.

Brazil bears the burden of having the highest debt


FIGURE 1: GDP COMPARISON - GOLDMAN SACHS ESTIMATES VS ACTUALS*

BRAZIL (USD BILLION) RUSSIA (USD BILLION) INDIA (USD BILLION) CHINA (USD BILLION)YEAR FORECAST ACTUAL FORECAST ACTUAL FORECAST ACTUAL FORECAST ACTUAL

2003 461.00 505.44 430.00 430.06 511.00 576.12 1353.00 1416.002004 435.00 599.73 476.00 582.73 554.00 661.05 1529.00 1649.002005 468.00 732.06 534.00 755.44 604.00 749.44 1724.00 1843.002006 502.00 784.50 594.00 863.55 659.00 814.07 1936.00 2040.00

* At current prices. Source: Econostats

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FIGURE 2: ESTIMATED REAL GDP GROWTHCOUNTRY 2005-2010 2025-2030 2045-2050

Brazil 4.0 %pa 3.8%pa 3.4%paRussia 4.5 %pa 3.0%pa 1.5%paChina 7.6 %pa 4.0%pa 2.8%paIndia 6.2 %pa 5.7%pa 4.9%pa

Source: Goldman Sachs Global Economics Paper No. 134 (2005)

REAL

GDP

(USD

trill

ion)

100

80

60

40

20

02005 2010E 2020E 2015E 2020E 2030E 2035E 2040E 2045E 2050E


FIGURE 3: REAL GPD – BRIC VS G7

BRICsG7

of all Latin American countries as a result of floating exchange rates, inflation targeting, and a tight fiscal policy, according to The Economist. Brazil’s economic position has improved because the demand and prices of its exports have risen, but primary surplus associated with higher taxes can lead to higher public debt. The INSS, Brazil’s social security administration, is pressuring the central government for increasing retirement expenditures while investment expenditures are declining as a fraction of its GDP.

Nontheless, the Russian economy has been growing at an average rate of 6.7% since 2002. This is attributable to high oil prices and a cheap ruble, according to Arvind Mahajan, Finance Professor at Texas A&M in the US. “Its foreign debt has declined from 90% of GDP to only 31% and foreign reserves have leaped from USD12 billion to USD180 billion within a decade”, he explains. “Russia has abundant natural resources, but still faces problems because the country lacks strong legal, financial and democratic institutions.”

Russia’s GDP growth is expected to undergo a slight decline in the long term and is vulnerable to oil prices. The Russian government is forecasts GDP growth to be approximately 6% for the period 2008 to 10 on the assumption oil prices fall somewhat but not below USD 50 per barrel.

India’s GDP growth rate is also expected to decline in the near future. The Centre for Monitoring Indian Economy has forecast GDP growth of 9.1% for the period 2007/08, but expects GDP to then slow to 7.9% for 2008/09 and fall further to 7.4% for 2009/10. A democratically elected government runs India, but its democracy has created obstacles of another kind. The current government has not been able to introduce reforms, such as privatisation of state-owned establishments primarily due to opposition from leftist allies. “Progress can’t be as swift because of democracy, Mahajan says. “Democracy can be bad news and good news – it’s bad because it makes everything move slower.” However, even with slower progress, India’s growth rate has exploded, averaging 6% growth per year over the last 25 years. If it can keep the pace up, India’s economy (in terms of purchasing power) will equal that of the US by 2050. And GDP growth rate could rise if appropriate financial reforms are introduced.

China’s GDP growth in 2007 is estimated to be 11.3% but it too is expected to slow, falling to to 10.1% in 2008 and 9.2% in 2009. Further into the future, China’s one child policy, while helping address overpopulation now, will result in an insufficient working-age population left to run China’s huge economy unless the government introduces imigration policies, negatively impacting GDP growth.

Cost of Living Index The Economist Intelligence Unit’s Worldwide Cost of Living Survey is a bi-annual

survey comparing the cost of a representative basket of goods and services in US dollar terms from over 130 cities worldwide to provide guidance for the calculation of executive allowances.

In the 2007 survey, Moscow topped the ranking as most expensive city in the world for expatriates, with a Cost of LIving index value of 123.9. Beijing was ranked 14th with an index value of 94.9, Sao Paulo was 34 with an index value of 85, and Mumbai ranked 68 with an index of 79.9.

Ratings The currency ratings given to each of the BRIC nations by Standard & Poor’s varies considerably.

Brazil’s currency rating was upgraded to BB+/Positive/B by S&P in May 2007. This gave an impetus to Brazil’s financial markets, as most investors were not expecting this change before 2009.

Russia’s currency rating improved to BBB+/Stable/A-2 as the country reaps the rewards of the global oil price boom. Also, Russia’s foreign reserves and balance sheet are improving.

S&P also lifted India’s currency rating from speculative BB+/B to the lowest investment grade BBB-/A-3.

China’s currency rating stands at A/Positive/A-1:As, driven by its strong economic growth and the continued commitment of the Chinese government towards reforms.

Demographics Collectively, BRIC will have a population 3.7 billion people by 2050 (Figure 4). India and China, currently the world’s two most populous countries, are expected to remain so for the next half century. India’s population is expected to grow at an average of nearly 1% through to 2050, surpassing that of China by 2030, to reach nearly 1.5 billion people.

According to the Goldman Sachs 2003 report, the BRIC middle class population (people earning more than USD3,000 per annum) will grow from 214.1 million in 2005 to 1,882.7 million in 2025. This compares to a minor increase in the US middle class population from 295.7 million to 349.7 million over the same period.

With 1.3 billion people, China is currently the most


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FIGURE 4: POPULATION GROWTH

COUNTRY POPULATION POPULATION POPULATION 2005 GROWTH 2050

Brazil 186 million 0.8% pa 266 millionRussia 142 million 0.2% pa 155 millionIndia 1,103 million 0.9% pa 1,651 millionMainland China 1,313 million 0.5% pa 1,643 millionUS 298 million 0.7% pa 408 million

Source: Global Economics Paper No. 134 (2005), Goldman Sachs

populous nation in the world. In an effort to control overpopulation, China introduced its one child policy and while this has helped lower population growth, it will have a devastating impact on China’s age dependency ratio in the middle of this century.

In contrast, India’s ratio will continue to fall through to the middle of this century. India has a very young population with 55% under the age of 24.

While China’s age dependency ratio is currently lower than that of India, this will reverse by around 2025 at which point, China will suffer a sharp rise. The age dependency ratio of the US and Europe will start deteriorating significantly from 2010.

Stock markets The Brazilian stock exchange is the São Paulo Stock Exchange (BOVESPA). The market capitalisation of BOVESPA rose by about 36% from 2006 to August 2007, to USD1.1 trillion.

The main stock exchanges in India are the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). The cumulative market capitalization of BSE and NSE was USD857.35 billion at April 2007. The emergence of India’s middle class as a major investor and a rapidly growing economy are the reasons behind the recent strong performance of the Indian stock market which rose by about 43% in financial year 2006.

The major stock exchanges in Russia are the Moscow Inter-Bank Currency Exchange (MICEX), the Russian Trading System (RTS) and the Saint-Petersburg Currency Exchange (SPCEX). Combined market capitalisation was about USD966.02 billion in 2006. The MICEX Index grew by about 67.50% and RTS Index by about 70.75% over the period 2005-06.

