The Screaming Pen

Providing Global Insight, Context, and Perspective

Chicken the China, the Chinese Chicken

A Changing Tide, the Spigot is Tightened

Since hitting an all time high on May 8, the MSCI Emerging Markets Index has fallen over 20%, as inflation fears and global monetary tightening begin to mop up the loose liquidity that has helped emerging market exchanges, along with other riskier assets, achieve strong annualized gains over the past few years.

With China experiencing staggering economic growth, one would think that the Chinese Stock Markets would have been on the winning end of a several year long emerging markets run. In fact, on June 6, 2005, while many Asian markets were continuously breaking multi-year highs, the Shenzen Compositie hit a six year low, puzzling amateur investors across the globe. Possible answers to China’s equity market conundrum can be found by taking a closer look.

The Times, they are a Shenzen

The Late Bird Gets the Sub Par Market Returns

China, a late bloomer in the Capital Markets game, did not have a stock market until 1990, and not a single Chinese company was listed abroad until 1993. As of 2003 -the latest information thescreamingpen.com could muster- over 66 million Chinese citizens participate in the domestic equity markets, with only 35 companies listed as private. It is estimated that at least two thirds of the shares listed on the Shanghai and the Shenzen, China’s two largest stock markets, are owned by the government. It is apparent that investors, especially those abroad, are hesitant to invest in companies whose balance sheets, among other things, could be compromised because of government involvement.

The Reforms of 2005

Realizing that capital inflows are essential to sustainable growth, the powers that be in China undertook some important reforms in 2005, including:

  • Public listing of the “Big Four” Chinese banks on overseas exchanges
  • Selling large stakes of domestic banks to international investors, which will result in increased capital inflows and much needed international banking expertise.
  • Reform of China’s A share market, which has resulted in 1/3 of China’s A shares being tradable.
  • The removal of capital gains taxes on securities held by foreign investors
  • The issuance of sovereign “Panda Bonds”, issued in Chinese currency.

Outlook and Conclusions

With the initiation of a global tightening cycle, it is possible that China may have missed out on the latest emerging markets rally. The good news is that China’s Eleventh Five Year Plan, which began on January 1, 2006, contains many provisions that aim to reform China’s financial sector even further. Hopefully these provisions are enacted.  This would allow China to efficiently handle foreign inflows of Capital, as well as wealth created at home.  If China continues down the road of financial sector reform, it will be a much needed step on the path to possible market maturity.

*Look for an overview of the Indian Financial sector reform in the coming days.

-JPL

Links of Interest

http://www.washingtonpost.com/wp-dyn/content/article/2006/06/08/AR2006060801493.html

thescreamingpen.com is not liable for any loss resulting from any action taken or reliance made by you on any information or material posted by it. You should make your own inquiries and seek independent advice from relevant industry professionals before acting or relying on any information or material which is made available to you pursuant to thescreaminpen.com’s information service, as it may not prove accurate. You rely on this information at your own risk. thscreamingpen.com is not for profit.

June 9, 2006 Posted by | Asia, Author: JPL, China, Chinese Stocks, Corruption, Emerging Markets, Globalisation, Investing, Politics, World Markets | 1 Comment

Dude, Where’s My W-2?

Let me tell you how it will be;
There’s one for you, nineteen for me.
‘Cause I’m the taxman,
Yeah, I’m the taxman.

-The Beatles

 

A Possible Impetus For Change

Last fall, the international media focused much of its attention on European elections that promised to shake up the old European order. For those seeking real economic change in the form of market liberalization, those elections were partial letdowns. For instance, many analysts believe that a clear-cut Merkel victory in Germany could have provided the impetus necessary for much needed economic reform and market liberalization in other Western European countries. Following the formation of a grand coalition in Germany, it appears that constant compromise may prevent Angela Merkel, the new Chancellor of Germany, from carrying out her intended reforms. It is also uncertain what direction Poland’s newly elected center right coalition government will take the country. Before coming to the conclusion that all hope is lost regarding Western European change, one must consider an economic force that has been slowly moving westward, originating in the tiny nation of Estonia. The flat tax, which applies a constant rate of taxation, is exerting economic pressure in the form of tax competition on the high tax economies of Western Europe, slowly forcing economic change in those countries.

