|KWR International Advisor #4
April 2000 Volume 2 Edition 2
Editor: Dr. Jonathan Lemco, Director and Senior Consultant
Deputy Editor: Dr. Scott B. MacDonald, Sr. Consultant
Publisher: Keith W. Rabin, President
Contributing Writers to this Edition: Jonathan Lemco, Scott B. MacDonald and Keith W. Rabin of KWR International, Peter M. Beck of the Korea Economic Institute
© 2000 KWR International, Inc. No reproduction is permitted without the express consent of KWR International, Inc.
Please forward all feedback, editorial, circulation and reproduction requests to KWRADVISOR@kwrintl.com.
TABLE OF CONTENTS
I. Volatility in The U.S. Stock Markets: Is It Time For Investors To Cut Their Losses?
II. India's Technological Revolution: A Primer
III. The Return of Hong Kong: Riding The New Economy
IV. Taiwan and China: A New Round In Cross-Straits Relations?
V. Reviewing President Kim's First Two Years: Building A New Economy
VI. Briefs: Russia United States
VII. Developing Effective Investment Promotion Programs
VIII. Book Review: Development and Democracy in The Southern Cone
Volatility in the U.S. Stock Markets: Is It Time For Investors To Cut Their Losses? by Jonathan Lemco and Scott B. MacDonald, KWR International
By any standard, the past two weeks have been periods of extraordinary volatility in the U.S. financial markets. We expect this volatility to continue for the foreseeable future, but do not think that prudent investors should lose faith.
We do not believe that investors should put new money into the beaten Nasdaq stocks, because many will have further to drop in the near term. But over the long term the largest and healthiest of the Nasdaq stocks will dominate their sectors and will prove to be good bets. In fact, in the next year or two, we think that there will be a massive shakeout among the "dot.com" stocks. A majority could fail or be bought out. If six months ago almost all of them had no trouble raising money, today it is most difficult to do so for a majority of them. After the expected shakeout however, the rich (Microsoft, Cisco Systems, Sun Microsystems, Yahoo, etc.) will inevitably get richer.
What prompted the current volatility? Many analysts have pointed to the newfound caution of such prominent Wall Street investment bulls as Abby Joseph Cohen of Goldman Sachs, Julian Robertson of Tiger Management and the legal decision against Microsoft. Mark Mobius of Templeton also weighed in with some caution on the international side. We think that these were all triggers for this week's stock market activity. But there are other factors as well. The U.S. Federal Reserve has been steadily raising interest rates this year, in part to slow the growth of equity values. Indeed, we suspect that there may be as many as three more interest rate increases of 25 basis points each before the end of the year.
But perhaps the most important reason is that there have been a flood of IPOs this year which have diverted investment funds. In the first three months of 2000, there have been 126 IPOs (with no sign of a letup yet). After the first three months of 1999, there had been only 69 IPOs. Furthermore, thus far in 2000 there have already been 166 "follow on" offerings compared to 102 at this time last year. In short, there have been more issues, more supply, in the U.S. marketplace. The expiration of many "lock-up" periods, which will allow inside investors to lock in on their paper profits has also increased the supply of internet-related equities onto the market.
Not surprisingly, many investors are receiving near-record numbers of margin calls. Between September 1999 to February 2000, margin debt was up 48% to $265.2 billion. Most of these funds are owed to online brokerage firms. As a consequence, we expect the Fed to move to raise margin requirements in the next few months, an action that was long in coming.
What should we expect in the next few weeks? First, investors should anticipate more volatility. And we may test new Nasdaq lows. Also, more funds will be transferred from the Nasdaq to the Dow and to the bond market. Furthermore, interest rate spreads on corporate bonds will continue to widen, at least in the next few days.
On the positive side, inflation should remain modest. Oil prices are beginning to stabilize and even fall slightly as OPEC increases supply. Also, wage growth has moderated. The money supply is back to 1998 levels. Furthermore, productivity is accelerating. In short, the short term outlook for inflation is good.
The uncertainty in the U.S. financial markets should continue for the next two weeks or so at a minimum. Investors would be well advised to hold tight, because the roller coaster ride is not over yet.
India's Technology Revolution: A Primer by Jonathan Lemco, Director and Senior Consultant, KWR International
In the past few years, India has emerged as a leader in the development and
manufacture of world-class computer software, internet, and telecommunication products. This has helped the nation to realize striking profits and substantial economic development in certain of its 40 states. India's software exports grew by 68% in 1998/99, totaling $2.65 billion. Furthermore, some $200 million of venture capital is currently available for Indian technology startups. We think that the Indian software industry is an attractive investment sight for the prudent investor. Of particular interest are projects involving wireless and internet technologies and services. Call centers and medical record transcription services are also good bets, owing to India's low-cost, technically proficient, English-speaking pool of skilled workers. All of India has not shared in this boom, however. Economic growth has been unevenly dispersed. Selected states in south and west of the country have benefited enormously from the technological revolution. But others have not and remain largely impoverished.
Over the past year, the Bombay stock exchange has been up more than 75%. The key drivers of this increase are software companies. In fact, India now possesses 3% of the global software market, and this number is growing dramatically. Software services account for just 1.3% of India's Gross Domestic Product. But the industry is growing more rapidly than any other in the country and is now an agent of profound corporate and economic change.
