Chinese hoteliers hope to catch a falling star

Chinese hoteliers hope to catch a falling star
By Josh Noble in Hong Kong

January 22, 2014 3:53 pm
In austerity China, only one thing can top a five-star rating: a four-star rating.
Last year, more than 50 Chinese hotels asked to have their five-star ratings downgraded, according to state-run news service Xinhua, as they attempt to regain business from chastened Communist party officials.
A number of other hotels have suspended their applications for five-star gradings in the hope of staying on government registers of acceptably austere accommodation.
The newfound humility of the hotel sector is the latest sign of Beijing’s running battle with bling.
President Xi Jinping, who came to power last year, has launched a nationwide campaign to stamp out the kind of lavish spending that became the norm for those in all echelons of the party apparatus at the height of China’s boom.
The aim is not only to quell corruption and waste but also to relieve potential social pressures from the wide and worsening inequality in one of the fastest growing economies.
It has sent shockwaves across the luxury industry, hitting products from Swiss watches to sports cars to shark’s fin soup.
Even as the festive lunar new year period approaches, banquets and parties have been cancelled while officials have been ordered not to accept the bribes – or “gifts” – to which many had become accustomed.
Other strict instructions include “travelling with smaller entourages, simplifying receptions, and practising frugality”, according to Xinhua. Government workers have been told to leave only clear dinner plates after a meal so as not to be accused of over-ordering at the taxpayer’s expense.
The result has been a plainer form of celebration as the country prepares to ring in the year of the horse. Toothpaste has replaced the iPad on the new year’s gift list, while the annual raffle no longer comes with a prize. Instead, workers are heading to the staff canteen.
Beijing’s clampdown on conspicuous consumption has spread far beyond the civil service. Many of China’s richest business people plan to cut down on giving presents over Chinese New Year, according to a report by wealth-tracker Hurun.
The excesses of the rulers were made clearer during the trial of Bo Xilai, the now-jailed former party head of Chongqing, a city-province of more than 30m. During his corruption hearing, details emerged of his personal fortune, a family villa in the south of France and of African getaways on private jets.
The round of belt-tightening has hit hotel operators particularly hard owing to the loss of banquet business and overnight guests. Chen Miaolin, vice-president of the China Tourism Association, told Xinhua that hotel revenue fell by around a quarter last year, in an economy growing more than 7 per cent.
But, as always in China, there are opportunities amid the crisis. Mr Chen, who also owns a chain of hotels, plans to close one of them after the new year holiday and reopen it as a nursing home. For him, silver may be the new gold.

Chinese offshore holdings: Xinhua reported it years ago

Chinese offshore holdings: Xinhua reported it years ago
23 January 2014 9:30AM
The fallout from a report on the secret offshore holdings of China’s business, military and political elites continues.
In case you missed it, here’s a brief summary of the report, compiled from leaked financial documents by the International Consortium of Investigative Journalists (ICIJ):
Relatives of at least five current or former members of China’s Politburo Standing Committee, the country’s most powerful decision making body, have incorporated companies in the Cook Islands or British Virgin Islands (BVI).
The files include details of a BVI company, Excellence Effort Property Development, 50% owned by Deng Jiagui, the brother-in-law of President Xi Jinping.
The Hong Kong office of Credit Suisse registered a BVI company for Wen Yunsong, son of former premier Wen Jiabao, while his father was still in office. Other western banks and consulting firms, including PricewaterhouseCoopers and UBS, also helped elites set up companies in tax havens.
Others notable persons include heads of state-owned enterprises, more than a dozen of the country’s wealthiest men and women, and members of the National People’s Congress,
It is estimated between US$1 trillion and US$4 trillion in untraced assets have left the China since 2000.
While the use of tax havens is not necessarily illegal, the revelations add to the increasing scrutiny of the accumulation of vast wealth by China’s powerful and well connected elite.
At the time of writing, the websites of many news outlets that had published details of the report were blocked or partially blocked in China. These include the website of the ICIJ itself, El País, a Uruguayan newspaper, France’s Le Monde, CBC of Canada, and The Guardian, which ran with the story on the front page of its UK edition Wednesday.
The Chinese internet has been scrubbed clean of news of the report. The Weibo blog account of the ICIJ has been deleted. A keyword search for ‘ICIJ’ and ‘China offshore’ on Baidu, China’s (censored) Google equivalent, turns up only one relevant search result: a discussion on Zhihu, a web forum known as a relatively free space for the exchange of online opinion. Zhihu is one of the services many Chinese are turning to as they abandon Weibo, which has been subject to a fierce crackdown on freedom of speech since the inauguration of President Xi.
Ironically, another Baidu search for ‘British Virgin Islands tax avoidance’ returns hundreds of results for pages that promise to explain the process of moving funds offshore.
The revelations come at an awkward time for the Chinese leadership. President Xi has led an anti-corruption drive in the government since coming to power. He has promised to target ‘tigers’ as well as ‘flies’ in the fight. Along the way his government has imprisoned civil activists who call for the full disclosure of officials’ assets. One prominent activist, Xu Zhiyong, went on trial the day the ICIJ report was published.
With the heads of many powerful state owned enterprises, titans of private industry — and the president’s own brother-in-law — now revealed to be hiding massive wealth abroad, Xi’s anti graft drive faces a make-or-break challenge to its credibility.
The ICIJ findings are a scandal, for sure. But they’re hardly a surprise. Reports on the secret wealth of the Chinese elite have been surfacing for several years now, thanks to extensive investigations by the New York Times, Bloomberg and others. The ICIJ report merely gives us an idea of the scope of the wealth being amassed.
There’s one other reason why the ICIJ findings aren’t necessarily a surprise. Official state media news agency Xinhua (hardly a bastion of investigative reporting) reported on Chinese companies’ exploiting the BVI as a tax haven back in November 2005. The Chinese language article is here. The author cites official statistics that ‘of the more than 80,000 companies registered in the BVI, around 20,000 have relations with Chinese enterprises.’ The report says Chinese enterprises are heading to the BVI for tax avoidance in droves.
The author goes on to interview Robert Matta, CEO of the BVI Financial Services Commission. Matta is asked, ‘How can Chinese enterprises take advantage of offshore centres to avoid taxes?’
It appears a lot of people read his answer.

For Liquor Makers, Cheer Dries Up in China; Liquor Companies Reeling From a Gift Crackdown Likely Won’t See Relief Soon

For Liquor Makers, Cheer Dries Up in China
Liquor Companies Reeling From a Gift Crackdown Likely Won’t See Relief Soon
PETER EVANS
Jan. 22, 2014 11:20 a.m. ET
LONDON—More than a year after the Chinese government banned extravagant gift giving and scaled back state-funded banquets, liquor makers are starting to feel punch drunk.
The crackdown on conspicuous consumption—part of an anticorruption drive led by President Xi Jinping —has hit spirits companies harder than most. Profit warnings, executive departures and restructuring drives have all been linked to the ban.
One potential opportunity for a revival is the coming Lunar New Year celebration over two weeks starting Jan. 31, traditionally the busiest sales period of the year for drinks companies in China. But the omens for a shot of New Year’s cheer don’t look good.
“No significant recovery can be expected due to the Chinese New Year,” Rémy CointreauSA, RCO.FR +0.34% the maker of Rémy Martin cognac, said Tuesday.
China is the world’s biggest alcohol market, making up 38% of global spirits consumption, according to the International Wine & Spirit Research industry body. The country is especially important for cognac makers: Rémy Cointreau derives about 40% of its total profit from cognac sales in China, while sales of the French liquor account for 15% of Pernod Ricard
SARI.FR +0.37% ‘s earnings.
At first, it was Chinese companies—especially those making baijiu, a rice-based white spirit—whose sales plummeted, some by more than 50% last year. But now, international competitors such as Pernod and Rémy Cointreau of France and DiageoDGE.LN +0.45%
PLC of Britain also have started to feel the heat.
Rémy said sales of its flagship cognac fell 35% in the three months through December as the group sharply reduced its shipments to China and tried to run down inventories that have piled up since the crackdown on corruption began.
Rémy said late last year that it expected operating profit in fiscal 2014 to drop 20%. Former Chief Executive Frédéric Pflanz blamed the “situation in China” for the profit warning. He resigned this month citing personal reasons, although some analysts have speculated that poor performance led to his departure.
The Lunar New Year marks an extended period of celebration in many other Asian countries. In China, giving expensive liquor—especially cognac—to gain favor with officials is common throughout the festival.
In the run-up to last year’s celebration, the Chinese government banned soldiers from drinking liquor at official banquets and toned down the lavish parties thrown by state-owned companies. Television commercials for expensive luxury gifts also were banned.
Although official sales figures aren’t released, analysts said spirits sales in China were down during Lunar New Year 2013. This year, many expect sales to fall again.
“It is a critical watershed for the spirits companies in Asia,” said Trevor Stirling, an analyst at Sanford C. Bernstein & Co. A “nightmare scenario” could emerge for Western liquor makers—as it did in Japan during the so-called lost decade of the 1990s—with patterns of entertainment changing for good and consumers reverting to less-expensive local spirits, he said.
The effect of such a shift would be catastrophic for the world’s leading beverage companies, many of whom rely on China to drive growth as Western markets remain sluggish.
Evidence of a slowdown is mounting. Overall spirits volume in China is expected to rise an average of 16% a year through 2016, down from 21% growth between 2006 and 2011, according to data tracker Euromonitor International.
Some of the decline can be attributed to China’s slowing economic growth. The country’s economy expanded 7.7% in the fourth quarter from a year earlier, slower than the 7.8% posted in the third quarter. But executives said the government’s austerity drive is eating into sales.
Pernod Ricard, the world’s second-largest distiller, warned late last year that the situation in China would weigh on profit this year. Diageo, the biggest, said government policies in China led to a substantial decline in sales of its Shui Jing Fang brand of baijiu, which the company bought outright last year.
Warwick Every-Burns, interim chief executive of Australia’s Treasury Wine Estates Ltd.TWE.AU -1.83% , the world’s No. 2 listed winemaker, said austerity measures in China were sapping demand and making forecasting for 2014 uncertain.
“We are observing signs that consumer pull-through in China is softening,” Mr. Every-Burns said, speaking at his company’s annual meeting. Treasury Wine declined to comment on recent sales in China, citing a quiet period before it releases its results in February.
Still, the size of the Chinese market means drinks companies are exploring ways to beat the government’s crackdown on elaborate gift giving. Consulting firms working in China said they had requests from clients in the spirits industry to help reposition their high-end products to fit in with austerity.
“Brands want to move away from signs of being visibly expensive,” said Adam Xu, a Shanghai-based director at management consulting firm Booz & Co. “There is now more of a focus on success than luxury.”

China’s First Default Is Coming: Here’s What To Expect

China’s First Default Is Coming: Here’s What To Expect
Tyler Durden on 01/22/2014 20:46 -0500
As we first reported one week ago, the first shadow default in Chinese history, the “Credit Equals Gold #1 Collective Trust Product” issued by China Credit Trust Co. Ltd. (CCT) due to mature Jan 31st with $492 million outstanding, appears ready to go down in the record books.
Of course, in a world awash and supported by moral hazard, where tens of trillions in financial asset values are artificial and only exist due to the benevolence of a central banker, it would be all too easy to say that China – fearing an all too likely bank run on comparable shadow products (of where there a many) as a result – would just step in and bail it out. However, at least until today, China has maintained a hard line on the issue, indicating that as part of its deleveraging program it would risk a controlled default detonation, in order to realign China’s credit conduits even though such default would symbolically coincide with the first day of the Chinese New Year.
In turn, virtually every sellside desk has issued notes and papers advising what this event would mean (“don’t panic, here’s a towel”, and “all shall be well”), and is holding conference calls with clients to put their mind at ease in the increasingly likely scenario that there is indeed a historic “first” default for a country in which such events have previously been prohibited.
So with under 10 days to go, for anyone who is still confused about the role of trusts in China’s financial system, a default’s significance, the underlying causes, the implications for the broad economy, and what the possible outcomes of the CCT product default are, here is Goldman’s Q&A on a potential Chinese trust default.
From Goldman Sachs: A Matter of Trust
Q. What has happened?
Local and international media (e.g. Caixin, Financial Times) have reported that a RMB 3bn three-year investment trust issued by China Credit Trust Company (CCT) is at risk of not making its principal repayment due investors on January 31 (which also happens to be the first day of the Chinese New Year). The trust assets were used to make a loan to a coal mine company for mine acquisition and related investments, but the company has still not received licenses related to two of five planned mines, and the owner of the company was reportedly arrested in 2012 for illegal deposit taking. It has been reported that ICBC referred the project to CCT, which structured the trust product as a “collective trust” rather than a “single trust” that typically is used by banks to securitize loans. The trust was sold through ICBC to approximately 700 private banking clients, and reports suggest that ICBC will not guarantee investors in the trust against losses. Our China banks team published detailed information on the trust structure, as well as shareholders and financials of the trust company (see “CCT trust product risk; potential scenarios imply slower trust/TSF growth”, January 20, 2014).
Q. What exactly is a Chinese “trust” and how is it structured?
A trust is essentially a private placement of debt. Investors in the trust must meet certain wealth requirements (several million RMB in assets would not be unusual, so the investors are either high net worth individuals or corporates) and investments have a minimum size (e.g. RMB 1mn). The appeal is a much higher yield than can be obtained through conventional bank deposits, in many cases 10% or higher, versus regulated multiyear bank term deposit rates in the low single digits. Trusts invest in a variety of sectors, including various industrial and commercial enterprises, local government infrastructure projects (via LGFVs), and real estate.
As our banks team noted, 29% of trust assets are invested in higher-risk industrial or commercial sectors.
A trust is not to be confused with a “wealth management product” (WMP). WMPs are available to a broader group of individuals, with much smaller minimum investments. They are typically sold through and managed by banks or securities brokers, with or without a guarantee of the payment of interest or principal (WMPs featuring explicit guarantees are booked on banks’ balance sheets; for other non-principal guaranteed products, implicit guarantees may be assumed by some investors). Funds from WMPs may be invested in a range of products including corporate bonds, trust loans, interbank assets, securitized loans, and discounted bills—so WMPs are best thought of as a “money market fund” or pool for other financial products.
Q. How do trusts fit within the “shadow banking” sector in China?
Trust assets total some RMB 10trn as of late 2013. Though small as a share of the total stock of credit in China (Exhibit 1), trust assets have been growing at an annual rate of over 50% in recent years. The net new credit extension from trusts approached RMB 2trn in 2013 based on estimates from our bank analysts, or more than one-tenth of broad credit flow (total social financing) for the year. (Please refer to the “CCT trust product risk” note cited above for further detail on trust asset growth and composition.)
Exhibit 1: Trusts still small as a share of total financing, but growing rapidly

