Ashton Wenborn | World Finance

Cuba to ditch complicated dual-currency system

Posted on January 21, 2014January 14, 2014 by Ashton Wenborn

Cuba has been undergoing a number of quiet but drastic reforms since Raul Castro assumed the presidency of the island nation from his brother, Fidel, in 2008. The latest, and perhaps most significant step towards modernising the country’s economy has been the announcement last month that Cuba would be doing away with it’s complicated dual currency system.

The arrangement has been very unpopular, and Castro has long since promised a solution, and now it seems like one might have arrived. Since 1994, the country has functioned with two currencies, one pegged to the dollar and one worth a fraction of it. The Cuban Peso (CUP) and the Convertible Cuban Peso (CUC) are both legal tender on the island, though neither are convertible in the foreign exchange markets. CUC is pegged to the dollar and most goods are valued in that currency, but the majority of people in Cuba are paid in CUP.

Restricted access
The complicated system has been used in Cuba since the collapse of the Soviet Union. Cuba had enjoyed an extremely beneficial trade agreement with the Eastern bloc, which had enabled it to bypass US embargos. So when the Soviet Union was dismantled, Cuba was left with limited access to hard currency, economically isolated and facing hardship.

Fidel was forced to legalise the dollar, reversing a decades old law that had made possession of the American currency punishable by prison. It was a momentous decision for Fidel Castro, both ideologically and practically.

[M]ost experts agree that a dual-currency system can never be anything but trouble

The legalisation of the dollar created a two tier economy that split those with access to the dollar from those that could only access the peso. State workers in particular, who were paid very little and in pesos, felt the brunt of this policy. With the dual-currency system, Fidel harboured a change in Cuba that had been exactly what he had fought against for so long; a country split by class, where a privileged minority could access luxury goods and benefit from the burgeoning tourism trade, and an underclass of state-workers who could only access the weak peso.

The CUC was brought in in 2004 to replace the dollar, but for many Cubans that was just a new name for an old problem. At the moment, the government controls almost all prices in Cuba, and companies must exchange their dollars and CUCs at official government exchanges, and neither CUCs nor CUP’s are exchangeable
outside the island.

The unification of the peso was announced by the official Communist Party newspaper Granma, which declared the move is “imperative to guarantee the re-establishment of the Cuban peso’s value and its role as money, that is as a unit of accounting, means of payment and savings.”

A historic divide
In 1994, Fidel Castro was backed into a corner and forced to accept the dollar as a viable currency or risk bankrupting his country, but most experts agree that a dual-currency system can never be anything but trouble. The issue is the exchange rate between the two currencies, which can either be left to be determined by the market, or be set by the local authority.

If the rate is market-determined, a second currency is only a way to inject liquidity into an economy. However, if the rate is set artificially and managed by an authority, the dual-currency system ceases to be dual as the overvalued currency will eventually replace the undervalued one. This is known as Gresham’s law, after Sir Thomas Gresham, a 16th century British financier who famously described the phenomenon: “Good money drives out bad money.”

The legalisation of the dollar created a two tier economy that split those with access to the dollar from those that could only access the peso

It is an ancient principle that had been predicted by Nicolaus Copernicus, and even by Greek philosopher Aristophanes at the end of the fifth century BC, before being coined by Gresham. The trouble in Cuba is that the government never allowed the more valuable currency, the dollar, the replace the undervalued currency, the peso, and in that it split the country’s economy in two.

The longer the system was allowed to exist, the more difficult the situation became to resolve, which is why currency unification has been a major goal of Raul Castro’s administration for the past few years.

At the time of the announcement the CUCs value was pegged to that of the dollar, and the CUP was worth around four cents. According to official Cuban statistics, most Cubans make around $20 a month in CUP’s. As the CUP’s are not accepted in most shops – particularly those selling sought-after imported goods – the dual currency system has long since been a major gripe for Cubans, who resent the restrictions.

“The currency unification isn’t a measure that will resolve on its own the current problems of the economy. But its adoption is vital to restoring value to the Cuban peso,” the announcement in Granma read. The announcement did include a date by which currency unification would be completed, but it has been speculated that the whole process might take over three years; the Cuban Central Bank will continue to back both currencies in the time being.

When the currencies are unified, Cuba will likely have to face up to a number of uncomfortable truths about the overall state of its economy. Many issues, such as an endemic lack of transparency and efficiency, have little or nothing to do with the dual currency system. But it will undoubtedly have the effect of improving Cuba’s credibility internationally.

The complete unification of the currencies is many months, maybe years, away from being fully achieved, but it could well be the policy that defines Raul Castro’s legacy as the reformer of Cuba

The news of the currency unification has already led to Russia and Cuba reaching an agreement to write off close to 90 percent of Cuba’s £32bn debt (acquired from the Soviet Union), putting an end to almost two decades of disagreements between the two countries. Though the agreement is still pending approval from the Duma – Russia’s Houses of Parliament – it would be a major step towards rehabilitation of the
Cuban economy.

The deal with Russia is the latest in a string of deals with other countries like China, Japan and Mexico which have helped Raul Castro re-structure Cuba’s active and commercial debt.

“The agreements with China, Japan, Mexico and Russia ease some outside financial restrictions on the Cuban economy and should facilitate trade ties with these countries,” Pavel Vidal, a former Cuban Central Bank economist now teaching at Colombia’s Javeriana University, told Reuters.

“The austerity measures adopted by the Government in 2009, and these accords to lower the foreign debt, help stabilise the island’s finances at a very important moment when a significant monetary reform over three years has begun.” Cuba’s situation is by no means unique, though.

China unified its official and swap market exchange rates in 1994, but the two currencies in Cuba are wound up much more tightly, and will thus be more difficult to fix. A major hurdle will be addressing the value of goods, which have long since been set by the government in dollars.

Though the Cuban Government has not offered details of the transition, it is likely that it will begin with some stores accepting CUPs as well as CUCs. Some state enterprises may start trading the two currencies using pre-set exchange rates. At the moment the rate stands as 25 CUPs to one CUC.

Defining Castro
In its announcement the Government has promised to make good on the peso, stating any of the inevitable devaluations before hand and giving people the opportunity to convert their holdings. It is likely that the new, unified peso will be valued at more than the CUP but less than the CUC, and for many Cubans that will represent an increase in spending power, which in turn could lead to inflation and shortages of some goods.

It is also likely that Cubans with access to that currency will meet the fall in the value of the CUC during the unification process with some resistance. Even before the announcement, rumours that a currency unification was on the horizon caused a palpable decline in the value of the CUC.

The Economist reported that big hotels in Havana have been offering to buy dollars, off the book and for above market rates, and that an underground network of currency traders is creeping up around the city. On the other hand, once the currencies are unified, Cuban state companies will be able to stop the practice of pretending that both types of pesos are the same value on their books and balance sheets. Though this practice has helped manage CUP inflation, it has also helped hide the many inefficiencies of state owned companies.

The complete unification of the currencies is many months, maybe years, away from being fully achieved, but it could well be the policy that defines Raul Castro’s legacy as the reformer of Cuba. If it was once feared that Raul would struggle to fill his brother’s shoes as president, it seems that by promoting prudent and timely economic reforms – which Fidel was so reluctant to do – the younger brother will have carved an even bigger name for himself in modern Cuban history.

Could Songdo be the world’s smartest city?

Posted on January 21, 2014February 17, 2014 by Ashton Wenborn

Seoul, in South Korea, is one of the ‘smartest’ cities in the world; it boasts the most cutting-edge infrastructure as part of daily life. The metro is not only the most extensive subway system by length, but also boasts ultra-fast Wi-Fi. The transport network itself is meticulously timed, with arrival and departure times displayed clearly on laser panels outside stations and bus stops. But a new development 40 miles outside of the South Korean capital is so advanced that Seoul will look positively medieval by comparison. The Songdo International Business District, constructed on a new embankment on the Incheon waterfront, is a purpose-built ‘smart city’, designed for efficiency and convenience.

Songdo by numbers

$40bn

Cost of the Songdo development (to-date)

40%

Area dedicated to outdoor spaces

40miles

Outside Seoul

Building a city from scratch to fulfil a specific need is not a new concept; Canberra, Brasilia and Abuja were all built in the last 60 years as functional capital cities. But Songdo is unique, being built as an integrated hi-tech environment. Developers describe Songdo as a ‘global business hub’ and ‘home to a variety of residential and retail developments’, but at a cost of over $40bn, is Songdo just a glorified model neighbourhood?

The smart city occupies 1,500 acres of land ‘reclaimed from the Yellow Sea’, making it the largest private real estate development in history. But it’s not the geographical space that makes Songdo remarkable. The district was built as part of former President Lee Myung-bak’s drive to promote low-carbon and sustainable growth as the principal avenue for development in South Korea.

For over half a century, the country’s economy has been dependant on exports and South Korea has become known for its hi-tech industry. When the global economic crisis struck in 2007 and 2008, and foreign demand for South Korean products slumped, the government launched a stimulus package aimed at developing the country’s own infrastructure, with a particular emphasis on green investments.

Lee launched the Framework Act for Low Carbon Green Growth, a $38bn economic stimulus package, 80 percent of which was earmarked for green and sustainable investments. In 2010 the National Assembly of Korea increased the value of the Framework Act to over $83.6bn, to be invested over five years.

Songdo has been a huge part of the move towards sustainable growth. The city is a novel model – 40 percent of its area is dedicated to outdoor spaces. By comparison, Seoul and other South Korean metropolises are densely populated with few open-air areas for residents. Songdo is unique, offering city inhabitants something they have never had access to before: green space for leisure. The district has been heavily promoting its 16 miles of bicycle lanes, its central park, and its waterways, which are based on New York City’s Central Park and Venice’s canals, respectively.

Business and leisure
While South Koreans might not have been wooed by the district’s state-of-the-art urban infrastructure, it has certainly been a selling point for international investors. Songdo is the first district in Korea to receive Leadership in Energy and Environmental Design (LEED) accreditation, and the largest project outside the US to be included in the LEED Neighbourhood Development Pilot Plan.

This means the entire development adheres to the strictest environmental standards for energy consumption and waste. According to developers, over $10bn was invested in the design and build of the 100 main buildings in the district, including the Northeast Asia Trade Tower, which will be Korea’s “tallest building and most advanced corporate centre,” according to Songdo’s promotional material.

In many ways Songdo is a living organism. The city’s infrastructure contains sensors that monitor and regulate everything from temperature to energy consumption and traffic

Because the district was built from scratch, it has given developers the opportunity to invest heavily in technologies that have yet to debut in conventional cities. Take Songdo’s smart rubbish disposal system, a futuristic bit of hardware that spans the whole complex. No rubbish trucks will ever roam the leafy streets of Songdo, instead all household and office waste is sucked through a network of underground tubes to vast sorting facilities where it is all processed, deodorised and treated. The aim is to eventually convert all this sorted and treated waste into energy for the community, but the system is not yet fully operational.

In many ways Songdo is a living organism. The city’s infrastructure contains sensors that monitor and regulate everything from temperature to energy consumption and traffic. Essentially, the city can interact with residents on a one-to-one basis. Smart grids and meters are already fairly common in Europe and the US, but the technology in Songdo is more pervasive than anything in the West. Because it was designed to this specification and not converted later like most ‘smart cities’ in the rest of the world, Songdo is completely geared towards sustainability; even the water pipes are designed to stop clean water, suitable for human consumption, being used in showers and toilets, and all of the embankment’s water goes through a sophisticated recycling system.

Everything in Songdo might have been meticulously designed, but there is one key element that has not gone according to plan. Since it’s official launch in 2009, the sustainable district remains woefully under-occupied. Despite it’s enviable location close to Seoul and it’s international airport – “just 15 minutes driving time from Incheon International Airport and three and a half hours flying time to a third of the world’s population and regional markets such as China, Russia and Japan,” reads the brochure – less than 20 percent of the commercial space in the district has been occupied.