India's success in the high tech sector was no accident. Throughout the 1990s, large numbers of educated, relatively low wage, English speaking engineers gravitated to such IT centers as Bangalore, Bombay, Delhi, Madras, Hyderabad and Pune, where foreign and domestic investors had set up small software plants. Today, the Indian software industry employs an estimated 280,000 software engineers in about 1,000 companies. These workers are the best and the brightest graduates of India's elite universities and technology institutes. Many are now multi-millionaires. Indeed, as of September 1999, the market capitalization of India's Information Technology industry reached $24.3 billion, up from $13.6 billion just six months earlier. But none of this would have been possible if the Indian economy has not begun to emerge from a two year long recession.
In fact, over the past few months, industrial production growth has improved, housing starts are up, and the fiscally prudent BJP government appears to be stable. Analysts at Credit Suisse First Boston forecast an average growth rate of 7.5% over the next five years in India. The World Bank cautions, however, in its most recent report, that this goal will be achieved only if serious economic reforms continue to be implemented on both the National and State levels of government.
The BJP has pledged to triple foreign investment in India. In fact, the finance minister has stated that he hopes to attract $10 billion in foreign direct investment in each of the next five years. This is more than triple the annual average of the past decade. In recent months, onerous foreign-exchange controls have been removed and new laws have opened the insurance sector to foreign investors. The government has also promised to encourage competition in the banking industry in the near term. In addition, in March 2000, the government passed legislation relaxing the tax burden for foreign venture capital firms setting up in India. The National Association of Software and Service Companies (Nasscom) asserts that these measures could lead to extra inflows of $3 billion in the next 18 months, some 30-40% by non-resident Indians.
Serious problems remain of course. The senior public service remains painfully slow in implementing new legislation. Infrastructure is often poor, there is a lack of agricultural deregulation, and the national fiscal deficit continues to drive up the cost of capital. Regional economic inequality is pervasive. Also, six southern and western states have attracted most of the $18 billion in FDI that has come into India in the past decade. Many of the remaining states have made little progress.
As problematic as these issues are, the software industry has emerged largely unscathed. As a new economic sector, it is relatively free of state involvement. In the absence of a stifling national or state bureaucracy, software entrepreneurs are succeeding against global competition. Today, India's information technology industry is characterized by strong exports, professional management, and top technical talent. Infosys, the first Indian software company to list on the U.S.-based Nasdaq exchange, has seen its share price soar. It is now in the Nasdaq top twenty. In October 1999, Satyam Infoway, one of India's new internet service providers, became the second company to list on the Nasdaq. Others, including internet portal Rediff.com and Zee Telefilms are poised to follow and Nasdaq recently announced that it will open up a representative office in India to facilitate future listings. Furthermore, such prominent western firms as Cisco, Microsoft, Texas Instruments, Oracle, Siemens, and SAP are recruiting Indian engineers for their research and development centers in India.
The rapid success of the Indian software industry has been remarkable. But the industry remains in its infancy. Fewer than three million Indian households own a personal computer, out of a population of over one billion. Furthermore, there are just 350,000 internet connections in India, but it is estimated that there are four internet users for every connection. Undoubtedly, internet usage will increase when cable TV access is increased in India. Currently, twenty million Indian homes have cable service. In fact, several international companies including the UK-based WorldTel have negotiated or are negotiating with various Indian state governments to set up community internet cafes.
We expect this trend to continue. In fact, there is every evidence that India's export-led software development industry has made it the model to emulate for the modernization of India's otherwise lackluster economy. Indian IT products are inexpensive by world standards. But they also stand out on the basis of quality, speed, reliability, and innovation.
The central government and almost all of India's forty state governments have created an IT development policy, including steps to encourage the use of computers in government. Ten years ago, few observers would have predicted that the Indian economy could have been transformed in this fashion. India has very far to go of course, to eliminate its widespread poverty, and to promote widespread economic development. But it has taken a major step in the right direction by nurturing its IT industry. In this sphere at least, it is a world-class competitor.
The Return of Hong Kong: Riding the New Economy? By Scott B. MacDonald, Senior Consultant, KWR International
Hong Kong is recovering from the 1997-98 Asian economic crisis. While this is good news worth cheering about, the city faces tough challenges. In particular, will Hong Kong be able to develop the "new economy", a development needed to sustain the current recovery and guarantee a competitive future? The answer is probably yes, but the path will be marked with a high degree of volatility both in financial markets and in society. For anyone wishing to invest in Hong Kong, the beginnings of the new economy will offer tremendous opportunities in the stock market (through ADRs), though an awareness of risks is essential.
The 1997-98 Asian economic crisis hit the Special Administrative Region (SAR) of Hong Kong hard. With the ceremonies from the city's handover from the United Kingdom to the People's Republic of China hardly over, Hong Kong was pummeled by a loss of confidence and a sharp decline in economic activity caused by the rest of Asia's crisis. Both the banking and property sectors, key elements of the economy, suffered, prompting the government to intervene in the stock market in August 1998. The massive buying of stocks was geared to support a stock market that threatened to collapse. Even the neighboring Chinese economy, which avoided much of the so-called Asian contagion, slowed as it grappled with strong deflationary forces. The combination of these negative factors put the Hong Kong dollar, based on its currency board and peg to the U.S. dollar, under massive pressure to devalue.