The major stock exchange in China is the Shanghai Stock Exchange (SSE), with a market capitalisation of about USD2.38 trillion in 2006. According to Salomon Smith Barney, the market capitalisation of the Chinese stock market will exceed that of Japan by 2015. At the same time, China faces significant hurdles, including fewer venture capitalists, limited entrepreneurs, and a nascent investor community. There are four types of shares available for traders in China, A-Shares, B-Shares, H-Shares and N-Shares. A-Shares are shares that are quoted in Renminbi for companies incorporated in mainland China. They are traded by mainlanders and select foreign institutional investors in A-Share markets. B-Shares are shares of companies quoted in foreign currencies for companies incorporated in mainland China and traded by mainlanders as well as foreigners. H-Shares are those of companies listed on the Hong Kong Stock Exchange but incorporated in mainland China. N-Shares are those of companies listed on New York Stock Exchange.

Individual investors in mainland China are not currently allowed to invest in H-shares, and China recently has stalled its proposal to allow them to. The Chinese government announced the plan on

20 August, prompting a sharp rise in both the HKSE Index and the Bank of New York China ADR Index. However, Premier Wen Jiabao has now stalled the proposal. “[We] should make scientific judgment and analysis on what impact the massive funds flooding into Hong Kong’s financial market would have,” he said. Individual cash deposits in China were worth USD2.2 trillion in 2007. Wen placed four conditions on the proposal proceeding, including passing a law to regulate outward flow of mainland funds, analysis of the impact on the HKSE, raising understanding among investors of the risks involved, and seeking opinion of financial regulators on the proposal.

Standard Life Investments estimates that by 2050, the stock market capitalisation of the BRIC nations will be equal to that of the leading global markets. It believes that China’s stock market could grow at the rate of nearly 10% annually until 2050, with Brazil’s growing at approximately 7% per year over that period. This, says Andrew Milligan, Head of Global Strategy, “implies an enormous shift in the balance of stock market power”.

Trade For the period 2000 to 2006, the trade output of the BRIC nations grew faster than the global average rate with the only exception being the growth in imports from Brazil, which were lesser that the global average. Each BRIC country grew exports from each by between 16% and 25%, while imports in Russia, India, and China grew by 23% or more, as compared to the global average growth of 11% for both exports and imports. China has emerged as one of the leading global trade partners and was ranked as the third largest global exporter in 2006, after the European Union and the US.

In 2006, the BRIC countries together contributed around 11.5% to the global merchandise trade, nearly twice the 2000 figure.The four BRIC countries export a diverse range merchandise. Brazil’s key exports include food and


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FIG 5: BRIC EXPORTS 2006

% of

wor

ld e

xpor

ts

10.0

8.0

6.0

4.0

2.0

0.0


8.1

1.1

2.5

1.0

Braz

il

Russ

ia

Indi

a

Chin

a

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machinery, Russia’s are oil and gas, India’s key export are software services and engineering goods, and China leading exports are consumer goods and office machinery.

While the US is one of the major trade partners of each BRIC nation at present, intra-BRIC trade is growing. In 2005 statistics, intra-BRIC exports were worth USD65.14 billion. Grant Thornton observes in its International Buisness Report 2007 that the interdependence of India and Brazil is higher compared to that of China and Russia. India and Brazil conducted 10.33% and 10.01% respectively of their total global exports within BRIC, while 3.54% and 6.67% of China and Russia’s exports respectively

were with other BRIC nations. Trade within the BRIC nations is favorable due to the complementary nature of export products. For example, Russia and Brazil have abundant resources of raw material and energy, both in keen demand in India and China.

Foreign Direct Investment The BRIC economies attracted nearly 10.5% of global FDI inflows in 2006. The main inflow was to China, with mainland China attracting an inflow of USD63 billion. Russia and Brazil received USD26.2 billion and USD18.78 billion respectively. India recorded an FDI inflow of USD17.7 billion in 2006/07.

FDI inflows to India are comparatively less than the other BRIC nations due to government restrictions on investment. However, that is changing and restrictions are being lessened. India now allows single brand FDI in the retail sector and investment in the real estate sector.

FDI inflow in BRIC has been mainly in sectors such as mining, manufacturing, and services, with large amounts of FDI flowing into automobiles, metal and steel, power, finance, real estate and telecommunications sectors.

BRIC contributes a significant amount to outward FDI as well. In 2005, Brazil, Russia, India and China made an outward investment of USD2.52 billion, USD13.13 billion, USD1.36 billion, and USD11.31 billion respectively. Accodring to UNCTAD’s Outward FDI Performance Index 2007, China, Brazil and India improved their rankings in 2006.

Key growth sectors Diverse factors drive economic growth in Brazil, Russia, India and China.

The leading sectors in Brazil include agriculture, mining, manufacturing, and service sectors. The agricultural sector, including food processing, accounts for approximately 30% of GDP and provides nearly 40% of the jobs in the country. The sector has grown at an average annual rate of 5% this decade and has potential to grow even further according to Grant Thornton. The country’s manufacturing sector has grown at the rate of 4% in recent years.

Oil and gas remain the most important drivers of Russia’s economy. It has the world’s largest natural gas reserves and the second largest coal reserves. A significant contribution to the Russian GDP comes from the exports of the entitles that produce energy. According to IMF and the World Bank, the oil and gas sector accounted for 23% of Russia’s GDP in 2006. The construction sector in Russia accounted for about 5.6% of the total GDP in 2006. The retail sector is not far behind, contributing 13.9% to the GDP in 2006.

In India, agriculture accounted for 19% of the country’s GDP in 2005, with manufacturing close behind at 15%. According to McKinsey, India’s IT sector generated revenues worth USD36 billion in 2005, (5% of the GDP) and holds promise for the future. It is estimated that by 2010, India’s IT sector will account for 7% of India’s GDP and generate USD60 billion in revenue per year.

China’s growth impetus is its manufacturing sector which accounts for nearly one-third of China’s GDP. According to Global Insight, China’s manufacturing output will exceed that of the US by 2025. A conservative estimate of the number of manufacturing sector employees in 2006 is 109 million, far more than the 14 million employees in the US, and 53 million employees in the G-7 countries combined.

Political systems The BRIC nations’ political systems are as varied as any other parameter on which they may be compared.

Brazil is a federal republic. Luiz Inacio Lula da Silva has been the President for two successive terms (2001 to 06 and 2006 to 11). In Brazil, a candidate cannot stand for the post of the president for three successive terms. However, there are speculations that Lula will amend the constitution so as to make a provision for his third consecutive run, an accusation Lula strenuously denies.

The situation in Russia currently is the subject of much speculation. Vladimir Putin was elected President in 2000 and re-elected in 2004. The Russian constitution restricts a candidate from running in the presidential elections three times in succession. However, it’s widely reported that Putin is exploring various options to enable him to regain the president’s badge in the near future.

India is the world’s largest democratic republic

WHAT MAKES BRIC UNIQUE IS

THAT IT IS ONLY AN IDEOLOGY, NOT

A FORMAL AGREEMENT AMONG

THESE COUNTRIES, AS IS THE CASE

WITH THE G7 COUNTRIES


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with a prime minister and president. Each serves a five year term. Presently, the country has a coalition government of 12 parties, with Manmohan Singh as prime minister. One of the major allies of the government is the Communist Party of India (CPI). However, the presence of a communist party as a strategic ally has led to sluggish policy framing and implementation.

China is a single-party socialist republic state ruled by the Communist Party of China. Before 1978, China’s state-owned work places provided all housing, education, healthcare, etc, to the country’s citizens. The subsequent growth of the private sector has led to a decrease in the regular control of the party over its citizens. Information is highly controlled in China (refer China In Briefs, page 24) and the state is not transparent. However, China is politically stable and analysts do not expect any political unrest in the near future. The longer-term future is less clear, with speculation that as China’s population becomes more educated and wealthy, they will demand more political rights.