Source: Goldman Sachs Global Investment Research.
Some clients have asked about comparisons between the Chinese trusts and the SIVs (structured investment vehicles, sometimes known as “conduits”) that were prominent in the US financial crisis. The SIVs were off-balance sheet vehicles generally funded with short-term commercial paper (“asset-backed commercial paper”) with a period of a few days to a few months. Initially, these SIVs invested in relatively low risk, short-term receivables, although over time exposures shifted towards more complex, longer-term structured products such as subprime mortgage-backed securities or collateralized debt obligations. As doubts about asset quality began to arise in 2007, market funding conditions for the SIVs quickly deteriorated, requiring sponsoring banks to provide liquidity support and ultimately consolidate these assets on the balance sheet, which exacerbated funding pressures as well as asset write-downs. Similarities to Chinese trusts include the linkages with banks, the off-balance sheet nature of the trusts (true for many WMPs also), and the maturity transformation aspect (though it should be noted this is less extreme in the case of trusts, where investors are often committed for a period of a year or more, than for most SIVs; even WMPs typically have commitments of 3-12 months). Important differences include the relatively simpler assets of Chinese trusts – often loans, as in the CCT example – and the fact that the Chinese banking system is funded domestically (many SIVs raised funding across borders).
Q. Why is the potential default of a trust important?
With a large volume of trust products scheduled to mature this year, who bears the losses in the event of a default could set an important precedent. In our detailed research on the China credit outlook last year (see “The China credit conundrum: risks, paths, and implications”, July 26, 2013), we explicitly identified “removal of implicit guarantees” as one of four potential ‘risk triggers’ for a broader credit crisis. If the realization of significant losses by investors causes others to pull back from funding various forms of “shadow banking” credit, overall credit conditions could theoretically tighten sharply, with consequent damage to growth.
From the perspective of policymakers, the default of a trust under the current circumstances might be seen as having less risk of contagion than some other “shadow banking” products. First, the trust is explicitly not guaranteed by either the trust company or the distributor. Second, the investor base of a trust is typically a relatively small group of wealthy/sophisticated investors (the minimum investment in the CCT trust mentioned above was RMB 3mn). This contrasts with broadly offered wealth management products, which have many more individual investors with less investment experience and more modest personal finances. Third, the particular circumstances of this trust (lending to an overcapacity sector, failure to obtain key business licenses, arrest of the borrowing company’s owner) might make it easier for authorities to portray as a special case. Put another way, if the authorities felt obliged to provide official support to this product, it is not clear under what circumstances they would be comfortable letting any trust or wealth management product default.
Q. What are the options for policymakers?
The fundamental issue for policymakers is how any losses would be distributed among 1) investors, 2) the trust company and/or distributing bank, 3) the government and government-related entities. Potential options include:
Allowing the trust to default (investors take losses). As noted above, this would call into question the implicit guarantees perceived by some trust buyers, thereby increasing the risk that new trusts or other non-guaranteed products such as WMPs face more difficulty obtaining funds, leading to tighter overall credit conditions. On the positive side, it would encourage greater focus on the underlying credit quality and better risk pricing going forward.
Trust company and/or distributing bank provide support (levered institutions take the principal and/or interest losses), making an implicit guarantee explicit. Although legally there are no guarantees of principal from either the trust company or ICBC, to the extent the trust company manager or the distributing bank were obligated by policymakers (or other reputational or legal considerations) to provide support, it could prompt loss recognition, or at the worst a need for capital raising or shrinkage of the balance sheet if losses are substantial. As such, the quality of the underlying assets and due diligence are key to determine whether and how much losses might be taken by these institutions. Investor demand for trusts might rise after such a demonstration of support, but the higher perceived liability on the part of financial institutions would presumably reduce their appetite for issuing such products in the future.
Government-backed entity provides support (government takes losses). In this case, the short-term market reaction would presumably be relief, as refinancing risks would be reduced and both banks and trusts would be off the hook. However, moral hazard for both issuers and investors would be increased, raising the risk of credit problems further down the road. Policymakers might try to minimize this moral hazard by providing support indirectly (via some government-supported entity or third party, rather than publicly and directly) and/or by providing only partial support. An example of the former occurred last year, when an “unnamed party”, possibly the local government which provided some land collateral and guarantees to the trust loans, intervened to purchase the defaulted loans of a steel plate manufacturer, enabling the investors in a CITIC WMP to be repaid fully (see “Latest China bailout reveals risk of local government’s hidden debts”, Reuters, May 7 2013).
Some mix of these options is of course possible, if the financial institutions or government provides partial support. Most observers seem to expect at least a partial bailout of the investors, reflecting a compromise between concerns about moral hazard and concerns about contagion. Unless there is a total bailout explicitly funded by the government, credit conditions in the trust sector seem likely to tighten at least modestly. Some central government level policymakers could be open to seeing a default, as it would encourage more careful risk assessment and help to contain credit growth going forward. However, other central government and many local government policymakers might be more inclined to contain the problem. Local officials in particular may feel more pressure to support key local enterprises that are major employers and taxpayers; in the current case, officials could in theory take actions such as granting mining licenses to make the trust assets more valuable.
Q. What should investors watch to track the broader market impact?
Besides the immediate news on what approach officials take in the case of the CCT trust, investors can watch other financial metrics for signs of stress. As always, interbank rates are useful as an indicator of the marginal cost of bank funding. Spreads to yields on nonbank products may reflect their perceived risk, although they could also be affected by other factors such as tight overall liquidity conditions. While we do not have high frequency data on trust yields, WMP yields have moved higher of late. Finally, data on credit volumes will be important to watch. To the extent conditions tighten, this should become visible in monthly total social financing flows (the trust portion in particular).
Q. What is the potential impact on economic growth and markets?
The growth impact of a trust default is highly uncertain, as it represents the product of two unknowns. The first unknown is the change in overall credit extension which would result from the default, and the second unknown is the sensitivity of economic growth to new credit. In work last year on the relationship between credit and growth (“The ‘credit impulse’ to Chinese growth”, April 11, 2013), we estimated a RMB 300bn change in the average monthly credit flow would have an impact of 80bp on sequential annualized real GDP growth in the following quarter (with further, gradually fading effects in subsequent quarters if the lower credit flow persisted). This is not far from the average monthly flow of trust loans in 2013 implied by our bank analysts’ estimates. So with our assumption on credit sensitivity, a hypothetical sharp tightening in funding conditions that stifled this flow of new credit (not affecting existing trusts) would imply an 80bp hit to sequential (annualized) growth the following quarter, and roughly a 50bp hit to yoy growth over the following year. Intuitively, the modest estimated impact stems from the small size of the trust sector in the overall financial system. We emphasize the very high degree of uncertainty in these calculations—this is a back-of-the-envelope illustration rather than a forecast. On the side of a smaller effect, officials could take steps to reduce the impact on trust lending or other lending channels could pick up the slack; on the side of a bigger impact, spillovers could occur to non-trust lending or to the real economy via effects on business or consumer confidence.
In the credit markets, more willingness to allow losses should lead to greater differentiation between stronger and weaker credits. This is a theme we have emphasized for some time, including in our in-depth work on the China credit outlook last summer.
A policy/credit tightening bias may put pressure on China equities in the near-term, particularly credit-dependent, investment-heavy cyclical sectors. Investors are unlikely to reward either option 1 or option 2 above, as the default option may trigger contagion and risks to growth (thus earnings as well) and the “bailout by financial institutions” option is structurally unappealing (thus risks valuation). Option 3 is probably the only outcome that would support a slight market rebound near-term, in our view, as immediate contagion is averted and listed financial conditions are protected from bearing losses—though at the cost of longer-term moral hazard.

China cannot relax war on corruption;; Western banks must also take care not to fuel illegality

China cannot relax war on corruption

Western banks must also take care not to fuel illegality

January 22, 2014 7:07 pm

When Xi Jinping became leader of the Chinese Communist party a little more than a year ago, he made the fight against corruption a central theme of his leadership. Over the past year China has seen the detention of dozens of top officials on suspicion of financial improprieties. More than 180,000 people have been punished for corruption. Mr Xi has left little doubt that he believes unchecked graft threatens the future of the Chinese Communist party. Yet two events this week raise doubts about how sincere his drive really is.
First, there is the trial of Xu Zhiyong, a human rights lawyer, which has started in Beijing. Mr Xu is part of a loose group of civic activists who are campaigning for rules requiring government officials to disclose their financial assets. The demands he is making appear to be perfectly in line with the leadership’s anti-corruption drive. But he is now on trial for “gathering crowds to disrupt public order” – suggesting that Mr Xi’s campaign has its limits.
The second event was publication of a report by a Washington- based organisation called the International Consortium of Investigative Journalists. The report claims that more than a dozen family members of China’s top political and military leaders are making use of offshore companies based in the British Virgin Islands.
Financial records received by the ICIJ reveal that more than 21,000 mainland Chinese and Hong Kong residents have used offshore tax havens in the Caribbean to store their wealth. It is unclear how much of this activity is illegal under Chinese law. But the report is a reminder that the Chinese public has been left largely in the dark about how their country’s elite has amassed its wealth – and where its money is deposited.
The scale of corruption among Chinese officials is undoubtedly one of the biggest threats to the Communist party’s long-term survival. China’s rapid economic growth is creating internal tensions because of widening income differentials. If the popular perception grows that Chinese leaders are spending more time lining their own pockets than running the country effectively, then political unrest will surely follow.
We should not dismiss the way Mr Xi is trying to deal with the problem. After all, there are limits to how quickly he can act. If he allows the anti-corruption drive to gather pace at uncontrolled speed, he may undermine the Communist party completely. This may explain why the Chinese leadership wants to set limits to the role played by activists such as Mr Xu. Still, the Chinese middle class is weary of the corruption and backhanders that have plagued the country’s commerce. Mr Xi runs the risk of alienating the public unless he demonstrates that the anti-corruption campaign is waged with a minimum of fear or favour.
In the meantime, western financial and corporate leaders need to realise that Chinese corruption is not an issue to which they can turn a blind eye, either. This is because the ICIJ suggests that western banks and accountancy firms have acted as middlemen in the establishment of offshore companies for Chinese clients.
There is still much we do not know about the offshore investments by the Chinese elite. But over recent years, several banks have fallen foul of international authorities because of their support for illegal activities. In 2012 HSBC was fined $1.92bn by US regulators after illegally conducting transactions on behalf of customers in Iran, Libya and Cuba. A decade ago a number of European banks were embarrassed when it emerged that they were handling billions of dollars of assets linked to the former Nigerian leader Sani Abacha. Whatever the challenges of doing business with China may be, western banks should make sure that they are not fuelling corrupt practices.

China households elude taxman – and official GDP bean-counters

China households elude taxman – and official GDP bean-counters
Wed, Jan 22 2014
By Koh Gui Qing

BEIJING, Jan 23 (Reuters) – China’s famously frugal households may be living larger than they are letting on.
Economists have long warned that China needs to pump up domestic spending to offset an over-reliance on credit-fuelled investment and exports for growth, and in their latest blueprint for reform China’s leaders have vowed to do just that.
Data released this week showing China’s economy grew 7.7 percent last year suggested the imbalance is worsening, with consumption unchanged at just under 50 percent of GDP, but investment growing to slightly more than half.
A growing number of economists, however, say official statistics have got it wrong. To avoid taxes, consumers routinely get employers to buy things for them, resulting in a gross underestimation of how much consumers spend and exaggerating just how lopsided China’s $9.4 trillion economy is.
“China’s consumption is not low,” said Zhu Tian, an economist at the China Europe International Business School in Shanghai, who co-authored a recent report on the subject. “It’s actually desirable,” he said.
Government estimates put household spending at roughly 36 percent of GDP, the result of a long decline from 49 percent in 1978. Household consumption in Thailand, which is slightly poorer than China in terms of GDP per citizen, is 56 percent of GDP, according to the World Bank. In the United States, households spend the equivalent of 69 percent of GDP.
But Zhu and other economists say government estimates overlook trillions of yuan in hidden household spending, particularly among China’s increasingly affluent middle class. Add that and household spending amounts to about half of GDP, and more than 60 percent when combined with government spending, according to Zhu’s study, which was published in September with Zhang Jun from Fudan University’s China Center for Economic Studies.
The implications are far-reaching, at least statistically. If Zhu and Zhang are right, not only do consumers represent a larger part of China’s economy than thought, but estimates of China’s vaunted household savings rates may be inflated, investment’s dominance may be overstated and China’s economy may be larger than current estimates.
The government may also be due a lot of income tax.
Zhu and Zhang go even further, saying that their findings challenge the notion that consumption is inadequate, a problem analysts and policymakers, including the World Bank, have blamed on inadequate social safety nets such as unemployment and health insurance.
REFLEXOLOGY AND SING-ALONGS
Collecting data on consumption is challenging in any developing country because so many of the things people buy are informal services not captured by tax authorities, such as foot massages, karaoke sessions or food from street vendors.
“All of these issues with statistics are common to fast-growing economies,” said Bert Hofman, chief economist for East Asia and the Pacific at the World Bank in Singapore.
China’s statistics have drawn their fair share of brickbats from economists, who have resorted to a host of exotic alternatives – from consumption of salt to sales of imported Audis – to gauge the true health of the second-largest economy.
China’s National Bureau of Statistics declined to comment, though it has in the past conceded it may be underestimating consumption. It plans to revise the way it calculates GDP as early as this year.
“After the correction,” said Hofman, “China will look a lot more normal – more balanced, some would say.”
In the meantime, economists say poor data collection paints an excessively bleak picture of consumption. One problem is sample size: China’s statisticians base their estimates of household spending in this nation of 1.35 billion people, or 402 million households, on surveys of just 100,000 households.
Then there is the way they add up expenditures. Take housing costs. China tallies data on how much households pay in rent, but uses outdated values to calculate the value of housing to home owners.
PERQUISITE REPUBLIC
But the list does not end at rent. To compensate for lower wages, companies in China routinely lavish employees with gifts ranging from mobile phones and household appliances to luxury cars and vacations.
“This happens all the time, and of course it is not the right way,” said Helen Qiao, an economist at Morgan Stanley in Hong Kong.
By taking part of their pay in undeclared perks, employees lower their taxable income and companies reduce their taxable profits. Perks are particularly popular among those Chinese with the biggest tax liabilities – its wealthy.
And while these items are for personal use, once a company pays for them instead of a private household, the expense is classified as a business cost and left out of consumption and GDP.
Omissions like that missed 7 trillion yuan ($1.2 trillion) worth of household spending in 2009, Zhu and Zhang estimate in their report. Morgan Stanley’s economists calculated last year that government statisticians missed roughly $1.6 trillion in spending in 2012, meaning household consumption was actually equivalent to 46 percent of GDP.
But even at 50 percent of GDP, China still needs to get households to consume more domestic services if it wants to create a viable and growing middle class, said Kevin Lai, an economist at Daiwa Securities in Hong Kong.
“You can forever keep investing in new capacity, but where is the demand?” Lai said. “At the end of the day, you need to find demand to feed that capacity.”
To Zhu, however, China’s consumption levels are already healthy; it is Beijing’s emphasis on boosting consumption that needs re-examination.
“All the talk about China investing too much and consuming too little is meaningless,” he said. “The focus of change should be on improving equity and the efficiency of investment, not stimulating consumption.”

China abandons its pursuit of growth at all costs; Beijing knows the stakes are too high to allow for anything other than a gradual change of dosage

China abandons its pursuit of growth at all costs

January 22, 2014 4:54 pm
By David Pilling
Beijing knows the stakes are too high to allow for anything other than a gradual change of dosage
If Hu Jintao was a growth junkie, Xi Jinping wants to put China’s economy on a methadone programme. Under Mr Hu, the former president, Beijing was addicted to economic expansion. China defied the collapse in external demand that followed the 2008 Lehman Brothers crisis by ramping up spending on roads, ports and smelters through a huge expansion of credit funnelled into the economy via compliant banks and local governments desperate to meet centralised growth targets. The economy grew at near double digits even as exports slowed dramatically and the current account surplus shrank from 10 per cent of output to just 2-3 per cent.
As with heroin, though, the ecstatic highs had side-effects. The economy became ever more dependent on quick fixes. It took more and more inputs – in the form of easy credit and cheap raw materials – to produce each unit of gross domestic product. Debt, some of it unrepayable, rose sharply. Capacity ballooned beyond demand.
Mr Xi, who took over the presidency in March last year, has served notice that enough is enough. From now on, China will not pursue expansion at all costs. The quality of growth will be emphasised. There have been several indications of a change of heart. Short-term interest rates have been allowed to rise almost 3 percentage points and credit growth has been slowed from a hair-raising peak of 23 per cent to a (still hardly abstemious) 18 per cent. The cost of material inputs, from electricity to water and land, will be subject to market forces.
Local governments are – at least according to official propaganda – from now on to be judged not by the speed of growth but by the progress they make in other areas, including cleaning up bad debts. When it comes to borrowing, the government has come clean, up to a point. Two audits have been published detailing the rise in public debt. Even the more sanguine one admits to a near 70 per cent rise in local government obligations in just two and a half years, or 40 per cent if contingent liabilities are excluded.
Implicit in this change of direction is a trade-off between growth and economic efficiency. The government is expecting growth of about 7.5 per cent in 2014. In previous years it has made its forecast deliberately low and then come in triumphantly above expectations. This year, if anything, it could go the other way. By the end of 2014 growth may be slowing towards 6 per cent, even if the result for the year as a whole is still likely to be 7 per cent or above.
A shift from the inefficient state sector entails risks but anyone who stands in the way could end up on the wrong side of the ‘law’
Very high growth is not as important as it once was. China’sworking-age population
has begun to shrink. Although many university graduates find it hard to get the jobs to which they aspire, unemployment for the economy as a whole is not likely to be a problem. If higher-quality growth is now the aim, the means is to allow the private sector a bigger role. The hope is that if the banking sector is liberalised and private companies are allowed to compete against inefficient state-owned enterprises, capital will be allocated to better-run corners of the Chinese economy.
Arthur Kroeber of GaveKal Dragonomics reckons that if every renminbi funnelled to the state sector were transferred to private enterprise, productivity could be as much as doubled. By that “magic trick” growth could be maintained even as levels of investment – still running at 6-7 percentage points above GDP – were cut. In practice, the transition is unlikely to be so smooth. This implies that, if the government does not revert to the norm of the Hu years by opening the credit spigots when the going gets tough, growth will slow faster than some are currently bargaining for.
Beijing will take things steadily so as not to provoke a crisis. In late December it gave local governments permission to roll over debt. Many have borrowed short-term in order to finance long-term projects, some of which will not turn a profit for years, if ever. Local authorities have been told to lengthen their debt maturities. That suggests they are being chivvied to put their finances on a sounder footing. Much attention has been paid to local government debt, much of it off balance sheet. But corporate borrowing may turn out to be a bigger problem. According to the Chinese Academy of Social Sciences, if state-owned enterprise borrowing is included, total government obligations rise to 151 per cent of GDP. In one of the first visible signs of stress, loans to a near-bankrupt coal company that were bundled up and sold to retail investors as a wealth management product are on the verge of default. ICBC, the world’s biggest bank by assets, which distributed the investment vehicle, has so far refused to stand behind the $500m issue.
A shift from the inefficient state sector – which actually expanded during the Hu years – to the private sector entails risks. It is also bound to tread on some powerful toes. Opposition, though, is likely to be muted given Mr Xi’s crackdown on corruption. Anyone who stands in the way could end up on the wrong side of the “law”. Some onlookers, in their perennial hunt for crisis, are waiting for the Chinese economy to blow up. The outcome, however, may be more benign: slower growth of somewhat better quality.

