The top ten great financial crises

The Dutch tulip crisis (1630s)
Perhaps it is possible to understand why investors abandoned all economic logic, and ignored historical evidence, during the dot com bubble. After all, the internet is an astonishing phenomenon, as is the personal computer. But tulip bulbs? What sane person would ruin their family’s fortunes over tulip bulbs? A large proportion of the Dutch well-to-do in the early 17th century, as it turns out.

It was the 1630s when tulipmania took hold, and as with most bubbles, the great and the good, in this case the local mayors, were investing heavily when the market began to wilt. Not wishing their investments to rot, the mayors initiated some neat financial engineering. They agreed to convert their contracts with the-planters from a contract to buy bulbs at a fixed price, to an option to do so if a higher price was reached. If not they paid a fraction of the contract price to the planters.

And so, in the winter of 1637, it was in everyone’s interests for the market to go up. By February 1637 the contract price was 20 times greater than the previous year. One person supposedly paid over 6,500 guilders for a single bulb, the equivalent of an Amsterdam townhouse. But, in the spring of 1637, as all bubbles do eventually, the tulip bulb market burst.

The South Sea Bubble
In February 1720, shares in the South Sea Company, based in England, were trading at £130; by June the price was an astonishing £1050. Adam Anderson, a clerk with the company, described events of the time as an “unaccountable frenzy”. By November 1720, however, the share price was back to £170. The frenzy had subdued. The South Sea bubble, as it is famously known, had burst.

While the South Sea Company may conjure up images of oceanic trading, it was actually established in 1711 as a rival to the Bank of England. Backed by the Lord Treasurer, Robert Harley, it was promised a monopoly of all trade to the Spanish colonies in South America (then the South Seas) in return for taking over and consolidating the national debt incurred as a result of the War of Spanish Succession.

Ultimately, the trading proved to be a diversion, the main money making enterprise being converting government debt into South Sea Company shares and then talking up the trade prospects to inflate the share price.

In a masterstroke of financial innovation four share subscription offers were made to the public using a credit payment system where investors made an upfront payment, paying the balance in instalments over a fixed period. Each issue involved a different down payment and instalment period.

Despite it being effectively the same product – the original shares and four different subscription contracts, the receipts of which quickly became tradeable – the prices of the four assets deviated from each other, and arbitraging failed to bring about price convergence.

The aberrant investor behaviour, described by one lawyer for a Dutch investor as “nothing so much as if all the lunatics had escaped out of the madhouse at once”, has been put down to factors such as complexity and excitement. It certainly must have been both to confuse one of the world’s greatest thinkers. “I can calculate the motions of the heavenly bodies but not the madness of people,” observed Sir Isaac Newton, who lost money amid the feverish speculation.

The Wall Street Crash
Ask the average person in the street to name a financial crisis or stock market crash and the chances are they will name the Wall Street Crash of 1929. Not a single steep one day fall, but rather a long protracted affair, the Crash involved not one but three “black” days – Thursday, Monday and Tuesday (October 24, 28 and 29)– in quick succession.

In August 1921, the Dow Jones Industrial Average was at 63.9. There followed a period of economic boom, through the Roaring Twenties, fuelled by the optimism of a new technological age – radio, cinema, the car, telephone, and aviation. Stock prices reached new records, driving the Dow to a peak of 381.17 in September 1929.

In October 1929, however, the market turned, it fell and continued to fall, (38 points on Black Monday). Mass selling overloaded the telephone and telegraph system. After a brief recovery, the Dow headed southwards once more, and by July 1932 had reached 41.22, it would take over 20 years to recover. At the same time the mass withdrawal of savings precipitated a banking crisis, with the number of banks declining from 25,568 in 1929, to 14,771 in 1933.

Apart from its severity the Wall Street Crash is notable for the great names that it reduced from riches to rags. William Crapo Durant, the founder of General Motors, King Camp Gillette of shaving razor fame, Charles Schwab, one of America’s greatest industrialists; these and many more great businessman (and ordinary investors) were ruined by the Crash of 29.

The Weimar Republic – a banking and currency crisis
A large bank gets into severe difficulties. It reacts by cutting back lending to other banks and to businesses, which in turn has a knock-on effect inducing turmoil in the financial markets. Sound familiar? But on this occasion it is not North America in 2007, but Germany in 1931.

In July 1931, the Weimar republic suffered a major economic blow. The Reichsbank, Germany’s central bank, found itself in difficulty because of a combination of factors, including the collapse of international trade and Germany’s debt burden, and reacted by reining back credit facilities. The result was a panic in the banking sector that led to the nationalisation of two of Germany’s biggest banks, the rescheduling of short-term foreign debt, and the introduction of capital controls.

More significant, however, were the long term effects. Germany ceased World War One reparation payments in 1932 and defaulted on is foreign debt in 1933, both events were important precursors to the rise of the NSDAP party in Germany and the eventual outbreak of the next world war.

Oil crisis 1973
Although not strictly a financial crisis, the oil crisis of 1973 merits inclusion in this list, if only because of the far reaching effects it had on western economies. The catalyst for the oil crisis was the Yom Kippur War, between Syria and Egypt on one side, and Israel on the other, which began on October 6, 1973. The conflict triggered a cascading sequence of events that caused chaos, inflation and recession in the West.

The Organisation of Arab Petroleum Exporting Countries (the Arab members of OPEC plus Egypt and Syria) announced an oil embargo, affecting the US and other nations that supported Israel. In the US, oil imports from the Arab nations plummeted from some 1.2 million barrels daily to around 20,000 barrels. Oil prices rose rapidly and the US suffered its first fuel shortage since the Second World War.

Across Europe the effects of the embargo were patchy. The Netherlands, which supplied arms to the Israelis, was badly hit, whilst France was relatively untroubled. After the embargo was announced on October 17, 1973, the NYSE lost nearly $100bn in just a few weeks. The embargo was lifted in March 1974, although the effects rumbled on, manifest most noticeably in an increased drive for energy security among western nations, as well a radical reshaping of the automobile industry and the rise of the hatchback.

Black Monday
Black Monday, or, if you are Australian, Black Tuesday, is the popular name for Monday, October 19, 1987, the most spectacular of global stock market crashes to date. Not the steepest one day market fall though, that honour lies with the Dow Jones’ 24.39 percent collapse on December 12, 1914.

The significance of Black Monday, when the Dow Jones fell by 22.6 percent, is severalfold. It was a substantial fall, the second largest in the Dow’s history in percentage terms. It was a global event, starting in Hong Kong and rippling across international time zones. By the end of the month markets had declined by 45 percent in Hong Kong, 41 percent in Australia, and 26 percent in the UK.

Perhaps the most interesting thing about Black Monday, however, is that it was not predicted, and has yet to be explained satisfactorily. Not that there is any shortage of suggested causes. Some attribute the crash to automated programme trading, derivative trades, and portfolio insurance, others to recession fears, others still to overvaluation of stocks.

Certainly the supposed “rational investor” of economic theory, capable of absorbing changes in events and making sensible well-informed, if self centred decisions, appeared to have vanished, replaced by irrational, excitable, exuberant investors, who blindly followed the crowd.

But, just as soon as the panic started, it was over. Historic blip behind it, the Dow Jones carried on climbing as normal service was resumed.

Black Wednesday
Another black day in the world of finance, at least from the UK’s perspective, Wednesday the 16th September 1992, was the day that the UK government was forced to withdraw from the European Exchange Rate Mechanism (ERM). The decision came on a day during which the UK treasury spent some $27bn of foreign currency reserves in an attempt to shore up the value of sterling (although the total cost weighing other factors is said to be £3.3bn). At the same time, currency speculators and investors, most notably George Soros, made a small fortune betting against the UK government’s ability to beat the markets.

The UK’s plight demonstrated the perils of fixed exchange rates. With UK sterling entering the ERM in 1990 tied to the deutschmark at DM 2.95, it soon became clear that keeping sterling within its exchange rate limits was at odds with the needs of the domestic economy. Germany was reining back inflation as result of a post unification boom, while the UK needed to promote growth on the back of the recession. When Germany’s interest rates went up, the UK found it painful to follow. A strong pound was damaging exports and prolonging recession.

Currency speculators figured it was a only a matter of time before the UK allowed sterling to devalue, beyond its narrow ERM bands, and that there was not the political will on behalf of the other EU countries to defend the pound. Consequently, they began to short sterling, confident they would be able to buy it back more cheaply in the near future.

Initially, the UK government resisted devaluation, mounting a concerted campaign to shore up sterling both through trading and by hiking interest rates. Matters came to a head on Black Wednesday, as the Chancellor of the Exchequer announced a series of interest rate rises in quick succession, from 10 percent to 15 percent (although the last was never implemented), it was clear to everyone that the game was up, however, and the UK withdrew from the ERM.

The Asian financial crisis
Whether you prefer to call it the Asian financial crisis, East Asian financial crisis, or IMF crisis, the fact remains that the financial crisis that gripped Asia from the summer of 1997 onwards was one of the most significant and long running financial events of the latter half of the 20th century.

Like many other crises, the Asian financial crisis follows an all too familiar pattern. First the boom. During the mid-1990s, foreign investment flooded into Asia and the emerging economies, resulting in high interest rates, high asset prices, and rapid growth rates. Countries like Thailand, Malaysia, Indonesia, the Philippines, Singapore, and South Korea were growing at average rates of over eight percent. Much of the investment was highly leveraged.

Then the bust. The US, emerging from its recession during the early 1990s, began to focus on keeping inflation down, and raised interest rates. Investors switched attention to the US; the US dollar increased in value. At the same time, many of the Asian nations had pegged their currencies to the US dollar and in an effort to remain an attractive investment destination were forced to raise interest rates and expend reserves defending their currencies to avoid devaluation.

You just know that there is going to be trouble when a Prime Minister makes a public announcement that they will not devalue their currency. And so it proved when, in June 1997, Prime Minister Chavalit Yongchaiyudh of Thailand refused to countenance devaluation of the baht, leaving the way clear for currency speculators. Inevitably the baht was eventually floated, and the currency slumped.

And so, temporarily, the “Asian economic miracle” shuddered to a halt, as panic spread throughout the region, badly affecting Indonesia, South Korea, Hong Kong, Malaysia, Laos and the Philippines, with the IMF pumping in $40 billion in an effort to stabilise currencies in South Korea, Thailand, and Indonesia.

On a wider scale the Asian crisis knocked confidence in lending to developed countries, which has a negative impact on oil prices, contributing in part to the Russian financial crisis.

The Russian financial crisis
The bank’s motto may have been, “We are for real, we are here to stay,” however Inkombank had not reckoned with the ferocity of Russia’s 1998 currency crisis, which reached a peak on August 13 1998.

Like many banking crises, the Russian banking crisis was caused by a combination of factors. In 1997 and 1998, the effects of a declining economy were exacerbated by the Asian financial crisis and the decline in demand and price of oil and other commodities that Russia produced.

In the background, amidst the impending crisis, the government were issuing short term bonds, known as GKOs, to help finance the budget deficit. However their issuance resembled something of a pyramid or Ponzi scheme, with the interest on matured obligations met using the proceeds of newly issued obligations.

Internal debt obligations became difficult to fulfil. By August 1, 1998 there was over $10 billion in unpaid wages owed to Russian workers. Various workers were on strike –including the coal miners. And as with the UK and the ERM crisis, Russia’s problems were compounded by its policy of linking the rouble, to another country’s currency, in this case the US dollar. Throughout 1997 and 1998 the Russian government expended billions of its US dollar reserves, supporting the rouble.

Finally, on August 13, 1998, the Russian financial system went into meltdown. Stock, bond, and currency markets collapsed, as investors scrambled to get their money back. The stock market was temporarily closed because of the steep falls. In the fallout, several banks closed, including the not so permanent Inkombank. Russia’s recovery, however, was surprisingly swift, driven in part by a rapid rise in the price of oil and other commodities.

The Great Credit Crunch (2007-08/09?)
In contrast to the short sharp shock of most stock market crashes, the present credit crunch crisis is more like death by a thousand cuts.

The origins of the crunch are well rehearsed. Speculative unsound mortgage lending, the repackaging and reselling of sub-prime mortgage debt as supposedly attractive financial products, the gradual realisation that those products were not quite as attractive as their credit ratings might suggest, the consequent unwinding of positions, recalling of funds, and reluctance of banks to lend money to each other.