Key challenges ahead

Brazil Public sector debt poses a significant hurdle for Brazil in its path to better economic growth. These accounted for nearly 50% of the country’s GDP in 2006. The country is plagued by debts due to the debt crisis of 1980 to 1990s and hyper inflation. Other challenges are unemployment in the manufacturing sector and regional inequality in income. Russia According to Grant Thornton’s International Business Report 2007, Russia’s key challenges include extensive corruption and lack of documentation of laws. Economic growth is highly reliant on commodity exports, leaving Russia’s economy vulnerable to variations in world commodity prices. Moreover, the Russian population is expected to decrease 22% by 2050 due to an increasing death rate due and declining in birth rate. HIV/AIDS also threatens to further increase the country’s death rate.

India According to Fidelity’s December 2006 ‘A Case for India’, India’s key challenge is its poor infrastructure in all fields including transportation, energy, and telecommunications. India also faces various macro economic challenges such as a budget deficits. Moreover, India’s natural resources are under pressure as they have to cater to the needs of 17% of the world’s population residing on 2.4% of the world’s surface area. Furthermore, according to the Economist Intelligence Unit (EIU), 60% of India’s working population is dependent on agriculture, which is governed by monsoons. Crop failure, as a result of lack or abundance of rainfall, can affect the growth of the country.

Another major problem that India faces is a significant social divide – rich citizens and states are getting richer while the poor are lagging behind. This growing wealth disparity may lead to social, political, and economical problems. India also needs to ensure complete transparency and improvement in laws to assist small-scale industries which can generate employment and encourage R&D.

China China’s looming age dependency crisis is a key challenge to future prosperity. Its one-child policy will result in the reduction of the working population in China in the coming decades, while improvements in longevity due to economic prosperity means the elderly population is estimated to become 20% of the total population by 2025.

China’s growth is largely driven by public spending and foreign investment. According to Fidelity’s December 2006 ‘A Case for China’, it needs to increase consumer spending and business investments for the country’s growth to be sustainable. Although the government is making efforts to increase consumer spending, it will take time to change the attitude of the Chinese people to whom debt is traditionally a no-no.

China’s exports industry faces stiff opposition from nations seeking to safeguard local manufacturers and trade deficits. Many countries threaten to impose trade restrictions on Chinese goods.

Finally, China also suffers from many microeconomic challenges, such as inefficient state-owned enterprises and an unstable banking system, which may impede its economic growth.

Conclusion

What makes BRIC unique is that it is only an ideology and not a formal agreement among these countries, as is the case with the G7 countries for example. BRIC continues to gain acceptance among investors, thanks to performance to date being even better than predicted when the term BRIC was coined. Of course, each of the BRIC nations has its own large consumer base which makes growth sustainable.

Each of the BRIC economies has the potential to sit within the top 10 countries by GDP by 2050. However, each has latent risks. Brazil is still reeling under its enormous public sector debt and this is compounded by unemployment in the manufacturing sector and regional inequality in income. Russia is plagued by widespread corruption and lack of documentation of laws which may hinder investment prospects. India has a poor infrastructure in all fields and must solve a significant social divide. China’s growth is largely driven by public spending and foreign investment – it needs to increase consumer spending and business investments for the country’s growth to be sustainable.If these risks are not carefully tackled, any one BRIC dream may turn to a nightmare.


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FURTHER READING/VIEWINGDreaming with BRICs: The path to 2050Goldman Sachs 2003

International Business Report 2007 Emerging MarketsGrant Thornton 2007

The new titansThe Economist, Sep 14 2006

Go to www.PortfolioConstruction.com.au/BRIC+

CHINA

Toying with toxins2007 was a tough year for brand China, with a diverse range of product recalls including products with design defects, toys with poisonous lead coatings, food contaminated with pesticides, carcinogens, and bacteria, and banned drugs.

According to a World Net Daily study of the product recalls by the US Consumer Product Safety Commission from January to June 2007, recalls of products made in China were twice the combined recalls of all other countries.

China’s Vice Premier Wu Yi has demanded a comprehensive quality monitoring network incorporating all aspects that could affect product quality, such as product design, raw materials, processing, sales, and services. Li Changjiang, the Chinese Minister of General Administration of Quality Supervision, Inspection, and Quarantine, maintains that China’s toy industry is not facing a serious setback due to the recalls. He said steps are being undertaken to ensure product quality, and criticised certain sections of the media and foreign governments ’playing up the issue’. He also believes that some countries used the recall for trade protectionism.

To revive its image, China is intensifying crackdowns on illegally made products, and stepping up supervision. A four-month product and food safety campaign was launched in late August 2007. The campaign aimed to target various food items and products, including processed food, drugs, pork, and both imported and exported goods that can affect humans.

China promotes tourism globallyAccording to the World Travel & Tourism Council (WTTC), China’s tourism industry is expected to grow at an average annual rate of 8.7% during 2007 to 2016. The 2008 Olympics and World Expo 2010 are expected to act as catalysts for this growth.

In 2006, 5.8% of global tourists visited China and 29% of the global tourists to the Asia Pacific region visited China. A United Nations World Tourism Organization (UNWTO) official noted recently that China is expected to be among the top three tourist destinations globally by 2008, and the number one tourist destination by 2014, surpassing France.

As it prepares for the World Expo 2010, Shanghai is participating in tourism exhibitions across Asia, North America, and Europe and is also upgrading its services for tourists from across the globe.

It plans to put on one of the largest exhibits at the China International Travel Mart held in Yunnan Province during November. According to the Shanghai Tourism Administrative Commission, the objective is primarily to showcase Shanghai’s numerous scenic spots, hotels, and tourist agencies. In November 2007, the city also actively participated in the World Trade Market in London and the European Incentive, Business Travel and Meetings Exhibition in Barcelona, Spain. Participating in such events is aimed at improving Shanghai’s image globally, thus bringing more visitors to the World Expo 2010.

Intel InsideIn September 2007, US semiconductor Intel started constructing its first chipset plant in Asia. The plant is being setup in the Economic and Technological Development Zone of the coastal city of Dalian in China. The factory, named Fab 68, is Intel’s eighth plant across the world and will manufacture flash memory chips and chipsets. Covering an area of 160,000 square metres, the initial project investment of USD2.5 billion is one of the biggest foreign investments in China to date. The facility is expected to encourage the growth of China’s semiconductor manufacturing industry.

Intel Chairman, Craig Barrett said Intel would use high-technology equipment to build an environment-friendly factory. CEO Paul Otellini said “Our goal in China is to support a transition from ‘manufactured in China’ to ‘innovated in China’.”

The recruitment of overseas and Chinese personnel for the plant has already begun. The facility is expected to create 1,700 employment opportunities. It will use 90-nanometer technology, an advanced chip making technique and the the most advanced technology to which the US has given export licence. Production at the site is slated to commence in 2010.

Investment in other technology-related fields is also growing as the government introduces reforms to protect the rights of investors.

China has stalled its proposal to allow mainland Chinese citizens to invest in HKSE-listed securities. The Chinese government announced the plan on 20 August, prompting a sharp rise in both the HKSE Index and the Bank of New York China ADR Index. However, Premier Wen Jiabao has now stalled the proposal. “[We] should make scientific judgment and analysis on what impact the massive funds flooding

into Hong Kong’s financial market would have,” he said. Individual cash deposits in China were worth USD2.2 trillion in 2007. Wen placed four conditions on the proposal proceeding, including passing a law to regulate outward flow of mainland funds, analysis of the impact on the HKSE, raising understanding among investors of the risks involved, and seeking opinion of financial regulators on the proposal.