Can China Innovate Without Dissent?

Can China Innovate Without Dissent?
By STEPHEN L. SASSJAN. 21, 2014
ITHACA, N.Y. — Will China achieve technological dominance over the United States, surpassing us in scientific and engineering innovation?
A lot of people seem to think so. China’s recent landing of an unmanned spacecraft on the Moon, its advances in renewable energies and high-speed rail, its increasing number of patent filings and its vast spending on research and development have contributed to a perception — held across much of the world, according to a Pew Research Center poll conducted last summer — that China is poised to overtake America as the world’s leading power, if it hasn’t already done so.
Concern that China — home of landmark innovations like printing and gunpowder — might reclaim its legacy as a land of invention is voiced at even the highest levels of the American government. In 2011, Steven Chu, the energy secretary at the time and a Nobel-winning physicist, remarked on China’s dominance in the production of low-cost solar-energy cells, urging, “We really can and should take back this technology lead.”
Americans shouldn’t be so worried. Yes, China has demonstrated skill in moving to higher-value manufacturing, and excelled at improving existing technologies, while producing them more cheaply. But it has not excelled in true innovation. (The first modern solar cell was invented in the United States.)
No one knows this better than the Chinese themselves. Before he stepped down as president in 2012, Hu Jintao directed that vast sums be spent on supporting scientific innovation to “achieve the great rejuvenation of the Chinese nation.”
But as a scientist who has taught in China, I don’t believe that China will lead in innovation anytime soon — or at least not until it moves its institutional culture away from suppression of dissent and toward freedom of expression and encouragement of critical thought.
Almost all the paradigm-shifting innovations over the past few hundred years — from Michael Faraday’s generating electricity by moving a copper wire through a magnetic field in London in 1831 to the invention of the transistor at Bell Laboratories in New Jersey in the 1940s — have emerged in countries with relatively high levels of political and intellectual liberty. Why is this?
A first reason is cultural: Free societies encourage people to be skeptical and ask critical questions. When I was teaching at a university in Beijing in 2009, my students acknowledged that I frequently asked if they had any questions — and that they rarely did. After my last lecture, at their insistence, we discussed the reasons for their reticence.
Several students pointed out that, from childhood, they were not encouraged to ask questions. I knew that the Cultural Revolution had upturned higher education — and intellectual inquiry generally — during their parents’ lifetimes, but as a guest I didn’t want to get into a political discussion. Instead, I gently pointed out to my students that they were planning to be scientists, and that skepticism and critical questioning were essential for separating the wheat from the chaff in all scholarly endeavors.
A second reason is institutional: Much of American innovation started with the bright ideas of a few individuals, working in an industrial, government or university laboratory, or perhaps a garage in Silicon Valley. While government support for R&D is essential, innovation is typically the product of a bottom-up approach. A classic example is the letter Albert Einstein wrote to President Franklin D. Roosevelt in 1939, arguing that nuclear fission could be the basis of a powerful bomb, which led to the Manhattan Project.
In 2006, I led a group of scientists from Cornell to discuss possible collaborations on nanotechnology with colleagues at Tsinghua University in Beijing and Shanghai Jiao Tong University. Over meals, Chinese colleagues told me that scientific research was initiated in a top-down manner.
A third reason is political. Free societies attract foreign talent. England gave birth to the steam engine in the 18th century in part because of Denis Papin, a Huguenot who had fled France for greater religious tolerance in England. His idea of using steam and atmospheric pressure to do work, taken up by Thomas Newcomen and James Watt, powered the first Industrial Revolution.
During a trip to China last fall, I couldn’t help but notice not only the lack of access to several Western news sources, but also the cynicism about the news in general. Those “in the know” distrusted what they were told by state news agencies like Xinhua and CCTV.
The case of Xia Yeliang, an associate professor of economics at Peking University, who was dismissed, supposedly for speaking out against one party rule, does not inspire confidence in academic freedom.
While in Beijing, my wife and I visited the 798 art district in the city’s northeast. During our stroll of galleries and studios, I asked about the artist and dissident Ai Weiwei, whom we had met in Berkeley, Calif., in 2008. The woman I spoke with said that it was too dangerous to try to visit him, because there were so many police around his compound.
The significance of China’s vast spending on R&D cannot be overstated, particularly at a time when the United States has made short-sighted cuts to the budgets of the National Institutes of Health, the National Science Foundation and other agencies that finance research.
Perhaps I’m wrong that political freedom is critical for scientific innovation. As a scientist, I have to be skeptical of my own conclusions. But sometime in this still-new century, we will see the results of this unfolding experiment. At the moment, I’d still bet on America.
Stephen L. Sass, professor emeritus of materials science and engineering at Cornell University, is the author of “The Substance of Civilization: Materials and Human History from the Stone Age to the Age of Silicon.”

Beijing’s Plans to Fix Traffic Problems with ‘Congestion Fee’ Stuck in Slow Lane; Many cities around the world have hit car users with fees that lessen congestion and pollution, but officials in China’s capital have been slow to copy the idea

Beijing’s Plans to Fix Traffic Problems with ‘Congestion Fee’ Stuck in Slow Lane

01.22.2014 19:20

Many cities around the world have hit car users with fees that lessen congestion and pollution, but officials in China’s capital have been slow to copy the idea
By staff reporter Liu Hongqiao and intern reporter Zhang Xia
Beijing) – At a press conference in Beijing in December, Steve Kearns of Transport for London, the city’s public transport operator, displayed two photographs. Both showed London streets, one at the end of 19th century, the other at the end of 20th.
“It’s hard to imagine that these two pictures are separated by only 100 years, judging by the primitive modes of transport we used before,” Kearns said, a reference to the horse carts in the first picture.
But despite the advances in technology, modern-day traffic problems mean the horse-powered vehicles in the first pictures required the same amount of time to cross London as the autos in the second.
In 1999, around 185,000 vehicles entered the City of London in Britain every day, and traffic was so bad that the average speed was just 15 kph. However, after a congestion charge was introduced in February 2003, the number of autos in the city within a city fell dramatically.
Many other cities around the world have adopted the congestion charge as a means of combating traffic-related problems. Experience from these cities shows that the congestion charge has helped improving local traffic situation, help raise funds to build public transport and aid the environment by reducing emissions.
In light of these success stories, research has begun into imposing the scheme in chronically congested Beijing. In December 2010, the city’s government proposed “studying the implementation of a congestion charge scheme on certain roads and putting it into practice over a given period.”
However, three years on, the capital’s traffic and pollution problems are worse than ever and there is no date set for implementing a congestion charge. The number of vehicles on the city’s road has increased from 4.69 million in 2010 to 5.4 million last year.
In October, there were renewed calls for a congestion charge program as part of the government’s promise to fight pollution from vehicles between 2013 and 2017. Other major cities in China are considering similar moves, although none has taken such a step.
Double Win
A congestion charge is essentially an economic method of regulating traffic by imposing fees on vehicle users that travel a city’s more crowded roads. Charges vary by city. London and Stockholm, in Sweden, charge according to region. Singapore targets individual roads. These zones tend to overlap with low-emission zones, which control traffic flow by imposing strict limits on vehicle emissions.
Data from the Stockholm government shows that during a seven-month trial in 2006, traffic flow fell by 20 percent and air quality improved by around 10 percent. The city’s air quality has improved immeasurably in recent years, with the congestion charge being perhaps the biggest reason for this. Residents who initially opposed the charge now strongly support it.
Milan is another success story. Silvia Moroni, of from the Italian city’s environmental bureau, says traffic and emissions have both fallen since a congestion charge was introduced in 2012.
For years, traffic jams have been the subject of much debate among Beijing’s Net users, who list it as one of their three main sources of frustration, along with air pollution and sandstorms. Reports from a government-backed institute, the Beijing Transportation Research Center, show that the capital’s traffic problems have worsened since the 2008 Olympics. Data collected in November revealed that traffic during morning and evening rush hours increased 4.3 percent and 6.1 percent, respectively, from the year before.
Transport expert Wang Quanlu, from the U.S. science and engineering research center Argonne National Laboratory, said that a congestion fee kills two birds with one stone. “Not only will it reduce traffic congestion, but it also improves the city’s air quality,” he said.
Because the quality of vehicles and oil is much lower in China than abroad, less auto use would result in even greater benefits here than elsewhere.
Research Requirement
Many foreign countries have ways to analyze transportation and its impacts on urban areas, Wang said. This information can be used to create congestion charge schemes that are appropriate for an individual city. However, Chinese cities lack such data.
A 2011 report from the independent Beijing Zhonglin Assets Co. Ltd. said that Beijing suffers economic losses of 105.6 billion yuan each year due to traffic congestion, or 7.5 percent of its GDP. This included environmental damage of over 45 billion yuan.
Despite these figures, academics are still debating the full extent of environmental damage caused by vehicle emissions. Professor Xie Shaodong, of the Department of Environmental Sciences at Peking University, said that not enough research has been done to yield a figure.
“The policymaking of foreign government is based on scientific analysis,” Xie said. “Before a policy is officially launched, a huge amount of time is spent conducting research to assess the environmental and economic benefits. Before we make policies, do we also make the relevant assessments?”
Footing the Bill
Despite the fact many believe a congestion charge would have positive results, some experts say that the severe overcrowding of Beijing’s public transport is an obstacle to such a imposing such a fee.
Beijing has been very ambitious in its plans to expand public transport links. The city government wants public transport as a share of total transport to rise to 52 percent by 2017, from the current 44 percent. This pales in comparison to London, where public transport accounted for 85 percent of all transport even before the vehicle charge was introduced.
Gunnar Soderholm, an environmental official in Stockholm, said a good public transport system is a prerequisite to introducing a congestion charge. Ding Yan, an environmental protection official in Beijing, shared similar concerns. “Although the Beijing public transport system is developing at quite a rate, it is still not capable of supporting the city’s huge population.”
Then there are reports that officials want to raise the price of public transport. Government subsidies for public transport rose to over 18 billion yuan last year, and plans are apparently in place to introduce higher rush hour fares for subways.
Wang says it is simply not sustainable for the government to keep subsidizing public transport, saying: “Eventually someone will have to foot the bill.” He said that if the funds raised from a congestion charge can be set aside to improve the public transport – as was the case in London – then the government would be relieved of a huge financial burden.
A Difficult Fit
Many experts Caixin interviewed said it would be difficult for Beijing and other Chinese cities to copy the success that London, Stockholm and other foreign cities have had with the congestion charge, especially considering their traffic problem and urban planning situations.
Zhao Jian, an economics professor at Beijing Jiaotong University, said that “Beijing’s congestion problems are so deep-seated that there is traffic practically everywhere.” He said a congestion charge in the capital would not be feasible in practice and would not produce the desired results.
Ding said the layout of Beijing’s roads would cause problems. Years of poor urban planning mean the city lacks the structure of foreign cities, a structure that lends itself to a congestion charge. He also predicted that difficulties in pricing would arise. If the fee was too low, it would have no effect. If it was too high, it would alienate all but the wealthiest people.
Congestion problems are a symptom of the country’s rapid urbanization. The Energy Foundation, a U.S. non-governmental organization, estimates that by 2023, there will be 200 vehicles per 1,000 people in China. Beijing reached this target three years ago. This indicates not only will traffic deteriorate in the likes of Beijing, Shanghai and Guangzhou, but it will also worsen in smaller cities as well.
Gong Huiming, who directs the program, is concerned. “In 10 years, more than 600 second- and third-tier cities will face the kind of congestion Beijing has now,” referring to the country’s smaller cities and those in its western regions.
“But how many of those cities have Beijing’s technological, managerial or financial capability? My biggest worry is that the authorities will waste the revenue generated from the charge.”
Ding, however, was more concerned about the public backlash if the government fails to achieve its goals with a congestion fee. “If the air pollution is still this bad in a year or two, how can the whole scheme by justified to the people?”
 

Authorities in Beijing have ordered high-end clubs in public park grounds to close or downgrade to an acceptable level, a move to curb officials’ extravagance.

Fancy clubs in parks closed
BEIJING, Jan. 15 (Xinhua) — Authorities in Beijing have ordered high-end clubs in public park grounds to close or downgrade to an acceptable level, a move to curb officials’ extravagance.
Business at two clubs in Beihai Park called Yushantang and Shanglinyuan, known for their luxurious decorations, expensive meals and services, has been suspended, according to a statement issued by the Beijing Municipal Commission for Discipline Inspection of the Communist Party of China (CPC) on Wednesday.
Two other clubs in the grounds of Zizhuyuan and Longtan parks have been ordered to lower their prices so ordinary people can afford their services, it said.
There are 24 private clubs or high-end recreational venues in public park grounds in Beijing. The clubs have been ordered to move out of the parks when their leases end. The parks should not allow such clubs to operate within the grounds, as required by Beijing Municipal Government.
The move, led by the commission with support from landscape, cultural relics and park management government departments, targets “unhealthy practices in clubs” and has been incorporated into China’s “mass-line” campaign.
The “mass-line” campaign was launched by the CPC Central Committee in June to bridge the gap between CPC officials and members, and the general public, while cleaning up undesirable work styles such as formalism, bureaucracy, hedonism and extravagance.
Public opposition towards private clubs has been on the increase. They are often unlawfully built with public resources, sometimes in historical buildings, and frequented by the rich and powerful.
Xinhua reporters found last month that a single dish on Yushantang’s menu cost as much as 10,000 yuan (1,654 U.S. dollars), or two months’ salary for the average local.
“The meals there are meant for officials and the wealthy, not for us,” said a senior citizen who was exercising in front of the club.
Jiangxi Province, Changsha in Hunan and Nanjing in Jiangsu, launched similar campaigns this month.
In a circular released by the Central Commission for Discipline Inspection (CCDI) and the steering group of the CPC’s “mass line” campaign in December, officials are ordered to shun high-end clubs to avoid extravagant practices and power-for-money or power-for-sex deals.
Kong Fanzhi, chief of the cultural relics bureau of Beijing, said fancy clubs in parks and historical buildings clearly invaded on public resources for the privileged.
“Parks and historical sites are public treasures, which should be open to the general public, rather than the privileged few,” said Kong, also a member of the Beijing municipal committee of the Chinese People’s Political Consultative Conference, a political advisory body.
He said clubs in historical buildings went against cultural protection regulations.
Zeng Yuanji, also a political advisor and deputy head of the graduate school of the Communication University of China, suggests authorities investigate why such clubs were built inside public parks in the first place under the supervision of park management departments.
“The fundamental root for the misconduct should be found out and eradicated to curb corruption,” he said.
Chinese President Xi Jinping on Tuesday stressed that the anti-graft fight is vital for the Party’s integrity in the long term, urging independent and forceful supervision from disciplinary agencies.
“Preventing the Party from being corrupted in its long-term rule of the country is a major political mission. And we must do it right,” said Xi, also general secretary of the CPC Central Committee, when addressing the third plenary session of the CCDI of the CPC. The session closed Wednesday.