If it feels as if the current crisis is interminable, that’s probably because it has been rumbling along since the beginning of 2007 when it became clear that a number of sub-prime lenders in the US were in trouble. Ever since, it has been an endless procession of write downs, financial losses, CEO resignations and now rights issues.

Along the way Wall Street investment bank Bear Stearns has been acquired by JP Morgan Chase, and the UK bank Northern Rock taken into public ownership. The response of the central banks wavered initially between wanting to avoid a banking catastrophe, and not wishing to encourage moral hazard and reward poor lending practices. In the end, the former won out, with concerted action pumping hundreds of billions of dollars into the system in an effort to lubricate interbank lending and bring down the LIBOR rate.

Has it worked? Who knows. Everyone has an opinion, but it is early days still. The only certain thing is that it will happen again, and that one quick read through the following shows that we should all, banks, investors, regulators and governments, know better. Forget neoclassical economics and efficient market theory; fear and greed, that is where it’s at.

A different Russia

It’s not every day Russia gets a new president. In fact it is eight years since the last one, Vladimir Putin, the former KGB operative who turned out to be highly provocative in the usual tradition of the old Soviet Union’s heads of state. After all, Boris Yeltsin was hardly non-controversial with his quixotic foreign policy and unpredictable style of politics.  And before him there was Mikhail Gorbachev who ushered in nothing less than a revolution.

Could it be that Dmitry Medvedev, who took over on May 7, will be the first Russian president not to fascinate and alarm the west in equal measure? Certainly, Poland’s foreign minister Radoslaw Sikorski thinks the 42 year-old former lawyer could herald a new era. As he told journalists in late April, Medvedev was “an interesting person because he is the first Russian leader in my memory who doesn’t come from the Communist party or the security services. It is a hopeful development.”

At last, a boring Russian President?
While not exactly boring, Russia is not the country it was eight years ago. Medvedev assumes control of a vastly stronger economy than the almost lawless one that Putin inherited. By dint of the out-going president’s “authoritarian capitalism”, the economy has been knocked into a semblance of western-style shape that is regarded as incomparably better than the one prevailing in the first few years after the disintegration of the Soviet Union. That was a period when even Soviet economists openly deplored the activities of the oligarchs who practically looted state assets in what was dubbed the “wild east”. As a (legitimate) businessman mourned at the time: “What we need is for Russia to become boring.”

Most observers give the Putin regime high marks for saving the economy from ruin. He has presided over average annual economic growth of nearly seven percent following the collapse of the rouble in 1988, a crisis that left Russia almost bankrupt. In nominal dollar terms, gross domestic product has exploded by six times in the last eight years. And while the public finances of several European economies are in deficit, Russia’s are almost a model of fiscal rectitude with $500bn of reserves locked away in the form of gold and foreign exchange.

Gains are shared
More importantly, the average Russian has enjoyed the benefits of the economy’s recovery with average monthly wages multiplying by eight times to $640 since 2000. The citizens’ new-found spending power – up by 11 percent a year in terms of real disposable income – is reflected in the phenomenal surge in the retail industry, and especially in luxury brands for which Russia has overnight become the world’s fastest-growing market. Western retail chains from Zara to Monsoon, Starbucks to Costa’s, have moved quickly to service a consumer market that will at the current rate of development become Europe’s biggest within seven short years. Indeed it was the headlong growth rates in brewer Scottish & Newcastle’s Russian and neighbouring markets – up 30 percent-plus for brands such as Baltika – that attracted the successful bid from Heineken.

Home-grown retailers have rapidly adopted western-style, customer-pleasing techniques that were infamously absent in the Soviet era. One of the fastest-growing is the Magnit discount supermarket – Russia’s Tesco – which has built up a 2000-outlet chain from almost a standing start ten years ago. Opening a new store every single day on average for the past three years, Magnit has introduced to Russians a wide range of affordable products for the first time.

However Medvedev certainly has work to do. Remarkable as it is, the Putin-engineered turnaround has come at a price. Inflation ran at nearly 12 percent last year and looks to be accelerating so far this year, partly because of the soaring, worldwide price of commodities that is affecting every corner of the economy. According to research by Russia-based investment funds, the cost of construction materials has risen by 150 percent in just 18 months, a phenomenal increase that could put in jeopardy the Kremlin’s plans to spend $1,000bn on a vast update of the nation’s infrastructure that would include everything from bridges to railways.

Additionally, a savage spike in food prices must be quickly reined in. According to finance minister Alexei Kudrin, the retail price of some food items shot up by 40 percent in a wild bout of commodity inflation late last year. These are events that Russians do not readily understand, as Kudrin observed in a recent interview. This is because most of them grew up in a totalitarian environment of brutal solutions, even if they only served to paper over the cracks. “Russia’s economy emerged from the Communist command economy, so some people lack an understanding of market mechanisms,” he said. “They think if the state has money it can solve any problems.”

$160bn to invest
Additionally, it is a measure of the abyss to which the economy sank before Putin’s election that in real terms gross domestic product has only just been restored to the level of 18 years ago. A steady hand on the helm who gets much of the credit for guiding Russia through this turbulent time, Kudrin reportedly had to fight all the way against the old-school, economically illiterate and xenophobic hard-liners known as the siloviki.  One of the finance minister’s hardest jobs has been to protect a cushion of reserves from the clutches of those who have all too quickly forgotten the cataclysmic event that triggered the crash of the rouble. He is sitting on a mountain of petrodollars – nearly $160bn in total invested in the Stabilisation Fund – that less prudent parties such as the oligarchs argue should be released into the general economy.

Instead, in late April it emerged that some $25bn will be converted into a sovereign wealth fund for investment in a wide range of global companies along the same lines as Norway’s long-established and much-admired fund.

“We would take holdings of no more than 3-4 percent,” explains deputy finance minister Dmitry Pankin in a remark that will relieve those countries, especially in western Europe, that feared the fund would be much more aggressive. “There would be no controlling shareholdings.” At least, not for a few years.

A well-intentioned sovereign wealth fund may go a long way to allaying some of the fears raised by Putin’s increasingly aggressive attitude towards the west. Certainly, he alarmed Germany’s Angela Merkel who is nervous about the out-going president’s use of Gazprom, the giant gas monopoly, almost as a geopolitical weapon. Headed by Alexei Miller, a long-time ally of Putin, Gazprom has declared its intentions of reaching a market value of $1,000bn, or more than four times its present value. As Merkel knows, such growth cannot come solely from within Russia. Gazprom has its eye on western energy assets.

Distrust of the west
As a former KGB man operating in East Germany’s Leipzig, Putin seems never to have shaken off an instinctive distrust of the west. Although president Bush greeted his (almost simultaneous) accession to power with the encouraging observation that Putin “is a man we can do business with”, relations with the United States and the west in general have deteriorated markedly since, notably because of Russian support for anti-independence rebels in the old satellite nations.

For instance in Georgia, a nation eager to do business with the west, its multi-lingual, France and US-educated young president Mikheil Saakashvili complains that Russian-backed separatists have fired missiles at his helicopter from the region of South Ossetia within his own country’s borders. And Putin has frequently resorted to bullying to try and crush what he regards as dangerously pro-western activities; in 2006 he banned the import of Georgian wine as a gesture of his displeasure among numerous other similar trade-based retaliations.

Meantime the dominant role of Putin-made appointments in Russia’s biggest companies ensures that he will continue to exercise an enormous sway over the commercial world inside and outside the country long after he steps down from his new role of prime minister. As well as Gazprom’s Alexei Miller, other Putin friends occupy the top jobs at defence-industry giant manufacturer Russian Technologies and Russian Railways.

Good relations with the Kremlin have proved the essential prerequisite for doing business in Russia. Without them, oligarchs have found some of their prize assets being plundered by what are effectively state-authorised actions. For instance Mikhail Fridman, who heads an oil to grocery conglomerate, may soon lose control of a 50 per cent stake in the Anglo-Russian TNK-BP oil company to Gazprom after a concerted bout of pressure from the government.

A baby-sat president?
The big question for Russia-watchers is the degree to which the new president will be his own man. According to Igor Yurgens, a former executive secretary of Russia’s peak business lobby group, the handover of power will come slowly as Putin fills the baby-sitting role of prime minister.  However he credits Medvedev with the ambition of modernising Russia through the introduction of younger, outward-looking professionals. “The extent to which he will be allowed to do this is not clear but he wants reformers, pro-west people and not xenophobic patriots”, summarises Yurgens, now the head of the Institute of Contemporary Development.

The new president’s background gives cause for optimism. For a start, he is not from the KGB. Medvedev is a lawyer, the son of university professors, and a fan of rock music who treasures his collection of Deep Purple albums. Within the Kremlin he is seen as the leader of a liberal-minded group of technocrats anxious to complete the process of converting Russia into a modern and rational economy. According to one informed analysis, the new president’s style will be a “controlled liberalism”.

Encouragingly, after his anointment for the top job, Medvedev had no reservations about arguing the case for reform, especially of the judicial system and the legislative process. If nothing else, this is a position that puts him firmly outside the ranks of the siloviki.

Meantime the new president will have a lot to discuss with his opposite numbers at the EU-Russia summit in June, and they with him.

China crisis

The Chinese economy has been growing at breakneck pace in recent years. Annual increases in gross domestic product in the 9-11 percent range mean its economy is now nudging up against Germany for the position of the world’s third largest, having overtaken the UK and France.

That extraordinary economic boom has lifted millions of Chinese citizens out of poverty, inspired economic reform and competition from other countries, and driven global flows of trade, capital and talent.

Western companies that used to see China as little more than a low-cost manufacturing base now see it is an important market in its own right. Many are clamouring to sell their products and services to its burgeoning middles classes. The number of affluent people in three major cities in China with personal annual income exceeding $26,000 will more than triple from 1.1 million in 2005 to 3.9 million in 2015, bankers HSBC predict. MasterCard says the amount of discretionary spending by affluent households in the country’s three largest cities could rise from about $18bn in 2005 to $117bn by 2015.

All this means that the health of the Chinese economy is more important than ever to the economic health of the wider world. Which is why some of the latest trends coming out of the country are causing concern. Two recent surveys from the Chinese central bank show a worrying downturn in economic confidence among the country’s bankers and business people. They fear that rapid economic growth may tip over into dangerous overheating.

In the first survey, 14 percent of companies felt the economy, which has hit its highest point since the first quarter in 1994, was growing too fast. In this year’s first quarter, only 7.9 percent of respondents thought the mainland’s economy was overheating. Those worries pushed a measure called the entrepreneurs’ confidence index down to down to 83.4 percent for the second quarter of the year – the lowest level in two years.

Bankers meanwhile are even more worried about the way things are going, according to the second survey. This showed that the industry’s confidence index plunged to 37 percent in the second quarter – that’s the lowest level ever. At the start of the year it stood at 61 percent. More than two thirds of bankers believe the economy is overheating, compared to just under half who took that view at the back end of last year.

Are these concerns justified? The World Economic Forum warned recently that Chinese industry is at a turning point. Wage pressures, while still mild at the macroeconomic level, are changing costs for many firms. Profits are also shrinking from the revenue side, as domestic competition in the manufacturing sector becomes ever more intense.

Structural factors contribute to the problem, said the report, Global Growth@Risk. With few companies ever declared bankrupt, struggling firms have continuing access to credit and jump into competitor’s product lines or new ventures, rather than innovate to exit the marketplace. It is also easy for new companies to enter a market by ripping off existing products, as intellectual property protection is weak. Again, this leads to increased competition and thin margins, leaving very little capital for investment in research and development and new product lines.

The WEF report calls this a vicious circle, one which the growth of the domestic consumer market can help to break. “As investors begin to take more of an interest in Chinese consumers than in cheap Chinese labour, many have begun to fund the development of local design capabilities,” it says.

China’s dependence on the consumption habits of US and EU consumers is probably its biggest economic vulnerability, according to the WEF. The domestic market is growing – the retail sector is growing at 13 percent and will probably accelerate to keep pace with urbanisation. But the big question is whether the market will grow fast enough to offset any downturn in export markets. If not, then when a downturn does hit the US or EU, “China will be left with huge overcapacity and a cyclical downturn of its own,” the WEF warned.