Ghost town
Pre-planned cities have been around for centuries, and they always face the same challenges: how to attract residents and businesses to a new, untested, and unpopulated area. China has faced this problem as the building boom of the early 2000s encouraged developers to invest in new cities and shopping districts that ultimately failed to attract buyers. Songdo is very well connected, and the business facilities are second to none, but attracting inhabitants may still be a slower process than developers hoped for.

In order to speed up the population process, developers have been investing heavily in top-quality international education centres. The hope is to entice a diverse international community. Before the end of 2014, four universities will inaugurate campuses in the business district, including the first overseas university to open a campus branch in Korea, the State University of New York, Stony Brook, as well as George Mason University and the University of Utah, all sponsored at least in part by the Ministry of Knowledge Economy. There is also an enormous, exclusive international school catering to children from kindergarten to high school.

Songdo is the city of the future; all that is missing are the residents

And while Songdo is not yet a hit with the international business community, young professionals have flocked to its leafy boulevards looking for a better lifestyle than the hectic streets of Seoul can offer. The district offers over 22,500 new housing units built to different specifications – from garden houses to sleek high-rises – all connected to the district’s energy, water and waste facilities.

But businesses may soon follow, attracted by the skilled workforce provided by the universities, the sustainability credentials and the tax breaks. “It’s the occupants who make a city,” Jonathan Thorpe, CIO of Gale International, the American developer behind Songdo, told the BBC. “You’re trying to create a diversity and a vitality that organic development creates, in and of itself,” he explained, “so it’s a challenge to try and replicate that in a masterplan setting. At the same time, with a masterplan you have the ability to size the infrastructure to make sure the city works – now and in 50 years’ time.”

And the brains behind Songdo have thought carefully about financial incentives for businesses. Companies relocating to the district will have access to tax reductions, estate support and subsidies. No property tax will be levied for 10 years, followed by three years where businesses need only pay 50 percent of taxes due; small- and medium-sized companies will also be considered for rent reduction; and employees of companies with over 30 percent international investment will be able to claim a variety of perks – from location subsidies to promotion results compensation.

For South Korea, Songdo is more than a hi-tech business district, but a template for future developments. It is the prototype for the green investment the government wants to build the economy on in the future. It is all designed to appeal to foreign investors, but its manicured gardens and glassy towers also give it an unmistakable air of luxury. This is the aspirational South Korea where everyone is wealthy and your mobile phone controls the temperature in your apartment. Songdo is the city of the future; all that is missing are the residents.

Mexico’s tax reforms: opportunities and obstacles

Posted on January 21, 2014February 20, 2014 by Ashton Wenborn

Congregated along Mexico’s border with America are hundreds of factories known as maquiladoras, or assembly plants. Mostly foreign and in particular American-owned, they export their products under long-standing, favourable tax arrangements that have contributed greatly to Mexico’s economy.

According to Mexican research institute Colegio de la Frontera Norte, the maquiladoras account for 60 percent of all jobs provided along the frontier states. And in Mexico as a whole, the factories’ contribution to the economy is second only to that of oil giant Pemex, easily the biggest business in the country. The more than 5,000 maquiladoras in Mexico provide 1.9 million jobs, estimates the Congressional Research Office.

As Richard Rubin, a local businessman associated with the factories, told the Christian Science Monitor, “Mexico would be crazy to destroy the maquila [assembly] industry.”

Stormy passage
But that may be an unwanted consequence of a tax package that was voted through congress in late 2013 after a stormy passage that saw the opposition walk out in protest because, it warned, the measures would damage the economy. The wide-ranging changes affect most sectors, from finance and the stock market to retailers and manufacturing. The financial sector, for example, will be hit by new rules on write-offs for bad debt.

Withholding taxes

Most countries apply withholding tax to dividends paid on securities, such as shares held by non-residents. In most years they collect around $3.7bn – but most of these nations also give it back under bilateral arrangements known as income tax treaties negotiated between governments.

The right to make a claim – or rather, a reclaim – arises because the rate applied under these treaties is generally lower than the default withholding rate, normally around 15 percent, fixed by most foreign governments. Some countries charge more, such as Brazil and India, who withhold 25 percent. The five-star location for foreign investors is the UK, which allows 100 percent reclaims on investments made in British companies.

But things are not always how they seem. Differing national regulations can result in higher or lower reclaims than expected. For instance, under Canada’s tax treaty with Israel, the rate is 15 percent, while withholding tax on divvies issued by Israeli companies is 20 percent. So Canadian investors in Israeli companies should get back five percent? Wrong. They generally recover 11 percent because the actual rate works out at nine percent. This is one reason why foreign investors in Mexico should work through international accountants.

From January, banks are permitted to deduct these for tax purposes only after they are legally defined as uncollectable. And that can happen only when the government, in the form of the National Banking and Securities Commission, issues a specific authorisation.

In an attempt to increase the taxable income available to it, the government has also dragged insurance companies into the net. Until now, these firms have been allowed to create and deduct so-called technical reserves accumulated for risk, actuarial and other purposes, as Ernst & Young points out. But henceforth deductions will be accepted only for actual and verifiable losses.

Of huge importance to so-called ‘bird-in-the-hand’ investors are new measures on withholding taxes. These comprise a 10 percent tax on dividend payments and distribution of profits by Mexican companies. Some consultants have pointed out that, because the distributing company will henceforth be defined as the taxpayer, this could effectively sideline cross-border tax treaties that normally allow shareholders to claim deductions.

And accountancy firms are still trying to figure out the implications of the regulations on payments to related parties – but it will certainly hit them in the wallet. “This is a very broad rule that would appear to require that the taxable base of a non-resident recipient of income from Mexico [must] be calculated based on Mexican rules,” suggests Ernst & Young. Loopholes will be hard to find.

And finally, there will be a tax on stock market gains. The current exemption on the sale of publicly traded shares will be axed and replaced with a 10 percent impost. Whatever the full implications turn out to be, the combined rules are certain to make ‘bird in the hand’ investors – those who prefer to take their gains in regular dividends rather than wait for capital gains – think twice about putting their money into big listed companies.

Changing rates
Meantime, the maquiladoras are weighing their options. All of them will lose some of the preferential tax breaks that first brought them here in the 60s. First, they will have to pay a new 16 percent sales tax on all goods imported for assembly prior to export.

Although the tax, which is designed to thwart tax cheats, is reimbursable, it will certainly have an effect on cash flow. Second, retail sales tax – long fixed at 11 percent to attract business from Arizona, Texas, New Mexico and other US border states – will increase to 16 percent in line with the rest of the country. And for good measure they will also be hit by a Mexico-wide hike in corporate tax from 17.5 percent to 30 percent.

Fortunately dropped from the package were plans for a second import tax on the factories. However, some factory owners are still threatening to shut down their businesses and go elsewhere.

The country’s tax system is chronically top-heavy

It is not hard to understand President Enrique Pena Nieto’s dilemma. His most pressing economic problem is Mexico’s low tax take, in fact the lowest by some margin of all 34 OECD member countries. The total tax revenues at his disposal amount to just 19 percent of GDP. By comparison, the ratio for Greece, notorious for tax evasion, stands at 31 percent. As the OECD points out, the country needs to widen its tax base to provide the health, infrastructure and social projects considered essential to improve the quality of life of Mexico’s 120 million people.

But the reforms will fall far short, says Mexico-watchers who say the tax take has to increase by three or four percent to achieve what is needed. “Representing barely a one percent additional share of fiscal revenue, [the package] will be insufficient to begin the process of weaning the government off Pemex’s revenues”, points out Andres Rozental of American think-tank the Brookings Institution.

The problem with Pemex
The country’s tax system is chronically top-heavy. Governments have relied for years on Pemex, the state-owned oil giant with 2012 revenues of $128.7bn, to keep the country’s accounts topped up. Indeed, Mexico has shamelessly milked the energy company’s profits. As the University of Pennsylvania’s Wharton business school points out, “Pemex pays out more than 60 percent of its revenues in royalties and taxes to the government, providing some 30 percent of total tax revenues”.

No wonder the company loses money despite its vast revenues. Pemex forks out four times as much in taxes as it invests, adds EMPRA, a Mexico City-based consultancy specialising in emerging markets.

While all three main political parties agree something must change, nothing will happen overnight in what is a highly political issue

It could be though that these reforms are tackling Mexico’s tax problems the wrong way round, say economists. Take, for example, the underground economy. Like other countries in the region, Mexico has a high level of informal labour that falls outside the tax net. If the government were to find ways of gathering these wages, the tax take would increase substantially.

Then there is Pemex itself. An infamously poor performer among international energy giants, it produces less oil now than it did a decade ago. Projected production for 2013 is approximately 2.5 million barrels, compared with 3.4 million in 2004. Meantime, other oil-rich countries such as Colombia and Brazil have doubled and tripled production. The problem? “Mexico has one of the world’s most closed oil and gas sectors,” explains Duncan Wood, Mexico specialist at Washington DC-based research institute the Woodrow Wilson Centre.

Oil workers in Mexico — Derrick hands working on a Pemex exploration oil rig. Mexico has long been reliant on the nationalised oil giant for income

While all three main political parties agree something must change, nothing will happen overnight in what is a highly political issue. Mexicans see Pemex as an almost untouchable national asset whose nationalisation in 1938 – the year foreign oil companies were kicked out – marked a turning point in the nation’s sovereignty. “The Mexican government wants to maintain control of the commercialisation of the oil for political reasons,” adds Wood.

The overall package barely merits a pass from most consultants. “The main fault is that it does almost nothing to widen the taxpayer base,” concludes the Brookings Institute’s Andrés Rozental, pointing out that it targets a capital middle class that already pays taxes and corporations that will only pass their costs on to consumers. Once again it seems Mexico will fail to amass the taxes due a country of its size.

Economic effectiveness: how an interim manager can help

Posted on January 20, 2014February 20, 2014 by Ashton Wenborn

According to certain economic indicators, Europe could be creeping out of recession. Throughout the continent the media has become more confident and entrepreneurs speak more bullishly about investment.

More importantly, the money to finance such investment is beginning to crawl its way towards economically worthwhile projects from the vaults of lenders where it has festered for years.

Things are still slow compared to the good old days, but we are comforted by the knowledge that, although crashes come overnight, recovery creeps back slowly. It’s a matter of confidence. If recovery isn’t officially here yet, we are now talking ourselves into it, and it will be here soon.

Preparing for the unknown
At the outset of the crisis I offered my thoughts as a professional in corporate troubleshooting and interim management, to companies facing the onset of a world economic slowdown.

These thoughts focused on the critical and difficult actions companies needed to take: selling off or closing down low margin businesses, slimming the profit and loss account to hack out those “nice to have” expenses that had built up and were easily ignored during the good times, and concentrating on core activities in which the company had a comparative advantage over others.

In the end, the key differentiator of many of the companies that successfully rode out the recession was the ability to re-engineer their strategic outlook with the key purpose of surviving, and, if possible, protecting profitability.

[T]he key differentiator of many of the companies that successfully rode out the recession was the ability to re-engineer their strategic outlook with the key purpose of surviving

For many it was a distant philosophy from the one of perpetually enriching shareholder value through growth and improved profitability, which had formed the conventional wisdom before the crisis.

As companies now consider the prospect of an improving economic environment, that drive for increasing shareholder value is back on the agenda. If it never left the agenda, at least now it seems an achievable goal.

Managers are looking at strategic adjustments, acquisitions, and entering new markets with existing and new products. The “in limbo” years of survival are over and the return of focus on enhancing shareholder value is back.

Management is being challenged to make the most of the new order in the knowledge that the first mover will often gain the advantage. There are, however, three key problems many companies will encounter in getting to the starting blocks to manage these complex new challenges.

Companies may have people who are competent at the tasks required, but they are usually busy on their day-to-day jobs and are not able to apply themselves diligently to the specific tasks that require undivided attention.

Some companies struggle where a number may have people who know what needs to be done, but have not had prior experience in that area. This makes implementation slower, riskier and a successful outcome less certain.