Big Web Crash in China: Experts Suspect Great Firewall

Big Web Crash in China: Experts Suspect Great Firewall
By NICOLE PERLROTH
Updated, 10:30 p.m.
SAN FRANCISCO — The story behind what may have been the biggest Internet failure in history involves an unlikely cast of characters, including a little-known company in a drab building in Wyoming and the world’s most elite army of Internet censors a continent away in China.
On Tuesday, most of China’s 500 million Internet users were unable to load websites for up to eight hours. Nearly every Chinese user and Internet company, including major services like Baidu and Sina.com, was affected.
Technology experts say China’s own Great Firewall — the country’s vast collection of censors and snooping technology used to control Internet traffic in and out of China — was most likely to blame, mistakenly redirecting the country’s traffic to several sites normally blocked inside China, some connected to a company based in the Wyoming building.
The Chinese authorities put a premium on control. Using the Great Firewall, they police the Internet to smother any hint of antigovernment sentiment, sometimes jailing dissidents and journalists; they blacklist major websites like Facebook and Twitter; and they block access to media outlets like The New York Times and Bloomberg News for unfavorable coverage of the country’s leaders.
But the strange story of Tuesday’s downtime shows that sometimes their efforts can backfire.
The China Internet Network Information Center, a state-run agency that deals with Internet affairs, said it had traced the problem to the country’s domain name system. One of China’s biggest antivirus software vendors, Qihoo 360 Technology, said the problems affected about three-quarters of the country’s domain-name system servers.
“I have never seen a bigger outage,” said Heiko Specht, an Internet analyst atCompuware
, a technology company based in Detroit. “Half of the world’s Internet users trying to access the Internet couldn’t.”
Those domain-name servers, which act like an Internet switchboard, routed traffic from some of China’s most popular sites to an Internet address that, according to records, is registered to Sophidea, a company based, at least on paper, in that Wyoming building, in Cheyenne. It is unclear where the company or its servers are physically based, however.
With so much Internet traffic flooding Sophidea’s Internet address, Mr. Specht said he believed it would have taken less than a millisecond for the company’s servers to crash.
Until last year, Sophidea was based in a 1,700-square-foot brick house on a residential block of Cheyenne. The house, and its former tenant, a business called Wyoming Corporate Services, was the subject of a lengthy Reuters article in 2011 that found that about 2,000 business entities had been registered to the home. Among them were a company controlled by a jailed former Ukraine prime minister, the owner of a company charged with helping online poker operators evade online gambling bans, and one entity that was banned from government contract work after selling counterfeit truck parts to the Pentagon.
Wyoming Corporate Services, which helps clients anywhere in the world create companies on paper and is designated to receive lawsuits on their behalf, moved its headquarters 10 blocks from its former base last year. Gerald Pitts, the Wyoming Corporate Services president, said in an interview on Wednesday that his company acted as the registered agent for 8,000 businesses, including Sophidea, though he did not know what the company did.
Technology experts say Sophidea appears to be a service that reroutes Internet traffic from one website to another to mask a person’s whereabouts, to make it easier to send spam for example — or to evade a firewall, like the ones that Chinese censors erect.
Sophidea’s managers are not publicly listed. Wyoming is light on business regulation. The state requires only that companies file a short annual report disclosing assets that are physically located in Wyoming and the name of one person submitting the report. According to Wyoming state records, Sophidea’s director is Mark Chen, with no associated contact information.
Mr. Pitts, of Wyoming Corporate Services, said he could not provide any further information for the company without a legal order.
But for less than a millisecond on Tuesday, the company’s operators may have been surprised to find that a huge portion of the world’s Internet traffic was firing at their servers and that their Internet address was the subject of much speculation within the Chinese media. Several Chinese newspapers named Sophidea’s Internet address as the “No. 1 suspect” in a cyberattack.
By late Tuesday, some technologists surmised that the disruption might have been caused by Chinese Internet censors who tried to block traffic to Sophidea’s websites because they could be used to evade the Great Firewall and mistakenly redirected traffic to the Internet address.
That theory was buttressed by the fact that a separate wave of Chinese Internet traffic Tuesday was simultaneously redirected to Internet addresses owned by Dynamic Internet Technology, a company that helps people evade China’s Great Firewall, and is typically blocked in China.
According to D.I.T.’s website, its clients include Epoch Times, a newspaper affiliated with the Falun Gong movement; Voice of America; Radio Free Asia; and Human Rights in China, an activist group based in New York.
Bill Xia, a Falun Gong adherent who founded D.I.T. after emigrating to the United States, said in an email that the problem could have been caused by a “misconfiguration” in the state’s firewall, which controls traffic across multiple Internet service providers in China. “Only the Great Firewall has this capability ready,” he said.
Greatfire.org, an independent site that monitors censorship in China, echoed that theory in a blog post.
One thing is certain, said Mr. Specht of Compuware: Chinese Internet users’ and companies’ trust in the Internet has been shaken. “Already Chinese Internet users do not have too much trust in the Internet,” he said.
Amy Qin contributed reporting from Beijing.

Argentina restricts internet shopping to curb capital flight

Argentina restricts internet shopping to curb capital flight

January 22, 2014 6:22 pm
By Jonathan Gilbert in Buenos Aires and John Paul Rathbone in London
Even as it seeks to regain access to international capital markets, Argentinaimposed new restrictions on online shopping on Wednesday in its latest attempt to curb capital flight and prevent a possible balance-of-payments crisis.
Anyone buying goods through international websites such as Amazon.com must now sign a declaration and produce it at a customs office, where the packages are collected. In addition, Argentines are only allowed to buy two international items annually, free of tax, up to a $25 total. Beyond that, they must pay a 50 per cent tax.
Jorge Capitanich, the head of Argentina’s cabinet of ministers, said the measure was to defend national interests by substituting national production over foreign goods. “We must ask ourselves if we want Argentine industry, Argentine workers,” he told reporters.
However, analysts said it would have little effect on stanching the country’s continued outflow of foreign reserves, which have fallen $1bn this year to stand at $29.5bn on Monday. Argentina had $40bn in reserves at the start of last year.
“The measure is a only Band-Aid,” said Ricardo Delgado, director of local consultancy Analytica Consultora. “It only addresses the symptoms of the fall in reserves, not the cause, which is high inflation.”
Private estimates put inflation at more than 28 per cent, against the official government rate of 11 per cent. High inflation has also pushed up the value of the black – oe “blue” – market exchange rate to almost 12 pesos per dollar, versus the official rate of 6.9.
The government said it is planning measures to clamp down on the blue market exchange rate, “although obviously I’m not going to say what they are before it happens,” Mr Capitanich said on Wednesday.
Argentina first introduced currency controls a week after Cristina Fernández was re-elected president by a landslide in 2011. Since then it has redoubled efforts to restrict transactions in foreign currency, including a recent 35 per cent tax on credit-card purchases made abroad.
“People are accustomed to taking refuge in the dollar, especially when they see the peso is overvalued,” said Gastón Rossi, a former vice-minister for the economy under Ms Fernández and director of LCG, a Buenos Aires consultancy. “They always find new ways to dollarise.”
People are accustomed to taking refuge in the dollar, especially when they see the peso is overvalued,” said Gastón Rossi, a former vice-minister for the economy under Ms Fernández and director of LCG, a Buenos Aires consultancy. “They always find new ways to dollarise
– Gastón Rossi
The online sales restriction comes as Argentina seeks to regain access to international capital markets through a process dubbed “financial normalisation”, 12 years after it defaulted on $100bn of international bonds.
Argentina, a G20 member, has agreed in principal to compensate Spanish oil company Repsol for the 2012 nationalisation of its majority stake in Argentine energy company YPF. It settled $677m of arbitration claims last year and is holding talks with the IMF on overhauling its statistics and so avoid censure and possible expulsion from the fund. This week, it also re-opened talks with the Paris Club to reschedule Argentina’s approximately $6.7bn of bilateral debt, not including accumulated interest.
On Tuesday, however, Axel Kicillof, the economy minister, said any Paris Club agreement remained months away and that Argentina would not submit to “any conditions”. Paris Club debt restructurings typically involve a simultaneous IMF program.
The sluggishness of the normalisation process is “ineffective against the growing stress on the balance of payments,” Siobhan Morden, head of Latin America strategy at Jefferies in New York, wrote in a note to clients on Wednesday. The nub of the problem, she said, is: “How do you motivate long-term capital flows under an unstable economic environment?”
Many had expected Argentine policy making to become less centralised in the figure of the president and more pragmatic after the government suffered a trouncing in October’s mid-term election, Ms Fernández shuffled her cabinet and appointed Mr Capitanich, an experienced state governor, as cabinet chief. But recent policies show little change of course, analysts say.
“There were expectations of change,” Mr Rossi said. “But it has become absolutely clear that the concentration of power has not been modified.”

Setting a Course for India’s Inflation Nirvana; The RBI’s New Inflation Target Could Mean Higher Rates for Longer

Setting a Course for India’s Inflation Nirvana
The RBI’s New Inflation Target Could Mean Higher Rates for Longer
ABHEEK BHATTACHARYA
Jan. 22, 2014 8:16 a.m. ET

Raghuram Rajan’s project of fixing India’s dilapidated central bank now has a plan. Sticking to it could prove tumultuous for investors.
In a report out Tuesday, a committee of top Reserve Bank of India officials and outside economists appointed by central bank chief Mr. Rajan made some notable recommendations, especially establishing a target for consumer-price inflation. This is likely what Mr. Rajan wanted to hear. He made similar recommendations when he chaired such a committee five years ago as a private citizen. This time, he has the power to implement them.

Going after consumer prices makes sense: Over the past five years retail inflation has rarely come below 8%, despite sickly growth. Such unstable prices are a big reason foreign investors abandoned India during the “taper” scare last year.
It’s encouraging that the committee specified headline inflation, rather than core inflation, given that as a poor country, India has a consumer basket that’s about 60% food and fuel. The RBI previously targeted “multiple indicators”—a jumble of inflation, growth, financial stability and exchange rates that confused investors about the bank’s intentions.
If Mr. Rajan adopts the new target, investors should gird for higher rates. As it stands, RBI’s policy rate is more than two percentage points below inflation. The inflation target would start at 8% in the first year, then drop to 6% and eventually to a range of 2% to 6%. Considering how stubborn Indian inflation has been, one could imagine the need to raise rates aggressively to stick to the target.
There are problems. One is the RBI’s ability to forecast what it’s targeting. The central bank’s inflation outlook often misses reality by wide margins. Consumer prices are particularly hard to forecast because of volatile food and fuel, says Vidya Mahambare, an economist at credit rater Crisil.
Politics is a bigger impediment, especially things outside of the RBI’s control. The committee recommended the government keep fiscal deficits below 3% of GDP and stop artificially boosting wages to prevent money sloshing around the economy. Sounds great, but that’s up to politicians in New Delhi, not Mr. Rajan.
That Mr. Rajan looks set to give India a new focus on inflation is undoubtedly a good thing. Hitting the target will be much harder.

Delhi’s corruption-slayer stumbles with pavement protest

Delhi’s corruption-slayer stumbles with pavement protest
Wednesday, January 22, 2014 – 17:00
Adam Plowright
AFP
NEW DELHI- Delhi’s “anarchist” chief minister Arvind Kejriwal faced savage press criticism Wednesday after a two-day protest in the capital that could check the dizzying rise of India’s new political star.
The 44-year-old anti-corruption campaigner, who took office less than a month ago amid a wave of support for his ideals, called for mass demonstrations on Monday to press for police reform.
After two days and a night sleeping rough on a pavement in the centre of the capital, he called off the agitation late Tuesday with few of his demands heeded and his credibility shaken.
“It seems Kejriwal, who branded himself an anarchist, is unable to transform himself from rabble-rouser to a responsible chief minister,” the Hindustan Times said in an editorial Wednesday.
Kejriwal formed his Aam Aadmi (common man) Party just over a year ago, and it made sensational gains in Delhi’s state election in December with its no-tolerance approach to endemic corruption.
Its core support came from the poor and the educated middle-class who saw an alternative to India’s graft-tainted Congress party, in power nationally, and the opposition Bharatiya Janata Party.
After taking office, he won plaudits for shunning the VIP culture of Indian politics, taking the metro to his inauguration and travelling elsewhere in his trademark small blue car.
Early moves such as providing abandoned buses for the homeless to sleep in earned favourable headlines, as did pledges to provide cheap electricity and free water.
A flood of members, including entrepreneurs and a television anchor, joined AAP and the party suggested it would contest up to 400 seats in national elections due by May.
But the radical tone of recent announcements from Kejriwal, who threatened to disrupt the annual Republic Day military parade on Sunday, and his decision to protest in a city he was elected to run, were widely criticised.
The Times of India said the sit-in had been a distraction from an opportunity to improve Delhi and show good governance, adding that “the middle class is unlikely to fall for such gimmickry”.
Others supported his cause and saw courage in his actions, meaning the episode might have lost him fewer voters than editorial writers in the English-speaking media have assumed.
“Who is he fighting for? Us!” said Vishesh Sharma, who sells snacks on a street in central Delhi. “What he did was right. These cops are corrupt and extort bribes from poor people like us.”
Samir Ahmad, who works in a parking lot in the same area, said Kejriwal’s target was “a very good cause”.
“Take our case, whenever there is any controversy or conflict in the parking lot and we call the cops, first they come late and then they try and extract money from us,” he said.
‘Defending vigilantism’
Kejriwal launched his protest on Monday to demand that five policemen whom he accused of misconduct be suspended and the city’s police force be put under his control, instead of the central government.
Some of the police he targeted were involved in a late-night incident last week when Delhi’s state law minister, AAP member Somnath Bharti, identified a house suspected of being used for prostitution and drug-dealing.
In front of the media, Bharti became angry when police refused to raid the property in the absence of a warrant.
Bharti and his supporters were then accused of detaining four African women, trapping them in a car and forcing one of them to urinate on the street, according to their lawyer and a police complaint.
The Hindu said in its Wednesday editorial it was “strange” that Kejriwal “should be defending vigilantism by his ministers”.
“Forgotten here is that Indian law does not permit arbitrary search and seizure, especially involving women in the dead of the night,” it added.
In a face-saving compromise, Kejriwal agreed to end his demonstration after securing an agreement – “a victory,” he called it – that two of the five targeted police officers would be sent on leave.
How the episode will affect Kejriwal’s credibility will be crucial for the national elections.
Most expect him to return to street protests and direct action, as he attacks many of the institutions he sees as upholding a corrupt system that has failed to deliver for the poor.
But not immediately.
After two days exposed to the elements, Kejriwal was reported to be suffering from bronchitis and underwent hospital tests.