There are also big institutional constraints to continued growth. China has surprised many western observers with its ability to generate free market-led growth without the types of political institutions generally associated with market activity, says the WEF report. This ‘institutional underdevelopment’ will need to be addressed lest it constrain growth in the near future. One major concern is the judicial and legal system, which still struggles with corruption. Low pay and local appointment and accountability for judges may need to be reviewed. A system of national appointments and rotating jurisdictional assignments could mitigate the possibility of corruption becoming locally entrenched. A freer press would help.

On the political risk side, Chinese growth is also threatened by the rise of protectionism in the West. Seeing the rapid growth of the Chinese economy, and forecasts for future growth that they find frankly alarming, some in the West are calling for action now to stop the potential Chinese domination of the world economy.

China has some levers that it can pull to reduce this risk, such as gradual currency reform and support for imports, “but the most important factors may be the diplomatic capabilities of future US governments and the flexibility of the US economy,” says the WEF report. “The latter will help absorb the effects of globalisation, and the former will help prevent amplification of any backlash.”

Interestingly, and perhaps naively, China does not see itself as expansionist, but as the WEF notes, with amusing understatement: “The rise of a great economic, and potentially military, power cannot help but reshape the attitudes of other countries towards China.”

Another risk to China’s continued economic growth is that the country will fall victim to its own success. The most important social issue in China is rising inequality. The boom may have created a wealthy middle class, but what about everyone else? “If rapid growth creates ‘two Chinas’ it will almost certainly prove unsustainable,” says the WEF.

The risk of growing inequality is something that the country’s leaders have publicly acknowledged, with words, at least. President Hu Jintao, for example, has called for “harmonious growth”.

Demographic changes are important here. People in China can currently retire at as young as 50, and the WEF says the number of working age people in China will peak within the next 10 years. Whether or not this becomes a drag on Chinese growth may depend on how successfully the country sustains growth up to that point. Unlike those in most Western countries, the Chinese government does not hold any retirement-related liabilities. With growth rates still high, however, concern for social welfare and stability has led the government to begin considering national retirement benefits, says the WEF.

The population is moving, too. As many as 400 million Chinese will move to cities in the next 20 years. This migration and urbanisation of the rural Chinese population has the potential to boost productivity and strengthen the development of consumer markets. So far, China has avoided the kid of mega-slums that blight much of the developing world, “but the risk may get worse if urbanisation rates accelerate,” the WEF report warns.

It will be difficult to provide the services and infrastructure required by this growing urban population, but the biggest challenge will be dealing with the environmental impact. Media coverage of the environmental damage wrought by China’s rapid growth has done little to enhance the country’s international reputation, especially ahead of next year’s Beijing Olympics. But environmental damage is also hampering further growth. The WEF report quotes Xinghai Fang, Deputy Director of the Office for Financial Services in Shanghai. “Tai Lake near Shanghai is now completely contaminated and local people can no longer drink the water,” he said. “Air pollution, soil contamination – these are all constraints. Fast growth is important, but environmental challenges are too large for the economy not to slow down.”

In the long term, if China is to secure its economic gains it needs to become an ‘innovation-oriented’ economy. The government knows this, and has made it a goal to achieve by 2020. But if the country is to reach that status, it needs a better return on its fast-rising investments in research and development (R&D) and higher education, according to a new OECD report.

In its first review of China’s innovation system, the OECD said China still had a long way to go to build a modern, high-performance national innovation system. R&D spending had increased at an annual rate of 19 percent since 1995 to reach $30bn in 2005, the sixth highest worldwide. “China has made impressive investments in R&D, human resources and R&D infrastructure to date, at the same time, China has still a long way to go to build a full-fledged and mature national innovation system,” the report said.

Much of China’s investment has focused on the high-technology sector, updating equipment and facilities, and experimental research for new products rather than on basic research, which is the foundation of long-term innovation. The OECD called for more investment in sectors such as services, energy, environmental technology and basic research.

To encourage domestic firms to innovate and benefit more from closer ties with the R&D centres of foreign companies, the government should enforce intellectual property rights (IPRs) more effectively and strengthen competition, said the OECD, echoing the WEF’s comments.

China should improve its governance of science and innovation policy, the report said. Its ability to allocate public resources to support government priorities has played a key role in closing the technological gap between China and the rest of the world. But the design, management and evaluation of programmes could be improved and made more market-oriented.

The central government should also consider creating a mechanism to co-ordinate initiatives more effectively across government departments at the national level and set guidelines to avoid duplication in regional and national science and innovation programmes, the OECD said. Creating an independent agency to monitor and evaluate the success of programmes would also help.

Universities play a key role in China’s innovation system. They run more than one in 10 Chinese science and technology firms, account for one in five patents granted each year and provide venture capital to promising start-ups. Further reform of these public research organisations would help increase the quality and efficiency of researchers: “this is important because current demand for talented managers or highly qualified researchers exceeds supply,” the OECD said.

It warned that, looking ahead, China could also face a shortage of skilled workers in science and technology, despite currently having more researchers than any other country except the US. In recent years, undergraduate degrees in science have even fallen in absolute terms. “China should improve the quality of science education to attract more students, with more emphasis on managerial expertise and entrepreneurship,” the OECD said.

China is already suffering from a chronic brain drain, a trend confirmed by a recent study from the Chinese Academy of Social Sciences, one of the major research and think tank institutes used by the Beijing government. Seven out of 10 Chinese who go to study abroad do not return, it found. Instead of coming home, they take post-graduate courses, get married, take jobs or change citizenship.

The report said this brain drain is a major reason why China still lacks research pioneers who can create an innovative society and economy. Earlier this year the government tried to start reversing the trend by offering a package of incentives to returnees, such as allowing them to earn more than the highly structured scale of salaries permits. But the number of Chinese studying abroad keeps increasing and is expected to be 200,000 a year by 2010. A separate survey showed that 30 percent of high school students in Shanghai and 50 percent of middle school students want to change their nationalities.

And this is a big problem. Booming China is, it seems, a seductive lure to everyone except educated Chinese. While Western businesses see China’s economic boom as an opportunity to enter an enormous new market, many of the brightest people in that market see it as an opportunity to leave. For the boom to be sustainable, that needs to change.

The first line of defence

It was one of the odder cases to come before the Court of Appeal in London during 2007, as a trio of senior judges solemnly studied two different trigger-operated plastic bottles of air freshener spray, to decide whether they were sufficiently different from each other.

However, it was also one of the most important cases of the year, the first time the UK Court of Appeal had given a ruling on the provisions at the heart of new European legislation on design rights, and the court’s detailed guidance, in its decision on the battle between the consumer goods giants Procter & Gamble and Reckitt Benckiser over their respective “Febreze” and “Airwick” trigger spray dispensers, on the key provisions of the new law are going to have huge implications not only for similar disputes in the UK, but right across the almost 30 countries in the European Union.

The attention given to the case, according to David Wilkinson, a partner in the Guildford, Surrey-based legal firm Stevens & Bolton, is a reflection of the increasing importance of “intellectual property rights” in general, including not only design rights, but trademarks, patents, copyright and so on.

Intellectual property disputes “are definitely on the increase,” Wilkinson says. “The reason is that the UK and Western economies generally, are much more knowledge-based than they used to be, with manufacturing having to be done in China and the Far East, which has meant that intellectual property has very much gone up the agenda in boardrooms. The IP rights are in many cases the most significant asset a company has, and therefore they’re keen to protect those rights and see they’re properly enforced.”

Stevens & Bolton employs about 150 people, with 100 or so fee earners, making it one of the largest “outside London” law firms in the South East of England. Much of the work it handles for clients covers intellectual property rights, including protection, infringements, disputes, licensing agreements, outsourcing and so on. Its clients come from all over the UK and internationally as well, including the United States, and their size ranges from largest multinationals to one-man businesses. Most of the lawyers working for the firm had previously worked for one or other of the big-name legal firms in London: “Essentially we’re doing the same kind of work as the City firms, but because of the location outside London, in Guildford, it’s considerably cheaper. That’s the premise on which the firm operates,” Wilkinson says.

Certainly Wilkinson and his colleagues are busy enough, with everything from helping to thwart manufacturers of pirated goods in the Far East to drawing up contracts between companies and their employees that will prevent departing staffers from walking out the door with a firm’s intellectual property “crown jewels”.

The commonest forms of intellectual property dispute “depend on the sector you’re talking about,” Wilkinson says. In the pharmaceutical sector, in electronics, mobile telephones, “that sort of thing the key right would be patents – we see a great number of disputes between companies involved in those areas. In other business sectors, different IP rights have greater importance, for example in what might be broadly called fast-moving consumer goods one, the things you might see in a supermarket, trade marks are particularly important.” Disputes involving design rights, like the one between P&G and Reckitt Benckiser over their room deodoriser sprays, are “increasingly” coming through the courts after the major revision of laws regarding design rights within Europe, Wilkinson says. In the media industries, television film and music, meanwhile, “the key concern is copyright, and if you’re a company in that area, copyright is going to be at the top of your agenda.”

Right now, “if you were to ask people involved in this area what has been the most active sector over the past 12 to 18 months it’d probably be in the field of mobile telephones,” Wilkinson says. That is not so much to do with law as to do with commerce: “It’s the new 3G mobile technology, new standards, new applications, you can do all sorts of new things on mobile telephones now. That has led to a real flood of litigation, not only in the UK but also in the United States, and other jurisdictions in Europe as the companies involved in that sector battle it out. People want to stake out their ground and protect their market position. Eventually it will settle down and people will get on with their lives, but there’s certainly a lot of activity in that area at the moment on the legal front.”

The trickiest disputes to sort out, Wilkinson says, are “where there is some form of personal animosity involved. Just as in a tricky divorce case, if the people don’t like each other that can make it difficult to resolve, and that can apply sometimes in intellectual property cases, for example if the people were former partners in business or shareholders – if they were on each other’s Christmas card list, if I can put it that way. When that sort of situation turns sour, it means that rather than being simply a commercial issue about commercial considerations, other factors come into play which can make it much more difficult to reach a sensible settlement.”

Guarding against people leaving with company “secrets” is “a big issue – I’ve definitely seen a lot of legal activity with regard to departing employees over the past few years and I think partly the reason why we’re seeing more cases litigated is because of the ease with which large quantities of information from a company can be downloaded onto a disk and someone walks out the door with it,” Wilkinson says. “Databases and so on can be absolutely key to a company’s financial performance. If an employee or a group of employees head off into the sunset and take that kind of information with them it can be very damaging indeed.”

There are, however, a number of steps that companies can take to help to ameliorate that kind of problem. “On a legal level it’s important to show that there are appropriate provisions in staff contracts concerning confidentiality,” Wilkinson says. “Also it may be appropriate to include non-compete covenants for limited periods so that people can’t engage in the same business activity for, say, six or 12 months after leaving. The point to make about non-compete covenants is that they can’t be unduly broad, because if they are the courts aren’t going to uphold them. Considerable care has to go into drafting them. So from a legal perspective it’s getting the contractual framework correct.

“But there’s also a lot that companies can do at the practical level, such as ensuring that databases can’t be downloaded onto disks without express permissions, ensuring that there’s password protection in place, regularly changing means of access to a company’s IT system, ensuring that when employees leave they hand over all relevant company information. All those sort of practical steps can help to ensure that they don’t take the crown jewels with them when they walk out the door.”

When it comes to protecting a company’s intellectual property rights from outsiders, Wilkinson says, “a lot of intellectual property rights are susceptible to registration – one thinks of patents, trademarks, design rights – and therefore a company that’s managing its IP well will consider in every case what should they be applying to register, a trademark or a design and so on.

“Once the registration is secured, it can not only act as a deterrent to third parties, they may well decide to go off and infringe someone else’s rights if they know that you’ve taken the time and trouble to secure registered protection. But also it generally means that when it comes to taking action it’s normally easier to do so on the basis of a registered right rather than an unregistered one. If one thinks of trademarks, for example, it’s possible to sue on a registered trademark, it’s also possible to protect a name which has been used in a business context even if it hasn’t been registered but it’s generally more difficult and more expensive to do so.”

On piracy, Wilkinson says, “at this end we work closely with customs and private investigators to ensure that where there is a suspicion of counterfeit products coming in, Customs are alerted and there’s a potentially very effective procedure in place here in the UK, and elsewhere in Europe, whereby offending goods can be seized at the point of entry into the European Community.

“There’s no doubt that organised crime is definitely involved in the field of counterfeits and piracy, and the police recognise that. The same people involved in the drugs trade can also be involved in dealing with counterfeit CDs or DVDs or whatever. Some things have potentially more serious effects than others. A counterfeit DVD you might be disappointed with the quality of the picture. But if it’s a pharmaceutical product, the consequences might be rather more far-reaching.