After a dismal 5.1% contraction in economic activity in 1998, Hong Kong is making a sustained comeback. Real GDP growth was 2.9% in 1999 and 4%-5% growth is expected for 2000. In contrast to much of Asia, the banking sector staved off collapse, with non-performing loans stabilizing at around 10% of assets. In late November 1999, the Hong Kong government successfully launched the Tracker Fund, a listed investment vehicle linked to the Hang Seng Index, as a first phase to reduce the equities they had purchased in the 1998 intervention. The HK dollar, once expected to suffer the fate of the Thai baht, Indonesian rupiah and Korean won, remained pegged to the dollar.
For Chief Executive Tung Chee-Hwa the upswing in the economy is a sweet victory in what has been an unexpectedly difficult tenure. Initial expectations in 1997 with the Chinese takeover had been that the economy would continue to expand at a comfortable rate and that political concerns would probably be the primary concern. The reality has proven to the reverse. Although political issues, such as the authority of the legislative body, human rights and the role of China remain important factors in the SAR's daily life and political discussions, the economy has overshadowed everything else. Moreover, the overriding nature of economic issues is not likely to go away anytime soon.
Unemployment remains high (at 6.1% at year-end 1999), the recovery is not broad-based, and questions continue to nag about the SAR's future economic foundations. The old manufactured base of the economy has long since packed up and moved north into the mainland, while Hong Kong's role as a regional financial center is challenged by old-time rival Singapore and increasingly by Shanghai, which can offer cheaper real estate and an improving infrastructure. An additional point of concern is China's entry into the WTO. This will force Hong Kong to reconsider how best to position itself to the ever-opening mainland economy.
Hong Kong, with a population of 7 million, also faces a challenge in its capacity to handle the inflow of migrants from China and elsewhere. Without some type of controls, Hong Kong's population is expected to swell to 8.3 million by 2010, a greater than 20% increase. This threatens to overwhelm an urban center that is reaching its natural and economic limits in accommodating its population. This situation could also have an impact on Hong Kong's ability to compete with less densely populated rival, Singapore. Singapore has gone to great lengths to control both its own population increases as well as controlling the inflow of foreigners. As the Far Eastern Economic Review (March 9, 2000) noted: "That difference could prove decisive as the New Economy puts a higher premium on the ability of cities to offer a clean and pleasant living environment. Hong Kong, already one of the world's most polluted and densely packed cities, could lose out to Singapore in the effort to be the most cosmopolitan city in the region."
Many of these concerns were reflected in the March 2000 budget presentation by Financial Secretary Donald Tsang Yam-kuen. The key points of discussion about and in the presentation of the 2000-01 budget were the economy's turnaround, an improvement in public finances and no new taxes. The financial secretary announced that the economy is expected to expand by 5% in 2000, while the budget deficit came in at HK$1.6 billion
at the end of fiscal year 1999-2000, well below the projected HK$36.5 billion deficit. The improvement is based on an increase in revenues, largely due to gains on the government's investment portfolio -- something not excepted to be repeated in the upcoming fiscal year. The proposed budget also contained new targets to control the number of civil servants. The total number of posts will be reduced by 10,000 or about 5%, in the next three years, back to the 1995 level.
The new budget is growth-oriented. At the same time, Financial Secretary Tsang emphasized that Hong Kong needs to move toward a broader tax base, noting that in fiscal year 1998-99, for the first time in half a century, Hong Kong had begun to experience deficits at the operating level. Consequently, the government faces pressure to raise revenues. With no general income tax, the government's revenues are heavily dependent on property related revenue. Furthermore, only a small part of the population pays the maximum rate of 15% tax on salaries, while more than 60% of the working population pay little or nothing. The need to broaden the tax base will have to be balanced with the need to spend more on education and the environment, two items essential to maintain a competitive soft infrastructure necessary for the new economy.
While the debate has opened up about the need to broaden the tax base, the private sector is shifting gears to the new economy. This was evident on March 1, 2000, when one of the first public forays into the internet caused a considerable stir in the local stock market. Billionaire Li Ka-shing issued shares of his tom.com, a Chinese-language internet portal. Tom.com is billed to be Asia's answer to AOL-Time Warner, a portal, initially in Chinese and later multilingual, for China-related news, entertainment and educational information. The IPO was nearly 670 times oversubscribed and the issue price shot up from HK$1.78 (23 U.S. cents) a share to HK$9.05 (U.S.$1.16) in the first hours of trading. Considering the lines of would-be investors who were turned away with nothing, no-one seemed to care that the portal is still under construction.
Hong Kong was also stirred in February 2000 when Pacific Century CyberWorks (PCCW), Asia's third largest internet investment company, made a successful takeover bid for Cable & Wireless HKT. The drama was even greater as CyberWorks beat out Singapore Telecommunications (SingTel), which was interested in Cable & Wireless HKT. CyberWorks had a market value of $26 billion at the time, making it larger than that of Amazon.com.
Hong Kong has a number of other new internet and internet-related stocks, some of which are available through ADRs. These include I-Cable (ICAB), Hong Kong Telecom and China.com (CHINA). I-Cable is a unit of blue-chip conglomerate Wharf Holdings and is the city's only pay television provider and an internet access and content provider. It operates Hong Kong's largest broadband network and plans to diversify into telephony.