Over time, companies may have developed accepted wisdoms whose justification is dubious, and whose authority is rarely challenged. It is difficult to dispel these from within.

Outsourcing professional assistance
This is where the Interim Manager can come in and add a new dimension, as this person is not an ordinary temporary worker used to fill a casual vacancy. It is someone who can become central to a company’s push for innovation, growth and investment; providing management, for a limited period, with the oxygen needed to cope with major new projects and change, while allowing them to carry on running the business.

They are professionals who dedicate their career to the provision of relevant services to business and normally come in at middle to senior management level. Interim Managers are widely available nowadays, and can be located through networks as well as through executive search agencies with dedicated departments.

A recent assignment

Cross-border acquisitions and mergers are always complex. Unfamiliarity with a foreign business environment, the potential for misunderstandings, and simply missing culturally different nuances, explain why so many internationally negotiated deals are never as attractive as first envisaged.

I was recently appointed by a group to work, initially, alongside an overstretched CFO in the process of assessing an overseas company for acquisition. The work culminated in my taking full responsibility for managing the business case analysis, the financial, commercial and legal due diligence, and negotiating the purchase price and key contractual terms and conditions.

The acquisition went ahead successfully at a price and with prospects that were generally considered to be beneficial to the buyer. My client’s knowledge that I had successfully managed such projects previously, that I had international negotiation experience and spoke the language of the vendors, allowed them to entrust the project largely to me.

The overstretched CFO ended up being less stretched, and I am now being asked to assist in certain aspects of the integration process into the mother group. One task often leads to another.

Before a company decides to hire an Interim Manager, it will have assessed the value of the additional expense of bringing such an individual onto the team. Interim Managers will tend to cost more than an equivalent level employee, although the cost will be much more flexible.

The company will also need to overcome the risk of a bad cultural fit, so that the manager can integrate and carry existing employees with him or her to a successful completion of the project.

This will require a series of meetings or interviews with different candidates, rather as in the hire of a full-time employee. So what are the key traits of an Interim Manager and how can he or she help companies avert the problems referred to above? The Interim Manager is a business leader, usually with considerable experience in corporate environments, who appreciates the goals of top management and is often able to work alongside them and manage large and complex projects.

They have expertise; can be left to their own devices and do not need to be supervised closely. This frees up company management to get on with running the company, and may avoid the need to hire an eventually more expensive long-term employee.

The Interim Manager is usually asked to carry out tasks they have dealt with before, with no requirement for on-the-job learning and has experience of navigating the pitfalls that disrupt or delay so many projects taken on by inexperienced teams.

It is key that they are independent and come to the job with an open disposition, an absence of pre-conceptions, history, allegiances, favours owed or owing, and are able to search for long-term alliances.

These traits allow the Interim Manager to avoid the politics and “treading on eggshells” that often mire organisations and prevent the right decisions being taken, for fear of going against a fashion or longstanding wisdoms (the so-called “sacred cows”).

Connecting for greater fluidity
Additional to these traits, there is an aspect of using an Interim Manager that many overlook and which transcends all others in the quest for effectiveness. It permits a level of fluidity to decision-making and action that is often difficult to achieve within companies.

The Interim Manager is usually hired with one particular objective or task in mind and he or she will be utterly focused on ensuring its successful completion. It is this last aspect, when combined with the wealth of experience and independence offered, that will make the use of Interim Managers so important in tackling strategically important projects when economic recovery arrives.

It is a certainty that the recovery will come, just as, proverbially, death and taxation cannot be avoided. Companies should already be thinking about aligning resources and selecting their external advisors.

The advice of an Interim Manager can even help companies manage their taxation. Maybe not avoid it, but certainly manage it better, which is worth considering.

Slim chances? Branson vies for Mexico’s telecoms market

Posted on January 20, 2014January 31, 2014 by Ashton Wenborn

Never one to shirk a business opportunity and adopt the role of corporate underdog, UK billionaire entrepreneur and self publicist Sir Richard Branson recently announced plans to enter Mexico’s telecoms market – a market where local billionaire businessman Carlos Slim holds sway, largely to the exclusion of any serious competition (see Fig. 1).

Branson may have an estimated $4.6bn fortune according to Forbes, but it’s chump change compared to the $73bn amassed by Slim (as of early-2013) – much of it through his company, América Móvil, which dominates the Mexican telecoms sector – making him one of the world’s richest men, alongside Bill Gates.

Branson is no stranger to Latin America, however, having already rolled out his company’s Virgin Mobile Latin America (VMLA) brand there through a company formed in 2010 backed by investors, including Juan Villalonga, former CEO of Spain’s Telefónica.

Indeed, in June 2011 VMLA announced ambitious plans to become Latin America’s leading mobile virtual network operator (MVNO). Since then the company has commenced operations in Chile (through Virgin Mobile Chile in Q2 2012), having received regulatory approval from Chile’s Subsecretaria de Telecomunicaciones. In December 2012, meanwhile, VMLA confirmed the closing of a second debt funding agreement with IFC, the World Bank Group unit, to fund Virgin Mobile Colombia.

The Colombia debt facility of $14m increased IFC’s support for Virgin Mobile in the Latin American region to $25m, including its strategic funding for Chile, which has now signed up almost 200,000 subscribers and is set to break even this year. The Chilean and Colombian operations augment an existing network of Virgin Mobile operations in seven countries (Australia, Canada, France, India, South Africa, the UK and the US) serving approximately 20 million mobile subscribers.

Billionaire underdog
Befitting his corporate underdog image, Branson has already said that there is room in the market for his Virgin Mobile Mexico operations – due to be rolled out in 2014 – and that América Móvil would unlikely suffer much from Virgin’s presence in the country.

Unsurprisingly, Virgin Mobile Mexico will tread a well worn model used elsewhere and trade as an MVNO, thus obviating any need for massive capital investment such as the building of masts. Instead, it will buy airtime wholesale from América Móvil’s rivals and use the Virgin brand to differentiate itself in the market.

For Branson, the recent liberalisation of the Mexican telecoms market – ostensibly aimed at loosening Slim’s stranglehold on it by promoting more competition – presents an opportunity.

New regulations passed in May impose a 50 percent market share limit on the domestic market. For Slim, whose wire line Telcel network serves more than two thirds of Mexico’s 100 million mobile users and provides 80 percent of the nation’s landlines, they may yet force him to offload some of his assets.

Telmex, the country’s dominant fixed line provider – also owned by Slim – was fined $50m by the Comision Federal de Competencia (CFC) back in March for engaging in what the regulator described as anticompetitive practices. The fine came after an investigation on wholesale lines Telmex sells to other service providers operating in Mexico, such as Axtel. In Axtel’s case it was found that Telmex had failed to provide services for a period of two years.

Cofetel, Mexico’s then telecoms regulator, had previously announced (in March 2012) new rules requiring Telmex to incorporate price and quality controls on wholesale services sold to competitive service providers, in order to prevent dominant service providers (like Telmex) from indulging in conduct that would hinder the development of equal competition. Or hurt consumers through the fixing of arbitrarily high prices for the services offered. Moreover, Telmex would have to deliver these services to competitors with the same quality it would have provided its own subsidiaries and that service orders would need to be completed punctually. Seemingly, Cofetel’s edicts fell on deaf ears.

Regulatory strength
Yet it remains to be seen how strong the new telecoms reform bill – which also prescribes changes for the broadcasting industry – will be, given any company either fined or told to sell off its assets will retain the right to lodge appeals suspending those decisions, in effect amounting to corporate stalling tactics commonly used when fighting competition rulings.

However, proponents of the market reforms argue the new regime will strip away around 80 percent of the legal cover firms have previously been able to employ to thwart regulators.

As part of the liberalised framework, a new and autonomous regulatory body, the Federal Telecommunications Institute (Ifetel), which came into being in September 2013, has been given powers to grant and revoke broadcast and telecommunications concessions. It has taken over responsibilities from Cofetel. The bill also ends the current 49 percent limit on foreign investment in fixed-line telephony and raises the foreign ownership cap for television to 49 percent. It also creates a state-owned ‘carrier of carriers’ telecom network that would allow rival companies to bypass Slim’s existing network.

Previous requirements that only Mexican nationals could beneficially own a majority of voting shares in companies engaged in telecommunications services acted as a deterrent to new investment, even though foreigners had been permitted to hold additional shares of capital stock to reflect a larger economic participation. By dispensing with this policy, it should eliminate distortions and inefficiencies in the market, as well as make it easier for new entrants to acquire and recapitalise existing market participants who’ve thus far been unable to compete effectively with the incumbents.

$4.6bn

Branson net worth

$24bn

Virgin Group revenue (2012)

50,000

Virgin Group employees

Meanwhile, Ifetel’s plan to issue decisions on pricing, network unbundling and interconnection rates will, on the face of it, promote competition and drive down prices. But it could prove to be a double-edged sword for smaller domestic providers and would-be entrants, given revenues may be negatively impacted and, by extension, cash generation.

Issues needing to be addressed over the coming months include not only which players are market dominant, but also so-called ‘unbundling’ that would allow rivals cheaper access to the dominant player’s network.

Another possible solution is asymmetric price caps on Telcel or Telmex that would penalise companies run by Slim, but no one else. Unusually, the measures have been incorporated into Mexico’s constitution instead of simple enabling legislation, thereby shielding them, in theory, from constitutional challenges. Meanwhile, secondary laws have to be in place by December 9. The regulator is expected to have until early March to determine which companies are dominant in their markets and take the necessary measures to guarantee competitive conditions accordingly. It shouldn’t prove too difficult a task; given Slim’s América Móvil operation continues to be the veritable ‘beast in the jungle’. That isn’t to say he has no competition, even though his competitors could best be described as also-rans when it comes to market share.

Limited competition
Significant opposition is limited, but does include Mexican broadcaster and mass media company Grupo Televisa. It controls roughly 60 percent of Mexico’s broadcasting market, with rival TV Azteca – part of the Grupo Salinas conglomerate and headed up by CEO Ricardo Salinas Pliego – controlling most of the rest. While Televisa’s core market remains in broadcasting, it does have a six percent share of Mexico’s mobile phones market, through its Grupo Iusacell unit in which its broadcasting rival TV Azteca has also invested.

The elephant in the room though, insofar as Slim is concerned, may well be Spanish telco giant Telefónica. Acknowledging the changing regulatory landscape, Telefónica’s Mexican unit (Telefónica Mexico) recently said it wanted to triple its local market share by revenue; largely through selling more smart phones and Wi-Fi services and targeting small businesses to add to the estimated (end-March 2103) 20.5 million landline, wireless and data subscriber base it already has.

On an industry revenue basis, the company currently has a wireless market share of 12 percent, but a customer base market share of 20 percent. Respectable numbers, yet hardly earth-shattering when set in the wider context.

As the OECD noted in its January 2012 Review of Telecommunication Policy and Regulation in Mexico, lack of competition in the Mexican market had led to inefficient telecommunications companies imposing significant costs on the Mexican economy and burdening the welfare of its population. It further noted a sector characterised by high prices – among the highest within the OECD countries – resulting in poor market penetration rates and low infrastructure development, leading to a loss of benefit to the economy estimated at $129.2bn over the 2005-09 period alone, or 1.8 percent GDP per annum.

While there had been growth in mobile, fixed, broadband and pay-television markets, Mexico compared unfavourably with other OECD countries that had developed more open and competitive markets and distributed the ensuing benefits to consumers. In addition, profit margins of the incumbent (América Móvil) were much higher than the OECD average, while investment per capita was lower than in any other major country.

Underperforming monopoly
Aside from Slim’s potential mounting pressures on the domestic front he has very real issues to deal with now – not least a consistent thumbs-down from the stock market reflecting, among other factors, disappointing investments, principally in Europe. Unsurprisingly, the company’s share price has, more often than not, underperformed Mexico’s benchmark IPC index of late.

It isn’t difficult to see why. The company witnessed a 46 percent profit slump in Q3 2013 to MXN 16.384bn ($1.25bn) from MXN 30.45bn pesos in the same period a year earlier, as customers made fewer phone calls and the company’s financing costs soared.

