Wednesday, November 2, 2011

The Differences Between the BRICS

Goldman Sachs Asset Management - Annual Benelux Conference - Part 1

Emerging Markets in the Spotlight, more than 'Greece': The Differences between the BRICs

Like every year, LMG visited the GSAM Annual Conference for institutional investors. Always a good crowd, representing big pension plans, investment advisers and consultants on the one hand and a heavy GSAM delegation on the other. Like most of the times, GSAM Chairman Jim O'Neill did the main speech and it was - as always - a good one, especially for those of us interested in Emerging and Frontier Markets. Not a big surprise I guess, knowing that Jim is 'Mr BRIC' himself (he coined the phrase).

The venue was nice as well: the Taets Art Gallery in Zaandam, just north of Amsterdam.

Inspiring was also the panel discussion. Normally those panels are often created just to make sure all important people or entities that would like to say something do get the floor. But definitely not so this time. Led by a Dutch journalist who lives in Russia for more than 20 years already (working as on the spot reporter for Dutch TV and some newspapers) former Dutch ambassadors in India, China and Brazil sparred with him about the differences between the BRIC nations. A great session. Very serious stuff, but at the same token light enough to make people laugh, while at the same time presenting a broader picture.

Take for instance this one:

Former Ambassador to Brazil: ''Brazil has really advanced so much. In this democracy we have electronic voting and election results are available within 3 hours after closing of the ballot boxes. From Rio to the sub-tropical far away rain forests near the Amazon.''

Russia journalist: ''Now that would really not impress anyone here in Russia. Here the election results are known 3 years before the elections!!

Russia: Stability as the Keyword
Funny and sad at the same time? Maybe yes, maybe no. The Russia journalist continued to explain that in Russia stability is one of the key issues and that would probably not come as a surprise, taking into account that it is a country with just 138.7 million people but with 1/6th of total land surface of the earth. Russians take pride in the fact that they did not just defend that territory so far with big success, but also - whenever there were big wars in the world - could show/maintain their role as super power. 

Does that mean that there is a big sense of 'Russian Nation' in Russia? An 'us' versus 'them'? Not really, except when attacked. Other than that, people do not really trust each other and definitely not the intelligentsia or elite. Some even estimate that corruption comprises more than 25 percent of GDP! But what they do share is their appreciation of Russian 'Culture'. And they are right so. Just check out Literature, Arts, Music, Architecture and you will know WHY.

Leaders in this country have to be tough. Trying to be popular? Well, up to a certain percentage that can work by being mister Sweet Guy, but both Yeltsin and Khrustyev know that this will in the end fail. A nice anecdote about the recent visit of Dutch Prime Minister Mark Rutte to Moscow is indicative. Rutte had a chance to present himself on one of the few relatively independent news media in Russia, one that would normally NOT present the Russian ruling elite's point of view. In other words: one of the few stations where he would have a broader platform than Putin. Viewers could vote if they felt that Rutte would be a good guy to be PM in Russia. A stunning majority voted YES. But to be frank: even if one of our LMG seniors would present there, a YES might be the result. Why, because this channel was intelligentsia related hoping to make statements against the ruling elite and since they can only do so indirectly, this survey was one of those scarce opportunities!

Rutte Meets Putin and Learns about the Difference between expected Leadership Qualities in both countries.

Now, Rutte did visit Putin afterwards and our rookie, nice guy PM wanted to break the ice by referring to the survey (with a big smile on his face so as to not look seriously, but just friendly). Putin reacted with a face, cold as ice: ''It is good for Russia and you (!), that you do not have a Russian passport.'' Welcome in Russia, Mark Rutte!

Russian lack of humor? Well, doing business with Russians regularly and knowing them via earlier work with the Chess Federation and as chess sponsor (FIDE, the world chess federation is to a large extent influenced by top level Russian representatives), we can only say: No Way! 

The moment you know more of them, they are loyal, good friends and incredible fun to be with. Just be careful with the drinking, because their stamina is huge. This is not where Too Much Love Will Kill You (as in the Brian May song), but Too Much Drinking. So the stereotype about drinking is true. And it partly explains why Russian men die at a so much younger age than gender colleagues elsewhere in the world (true, crime and corruption are part of the explanation as well!).