The trend for Hong Kong's major companies to plug into the internet and the new economy is likely to continue to gain in momentum. Sun Hung Kai Properties, a major real estate company, has announced plans to spin off its internet infrastructure and services arm, SUNeVision, with a HK$3 billion IPO. Discussions are underway with a number of other large Hong Kong blue chips, concerned about being left behind.
While the excitement vis-Ã-vis internet stocks is taking off in Hong Kong, the government is also pro-active in helping to develop a support system for the new economy. The SAR administration has already launched the Growth Enterprise Market (GEM), which functions like the NASDAQ, and will launch sometime in the year the fully automatic exchange trading system AMS3, which allows online trading. The government will also be launching the eIRC (electronic Investor Resources Centre), which will bring investor education to the public. Reinforcing these actions, Andrew Sheng, Chairman of the Securities and Futures Commission stated: "The potential of the new economy is huge and Hong Kong should be in the forefront of that growth."
Another development that the government has promoted, which is reinforced by the internet, is greater transparency and disclosure. To strengthen the sanctions against false or misleading information, there is now a bill before the Legislative Council that creates offences for anyone who provides the Securities and Futures Commission and the recognized exchanges and clearing houses false or misleading information. The Composite Bill, which will be published for public discussion in April and is expected to be put into the Legislative Council before the end of the year, will contain a number of provisions aimed at strengthening corporate disclosure. As Sheng stated in March 2000: "Our legal framework has to ensure that issuers and management do not provide bad or misleading information."
Hong Kong remains one of the most advanced economies in Asia. For it to remain that way it will have to fully embrace the internet and related technologies that allow it to make the most competitive use of its human capital. This, however, poses difficult challenges in terms of dealing with such issues as population control, broadening the revenue base, and cleaning up the environment -- all issues that include consultation and politicking within the Legislative Council and with the SAR's counterparts in the People's Republic of China. And concerns have already been raised that since the Chinese takeover there has been an erosion in the rule of law. Yet, success has its monetary rewards, something that the both the private and public sectors in Hong Kong and China can appreciate. With the trend toward greater numbers of new economy companies setting up shop, issuing shares on the GEM, and plugging Hong Kong into the global grid, prospects for the territory's future economic development might have made a giant step forward. Only time will tell.
Taiwan and China: A New Round in Cross-Straits Relations?
By Scott B. MacDonald, Senior Consultant, KWR International
For anyone looking for peace and calm in Asia, the recent presidential elections in Taiwan augur, at least in the short term, greater tensions between Taipei's new leadership and Beijing. At the same time, the elections were a watershed event in Taiwan's political development, with the opposition defeating a long-entrenched ruling party. Although many questions now exist about how Chen will govern with a minority holding of seats in the Legislative Yuan, our medium-term outlook for Taiwan remains relatively positive. That view is supported by the existence of a sophisticated private sector, $110 billion in foreign exchange reserves and a government with net public assets of 14% of GDP. Moreover, we do not believe that either Taiwan or China wants a military confrontation that would most likely drag in the United States.
The old issue of Taiwan's status vis-Ã-vis mainland China has taken a new direction as the opposition candidate of the Democratic Progressive Party (DPP), Chen Shui-bian, won a close contest with 39% of the total vote. He defeated James Sung, an independent candidate who left the ruling Kuomintang (Nationalist) Party KMT), with 37% of the vote and Lien Chan, the Nationalist candidate and Vice President in the outgoing KMT government, with 23% of the vote. Both the government in Beijing and the Nationalists had strongly suggested that if Chen were to win, a slide towards military conflict was inevitable. With Chen victorious, both Beijing and the Nationalists have had to reconsider their positions. It would appear that everyone is waiting for President-elect Chen to set the tone of the next stage in relations between Taiwan's prosperous and democratic state and China's not-as-prosperous and authoritarian regime.
Although we expect a higher degree of rhetoric coming from China's leadership and a willingness to demonstrate its military fangs, we also anticipate that President-elect Chen will react in a moderate fashion to contain tensions. A recent example of China's anger is its heated rhetoric concerning the apparent pro-independence stance of Taiwan's Vice President-elect. Despite this heated rhetoric, President-elect Chen has invited PRC Premier Zhu Rongji to Taipei for consultations. Even during the campaign, he carefully moved away from the hard stance on declaring independence that he had earlier embraced. The president-elect is well aware of what the stakes are if he moves in a direction that is regarded as blatantly antagonistic to his counterparts in Beijing. He also stated after the election that he will seek to improve relations with China through direct transport links and has reiterated that he will not try to change Taiwan's constitution to assert its independence.
Chen is 49-years of age, holds a law degree from Taiwan National University, and has been in politics for a number of years, including a term as mayor of Taipei. He also served a term of prison for his political beliefs during an earlier period, prior to Taiwan's political liberalization. The party he presides over, the DPP, was established in 1986 and until recently advocated independence from China. However, in the December 1998 parliamentary elections, the DPP lost ground with voters. It was felt that voters were concerned that an outright declaration of independence would result in a Chinese invasion. Since that electoral contest, the DPP toned down its stance and has sought to present a more flexible view on the matter, though not entirely surrendering its long-term goal of independence.