Gov’t u-turn on offshore investment


TOP 10 M&A DEALS - JAN 07 TO 0CT 07TARGET INDUSTRY ACQUIRER CO COUNTRY VALUE (USD)China Minsheng Banking Corp Banks Investor Group China 1,410.27City Centre Devel Phases Land subdividers and developers China Real Estate Opp Luxembourg 548.14Guangzhou Hengda Indl Grp Investors Investor Group United States 400.00Allyes AdNetwork Information retrieval services Focus Media(China)Holding Co China 300.00China Huarong AM-Loans Investment advice Corstone Capital Ltd China 260.00Harbin Songjiang Copper Co Copper ores China Mining Resources Grp Ltd Hong Kong 233.76Zhuhai Zhongfu Entrp Co Ltd Plastics bottles Asia Bottles(HK)Co Ltd Hong Kong 225.00Shifang Hongda Dvlp Co Ltd Investors Hongda Group Co Ltd China 155.13Chengdu Dr Peng Tech Co Ltd Steel works, blast furnaces Investor Group China 152.86Gold Horse International Inc Engineering services Speedhaul Holdings Inc United States 145.50 Source: Thomson One Banker

China now ranks third in the world in terms of patent applications handled, lagging only Japan and the US. According to Tian Lipu, Director of China’s State Intellectual Property Office (SIPO) the country received 122,318 patent applications from Chinese nationals in 2006 and another 88,172 from foreigners. The number of applications was up on 2005 by 30.8% and 10.4% respectively. Patents are categorised as inventions, new designs, and innovative utilities. Multinationals or their local joint ventures dominated applications for invention patents, the most valuable of the three categories, in 2006. Local companies contributed to most of the other two categories.

The rise in patent applications has been accompanied by a rise in the number of approvals. Over 168,000 patents were approved in the first half

of 2007, a 40.5% increase from the corresponding period last year.

Nonetheless, Tian is calling for further effort to encourage inventions and increase awareness about intellectual property in the country. Although China is the chosen destination of most multinationals applying for patents, the procedure still takes three to four years due to severe staff shortages at SIPO and its functioning body, the China Patent Office. The result is in large-scale infringement of intellectual property before it is protected.

China is now planning to implement a national strategy on intellectual property rights (IPR) to sustain the country’s development. Stressing the importance of IPR, Tian said, “If we cannot effectively protect IPR, the biggest victim will be the Chinese themselves.”

Strong growth in patent applications

Practitioners Tour 24 Feb - 02 Mar 08www.PortfolioConstruction.com.au/BRIC+

The 2007 Press Freedom Index prepared by Reporters Without Borders ranks China 163 among 169 nations.

The government disallows journalists from attending court trials, or reporting investigations on food and product safety. It disrupts signals of international news channels during telecasts of controversial topics such as Tibet and Taiwan and last year, under pressure from the Chinese government, Internet search engine giant Google agreed to censor its sites. (It also decided not to offer e-mail, chat room, and blogging services because of the possibility the government would ask for user data.)

In the lead up to the Beijing Olympics, the World Association of Newspapers has called for all participants to exert pressure on the Chinese government to reform its press policies, accusing China of not keeping its promises made to the IOC to improve the situation before the Olympics.

Freedom of press

More In Brief updatesPortfolioConstruction.com.au/BRIC+


IN BRIEF

INDIA

TOP 10 M&A DEALS - JAN 07 TO 0CT 07TARGET INDUSTRY ACQUIRER CO COUNTRY VALUE (USD)Hutchison Essar Ltd Telephone communications Vodafone Group PLC UK 12,748.00IPCL Plastics materials, synthetic resins Reliance Industries Ltd India 948.00Anchor Electn & Electrical Ltd Switchgear, switchboard equip Matsushita Electric Works Ltd Japan 467.72Reliance Telecom Telephone communications Investor Group USA 347.98Air Sahara Air transportation, scheduled Jet Airways(India)Ltd India 339.10HDFC Bank Ltd Banks HDFC India 337.29Motor Industries Co Ltd Motors and generators Robert Bosch GmbH Germany 331.74Adani Power Ltd Cogeneration, alt energy sources 3i India Infrastructure Fund India 227.00Infrastructure Dvlp Fin Co Ltd Personal credit institutions Khazanah Nasional Bhd Malaysia 186.15Sharekhan Ltd Information retrieval services Citigroup Venture Capital UK 175.00 Source: Thomson One Banker

The Indian Gems and Jewellery market is one of the largest markets in the world. India consumes approximately 800 tonnes of gold each year, nearly 20% of annual global demand and has traditionally been the largest gold consuming country. In 2006, Indians purchased approximately 700 tonnes of gold. Jewellery accounted for about 73% – in 2006, Indian consumers purchased USD13.5 billion or 8.3% of global jewellery sales – with the remainder being investment (coins and bars).

India is also home to the world’s largest diamond processing industry. The processes 80% of the world’s diamonds by carat and 57% by value. The Indian gems and jewellery industry exported USD17.1 billion in 2006-07, up 3% over the prior year. Exports of polished diamonds and gold jewellery accounted for 95% of the total exports by value.

Jewellers are investing more on developing contemporary jewellery designs in a bit to attract offshort buyers. C.K. Venkatraman, COO of TATa enteprise Tanishq, one of the leading jewllery brands in India says “NRIs and foreigners make up 5% of our total footfall”. T. Shantha Kumar, Managing Director of diamond and jewellery exporter, Kirtilals, notes “NRIs and foreigners (including visitors from Western and Australia) are driving up sales significantly. Designers are also going the distance to track the latest preferences.”

All that glitters is gold

India to establish FDI centresThe Indian government has announced plans to set up Foreign Direct Investment (FDI) assistance centers in 10 nations worldwide – the US, Japan, Taiwan, the UK, Germany, Singapore, France, South Korea, Switzerland, and Italy.

The centers will assist foreign investors to gather first-hand information on areas such as how to invest in India, details on particular sectors, and the country’s FDI laws. The prime objectives of the facilitation centers will be to promote joint ventures and collaborations, provide encouragement to business delegations to visit India, and offer incubation services.

The Department of Industrial Policy and Promotion (DIPP) of the Indian government will initiate the process by connecting with the embassies in those nations to begin implementation of the scheme.

India’s Ministry of External Affairs is also encouraging the program and industry bodies, such as the Confederation of Indian Industries (CII) and Federation of Indian Chambers of Commerce and Industry (FICCI), will be actively involved in the process.

In 2006/07, FDI inflow into the country was about USD5 billion. Approximately 70% of the FDI came through mergers and acquisitions, and the rest from active greenfield investments. In contrast, FDI inflows to China reached USD72.4 billion in 2005, far in excess of India’s. The scheme will generate active participation from the central government, state governments, and industry bodies.

The Indian republic elected its 13th President in July 2007. Pratibha Devisingh Patil is the first woman President in India. She is being hailed as a role model for India’s women, and for india’s downtrodden. Born in a lower peasant caste family, her appointment demonstrates to the Indian populace that anyone can rise to the top.

Sonia Gandhi, Chairperson of UPA and National Advisory Committee, and India’s most powerful politician said, “This is a very special moment for us women, and men of course, in our country because for the first time we have a woman being elected president of India.”