“We’ve been involved in the garment sector in the importation of counterfeit brand label products. Cigarette lighters is another one which is again potentially dangerous – the evidence was that if the counterfeit product was dropped it might explode, and there had been injuries to children and so on

“Wherever possible, companies who are concerned about potentially taking action in China should try to ensure that they have appropriate Chinese registered protection in place – if it’s a trademark, in other words, try to get it registered in China. Try to obtain a Chinese patent. Because the Chinese courts take Chinese intellectual property rights rather more seriously than they do foreign intellectual property rights.”

While in Europe companies can rely on a European Community-wide system of design and trademark registration, despite much effort there is still a long way to go for a community-wide system of patent protection. ” There’s no doubt that industry generally in principle would favour the idea of a single patent that would cover the whole of Europe because it would be cheaper that obtaining a patent in all the various territories and also potentially cheaper and easier to enforce,” Wilkinson says. “But there are a lot of practical difficulties surrounding the proposals, such as where’s the court going to be to decide Community-wide patents, how’s it going to be staffed, are Community patents going to be translated into all the national languages of the EC, and if so that will be hugely expensive, or will it just be into some languages, in which case some people could be sued for infringing a patent that’s not in their home language, and that could be conceived as unfair.

“I think it may well come along some day but I don’t think it’s necessarily imminent. The language difficulty alone makes it very difficult to create a supernational, Community-wide right in the patents sphere. That’s not to say it’s impossible, we can have Community trademarks, we do have a Community design system, but so far a Community patent has eluded us. There’s a working group which is reported to have made ‘some progress’ towards a Community patent and some specific results are expected in 2008. We’ll have to wait and see. But I don’t think anyone is expecting to see a Community patent up and running imminently.”

One area where there might be legislation, Wilkinson thinks, is in copyright, over the issue of “fair use”. In the United States, he says, “they have a ‘fair use’ doctrine that is quite a broad, vague and fuzzy round the edges concept, but it means that if someone is using someone else’s copyrighted work in a way that is deemed to be ‘fair’, that will not amount to infringement Here in the UK we’ve taken a different approach: we’ve provided literally dozens of specific exceptions to copyright infringement in the statutes, rather than having one general concept of fair use.

“What that has tended to mean is that the exceptions can’t really keep pace with technological change – the issue of ‘user-generated content’ for example, where people upload clips onto, say, YouTube that are seen as infringing copyright. It also means that the statute is very long and very unwieldy. That’s one area where there has been comment from the judiciary that the situation is so complex this is something that legislators might want to consider.”

The problem, Wilkinson says, is already being thrashed out in the courts as, for example, organisations such as the Premier League in England try to prevent people posting clips on sites such as YouTube of scenes from football matches that the League says are its copyright. “User-generated copy, in particular, is seen as the future by media companies, they want to make money from it by advertising to the communities that user-generated content builds up, but it’s a future fraught with legal risk. Because the moment you give people the freedom to post whatever they want on a website that you’re running, you tun the risk that they’re going to post infringing clips, or defamatory material, or who knows what, and you could be potentially held liable for it.” One more headache for companies – one more area for Stevens & Bolton to apply its expertise to.

Further Qatar innovation and growth

Qatar Islamic Bank (QIB), one of the five largest largest Islamic banks in the world, has successfully increased the number of shareholders in the subsidiary Al Jazeera Islamic Company (AJIC). This has been achieved by the successful conclusion of a strategic shareholding partnership in AJIC. QIB offered six million shares to potential investors at QR65 per share, including a premium of QR55 per share, which delivered QR330million profit. Qatar Central Bank has approved the list of the shareholders and has also granted its consent for the restructuring of AJIC as a regulated finance company.

“This is a first step for a new and brighter future for Al Jazeera Islamic Company,” said QIB CEO Salah Jaidah. “Our aim is to unlock the productive potential of AJIC and streamline the enterprise to promote quality of service, efficiency, revenue generation, economic development and employment, as well as competition in the market place.”

When QIB first announced its plan to open up the share holding of Al Jazeera Islamic Company, it said the objective was to sell to potential investors and increase the number of shareholders from two to 10, as per Qatar Central bank requirements. Now this has been achieved, QIB has kept a leading position with 30 percent of Al Jazeera company shares with Al Awkaf (previous partner) keeping 20 percent and the balance sold to strategic partners.

Salah Jaidah declared: “We are proud of the high level of interest that strategic partners had in Al Jazeera Islamic Company and the faith they had put in our future plans. We have completed this project in a short period of time and are delighted with the high level of partners we now have on board’.

In fact, the new shareholders in addition to QIB and Al Awkaf are prominent institutions from both the local and the regional market. They include Qatar National Bank, Qatar Insurance Company and Kuwait’s Global Investment House. Salah Jaidah pointed out: “The new set-up with 10 shareholders is as per the QCB requirements and we will now be able to operate Al Jazeera Company as a regulated financing company”.

Significant growth
With the number of expatriates increasing and the current economy boom, the financing companies’ volume of business is significantly growing and this change in AJIC was made to address the market needs. Al Jazeera Islamic Company will be targeting consumers and small and medium enterprise financing, two sectors showing exponential growth.

Salah Jaidah added: “In addition to the changes in the shareholding, we are also planning an expansion in terms of branches and employees.”

This exciting development follows the signing by QIB of a $300m bridge murabaha and a sukuk mandate. QIB has funded the bridge murabaha for a maximum period of 12 months, financed by ABN AMRO and Standard Chartered.

Salah Jaidah said the bridge murabaha was part of the asset and liability management strategy of QIB. “Both ABN AMRO and Standard Chartered  have funded this bridge on a 50/50 basis and I am very pleased with the highly competitive rate given to QIB, which is a sound proof of the trust international banks have in us and our long term vision,” he added. Over the past 12 months, QIB has been upgraded from BBB+ to A- by both Fitch and Capital intelligence.

Salah Jaidah added that the sukuk was one of the financing instruments that the bank was keen on developing. “The large number of projects and companies in need of financing, along with the large amount of liquidity available in the GCC, makes sukuk the perfect Islamic product to use,” he said. “In the last week of November (2007) we launched the marketing of a $150m sukuk musharaka in Doha, Manama and Dubai for our customer Salam Bounian and we are now preparing to embark on a new sukuk for QIB this time, within the next six to 12 months.”

In addition to the bridge financing, the two banks are also mandated for a sukuk issuance on behalf of QIB. This sukuk is planned to be issued this year and part of it will be used to reimburse the bridge financing. In December 2007, Qatar Islamic Bank organised a workshop on Sharia’a compliant financing instruments at the Euromoney Middle East Debt Markets Conference, to discuss the nascent debt markets of the Middle East, and specifically the GCC.

The conference, held at the Four Seasons Hotel in Doha, Qatar, was opened by his EE Yousef H. Kamal, Minister of Finance and Acting Minister of Economy and Commerce, and brought together some 250 high-profile delegates from around the GCC and international markets, most of them representing financial institutions that are issuers of debt securities in the Middle East, investors in such securities or intermediaries with a significant presence in the market.

QIB took the opportunity to address the very relevant subject of sukuks in their workshop. Sukuks are the Islamic equivalent of bonds that are quickly gaining popularity in the region. “Since conventional, fixed income, interest bearing bonds are not permitted under Islamic law, Sukuks are specifically designed to be compatible with Shariah law,” explained Jean-Marc Riegel, General Manager of Investment Banking & Development Group, QIB. “They have become a force to be reckoned with, and we thought it was time we brought the discussion to the table.”

Structures and regulations
The workshop touched upon an array of related topics, including the structures and regulations for financial institutions, companies and bonds, project financing and Islamic financing.

According to Euromoney, the conference was organised “to promote the benefits of debt capital markets to potential and current issuers within the region and to develop the region’s debt capital market structures, legislation and investor base.” The conference featured keynote addresses by leading regional and international finance experts, but the majority of the time was devoted to interactive Davos-style panel discussions and workshops mandated and moderated by Euromoney. The workshops were organised by such renowned financial institutions as Goldman Sachs, QIB and the Qatar Financial Center (QFC).

The phenomenal growth in the GCC and the Middle East in the past few years has provided local & international investors with great investment opportunities in the government as well as private sectors. This growth is expected to continue unabated, and along with it the demand for financing. “The increasing appetite within the region for Islamic financing via sukuks has played a vital role in matching the needs of borrowers and investors, thus establishing their place in the global capital debt markets” said Jean-Marc Riegel. “Besides, the countries in the Middle East have also realised the importance of global markets, and privatisation has played a pivotal part in the process.”

The global market for Islamic financial products is currently worth around $80billion and, according to some projections, could reach up to $500billion in the years to come as more and more institutional and private investors see Islamic financing as a means to providing liquidity, diversification and sustainable returns.

The added value that sukuks offer to the global capital debt markets is expected to drive their growth, and they might eventually even come to match the existing modes of financing in the conventional debt markets.

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Old world order

The populations of the Group of Seven (G7) leading economies are getting smaller and older. That is a long-term trend, and one that is widely believed to be irreversible. It sounds like good news – generally, it’s only rock-stars who want to live hard and die young; most people would rather live sensibly and die old – as old as possible. But the combination of increased longevity, falling fertility rates, and the retirement of the baby boom generation will mean that, by 2050, in most G7 countries the ratios of elderly people to the working-age population is likely to have doubled. That shifting balance causes potential problems.

A recent report from the International Monetary Fund warned that governments in advanced economies will have to step up their spending on the elderly in coming decades, and should prepare now by strengthening their fiscal positions in the near term. But few are.

Life expectancy
The report cited United Nations projections that show that the old-age population in the G7 countries will increase by an average of 80 percent between 2005 and 2050. Life expectancy in the European Union countries will rise by about six years over the next five decades. Given the age structure of European populations, the old-age dependency ratio is expected to double to about 50 percent from 25 percent, owing to a small decline in the working-age population and a sharp rise in the elderly population.

Those are expensive changes. “Such developments imply a steep increase in age-related government spending in G7 countries ­­– by an average of four percentage points of GDP over the next 45 years,” the IMF report said. Estimates vary substantially across countries, with Canada at the high end (with growth estimated at nine percentage points of GDP), and Italy and Japan at the low end (with growth rising by about two percentage points). The bulk of the spending increase will cover additional health care costs, with long-term care and pension spending accounting for the rest.

Making this sort of long-term prediction is increasingly necessary, but not easy, the IMF said. “Assessing the impact of demographic changes on the sustainability of public finances is complicated by uncertainties about long-term technological, demographic, labour supply, and productivity growth forecasts – especially the strength of the link between aging and health care costs.” Given the uncertainties, governments should plan to fund the worst-case scenarios, the IMF said.

Its report used two measures to assess the evolution of fiscal sustainability for each of the G7 countries and evaluated the impact of policy. Under either measure, the estimated fiscal adjustment needed to ensure long-run fiscal sustainability (i.e. stabilizing fiscal debt at a permanently sustainable level) is large for all G7 countries. It requires an average improvement of 4-4.5 percentage points of GDP in the primary fiscal balance, defined as revenues less non-interest spending, relative to 2005 positions.

Nearly two thirds of the fiscal adjustment reflects the expected rise in age-related spending, while the remaining one third owes to the interest on public debt. The largest primary gaps are in Japan, which had the largest primary deficit and a high debt level in 2005, and the United States, owing to a combination of a high primary deficit and large projected increases in age-related spending. The smallest primary gap was in for Canada, whose primary surplus of 5.5 percent of GDP helps offset the projected impact of the very large expected gains in age-related spending.

Fiscal positions
How well prepared are these countries for an age-related cost crunch? Not very, according to the IMF. It sends the trends leading up to 2005, when its analysis stopped, were ‘disturbing.’ The fiscal positions of all G7 countries except Japan worsened during 2001-05 by 2.7 percentage points of GDP. Even in Japan, whose fiscal sustainability improved over the five-year period, the end-2005 fiscal position was unsustainable.

The IMF said that the main cause of the deterioration in fiscal sustainability in the G7 countries was a worsening primary fiscal balance – which deteriorated by 2.8 percentage points of GDP. The countries showing the sharpest falls were the UK and the US, whose fiscal balances worsened by 5.5 percentage points of GDP.