Taiwan probes Foxconn ex-employees over bribery claims; a key suspect had pocketed US$3.33 million in kickbacks from suppliers by using his top position in a procurement committee that buys up to TW$50 billion of equipment a year

Taiwan probes Foxconn ex-employees over bribery claims
Wednesday, January 22, 2014 – 15:26
AFP
TAIPEI – Taiwanese authorities launched island-wide raids to investigate allegations that some former managers at the technology giant Foxconn had solicited bribes from suppliers, prosecutors and the company said Wednesday.
More than a dozen people, including former employees, were questioned and at least one suspect was detained as investigators on Tuesday searched 19 locations including residences and offices of suppliers, local media said citing authorities.
The investigation is the latest setback for the company, which has come under the spotlight after suicides, labour unrest and the use of underage interns at its Chinese plants in recent years.
The “integrity of our employees and suppliers is something we take very seriously… The discovery that a small group of employees and suppliers violated our code of conduct is very disappointing,” the company said in a statement Tuesday.
The allegations surfaced after Taiwanese media reported last year that a manager at Foxconn – which assembles products for Apple, Sony and Nokia – had been detained by police in the southern Chinese city of Shenzhen.
The Taiwanese manager allegedly solicited and accepted bribes from suppliers in exchange for buying their machines and equipment for the company, reports said, adding that this appeared not to be an isolated case.
Foxconn said at that time it was reviewing its acquisition procedures and the integrity of managers, and that its operations in China had not been affected.
Taiwan’s Apple Daily newspaper on Wednesday said a key suspect had allegedly pocketed around Tw$100 million (US$3.33 million) in kickbacks from suppliers by using his top position in a procurement committee that buys up to Tw$50 billion of equipment a year.
In its latest statement, the company said the alleged violations were limited to the procurement of consumables and accessory equipment.
Foxconn, also known as Hon Hai in Taiwan, is the world’s largest maker of computer components and employs about one million workers at its factories across China.

Davos is no place for a comeback by the failed kings of finance; Too early to forgive those reinventing themselves for a post-crisis world

Davos is no place for a comeback by the failed kings of finance
By Patrick Jenkins
Too early to forgive those reinventing themselves for a post-crisis world, says Patrick Jenkins
There might be hope yet for Fred Goodwin. Evidence is accumulating that the men at the top of big western banks when the financial crisis of 2007-08 took hold are reinventing themselves for a post-crisis world.
This month Sandy Weill, creator of the vast Citigroup empire that became the biggest US bank casualty in the crisis, popped up as chairman of the new Bermudan reinsurance group Hamilton. The business, neatly enough, specialises in catastrophe cover.
Just before Christmas Bob Diamond – unceremoniously ejected from Barclays in the summer of 2012 over his involvement in 2008 Libor manipulation – emerged with a bold business plan to break into African banking. Teaming up with the Ugandan entrepreneur Ashish Thakkar, Mr Diamond made an oblique but splashy return to prominence, floating an acquisition vehicle,Atlas Mara, in London.
Earlier last year Martin Sullivan, chief executive of the insurance group AIG when it became the biggest financial company to fail and be bailed out, was appointed chairman of a Lloyd’s of London underwriter, the ultimate symbol of the City establishment.
Is the world forgiving and forgetting?
The narrative is not so straightforward. For a start, none of the three reinvented financiers is doing a really big job. What is more, none of them was at the extreme end of those tarnished by the crisis. In comparison with many rivals, Barclays survived relatively unscathed in the tumult. At Citi, Mr Weill had ceased to be chief executive in 2003 (though he remained chairman until 2006). And Mr Sullivan only took charge of AIG a year before the crisis, inheriting an unmanageable byzantine empire from its architect Hank Greenberg.
They are far from the first to return to the fold, either. Mr Sullivan was actually one of the earliest to re-emerge post-crisis, appointed deputy chairman of the giant insurance broker Willis in 2010 – albeit for barely two years.
Some of the bankers to stage the quickest comebacks after the crisis were ironically also some of the most vociferously criticised for their mismanagement of it.
Marcel Rohner, accused of “staggering ignorance” by a British parliamentary committee, left UBS under such a cloud that you might have thought his career irrecoverable. Yet three years ago he was appointed to the board of UBS’s Swiss rival Union Bancaire Privée, one of the country’s top private banks.
Mr Rohner’s former UBS colleague, the investment banking boss Huw Jenkins, has also bounced back and is now a senior figure at the thriving Brazilian bank BTG Pactual.
Others have enjoyed rapid rehabilitation outside banking and finance. In early 2008, after being lambasted and ousted as chief executive of Merrill Lynch, Stan O’Neal was appointed to the board of the aluminium giant Alcoa, where he remains a non-executive.
Andy Hornby barely had time for a holiday after leaving the foundering HBOS upon its takeover by Lloyds, before he pitched up as chief executive of the drugs group Alliance Boots in 2009. He is now CEO of Coral, the bookmaker.
Comebacks, some of them reasonably successful, clearly outnumber the opposite public response – vilification and ostracism. Jail sentences are rare. A couple of Icelandic bank bosses and the former head of Germany’s IKB are among the few to have been tried and convicted.
Nonetheless, the vast majority of former high-flying bankers are today low-profile also-rans, many of them with face-saving roles as advisers – Johnny Cameron, the former investment banking boss at Royal Bank of Scotland, is at Gleacher Shacklock; Eric Daniels, the old head of Lloyds, is at StormHarbour. Rodrigo Rato, the former Spanish economy minister and managing director of the International Monetary Fund, who oversaw the failure of Bankia, has been reduced to sitting on an 11-member international advisory board at Santander.
Dick Fuld, the man at the helm of Lehman Brothers when it collapsed, tried valiantly enough to reinvent himself. In 2009 he founded Matrix Advisors, a mergers and acquisitions advisory boutique, but it came to little. Jimmy Cayne, the former head of Bear Stearns, seems to have devoted himself to playing bridge.
For Mr Goodwin – the former head of Royal Bank of Scotland who became the most reviled of all bankers – redemption still looks elusive. He was ignominiously stripped of his knighthood in a populist swipe by Prime Minister David Cameron a year ago. And the one modest role he did get – as a consultant to a local Scottish architecture practice – ended after there proved to be insufficient work to occupy him.
Even among those who have reinvented themselves successfully, few can claim fully fledged reintegration into the echelons of the great and the good. Just look around the delegates at this week’s annual jamboree of capitalism in Davos. Mr Jenkins is there. Mr Diamond is there.
But these are rare examples of real comeback ambition. The vast majority of the old stars seem unwilling or unable to shine again.

Africa’s Richest Man Sees Company Joining Top 100 by 2017

Africa’s Richest Man Sees Company Joining Top 100 by 2017

Africa’s richest man Aliko Dangote said his Dangote Group would join the ranks of the world’s biggest 100 companies within three years as he invests in cement, agriculture and oil refining across the continent.

“We are targeted now to be one of the 100, in terms of ranking, global companies by 2017,” Dangote said yesterday in an interview at the World Economic Forum in Davos, where he is this year’s co-chairman. Lagos, Nigeria-based Dangote’s plan is “to be one of the leaders in terms of all the sectors we’re involved with,” its owner said.

Dangote is investing $16 billion over the next four years in cement, sugar, rice and oil, including the construction of a $9 billion oil refinery in southwest Nigeria. The company is considering the purchase of crude fields in Africa’s biggest oil producer to help supply energy to its petrochemical complex and cement plants, Group Executive Director Devakumar Edwin said in an interview in Lagos last week.

Aliko Dangote has seen his wealth climb $1.2 billion in the month to date, making him the world’s 27th richest person with a net worth estimated at $25.1 billion, according to the Bloomberg Billionaires’ Index.

“I’m going to actually put quite a lot of money in sugar and rice and then oil,” he said. “We invested heavily in Nigeria, but we’re not only looking at Nigeria, we’re looking at the regional market.”

Bad Dream

African policies have transformed the private sector, particularly in agriculture, Dangote said on a WEF panel today.

“If I had had a dream five years ago and you told me that I was going into agriculture, I would totally say no — that it would not only be a mistake, it must have been a bad dream,” he said.

Dangote said he would like to emulate the philanthropy of world’s richest man Bill Gates and said he spent $100 million in 2013 “giving back to society” in the areas of health and education.

To contact the reporters on this story: Matthew G. Miller in Davos, Switzerland at mmiller144@bloomberg.net; Chris Kay in Lagos at ckay5@bloomberg.net

Toxic Pubs: Punch Taverns’ financial engineering has harmed the pub industry

Punch Taverns’ financial engineering has harmed the pub industry
After 14 months of wrangling, Punch still couldn’t come up with an agreed deal with its bondholders
After 14 months of wrangling, and three sets of proposals for restructuring £2.3bn of securitised debt, pub landlord Punch Taverns still couldn’t come up with an agreed deal with its bondholders.
Instead, chairman Stephen Billingham produced a fourth proposal, declared the terms “final”, and told the various bondholders to vote.
If the answer is no among any one of 16 classes of bondholder, he says default and administration will follow.
Depending on your point of view, Billingham is either behaving recklessly in imposing a deadline, or is sensibly calling time on a process that has run for long enough.
Billingham’s gamble is justified. Clearly, he would be in a stronger position if he had been able to announce support from the two main groupings – the Association of British Insurers, representing the senior bondholders, and the hedge funds who dominate the junior varieties.
But, arguably, any attempt to secure a pre-agreement would simply generate yet another round of bickering.
The deep problem is that Punch’s capital structure – designed by over-confident, over-paid and long-departed financial engineers – is a complete mess.
Special clauses on access to the “liquidity facility” (don’t ask) apply on default. That gave the junior bondholders a hook on which to hang their claims for gentler treatment that would normally apply in a restructuring.
The seniors were understandably irate, especially as shareholders will avoid being wiped out entirely, which, by rights, they should be.
In the end, a vote seems a reasonable way to proceed if Billingham is convinced that it is now “economically rational” for all 16 classes to give approval.
If he’s right, Punch Taverns can limp on with a slightly lighter debt burden.
But this grotesque financial experiment, which has done only harm to the pub industry, should never be repeated.

Sri Lanka to sack officer over ‘false’ GDP data row

Sri Lanka to sack officer over ‘false’ GDP data row
Wednesday, January 22, 2014 – 19:21
AFP
COLOMBO – Sri Lanka’s main statistics office Wednesday said a senior official who denounced alleged government pressure to inflate economic growth data would be sacked after he was found guilty of leaking confidential information.
Accounts Director H.S. Wanasinghe faced two separate disciplinary hearings after he complained to the Asian Development Bank (ADB) and an opposition lawmaker that the government was manipulating data.
“We have recommended to the PSC (Public Service Commission) to sack him and it will be done soon,” Census and Statistics chief D.C.A. Gunawardena told reporters in Colombo.
Wanasinghe alleged that he was ordered to increase GDP growth rate for the first quarter of 2013 to 6.0 percent when his calculation showed it was only 5.4 percent.
Sri Lanka’s main opposition last month read out a statement by Wanasinghe narrating how he was under instructions to change national accounts to suit the government, an allegation which the authorities deny.
The anti-corruption watchdog Transparency International (TI) said the senior officer should be treated as a “whistle-blower” and be protected instead of being sacked.
“What we see is a systematic approach of a cover up rather than an investigation into what he has revealed,” TI Sri Lanka chairman J.C. Weliamuna told AFP. “Sacking a senior officer for raising this issue is completely unacceptable.”
Statistics chief Gunawardena denied that he was under pressure to change economic data to suit the government which relies heavily on foreign borrowings.
“It is a funny joke,” he said of the allegations. “People can talk about any rubbish, but the department of Census and Statistics has no political agenda.”
President Mahinda Rajapakse, who is also the finance minister, told parliament in November that he expected the economy to grow 7.5-8.0 percent in calendar 2014, up from a provisional 7.2 percent in 2013 and 6.4 percent in 2012.
The economy recorded 8.0 percent-plus growth for two straight years after the end of Sri Lanka’s decades-long civil war which saw troops crush separatist Tamil Tiger rebels in 2009.
UN human rights chief Navi Pillay said in August last year after a visit to Sri Lanka that the country under Rajapakse “is showing signs of heading in an increasingly authoritarian direction.”

IMF Questions South Korea’s Currency Policy

IMF Questions South Korea’s Currency Policy
IAN TALLEY
Jan. 22, 2014 6:17 p.m. ET
WASHINGTON—The International Monetary Fund on Wednesday questioned South Korea’s currency policy, telling Seoul that it should only intervene in exchange-rate markets to prevent volatility that might damage the economy.
The unusually explicit scrutiny of Korea’s currency policy comes after Bank of Korea’s top official indicated early this year the central bank is ready to intervene in currency markets to curb the won’s strength. It also follows U.S. criticism late last year in which the Treasury Department said it was concerned that Korea had resumed currency intervention and needed to be more transparent about its activities.
“The won should continue to be market determined, with intervention limited to smoothing disorderly market conditions,” the IMF’s executive board said in a statement on the annual review of the country’s economy.
The fund says the won is “moderately undervalued,” accounting for inflation, but the currency is coming under increased appreciation pressure by markets as the emerging market outperforms many of its peers.
Korean officials say their efforts are meant to stabilize markets. But some U.S. economists say Korea wants to keep a lid on the value of the exchange rate to bar exports from becoming too expensive.
Although countries can devalue their currency by buying foreign currency, it comes at the expense of other countries’ exchange rates rising and can fuel trade and political tensions between governments.
To avoid creating friction over currency policies, the IMF said, Korea should be more candid about its exchange rate operations.
IMF directors “considered that increased transparency in interventions would help enhance the credibility of the authorities’ exchange rate policy,” the fund said.
The executive board appeared to be divided, however, about whether the country should continue to build up foreign currency buffers to protect against potential economic crises.
“Some directors considered that the current level of reserves is adequate and does not warrant further accumulation, while a few others, noting the proven benefits of building a strong buffer in past crises, cautioned against prejudging the case,” the board said.

Thomas Dundon is poised to become a subprime billionaire; Subprime-Car-Loan Firm Has Flourished as Other Lenders Have Struggled

Auto Lender’s Drive Reaps a Fortune
Subprime-Car-Loan Firm Has Flourished as Other Lenders Have Struggled
ANDREW R. JOHNSON and TELIS DEMOS
Jan. 22, 2014 7:22 p.m. ET

Thomas Dundon’s 13,556-square-foot Dallas home features eight bedrooms, indoor and outdoor tennis courts, three wet bars, a swimming pool and an indoor slide that goes from the second floor to the first.
Those are only some of the spoils Mr. Dundon, 42 years old, has collected during his journey to the top of the subprime auto-lending business, where lenders make loans to borrowers with blemished credit. In 2012 alone he raked in $85.2 million in total compensation.
Now Mr. Dundon is poised to become a subprime billionaire.
Santander Consumer USA Holdings Inc., the Dallas-based auto-lending and consumer-finance company run by Mr. Dundon, is slated to debut as a publicly traded company Thursday. Owners of the firm, a unit of Spanish lender Banco Santander
SA, SAN.MC -0.82% raised $1.8 billion by selling about 75 million shares, or 22% of its outstanding common stock, at $24 a share. The deal values the company at about $8.3 billion, not including the exercising of stock options.
Mr. Dundon, the chief executive, stands to see his stake valued at $1.2 billion, based on the 13.6% share of the company that he will hold after the initial public offering, including stock options.
“It would not have crossed anyone’s mind that this was possible,” Mr. Dundon said about the company’s success in an interview Wednesday. “I’m not sure if we did it over again that you could replicate the success.”
The windfall is notable in an industry still dogged by the memories of the financial crisis. Subprime mortgages were among the first to go bust when the housing market foundered, erasing billions of dollars in assets for lenders, the Wall Street firms that packaged their loans into securities and the investors who bought them. Subprime mortgage lending activity has shriveled to just a tiny fraction of its peak during the housing boom.
But auto loans are a different breed. Subprime auto loans weren’t hit by the huge losses seen in other lending segments. Industry experts say many borrowers continued to make auto-loan payments before they paid down other types of loans, including mortgages and credit cards, because they rely on their vehicles to get to work.
Mr. Dundon keeps a high profile in sports-crazed Dallas. He attended the wedding of Dallas Cowboys quarterback Tony Romo in 2011, according to local news reports, and has played in golf tournaments with professional golfer Hunter Mahan.
But Mr. Dundon’s friends and acquaintances paint a picture of a self-made entrepreneur who came from humble beginnings. He earned his fortune by remaining intensely focused on achieving the goals he set for himself and his business partners, and by refusing to dwell on setbacks, according to those who know him.