The President of India is the head of state and first citizen of India and the Supreme Commander of the Indian armed forces. In theory, the President possesses considerable power. In practice, the role is comparable to that of a constitutional monarch., and indeed the office replaced that of the British monarch (represented by the Governor General) upon India’s independence. With few exceptions, most of the authority vested in the President is in practice exercised by the Council of Ministers, headed by the Prime Minister.

India elects 1st woman Presdent


India to miss poverty deadlineAccording to a report by the United Nations (UN) and the Asian Development Bank (ADB), India will not be able to meet the target set by the UN to reduce poverty and hunger in the country by 50% by 2015. The Millennium Development Goals campaign, launched in 2000, gave developing nations 15 years to reduce poverty and hunger by 50% from 1990 levels.

The UN and ADB report notes that no Asian country will be able to achieve all the targets set.

However, India is falling considerably behind other nations. It is still affected by high infant mortality rates, lagging behind Bangladesh and Nepal in this regard.

India needs to reduce its infant mortality rate by two-thirds by 2015 to meet the target. However, India is set to achieve or has already achieved targets in areas such as primary education, HIV/AIDS, tuberculosis, and access to clean water. Its progress is slow in maternal and child health, infant mortality, and climate change issues.

According to World Bank estimates, India has more than one-third of the world’s poor, and more than 33% of its 1.1 billion population lives on less than USD1 a day.

Indian HNWIs increase sharplyThe number of high net worth individuals (HNWIs) in India has been on the rise for the last decade, driven primarily by the growing economy and booming stock market. According to a report by Merrill Lynch and CapGemini Financial Services released in October, there were 100,000 HNWIs in India at the end of 2006, up 20.5% over the year. India ranked second only to Singapore (21.2%) for the highest year-on-year growth in the number of HNWIs in the Asia-Pacific region. HNWIs are defined as people with net financial assets of at least USD1 millio, exclusing their primary residence and consumables.

According to President of Merrill Lynch’s Global Private Client Group, Robert McCann, “This year’s Report found that the number of wealthy people, and the amount of wealth that they control, continued to increase in 2006, with extraordinary wealth creation in Singapore and India.”

It was estimated that of the 100,000 HNWIs, about 858 were in the “ultra-HNWIs” category (more than USD30 million in financial assets).

The 15% appreciation of the Indian Rupee against the US Dollar during the last year also contributed to the rise in the number of Indian HNWIs. Indian HNWIs together hold approximately USD350 billion in financial assets.

The report indicated that the total HNWI population in India is relatively younger than that in other Asian economies. Salil Parekh, Executive Chairman, Capgemini India, said “For instance, 76% of the HNWIs in India were younger than 55 years of age. By contrast, as significant proportion of HNWIs were over 55 in Japan (73%) and South Korea (61%). While younger HNWIs are less risk averse in their approach to investing and desire higher returns within a shorter timeframe, HNWIs over age 55 tend to favor solutions that provide wealth preservation.”

The majority of HNWIs in all markets are male, but the proportions of male HNWIs are highest in India, Australia and South Korea at more than 80%.

According to the Forbes Rich List, India is also home to about 40 billionaires.

The popularity of beer is on the rise among Indians according to a research report by global research frim, Canadean. In 2006, consumption of beer in India reached about 87 million cases, approximately one litre per person per year. While very low compared to other nations – for instance, the US (84 litres per person per year) and Australia (109.9 litres per person per year)– the Indian beer market grew 90% over the

period 2002 to 2007 driven not by better economic conditions, changing lifestyles and de-regulation.

The market is currently dominated by United Breweries’ Kingfisher and SAB Miller, which together hold about 80%. However, the sharp growth in the Indian beer market has brought other international brands to India including Budweiser, Heineken, Scottish & Newcastle, Cobra, and Carlsberg.

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RUSSIA

Russia is the second largest arm trader worldwide. In August 2007, Rosoboronexport, the state-owned enterprise that solely handles the export and import of military products, technologies, and services announced that its three major subsidiaries will go public by 2009. The enterprise earned USD5.3 billion from arm sales in 2006 and aims to consolidate the state’s control over various industries such as metal, warships, helicopters, and aviation.

It has three major subsidiaries – AvtoVaz (Russia’s leading automaker), VSMPO-Avisma (the world’s largest titanium plant), and Helicopters of Russia. Rosoboronexport has around 66% stake in VSMPO and 31.3% in Oboronprom Company which controls the Helicopters of Russia holding. Vladislav Tetyukhin, the General Director of VSMPO-Avisma, announced that Rosoboronexport will continue to have a major stake in the firm after the IPO.

According to Tetyukhin, the IPO will be launched on Western stock exchanges. For instance, in the US, it will be launched using American Depository Receipts, which represent ownership in the shares of a foreign company trading on US financial markets.

Industry analysts generally welcomed the announcement. Potential investors are not expected to fear the government’s holding in the companies as companies such as VSMPO-Avisma can exploit state powers to expand their market, according to Alexei Morozov, an analyst at UBS Investment Bank.

Currently, VSMPO-Avisma and AvtoVaz are traded on Russian stock exchanges. In August 2007, AvtoVaz had a market cap of approximately USD4.35 billion, and VSMPO-Avisma about USD3 billion.

Arms trader to list

Noise pollution hits Moscow hardNoise pollution in Moscow is very high and 70% of Moscow citizens live in an undesirably nosiy environment, according to a report from Moscow’s Environmental Health Service. The contributors are heavy road and air traffic, and the 24/7 construction work. Environmentalists observe that noise in the city has reached critical levels, up by 10 to 25 decibels in certain areas. The standard acceptable noise limit is 55 decibels during the day and 45 decibels at night. In Great Britain, the use of hearing protection devices is recommended when noise levels reache 85 decibels, a regular situation on certain Moscow streets.

Moscow’s Environmental Health Service receives, on average, 300 complaints annually about noise pollution which it says is increasing 12% every year.

Moscow has a 24-hour hotline service where the complainants can dial in and ask experts to decide whether the noise they’re experiencing is acceptable. However, it is a limited service with only seven people monitoring sound levels across the entire city.

The power to impose fines lies in the hand of the police and the Federal Service for the Oversight of Consumer Protection and Welfare. Individual offenders are fined by the police, while the FSOCPW imposes fines on establishments such as restaurants. The fine for individuals is USD4 and USD368 for organisations.

The noise level is unlikely to reduce as construction activities and car ownership in the city has increased.

In August 2007, Russia became the first country to send a manned submarine to acquire energy resources lying in the seabed of the North Pole. As a result, it is now claiming the Lomonosov ridge as part of its territory.

Below the seabed, there is believed to be one-fourth of the world’s undiscovered oil and gas resources, according to the US Geological Survey, as well as gold, uranium, and titanium. Estimates of the oil and gass reserves range from 10 billion tons worth more than USD2 trillion to close to 100 billion tons.

Russia spent approximately USD74 million on this latest voyage to claim the vast underwater resources.

The Arctic region does not come under any country’s jurisdiction and is governed primarily by the International Seabed Authority. In 2001, Russia sought 1.2 million square kilometres of the Arctic

Ocean under the UN Convention on the Law of the Sea. It gives rights to five arctic nations – Canada, the US, Russia, Norway, and Denmark – to exploit the Arctic seabed within 200 miles of their territories. All countries except the US have confirmed the agreement which governs exploitation rights disputes.

The agency asked for reliable data from Russia to support its demand and a preliminary research was carried out using two sumbersibles, before this latest expedition. The study suggests that the ridge is an extension of the Siberian Continental Shelf.