While China has no interest in making life for Chen easy, it also has no interest in goading the incoming government into taking a harder stance. Despite the Chinese line that it will invade in response to any declaration of independence, the military, political and economic costs of such an action would be high. China does not want to jeopardize its chances of entering the WTO and obtaining permanent normal trading rights with the United States (which is now under discussion in the U.S. Congress). Moreover, it is questionable whether the Chinese military is up to the task of launching a successful invasion. In the worse case, such a conflict would be damaging to both China's and Taiwan's economies and leave President Jiang Zemin's government in Beijing in an unstable political position. Potential political instability in China would, in turn, not be good for Asia's stock markets.
There are analysts that believe that the next four years will witness a higher degree of tension in cross-straits relations after Chen becomes president on May 20, 2000. As Professor Andrew Nathan of Columbia University noted: "The Chinese simply don't trust Chen Shui-bian. They think his ultimate goal is to cheat China." While we believe the potential for greater tensions clearly exists, we also note that Chen is going to be hard-pressed at home. As Standard & Poor's commented (March 20, 2000): "The new, inexperienced cabinet faces an uphill struggle as it takes on a half-century old parliamentary and governmental machinery, established by, and well oiled under, the KMT, to fight corruption and break apart the old KMT business nexus. The DPP only holds 70 out of the 225-seat parliament, or Legislative Yuan while the KMT holds an 11-seat majority in name." This situation puts pressure on Chen the DPP to form a coalition, possibly with those ex-KMT members who left the party with James Soong, who ran a competitive presidential campaign.
Taiwan has made considerable strides in its economic and political development since the 1980s. The process of creating a more open and liberal society, based on strong capitalist foundations will continue. The potential threat from China will remain just that - a potential threat, especially if the incoming Chen DPP administration carefully plays its hand and does not opt for a declaration of independence. A conciliatory Taiwan will also make it difficult for China to ramp up the rhetoric and slip back to making bald military threats. The March 20, 2000 decision of Taiwan's parliament to drop a five-year ban on direct trade, transport and postal links to mainland China, opening limited exchanges between offshore islands and Chinese cities is perhaps a signal that the next round of cross-straits relations could be a vast improvement on current expectations.
Reviewing President Kim's First Two Years: Building A New Economy By Peter M. Beck, Director of Research and Academic Affairs, Korea Economic Institute of America
(This article was originally published on February 24, 2000 by the Korea Times)
When Kim Dae-jung narrowly won the presidential election in December, 1997, he inherited an economy in tatters. Battered by the economic upheavals that swept across Asia in the summer and fall of 1997, Korea teetered on the edge of default and her proud economic Mandarins were forced to go to the IMF with cup in hand. The ``Miracle on the Han River'' seemed to evaporate overnight. The loan package arranged by the IMF in late November initially failed to stop the economic hemorrhaging, and then-presidential candidate Kim Dae-jung briefly questioned the conditions attached to the IMF loans. However, upon his election, Kim quickly recognized the importance of the IMF agreement in restoring Korea's economic health. Koreans received a hint of the type of leader they had elected when Kim effectively took the reins of government two months before his inauguration. The situation was too grave to wait on. Korea was experiencing its most severe economic contraction in more than four decades.
Given the severity of the downturn, Korea's economic recovery over the past year has been nothing short of spectacular, and the Kim administration rightfully deserves much of the credit. Despite a press that constantly referred to the ``IMF hanpa'' (cold wave) and ``IMF cheje'' (regime), President Kim helped remind Koreans that the economic crisis was home grown: Indiscriminate lending by Korea's banks to the chaebol (conglomerates) led to reckless investment decisions and a string of bankruptcies in 1997. When the economic crisis hit Southeast Asia, foreign banks and investors began to see Korea's vulnerabilities in a new light, which eventually led to panic. Thus, the first task of the Kim administration was restoring investor confidence. The administration held a series of intensive meetings with foreign creditors and quickly succeeded in rescheduling one-quarter of Korea's short-term liabilities. The successful launch of a sovereign bond issue in New York two months later confirmed that the stabilization package was taking hold.
The Kim administration also recognized that the key to restoring Korea's economic vitality was addressing the vulnerabilities that led to the crisis in the first place. The government launched a series of sweeping reforms of the financial and corporate sectors and adopted a proactive foreign investment policy. Scores of banks were closed, merged or taken over by the government, and 64 billion won was earmarked for recapitalization of the surviving banks. The chaebol were pressured to lower their perilously high debt-equity ratios and establish greater corporate transparency and accountability. In undertaking reform, the government has faced a dilemma. On the one hand, the government has declared the invisible hand of the market rather than the visible hand of the government to be the guiding principle for the Korean economy. On the other, the government's sometimes heavy-handed approach to financial and corporate reform suggests that it has merely gone from picking the winners to picking the losers.
Foreign direct investment, instead of being seen as a threat to Korea's sovereignty, is now viewed as vital to the financial and corporate reform process. Foreign investment can help firms lower not only their debt-to-equity ratios and secure a more stable and long-term form of investment, but they can also acquire new technologies and managerial practices. Phillips Electronics, Goldman Sachs, Hewlett Packard and Qualcomm are just a few of the companies that have made significant investments in Korea -- a clear vote in favor of Korea's long term economic prospects.
