Newsletter 3
Newsletter 3
Newsletter 3
THIS ISSUE
Italy, the next victim? p.2
Dear Friends
Time has flown with the speed of light and so it is the moment for the third iFund Newsletter which is devoted to two economies that currently find themselves in two completely converse economic situations. With no further ado, comments and suggestions are more than welcome, so with high expectations and little sense of criticism, lets proceed. The BRIC countries have been lately referred to as the countries with the highest growth potential which mainly derives high labour availability and low expenses, favourable conditions for investment as well as presence of natural resources. Hence, they are frequently called the next future big deal as people readily invest there for the hope of future growth. At the same time there are the so called PIIGS, which currently experience a state of negative or virtually no growth as well as suffer from severe problems due many fiscal and financial flaws. In this issue we will try to shed light on two representatives of each of the two groups, what problems they face and what are their growth prospects in the future. Yours financially, iFund
Since 2009 I doubt if there was a single day without appearing the word PIIGS in biggest media channels and newspapers. We are terribly sick of hearing anything from Greece about its sovereign debt. By investigating this issue we would like to shift your attention from medias beloved Greece to Italy. The Brazilian Miracle p.3
The second article is devoted to the an emerging giant of Latin America Brazil, which despite multiple economic mishaps has established a strong and vibrant economy which is bound to be one of the leading forces in the forthcoming decades. Board updates Upcoming Events p.5 p.5
Since 2009 I doubt if there was a single day without appearing the word PIIGS in biggest media channels and newspapers. We are terribly sick of hearing anything from Greece about its sovereign debt. By investigating this issue we would like to shift your attention from medias beloved Greece to Italy. Though it is easy to poke fun at Italy, with its sometimes silly politics, archaic economic structure, low productivity and poor competitiveness, the government nevertheless should be praised for its sound financial management. Italy's government debt level has not spiked upwards like it has in so many other developed economies in recent years, and it is roughly the same today as in the late 1990s. Nor did the government blow out its budget during the financial crisis. But markets have punished Italy anyway. More than 6% yield from European countrys bond sounds impossible to be true? To our biggest surprise, Greece was able suggest even more, since this country has had 98% chance of default recently. Needless to say, that the question whether Greece will default or not is senseless. Who is the next one and what is going to happen? Ciao Italy, we havent forgotten you.... There is no doubt that Italys governments debt is considered to be the key problem, projected to reach 120 % GDP this year (the second biggest after Greece) and is directing the country to follow the way of Greece. Italian politicians are perfectly aware of ongoing issues and seemingly some ices might be broken. Silvio Berlusconi, who obviously has been paying more attention to reviving his cranky image after all sex scandals than solving countrys fiscal troubles, deserved some credits, as long as Italy's much-altered austerity package is approved and strictly followed. Italy may sell municipal utilities and real estate as part of a plan to dispose of state assets valued at as much as 500 billion EUR. Nevertheless the European Commission
does not think that Italy's fiscal consolidation plans are supposed to have negative impact on growth for this year. Finally, we all perfectly know that ECB is buying Italian bonds and all those steps are supposed to be the way out of this gruel... Believe or not that is far away from enough and the government is turning to cash-rich China in the hope that Beijing will help rescue it from financial crisis by purchasing Italian governments bonds and making investments in strategic companies. The CEBR said it had modelled good and bad scenarios for the two countries and Italy could not support its debt even if rates fall back unless the euro-zone's third-largest economy sharply increases growth."Realistically, Italy is bound to default, but Spain may just get away without having to do so," said the London-based consultancy. The CEBR said the situation is better for Spain as its debt is much lower, and calculates that even under its bad scenario Madrid's debt ratio would climb to no higher than 75 per cent of national output. "Fingers crossed but there is a real chance that Spain may avoid default and debt restructuring unless it gets dragged down by contagion," said the consultancy. It calculated that the maximum sustainable bond yields for weaker southern European countries whose competitiveness has been hit by staying in the euro is really 4-5 per cent, rather than the 6-7 per cent advanced by many analysts and the markets. Unfortunately, it is getting more and more complicated to pursue borrowing for Italy. In any case if the yields of government bonds will begin its climbing to hill, no one is considered to be having such large funds for rescuing Italy arrivederci, Italia!!! By Liudvikas Galvanauskas
A nice and objective evaluation of why Brazil is a perfect subject for investment: http://www.investingdaily.com/id/18 382/brazil-is-the-best-emergingmarket.html Shoul Brazil follow Chinas case of astounding growth. This article finds the similarities between China and Brazil as well as gives an evaluation of whether one can expect convergence between the two countries: http://www.investmentu.com/2011/ March/china-brazil-emergingmarkets.html Another amusing piice of news regarding China and Brazil: http://dailyreckoning.com/emerging -market-growth-and-prosperityfrom-brazil-to-china/ Brazil and the other economies are said to set the tone in the world economy, as said by the World Bank. Check out the complete coverage on that: http://web.worldbank.org/WBSITE/ EXTERNAL/COUNTRIES/LACEXT/B RAZILEXTN/0,,contentMDK:229160 98~menuPK:322347~pagePK:1497 618~piPK:217854~theSitePK:32234 1,00.html
zones, physical proximity to the U.S., cultural compatibility, and cost savings on labor all make Brazil very attractive to companies looking to outsource tasks such as web design and programming. Serious flaws on the way The largest overhang to the Brazilian economy has been systemic inflation and structurally high interest rates. The current benchmark government-lending rate, the Selic, is yielding 12.50%; with inflation running around 6.9% that translates into 5.6% real rate of return. Far greater than almost everywhere except Greece and Portugal, yet the bewildering 12% interest rate is honestly a sign that the economy may be outpacing normal growth.