These countries do seem to be waking up to the problem. The IMF said most G7 countries have recently adopted substantial reforms to contain the growth of age-related public spending, making more progress on pensions than on health care. Over the past five years, for example, France, Germany, Italy, and Japan have passed pension reforms that should bring about sizable savings. “But additional structural reforms or fiscal consolidation in other areas will be needed,” it said. New reforms are also planned, notably health care reforms in Germany and Japan.

Any delay in dealing with the issue will prove expensive, according to the IMF’s analysis. Its report looks at the difference in outcomes if the G7 act immediately, compared to further delay. If a country adjusts its fiscal policy within the next five years, the cost to economic activity would be substantially less and the country would experience gains in long-run output. The economy would grow faster by an average of 0.3 percentage points a year over the next 10 years, according to the IMF. If it delays for 10 years, public debt levels will increase substantially.

Delaying adjustment and allowing public debt to increase implies the need to run permanently larger primary surpluses to service the higher interest costs on the debt. On average, the primary balance required to stabilise public debt on a sustainable basis is 1.1 percentage points of GDP higher in the end than in the immediate adjustment scenario, the report said. Delayed adjustment also entails lower economic growth over the next 10 years, owing to increasing crowding out effects and a large rise in payroll taxes.

Fiscal adjustment
When those factors are added up, early fiscal adjustment can be expected to deliver a permanent economic output gain averaging about two percent of GDP, said the IMF, while “postponing adjustment increases the size of the fiscal adjustment ultimately required to restore sustainability.” Given the upside risk to fiscal spending pressures, early fiscal adjustment would also allow greater fiscal scope to absorb any higher-than-expected age-related spending needs. “The sooner G7 countries begin to adjust their fiscal positions the better, both for their own fiscal sustainability and for long-run growth,” it said.

An ageing population isn’t a problem solely for the G7 countries to worry about. In China, for example, the authorities have warned that an ageing population could erode its position as the world’s major supplier of low-cost labour. There are currently six workers for each retiree in China, but that could narrow to two-to-one between 2030 and 2050, the National Committee on Ageing says. Officials say the economy will suffer as there will be fewer people working and more older people to support. “We might encounter the heaviest burden especially after 2030, when the demographic dividend is set to end,” Yan Qingchun, deputy director of the office of the ageing committee, told China Daily. “With fewer people of working age and more pressure in supporting the elderly, the economy will suffer if productivity sees no major progress,” he added.

The change is partly because of improvements in healthcare and China’s one-child policy, but also because fewer couples are having children. Estimates say that by 2050, the number of over-60s in China will climb to 437 million – more than a quarter of the population. Zhang Kaidi, director of the China Research Centre on Ageing, told China Daily that the country is “not prepared” for the problems presented by an ageing population. He warned that the authorities need to “allocate more funds to build a comprehensive and efficient system of support for the elderly.”

Age proportions
Other countries face the same challenge. According to the United Nations, the proportions of older persons (60 years or older) are increasing at the same time as in the proportions of the young (under age 15) are declining. By 2050, the number of older persons in the world will exceed the number of young for the first time in history. Moreover, by 1998 this historic reversal in relative proportions of young and old had already taken place in the more developed regions.

The UN predicts that population ageing will have an impact on economic growth, savings, investment and consumption, labour markets, pensions, taxation and intergenerational transfers. In the social sphere, population ageing affects health and health care, family composition and living arrangements, housing and migration. In the political arena, population ageing can influence voting patterns and representation.

Population ageing is enduring, the UN says. During the twentieth century the proportion of older persons continued to rise, and this trend will continue into the twenty-first century. For example, the proportion of older persons was 8 percent in 1950 and 10 percent in 2000, and will to reach 21 percent in 2050.

It is also largely irreversible. The increase in the older population is the result of the demographic transition from high to low levels of fertility and mortality. As the twenty-first century began, the world population included approximately 600 million older persons, triple the number recorded fifty years earlier. By mid-century, there will be some two billion older persons–once again, a tripling of this age group in a span of 50 years. Globally the population of older persons is growing by two percent each year, considerably faster than the population as a whole. For at least the next twenty-five years, the older population will continue growing more rapidly than other age groups. The growth rate of those 60 or older will reach 2.8 percent annually in 2025-2030. Such rapid growth will require far-reaching economic and social adjustments in most countries, the UN says.

As the pace of population ageing is much faster in developing countries than in developed countries, developing countries will have less time to adjust to the consequences of population ageing. Moreover, population ageing in the developing countries is taking place at much lower levels of socio-economic development than was the case in the developed countries. The G7 might be slow to respond to the economic challenges laid down by an ageing population, but developing nations will not have that luxury.

EU to stick to climate plans

At stake, as pointed out by Commission President Jose Manuel Barroso, is Europe’s credibility in claiming to lead the world in the fight against global warming. European Union leaders agreed last March to cut greenhouse gas emissions by 20 percent in 2020 from 1990 levels, as well as use renewable sources for 20 percent of power production and biofuels for 10 percent of transport fuel by the same date.

The Brussels executive will propose how to share the burden of cuts in carbon dioxide output and of increased use of renewables such as solar, wind and water power and biomass. It will also unveil a major reform of the European Union’s emissions trading system (ETS). “Our package is a demonstration of our willingness to put our money where our mouth is,” Mr Barroso told the European Parliament, reacting to a torrent of letters of special pleading or protest from governments and industry lobby groups.

Despite the noise, officials say the EU is well on its way to meeting the targets. However, green campaigners say they are insufficient to arrest global warming and lack ambition, falling below the 25-40 percent emissions cut by industrialised nations called for by a UN climate change conference in Bali, Indonesia.

“Coming up with just a 20 percent proposal goes against both the scientific advice on what is needed to prevent a climate crisis and the moral obligation entered into in Bali,” said Stefan Singer of the environmental campaign group WWF. “It would give a very bad signal to the rest of the world.”

Design flaw
Brussels responds that the 27-nation EU is prepared to raise its target to a 30 percent cut by 2020 if other major industrialised and emerging economies join in reductions. Under the Commission plan, half the EU’s emission reductions are to come from the ETS, which almost collapsed when the price of carbon crashed in 2006 after it turned out member states had allocated too many permits to emit to their industries.

To overcome what Brussels sees as that design flaw, the Commission will in future set EU-wide emissions limits for all sectors covered by the trading scheme, and most permits will be auctioned off instead of handed out for free. Representatives of big utilities, oil refiners and industries such as steel and aluminium have warned that making them buy permits at auction will force up energy prices and could drive heavy industry out of Europe.

Brussels is set to shrug off many of those protests, pointing to the utilities’ healthy profits, although last-minute wrangling continues over the scope of auctioning and pace of its phasing-in, EU officials say. The other half of the EU’s emissions cuts will have to come from buildings, heating and cooling and transport, with each country receiving a target for CO2 reductions and a separate goal for increasing renewable energy use.

The Commission’s main yardstick in setting national targets is gross domestic product per capita. The richest EU countries will be expected to cut emissions by 20 percent from 2005 levels while the poorest new member states will be allowed to emit up to 20 percent more by 2020 to allow them an economic catch-up.

Some countries such as Sweden fear a double blow because they are rich and already use a lot of renewable energy. With its many hydroelectric dams, Sweden is top of the EU class, drawing 39.8 percent of power from renewable sources, while Britain, despite its green preaching, is second-bottom with just 1.3 percent.

France meanwhile is demanding special consideration because it gets most of its electricity from low-carbon nuclear plants and its emissions are 25 percent lower than the EU average. Germany and Spain object to tentative plans to allow companies to trade renewable energy, which they argue could wreck their successful schemes that provide a guaranteed price and grid access to renewable power generators.

Grand coalition
But Berlin endorsed the EU’s expected renewable target on Thursday, when Environment Minister Sigmar Gabriel told parliament: “For us in Germany it means roughly doubling our use. The grand coalition and the cabinet already agreed that we will meet this goal for renewable energy and this was a great success for co-operation in this coalition.” Despite all the special pleading from utilities, heavy industry and member governments, Commission officials say the EU targets will not be very hard to achieve.

One official involved in preparing the package said that according to Brussels’ projections, the EU will already have cut emissions by 15.9 percent in 2010 from 1990 levels. It should not be too tough to achieve the extra 4.1 percent cut over an entire decade, especially since aviation and car emissions will be cut under other EU policies now in the works. 

Profits forecast for clean energy

Climate change has been on investment banks’ radar screens for more than a decade. But the promise of high returns from the renewable energy sector has until recently failed to materialise.

Progress has been hindered by regulatory tussles about emissions, unproven technologies, weak performance from some public companies, difficulty in valuations and patchy investor demand.

However, investment bankers expect this year to be the one when the sector delivers. They spent the past 12 months building their teams to take advantage of the well-financed wave of companies focused on emissions technologies, clean coal and other forms of new energy technologies.

John Cavalier, head of alternative energy investment banking at Credit Suisse, said: “Some people say this is a bubble and a fad. We know this is for real and people need to understand that climate change is a scientific reality. We believe the drivers today are permanent drivers.”

Alternative energy
Andrew Safran, global head of energy, power and chemicals investment banking at Citigroup, said: “The alternative energy sectors, while not huge today, will become important for us.”

Most of the large banks, including Morgan Stanley, Citigroup, Merrill Lynch, Credit Suisse and Goldman Sachs, have between 10 and 20 full-time staff devoted to the sector. The heads of these groups have proceeded with caution and despite a few hires, such as the move of Jim Metcalfe from Lehman to UBS, most staffing has come from internal moves.

Citigroup started a renewable energy task force 18 months ago. Credit Suisse and Merrill Lynch have created bank-wide committees to oversee clean technology efforts that range from Asia to the US and include sectors such as utilities, industrials and food and beverage.

The banks are also making principal investments in the sector and boosting their carbon emissions trading desks.

Parker Weil, co-head of the Americas energy and power group at Merrill Lynch, said: “Co-ordination is critical to ensure the firm is consistent in the technology bets we make around the world.”

Factors boosting the importance of clean technology include the rising price of oil, which touched $100 a barrel last week, the high cost of building coal and nuclear plants and the political focus on global warming.

Even the US, with the Lieberman-Warner climate change bill, and China, with Premier Wen Jiabao’s vow to plough $300bn (€204bn) into energy-efficient and environmental-friendly sectors, are beginning to join the global consensus on measures to tackle climate change.

But Europe remains the standard-bearer, according to Kevin Genieser, head of the alternative energy practice at Morgan Stanley. He said: “Europe took the lead in developing clean energy technologies, which were much more accepted there. Europe was quick to recognise the potential for growth.”

Between 2002 and 2006, clean technology investing tripled to $63.3bn, according to New Energy Finance, an industry research group. Weil said: “My sense is the sector will continue growing, supported by the tremendous amount of capital that has been raised by funds looking to invest in renewable energy.”

A fund from Riverstone, a private equity company specialising in the energy and power sectors, is looking to raise up to $4bn, according to market sources.

Clean energy
Tim Kingston, head of power and renewable energy investment banking at Goldman Sachs, said: “We recognised early on the importance of clean energy, particularly as it relates to clients across several industries, including utilities, unregulated energy, technology and general industrial.

“We are also involved with the venture capital community in California to help further develop opportunities.”

There is more worldwide recognition of climate-change issues as well as a greater financial infrastructure to support it. The large investment banks are working with exchanges to support markets for renewable energy.

Last month, the New York Mercantile Exchange created the Green Exchange to provide futures, options and swap contracts for markets focused on climate change and renewable energy.

The venture includes Morgan Stanley, Credit Suisse, JP Morgan, Merrill Lynch, Tudor Investment, Icap, Constellation Energy and Evolution Markets. The market will start trading in the first quarter and is expected to be an official exchange within a year.

In addition, Credit Suisse is launching the Credit Suisse Global Alternative Energy Index this month. Last year, new energy companies launched equity offerings, including initial public offerings totalling $20.8bn, triple the volume in 2006, according to investment banking research provider Dealogic. That reversed a three-year trend in which equities volumes for clean technology companies fell steadily.

Cavalier said: “When you have growth rates of 35% to 40% annually in solar and wind and you see about $75bn in capital spent last year growing to $100bn, you sense there is going to be a large amount of capital markets activity to fund the growth rate.”

Investor demand appears to be improving globally for public financings. In December, the $6bn IPO of alternative energy spin-off Iberdrola Renovables was 1.5 times subscribed by international institutions and sold 65% of the offering to institutional investors outside Spain.