Reactionary Yet Opportunistic

From a historical perspective, it is interesting that many of the countries who have enacted constant rates are ex-communist nations who have voluntarily moved in the opposite direction of Soviet central planning, the failed communist system that attempted to control every aspect of economic activity. Much like the iron curtain before it, the flat tax movement and free market values are slowly moving westward, with Greece facing a crucial decision this year regarding the adoption of a 25% flat tax. In the recent Polish election, the pro flat tax Civic Platform Party came in a close second, and will now share power with the victorious Law and Justice party. In Germany, the early election campaign of Angela Merkel featured a proposed finance minister who was an outspoken supporter of a flat tax. Unlike the spread of communism, however, the flat tax movement is being voluntarily implemented.

Mail Order Brides are no Longer Estonia’s Chief Export

 

The flat tax system, which uses a single tax rate that is applied to wage earners and corporations that begins taxing after a certain income threshold is reached, has been successful in several nations beginning in 1994, when Estonia introduced a 24% tax rate. By attracting business from abroad, Estonia’s economy grew at double digits in 1997, and has averaged about 6% GDP growth per year since. Russia, a nation whose complicated tax code caused widespread evasion, instituted a flat tax in 2001. It is estimated that in the years leading up to the 2001 flat tax, Russia’s biggest corporations ignored 29% of their tax obligations, while 63% substituted goods or services instead of hard currency. This made Russia susceptible to debt defaults as their coffers reached record lows. In 1998 Russian government revenues were 12.4% of GDP. By implementing a simplified tax code, Russia eliminated loopholes and increased its revenues in real terms by 28% in 2001, 21% in 2002, and 31% in 2004.

Opponents of a flat tax, who believe that a flat tax is meant to line the pockets of the rich and will result in lower government revenues, fail to realize that flat tax systems do not tax earners below a certain threshold, allowing the poorest workers to be exempt from taxes. The revenue question is answered by looking at Russia, a nation who learned that the best way to get higher revenues is to give people more incentive to report their taxes by keeping tax rates low. Ideally, a low tax rate would result in more wealth creation, which could generate even greater revenue. Remember, the examples cited in this article are from countries that had an insanely restrictive, command style tax code. The flat tax is also making Western Europe increasingly uncompetitive, as businesses and investment dollars flow into Eastern Europe.

Implications

In response to widespread eastern European acceptance of a flat tax, Western Europe is beginning to consider tax reform. According to the Economist, Germany has already made plans to cut its corporate tax rate from 25% to 19%, and the in Britain, the Opposition Conservatives announced on September 7, that they would set up a panel to study a flat tax proposal. As investment dollars and businesses continue to flock to Eastern Europe from Western Europe, it will be increasingly apparent to Western Europe that in order to maintain its standard of living, it will need to make radical changes in its tax policy.

Conclusions

It will be interesting to see how the Western European nations deal with tax competition from the east. It is apparent that the increasingly uncompetitive Western European nations will need to modernize their economies in order to compete. It will also be interesting to see how the continued success of an Eastern European flat tax effects the current tax situation in America, where our own tax code has broken the nine million word mark.

-JPL

Links of Interest

http://www.washingtonpost.com/wp-dyn/content/article/2006/05/31/AR2006053102043.html

 

May 31, 2006 Posted by | Author: JPL, Emerging Markets, Europe, Flat Tax, Germany, Globalisation, Politics, Russia, Unemployment, World Markets | 16 Comments

The Stampede of the Global Herd

Yesterday marked the eleventh day in a row that the MSCI Emerging Markets Index fell, an event that has not occurred since August 13, 1998, the very same day that Russia defaulted on her foreign debt. Russia’s debt default marked the spread of the Asian Contagion, a financial crisis that swept across Asia after the devaluation of the Thai Baht. This time it appears that things are much different, as the fundamentals of many emerging market economies appear quite strong. And although Indian Brokers, who witnessed shares drop more than ten percent before the government intervened yesterday, will probably not find solace in solid fundamentals, it appears that the current drop in the emerging markets is due to investors fleeing risky assets in the face of a global tightening cycle, possible inflation, and cooling global growth. And although some investors are losing their shirts, it appears that this may be a price correction, not a crisis.