Almost half of the company’s core profit comes from Mexico, where service revenues, or income from customers’ phone calls, dropped 1.4 percent. Total revenue, though, rose 0.7 percent to MXN 194.221bn, helped by gains from selling more expensive mobile phones.

Another galling thing for Slim has been the company’s seemingly faltering European strategy, as he has sought to diversify away from the home market. Investors had already voiced concerns that América Móvil’s near-23 percent investment in Telekom Austria could follow the same path as its KPN investment, where a rights issue earlier in 2013 forced the company to buy more shares at a lower price to maintain its participation. Many thought that América Móvil, which had accumulated nearly 30 percent of KPN, was outmanoeuvred when its holding was effectively chopped in half after a foundation set up to protect the interests of KPN shareholders executed an option to acquire almost 50 percent of KPN’s voting stock. Slim had accumulated his 30 percent stake, paying an average €8 per share, while his subsequent €7.2bn ($9.5bn) €2.40 a share offer in August this year (for all remaining stock he didn’t already own) was deemed too low. Having walked away after the bid was rejected Slim ended up sitting on a loss estimated at around €850m-900m. The ball firmly remains in Slim’s court, however, and he may yet come back in with a revised offer.

$73bn

Carlos slim net worth

$59.3bn

América Móvil revenue (2012)

158,694

América Móvil employees

Despite this setback Slim has deep pockets and won’t be deterred from seeking other European opportunities, though not necessarily at any cost. Ratings agency Fitch expects América Móvil’s net debt-to-EBITDA to remain stable during 2013 and to trend slightly downward in 2014. While its expectations for the long-term net debt-to-EBITDA is approximately 1.2x – a level slightly higher than its previous expectation of 1.0x – Fitch still considers this within the limits of the company’s current rating category.

Digital media research group eMarketer estimated (in a December 2012 report: As Mobile Gains Ground in Mexico, Advertisers Take Note) that the number of mobile connections in Mexico was 98 million in 2012, equal to 85.2 percent of the total population. By contrast, the number of mobile connections as a percentage of population in Brazil was 134 percent, according to its estimates. If these numbers suggest the Mexican pie can become larger, the big question remains as to whether it will amount to anything more than a few crumbs for new market entrants such as Sir Richard Branson – even after factoring in the long standing political pressure that has been heaped on Carlos Slim. Much will depend upon the political and economic will of regulators.

For his part, Slim remains comfortable, saying in a recent interview that he doesn’t think profitability in the newly liberalised domestic landscape will be any problem, arguing it is coming from productivity, efficiency, management, austerity, and the way the business is managed.

He also probably has bigger fish to fry than Richard Branson.

Transfer pricing: using technology to avoid the pitfalls

Posted on January 20, 2014February 20, 2014 by Ashton Wenborn

Failure to address the difficulties many companies face with transfer pricing can lead to significant business risks, such as financial reporting issues, increased tax liabilities, and higher costs in terms of intercompany accounting and tax compliance.

To meet this challenge, many companies are adopting a holistic approach to executing transfer pricing – one that integrates the transfer pricing process with day-to-day operations.

Companies are also exploring new ways to improve transfer pricing processes and leverage technology to drive efficiencies and reduce risk. When taken as a whole, this approach is referred to as Operational Transfer Pricing.

The role of technology
Transfer pricing user requirements beyond intercompany eliminations are commonly scoped out of major technology upgrades or new implementations. As a result, transfer pricing implementation frequently involves offline or manual processes across multiple departments, regions and systems, adding time, cost and risk to the close process. Many of these inefficiencies can be alleviated by enabling technologies.

Technology further improves data gathering and quality of information which supports the enhanced integrity and monitoring of intercompany transactions

Companies that integrate technology may be capable of achieving significant benefits. Streamlined processes and controls can help companies drive earnings per share through greater realisation of tax planning goals and possible reduction in FTEs, while shifting tasks from routine to value enhancing.

Technology further improves data gathering and quality of information which supports the enhanced integrity and monitoring of intercompany transactions, as well as the ability to efficiently manage workflow and compliance requirements. These enhancements may increase financial reporting accuracy and timing, and reduce financial statement and tax audit risk.

A wide spectrum of tools exists to support the intercompany transfer pricing process. These can be broadly categorised into policy management, policy implementation, and compliance tools.

Many companies choose to work with a consulting professional to determine ‘best fit’ based on technology user requirements and the companies’ overall information technology landscape.

In developing a transfer pricing policy, companies should identify intercompany transactions, align intercompany agreements with transfer pricing policies, and design methods to facilitate the implementation of these polices.

Policy management and implementation
Workflow tools can support the entire transfer pricing process by facilitating information-gathering activities and providing a well-structured database for maintaining documents to support a company’s transfer pricing policies.

Benefits can include improved data quality and enhanced monitoring and reporting capabilities, which can enable companies to promptly identify and mitigate areas of risk

The potential benefits of such tools include oversight of tax and non-tax compliance requirements, centralised documentation storage and standardised reporting across the organisation.

Technology can also be used to help protect the integrity of transfer pricing data used for reporting and compliance, by ensuring that accounting procedures are integrated with transfer pricing policies and results are monitored regularly.

Easily identify areas of risk
Leading tools in this area feature automated calculation of segmented transfer pricing results, near real-time monitoring of intercompany profits, and the ability to make prospective unit price adjustments throughout the year.

Benefits can include improved data quality and enhanced monitoring and reporting capabilities, which can enable companies to promptly identify and mitigate areas of risk, plan and execute efficient tax structures, and make better-informed business decisions. Critical to the success of a transfer pricing policy implementation is cost-effective and efficient compliance management.

Tools within this area can support the step-by-step preparation and maintenance of transfer pricing documentation in accordance with local and global tax requirements. Key features include benchmarking resources, information on current transfer pricing rules and requirements, and ready-to-use report templates. Workflow capabilities enable real-time project tracking, review of documentation content and centralised information management.

KPMG member firms have operational transfer pricing professionals around the world who apply in-depth knowledge of global transfer pricing practices and market leading technologies to help companies effectively manage their global transfer pricing obligations.

For further information email Bernhard von Thaden (Los Angeles) at bvonthaden@kpmg.com; Jerry Klopfer (Chicago) at jklopfer@kpmg.com; Marco Pace (New York) at marcopace@kpmg.com; Komal Dhall (London) at kdhall1@kpmg.co.uk;

BTG Pactual invests in Europe’s public-private partnerships

Posted on January 20, 2014January 14, 2014 by Ashton Wenborn

Recently, Spain has been labelled an economic wasteland beyond all reasonable chance of repair, so much so that investment has waned to quite extraordinarily low levels. Growth has stifled as confidence in the eurozone’s fourth largest economy has taken a nosedive. Nonetheless, analysts believe that Spain’s fortunes are on the upswing, and that PPPs are likely to play a significant part in boosting the region’s prospects.

Reaching global shores
While a propensity for privatisation is certainly gaining ground in Spain, the benefits are far from exclusive to European shores, with nations as far afield as Latin America turning to PPPs as a means of plugging the infrastructure gap and generating economic growth (see Fig. 1). Aside from boosting government coffers, PPPs can also serve to revitalise consumer confidence, improve efficiency and lessen the burden on the public sector – these being circumstances that have too long plagued a global economy in decline.

One of the clearest examples of a PPP having benefitted fragile Spain is with the privatisation of the Catalonian toll road Túnels de Barcelona e Cadí. The deal – which was jointly undertaken by Invicat (fully owned by Abertis) and Latin America investment banking firm BTG Pactual – amounted to a settlement worth €430m in December 2012, and serves as an example of how privatisation can breed success.

“We participated in the water privatisation process soon after looking at this opportunity, and concluded that it was certainly interesting,” says Renato Mazzola of the Toll Road Concession, who is head of Infrastructure investments at BTG.

The multinational firm previously co-headed a consortium, along with ACCIONA, in what amounted to a €1bn water privatisation deal that extended to an estimated five million people across Catalonia. The company believes this second Catalan project – though worth less –is of an equal if not greater importance to a country in the midst of economic turmoil, stating that the privatisation of key infrastructure links can so often serve to stimulate economic growth.

“Privatisation can bring unparalleled benefits to the project with respect to procedures, maintenance and operations in a way that governments cannot,” says Mazzola. “I think when you have a private rather than a state operator, you’re able to utilise synergies from other assets around the world, and combine them in such a way that the project is made more efficient.”

Privatisation can bring unparalleled benefits to the project with respect to procedures, maintenance and operations in a way that governments cannot

Georgiana de Grivel, BTG’s Investor Officer told World Finance, “private ownership usually enhances the quality of the service in question because the party’s interests lie with customer satisfaction as, at the end of the day, that’s what’s going to bring more customers into the fold.”

Benefits beyond profit
PPPs also offset the burden on taxpayers and shift accountability to rest with private as opposed to public parties, in effect lifting consumer confidence and restoring a measure of satisfaction to an otherwise disillusioned public. Mazzola believes the concession to be crucial in spurring economic growth in Catalonia, “not only can the government actually raise the money to comply with financial requirements, but reallocate resources elsewhere, whether it be to areas where there is a greater need for investment or ones where the private sector is not necessarily interested in investing.”

“PPPs can also bring further infrastructure investment to the region,” says de Grivel. “For local and international investors who may well have been wary of investing in the past, having an international player involved will serve as a comfort to those who are undecided on the region.” The toll road privatisation has given the government an immediate sum of €310m, with the remaining 28 percent due to be paid on completion of the concession period 25 years down the line.

Mazzola states that, “for the government, it was important that they were able to raise the money they needed in order to meet their primary financial requirements. I think it was a win-win situation for all parties involved.” BTG won the concession through a rigorous bidding process, which saw the firm put together an incredibly attractive proposal.

“I think a lot of people believed the concession would not draw any bidders, but we were able to work an attractive project finance structure with a few commercial banks – and obviously in any infrastructure project financing is key.

“When we were bidding for the project the market conditions were extremely bad, there were very few banks willing to put money on the table, but given the close relationship that BTG and Abertis have with several commercial banks I think the banks were willing to commit the financing on this occasion.”

Pre-established experience
Speaking on the supposed reasons why BTG was selected, de Grivel says, “I think we also had an attractive consortium for the government being an investor group with further plans of investing in the region, and a proven operational track record through Abertis. “The Spanish conglomerate accounts for the majority of toll road concessions in the region… this same partnership was also attractive for banks given our experience in the sector.” Investment in infrastructure is something that BTG are all-too-familiar with, being headquartered in Brazil and believing – as so many do – that Latin America as a whole demands a huge infrastructure drive if it is to sustain its gains in the near future.

“Latin America in general is lagging behind compared to other regions in the world,” says Mazzola. “There is no question whatsoever about the need for infrastructure in Brazil, Colombia and Peru. However, this need is not excluded to larger nations and extends to smaller Latin American economies such as Paraguay as well.”

Deficiencies in Latin American infrastructure are well known, and are so often cited as one of the principal factors inhibiting the native emerging markets from progress. “If there is one economy that is ahead of the game then it is Chile, however the vast majority of Latin American nations require an upturn in infrastructure investment, and for this reason many governments have made this their primary focus.”

With government budgets squeezed and the infrastructure gap widening– $200bn a year according to Reuters – the onus lies more so with private players to cement a stronger platform from which Latin America can thrive.

BTG has invested in a number of infrastructure assets in Latin America and have in part contributed to what have been a productive year in terms of bolstering transportation, power, telecommunications and oil and gas assets

Although the likes of Brazil, Peru and Colombia have fallen behind somewhat on the infrastructure front, BTG has invested in a number of infrastructure assets in Latin America and have in part contributed to what have been a productive year in terms of bolstering transportation, power, telecommunications and oil and gas assets. “More foreign and local capital is being allocated to infrastructure, although I think the region as a whole requires a lot more investment in the future,” says Mazzola. “We do see a lot of international – especially European – investors participating in the region but most have seen a number of very strong and active local players emerge recently. “Obviously a combination of foreign and local capital in the region is always appreciated, but most importantly we must continue to see governments and private sectors build upon exiting infrastructure so that they’re able to guarantee the future economic success of the region.”