Yingli Green Energy held a $173.6m follow-on and a $150m convertibles offering in December 2007; the follow-on was priced 182% above the IPO price from six months earlier. The convert lured 115 investors who made the offering seven times subscribed, according to the bookrunners.

Mature business
But it is rare to find companies seasoned enough to go public. Safran said: “In mature businesses, you are valuing a lot of companies at a multiple of cashflow. In the alternative energy sector, you do not have cashflow because the companies are in their infancy or growing.”

The sector is small and highly fragmented. The market capitalisation of the renewable energy sector is less than $1.3 trillion, according to Morgan Stanley. Renewable energy makes up less than 10% of the revenues from the energy groups of most investment banks.

In addition, the technologies have impediments. There is a backlog for manufacturers of wind turbines, for example. Ethanol is too corrosive to ship through pipelines. Geothermal power from geysers cannot travel far. Solar power is waiting for more efficient fuel cells. And coal gasification is an unproven technology.

Performance has been variable among sectors. While ethanol was a notable bust, solar companies have performed better. Credit Suisse said the market capitalisation for pure-play solar companies has jumped from $1bn in 2004 to $118.3bn.

The bank estimated the wind sector, which has been developing for more than 10 years in Europe and about five years in the US, could bring in annual revenues of $10bn to $12bn, most in commercial-bank debt.

Weil said: “Many projects will be funded through increased equity component, tax credits and more expensive debt. Increased debt costs of 100 to 200 basis points will decrease the equity returns of some of these projects but the overall need for renewable energy will justify the investment.

Most of the popular sub-sectors do not rely on debt, however. Throughout last year, the breakdown of investment banking revenues by product is confined to equities and M&A but includes debt funding.

Between 2005 and 2007 Credit Suisse’s renewable energy team underwrote 14 debt financings, advised on 13 M&A deals and worked on 20 follow-ons and IPOs. Citigroup’s team has done 15 transactions in M&A and equity.

No bank dominates the renewable energy sectors. The top five advisers in renewable energy mergers in 2007 were Goldman Sachs, Citigroup, Deutsche Bank, Lexicon Partners and ING, according to Dealogic.

In the pitchbook that Credit Suisse provides to clients, the bank ranks itself among the top three leaders on deals worth more than $50m, holding court at the top of solar volume with Morgan Stanley, wind volumes with Goldman Sachs and ABN Amro and biofuels between Morgan Stanley and UBS.

The global nature of the business provides an opening for banks that might be listed in the second-tier in M&A and equities. ING, Dresdner Kleinwort and ABN Amro appear prominently in alternatives because of the importance of the Netherlands and Germany to the wind, solar and biofuel sectors.

Investors flock to ‘safe haven’ gold

The recent crisis in America’s subprime mortgage market sent ripples through stock markets across the globe. The ensuing panic-selling by jittery investors resulted in a worldwide slide of share prices and the threat of serious economic consequences. This, alongside several interest rate cuts from the US Federal Reserve Bank, has sent the dollar sharply lower.

A widespread loss of investor confidence in the banking system and traditional investments has led to a ‘flight from risk’, where investors look to a safer investment option, such as gold, which has proven itself to be a safe haven in times of financial crisis.

This is the conclusion of recent research commissioned by the World Gold Council (WGC) which examines the performance of gold compared with other mainstream assets during the current credit crisis as well as during significant periods of financial distress in recent history.

The WGC analysis looked at gold’s performance in the aftermath of 11 September, 2001, the bursting of the bubble and the Asian currency and rouble crises, showcasing gold’s role as a portfolio diversifier and safe haven cushioning investors against losses.
2007 credit crunch

The current credit crisis saw gold initially underperforming as it was liquidated to cover losses in other assets. However, as tensions mounted, investors looked to gold as a ‘safe haven’ investment and it has since been the best performing asset in all major currencies, apart from oil.

The WGC report tracked gold’s performance against the major bond and equity markets, the G-6 trade-weighted dollar and oil for two significant periods in the financial markets in 2007 – 25 February to 25 June and 26 June to 26 September.

In the first period gold underperformed as investors remained unconcerned about growing tensions in financial markets (See Chart: Gold vs other asset classes, ‘credit crunch’ 2007). However, as the threat of financial crisis became more evident in the June to September period, gold outperformed the major equities and bonds, overshadowed only by oil. Gold also gained 9.6% in trade-weighted dollar terms in this period.

From September onward, gold has been the clear outperformer as investor nervousness has ebbed and flowed and the dollar has been under heavy pressure. Gold has also been shown to be the strongest performer in all major local currencies.

Gold after 9/11
In the weeks following the terrorist attacks of September 11, 2001, shock waves were sent through stock markets worldwide. Heightened political tension and panic-selling in the immediate aftermath saw the gold price fall from $287 to $279. In the following weeks, investor interest in gold increased, with people viewing it as a safe haven that would cushion portfolios against further losses. A flight into gold followed as equity markets and the oil price lost ground.

After the attacks, the world’s markets continued trading and it took Wall Street only one week to become fully operational again, providing a great boost to investor confidence. This new-found confidence was the reason for gold’s underperformance in October 2001, as investors took an optimistic view of the medium term and sought out value in the equity markets.

In the three months from September 11 onward, the bond markets were the strongest performers in the UK and eurozone, and equities were strongest in the US and Japan. Gold was the second best performing asset in three of the four regions.

The bubble bursts
Spring 2000 saw the burst of the technology equity bubble, with the overall market decline lasting from 10 March to 14 April. The technology-heavy NASDAQ dropped 34 percent over the period; while the S+P and gold fell by just three percent. The immediate investor reaction to the bust was a flight to gold and bonds, although, over ensuing weeks, the bond market was the primary beneficiary of investor nervousness.

It took until the end of June for investor confidence to filter back into the markets. From March to June 2000, equities were the strongest performer in the US, while gold was the strongest in the UK and bonds the strongest in Europe and Japan.

There were a number of reasons for gold not being the strongest performer in dollar terms over this period – including the independent strength of the dollar, central bank gold sales and earlier investment activity that had taken place in 1999 as investors became concerned about possible ramifications of Y2K at the turn of the millennium.
Asian currency and rouble crises

The close of the 1990s was a time of financial upheaval. It began with the crisis in the Asian economies, followed by the rouble crisis in Russia and problems at Long Term Capital Management (LTCM). The period of stress spanned from July 1997 to April 1998 and during this time gold’s performance was mixed.

During the Asian crisis, gold found itself under pressure, but this can be seen as confirmation of gold’s role as a safe haven, rather than an argument against it. The Korean government found itself in particular difficulty. After the fall of the Korean won, the country’s government offered to buy gold from the populace, which was subsequently sold on the international market to raise much-need dollars to meet Korean international debt obligations.

In the spring of 1998, the rouble crisis developed as the government in Russia worked to maintain the rouble’s exchange rate steady against the dollar despite increasing internal strain. The government was forced into devaluation in August and the rouble subsequently floated in September.

Gold’s immediate response in September was minimal, but the metal’s comparatively low volatility over this period reinforced its use as a stabiliser in investment portfolios.

Golden days
Gold cannot be considered a panacea for all ills. The performance of the price depends heavily on the nature of the external problem. Where geopolitical tensions are involved, the price tends to rise as investors use it as a hedge against risk and for its portability and universal acceptance as a currency. For the gold price to rally in the wake of a crisis there generally needs to be an element of financial tension that could have an impact on the smooth running of financial markets.

The report also stressed that while dollar weakness has been an important element in contributing to the rally in the dollar gold price during the recent credit crisis, it is not a necessary condition. It also highlighted that gold has acted as a safe haven for investors across the globe, and worked as a hedge against both equity weakness and tensions in the bond markets, although the relationship with equities was generally found to be stronger.

SEPA – simpler, faster, safer

At the end of last month, January 28, the European banking industry implemented a process that will make it simpler, faster and cheaper to transfer money across national borders. This is the first visible outcome of an ambitious project to harmonise and modernise the retail payments market in the European Union. More practical steps will follow, bringing benefits to bank customers across Europe, and opening up new opportunities for the banks themselves.

Single Euro Payments Area (SEPA) is the name of the project that harmonises rules for euro payments. It will enable bank customers to make more efficient payments in euro, irrespective of their location. The European Central Bank (ECB) and the national central banks of the Euro system have a keen interest in the efficient functioning of the financial system. We are fully committed to help making SEPA a success.

Opportunities for Europe
The SEPA project is an important step towards more financial integration in Europe. It removes the fragmentation in the retail payments markets by introducing a single set of payment instruments or services for euro payments. SEPA is also introducing equal access conditions to payment services or products, thereby ensuring that market players are treated equally across Europe.

With its harmonisation and restructuring efforts, SEPA is a crucial driver for opening up the different national retail payments markets, encouraging European-wide competition and fostering innovation. Banks and other payment service providers are able to offer their services in different European countries, which will intensify competition to the benefit of European citizens. SEPA is also increasing the possibilities for economies of scale and scope, for example in the processing platforms, and is thus stimulating investment opportunities. Indeed, SEPA allows for more rationalisation, consolidation and expansion, all of which we already see happening now.

SEPA will also bring opportunities for corporates and customers as it will simplify their euro payments and allow for cost savings. From one single account it will be possible to reach all other accounts in Europe. Merchants and corporates will also benefit from more efficient processes and common standards for their payments. And payment cards will be used more widely, which will ultimately reduce the costs of cash handling. The introduction of chip and pin for every card will further improve customer safety and convenience.

SEPA will initiate a modernisation process in Europe, which will bring new and innovative products. The SEPA instruments, which have been designed for credit transfers and direct debits, are the basis on which further developments will be made. Several future-oriented initiatives, such as e-invoicing, online payments (web-retail) and mobile payments, permit efficiency gains for customers. For banks, SEPA is an opportunity to reach wider audiences and new sources of revenue.

Challenges of SEPA
SEPA has already led to many changes in the banking industry and will continue to bring new challenges in the years to come. The banking industry is facing in particular three main challenges, which are of a technical, commercial and legal nature respectively. The industry must address these challenges together by removing the barriers that exist between the current national payments markets.

A first challenge is of a technical nature. So far, the banking industry has been very successful in developing common technical standards that enable the smooth connection of systems and the transfer of messages between different banks in Europe. Technical standards are the basis for payment systems, ensuring the transfer of funds. In the years to come the industry should further deepen and widen its standardisation efforts, which could lead to new challenges. National fragmentation through different standards, e.g. in the customer-to-bank space, should soon belong to the past and common standards should be in place. The Euro system fully supports the work of the industry in this field and encourages the adoption of international best practices and standards, such as those developed by the International Standards Organisation (ISO).

A second challenge is of a commercial nature. With SEPA, the banking industry has developed new rules and business practices for euro payments. These are referred to as the ‘rulebooks’ that ensure common treatment for transferring funds in Europe. In particular, the banking industry has agreed on the common rulebooks for credit transfers and direct debits, and two frameworks, one for card payments and the other for clearing and settlement mechanisms. The Euro system fully supports the banks’ work in this field. The challenge for the industry is to develop common rules that will allow different entities to provide more innovative services throughout Europe. The younger generation of bank customers in particular increasingly prefer online and mobile transactions, and a solid common framework for Europe must be developed.

A third challenge is of a legal nature. For a long time the national regulatory differences in Europe hindered the provision of efficient and automated services across borders. The Payment Services Directive will remove these legal barriers. The Directive will create a clear and homogenous framework for making payments in euro, and should be transposed by November 2009 at the latest. The Euro system strongly supports the work on the Directive as it will provide the legal certainty that is necessary for operations across Member States. A coherent and early adoption of the Directive is imperative for the banking industry, as it will facilitate the implementation of SEPA. The European Commission and the ECB are therefore closely monitoring the implementation of the Directive into national legislation.

A bright future
The ECB’s outlook for SEPA is a truly integrated market where all euro payments are treated as domestic payments and the level of safety and efficiency meets customers’ needs. To realise the SEPA vision, strong commitment from all the stakeholders is required.

The banking industry has showed its commitment to the project and has laid the foundation for a new payments landscape in Europe. In January 2008, with the launch of the new SEPA credit transfers, the future begins in Europe. The SEPA direct debit will be launched in a second wave, during 2008-2009.