Seeing Red

Come On, Let Me See Ya Grill

Wait and See

While yesterday’s returns marked the end of an eleven day downturn in the emerging markets, it still did not end the doomsayers from predicting that today’s economic conditions are similar to either 1) the conditions preceding the October 19, 1987 crash or 2) the conditions that led to the Asian contagion. This could not be further from the truth, as there are crucial differences between now and 1987. In 1987, stocks were pricey, and treasuries were quite cheap. Today, equities are historically cheap, with investors paying a premium for treasuries. This is important because if investors flee equities all together, which would be required for a crash, they would have to pay a premium for treasuries as housing is showing signs of cooling, and the dollar is relatively weak. The spread of the EMBI+ to the Ten Year U.S. Treasury note still remains at close to record tights, signalling debt investor’s continued confidence in the fundamentals of the emerging markets. In 1998, the spread widened sharply, signalling falling confidence in the emerging market economies.

Conclusions

Although this is probably not a crisis, it could signal a change in investor sentiment, especially as monetary policy tightens worldwide. The managers of Large Cap mutual funds, some of whom have been predicting a return to their asset class for the past several years, may finally get their wish as investors may continue to flee assets that love loose liquidity such as emerging market stocks, commodities, housing, and small capitalization stocks. It will be important to keep an eye on the international markets, along with less risky asset classes that may benefit from the global herd fleeing risky assets in favor of traditionally safer bets. If there is not a change in sentiment, however, this may be a great buying opportunity.

-JPL
thescreamingpen.com is not liable for any loss resulting from any action taken or reliance made by you on any information or material posted by it. You should make your own inquiries and seek independent advice from relevant industry professionals before acting or relying on any information or material which is made available to you pursuant to thescreaminpen.com’s information service, as it may not prove accurate. You rely on this information at your own risk. thscreamingpen.com is not for profit.

May 23, 2006 Posted by | Asia, Author: JPL, Emerging Markets, Financial Markets, Investing, World Markets | Leave a comment

Buying Korean

The Trouble with Entering the South Korean Market

There is perhaps no country with such loyal devotion to its homegrown companies as South Korea. Domestic all-stars Samsung, Hyundai, LG, and others have easily maintained dominance due to the fealty of Korean citizens and, also importantly, favorable relations with government, while foreign darlings from Apple to Hollywood’s movie industry have run up against tremendous difficulty penetrating the market.

While even conservative estimates of the worldwide market share controlled by Apple’s iPod put the figure around 25%, in Korea this plummets to 1.8%; Korean firms iRiver, Samsung, and Cowon are the clear mp3 industry leaders here. In cinema, government regulation mandates that movie theaters run only Korean movies for 146 days a year. From July this number will drop to 73 days per year, yet the reduction will be brooked due to robust demand for domestically produced movies.

 
Not Seoul Tasty

Allegiance to things Korean is found in sports too – from soccer to ice skating – and in health care, with many Koreans living abroad in the United States and Europe preferring to return home for complicated surgeries. Moreover, many Koreans question whether last year’s cloning scandal involving Hwang Woo-suk of Seoul National University, despite his own admission of falsification, was truly worthy of international opprobrium or merely an attempt by foreigners to undermine the nation’s scientific achievement. Foreign brands looking to enter the Korean market should be fully aware of this national mindset, which additionally doesn’t appear to be changing with the generations: young Koreans routinely preoccupy themselves with a firm’s nationality and prefer to “buy Korean.”

Difficult, but not Impossible

American brands looking to make inroads in Korea can take solace, however, in the success made by at least one foreign firm. With over 50 locations in the country as of May 2006, Outback Steakhouse – an American-based (Tampa, Florida), yet Australian-themed concept restaurant – is viewed as fine dining by many Koreans. Outback’s prosperity clearly may relate to its identification with “the lucky country,” a place better liked in Korea than is the United States. Next: Kangaroo-inspired iPods?

– DML

 2006. All rights reserved.

May 7, 2006 Posted by | Asia, Author: DML, Business, Country Profiles, Korea, World Markets | Leave a comment