The drinking stereotype is far more correct  than the one about Russians being trustworthy or not, with the verdict than most of the time being that they cannot be trusted. I rather do business in Russia with the right partner without a detailed written contract than I would do so in the US. Of course I am aware of the fact that critics would say that this is so because with or without a contract wouldn't make a difference in Russia anyway. Even if that were true to a certain extent, then be fair and compare that to the US situation where I could have a contract but even if I were right a court case against a multinational or the government would kill me financially before I end up winning the case.

In terms of market valuations Russia is the cheapest of the BRIC nations and one without a real middle class. Result: an interesting country for those who do business with the elite and top ranks, a total waste of time for those who focus on the lower layers of society. So do not bring supermarkets to Russia, but if you have luxury products to offer or want to buy stakes in Russian firms focusing on the upper classes: understand that this market might be more interesting than China, especially at current valuation levels. Add to that the resource availability and you might be willing to overcome doubts about crime and corruption to such an extent that you even start to like the Stability aspect!

Brazil: Where the Keywords are 'Future' and 'Crime'
Brazil has done a great job and in a reasonably democratic fashion. Is the so-called 'Country of the Future' this time really the country of the future? A cynical Brazilian saying was that 'Brazil is the Country of the Future and it will always be!'.
Well, a lot has been achieved and in mining, energy and agriculture the country has made huge progress and Embraer is now the third largest Aviation company in the world.

Embraer: Showing that Brazil is more than Football, Samba and Carnival

But at the same token Brazil is still the country where you should make sure NOT to use your GPS to find your way, because those damn things tend to go for the shortest routes. And short routes could take you through the favelas. Those shanty towns where crime rules.

But that is not to say that the country did not make great progress under former president Lula da Silva. It did, especially in the aforementioned industries. 

But democracies do always struggle with their balancing act whenever crime and corruption are important, and a period of less economic progress could easily translate into a shift in the balance of power between those responsible for regular economic growth and those in control of the invisible economy. At the moment the government is winning, but there is no guarantee that this will remain the case.

But it would be unfair not to give the Brazilians both credit and benefit of the doubt for their achievements. 

India: The inward-looking biggest democracy of the world
India is the world's biggest democracy. But also, as many people forget after Indonesia home to the largest Muslim population albeit that they are a minority in India. But notwithstanding Western folklore India versus Pakistan is NOT the main issue in India politically. Not at all. And it was good to hear that, because those of you who follow our LMG Facebook Page do know that we have our biggest traction in India and Pakistan with most often great discussions between our Indian and Pakistani friends. The real problem in India is China and India giving home to the Dalai Lama is in that respect a logical move. What is good for India is bad for China and vice versa. Although India is far less of a problem for China than the other way round. Our explanations about China below will help explain this dichotomy.

Balance in India: Inward-oriented but definitely a High Growth Country

Indian society is about balance, equilibrium, traditions and going back to business as usual et cetera. This is even so after terrorist attacks or other turbulence. And Indians are incredibly good at this shifting back to normality. This enormous focus on balance does have its weaknesses when having to perform cross-border geopolitics inside supranational bodies like the World Bank, IMF, G-20 et cetera. It always seems as if India is not capable of getting the role it deserves. Even with its current recognition of the importance of Africa as the resource rich continent that has to be uncovered, they are again lagging the Chinese who are more aggressive when it comes to promoting their national interests internationally.

But the Indians are not at all silly. And they know about their international weakness. Result: they focus more than the other giants on domestic growth instead of exports. And that has helped them tremendously during the period of the Global Financial Crisis when contagion between markets made the other giants struggle when Western financial systems ended up in disarray.

Not so India: the focus on domestic growth insulated them from a lot of the Western problems. Add to that the fact that India has a relatively young population - unlike China - and India knows that sooner or later the Chinese (although they are good long-term chess players as well!) will have to struggle with their internal demographic time bomb. In other words: India's glory days will come, sooner or later.

But the problem is of course: how much sooner or later. And what will the country do about its biggest internal time bomb: poverty and inequality?