The success of the single euro payments market, however, does not only depend on the alignment of national practices or on banks developing new services; it also requires economic actors in all countries to change their habits. The banking industry, therefore, must continue its work and engage customers in the further development of SEPA. The modern, informed and demanding European customer wants an attractive offer and future-oriented products and services.

The ECB and the national central banks of the euro area are supporting the developments of SEPA, and will pay particular attention to ensure that the new landscape has all the characteristics of an integrated market which benefits customers. The ECB is acting as a helping hand or ‘catalyst’ for private sector initiatives and is monitoring the progress of SEPA. As a catalyst, the ECB is making special efforts to foster collective action that facilitates financial integration and provides better services for customers. In this respect, the ECB is paying particular attention to providing clarity on all features of direct debits, addressing the need for at least one additional European debit card scheme and ensuring the reach ability of banks.

SEPA has initiated the necessary developments that will bring Europe closer to enjoying an integrated and sophisticated retail payments market. It is now up to banking industry to not lose momentum and to maintain its efforts to develop further ‘state of the art’ products and services.

Setting the foundations

The economy grew by over four percent in 2007: What are the projections for 2008 and which sectors are expected to drive this growth?
Calendar 2007 represented the sixth consecutive year of growth in real GDP and this expansion should persist into 2008. During the coming year, growth is expected to slow down somewhat to three percent to 3.5 percent with some weakening in both the traded and non-traded sectors.

The expected expansion in the economy in 2008 is more in line with the long-term trend for Barbados. None of the foreign exchange earning sectors is expected to achieve two percent growth.

The economic activity will therefore be driven mainly by the construction and distribution sectors and these will again spur expansion in utility usage, transportation, storage, communications and other services.

What impact do you think the declining US dollar will have on economic growth in Barbados given that the Barbados dollar is pegged to the US dollar at $2 to $1?
Since the Barbados dollar is fixed to the US dollar, the decline in value of the US dollar will not impact on trade and other transactions with the US itself. This is in Barbados’ interest since the US is Barbados’ leading trading partner. The fall in value in the US dollar, however, should encourage increased numbers of visitors from the UK and Europe since a holiday in Barbados would now be cheaper. Conversely, goods and services imported from the non-dollar countries will be more expensive. So that the net impact on the external current account will depend on the relative strengths of increased tourism expenditure and higher payments for imports.

Given the increasing likelihood that your major trading partner, the US, will go into recession during the year, how can new monetary and financial policies help to protect the Barbadian economy?
During 2007 a decision was taken to alter the way the Bank does business in two important areas. Firstly, as part of a package of financial liberalisation measures, the Minister of Finance decided that the Bank would be given the right to change its benchmark interest rate without reference to him. This initiative will enable the Bank to respond more quickly to negative trends in the macroeconomic environment by shortening the lag period associated with monetary policy.

The Bank is also seeking to rationalise its toolkit of monetary policy measures so that they are more focused on particular objectives and can deliver the desired results. To this end the Bank expects during the coming year to be able to rely more market related instruments in determining monetary policy measures. Open market operations which are already in use in some other Caricom countries are intended to make the financial sector more efficient by improving the quality of intermediation and channeling resources into their most productive use.

Barbados is also committed under the agreement which establishes the Caricom Single Market and Economy (CSME) to virtually liberalise its capital account for transactions with other Caricom countries. It is expected that such a move will attract additional foreign investment to Barbados. Concomitant with capital account liberalisation the Bank is co-operating with commercial banks to devise a monetary system which will still enable it to track foreign exchange flows. Such monitoring will, inter alia, help to identify speculative inflows which are potentially destabilising when they are reversed.

How is the country managing the inflationary pressures occasioned by the volatile petroleum and other commodity prices?
Policy options in this regard are limited since inflation in Barbados is largely determined abroad. To the extent that some of the price increases derive from institutional features and the structure of the distributive sector, the Government has already met with key players and agrees to reduce taxes on a range of consumer items. There has also been agreement in principle by major distributors to cut their profit margins. Moral suasion is being used to persuade consumers to rely more on domestically-produced goods wherever possible. In the case of petroleum products there are possibilities for conservation by modifying travel habits and the consumption of energy generally.

How is Barbados adapting to the on-going changes in the global environment with respect to: trade in goods and services, financial sector regulation; Basel II; anti-money laundering and countering terrorism financing, and auditing and governance standards?
The two sectors which are most affected by the trade liberalisation are manufacturing and agriculture. For more than a decade the Government of Barbados has been assisting entities in these sectors in adapting to the new trade rules. While the Government has sought to comply with the requirements of the World Trade Organisation (WTO) it has also provided manufacturing firms with incentives to purchase new plant and equipment and assistance with improving the quality of their products. In the sugar industry a decision has been taken to reorient production away from raw sugar towards special sugars (whose income elasticities are much higher) and ethanol for fuel. Simultaneously, efforts are continuing within the framework of the Regional Negotiating Machinery to get the WTO to reorganise the special needs of small developing countries.

In the area of financial sector regulation the Central Bank has taken the lead in ensuring that practices and legislation are up to international standards. This covers areas such as Basel II, corporate governance, liquidity and credit risk as well as business continuity. In this regard, the Bank has recently partnered with a regional entity in hosting a highly-successful seminar/workshop on operational risk management for financial institutions.

With respect to legislation, the Bank continues to issue guidelines pertaining to corporate governance, as well as anti-money laundering/financing of terrorism. During the last two years, necessary amendments were made to the Financial Institutions Act and the International Financial Services Act in order to make them more relevant to the financial services sector. In addition, work continues on preparations for implementing Basel II, including completion of guidance notes and training sessions for the industry.

Offshore banking and financial services have become an increasingly important source of foreign exchange and economic growth. But as competition increases and standards keep rising, what is Barbados’ strategy to remain competitive?
Barbados has a number of attractive attributes which can help it to remain competitive as a provider of financial services. First of all, it has a reputation as a stable democracy where there is the utmost respect for the law. It is very important to a prospective investor to be assured that there is little or no political and social risk associated with doing business in a country.

Secondly, as was mentioned before, the laws and regulations which govern the financial sector are best practice and in the few areas in which there are deficiencies there are on-going efforts to correct them.

Thirdly, Barbados has a large and growing number of skilled professionals who are highly competent in their respective fields. These include accountants, lawyers, wealth managers and tax and insurance specialists. They have helped the country to acquire a reputation for service excellence which is so important to clients.

Also important is the standard of living in Barbados which is similar to that to which the average North Atlantic investor is accustomed. The country is ranked as the world’s leading developing country by the United Nations. Its demographic and social indicators are similar to those in developed market economies and its spending on health and education ranks among the highest in the world for a small country. Investors from North America and Europe therefore feel more comfortable doing business in Barbados than in some other developing countries.

The CARICOM region offers a market of approximately six million people. Since the inauguration of the Caricom Single Market (CSM) in 2006 what have been the benefits to date for Barbados’ financial market?
There is little doubt that the inauguration of the Caricom Single Market has helped to deepen the financial market in Barbados. More regional companies are now listed on the local stock exchange, providing Barbadian residents with additional investment options.

There is also now more interest on the part of regional investors in investing in Barbados and a growing number of Barbadian nationals are keen to invest in the region. Inward investment clearly provides additional liquidity in the local market and this can potentially attract more participants. When Barbadian residents are able to invest in the region without restriction it will allow financial resources to fetch their most productive return, especially when high levels of domestic liquidity prevents this in the domestic economy.

Where do you see Barbados in the next 10 years?
At the end of the next decade Barbados should be well on its way to achieving the developed country status for which a deadline of 2025 has been set. It has already laid the foundation for this goal by building a stable democracy with political stability, high living standards as well as excellent physical and social infrastructure. Based on the wide-ranging economic reforms which have already been implemented, the economy should be in a position to raise the average annual rate of economic growth to around five percent, from the current three percent or so. A higher rate of growth, coupled with a change in the structure of production will enable the country to earn the foreign exchange which is so vital to economic diversification, job creation and continued improvement in living standards.

Power giants search for new energy boost

A combination of a growing worldwide demand for power and a shortage of top-level staff has created a highly competitive market for the people with the right talent. “It’s a very good time to be an engineer,” says Tony Ward, a director in the energy, chemicals and utilities group at Ernst & Young. The flip side of the coin, though, is that it is not such a great time for the companies doing their best to retain or recruit suitably qualified staff to drive their projects forward.

The scale of the problem was brought sharply into the spotlight when it was revealed that the global oil and gas industry faces a 15 percent shortage of qualified engineers by 2010 – a shortfall of between 5,500 and 6,000. According to Pritesh Patel, of consultants Cambridge Energy Research Associates (CERA), the industry faces the prospect of leaving up to 15 percent of posts vacant over the next two years.

There are already too few engineers to meet exploration and production project demand and this is perhaps reflected in the way that last year (2007) BP postponed several deepwater developments in the Gulf of Mexico, including Tubular Bells, Dorado and Puma. The company partly blamed “resource constraints” for this delay.

Expert forecasts predict that global output from deepwater projects is due to rise from four million to 11 million barrels of oil per day by 2017. But Pritesh Patel warns that these figures as based on the industry avoiding major delays – and points out that the shortage of engineers has been building up over the past few decades.

The Middle East and Libya accounts for 20 percent of global projects adding productive capacity up to 2011, according to CERA. It is also the region requiring the most manpower during this period, with 35 percent of global projected total. Experts point to a critical bottleneck being the shortage of skilled staff, with an industry workforce dominated by people nearing retirement and inexperienced graduates. Libya, in particular, could suffer more than most through an expected shortage of engineers and other oil personnel, according to CERA.

Conventional and nuclear
The sector’s problems are compounded by the fact that competition for the oil and gas industry’s talent is expected to rise in the next few years as both conventional and nuclear power plants are built. Some companies have responded by opening new training centres in south-east Asia, but their trainees will not gain the skills to manage, much less design, major projects for several years.

Large oil and gas producers have the advantage over smaller rivals through their ability to offer longer contracts and better rates of pay. They are also increasingly aware of the need to add a raft of incentives, so staff stay in their employ and qualified newcomers are drawn in.

At Devon, the largest independent oil and gas producer in America, company president John Richels personally sends birthday cards to each and every one of his 3,478 US-based workers. Devon also hold regular office social gatherings, such as picnics, and host a lavish Christmas party for workers and their partners. Part of the company’s enlightened campaign has involved the appointment of a senior level executive, senior vice-president of human resources Frank Rudolph, to tackle the retirement crunch head-on.

“A lot of little things make the difference,” says Mr Rudolph. These include includes an ongoing kid glove treatment of prospective new recruits. Senior executives escort them on a field trip to a gas field in Texas, and when the students return to university they are kept in touch with the company thanks to emails and phone calls from Devon workers and even care packages of food and drink during final examinations.

The need for this constant PR campaign is apparent when it is considered that about half of Devon’s 5,000 employees will reach retirement age in the next decade. Elsewhere, the picture is equally challenging. CERA predicts that more than a half of today’s engineers, whose average age is 51, will retire by 2015, an erosion rate of six percent per annum.

An influx of new entrants will offset this by five percent by 2010 – but there will be a knowledge gap, says Pritesh Patel. A survey of the industry’s human resource leaders revealed the personnel crisis was a “top five business challenge” for financial growth, according to Dina Pyron, an Ernst & Young partner and HR specialist.

Lost benefits
In the face of this problem, Chevron, the second largest oil company in America, is attempting to retain staff by calculating their retirement benefits every year, so they are constantly aware of the benefits they stand to lose if they switch to another company.

Chevron are also very conscious of the needs of high-performing workers and those nearing retirement age. “We try to scratch the itch,” Jim Schultz, the company’s human resources manager, recently told the Financial Times. “It really is about knowledge retention.” This means offering key employees flexible hours, more pay, phased retirement and the opportunity to work from home.

A typical example is 66-year-old geologist Susan Longacre, who retired from Chevron six years ago but still works up to eight weeks a year for her old bosses. The reason is that the company has only about 15 other geologists with Susan’s experience of reading samples drawn from deep underground to predict potential volumes of hydrocarbon resources. “It’s a process that takes time,” says Ms Longacre. “You learn it, elbow to elbow, over the core sample.”

Royal Dutch Shell is one oil company that has been aware of recruiting issues for some time. For the last decade, bosses have operated a business challenge reminiscent of Sir Alan’s Sugar’s TV show, The Apprentice, allowing 50 go-getting university students to spend a week working for Shell on a fictitious desert island. They are judged on everything from refining and exploration to finance and marketing, as company chiefs pose business challenges that could crop up during a five-year business strategy.