“He’s hyper-focused,” said Mark Molthan, a Dallas real-estate developer who built Mr. Dundon’s home and has known him since high school. “When he knows what he wants…he figures out a way to get it.”
Mr. Dundon attended high school in Plano, near Dallas, and was the president of the Phi Gamma Delta fraternity at Southern Methodist University.
Former fraternity members recall Mr. Dundon’s leadership skills following a fire that destroyed Phi Gamma Delta’s house in 1992. Jon Altschuler, a commercial real-estate executive in Dallas who was in Phi Gamma Delta at the time, said Mr. Dundon led the effort to find replacement housing for the fraternity while continuing to recruit new members. He also was instrumental in marshaling support from the local business community to raise funds to support the fraternity’s operations.
After graduating in 1993 with a degree in economics, Mr. Dundon started a burger restaurant in Fort Worth, Texas, called Izzy’s. The venture lasted less than a year, according to friends. But the experience didn’t seem to faze Mr. Dundon, friends said. He often joked that Izzy’s became “Wasy’s,” they said.
“He just moved on,” said Mr. Altschuler. “He’s never been a down-in-the-dumps kind of guy.”
After the burger joint failed, Mr. Dundon got his start in the auto business, winning a job in the finance department of a Dallas auto dealer. He and some co-workers in 1995 struck out on their own to form an auto-finance company whose rapid success attracted outside investors. Banco Santander in 2006 agreed to buy a 90% stake in the company for $650 million. In 2011, Santander sold part of its stake to private-equity firms Warburg Pincus LLC, Kohlberg Kravis Roberts & Co. and Centerbridge Partners LP, which together owned about 24% of the company before the IPO.
For the first nine months of 2013, the company earned $581.7 million, or $1.69 a share, down from $611.7 million, or $1.72 a share, a year earlier. The company’s net charge-off rate, or loans deemed uncollectable, for the first nine months of 2013 was 4.6%, down from 5.1% a year earlier.
The IPO comes amid a boom in auto lending, which has been a rare bright spot for lenders facing tepid customer demand for other types of credit. Loans to borrowers with weak credit have been particularly strong. Auto-loan originations to subprime borrowers—defined as consumers with scores below 660 on the industry’s FICO measure—totaled $153 billion last year, up from $66 billion in 2009, according to Moody’s Analytics and Equifax.
Other large consumer-finance companies are considering going public, as well. Ally Financial Inc., the former finance arm of General Motors Co., is looking to launch an IPO after the Federal Reserve releases results of its annual “stress tests” of big banks, people familiar with the matter have said. General Electric Co., meanwhile, wants to spin off its consumer-finance arm through an IPO this year, the company has said.
Despite Mr. Dundon’s success, friends say he hasn’t let his ego swell and remains focused on his family. He and his wife, Veruschka, have four children, and they often allow their kids’ sports teams and others to use the athletic facilities on their property, according to Mr. Dundon and his friends.
Mr. Molthan said Mr. Dundon had his estate built with his children in mind.
“It’s definitely a kid’s wonderland,” Mr. Molthan said.

Vietnam’s Stock Surge Encourages IPOs; New Listings in Developing ‘Frontier Market’ Will Enable Foreign Investors to Tap Country’s Growth

Vietnam’s Stock Surge Encourages IPOs
New Listings in Developing ‘Frontier Market’ Will Enable Foreign Investors to Tap Country’s Growth
JAKE MAXWELL WATTS and NGUYEN PHAM MUOI
Updated Jan. 22, 2014 11:57 a.m. ET
Rising share prices are encouraging the government, which owns many companies ranging from the country’s flagship airline to its largest brewery, to privatize by selling shares in Vietnam’s capital markets. Officials recently have signaled that they are proceeding with privatization plans, which has bolstered investors’ optimism about the government’s intent to liberalize some sectors of the economy.
Some bullish investors say the anticipated wave of initial public offerings is a sign that Vietnam is developing as a so-called frontier market and could eventually appeal to a broader range of money managers. Frontier markets are considered among the riskiest places to invest.
Investors are increasingly turning to smaller economies like Vietnam as growth slows in better-traveled emerging markets such as Brazil and India. Vietnam’s government predicts its export-driven economy will grow 5.8% in 2014, according to local media reports, up from 5.4% last year.
But like most frontier markets, Vietnam’s stock market is small. The roughly 300 publicly traded companies on the Hochiminh Stock Exchange have a combined market capitalization of $43.6 billion, smaller than package-delivery company FedEx Corp.FDX +0.11% Many shares are thinly traded or have caps on foreign ownership, so it can be hard for investors to gain a foothold and even more difficult to leave during times of stress.
As more companies list, it will alleviate some of those fears, said Sean Lynch, global investment strategist at Wells Fargo Private Bank, with $170 billion in assets. “The IPOs in Vietnam this year are a positive” because it expands the options for money managers, Mr. Lynch said. “Deeper markets can absorb more investment dollars.”
He said the bank’s most aggressive funds aim to invest 2% of assets in frontier economies and would potentially buy newly floated shares of Vietnam’s garment, automobile and airline companies when they hit the market.
The Hochiminh Stock Exchange’s VN Index is up 9.4% in January and touched a four-year high this week. MSCI Inc.’s index of Vietnamese shares is up more in 2014 than any other country tracked by the company.
Vietnam sets restrictions on foreign-ownership stakes in local firms, and at least 10 of the country’s 30 largest listed companies are already at their limits, according to data from Ho Chi Minh Securities Corp.
The government is starting to loosen some of those rules. It is set to raise the limit on foreign holdings of Vietnamese financial institutions to 20% from 15% starting Feb. 20. It will likely raise the cap on foreign ownership in other sectors to 60% from 49%.
Kevin Snowball, chief executive of PXP Vietnam Asset Management Ltd., which has $140 million in assets under management, said he may invest in some of this year’s IPOs. He is particularly interested in the planned listings of flag carrier Vietnam Airlines Corp. and apparel exporter Vietnam National Textile & Garment Group, or Vinatex.
“There is very little listed in the stock market that gives you access to [Vietnam’s] export story,” Mr. Snowball said.
In this year’s first listing, shares in the Joint Stock Commercial Bank for Investment & Development of Vietnam, or BIDV, will begin trading on Friday. Other companies that have signaled their intention to list include building-materials supplier Viglacera Corp., telecom operator MobiFone and beer maker Saigon Beer Alcohol Beverage Corp., or Sabeco.
“The IPOs are opportunities for foreign investors, who have been waiting for some years for the local market to open further,” said Nguyen Duy Hung, chief executive and chairman of Saigon Securities, a broker and asset manager.
Not everyone is prepared to jump in. Some Vietnam-based funds say the country hasn’t fully tackled a long-standing problem of bad debt, particularly among state-owned enterprises. BIDV held its IPO in December 2011 but delayed trading of its shares amid widespread mistrust of Vietnam’s finance sector.
For some foreign investors, Vietnam isn’t big enough to warrant a look. Small frontier markets, they say, could essentially shut down at times of stress, making it hard to take money out.
“Vietnam’s relatively small equity market…and its lack of liquidity make it an unattractive investment option for us,” said Audrey Kaplan, senior portfolio manager of the $614.5 million Federated InterContinental Fund.
Others see signs that Vietnam is solving its banking-sector problems, while they predict the IPOs will boost the size and stability of the stock market. Analysts say 2014 will be a big test for Vietnam, particularly as soaring U.S. share prices and an improved outlook for most European economies lure investors back to developed markets.
Bad debt in the banking system was 3.8% of the total, down from nearly 8% at the end of 2012, though some independent analysts say it could be considerably higher. In July, Vietnam formed a state-owned bank to take on financial institutions’ bad debt, and the country’s central bank aims to lower the figure to 3% by the end of 2015.
HSBC HSBA.LN -0.74% recently upgraded its outlook for Vietnam to “positive” from “neutral” but warned domestic demand is struggling due to “an overhang of bad debts.”
“Foreign-capital inflows will find good opportunities” in Vietnam, said Giang Trung Kien, chief analyst with FPT Securities. “Economic indicators suggest the Vietnamese economic recovery is likely to continue to improve and stabilize this year.”

Can an Embattled Thailand Find Compromise?

Can an Embattled Thailand Find Compromise?

As with so many seemingly intractable fights, the warring camps that have paralyzed Thailand both say they want the same thing: a cleaner, more legitimate democratic process. It’s time for them to prove it.

The country’s long-running political soap opera has lately taken a darker turn. The ruling Pheu Thai party of Prime Minister Yingluck Shinawatra has vowed to forge ahead with elections on Feb. 2, which the opposition promises to boycott. A 60-day “state of emergency” in Bangkok and surrounding areas has raised the prospect of violence between police and protesters. Under such conditions, a victory at the polls would leave a new Pheu Thai government with a dangerously weak mandate, increasing the likelihood of intervention by the army or the king.

Both sides protest their innocence. Yingluck, the sister of controversial tycoon and former Prime Minister Thaksin Shinawatra, has offered to discuss electoral reforms, but insists they can be enacted only by a new legislature. Her opponents demand that her government be replaced by an unelected group of “wise men” who would carry out reforms over the next 18 months, before overseeing any new vote. It might be easier to sympathize with one side or the other if both had not ignored the recommendations of a multitude of reform commissions while in office over the past decade.

One idea raised recently would be to form a small body — including members of both Pheu Thai and the opposition, as well as third-party figures — to hash out a half-dozen crucial political reforms, such as checks and balances on state power and measures that would reduce corruption and increase fiscal discipline. Although discussions would begin immediately, the commission’s work would continue past the Feb. 2 elections, no matter who wins. Parties would commit in advance to implementing the body’s recommendations — or to calling new elections if the commission judged they were needed.

If the parties are sincere in their claims, they should be looking for just such a middle ground. Even if they’re not, however, some agreed process would at least allow both to climb down from a confrontation that neither can win outright.

Assuming that, as part of such a compromise, the opposition agreed to participate in elections, the Feb. 2 vote could even be postponed for a couple of months to let tempers cool and give candidates time to campaign properly. (Rescheduling the vote would be extremely difficult constitutionally but perhaps not impossible.) The pause would be meant not to circumvent the democratic process — a fair description of the opposition’s current demands — but to bolster the legitimacy of the results.

Yingluck need only look to her embattled counterpart Sheikh Hasina Wajed, prime minister of Bangladesh, to see that winning an uncontested election marred by violence would be no victory at all. To plow ahead, using her draconian new security powers to detain opposition leaders and disperse protesters, would treat only the symptoms of Thailand’s malaise, not the cause.

By the same token, for the opposition to continue to reject any compromise would prove what many suspect — that its main goal is to regain power for Thai elites, who have lost their electoral majority to poorer rural citizens from the populous north. Ordinary Thais and elites alike have plenty of reason to criticize Pheu Thai’s stewardship of the economy. Sooner or later, opposition leaders will have to learn to beat their opponents with better ideas, not by rigging the system.

The alternatives to compromise now are a disputed election or a coup, either of which would keep the conflict going. Vague hints from top generals about the possibility of a military takeover damage Thailand’s economy and further dim its appeal as an investment destination. The country would be better served if both king and army — the two most powerful forces in Thailand – – used that leverage to push the two sides toward the middle ground they seem unable to find on their own.

To contact the Bloomberg View editorial board: view@bloomberg.net.

EB-5 visas, a federal program that allows foreigners to live in the U.S. if they invest in job-creating ventures took in a record number of applications last year

EB-5 Visas for Investors See Record Demand
Program Saw 6,434 Foreigners Apply in the Latest Year
ANGUS LOTEN
Jan. 20, 2014 7:22 p.m. ET
A federal program that allows foreigners to live in the U.S. if they invest in job-creating ventures took in a record number of applications last year.
Known as an EB-5 visa, the program has boomed over the past seven years, as traditional forms of financing dried up for projects ranging from hotels and casinos to wind farms and frozen-yogurt franchises. The minimum investment under the program is $500,000. Companies that have tapped EB-5 investors for cash include Marriott International Inc.MAR +0.75% and Sony Pictures Entertainment Inc.
Last year, 6,434 foreign investors applied for visas under the program, up from 6,040 in 2012, according to data from U.S. Citizenship and Immigration Services, the agency within the Department of Homeland Security that oversees the program. As of Sept. 30, the end of the federal government’s fiscal year, the agency had approved 3,696 investors, most Chinese, and denied 942.
If approved, investors receive a temporary visa for themselves and their families that can be converted into permanent residency—that is, a green card—if the investment is shown to have created at least 10 jobs within two years.
Last year, 6,895 Chinese nationals were issued visas through the program, outpacing all other nationalities by a wide margin, according to State Department data. South Koreans, the next largest group, were issued 364. A single EB-5 application can account for multiple visas for investors’ immediate family.
The 5% rate of growth in the program in 2013 was lower than in recent years, when the number of applications increased by 58%, in 2012, and 94% in 2011.
Launched by Congress in 1990, the program has recently been plagued by allegations of fraud and charges of mismanagement by immigration officials. That has led to increased scrutiny of the program by the immigration agency, which has caused delays in the application process, immigration lawyers say.
To date, the agency estimates the program has raised $8.6 billion and created at least 57,300 jobs since 1990.