Speaking specifically about the measures BTG have undertaken to develop the region’s infrastructure, Mazzola is confident of further growth. “We’ve just raised a second infrastructure fund amounting to $1.8bn, which is the largest infrastructure fund in the region, and we are mainly focusing on oil and gas, energy, telecommunications and logistics, which represent the four areas of investment that we’ve already made.

“We’re also looking for opportunities in the water sector, so there’s quite a few areas that I think are targets for us as we look for one of these five opportunities.” As demonstrated by the Catalonian highway concession, PPPs can so often be the key to economic growth. Recognising that there are many more opportunities of this sort to be had overseas, BTG this year co-headed a $1.5bn joint venture to acquire a 50 percent stake in state-owned Petrobras’ African assets in Angola, Benin, Gabon, Namibia, Nigeria and Tanzania.

“We’re going to continue with our focus on Europe and Latin America so that we’re able to participate in markets outside of Brazil, which is the case right now in Chile too. We’re very optimistic about our current investments, and we’re confident that there are some great investment opportunities in many major regions across the globe.”

China’s economic growth slows

Posted on January 20, 2014September 20, 2017 by Ashton Wenborn

Even though it has propelled the global economy for much of the last decade, recent figures have shown China’s economy is slowing down to its lowest rate in 14 years. Official figures released today reveal that GDP growth for 2013 was 7.7 percent, down 0.01 percent on the previous year’s number.

Despite this slump, growth was higher than the government’s pessimistic target of 7.5 percent. China has sought to rebalance its economy in the last year, with an effort to step back from the heavy investment that has bolstered growth over the last decade. Instead, the regime has looked to encourage more of a domestic consumption-fuelled economy.

Despite this slump, growth was higher than the government’s pessimistic target of 7.5 percent

Many observers feel that this slow down in growth is not the disaster some think it might be, as it signifies a step towards a more realistic and sustainable level economy. HSBC’s Qu Hongbin, Co-Head of Asia Economics Research and Chief Economist for China, said in a note that China had ended 2013 on a “firm footing”.

“Fourth quarter GDP growth came in a tough higher than expected at 7.7 percent year-on-year, taking full year GDP growth to 7.7 percent, above the official target of 7.5 percent. Overall this sets the stage for Beijing to push forward its economic reforms in 2014. We expect the growth momentum to be maintained in the coming year thanks to the improving external outlook, ongoing reform measures designed to boost private investment and consumption, and the stable and supportive policy stance in the context of mild inflationary pressures.”

Reacting to the news, Mizuho Securities analyst Jianguang Shen said that consumption had remained “relatively resilient”. “Improving exports and resilient consumption were positive trends starting from Q4 2013, but investment growth began decelerating, mainly due to borrowing costs and increasing stress in the shadow-banking sector. We expect this divergent development…to continue in 2014.”

Announcing the news, China’s National Bureau of Statistics (NBS) chief Ma Jiantang said that it was a “critical period” for the country’s economy. “Generally speaking China’s economy showed good momentum of stable and moderate growth in 2013, which is a hard-earned achievement. However, we should keep in mind that the deep-rooted problems built up over time are yet to be solved in what is a critical period for China’s economy.”

In a note to investors, Shen agreed that the government faces a difficult balancing act in the coming months. “The government is faced with the difficult task of pushing for structural reforms whilst at the same time trying to avoid the risks associated with radical changes. We maintain our 2014 GDP growth forecast of 7.6 percent year-on-year, assuming that the government can fend off a full-blown financial crisis.”

Can Obama save his legacy?

Posted on January 20, 2014January 28, 2014 by Ashton Wenborn

United States President Barack Obama — Obama listens attentively during a January 2014 meeting with young people who are helping with healthcare enrolment efforts. The President wanted to hear about their experiences in spreading the word about the importance of signing up for affordable healthcare insurance

Hailed as the saviour of the western world and heralded as the champion of a new dawn of politics, the reaction that greeted Barack Obama’s victory in the 2008 US Presidential election reached absurd levels of hysteria. The expectation that surrounded Obama was so high that many people thought he would be able to deftly solve the biggest financial crisis in nearly a century, while at the same time overhauling the country’s much criticised healthcare sector and improve the US’s damaged global reputation.

The reality, however, has been somewhat different. While the economy has got back on track, it has hardly been as a result of a new form of conciliatory deal making in Washington. Nor has he made good on many of his promises, from closing the Guantanamo Bay detention camp to curbing lobbying in Washington. Countless promises made in his initial campaign have either been watered down or completely ignored, resulting in his many supporters decrying his lack of progress.

As successfully re-elected presidents enter their second terms they often look towards implementing some form of ambitious, headline grabbing policy that will secure their legacy for decades to come. Freed from the shackles of having to think about another election campaign and keeping people onside, second term presidents are often successful at getting more done than in their initial terms. However, with so many criticisms over broken promises and political cooperation at an all-time low, many wonder whether Obama will be able to salvage some form of legacy in the remaining two years of his presidency.

[W]ith so many criticisms over broken promises and political cooperation at an all-time low, many wonder whether Obama will be able to salvage some form of legacy in the remaining two years of his presidency

More often than not legacy-building comes in the form of foreign policy initiatives, with both George W Bush and Bill Clinton attempting to force progress on the Israel-Palestine issue. In this instance, Obama has similarly sought to make his mark in the last few months. A ground breaking deal with Iran over its nuclear ambitions should be hailed as a significant step towards bringing back into the fold what has been a troublesome player in the world’s most volatile region, even if it was condemned by many as having isolated the US’s traditionally close ally Israel.

Moves by Obama to force an agreement between Israel and Palestine should also be welcomed, although whether he will have any success in persuading intransigent Israeli Prime Minister Benjamin Netanyahu to adopt a plan based on 1967 borders remains to be seen, especially after the supposed betrayal over the Iran deal.

However, much of the attention should be on settling the issue of Syria. Obama’s indecision over action in Libya was followed by his failure to stick to his ‘red line’ threat to President Assad over the use of chemical weapons, conceding the initiative to Russian President Vladimir Putin. In the coming year, he should look to seize back that initiative by making it abundantly clear to Assad that a conclusion to the fighting in Syria must be reached. While military action should be seen as a last resort, any further uses of chemical weapons should result in the harshest of actions from the international community – led by the US.

Obama’s much-anticipated assault on the private healthcare industry barely made it through fraught negotiations with Senators and Representatives, resulting in a much-watered down version of his initial proposals. What was eventually launched towards the end of 2013, Obamacare, was beset by online technical problems, further harming his reputation and giving his administration an air of incompetence. Critics highlighted basic faults in the website that people needed to sign up to, and the money invested in running the programme was clearly misspent.

Even though he promised to curb the sort of surveillance tactics that had become popular during the Bush administration – such as the Patriot Act – Obama suffered an embarrassing 2013 as a result of the Edward Snowden revelations over domestic and overseas spying by the National Security Agency (NSA). Scolded by international leaders that included Germany’s Chancellor Angela Merkel and French President Francois Hollande over the NSA’s supposed tapping of their phones, Obama must use 2014 as the year to rebuild these relationships and improve trust. Recently announced plans to protect foreigners from NSA spying, as well as a demand for presidential approval for spying on foreign leaders, is not enough.

He should start by pardoning Snowden. An act of heroic whistleblowing or despicable treachery – depending on how comfortable you are with government snooping – Snowden has been stuck in Russia seeking political asylum since his revelations in June last year. Even though he revealed hugely damaging information about the US’s surveillance activities, he has highlighted a worrying lurch towards government distrust of its citizens and its allies. For a country that so fervently promotes freedom of speech and expression around the world, it is depressing to see it collect such vast swathes of information about people that it may use against them.

Obama has undoubtedly been a huge disappointment to those who so passionately hailed his election in 2008. However, it is not too late to salvage his presidency and address many of the things he set out to achieve in the first place. Saving his healthcare reforms is also possible; provided he brings the right sort of people into oversee it. Closing Guantanamo Bay would be a symbolic move, as would bringing about some more dialogue between Israel and Palestine. Tackling Syria is even possible if he has the courage of his convictions.

A presidency that offered so much has been hampered by Obama’s relative belligerence in dealing with opponents. Now that he doesn’t need to worry about being re-elected, he should be bolder and more forceful if he’s going to be remembered as anything more than a damp squib.

Iran’s nuclear deal: problematic or progressive?

Posted on January 20, 2014February 20, 2014 by Ashton Wenborn

An “historic mistake” that had made the world a “much more dangerous place” is how Israeli Prime Minister Benjamin Netanyahu described the recent agreement between Western leaders and Iran. The deal set out in Geneva and negotiated in November between Iran and the so-called P5+1 group of nations – the US, UK, France, Germany, Russia and China – took many sleepless nights to finalise.

Iran’s nuclear deal in pictures

Former Iranian President Mahmoud Ahmadinejad at the United Nations General Assembly in NYC, 2012 Iran’s parliament speaker and former Tehran’s top nuclear investigator Ali Larijani speaks to members of the press in Geneva, Switzerland
US Secretary of State John Kerry addressing a press conference during talks on Iran’s nuclear programme in Geneva, Switzerland

A satellite image of the Arak Nuclear Reactor in Iran. Construction will continue despite global disdain

The hope, however, is that it will lead to far greater engagement between the West and what has been a thorn in the side of the pursuit for peace in the Middle East. With this renewed, if tentative, step towards cooperation with the rest of the world, Iran is at an intriguing crossroads.

On one path is further engagement with the international community, potentially leading to an inflow of foreign capital and a boost to its industries. On the other is a continuation of the double-dealing, mischievous approach that has caused the country to be shunned – and sanctioned – for so long.

The country’s rumoured intention to secure a nuclear weapon has caused strife across the Middle East for more than a decade now. While it has always maintained it is purely pursuing a peaceful nuclear energy programme, concerns from the international community meant burdensome sanctions have decimated its economy.

Getting to a point where Iran sat round a table with world leaders – and most importantly the US – has been a long and torturous affair. Since the revolution in 1979, the country has presented the US as the ‘Great Satan’, stirring up anti-Western sentiment for more than 30 years. Its relations with its regional neighbours have been fraught with conflict and distrust, and Iran is seen as a troublesome presence by Israel, Saudi Arabia and Iraq.

A wolf in sheep’s clothes?
The election of 64-year-old Hassan Fereydoon Rouhani in June 2013 was heralded by many as a move towards moderation for the country, an encouraging sign after the pantomime-villain that was President Ahmadinejad. With a campaign slogan of “moderation and wisdom”, he has been praised for his stance on civil rights, the economy and his willingness to seek a diplomatic solution to the issue around Iran’s nuclear capabilities.

However, some are sceptical of his moderate credentials, pointing out that he was approved by the conservative Guardian Council that has the ultimate control in the country. They point out that the Twitter-using Rouhani may just be the acceptable face of a still extremely conservative, religious regime.

Author Cyrus Massoudi, whose Land of the Turquoise Mountains covers his account of a modern Iran, said that while it was important to be wary of previous examples of candidates not matching their moderate rhetoric, the new strategy of engaging with the West was encouraging.

“Every candidate that runs for presidency has been approved by the regime and in the majority of cases will have been a part of it at some stage. Rouhani is no exception. As has been seen in the past, genuine progressive intentions do not necessarily translate into lasting reform, but this new rapprochement with the West may herald a need to revise certain attitudes.”

Economic reforms
With an economy that is 50 percent planned by the government, Iran’s government needed to make some form of concession to the West in order to loosen the sanctions. Dominated by oil and gas production, the country’s exports have been hampered by an out of control currency and restrictions on the export market.

Both the food and energy markets are heavily subsidised by the regime, which has placed a considerable burden on the economy. While recent years have seen attempts to reduce the subsidies, more reforms are needed if the country is to attract private-sector growth and foreign investment.