The US has also sent a team for research expedition, while Denmark and Canada sent a joint expedition last year to stake claims on the Lomonosov ridge. With other nations also in the race to claim the multi-billion-dollar resources, Russia is not likely to be able to settle the issue soon.

Further expeditions to the Arctic will help Russia collect data for a new submission in 2009.

Russia races to strike oil in North Pole


TOP 10 M&A DEALS - JAN 07 TO 0CT 07TARGET INDUSTRY ACQUIRER CO COUNTRY VALUE (USD)Yukossibneft Oil Co-Lot 10 Crude petroleum and natural gas LLC Neft-Aktiv Russian Fed 6,814.31Yukossibneft Oil Co-Lot 11 Crude petroleum and natural gas LLC Neft-Aktiv Russian Fed 6,407.50Gazprom Neft Crude petroleum and natural gas EniNeftegaz Italy 5,835.20WGC-4 Electric services E ON AG Germany 3,947.29Yukos Oil Co-Certain Assets Crude petroleum and natural gas OOO Paran Russian Fed 3,877.46WGC-3 Electric services OAO MMC Norilsk Nickel Group Russian Fed 3,087.57OAO Mosenergo Electric services OAO Gazprom Russian Fed 2,326.17OJS Holding Co Yakutugol Bituminous coal, lignite mining OAO Mechel Russian Fed 2,324.58WGC-4 Electric services E ON AG Germany 1,888.26OGK-5 Electric services ENEL Investment Holding BV Netherlands 1,517.79 Source: Thomson One Banker

Russia is facing a major crisis as the country’s death increases and birth rate dwindles. The average life expectancy of adult men in Russia is 60 years, lower than that in Indonesia, the Philippines, and even some parts of Africa.

The high death rate is due to a multitude of reasons. Alcohol and tobacco consumption is leading to 1.2 million deaths annually. Suicides account for a startling one-third of all unnatural deaths.

If these trends continue, average life expectancy for males will fall to 53 years, according to the World Bank.

The Russian population has fallen 3% from 1992 to 2006, from 148.7 million to 143.8 million. Meanwhile, the 2006 birth rate (9.2 per 1,000

people) was about 15% less than in 2005. The average number of children born to each Russian woman has fallen to 1.40 from 2.17 over the past five years, and infant mortality is also rising.

Alexander Lehmann, Senior Economist and Specialist on Russia’s macroeconomy at the European Bank for Reconstruction and Development in London, says skilled labour is expected to fall short by 15 million by 2020, making it difficult for the Russian government to maintain high growth rates.

The declining labor force is also leading to significant wage rises. In addition, foreign investors are finding it hard to fight absenteeism due to ill health, which the World Bank estimates results in 0.55% to 1.37% loss of GDP per year.

Population dwindles at alarming rate

The government in Moscow is ensuring that social messages have strong visual presence in the city.

What started as fillers for a lack of paying billboard advertisers in hoardings installed along escalators and tunnel walls 13 years ago has now turned into one of the government’s major tools for spreading social awareness.

A law was passed in 2006 requiring that 5% of Moscow’s billbooard advertising inventory be set aside for social advertising. Certain areas of the city have increased this to 15%.

The topics of the posters are decided by the government’s ministries and range from tips on how to look more beautiful to issues related to sex.

The billboards enjoy a healthy daily viewership of close to 9 million people.

Vladimir Makarov, the Chairman of Moscow’s Committee on Advertising and Information, is hopeful saying “Social advertising undeniably helps our government, our President.”

Billboard blitz

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BRAZIL

TOP 10 M&A DEALS - JAN 07 TO 0CT 07TARGET INDUSTRY ACQUIRER CO COUNTRY VALUE (USD)Sistema Minas-Rio Iron ores Anglo American PLC United Kingdom 2,450.99Serasa - Centralizacao de Credit reporting services Experian Group Ltd United Kingdom 1,199.28Atacadao Groceries, general line Carrefour SA France 1,123.41Cia Acucareira Vale do Rosario Cane sugar, except refining B5 SA Brazil 750.00McDonald’s Corp-Latin America Eating places Investor Group Argentina 700.00Grupo Dedini Agro Cane sugar refining Abengoa Bioenergy Co Spain 678.80Copesul Industrial inorganic chemicals EDSP58 Participacoes SA Brazil 652.67DM Industria Farmaceutica Ltd Pharmaceutical preparations Hypermarcas Brazil 650.00Magnesita SA Clay, ceramic, refractory minerals RPAR Holding SA Brazil 638.95Solpart Participacoes SA Telephone communications Investor Group Brazil 515.00 Source: Thomson One Banker

Companhia Vale do Rio Doce (CVRD), one of the world’s major producers and exporters of iron ore, plans to invest USD59 billion over the next five years in order to more than double its copper, nickel, and iron ore production by 2012.

CVRD has earmarked USD11 billion for investment in 30 projects across various countries including Brazil (USD8 billion), Canada, Chile, Australia, Indonesia, Mozambique, New Caledonia, Oman, and Peru, in 2008. This is the biggest investment decision made in the history of the company as well as that of the mining industry.

According to CVRD officials, this decision is based on the company’s belief in the growing global economy and an increase in the demand. CVRD, which deals mainly in iron ore production, is exploring production opportunities in other metals as well. In late 2006, CVRD bought Inco, a Canadian nickel company, for USD17.1 billion.

CVRD to invest $59b

The Lula factor – Brazil after 2010It is time to think about Brazil’s future after Lula da Silva’s presidential term ends in early 2011, accoridng to Ted Goertzel, PhD, Professor of Sociology at Rutgers University in the US. Lula has been at the helm for two successive terms (2001-06 and 2006-11) and in Brazil, a candidate cannot contest for the post of President for a third successive term. Goertzel’s predictions for ‘Life after Lula’ include:1. Elections will be held on schedule in 2010. 2. The new President will not belong to the Worker’s Party as it does not have any strong candidates. Moreover, traditionally, governors have been chosen as presidents and this is unlikely to change. 3. The market-friendly model established by Fernando Henrique Cardoso, former Brazilian President, will be taken forward by the new government. It is also expected that inflation will be stable and there economic growth will remain steady. 4. Effective policing measures such as those adopted in Sao Paulo will control the crime rate in various other states. 5. Corruption levels will decrease and Brazil will improve its Transparency International Corruption Perception Survey rank. 6. Political reforms promoting fidelity among parties and legislators will give parties a stronger role in the legislature. 7. The Brazilian political scenario is likely to be demarcated into northern and southern lines due to the lop-sided policies that impose a tax constraint on wealthier southern states. 8. During Lula’s tenure, land reforms will result in a fewer number of families being settled each year due to increased cost of land reform. 9. Contrary to recent trends, deforestation will be high, at a rate of about 10,000 square kilometres per year.

Brazil is the last place in the world to buy an iPod, according to a recent study by the Commonwealth Bank. The bank used the 4GB slimline iPod Nano to create an index similar to The Economist’s Big Mac index and compare global currencies and purchasing power in 55 countries. The study revealed that Brazilians pay the most for an iPod (USD369.61) and those in Hong Kong pay the least (USD148.12). Bulgaria and Argentina are close behind Brazil (USD318.60 and USD317.45 respectively). Craig James, Chief Equities Economist at Commonwealth Bank, believes that as well as highlighting the effects of tariff and taxation, the results also emphasise the falling value of the US Dollar against the other currencies.