Foreign analysts generally agree that Korea's turnaround has been truly impressive. The numbers speak for themselves: After shrinking by 5.8 percent in 1998, the economy roared back in 1999, posting a better than 10 percent growth rate. What began as a technical rebound and fiscal stimulus-led growth gradually evolved into a robust recovery. Exports also recovered, with semiconductors, automobiles, liquid crystal displays and mobile phones leading the way. Foreign investment during 1998 and 1999 exceeded that of the cumulative total for the previous 40 years. Foreign exchange reserves went from a perilously low $3.9 billion in December, 1997 to $74.0 billion at the end of 1999, nearly double Korea's short- term external liabilities. The exchange rate has strengthened to the point of actually causing concern about eroding Korea's international competitiveness (which has already been in decline since the early 1990s), and unemployment has come down from the highs of a year ago, though it has risen again recently. Despite worries of a second economic crisis in the wake of Daewoo's implosion in July 1999, the economic recovery remained on track.
In spite of the sharp downturn, labor unrest has failed to materialize for the most part, defying the expectations of most foreign analysts. This reflects the fact Kim Dae-jung came into office with labor's support and trust. While the disparity between rich and poor has widened (although still much better than that of the United States), the Kim administration has aggressively expanded the social safety net without exploding the government's budget deficit.
The chaebol have rightly received the brunt of the blame for leaving the Korean economy vulnerable to crisis, but it does not logically follow that they should be broken up. Rather, the chaebol must focus on their core competencies. For example, the economic rationale for building the Samsung automobile plant in Pusan was highly dubious, but Samsung Electronics will continue to be one of the engines of growth for the Korean economy and a world leader for key high-tech goods. Samsung and others gambled correctly that CDMA (code division multiple access) would become the global standard for wireless telecommunications. The ``big deals'' pushed by the government are at best an intermediate step in the corporate restructuring process. Besides leading to increased market concentration, the business swaps undertaken to date have not led to significant capacity or debt reduction.
Daewoo's implosion sends a clear signal that no company is ``too big to fail.'' Former Daewoo chairman Kim Woo-choong displayed the ultimate hubris: Rather than trim down his far-flung corporate empire, Kim instead undertook an expansionary business plan and raised Daewoo's indebtedness to an unsustainable level. Foreign analysts are carefully watching to see how the company is liquidated and the role foreign companies play in the process. Several international auto makers are currently vying for Daewoo Motors. The temptation may be great to try and keep Daewoo Motors in domestic hands, but Hyundai already controls 70 percent of the domestic market and the auto industry would benefit greatly from a capital, technology and management infusion if Daewoo were sold to a foreign auto maker.
A number of the smaller chaebol (6-64) have entered into workouts with their creditors, but little actual progress has been made to date. Most chaebol have lowered their debt-to-equity ratios, but there is still a long way to go. The bulk of the declines to date have been a result of questionable asset revaluations and equity issues rather than the actual reduction of debt burdens. One real sign of progress will be when the chaebol release consolidated financial statements, giving investors and creditors a clearer picture of a conglomerate's overall financial condition. Ultimately, the chaebol must adopt professional management, but, as the Daewoo case shows, few founding families are prepared to depart willingly.
Small and medium-sized firms are also vital to Korea's economic future. Companies like Daum Communications and Serome Technology are mastering the global information technology market. Investors are increasingly recognizing this transformation as reflected by the shift in stock ownership from the blue chip KOSPI companies to the hi-tech startup-heavy KOSDAQ.
While most observers admire Korea's rapid recovery and the determination of President Kim to build a new economy, many remain skeptical about the chaebols' commitment to restructuring. Much remains to be done in the financial sector as well. Banks will require a second major capital infusion. Many remain saddled with nonperforming loans and have yet to mark to market. With the nationalization of several banks, the government must now devise an effective exit strategy. Korea First Bank was finally sold to Newbridge Capital after a year of negotiations, but the deal between Seoul Bank and HSBC fell through. Ironically, of the two deals, the proposed HSBC-Seoul Bank merger was widely viewed as being more beneficial to the Korean banking sector as HSBC was considered a long-term market player and Newbridge a quick return-oriented institution.
Non-bank financial institutions (NBFIs), like the investment trust companies, will also require government attention sooner rather than later, but likely not until after the April 13 elections. Ultimately, NBFIs should be subject to government supervision. More broadly, banks and NBFIs alike must improve their credit analysis and lending practices. This process has only just begun and will take considerable time.
Finally, Korea's external environment remains uncertain. A sharp downturn in the economies of one or more of Korea's leading trade partners could dampen Korea's recovery. Japan's economy remains anemic and shows signs of reentering recession; China faces the difficult task of industrial restructuring; and the record economic expansion in the United States cannot last forever. Moreover, world oil prices have tripled in the past year.
President Kim correctly saw the economic crisis as an opportunity to lay the foundations for a new economy, one that is a dynamic mix of large and smaller firms, and information technology-based. The Kim administration has advanced the reform process further than any previous government, authoritarian or democratic, but much remains to be done. One of the true measures of success will be when Korea is able to improve its international competitiveness. Nevertheless, I am reminded of the old Korean proverb, ``Shijaki banida'' -- beginning is half the job.
* * *
Peter M. Beck is the Director of Research and Academic Affairs at the Korea
Economic Institute of America in Washington, D.C. He can be reached by e-mail at email@example.com.
BRIEFS by Jonathan Lemco, Director and Senior Consultant, KWR International
On March 26, Vladimir Putin was elected President of Russia with an absolute majority of the vote. From an investor's perspective, what might we expect of Boris Yeltsin's handpicked successor?