The overreliance on oil and gas – Iran has the second largest natural gas reserves in the world, and the third largest oil reserves – has meant that restrictions on energy exports have seriously damaged the economy (see Fig. 1). The deal with the West should, in theory, lead to the economy getting a much-needed shot in the arm.

However, according to Massoudi, wider reforms are still needed. “The longer-term implications are dependent on whether the terms of the deal are upheld by the Iranian regime. That there has been successful dialogue for the first time in over 30 years is in itself a positive step – everywhere outside of Israel and Saudi Arabia at least – but only the start of what will no doubt be a long and tortuous process.

“In the short term, the freeing up of vital oil revenues will give the economy the shot in the arm it desperately needs but President Rouhani’s stated goals of stabilising the currency and curbing inflation are still a long way away and will be reliant on a more permanent loosening of the sanctions.”

News of the deal caused Iran’s currency – the rial – to immediately jump more than three percent against the dollar, as hopes were raised that the economy would recover from the sanctions. Iran’s currency has fluctuated wildly in recent years as a consequence of the currency rates.

The government’s attempts to bring it under control, as well as reducing the key problem of an inflation rate of about 40 percent, has been erratic over the last couple of years. Former President Mahmoud Ahmadinejad was heavily criticised for his policies, and so it is hoped that the more moderate Rouhani will be able to get things under control.

As part of the deal, $4.2bn worth of oil revenues will be unfrozen, as well as $1.5bn worth of revenues from trade in gold and precious metals. Although negligible compared to the $30bn worth of revenues from oil that the country will miss out on over the next six months due to sanctions, it will certainly help things.

Despite the deal, US President Obama has maintained oil sanctions on Iran

Massoudi also believes that President Rouhani will try to put a block on cheap foreign imports in order to help the country’s agricultural and industrial sectors. “President Rouhani has identified the need to curb the reliance on cheaper foreign imports in an effort to revitalise the largely ailing industrial and agricultural sectors as a means to future economic stability, but more immediately oil and gas revenues should see the sharpest increase.”

Despite the deal, US President Obama has maintained oil sanctions on Iran. He said in a statement, “There is a sufficient supply of petroleum and petroleum products from countries other than Iran to permit a significant reduction in the volume of petroleum and petroleum products purchased from Iran by or through foreign financial institutions. I will closely monitor this situation to ensure that the market can continue to accommodate a reduction in purchases of petroleum and petroleum products from Iran.”

US Secretary of State John Kerry, who helped to broker the deal, added, “The Joint Action Plan agreed in Geneva does not offer relief from sanctions with respect to any increases in Iranian crude oil purchases by existing customers or any purchases by new customers.”

However, Iranian oil minister Bijan Zangeneh told reporters in December that the country planned to increase oil output, regardless of whether crude prices fell. “Under any circumstances we will reach five million barells per day even if the price of oil falls to $20 per barrel. We will not give up our rights on this issue.”

Israeli scepticism
The issue of Iran obtaining a nuclear weapon is still of great concern to Israel, however. The country has led the calls for sanctions to continue, having been the main cheerleader for the policy that has restricted Iran for the last decade. While the deal will see Iran’s uranium enrichment programme be restricted to the five percent civilian level, as well as daily inspections from UN observers, it is not enough for Netanyahu.

The morning after the deal was announced, he condemned what he perceived to be an overly generous concession that Western leaders had made to Iran. “What was achieved last night in Geneva is not an historic agreement, but an historic mistake. Today the world has become a much more dangerous place because the most dangerous regime in the world has taken a significant step toward attaining the most dangerous weapon in the world.”

Speaking in a subsequent trip to Rome, Netanyahu said, “There is a rush to accommodate Iran as if it has changed anything in its policies. The Iranian regime, though it smiles, continues to butcher people in Syria and sponsor terrorism.”

In an attempt to justify the sanctions over the last decade, Netanyahu said, “Great work has been done over the past decade in putting powerful, binding sanctions on Iran. These sanctions have been eased, but for what in return? We need substance, we cannot be satisfied with political theatre.”

He was also dismissive of Rouhani and the supposed moderate tone the country was now taking. “I would like to dispel any illusions. Iran aspires to attain an atomic bomb. It would thus threaten not only Israel but also Italy, Europe and the entire world. There should be no illusions about this charm offensive.

“Today there is a regime in Iran that supports terrorism, facilitates the massacre of civilians in Syria and unceasingly arms its proxies – Hamas, Hezbollah and Islamic Jihad – with deadly missiles. If tangible steps are not taken soon, it is liable to collapse and the efforts of years will vanish without anything in exchange,” he said. “But at the same time, I tell you and promise in the spirit of the Maccabees, we will not allow Iran to receive a military nuclear capability.”

A country that has such a rich and varied cultural history, as well as the foundations to be an economic powerhouse, has been in the international wilderness for far too long

Equally concerned about Iran’s new acceptance by the West was Saudi Arabia. The country worries that its regional dominance in the energy market would be under threat from a newly unshackled Iran. However, Iran’s Foreign Minister, Javad Zarif, has been keen to stress his country’s determination to engage with the Saudis. On a recent tour of the Gulf, Zarif said the deal with the West should not be “at the expense of any country in the region.”

“We look at Saudi Arabia as an important and influential regional country and we are working to strengthen cooperation with it for the benefit of the region,” he added.

Improving relations with its neighbouring countries is essential if Iran wants to be welcomed back into the international community. For years it has sought to antagonise the likes of Israel and Saudi Arabia, while stirring up trouble in Iraq and Syria, with no bigger proponent of this tactic than former President Ahmadinejad.

Massoudi believes that until it addresses these issues, sanctions will not be removed. “Iran will need to revise its foreign policy towards these countries if it is serious about building long-term bridges and working towards a more permanent alleviation of the sanctions.”

A new era of calm
A country that has such a rich and varied cultural history, as well as the foundations to be an economic powerhouse, has been in the international wilderness for far too long. While it has been an antagonistic presence in the region for many years, increasing cooperation with the international community is the only way that calm will be brought to the region.

As sanctions have tightened their grip on the country’s economy, the regime has been faced with a choice of continuing with decade-old policies or engaging with the world and moving forward. More sanctions would push the country to the brink of doing something drastic, and it should be welcomed that it has now sought to engage with the rest of the world in order to improve the lot of its people.

Israeli concerns may well be justified, but more of the same strategy would not have helped matters, and in fact may have led to the US considering military action. All should welcome the fact that the world appears to be a step further away from that prospect. The tentative agreement reached in November should herald a new dawn of cooperation for Iran, but more steps are needed before it is fully accepted back in the international fold.

In six months time, both sides want to begin discussions over a wider-ranging deal, and so this first step must be grasped by the regime to show it is serious about international engagement again. “There is a genuine desire to carry on down this path from the more pragmatic sectors of the regime but only time will tell,” says Massoudi.

Anheuser-Busch InBev buys back oriental brewery

Posted on January 20, 2014April 28, 2014 by Ashton Wenborn

Anheuser-Busch InBev has announced that they are to buy back Oriental Brewery (OB) five years on from its original sale and six months earlier than the July date that was agreed upon by KKR and Affinity Equity Partners. The acquisition, which is valued at $5.8bn including debt, will see the world’s largest brewer regain a foothold in the Korean beer market, which is currently exhibiting twice the growth rate as the rest of the world.

The acquisition…will see the world’s largest brewer regain a foothold in the Korean beer market, which is currently exhibiting twice the growth rate as the rest of the world

“We are excited to invest in South Korea and to be working with the OB team again. OB will strengthen our position in the fast-growing Asia Pacific region and will become a significant contributor to our Asia Pacific Zone,” said AB InBev’s Chief Executive, Carlos Brito in a press statement. “We expect to be strong contributors to the Korean economy and community, fulfilling our global commitment to establish AB InBev as a leading corporate citizen in the markets in which we operate.”

Although AB InBev are paying over three times the original sale price, the Belgian brewer believes the opportunity in the region to be well worth the price tag. South Korea’s beer market is forecast by Plato Logic Limited to expand more than 13 percent through 2012 to 2022, and has grown at an annual rate of approximately two percent through 2009 to 2012, which represents a considerable opportunity for brewers such as AB InBev.

Over the course of the past five years, OB’s domestic market share has gone from 40 to 60 percent since KKR acquired the company for $1.8bn in mid-2009, at which time InBev was seeking to curtail its debts following a $52bn takeover of Anheuser-Busch.

“The success experienced since 2009 is a testament to all the employees of OB, and we are gratified to have invested in the company and supported the company’s growth as well as their environmental and citizenship initiatives,” said the Chairman and Managing Partner of Affinity, Kok Yew Tang in a statement.

Trapped on a sinking island

Posted on January 20, 2014September 20, 2017 by Ashton Wenborn

Like politicians everywhere, Puerto Rico’s legislators never like to be reminded of failure – not least (in their case) the island’s dubious distinction of sliding into recession in 2006 when much of the West was still in the throes of an economic boom.

After eventually becoming a self-governing US territory (a new constitution was approved in 1952), which was a legacy of the US victory in the 1898 Spanish-American War, the island latterly entered an economic cycle punctuated by fiscal mismanagement that hit its nadir in 2006 when yet another budget crisis this time saw the government temporarily shut down, putting 100,000 people out of work.

Puerto Rico by numbers

3.66m

Population

13.2%

Unemployment rate (June 2013)

$1.38bn

Deficit hoped to be wiped by 2016

The closure came after the legislature and then Governor Anibal Acevedo Vila failed to seal a last-minute deal to address the government’s $740m budget shortfall. Debt meanwhile continued to mount.

While the leader of the Senate offered to implement a 5.9 percent sales tax to help pay off an emergency $532m line of credit the government needed in order to see it through the fiscal year, this was subsequently vetoed by the island’s House of Representatives, which would only go up to 5.5 percent.

Exemption to the rule
Vila, who was later to be charged by US authorities for campaign finance violations, said neither plan was sufficient and that a seven percent tax would be required to pay for an additional $640m loan. The straw that finally broke the camel’s back though was a decision by the US Congress removing an exemption, allowing US companies to avoid paying tax on profits generated by their Puerto Rican manufacturing operations; ostensibly because US legislators concluded their own taxpayers had been systematically bilked.

The island meanwhile found it increasingly difficult to finance – through the use of so-called ‘triple tax-free bonds’ – its accumulating debt, resulting from a decades old industrial policy that had seen heavy investment in education, infrastructure and high-tech manufacture. Hence, when Congress pulled the tax exemption rug from under the economy the fiscal landscape became even more hostile.

Superficially, Puerto Rico may have the appearance of a typical US state, including a governor and bicameral legislature; yet its extensive use of public corporations to deliver public services sets it apart from US states. Directly and indirectly the island manages more than 40 public benefit corporations, leading to charges that such a structure limits both transparency and fiscal accountability in its public sector.

Looming large over the economy is the Government Development Bank (GDB), which acts as the fiscal agent and primary lender to the island’s political subdivisions and public corporations. Hence, growth and financial stability in many respects are a function of a healthy GDB. Complicating the issue further, the island cannot legally file for bankruptcy – a legacy of becoming a US territory – given its constitution states debt payments must be made before anything else is paid for. Unsurprisingly, for decades the island was (and continues to be) sustained by federal subsidies from pensions to food stamps – a reflection of its people being poorer than the American average.

Debt spirals out of control
While debt has been issued to finance the annual budget deficit – now rolling over into its 13th straight year – the island has required market access to meet payroll and other obligations. Between 2001 and 2010, gross public debt soared from 25 percent to 90 percent of GDP. It eased back to 84 percent of GDP in 2012, according to data from Morgan Stanley, while unemployment had slowed to 13.2 percent as recently as June 2013, having peaked at 16.9 percent in May 2010.

A closer examination of the island’s $3trn plus municipal bond market though will readily show that successive government objectives of fixing the island’s finances have subsequently proven hollow – borrowings by the government (and its agencies) more than doubling over the 2004-13 period to $70bn – this at a time when the economy contracted 16 percent.