Brazil not the place to buy an iPod


Fears of looming energy crisisBrazil may face an energy crisis in the next four years due to the absence of new investments in the sector. According to Claudio Sales, the Head of electricity industry body Acende Brasil, the country may face a shortage of 1,800 megawatts in 2011. “We don’t have time to diddle any more or we’ll have to take emergency measures again”, Sales said. He also believes that the shortage may lead to rationing of power, as was done in 2001.

Brazilian President, Lula da Silva, recently said that Brazil is an energy superpower. However, Jerson

Kelman, Director General of industry regulator Aneel, claims the government has changed its view and admits to a need of 1,400 megawatts by 2011.

Hydroelectricity currently accounts for 80% of the power generated in Brazil and building further hydroelectricity plants could be a solution to the crisis. However, construction of new hydroelectricity plants will take more than four years and domestic gas production will also only be possible after 2011. Therefore, promotion of renewable fuels and small-scale generators seems to be the likely government path in the short term.

Experts have also suggested reforms in the energy sector. The energy distributors’ association feels that there is need to decentralise power generation. It is also of the opinion that the government should regulate the legislation which grants a discount in transmission costs for alternative energy generators.

Foreigners fuel real estate boom

Brazil is currently experiencing a major real estate boom due to heavy investment by foreign nationals, and the Brazilian government has responded to calls for major land reforms. With foreigners investing considerably in the Amazon to buy agricultural land, the Brazilian government is planning to increase the restrictions on land ownership.

The government has been firm in saying that it wants domestic control on the resource-rich land and productive farms. President Lula da Silva said in a recent statement, “We need to be careful so that we do not allow people from other countries to buy all of Brazil’s lands to produce sugarcane.”

Current restrictions on foreign nationals buying land have often been circumvented by investments coming through Brazilian firms. However, Rock Hackbart, President of Incra, the agency in charge of land reforms in Brazil, believes this phenomenon is set to change as the government’s key objective will be to limit land acquisition by foreign capital through Brazilian firms.

The new restrictions are expected to be along the same lines as the previous ones which permit buying of 100 MEIs (Módulos de Exploração Indefinida – Undefined Exploration Modules) by foreign firms. This unit, MEI, varies dramatcially from one municipality to another: 1 MEI is equivalent to 5 hectares in Salvador, but is equal to 70 hectares in Amapá.

Brazilians are well known for spending on beauty products. Now, being good ambassadors for their products is resulting in export growth. In 2006, Brazilian companies exported cosmetics, toiletries, and fragrances worth USD484 million, according to João Carlos Basilio da Silva, President of the Brazilian Toiletry, Perfumery and Cosmetic Association. “We

have doubled our foreign trade in only three years,” he says. “The growth in our exports this year surpassed the international average, indicating that we have expanded our share of the world market.” At present, South American countries account for 61% of Brazil’s beauty product exports. Russia, Cuba, and Angola have also begun to surface as key customers.

Beautifying the world the Amazonian way

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+MEXICOInvestment flows to Mexican minesMexico, already one of the leading metal producers in the world, is witnessing an enormous investment flow into its mining sector. According to Norberto Roque, Mexico’s General Mining Coordinator, “In the last six years, investment grew by 202%, with the most important segment being exploration.”

As a producer of 27 metals and 47 non-metallic minerals, Mexico holds a 2.2% share in the world metal production. It is home to one of the world’s largest silver mines. Other major minerals extracted from the land include gold, copper, zinc, and lead.

In 2006, around USD1.3 billion was invested in mining activities in Mexico, which also witnessed investments from 210 foreign firms. In 2007, total foreign investment is estimated to nearly double to approximately USD3.5 billion. The major investors are firms based in the US, Australia, and Canada. Currently, about 200 Canadian companies are carrying out exploration in over 400 projects in Mexico.

Many mines in the country which were closed in the 1990s have been reopened by small companies. This has resulted in smaller gestation periods as these players do not have to spend time on drilling activities.

The Mexican government has also formulated affable policies that offer tax incentives in the mineral extraction process, which has resulted in increased investment from mining players. For instance, the mineral extraction tax is 7% less in Mexico than in Chile and Peru. Such favourable mineral policies and a geological advantage in terms of mineral reserves have helped the flow of investments into the country. Private investments in mining activities are expected to rise to USD15 billion by 2012, according to Roque.

Miguel Caballero owns a boutique in Mexico City that sells bullet-proof designer garments. Caballero designs armored waistcoats, jackets, T-shirts, and blouses. He also has a showroom in Bogotá, Colombia.

The bullet-proof vest produced by Miguel weighs one-fifth of a normal bullet-proof vest. This is because he uses an inside lining which has flexible plating. This patented material is woven from aramid, nylon, and polyester, and is lighter than conventional Kevlar. The vest can withstand bullets of up to 12 millimetres calibre. The thin and light materials make the protection unnoticeable.

Miguel got the idea to make a light-weight bullet-proof jacket while a student of business management and textile technology. He noticed the bodyguard of one of the fellow students was sweating due to his armored vest which weighed five kilograms. This

gave him the idea to prodoce light-weight bullet-proof jackets.According to the designer, Mexico’s wealthy people are in need of protection

due to the country’s high crime rate. This has resulted in ideal market conditions for his bullet-proof collection. The September 11 attacks in the US also resulted in increased sales of his products worldwide. And Caballero bullet-proof jackets are not cheap, costing about USD2,000 each. However, that price is still 30% lower compared to products offered by Miguel’s competitors.

Caballero’s clientele includes Jordan’s King Abdullah II, Mexican President Felipe Calderon, Venezuelan President Hugo Chavez, and Spain’s Crown Prince Felipe. The business has grown from a staff of 4 employees to 130. In 2006, he produced a range of 300 garments for a sales turnover of USD5 million.

Designer bullet-proof clothing for the richChichen Itza was named one of the Seven Modern Wonders of the World, following a worldwide poll of 100 million people. Announced by the New 7 Wonders organization on in July 2007, the Seven Wonders are equivalent in status, with no individual ranking awarded to them. The other Wonders are the Christ the Redeemer statue in Brazil; the Colosseum in Rome; the Taj Mahal in India; the Great Wall of China; the ancient City of Petra in Jordan; and, the Inca ruins of Machu Picchu in Peru.

Chichen Itza, an archaeological site in Mexico, was built by the Mayas in the Yucatan peninsula. It is a combination of three words In 600 AD, Chichen Itza was the supreme power in the region and was ruled by a council made up of elite families. Chichen Itza’s decline followed a civil war in 1221 AD.

This site is made up of many stone structures, such as palaces, temples, and markets. It’s history still has many mysteries attached to it and the exact period of the construction of the site is still debated. It exhibits both Toltec and Mayan influences.

There has been a huge dispute over its ownership since its inclusion in the Seven Wonders list. A Yucatá family, has claimed ownership of the site.

As a result of being named one of the Seven Wonders of the World, the site is attracting more tourists than ever, resulting in fears of increased wear and tear. The Mexican government is therefore considering restricting the number of tourists visiting the heritage site.