But all in all: there is definitely a good case to make for India as well. And again, Indians are smart. If inequality is a problem nationally and export orientation is not there, then one can also export laborers. With the Middle East next door this strategy has worked and might continue to work. Just check out the average company or office building in Abu Dhabi, Dubai, Saudi Arabia and you know what we are talking about. And this is not just an export of educated workers. The brain drain has been a problem in India in the past, but the Indian top level educational system is such a fantastic rat race that the Institute's of Technology and Management will continue to deliver top talen in IT, Physics, Economics, Finance, Chemistry et cetera. Dozens of Western multinationals recognize this and have created research laboratories in India, with cities like Bangalore thriving on them, and on internal Indian entrepreneurial initiatives along the same lines.

China: The Middle Kingdom, Heaven on Earth ruled by a Social Contract
Then let's end our BRIC travel in China. The Middle Kingdom is back to where it was before the Industrial Revolution. That is: on a growth path toward a 30 percent stake of world GDP. Not sure if they will get that far, because of the demographic troubles (the population is getting older), but growth is there and high single and low double digit economic progress seems to be standard.

China: The Renaissance of the Middle Kingdom. Back where it belongs.

But will China develop into a world power? According to a former Dutch ambassador to China that way of thinking is totally wrong. It is Western thinking. China is the Middle Kingdom. A kind of Heaven on Earth concept, ruled by an elite based on a Social Contract: for and by Chinese. That social contract is simple. The elite - be it the Emperor like in the past, or the Communist Party now - has to deliver progress. If they do, the average people focus on economic growth and spiritual balance and happiness at the family level. The ruling class has to deliver the infrastructure in which this progress can be achieved. If they do, fine so. Just the occasional intellectual will be worried about democracy, human rights and moral values. Not so the bulk of the Chinese. They worry about what car to buy, which Luis Vuitton bag to get and: in case corruption and organized crime might want to fool people by selling them fake products without people knowing it (i.e. different from what the Chinese try to sell naive foreigners!), those rulers should act with severe punishment.

It is therefore no surprise that the Chinese government is one of the toughest fighters against corruption and other crime. Penalties even worse than those in countries like Iran. At the same token - so as to complicate matters - do not try to do business with Chinese without offering them presents. There is a thin line between the regular gift policy and corruption, but it is there.

China's goal is not global dominance. The goal is growth of the Middle Kingdom. Foreigners? They can benefit as long as they deliver what the Middle Kingdom needs. That explains the Chinese 'Grasshopper Capitalism' in Africa. Westerners having trouble doing business with Iran? Because that country has a different system that Westerners don't like. Who cares? The Chinese care about China. And they are more than happy to do business with anyone as long as it benefits the Middle Kingdom.

If you keep all this in mind you can do fantastic business with China as long as you remember that you will never become Chinese. And also remember that you should not address the issue of the three T's in some kind of intellectual way, hoping to change the vision of the Chinese leaders. Three T's? Tibet, Taiwan and Turks (the Uyghur people): don't even think about the Chinese being willing to discuss the issue or change their mind. They won't. The only thing you will achieve is that they might reduce the amount of business they do with you.

Therefore: China the number one catalyst of global growth? Yes, for sure. China a certain success story? Maybe. Markets are markets and if too many foreigners from the outside want to go in and benefit from this obvious growth story, prices go up and you might pay too much. And the Chinese won't stop that process. After all you are one of those foreigners aren't you, so who cares?

So the Chinese growth story will continue to follow a long-term growth path. It is essential that the elite - under the existing social contract - ensures long-term growth. This is their advantage vis-a-vis other countries where democracy is a great and fair system, but one that penalizes long-term decision taking in comparison with an excess short-term orientation. But again: the Chinese don't care. They just expand. They have to worry about two weaknesses:

1) The population is getting older, which creates a demographic time bomb; and
2) The social contract is just that. As soon as the leaders don't deliver, the biggest population in the world will get dissatisfied. And unlike in many other countries, this will not translate into bad moods, grief, talking, debate and not doing anything. It will transition quickly into actions against the elite. And the latter know it. Even the soldiers in the People's Army are trained and educated with this perception as part of what makes them tick. If their elite doesn't deliver? Then they won't be too loyal anymore.

Of course China remains the catalyst in the short term, but we feel that one has to be careful not to get overly enthusiastic as an outsider. The probability of paying too much is too high. In the near future it might be wiser to benefit from China by investing elsewhere in the world in countries that might benefit from China's demands for certain products. Africa might be an interesting growth story because of China's needs and in the slipstream those of India.

In a next entry more about the technical stuff that was discussed at this seminar.