Why We Are Lucky To Live In The Era Of Indexing

Why We Are Lucky To Live In The Era Of Indexing
by ElliotTurnerJanuary 22, 2014
Last week we were greeted with writings from two of the best investors and thought-leaders: Howard Marks of Oaktree and Murray Stahl of Horizon Kinetics. The decades of wisdom acquired by both Marks and Stahl now share with us youngens via these readings is a gift we must all take advantage of. I am about to grossly oversimplify the points from both of these greats in order to riff off of it into a point of my own. I give this warning both to preempt any complaints about my simplification, and as a suggestion to do yourself a favor and read what both of these gentlemen have to say before going one sentence further here. If you are kind and/or interest enough to return to this site, once done with those piece, please feel free to do so.
Since I received a link to Marks’ memo first, my evening reading started there and proceeded to Stahl’s piece. This was a fortunate coincidence. Marks lays out the case for the role luck plays in living life and attaining success in financial markets, tracing it to the idea markets are mostly efficient, but for those areas with a “lack of information…and competition.” Meanwhile, Stahl examines what he believes to be one of the single largest sources of market inefficiency today in what he calls “indexation.” After reading both pieces, I couldn’t help but think: “we are lucky to be investors in markets in this era of indexation.” This one thought struck me as the perfect conjunction between the two pieces.
Stahl has used the word “indexation” to explain the phenomenon whereby more assets and managers are investing in indices and ETFs which are designed to “provide portfolio exposure to very specific criteria, such as an asset class, an industry sub-sector, a growth metric, a stock market capitalization band, and so forth.” Over time, Stahl has discovered and invested in several of the inefficiencies resulting from such a phenomenon, including the “owner-operator” whose major stockholder manages the company, spin-offs designed to streamline business operations, etc. I recommend reading Stahl as to why these opportunities arise in today’s market.
Why do I say we are lucky to invest in this era of indexation? Because, as Stahl argues, indexation is an incredible source of market inefficiency. As more and more dollars seek out exposure in the broadest of ways, there is ample opportunity for those of us who seek to “turn over as many rocks as possible” to find the right opportunity. Two of my favorite setups fit this bill, although I never specifically delineated these ideas in writing as an outgrowth of indexation. This is so because both setups existed as long as there have been markets, and are in many respects traceable to behavioral traits of human beings. What has changed is that indexation provides a natural outlet through which these behavioral weaknesses are even more pronounced than in years past. I have named these setups “Guilty by Association” and “I’ve got a Label, but I don’t Subscribe.” While there are similarities between the two, they deserve to be thought about separately.
“Guilty by Association”
When a company is “Guilty by Association” they are treated in the same way as another, more identifiable peer group or index solely by some kind of perceived proximity. These tend to be situations that are more macro in nature, where a broader problem is reflected upon a specific company or sector. Some examples might be helpful.
During the crisis period in Europe, all European stocks were hit with equal force. The market “threw the good out with the bad” so-to-speak. One particular class of opportunities we spent considerable time on (and ultimately made significant investments in) was businesses listed in Europe, with a revenue base that was largely global. In other words, these were companies that traded in Europe, though they did the majority of their business outside of Europe itself. In these situations, there was selling, even from investors not situated in Europe, due to fears about the Eurozone’s viability. Yet, these companies themselves were in a position where if the Euro actually collapsed, they were unlikely to be significantly impacted in a negative way. In other words, they were “Guilty by Association” with the currency in which their shares were priced.
Another example would be the hatred of muni bonds in today’s environment. This entire asset class is hated due to concerns about Detroit’s bankruptcy and Puerto Rico’s solvency woes. Because Detroit and Puerto Rico are municipalities, conventional investment wisdom beholds that municipal bonds in the general sense must therefore be in trouble. This kind of extrapolation is abundant and wrong.
Indexation impacts these areas because people who invest in broad-based ETFs or indices sell their exposure entirely, in order to avoid the perceived fear. In doing so, the selling of the basket forces mechanical selling of all the subsidiary components without consideration for which specific constituents are and are not impacted on a fundamental level by the fear. Thus, the good that gets thrown out with the bad and is “guilty by association.”
“I’ve got a Label, but I don’t Subscribe”
This is the micro twin of “guilty by association.” Since so much money is moving into ETFs, and ETFs are trading with all kinds of sector and niche labels, there is pressure to fit each and every company into some kind of cookie-cutter genre. These labels impact how analysts and investors alike think about specific companies. Stocks get assigned to analysts based on the “sector” they cover, and many investors invest in sectors or companies that are in accordance with a specific mandate. I had been planning a blog post for a while called “Beware of Labels,” but I think all of those points would better fit the context of this post. One of the biggest misnomers in today’s markets is the “technology” label.  Mr. Market today dumbs “technology” down to mean: a) any company that is on the Internet; and/or, b) any company that makes hardware.
In my opinion, there simply is no such thing as an Internet company. There are retail companies who operate on the Internet (and at this point is there a single retail company who doesn’t operate on the Internet?), there are B2B companies who use the Internet to offer their services, there are financial platforms who provide web-based platforms. To ascribe the label “Internet” to one company and not another is merely referential of the fact that some companies are old and some companies are new. And even that is an oversimplification, for there are older Internet companies that are still called as much, despite being more analogous to marketing companies. And yet somehow, all these various, wide-ranging businesses end up with the “Technology” label despite the fact that their differences are far more pronounced and abundant than their similarities.
In a perfect world, we would throw away the technology label and call these companies what they are, whether that be media, retail, etc., but this isn’t a perfect world and that creates opportunities for us investors seeking out inefficiencies. Heck the “Telecommunications” sector is somehow a sub-sector of “Technology” and includes a company as old as AT&T (though I am aware AT&T today was actually one of the Baby Bells who ended up swallowing Mama whole). The biggest impact labeling has is in how analysts model these companies and the types of investors who are drawn to (or pushed away from) different sectors. We all know how popular comparables analysis and that too gets incredibly misleading when similarities and differences are conflated with one another.
An example of this would be my investment experience with Google. Over the past few years, Mr. Market has called Google an “Internet stock” and a “one-trick-pony” at that. To that end, analysts and investors alike oversimplified in comparing Google only to other Internet stocks, and in a perceived battle against Apple, this same community viewed the company as out of its league (See GigaOM
, CBS News and HBR on the “one-trick-pony”). I took a different perspective: Google is more akin to a media company whose advantage lies in the infrastructure and distribution side. Wikipedia describes media as “the storage and transmission channels or tools used to store and deliver information or data.” This certainly seems like an apropos description of Google, and it’s more clearly reflective of who pays Google money at the end of the day–advertisers, much like how we think about “traditional” media. If you think about Google this way, and realize one of the company’s crucial advantages is in how it stores, aggregates, categorizes and distributes information, it’s clear that Google does and can do far more things than “just” search. YouTube is a natural fit in this type of company, more so than just an Internet or search company, and as such, it leverages the advantages of Google’s platform while also leaving open the opportunity for Google to naturally segue into other areas altogether. Within that context, Google looks far less like a one-trick-pony, YouTube’s valuation becomes increasingly important (see my writeup on the importance of YouTube), and the company is in fact more diverse and capable beyond “just” search.
Labeling is a human endeavor; something we do in many disparate fields. One of the most well-known is the biological taxonomy (I think every adult still remembers “King Phillip came over for good spaghetti”), which is an organizational hierarchy. While labels have always been used in stock markets, only now are they actual forces behind the mechanical allocation of capital. This is so due to the proliferation of ETFs and “indexation.” Even in biology, there are blurred lines between different species, etc. This is but one reason why we have seen a great increase in spin-offs: when some companies who are thought of and thus modeled “that” way, have a subsidiary that doesn’t fit the bigger mold, that subsidiary tends to be “underappreciated” by Mr. Market.
Market Inefficiencies
A lot of people, myself included, like ripping on the Efficient Market Hypothesis. This is certainly not without merit; however, as Marks emphatically argues, there is much truth and wisdom in the idea that market participants are in fact really good at incorporating known information into the price of securities. When we look to make investments, we must then do what Marks’ implies in another of his spectacular memos, by asking ourselves “what is the mistake that makes this a mispriced investment opportunity?” With these two examples based on the problems associated with Stahl’s “indexation” we have two areas in the abstract within which we can identify mistakes. To that end, we are lucky to live in this era of indexation for how it exposes the market to repeatedly and mistakenly misvalue companies.

Muddy Waters Turns Up Heat on Auditor PwC of Chinese Firm NQ Mobile

Muddy Waters Turns Up Heat on Auditor of Chinese Firm
By WILLIAM ALDEN
Carson C. Block has already issued a blistering critique of NQ Mobile, a Chinese mobile security company. Now, he is going after NQ Mobile’s auditor.
Mr. Block, the head of the Muddy Waters research firm, has sent a letter to senior executives of PricewaterhouseCoopers, urging the accounting giant to take a closer look at the books of NQ Mobile, which Mr. Block contends are a “massive fraud.”
If the accounting firm is prevented from doing so, then it should consider resigning as NQ Mobile’s auditor, Mr. Block wrote. The letter, dated Jan. 13, has not been previously reported.
“Any PwC partner who believes the value of the PwC brand is worth preserving should take heed of the experience of other firms operating in China,” Mr. Block said in the letter. “Further unqualified opinions for NQ will likely end in embarrassment and litigation against the firm and its partners.”
A spokesman for PricewaterhouseCoopers declined to comment.
The letter — addressed to Dennis M. Nally, the chairman of PricewaterhouseCoopers International; Raymund Chao, the audit and assurance leader in Beijing; and Robert E. Moritz, the chairman and senior partner of the accounting firm — is the latest move in a months-long campaign by Mr. Block, a short-seller known for harsh reports purporting to uncover fraud at Chinese companies.
A previous target of his, a Chinese forestry company called Sino-Forest, filed for bankruptcy less than a year after Mr. Block called it a “multibillion-dollar Ponzi scheme.”
Mr. Block fired his initial salvo against NQ Mobile in October, saying that the majority of its China security revenue in 2012 was “fictitious.” The report, which also raised questions about NQ Mobile’s international revenue, sent the company’s stock price falling by half.
Last month, Muddy Waters offered to pay an auditing firm to review the results of an investigation being conducted by NQ Mobile’s independent board committee.
The Chinese company has denied Mr. Block’s accusations. And it still has some friends on Wall Street. Altimeter Capital Management, a hedge fund based in Boston, said in a regulatory filing on Tuesday that it had increased its stake in NQ Mobile to about 17.3 percent.
Muddy Waters is “very concerned” about PricewaterhouseCoopers’s audit of NQ Mobile’s financial statements for 2013, Mr. Block said in the January letter, which urged the accounting firm to perform “additional tests and procedures in response to clear heightened fraud risk.”
“If NQ Mobile prevents PwC from obtaining sufficient appropriate evidence to evaluate whether illegal acts material to the financial statements have (or are likely to have) occurred, PwC should probably disclaim an opinion on the NQ financial statements,” Mr. Block said in the letter. “If NQ management refuses to accept a modified a PwC report, PwC should resign from the engagement, possibly withdraw its opinions on prior financial statements and warn investors on management’s representations.”
“If PwC is unable to determine whether the acts are illegal because NQ imposes limitations on its work or because PwC is unable to interpret applicable laws, regulations or surrounding facts,” the letter went on, “PwC may have to resign the NQ audit.”

What Are the Top Five Risks the World Faces in 2014?

What Are the Top Five Risks the World Faces in 2014?
Jan 17, 2014 Global Focus
Extreme weather events. Climate change. Cyber-attacks. Mounting rates of unemployment and under-employment. Growing income disparities. More than ever before, corporations and governments all around the globe are deeply concerned about enacting strategies that address and mitigate the sorts of occurrences that can cause significant negative impact for countries and industries for as long as ten years.
To address their concerns, the World Economic Forum (WEF), based in Davos, Switzerland, issued its “Global Risks 2014” report this week. Two of the report’s contributors — Howard Kunreuther, Wharton operations and information management professor and co-director of the school’s Risk Management and Decision Processes Center, and Erwann Michel-Kerjan, the center’s managing director — offered Knowledge@Wharton their assessments of the report’s major takeaways and the challenges that lie ahead for global risk managers.
Both Kunreuther and Michel-Kerjan are optimistic that the 2014 edition of the annually published report — titled, “Understanding Systemic Risks in a Changing Global Environment” — will contribute to a steadily growing understanding of global risks. “We have found that, because of a whole series of events that have happened in recent years, corporations are paying much more attention to issues of global risk and recognizing that risk management is something that they have to put on the table,” Kunreuther says. “From that vantage point, this report is something that [executives] have found very useful because it highlights not only what they may be thinking, but also what a [number] of experts around the world are thinking” across various disciplines.
Perhaps not surprisingly, perceptions about what constitutes a major risk have transformed rapidly in recent years. For example, the top five global risks identified in the 2014 Report are entirely different from the top five risks identified by executives, researchers and other experts who were surveyed in 2007, Kunreuther and Michel-Kerjan note. This year, the most likely five risks, ranked in descending order, were income disparity, extreme weather events, unemployment and underemployment, climate change and cyber-attacks. In 2007, the five systemic risks rated most likely were, in descending order, the breakdown of official information infrastructure, followed by chronic disease in developed countries, oil price shock, China’s economic hard landing and, finally, asset price collapse.
This year, the most likely five risks, ranked in descending order, were income disparity, extreme weather events, unemployment and underemployment, climate change and cyber-attacks.
When ranked in terms of their potential impact — rather than likelihood — the five highest-ranked risks for 2014 were also completely different from those identified by respondents in 2007. In 2014, the five most impactful risks were fiscal crises, followed by climate change, water crises, unemployment and under-employment, and critical information infrastructure breakdown. Not one of these five risks was ranked as having the most potential impact in 2007. The 2007 top-five list began with asset price collapse, followed by retrenchment from globalization, interstate and civil wars, pandemics and, finally, oil price shock.
According to Kunreuther, the disparity is “extremely interesting” because “it highlights one of the major challenges one faces as one begins to look at the likelihood and consequences” of various risks. On the likelihood side, there is the “broader challenge of short-term thinking and myopia” whenever a threatening event occurs, he says. At the time such events occur, there may be good reason to believe they will continue to have an impact, such as the prominence of an oil and gas price spike on the lists in 2008 and 2009. “It may be right that attention has to be paid [to these challenging events when they happen], but … over a period of time, as with asset price deflation, that [event] may not emerge as [a major risk] from the point of view of likelihood or even consequences.”
Other kinds of risks that may not always appear in the top-five lists are nevertheless widely recognized as “going to be around for a while” by experts despite their absence, Kunreuther adds. In 2011, climate change was ranked fifth for likelihood and second for impact, but dropped off the list entirely until 2014, when it re-emerged — in part because of the destructive power of Hurricane Sandy. “Climate change is recognized, in general, as a long-term problem, but it did not have a lot of salience in 2007 and 2010” in the absence of dramatic news events, he notes.
Connecting the Dots
The 2014 report also highlights the critical issue of global interdependency. It includes a “Global Risks 2014 Interconnections Map,” which demonstrates that “the numerous and complex interconnections between [risks] can create consequences that are disproportionate and difficult to predict.” The map attempts to connect the dots by identifying and visualizing the underlying patterns between various risks and effects. The goal is to understand the impact of systemic risks in order to mitigate them “by identifying the transmission channels between risks and potential second- and third-order effects.” Importantly, Kunreuther and Michel-Kerjan point out, these interconnections “do not represent direct casualty,” but are likely to represent indirect impact or mitigation trade-offs.
“Risks should not be considered in silos…. Just because you are an environmental [specialist], that doesn’t mean you should be unconcerned about fiscal issues.”–Erwann Michel-Kerjan
The report also distinguishes between the way male and female respondents view various risks. Studies show “that women are more likely to be concerned about environmental issues,” the report notes, while adding that “some argue this reflects a tendency for women to think more [about] the long term than men, and to have a more network-focused rather than linear approach to problem-solving.” Moreover, the report adds, “the younger generation” – identified as aged 30 or below – “is more concerned about the potential impact of global risks, while perceptions of likelihood show no such consistent deviation.” Younger individuals also responded that an oil-price shock, the loss of biodiversity and collapse of the ecosystem, and the occurrence of various natural catastrophes were “more likely” than did those respondents who were over 30 years of age. Younger individuals also considered such events “more impactful” if they were to occur.
For his part, Kunreuther notes that “interdependency and the challenges that we face with interdependency” are a major theme of the 2014 report. For example, he says, “climate change is a global risk – everyone has to pull their weight. [Addressing it] requires the global community to try to take some steps, but [we] also have some real challenges with respect to doing that.”
Michel-Kerjan points out that in the case of systemic risks, such as asset price collapses, “whether it started in the U.S. or in Asia, everyone will be interconnected.” He adds that the 2014 report is hardly the first to stress that “risks should not be considered in silos…. Just because you are an environmental [specialist], that doesn’t mean you should be unconcerned about fiscal issues.” However, he concedes that such behavior requires a significant change in mindset. Numerous other reports have called for people not to “think in silos, but that is hard to do. People love boxes,” he says.
Diverse Strategies
Every corporation has its own set of agendas, depending on what kinds of challenges it faces, notes Kunreuther. “They are going to treat this report differently because they focus on the things that are of concern to them. A company that might be involved in supply chain problems will think about interdependency in a very different way from a company that is more self-sufficient. There are companies associated with issues of carbon emissions, climate change and greenhouse gas reduction, for example, that are taking a leadership role in terms of [what] we should do” to address those risks.
Kunreuther adds that the 2014 report doesn’t “talk about exactly what these companies should be doing [to mitigate risks]…. It is not designed to be prescriptive.” Instead, it provides a high-level list of some of the strategies that companies have been pursuing, “guided by [the] firm’s risk appetite [and] the level of risk an organization is prepared to accept to achieve its objectives, such as profitability and safety goals,” according to the report.
According to the report, income inequality is “most likely to cause serious damage globally in the coming decade.” Kunreuther points out that the problem can’t be isolated: Developed as well as developing economies will need to take steps to deal with issues of income inequality and affordability. Because of the interconnected nature of the potential risks the report highlights, “firms are trying to take a much more forward-looking approach – and to develop long-term strategies for dealing with them, which they had not necessarily been doing five years ago,” Kunreuther says. “And so, we are more optimistic on two levels. First, we are hearing more about firms doing this. Second, we are also recognizing that – from other studies – firms want to be given some benchmarks as to how they could go forward.”