>From all reports, Putin is not an ideologue, but rather a pragmatist focused on holding power for its own sake. Until fairly recently, Putin operated behind the scenes in a variety of government posts, perhaps most notably the KGB. He appears to be a canny political actor, able to survive and even to thrive within the state apparatus. Obviously, the new President has chosen his allies well. Furthermore, as one of the strongest advocates of the government's hard line strategy in the Chechen Republic, Putin is clearly in sync with the public mood.
The Russian economy is in tatters, and Putin will be judged on his ability to promote growth. In a manifesto published in December, he acknowledged that radical steps were needed to get the economy back of track. In fact, Putin promised to promote a growth rate of 8-10% within a few years-a very tall order given that Russia has had almost no growth in twenty years (with 1999 a notable exception). Key to this increase would be foreign investment, which reached a peak of $6 billion in 1997-a very small amount given Russia's tremendous needs and its potential.
Overall investment in the Russian economy was 14.7% of GDP in 1999. This compares unfavorably to 40% of GDP investment levels in China, Malaysia, and Thailand, all of which had also been in economic slumps.
President Putin's first important task to revive the economy will be to appoint a savvy and competent cabinet. He must also convince investors that he can enforce the rule of law in the country, such that all economic players are treated fairly. This will be no easy task, given the high level of corruption within the bureaucracy. Some analysts suggest that Putin must take quick action to eliminate the influence of the so-called "oligarchs" who have an inordinate degree of power in Russian public life. To many, they seem to be above the law. If Putin is able to cut them down to size, his credibility will be further enhanced. But the oligarchs are powerful and rich and will not be easily displaced.
There are other problems as well. For example, to a significant degree the economy is de-monetised. A recent OECD survey of Russia revealed that non-cash receipts at 200 industrial companies peaked at over 50% of the total in August 1998, before falling to 43% in April 1999. For 2000 large enterprises and natural monopolies, the share of non-cash receipts was more than 50% in early 1999. So this is a barter economy in large part. Non-cash transactions are used to hide subsidies, especially to energy. And of course, the ultimate goal is to avoid paying taxes. Putin will be asked to increase national revenues for several reasons. One of the most important will be so that he can pay public servants enough to reduce their incentives to take bribes.
President Putin does enjoy a few advantages, however, as he begins his term. For the time being, he will enjoy a brief political honeymoon to put forward tough new policies. Furthermore, it is hoped that Russian policymakers will have learned what not to do to achieve sustainable growth. The lessons of the 1998 financial collapse are not likely to be forgotten soon. Furthermore, there is slowly emerging a new generation of western-influenced leaders in the public and private sectors to replace the Soviet old guard.
But there is much work to be done, and the window of opportunity for Putin might slam shut at the first major setback. International investors will watch closely Putin's choice for Prime Minister. They will pay careful attention to whether he can successfully implement a new tax code and a land law. Popular expectations of the new president are high, and if he does not deliver some hint of improvement soon, his political opposition on the left and the right will be poised to take full advantage and stifle his reform agenda. The critical time for ambitious change is now.
The two contenders for the U.S. Presidential election in November are now set. Vice President Al Gore will win the Democratic nomination, and Governor George Bush of Texas will win the Republican one.
Gore is proving himself a canny politician. He has just retreated from the Clinton Administration position on the Elian Gonzalez case, by asserting that the boy might be allowed to stay with his relatives in Florida rather than be returned to his father in Cuba. (In contrast, the U.S. government has taken the position that the father and son should be reunited.) Throughout this presidential campaign, Gore has taken what some analysts believe is the expedient vote-getting position, rather than ones that might be closer to his political convictions. Vice President Gore has stressed that a priority of his administration would be campaign finance reform, a policy that was the centerpiece of defeated Republican candidate John McCain's campaign. Clearly, Gore is taking this position to attract McCain supporters, who were often political independents. Surveys reveal that the race with George Bush would be close, but that Gore has a small advantage at present. This may be due in large part to the fact that the Clinton administration has been in government at a time of extraordinary national prosperity and economic growth. Gore will be quick to claim some credit for that.
Governor Bush has emerged as the frontrunner for the Republican nomination, but one might be hard-pressed to identify too many issues that he cares deeply about. This is probably a good thing for his candidacy, because if he adheres too closely to the socially conservative wing of his party, he will lose the presidential election. Bush faces a real problem however, in that the issues that Americans care most about right now-health care and education- are issues that are tied most closely to the Democratic Party. The Republicans are coming to this debate late.
>From an investor perspective, both Gore and Bush are strong proponents of freer trade, although either would be hampered by a congress that is less than enthusiastic about passing new free trade agreements at present. Both candidates distance themselves from the isolationist factions within their respective parties and instead favor active foreign policies, although Gore's grasp of foreign policy issues is more impressive. Both candidates are pragmatic and driven by polls, which is not surprising given the many strands of thinking that are represented in their respective coalitions. The race has far to run before it is all settled on November 7.
Developing Effective Investment Programs By Keith W. Rabin, President, KWR International
(The following article was originally published in the March 2000 edition of International Relations, a monthly magazine published by the Korea Local Government Authorities Foundation for International Relations. While it is directed toward local Korean government officials, the points raised are equally applicable to any government agency or private sector firm or institution that is seeking to attract the attention and capital of global investors or to otherwise communicate its interests and objectives to targeted constituencies in the U.S. and other international markets.)