This year, Shell have doubled their recruiting efforts by holding two of these business challenges – and hiring up to half of all the contestants. Despite efforts such as these, Dina Pyron says there may still be a recruiting void in the near future. “This is going to become a critical issue,” she adds. “Companies are going to have to come out with something more creative. This is not an industry that moves at a rapid, innovative pace. It’s an open door for the company that says, ‘We need to do something more innovative to distinguish ourselves.’”

Some companies have already taken the hint. In Venezuela, the national oil company Citgo offers staff a range of unusual perks and incentives. They include an inter-office baseball tournament which involves jetting employees in style from Houston to Caracas to play.

At Texas-based Stress Engineering, the president, Joe Fowler, has made the company employee-owned – and held staff turnover down to two percent.

At Arthur D. Little, the world’s first management consultancy (founded in 1886), bosses are not resting on their laurels. Company director Priscilla McLeroy says the global consultancy is filling jobs once reserved for professionals trained in oil and gas by signing up PhDs from other sectors.

Attracting talent
They recently recruited a postgraduate in microbiology to help on an enhanced oil recovery programme that would normally be undertaken by a reservoir engineer. Ms McLeroy believes that one way to attract talent could lie in characterising projects as “energy”, which conjures up sexy images of sustainable business, instead of ‘oil and gas,’ which is usually associated with visions of undesirable hydrocarbons.

“Demand for all sorts of energy continues to rise,” says Bruce Williamson, chief executive of Dynegy, a leading Texas-based power company once known as “The Natural Gas Clearinghouse” which has two new plants under construction. A boom in power plants is expected in the wake of new laws governing carbon output and will almost certainly run parallel to the building of new nuclear plants.

Last September (2007), American power generator NRG Energy applied for official permission to build a new nuclear plant in the United States – the first in almost 30 years. The Bush administration now expects this move to spark up to 30 similar applications from other power corporations that are encouraged by the gradual acceptance of nuclear energy as the popular choice through its low carbon footprint and less detrimental effect on global warming.

And it seems almost inevitable that the demands of these expanding companies will only add further to the staff recruiting and retention problems of the oil and gas industry.

Big oil and gas potential in Albania

Since it first opened its doors in 2004 Baar, Switzerland based Manas Petroleum has assembled a well-diversified portfolio of high impact exploration plays spanning two continents and five countries. It includes agreements on and varying interests in over five million acres in Central Asia and Eastern Europe. Only a week ago Manas added to its stable of high impact projects when it was awarded an exploration license in the Magellan basin in Southern Chile – an area that is rapidly becoming one of South America’s oil and gas exploration hot-spots. The company has recruited Mr. Ricardo Ponce for that project. Mr. Ponce used to be the General Manager of world wide exploration for Chilean state owned Sipetrol. That was when Sipetrol wisely farmed into Apache’s now spectacularly successful El Diyur, Egypt gas play. This time Apache is not a partner but a neighbor in the Magellan, a region the company says reminds them (in their Q1 confernece call) of Egypt’s early days.

While Chile is Manas Petroleum’s latest project, the company’s first project was its Kyrgyz Republic Fergana basin oil exploration play. It was a natural beginning for the company as Manas CEO Dr. Alexander Becker received his PhD in structural geology at Kyrgyz Republic’s Frunze Academy of Science (Bishkek) after which he quickly set about discovering two oil fields and was subsequently named by the Soviets, the area’s top mapping geologist. After a stint as an award winning researcher at Israel’s Ben Gurion University he got back to the business of finding oil. Manas Petroleum is the result. It is clear that Dr. Becker’s knowledge of the region’s bureaucracy, politics and geology has been more than a little help in assembling the now world-class Kyrgyz project. In 2006 UK based engineers Scott Pickford estimated that part of Manas Petroleum’s Kyrgyz Fergana holdings had a P50 an in place resource of 1.2 billion barrels of light oil – an estimate the company is confident will be significantly upgraded.

Overall strategy
Those licenses have since been farmed out to Australian major Santos leaving Manas with a 25 percent interest, 20 percent of which is carried until production. “Kyrgyz is a good example of our overall strategy” says Manas Director of Business Development Neil Maedel as he points out that the company is working to close a similar deal for the company’s neighboring Tajik license and that other large projects with accompanying farm-outs “are certainly part of the strategy”. That the company’s Central Asian portfolio looks exceptional is clear. But what is generating the most excitement, as Dr. Becker pointed out in a recent interview, is Manas Petroleum’s oil and gas Production Sharing Contracts which cover over 3,000 square kilometers in Albania.

Albania has been known for its oil for a very long time. Almost 2000 years ago the Romans mined bitumen, an oil product, in Southwestern Albania. Albania’s first oil well was drilled in 1918. But it was not until the late 1920s when intensive drilling by companies including Standard Oil and the Anglo Persian Oil Company (now British Petroleum) led to the discovery and development of shallow fields near known tar sands and bitumen occurrences. Albania’s Patos Marinza is among them. It was discovered in 1932 and still has approximately 2 billion barrels of oil in place, making it Europe’s largest onshore oil field.

In the 1960s the use of seismic with the help of Chinese partners led to the discovery of deeper fields that instead of heavy oxidized high sulfur crude contained light crude oil. But the ultra-Stalinist regime of Enver Hohxa was anything but good for the country’s development – the oil and gas sector included. And as even the Soviets grew somewhat moderate, an increasingly paranoid Hohxa government spent most of its energy preparing for an invasion that never came. By the 1980s the regime had built more than 700,000 concrete bunkers for its 3.5 million people.

Hohxa died in 1985 and as the Soviet Union was collapsing in the late 1980s so did the dysfunctional Hohxa government. In 1990 after more than a half century of isolation, the first Albanian offshore licensing round was opened. It was followed in 1992 by the country’s first onshore round which was won by a French company called Coparex, a Croatian company called INA Naftaplin (reputed to have supplied half of Croatia’s oil over the past 50 years) and Shell.

Analyse this
Shell and Coparex subsequently spent a combined $25 million to acquire, analyze and reprocess approximately 4,000 km of seismic. In doing so they discovered a deep under-thrust structure which by their calculations had the potential to hold a combined 820 million barrels of recoverable light oil.

Shell and Coparex’s combined calculations showed a potential for 820 million barrels of recoverable light oil. The two companies’ seismic imaging revealed that the same thrust sheet which holds all of Albania’s oil reserves plunged to a depth of around 4 kilometers to form a giant sub-thrusted anticline under their licenses. Gustavson Associates, a global mining and petroleum engineering firm summarized what subsequently happened by saying:

“Shell and Coparex suspended all exploration activity and abandoned the blocks in reaction to extreme unrest in Albania and conflict in neighboring Kosovo, allowing Manas to later acquire these superbly defined, giant, virtually drill ready prospects.”

Since then much has changed for the better. Albanian diaspora, which work mostly in the EU and the US, remit over a billion dollars annually back to the country’s economy, while the EU also works to rebuild Albania, all with a profoundly positive effect on its small population. The Southeast European Times recently said “Albania has become a construction site” while last year the Economist magazine published an article entitled “Good Times at last” which praised the country’s performance. The IMF said in its latest quarterly review that Albania had met all targets set by the institution, while ratings agency Moody’s gave the country a B1 grade – its first ever – putting it at the same level as Jamaica and the Ukraine. Albania is expected to join NATO next year, although EU membership still looks a ways off.

In 2005, Occidental Petroleum made a light oil discovery in Albania, approximately 50 kilometers south of the Manas blocks. This occurred just as Manas was initiating its efforts to negotiate Production Sharing Contracts with the Albanian government.

The discovery dramatically reduced the exploration risks associated with the Tirana sub thrust anticline that was discovered by Shell and Coparex because it further confirmed that it was the oil-saturated Ionian thrust sheet. Gustavson describes the discovery as having “substantially reduced exploration risks” as it “greatly increases the probability that the giant anticline outlined by Shell and Coparex seismic is in fact the oil saturated Ionian formation”. In its conclusion in a subsequent discussion on the risks and probability of success for all of the Manas Albanian prospects Gustavson says: “The probability of success for a wildcat well in a structurally complex area such as this is relatively high due to the fact that it is in a structurally favorable area, there exists a proven hydrocarbon source and analogous production exists only 20 to 30 kilometers away”.

The Albanian project is the brainchild of Manas Chairman Heinz Juergen Scholz. Mr Scholz is a Physicist, Engineer and automation expert who built hi-tech factories and telecommunication networks in the Former Soviet Union. He advised Soviet Ministries regarding the sale of Russia’s East German telecommunication network following the Soviet Union’s collapse and has collaborated his research with scientific institutes in the Russian Federation. Mr Scholz knows his way around the Former Soviet Union and its satellite countries and it is Mr Scholz that played a major role in negotiating the company’s Albanian PSC’s. And notably, as success appeared increasingly certain, he also began recruiting the region’s top geological talent.

They include Dr. Agim Mesonjesi who is a PhD petroleum geologist and was part of Occidental’s original Albanian exploration team. Dr. Vilson Bare has also joined Manas – he is an expert geophysicist who received his Doctorate from the Tirana University (for his thesis on the “Study of diffraction in seismic section and its uses in geological interpretation). Professor Selam Meço (paleontology, University of Tirana) is also assisting in the project. Another exceptional player to be involved is UK based reservoir engineer Chris Pitman. Mr Pitman is also the Managing Director of Energy Advisors Limited and a former advisor to BNP Paribas (Paris) and the Abu Dhabi Investment Company.

Expert in the field
The Albanian team played a vital role together with Ukrainian geologist Yaroslav Bandurak (Manas Petroleum’s head geologist) to merge and refine the Shell, Coparex and state oil company Albpetrol previous work. Their data sets were combined for the first time and together with the formidable geological talents brought to bear by the group, resulted in a huge improvement on what Gustavson has already referred to as (Shell & Coparex’s) “superbly defined virtually drill ready exploration targets”.

The Manas team results defined and discovered a total of eight giant prospects which according to Gustavson calculations have the (P10) capacity to hold up to 5 billion barrels of light oil and 5 trillion cubic feet of natural gas if the prospects are oil filled.

If they contain oil with a gas cap the amount of recoverable oil drops to a still breath-taking 2.4 billion barrels of oil with 26 trillion cubic feet (Tcf) of gas. If mainly gas, the P10 amount recoverable is 46 Tcf an amount that would make it Europe’s largest field outside of Russia. These amounts are the headline best case volumes. Gustavson puts the most likely volume (P50) if principally oil at 2.98 billion barrels with 3 Tcf of gas.

If oil with a gas cap the amounts are 1.4 billion Bbls of oil and 15 Tcf of gas and if just gas the P50 is 28 Tcf. The lowest case estimate for the prospects if oil filled, oil and gas or just gas is a respective 1.636 billion barrels, 738 million barrels with 8Tcf of gas and 16 Tcf of gas. Critically any of the above would make Manas a major oil and gas company.

No matter how good the Albanian project might be, however, Dr. Becker is quick to emphasize, that there are unknowns and with exploration there is always potential for disappointment. We know the prospects’ reservoir capacity is very large and that there is oil in the system. “But we will never really know for sure if some unexpected geological event has intervened”. This we will not know until the prospects are drilled”.

We can reduce the impact of these risks. The only way around this is to diversify our geological (and political risks). “We already have very high quality high impact plays in five countries”, Dr. Becker reminds us. “And in the next six months our goal is to add several more to what think is already an all-star list.”

Staggering figures
Currently, independent engineering reports give the company a P50 oil resources of just over 4 billion barrels. “That does not include Tajikistan or any other new ventures which have yet to be independently assessed – giving substantial room for growth.” says Manas Director Neil Maedel. “To see the direction we hope our strategy will take us” he advises, “divide the number of shares Manas has outstanding into the independently engineered resources (which to be conservative we will use 3 billion barrels) which we already have. The number is around 26 barrels per share. Divide it into our share price and you will get around $0.16 per barrel. In comparison North Sea proven reserves sell for about $20 per barrel. Somewhere in between is the exploration and development potential. Best yet is that we are getting other companies to take on most of the risks and pay the bills. We may end up with less of a project but we also get to play safe and smart by spreading our risks among many great high potential projects. And that is how we plan to build a large oil exploration company”.