Biotech IPOs: What Entrepreneurs Can Learn from a Banner Year

Biotech IPOs: What Entrepreneurs Can Learn from a Banner Year
Jan 22, 2014 Health Economics North America
The data is in, and there is no question that 2013 was the most active year for biotechnology initial public offerings since 2000. During the 12 months ended in December, 38 biotech companies debuted on Wall Street, all but two of which were listed on the Nasdaq exchange, according to FactSet, a Norwalk, Conn.-based provider of financial analytics. The performance of the biotech class of 2013 was rather impressive: As a group, the shares of the newly public companies rose 43% through the end of the year.
Is it a biotech bubble? Or will investors continue to pour money into this exciting but still quite young industry? And what can managers of biotech companies learn about raising capital from the experiences of those who ventured onto the public markets last year? All important questions, to be sure — but challenging to answer in this industry, where disappointments are more common than successes, and the time between an idea for a new medicine and an actual product can be as long as 20 years.
“There’s a huge amount of real uncertainty about the likely performance of some of these companies — scientific uncertainty about whether drugs will pan out in [late-stage] trials and market uncertainty as to how the products will be accepted,” says Patricia Danzon, Wharton professor of health care management. “There have been past booms that have ended up being bubbles, but with these early-stage companies, we may not know until the drugs succeed or fail on the market.”
“There’s a huge amount of real uncertainty about the likely performance of some of these companies.” –Patricia Danzon
Danzon notes that one of the most surprising aspects of this biotech boom was that it came at a time when mergers and acquisitions in the life sciences industry — the other popular exit strategy for private investors in small companies — have been rather stagnant. Indeed, the volume of M&A deals in the third quarter of 2013 increased 10% over the previous quarter, but was down by the same amount as compared to the same quarter a year ago, according to a report released in November by PricewaterhouseCoopers.
“It seemed as if, on the one hand, big pharma was looking at these companies and choosing not to acquire, while public investors were willing to acquire them,” Danzon says. “That might suggest that public investors were being overly optimistic.”
Danzon adds that she wouldn’t be surprised if more biotech companies jump through the open IPO window in the coming months, because a public offering can be a much more attractive proposition than an acquisition, particularly in life sciences. “Given the high risks and the significant number of failures that have occurred, pharma tends to acquire now with a lot of payment contingencies,” such as valuations that are tied to the acquired company hitting certain research milestones, she says. “One can see this from the standpoint of the smaller companies. If the IPO window is open, they may choose to go that route rather than accept acquisition offers that have contingencies. The IPO is money you get now. For the investors, it’s probably a better exit.”
The Influence of M&A
Some biotech industry watchers are betting that the resurgence of biotech IPOs will actually re-awaken the appetite for M&A, says Stephen Sammut, a senior fellow in the health care management department at Wharton and a lecturer in the Wharton entrepreneurship program. That’s because publicly held companies are often more attractive bait for potential acquirers than are private biotech firms.
“Most of the biotech acquisitions occur after the companies have gone public,” says Sammut, who is also a partner at Burrill & Co., a San Francisco-based life sciences venture capital firm. “There are two principal reasons for that. The first is that, in most instances, companies don’t become targets for acquisition until their products are much further along in clinical development. The proceeds of the public offering may well allow a company to bring its products to [later stages] of clinical development and therefore be much more attractive to a multinational company for acquisition. The other factor is that it does give acquirers some comfort to know that they’re buying a company that has undergone the scrubbing process of an initial public offering and [Securities and Exchange Commission] filings for some period of time. That translates to risk mitigation on clinical development. They’re more than happy to pay a premium for such companies.”
What’s more, pharma companies are facing increasing pressure to produce growth, which has been hard to come by in recent years due to the loss of patent protection on such blockbuster drugs as Pfizer’s cholesterol pill Lipitor. That’s why many large companies are looking to smaller, more innovative biotech firms to fill their pipelines. Even large companies that are not yet facing patent expirations are showing a willingness to shell out huge sums for smaller innovators. For example, last summer, Amgen upped its offer to buy cancer drug maker Onyx Pharmaceuticals from $9.3 billion to $9.7 billion. Such deals — along with generally healthy balance sheets and access to capital among life sciences companies — prompted PricewaterhouseCoopers to predict that M&A will increase in the coming quarters.
Sammut expects that the appetite for biotech IPOs will also persist, even though there was a slight slowdown toward the end of the year: Only seven biotech firms went public in the fourth quarter, as compared to 15 in the second quarter. The factors driving this boom are quite different than they were in 2000, he says, and current conditions portend a continued enthusiasm for biotech.
“What happened in 2000 was there was an overflow phenomenon from the tech boom on the one hand and the tech burst on the other.” –Stephen Sammut
“What happened in 2000 was there was an overflow phenomenon from the tech boom on the one hand and the tech burst on the other. There was an overabundance of capital looking for opportunities,” Sammut says. “As 2000 wore on and the tech stocks were in free-fall, there was still capital searching for good opportunities, and it buoyed the IPO market.”
The 2000 biotech boom also coincided with the mapping of the human genome — a milestone that investors mistakenly assumed would lead to an immediate revolution in drug development. “That has not materialized,” Sammut notes.
Now, however, he points out, there are strong signs that the genomic revolution may be starting. In 2012, the FDA approved 39 novel drugs — the highest approval rate in 16 years. The agency green-lit another 27 in 2013. “A large proportion of those drugs were products of the biotechnology industry. That, I think, sounded a wake-up call,” according to Sammut. “Are we at last seeing the fruits of nearly 40 years of investing in biotechnology? We’re at least seeing the front end of that.”
The performance of the Nasdaq Biotechnology Index reflected some of the industry’s recent accomplishments, and likely encouraged managers of privately held companies to jump into the IPO market. The index had a 66% return in 2013 — its best performance in at least 10 years, says David Krein, managing director and head of index research at Nasdaq, adding that in 2012, the biotech index rose 32%. “The big run of IPOs was backloaded in the second half, but it really came after a two-plus year run on biotech stocks generally,” he notes.
Biotech also outperformed the health care industry as a whole. “The health care sector itself was up 42%. So even within health care, biotech was a leader,” Krein says. The Nasdaq US Benchmark Index — which reflects the broader market — was up about 33%, he adds.
Some of the new biotech offerings performed so well last year that they were added to the Nasdaq Biotech Index, including Epizyme, Agios Pharmaceuticals and Chimerix. Because the index serves as the basis for the iShares Nasdaq Biotechnology Index Fund, which is an exchange traded fund (ETF), any company added to it automatically gains access to a whole new group of individual investors. “The ETF market has become in aggregate quite significant in investor portfolios, so these index changes actually result in meaningful capital flows,” Krein says.
Weighing the Pros and Cons of the IPO
The ability to exploit favorable market conditions and gain access to new investors is one of the major advantages of going public, states Wharton finance professor Luke Taylor. But that alone should not drive the decision to go public, he adds. There are, in fact, at least as many cons to the IPO as there are pros, Taylor notes.
“As soon as a company gets enough good news, it should go public.” –Luke Taylor
“The cons are increased disclosure. You may not want your competitors seeing all your performance information,” he says. “If you’re public, you’re under a lot of pressure to produce short-term results, possibly at the expense of long-term results. There’s a lock-up period of roughly six months when the founders and VCs cannot sell their shares. And you do lose some control.”
Taylor has done research looking at all the factors that surround the decision about whether to go public. The bottom line: Entrepreneurs should ride the news cycle. “As soon as a company gets enough good news, it should go public,” Taylor says. Once a company has enough good news, he adds, the so-called diversification benefit of going public — the ability for the founder and other investors to take their money out of one company and spread it around — outweighs the benefits of staying private. The capital raised also gives the company the ability to accelerate clinical trials of lead drugs, and to take other projects off the back burner, he notes.
Biotech companies that went public in 2013 witnessed the effects of both good and bad news. Acceleron Pharma, for example, rose 164% from its September IPO through the end of the year, according to FactSet. Much of the gain came in December, when the company announced that it had advanced its anemia drug into mid-stage trials, prompting a $7 million milestone payment from its biotech partner, Celgene. On the other end of the stock-performance spectrum was Prosensa Holdings, which dropped 64% from its June debut. It didn’t help that shortly after the IPO, Prosensa announced that its experimental drug to treat Duchenne muscular dystrophy failed in a late-stage clinical trial.
One of the most important lessons the biotech industry will take away from the boom of 2013 will come from observing how the CEOs of the newly public companies manage their capital over the long run, Danzon says. “One of the facts about biotech is that oftentimes, the companies that do succeed have a strategy that is quite different from [what they intended initially],” she notes. “It’s as much betting on management as it is on the actual drugs. If the original strategy fails, there’s always the question

Dow Jones CEO’s abrupt exit throws strategy into doubt

Dow Jones CEO’s abrupt exit throws strategy into doubt
6:20am EST
By Jennifer Saba
NEW YORK (Reuters) – News Corp said Lex Fenwick was leaving as chief executive of Dow Jones, less than two years after taking the helm, an abrupt departure that calls into question the future of its news wires and other products aimed at financial institutions.
Rupert Murdoch’s News Corp, which owns Dow Jones, did not explain the departure but said it was reviewing the one-size-fits-all strategy Fenwick had put in place for its news wires and other products. The bundled product offering that resulted, known as DJX, alienated some of the banks, hedge funds and retail brokers that were its main customers because of its rigid pricing structure.
“We’re reviewing the institutional strategy of Dow Jones with an eye towards changes that will deliver even more value to its customers,” News Corp Chief Executive Robert Thomson said in a statement on Tuesday.
News Corp said that William Lewis will take over as interim CEO. Lewis worked at News Corp’s British newspaper unit and the Financial Times.
Fenwick, 54, was appointed CEO of Dow Jones – publisher of The Wall Street Journal – in February 2012 after more than two decades at Bloomberg LP and did not immediately respond to a request seeking comment.
He was seen by some as a controversial leader, known for his hard-charging style and expletive-laced outbursts, who was tasked with overhauling Dow Jones’ institutional business. Following his arrival, a significant number of senior executives left the company.
People familiar with Dow Jones said that Fenwick staked Dow Jones’ turnaround on a product that was supposed to challenge Bloomberg as one of the dominant suppliers of financial news and data. Known as DJX, it essentially pulled all of Dow Jones offerings like news database Factiva and the real-time news wires on a single platform for one price.
It was a risky move: customers were used to cherry-picking from Dow Jones’ lineup of products and negotiating on price – a matter where Fenwick was unbending, taking a page from his former employer, where refusing to discount has paid off.
Thomson was quoted in the statement as saying the media company was “planning improvements to DJX” and said greater flexibility in its product offerings was likely in the near term.
DJX was launched last year and had yet to gain traction in the marketplace. During News Corp’s past earnings reports, the company had flagged weakness at Dow Jones’ institutional division. Several financial customers expressed concern last year over plans for DJX – especially its higher cost, according to people familiar with the matter.
Like Bloomberg, Thomson Reuters competes with Dow Jones in providing news and financial data to banks and other financial institutions.
Known for his purple suits and taste for modern art, Fenwick imposed his flashy style on the more button-down atmosphere of Dow Jones. He tore down office walls to create an open floor plan, installed a low-hanging crystal chandelier, and provided pricey espresso machines that one person familiar with the matter said cost about $30,000.
Rob Copeland, a reporter at the Wall Street Journal quipped on Twitter after the news was announced: “.@newscorp CEO confirms: @WSJsnackbar coffee machines sticking around.”
Fenwick spent most of his career at Bloomberg, where he was known as a master salesman who rose to the top ranks to lead the financial news and data company. He was CEO of Bloomberg LP until 2008, when he was demoted to lead Bloomberg Ventures.
It is unclear if Lewis will eventually get the top job at Dow Jones where a search is underway. Some people familiar with the matter predict that Lewis will remain in the role. At a meeting where Thomson introduced Lewis to the newsroom, Thomson never used the word interim.
Lewis was recruited to lead News Corp’s management and standards committee in the wake of the phone hacking scandal from 2011 to 2012. He was named chief creative officer of News Corp last year when the company split from its cable TV and movie properties now under 21st Century Fox.

Davos bosses tread warily in rocky emerging markets; MNCs are becoming more picky about emerging market investments as slowing growth in upstart economies and a recovery in the West takes the shine off a previous sure-fire strategic bet

Davos bosses tread warily in rocky emerging markets
7:59pm EST
By Ben Hirschler
DAVOS, Switzerland (Reuters) – Multinational companies are becoming more picky about emerging market investments as slowing growth in upstart economies and a recovery in the West takes the shine off a previous sure-fire strategic bet.
Executives in Davos said they remained committed to tapping into rising middle classes from Shanghai to Lagos, but some are pulling back and redeploying resources in particularly difficult, low-margin regions.
“It was a gold rush. Now the gold rush is over,” said Jeff Joerres, chief executive of staffing company Manpower Group (MAN.N: Quote, Profile, Research, Stock Buzz), whose clients include many top international firms.
“In the past, regardless of industry and regardless of product, you just ran to those emerging markets because there was an arbitrage opportunity. Now there’s a much more sanguine decision-making process.”
The new mood follows a marked shift in the balance between the world’s main engines of economic growth that will see developed economies, led by the United States, regaining their role as the central driver of global output in 2014.
Emerging markets will still grow at a faster clip than developed markets this year but the difference in growth rates will be the lowest since 2002.
The World Bank last week raised its forecast for global growth for the first time in three years, to 3.2 percent in 2014 from 2.4 percent in 2013. But it cut forecasts for developing countries to 5.3 percent for 2014, from 5.6 percent predicted in June.
MIDLIFE CRISIS?
The balance between emerging and developed economies is a central topic at this week’s World Economic Forum annual meeting in the Swiss Alps, as highlighted by a session on Thursday entitled “BRICS in Midlife Crisis?”
Growth rates for Brazil, Russia, India and China are half their pre-financial crisis levels – and companies are taking a hard look at alternatives beyond the “big four”.
The Middle East and Indonesia were highlighted as hot-spots for online growth by Yahoo (YHOO.O: Quote,Profile, Research, Stock Buzz) CEO Marissa Mayer, while Marriott International (MAR.O: Quote, Profile,Research, Stock Buzz) boss Arne Sorenson said his group was opening a new hotel in Rwanda.
However, a top executive at a U.S. tech company, who did not want to be identified, said his firm was having an especially tough time in Brazil, with big uncertainties also in Russia, leading the company to look at deploying resources elsewhere.
In fact 60 percent of firms now expect to shift investment away from the BRICs towards other more rapidly growing markets, according to an Accenture survey of more than 1,000 executives.
“It’s getting tougher and more competitive and some companies will find that they haven’t got the right strategy in certain places,” said Mark Spelman, Accenture’s strategy head.
“There may be some that will pull out, but we will continue to see more investment at the same time.”
From autos to soap to whisky, multinational companies have been increasing their exposure to emerging markets dramatically in recent years.
Europe’s top 505 companies generated a third of their sales in emerging markets in 2013, or 2.8 times more than in 1997, according to Morgan Stanley. But the curve from here is set to flatten.
“You should expect that line to go sideways for a while, but I don’t think it will fall materially,” said Morgan Stanley strategist Graham Secker.
“Companies will perhaps focus a bit more on opportunities in developed markets – for example, a European chemical company might want to relocate some assets in the U.S. to take advantage of low energy costs.”
MEGA-CITIES
In a few cases, companies are heading for the exit or scrapping certain product lines in some emerging markets.
Cosmetics maker Revlon (REV.N: Quote, Profile, Research, Stock Buzz) said at the end of December it would leave China, where sales have been falling, and French rival L’Oreal (OREP.PA: Quote, Profile, Research,Stock Buzz) has stopped selling its Garnier beauty products in the country.
In India, too, difficult market conditions have prompted frustrated foreign companies in sectors ranging from telecoms to retail to curb their ambitions.
The majority of firms, however, view current weakness in emerging markets as a strategic hazard that will not seriously derail planning assumptions based on solid long-term demographics.
“Since emerging markets are developing day by day, sometimes they may go down and sometimes they may go up. We should not be so much influenced by short-term trends or phenomena,” said Toshiba (6502.T:Quote, Profile, Research, Stock Buzz) chairman Atsutoshi Nishida.
Consumer goods giant Unilever (ULVR.L: Quote, Profile, Research, Stock Buzz) (UNc.AS: Quote, Profile,Research, Stock Buzz), which now generates well over half its sales in emerging markets, also says it not going to be deflected by tough times in Brazil, India and Indonesia.
That approach makes sound sense in the eyes of Martin Sorrell, head of advertising agency WPP (WPP.L:Quote, Profile, Research, Stock Buzz), who is a long-term bull of emerging markets.
“Having emerging markets exposure was an advantage with analysts and financial markets a year ago and now it’s a disadvantage, which is ludicrous. Whatever happens, these markets are the future,” he said.
Indeed, a glance at the world’s biggest cities suggests international companies ignore the mega-trend towards developing nations at their peril.
Only one of the world’s 10 biggest conurbations now lies in North America or Europe, according to consultancy Demographia – and New York’s position at No.8 looks precarious given the far faster pace of growth of cities in Asia and Africa.