Indeed, despite unemployment having seemingly peaked, Puerto Rico’s problems are far from over. Against a backdrop of an ageing and shrinking population (of 3.66 million) the island has continued to run annual budget deficits of around 2.5 percent of GDP in recent years and sought to reduce them by levying yet more taxes, raising the retirement age for government employees, and increasing the share of their salaries they contribute to their pensions – the objective being to wipe out a $1.38bn deficit this year by 2016.

Described by some commentators as the ‘Greece of the Caribbean’, the similarities between Puerto Rico and Greece are striking in many ways. Greece was living beyond its means even before it joined the euro with public sector wages, for example, surging 50 percent between 1999 and 2007 – far faster than in most other eurozone countries.

Adding to the problem, public coffers were progressively drained as tax evasion – almost a national sport – lurched further out of control, leading to the budget deficit itself becoming uncontrollable without the implementation of drastic measures.

Not helping matters either was that much of the Greek government’s borrowings had been concealed as successive Greek governments sought to meet the 3 percent of GDP cap on borrowing required of euro members.

When the global financial downturn hit – and Greece’s hidden borrowings came to light – the country was ill prepared to cope. While Greece is now in its sixth year of recession, aggravated by swingeing public spending cuts linked to a €240bn ($320bn) bailout from the euro area and IMF. Puerto Rico’s Government Development Bank, tasked with handling the commonwealth’s capital market transactions, claimed in a recent statement that the island’s capacity to service its public debt was being unfairly compared to Greece. Yet neither economy, linked as they are to the euro and US dollar respectively, have any control over monetary policy – hence neither can devalue their currency to kick-start the economy.

Moreover, neither have a strong productive base, while both economies are economic mirages based on consumption that has been sustained by a monetary illusion. That is, by having access to a stronger currency than their fundamentals warrant, according to Sergio M Marxuach, Policy Director and General Counsel at the Puerto Rico think tank The Center for a New Economy (CNE).

Ineffectively treading water
Certainly the portents for Alejandro García Padilla weren’t looking good when he assumed office as Governor of Puerto Rico back in January 2013. Unemployment stood at 14.6 percent – more than any US state – and murders were at an all-time high as the drugs trade continued to plague the island.

In addition, the economy was being weighed down by debt of $70bn worth of bonds outstanding and a budget deficit of $2.2bn (later to be revised down), leading to rating agencies downgrading the island’s bonds to near-junk status. Total income tax collections meanwhile fell for a fifth straight year and were $4.4bn in fiscal 2013, (FY 2012: $4.54bn; FY 2011: $5.19bn).

Nearly all other categories of income taxes also declined, but for a $92m year-on-year rise in those collected from non-residents. Excise tax collections on cigarettes and motor vehicles also showed increases in the last fiscal year. The current fiscal 2014 budget covering the 12 months that began July 1 relies on a projected $1.38bn from tax increases.

However, the island’s Treasury Department said an initial fiscal 2013 general fund deficit projected at $965m by an earlier administration now looked to total $247m, suggesting that economic forecasting isn’t necessarily one of the government’s strengths. The island’s general fund covers education and other essential spending. Treasury Secretary Melba Acosta-Febo added in a statement that her department had just added 65 auditors to reduce tax evasion on the island.

The blame game is always subject to rigorous political debate, and if economic mismanagement is at the top of the list no such list would be complete without the inclusion of Wall Street. As it borrows frequently to fund operations, Puerto Rico must retain market access to avoid a bond default.

In October 2013 the nation suffered the ignominy of seeing 10 year debt yields climb to 7.94 percent (13 percent on a taxable basis) – exceeding that of an economically incompetent post-Chavez Venezuela, which was witnessing 12.6 percent on similar maturity US dollar debt.

If much of the froth in the Puerto Rican munibonds market was down to their attractiveness to US investors from a tax standpoint, events have subsequently shown how quickly fund managers can head for the exit. Interest on Puerto Rican bonds is exempt from state and local taxes in the US for most investors. Coupled with attractive yields, due to credit ratings just above ‘junk’ status, they’ve proven popular. So much so that 77 percent of US based muni-bond mutual funds reportedly hold Puerto Rican debt.

Reactionary-based business
Chasing yield can become self defeating after a while, especially when markets temporarily head south as they did last May when US Federal Reserve Chairman, Ben Bernanke spooked investors by flagging up the possibility of reducing monetary stimulus to the US economy.

Investors have reacted to selloffs in the interim by pulling tens of billions of dollars out of US muni-bond funds, forcing those funds loaded with Puerto Rican paper to offload some of those holdings. Prices fall, further investor redemptions ensue, more bonds are sold off and the vicious circle continues.

Puerto Rico’s current budget expects to raise more than $2.5bn in revenue though new taxes and other levies

Also in October ratings agency Moody’s downgraded $6.8bn of Puerto Rico sales tax revenue bonds to A2 from Aa3. While the bonds still maintain a high investment grade, it noted the island’s continued weak economy (a 5.4 percent contraction over the year to August 2013) and an even weaker underlying credit rating, given general obligation bonds are rated just one notch above junk.

The downgrade also reflected the agency’s view that the sales tax bonds are more tightly linked to the sovereign’s underlying credit rating than the previous six-notch gap had suggested. The agency affirmed Puerto Rico’s general obligation bonds at Baa3 and $9.2bn in subordinate sales tax bonds at A3.

The outlook for both ratings was revised to negative from stable, however, because of the negative outlook of the commonwealth’s general obligation bonds, trading at the time at some 70 cents on the dollar and yielding 8.8 percent.

Puerto Rico’s current budget expects to raise more than $2.5bn in revenue though new taxes and other levies. Or, to put it another way, an estimated 25 percent of the general fund budget. Yet, despite such optimism, which also includes a five-year economic plan designed to create 130,000 jobs by 2018, the markets are saying otherwise – the S&P Municipal Bond Puerto Rico index showing a 17.8 percent decline, year-on-year, as of early November.

US investment research group Morningstar estimated in September that Puerto Rico can only cover 11.2 percent of its public pension costs – even less than that of the notoriously underfunded Illinois retirement system. It added that Puerto Rico’s liability now equates to $8,900 per person, and this as three of the island’s public pension plans are projected to deplete their respective assets over the coming years.

The pensions time bomb, prompting an overhaul earlier this year to bring down the island’s $37.3bn of unfunded pension liabilities, in part explains why the economy has tipped back into recession.

Meanwhile, $35bn of pension debt is likely to remain on the books for years. Any further ratings downgrades will mean higher government borrowing costs. Then the big question is what can the government do once it runs out of funds to cover pensions, social welfare funds and debt servicing.

As a federal territory it remains unclear how Puerto Rico can be ‘restructured’ should the doomsday scenario of default come to pass, for example. As it is not a municipality it doesn’t have the option of reorganising its debt via a US style bankruptcy. While the US Congress would likely get involved, it remains open to question from a legal standpoint, as to how they would.

In the meantime, markets stand ready to further punish Puerto Rico if its economic situation fails to improve soon. That will only exacerbate the market-dependent island’s already serious economic problems. Time is running out.

Puerto Rico in pictures

Mastering the Mauritian insurance market

Posted on January 20, 2014January 13, 2014 by Ashton Wenborn

The insurance market in Mauritius – as with the wider island economy – is small yet dynamic, and best characterised by emerging opportunities for growth. Although the market is naturally quite limited in scale, it is nonetheless occupied by as many as 14 insurance firms, the majority of which are struggling for survival in what is proving to be an increasingly challenging marketplace.

During the process of these firms setting up in Mauritius, many small companies have merged with others to allow them the best possible chance of competing with the stiff competition in the sector. However, one of the larger and more experienced firms in operation, the New India Assurance Company (New India), which has a history dating as far back as 1919 and a huge presence in India and Afro-Asia, is capitalising on its rich experience in the industry.

Historic local presence
Although the firm’s headquarters are in Mumbai, New India has maintained a presence in Mauritius for over 77 years and has, since its beginnings, endeavoured to become the most respected, trusted and preferred non-life insurer in the region. The company’s assets have increased for three years running in Mauritius, and have risen from $34.44m in 2011 to $39.76m in 2013 (see Fig. 1), which offers an indication of the pace at which New India is growing.

The company has a number of advantages over rival insurers in the region, too, in that it is wholly owned by the Indian government and backed by $8.4bn worth of global assets. These foundations have allowed New India to procure more business in new markets and leverage its business elsewhere, which has been crucial in the company posting consistent profits these past seven years.

The company’s mission is to develop general insurance business in the best interest of the community and to provide financial security to individuals, trade, commerce and all other segments of society by offering insurance products and services of a high quality and at an affordable rate.

This client-centric and forward-thinking ethos can best be seen in Mauritius, where New India has made it its highest priority to not only cater to customers’ needs, but to maintain high standards of public conduct and transparency in all it does.

Technology and transparency
One of the ways in which New India has differentiated its services from those of its competitors is by introducing new software called Web-Based Agent’s Modules, which is accessible to all of the company’s accredited agents and allows them to issue certificates and receipts from their offices. The system is the first of its kind in Mauritius and has not only streamlined New India’s services but instilled a greater measure of transparency to the Mauritian market.

At present, New India is operating through 27 accredited agents’ offices and has plans to introduce a further 10 in the coming year. Coverage of this scale is part and parcel of the company’s ability to astutely analyse and evaluate the marketplace, as well as adjust to any major changes with immediate effect.

Also in keeping with New India’s dedication to customers is the appointment of a complaints coordinator, who is charged with handling any grievances customers might have. Regardless of this position, New India last year received the least number of complaints in its history, due in large part to the company’s well-defined systems, faultless authority delegation, compliance with regulatory requirements, and the required technical expertise to negotiate a challenging Mauritian marketplace.

The island’s insurance industry is one rife with lucrative opportunities, which will no doubt be capitalised on provided that firms follow New India’s example and expand upon their existing products and services.

The call of corporate consolidation

Posted on January 20, 2014September 20, 2017 by Ashton Wenborn

It’s highly unlikely that the average American consumer had heard of a company called
Shuanghui International until the middle of this year – but they certainly will over the next few years. The Hong Kong-based but mainly China mainland-owned company is a producer of meat products that only got going 30 years ago. As for its Shuanghui brand (Shineway in English), it was launched barely 20 years ago.

But in September, Shuanghui pulled off the biggest-yet takeover of an American company by a Chinese one when US regulators approved its $4.72bn acquisition of Smithfield Foods, a global conglomerate. Shuanghui, led by Managing Director Zhijun Yang, who worked his way up from the shop floor, had to fight for the deal. The notably defensive committee on foreign investment (CFIUS) signed off on the takeover only after senior representatives of both parties in Congress took a long and hard look at it under what they described as a “thorough review” of the deal.

$221bn

Global M&A transactions, 1985

$2.3trn

Global M&A transactions, 2010

According to M&A lawyers, politicians would have got investigators to give the Chinese company a forensic examination, including finding out the location of Smithfield’s processing plants. If they are near military bases, for example, the takeover may have been pushed off the table. After all, the foreign investment committee has blocked at least three transactions since 2009 that would have had Chinese companies owning premises near sensitive locations.

But with the committee satisfied that Shuanghui is only concerned with selling Smithfield’s products around the world, and especially in China, rather than steal military secrets, the transaction is seen as a landmark in global M&A. As Forbes contributor Jack Perkowski pointed out, the deal can only be of benefit to America because it opens up the vast mainland Chinese market to US producers. “This is the beginning of an important new trend – look for more transactions [like it] in the future,” he commented.

The Shuanghui-Smithfield transaction is, however, only one example of something of a stampede by highly acquisitive Chinese companies to do M&A deals outside their own borders. Indeed, it is the most significant development of a more buoyant M&A sector in 2013 as global deals, whether by Chinese or other companies, finally began to approach the size they achieved before the financial crisis.