Chichen Itza a wonder


TOP 10 M&A DEALS - JAN 07 TO 0CT 07TARGET INDUSTRY ACQUIRER CO COUNTRY VALUE (USD)Grupo Imsa SA de CV Steel works, blast furnaces, mills Ternium SA Argentina 1,727.05Grupo Gayosso Funeral service and crematories Advent International Corp United States 317.00Ixe Grupo Financiero SA de CV Investors Brysam Global Partners United States 230.00Grupo Lamosa-Shopping Ctrs Operators of non-residential bldgs Prudential RE Investors United States 164.00Grupo Aeroportuario del Airports and airport terminal servs Investor Group Mexico 153.34Grupo Cydsa SA de CV-Crysel Cellulosic man-made fibers Zoltek Cos, Inc. United States 100.00Grupo Nugar Motor vehicle parts and accessories Cie Automotive SA Spain 76.44Alliant Energy-Laguna Del Mar Electric services Salvago Mexico Mexico 65.00Acabados y Cortes Textiles SA- Fabricated textile products Tavex Algodonera SA Spain 62.50Grupo Aeroportuario del Airports, airport terminal services Investor Group Mexico 39.77 Source: Thomson One Banker

Mexicans have long been traveling to the US for quality healthcare treatment. However, that is now reversing as more and more Americans travel to Mexico for low-cost, high-quality treatment. Last year, around 1 million people globally traveled overseas for healthcare treatments, spending approximately USD60 billion – and 150,000 were Americans.

According to Milica Bookman, Professor of Economics at St. Joseph University in Philadelphia, Americans in need of treatment travel to Mexico due to its lower costs and proximity to the US. Milica believes that Mexico and other Central and South American countries have an edge over their Asian counterparts due to their geographical proximity to the US.

The trend has resulted in increased foreign investment in Mexico’s medical sector. Two US firms, the International Hospital Corporation and CHRISTUS Health System, are now providing medical facilities in Mexico.

Between 40,000 and 80,000 American retirees currently live in Mexico, in part so that they can readily access cheaper healthcare services. This has triggered real estate development opportunities with real estate developers in the country now investing in residential facilities for the aged. According to Flavio Olivieri, a member of Tijuana’s Economic Development Council, “With the right facilities in place, Mexico could give (American retirees) a better quality of life at a better price than they could find in the US.”

The US insurance market now offers a few health plans offering low premiums to patients traveling across the border. “When insurance companies begin participating in the medical tourism industry, countries such as Mexico will benefit immensely,” opines Ms Bookman – creating a win-win situation for American patients and the Mexico healthcare sector.

Mexico grows medical tourism

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The number of police deaths in Mexico is on the rise with at least 61 policemen killed in the first quarter of 2007. The northern state of Nuevo Leon is reported to be the most violent area, with around a quarter of the deaths from this particular region.

According to Mexican officials, the policemen were killed in situations relating to drug-related violence and organized crime, which is on a rise. The number of police killings related to organized crime rose 50% in 2007, according to official statistics. It is

believed that the crackdown of the Felipe government on drug-related violence last year has led to this.

The governments of Mexican and the US have announced a two-year USD1.4 billion joint program to eradicate drug trafficking and organised crime from the region. As a first step to this joint program, the Bush administration has asked for USD500 million from the US Congress, to be used for intelligence, training, and equipment for controlling and monitoring drug trafficking.

Police death toll rising due to drug wars

The Chairman of Indo-Mexico Business Board, Luis Wertman, believes Mexico will draw an investment of USD10 billion from India by 2012. He made this statement during a forum called ‘India-Mexico: Opportunities for Business’, organised by various industry bodies.

Indian companies have already begun to establish their presence in Mexico. Videocon acquired a television manufacturing plant in the country, and Dr. Reddy’s Lab acquired a pharmaceutical company. Lakshmi Mittal of ArcelorMittal has made the highest investment by a non-resident Indian in Mexico. Investment in Mexico by Indian companies has also increased with IT companies, such as Infosys and TCS, starting their Mexican operations.

It’s not all one way funding, however. Mexico is also looking to investment opportunities in India. For instance, Mexico’s agro-based industries are planning to invest in India’s processed food sector.

Wertman also observed that of the millions of Indians going abroad each year, less than 5,000 visit Mexico. He stressed the need to boost tourism between the two countries.

Mexico seeks USD10 from India


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COMMENT

LAST WORD

IT’S HARD TO BELIEVE the BRIC acronym has so quickly become synonymous with developing and emerging markets. Two particular aspects of BRIC are especially interesting and will provide plenty of food for thought in the months and years ahead.

The fi rst is the downstream consequences of the BRIC economies. While Brazil, Russia, India and China each have the potential to dominate the global economy in their own right (particularly China and India), it is the surrounding markets and economies – already enjoying the downstream benefi ts arising from their more prominent and powerful neighbours – that offer some of the most interesting long-term growth potential.

China’s manufacturing industries are already creating new and expanding opportunities for even lower cost manufacturers in Vietnam, Thailand, Malaysia, and some smaller countries in South East Asia. India’s ambitions to be the knowledge capital of the world will create spin off opportunities in Pakistan, Sri Lanka and surrounding countries which offer a similar youthful, educated and English-speaking workforce. Russia’s near monopoly of world resources, particularly in oil and gas, offers exciting potential for the countries of Eastern Europe, particularly Kazakhstan, Ukraine, Poland and the Scandinavian countries. Brazil’s rich commodities sector refl ects the potential of Latin America, particularly Chile, Argentina, Peru, Columbia and Venezuela.

In my view, it won’t be long before we see more direct infl uence by the BRICs on other countries as the BRICs start to form closer alliances, trade agreements and co-operatives. That’s why we call them all BRIC+.

The second aspect is that the individual BRIC economies are uncorrelated – the success of one is not really dependant on the continuing success of any other. This is very helpful from a diversifi cation perspective and allows investors to hold a BRIC portfolio without fear that problems in one country (for example, political, economic or social upheaval) will have a signifi cant negative impact on the others (at least from a fundamental perspective). One reason is the unrelated way in which each BRIC country began its journey to prominence.

China emerged from its dark ages in 1992 when Deng Xiaoping began the process of reform by declaring “to be rich is glorious”, a stark contrast to the views of Chairman Mao. China revamped its ideology, overhauled its industry, and revised its political philosophy to emerge as the innovation powerhouse we see today.

The catalyst for the rise of modern India was the Y2K bug. Thousands of Indian software engineers were recruited into the US to rework code amidst fears of a global IT collapse. In the process, the US discovered the strength of Indian engineers – fertile ground for Indian companies to argue their outsourcing case.

In the late 1980s, the USSR was tottering under the combined effects of perestroika and glasnost. A unproductive socialist industrial setup, a currency held at an unrealistic level, and the expenditure required to maintain its superpower status combined to result in the 1991 Soviet breakup. Free enterprise and private participation in economic development was ushered in – and Russia hasn’t looked back.

During the 1970s, Brazil’s economy was a basket case, hampered by infl ation and debt problems as the Government attempted to achieve high growth in the face of a rising trade defi cit. Between 1988 and 1997, infl ation averaged almost 600%! From 1998, successive Governments introduced an infl ation-targeting regime and restrained fi scal policy, bringing infl ation down to 4.5% by 2006. Brazil’s future depends more on the maintenance of economic discipline and political stability rather than external infl uences.

The result of this diverse development is that while the BRIC countries share some common characteristics, each is unique and has the potential to become an economic super-power in its own right. Together, the whole BRIC+ is greater than the sum of its parts.

DAVID THOMASPrincipalThink Global Consulting (Half of the BRIC+ team)


JAN Study Tour – India (Executive Forum)

FEB Study Tour – China (Au Practitioners)

MAR Study Tour – China (NZ Practitioners)

APR Digest – Autumn 2008

APR Masterclass

AUG Digest – Winter/Spring2008

SEP Study Tour – Russia (Practitioners)

DEC Digest – Summer 2008/2009

For further details, and other BRIC+ resources

www.PortfolioConstruction.com.au/BRIC+

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ISSUE ONE SUMMER 2007/2008 · 11/23/2007 · A copy of the PDS can be obtained by contacting...

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