The consumption of Brazil is a large 63.1% of GDP, essentially unchanged over the latest decade. And for a developing economy, the investment share is remarkably low in levels, 16.4% of GDP in 2008 (compared to Indias 32.2% share). Brazil in particular must re-arrange its consumption/savings relationship, as the share of investment as a percentage of GDP has changed little over the past decade. Brazils experience is in sharp opposition to India, which continues to increase overall investment, primarily through increased FDI. All in all, the saving and investment story adds up to a level of productive capital stock. Without investment, there is no capital stock growth. And without capital stock growth, there is little productive GDP growth. Actually this relationship can be clearly seen by comparing Brazil with other emerging economies, where the level of capital per worker is not increasing for 30 consecutive years. This implies that the production in the country is clearly extensive but not intensive as opposed to India and China. Hnce, there is no wonder why the country is facing such rapidly growing factor prices, as surging wages push up both consumer and production prices (PPI exceeded 7% y-o-y in July).
10-year government bond interest rates. Source: tradingeconomics.com Given that Brazil has sound banking, monetary, and fiscal policy (in fact it has a reserve surplus) in addition to its strong export economy, it seems strange that Brazil has historically and perpetually carried a huge premium in its real rates compared to similar emerging markets such as India and Turkey. Brazil has had three distinct periods of hyperinflation: the 30s, the 70s, and most recently in the early 90s. The traumatic impact of facing a 100% inflation rate is manifold; internally it decimates the savings rate and impetus for investment. Brazilians have been conditioned to not save and have little incentive to invest. In short, both countries need to increase their savings rates in order to boost overall investment and, in turn, worker productivity. The lack of savings has led to little capital available for lending. This in turn has led to extremely high lending rates. If you thought that 12.5% on a basic government bond was high, what do you think about paying 30% to 40% for an auto loan or 25% for a five-year mortgage? The reasons for these blowout rates are twofold: lack of capital available (see above about low savings rate) and the historical volatility of inflation and interest rates. This makes it a necessity for banks to require a risk premium when making loans.
Price ndices (Red Producer Price Index, Blue Consumer Price Index) 2002-2009
Exchange rate (Real/USD), the upward trend until 2007 denotes depreciation (Real losing value, but Brazil as a whole gaining competitiveness)
Capital per worker across emerging economies 1980-2009. Source: newsneconomics.com Conclusively, although the prosperous Brazilian economy brings about several signs of future unsustainable growth, it is certainly a deal-breaker in the short run, especially given its non-capital investment in people and large openness to FDI. If the latter is to be fixed through more liberal reforms and more stable prices levels, the economy is still possesses undiscovered potential for years to come. By Igors Pauks
Brazilian Balance of payments: The blue line denotes current account (inflow and outflow of goods and services, transfer payments, and participation fees) The read line denotes capital account (inflow or outflow of cash, financial assets, etc.) Note that normally current and capital accounts are inversely related: whenever there is a current accounts surplus (because of, say, positive net exports) then the country is basically a lender to other countries, meaning that its capital account will be negative.
Board updates
Here the iFund board posts weekly updates on what has been done or achieved during the week by the board: 1. Linedata Services is to become the Technological Partner of Investment Fund Agreements were reached with the American Embassy in Latvia for monetary support in providing a data feed for S&P 500 and NASDAQ 100 companies Thomson Reuters (the big financial news agency) has agreed to support us by providing a free data feed on the quotes of the largest financial markets during the Investment Game The negotiations with Finasta and PwC have entered a deadlock and it seems that the outcome will be quite unclear A detailed plan, vision and for this years Investment Game has been created and the main work will be commenced soon.
2.
Upcoming Events
Guest lecture: Striving Towards Success: the Story of Vadims and His Way to Barclays Capital M&A Division in the United Kingdom
September 20, 16.00 17.00 in 303
3.
4.
5.