Even by halfway through the year, it was clear that a seismic shift was occurring in the global M&A market. By then Chinese companies had wrapped up no less than 98 cross-border transactions valued at $35.3bn, according to data from consultant Deloitte Touche Tohmatsu China. The two main target markets were Europe and the US, with mega-deals – anything above $1bn – accounting for well over a dozen transactions. And since then the deals have kept rolling in. With just one month remaining in 2013, Chinese companies had splashed nearly $61bn on foreign acquisitions, the highest on record.

According to the consultant’s local M&A expert, Stanley Lah, China’s increasingly bold move offshore (see area graph) is a reflection of growing confidence built on the back of more demanding and affluent consumers. Reflecting the nation’s thirst for premium European whiskies and spirits, they want higher-quality products made by prestige brands. “With US, European and Chinese economies having shown signs of growth, it should be no surprise that Chinese companies are becoming more optimistic,” Lah wrote in a report.

Big deals Stateside
Significant as they are, China-inspired deals do not top the charts for 2013. Indeed, they pale in size when compared with those taking place in the US. With interest rates at historically low levels because the US Federal Reserve has pumped so much money into the economy, acquisition-hungry American companies could not resist the temptation of low single-digit loans to fund raids on rivals or complementary businesses.

“The silver lining [in M&A by US companies] is that the Fed has made it clear they’re not going to pull back on easing near-term,” Paul Parker, Head of Global Corporate Finance and M&A at Barclays, told Reuters in September. “Therefore companies do have a window to take advantage of the rate environment, which is still historically low.”

The towering acquisition of the year of course was Verizon Communication’s $130bn purchase of the US wireless business of Vodafone (see bar chart). Launched in late August, it involved Verizon buying the UK telecommunications group’s 45 percent interest in Verizon Wireless. The price was irresistible – Vodafone will return £54bn to its shareholders, including £22bn in the UK. As Chief Executive Vittoria Colao said, echoing the basic rationale behind most M&A transactions: “We got an offer that was thought was in the interests of our shareholders to accept – at the end of the day it’s as simple as that.”

Until Verizon’s mammoth deal, it seemed that the top three would be the $28bn takeover of food group HJ Heinz by Warren Buffett’s Berkshire Hathaway and 3G Capital, followed by Michael Dell’s buy-back of his computer manufacturing company for $25bn and the $23.3bn acquisition of Virgin Media by Liberty Global.

But as people live longer around the globe, it was the rush for healthcare and life-science companies that dominated the top 10. In fourth place was Life Technologies after it was snapped up for $13.6bn by New York exchange-listed Thermo Fisher Scientific. Other top 10 healthcare deals in the sector include Onyx Pharmaceuticals (bought for $10.4bn by Angen), Bausch + Lomb ($8.7bn by Valiant Pharmaceuticals International), and Ireland’s biotech group Elan ($8.6bn by Perrigo).

The number of global deals may have fallen by around 10 percent to 25,374 compared with 2012, but nearly all of these are below the radar, well under the $100m mark by value. It is however the size of the transactions that is instilling a growing confidence in most markets as well as China.

“Overall deal activity is a good barometer of chief executive and board confidence,” explains Patrick Ramsey, joint head of Americas M&A at Bank of America Merrill Lynch. “But big-deal activity – $10bn and plus – is the best barometer of confidence. And we’ve seen more big-deal announcements this year-to-date than in any year since 2008.”

Rush to debt
Quite apart from the fact the M&A market is generally healthier, one of its most noteworthy aspects is how the big deals have been funded. For the first time in a long time, investors are rushing to back big-ticket debt splurges, as Verizon’s acquisition shows. After the transaction was approved, the US communications giant went to the market to raise the money. It offered $49bn in bonds to investors, a daring three and a half times the $14bn raised by Apple a few months earlier. At the outset it looked like the tactic could be a mistake – but Verizon took the plunge and got swamped. In a week-long debt-buying frenzy, Verizon’s brokers received about $100bn in bids.

For the first time in a long time, investors are rushing to back big-ticket debt splurges

According to underwriter Morgan Stanley’s Paul Spivack, Global Head of Investment Grade Syndication, the level of interest was a shock. “We had orders in this book that exceeded anything we’ve seen before”, he told the Wall Street Journal.

After years of investor nervousness about mega-transactions, the ease with which Verizon’s gargantuan acquisition was funded suggests the debt markets are regaining confidence and everybody is winning as a result. First, Verizon gets cheaper and more predictable debt than it otherwise would through loans organised by a syndicate of banks. Second, investors book a higher-yielding return from the corporate bonds than they would from, say, buying US Treasury bills.

And finally, the dealmakers – the Wall Street firms that oiled the acquisition – booked a total of $265m in fees. According to public filings, Barclays, Morgan Stanley, Morgan Chase and Bank of America took around $41m each for leading the debt sale.

More transactions, more regulation
Despite the bigger transactions, M&A consultants say the deal-making climate is changing. Just one fly in the ointment is the eagle-eyed attention of regulators. In Europe, Brussels’ bureaucrats usually involve themselves in sizeable transactions, while the US Justice Department has been particularly active. Its anti-trust lawyers only withdrew in November their objections to the merger of American Airlines with US Airways. And as the price of approving its $20.1bn acquisition of Mexico’s Modelo group, they forced brewer Anheuser Busch Inbev to sell off one of the company’s breweries, among other conditions.

“We’re seeing more activism out of the anti-trust regulators”, says Scott Barshay, Head of the Corporate Department at law firm Cravath, Swaine & Moore. “As a result, fewer deals are being pursued because of fears the regulators will just turn them down or demand too high a price.”

[T]he sun could be about to come out in Europe after five years of M&A gloom

In fact, some regulators are trampling all over transactions on the skimpiest of authority. The UK’s competition authorities are a case in point. When Netherlands-based specialty chemicals group Akzo Nobel tried to buy all of Metlac, an Italian competitor, in July, the Competition Commission jumped in boots and all. Even though both companies were based outside Britain, it blocked the merger on the grounds that the companies make sales in the UK. Of nine competition authorities that could have intervened, the UK regulator was the only one to take such a step.

As multinational law firm Norton Rose Fulbright points out, this was a landmark ruling. After all, Akzo Nobel did not ‘carry on business’ in the UK, which is the usual requirement for such intervention. The overriding lesson, warn consultants, is that firms should hire a lawyer well before launching a cross-border M&A – and incurring considerable costs. Regulators are adopting increasingly generous interpretations of commercial law to get involved in M&A deals.

As lawyer Vera Rechsteiner of Houston-based law firm Andrews Kurth explained in a November note to clients: “[In the US] A transaction may be [deemed] ‘cross-border’ for any number of reasons, including foreign deal participants, non-US assets or the application of non-US laws, to name a few.”

Raking the ashes
Without the jump in interest from Asia, particularly China, and the UK, deal making in mainland Europe would languish even further than it does. M&A activity collapsed by nearly a quarter during the year in Europe to a total of $383.3bn, despite Vodafone’s €7.7bn takeover of Kabel Deutschland, and – the big deal of the year – the $35bn merger of French advertising agency Publicis with America’s Omnicom.

And opportunist investors are raking over the ashes of the financial crisis. As the employees of Spain’s Panrico, one of the world’s biggest doughnut manufacturers, will vouch, a fast-emerging phenomenon in Europe is the distressed M&A. In the case of Panrico, which collapsed earlier this year, Los Angeles-based Oaktree Capital snapped up the debt and, with it, the assets. Immediately, the private-equity firm launched a painful restructuring that involved lower wages and redundancies, triggering protests by employees.

Howard Marks, Chairman of Oaktree Capital Management, which subsumed and then restructured Panrico Donuts

But this is a Europe-wide phenomenon, even in the EU’s economic powerhouse. “Distressed M&A transactions are currently en vogue – especially in Germany,” confirm researchers Juergen van Kann and Rouven Redeker of New York-based law firm Fried Frank Harris Shriver & Jacobsen. Right now, there are several high-profile examples – energy group Solarworld and DIY chain Praktiker, to name just two.

New insolvency laws in Germany have made it easier for opportunistic funds to jump into the fray and acquire assets on the cheap. Alarmed at the way some insolvency specialists were plundering assets through sky-high fees at the expense of creditors, Bonn passed a law in early 2012 that among other things gave creditors more say in post-collapse proceedings. Any important creditor can be elected to the creditors’ committee, including third parties such as vulture funds that are often highly adept at rescuing a company in trouble, albeit at a price.

However, the sun could be about to come out in Europe after five years of M&A gloom. “All things seem to point to a future increase of activity,” says Gilbert Pozzi, Goldman Sach’s Head of M&A for Europe, the Middle East and Africa. Indeed, in late November, Germany’s third-biggest cable company, Tele Columbus, made an offer for junior rival Primacom.

Some things don’t change though. As French-born Harvard Professor Marc Bertoneche pointed out recently in a review of mounting M&A fever, these deals often come unstuck. And he cites a range of causes, including overvaluations, clashes of culture, absence of a disciplined post-M&A strategy, and inability to resist pressure from banks and others with a vested interest in a deal.

“All the studies agree on the conclusion that 50-70 percent of M&A transactions do not create value, a statistic that is nearly as high as the rate of failure in the marriage and partnership of Hollywood stars,” he said. So, 30-50 percent of all that money will be wasted.

New India invests in Omani insurance sector

Posted on January 17, 2014January 14, 2014 by Ashton Wenborn

Not content with having recorded the highest profits of the entire Indian general insurance sector last year, the success of the New India Assurance Company (New India) is in large part indebted to a commitment to expand further afield and introduce excellent products and services to new markets. Throughout the firm’s 93-year history, New India has extended its reach to 22 countries and five continents while simultaneously maintaining its high standing in the industry.

New India is among India’s largest and most financially secure non-life insurance companies and has spearheaded a number of innovations in the industry, ranging from domestic airlines to satellite insurance. Moreover, the company has been awarded an ‘A’ rating by AM Best for each of the previous nine years, based on a healthy capital position, excellent liquidity, strong operating performance and a high insolvency margin. The company is also the first insurance provider in the region to have secured a ‘AAA’ status from the Credit Rating Information Services of India (CRISIL), which reflects the company’s financial capacity to meet policyholders’ obligations.

Success in Oman
One of the markets in which we’ve seen our business grow substantially is Oman, which has, since our establishment there in 1974, proven an extremely hospitable climate for the insurance sector. New India was the first Indian insurance provider to enter the sultanate and has since built and consolidated a strong insurance base, merited widespread customer praise and advocated transparency in the wider industry.

The ongoing industrialisation drive in Oman, along with continued growth in the oil sector, has given rise to new opportunities in general insurance – project insurance being the single biggest beneficiary. With the upward trend in infrastructure and commercial projects set to continue for the foreseeable future, New India’s high standing in the market ensures the firm is well positioned to capitalise on this growth in the years to come, which will no doubt prove mutually beneficial to both company and country.

New India sees Omanis and Indians working together at every juncture, with more than 60 percent of the company’s workforce made up of Omani nationals

Oman’s insurance market consists of 20 general insurance companies, 10 of which are national and the remaining 10 foreign. Among the 10 foreign general insurance companies in operation, New India is the leader by some margin, with 34 percent of the market share and a reputation that is unmatched by any other in the region. As an indication of New India’s market dominance, the firm boasted gross premiums of RO27.5m ($71.5m) last year alone.

Nurturing the industry
New India stands at the forefront of devising unique insurance products and services and offers a range of value added services in catering to its exhaustive range of clients. The personal accident insurance cover, devised for customers of money exchange transfer companies in Oman, is testament to this commitment, as well as to the company’s wider efforts to address insurance shortfalls in the surrounding region.

Aside from matters of business, New India also seeks to consider those in the communities in which it works by introducing Omani nationals to the staff and providing them with the appropriate training and experience to progress in the region’s budding insurance sector. New India sees Omanis and Indians working together at every juncture, with more than 60 percent of the company’s workforce made up of Omani nationals. Far from an unfamiliar resident to Omani shores, at New India well-trained Omani personnel play a crucial role in nurturing the nation’s thriving insurance sector.