Over the past five years, Korea's national government has moved to decentralize and empower its provinces and municipalities -- providing unprecedented opportunities for control on the local level -- yet creating new and demanding responsibilities. The post "IMF" era has accelerated this trend and government organizations now find themselves challenged by the need to access the foreign investment and technical knowledge required to maintain and enhance their long-term competitiveness and economic viability.
Reacting to this imperative, many national, provincial and municipal agencies have organized "road show" expeditions to foreign cities. Political leaders, bureaucrats, corporate executives and project representatives travel long distances to meet briefly with potential investors and corporate partners. To date, these often costly exercises have produced mixed results, leading many to question whether these efforts can achieve the results needed to justify the investment.
The inability of these events to generate meaningful progress by themselves should not be surprising. If a U.S. firm or municipality were seeking to develop a presence in Korea, one would not imagine that they would gain much from a single effort that consisted of a one-day seminar in Seoul, followed by a number of one-on-one meetings -- regardless of the quality of the program or participants in attendance.
Koreans -- who place so much emphasis on relationships within their own society -- need to understand that in foreign countries as well there is a critical need to develop and nurture business and investments over time.
When organized effectively, road shows provide a wonderful opportunity to build interest and awareness in a particular region or project. However, the tendency to view a road show as an end, in and of itself, rather than as a key component within a complex, on-going process, has prevented Korean government agencies from achieving the full value that can be realized through these initiatives.
Having developed numerous investment promotion programs for government and corporate entities in Korea and all over the world, KWR International has developed several key reference points that should be considered by every Korean government agency seeking to attract investment into their province or municipality:
1) RESEARCH THE COMPETITION: Korean local governments face stiff competition from localities all over the world. Local governments must analyze all potential competitors in order to develop a credible strategy. For example, Korea lacks the English-language capabilities of Asian economies such as the Philippines, Hong Kong, Malaysia and India, not to mention British Caribbean countries or Ireland. Therefore, a strategy that seeks to directly compete against these economies to create back- office operations for U.S. and European multinationals is not likely to be successful. On the other hand, high education levels, established production expertise and strong corporate capabilities allow Korean localities to provide strengths over these other destinations, who are generally limited to their ability to provide real estate and low-cost labor.
2) DEFINE COMPETITIVE ADVANTAGE: Successful investment promotion programs clearly illustrate the attractiveness of a destination. One cannot adopt meaningless slogans such as "Province ëA' is Right for You", which can be applied almost equally well to every locality in the world. Local governments must differentiate themselves. Positive examples include Inchon's emphasis on its infrastructural strength, Kangwon's attractiveness as a tourism destination or Taegu's Milan Project. Each draws on the respective strengths of the locality and provides investors and corporate site selectors with a rational reason to pay further consideration.
3) TARGET AUDIENCE: U.S. firms and investors tend to be specialized in their requirements. Different projects appeal to different constituencies and must be marketed in a different manner. For example, a government planning a bond issue will likely seek to meet with investment banks, credit agencies and perhaps institutional investors. Those emphasizing FDI need to appeal directly to site locators and corporations. Companies seeking venture capital or to partner with U.S. firms will require a third approach.
4) EMPHASIZE VALUE OVER COST: Korea's rapid industrialization has given rise to higher costs and wages, eroding the cost advantage it enjoyed during earlier stages of its development. To sustain a higher cost structure, Korean localities must offer tangible value beyond simple cost savings. Otherwise they will need to compete solely on price against lower-cost destinations such as China, Malaysia, Thailand or India.
5) DEVELOP A COHESIVE PROGRAM: Companies that seek to introduce new products into the market cannot achieve success through a one-day promotion. They must develop a sales, distribution and customer service network to nurture and maintain the interest of their target customers. Successful investment promotion programs adopt a similar approach. They incorporate a well-defined strategy within a well-orchestrated ongoing program. This is essential, as an unfocused approach consisting of a series of discrete, disconnected events lacks continuity and is unlikely to generate meaningful results. Investors, corporations, intermediaries and other entities need to be supported throughout all phases of a transaction. Additionally, as one of the best ways to attract investment is to point to success stories, it is critical to continue to maintain support to past investors as well.
6) VISION BEFORE DETAILS: To justify the allocation of the considerable resources required to successfully evaluate the feasibility of an investment, an investor must first be convinced of the general attractiveness of a project. At that point they will likely have their own unique criteria and objectives and are unlikely to simply accept the parameters defined by a project sponsor. Therefore, while local governments need to fully understand all aspects of projects in their portfolio, they should not overload their presentations with technical details. These can be addressed in follow-up meetings and will distract from conveying the essential attractiveness of an investment opportunity.
7) SUBSTANCE BEFORE STYLE: Simplification and an emphasis on vision does not, however, mean that a presentation be devoid of substance. While one must make a good impression, investors are far more likely to be impressed with intelligent, credible information than elaborately designed, costly brochures and materials that offer little tangible value. Should there be sufficient resources to allow both the development of well-defined messages and information and as well as well-designed materials, local governments need to make sure they obtain the input of trained professionals who are familiar with both the subject matter as well as the local language. Even if they contain appropriate information, fancy materials filled with grammatical and spelling errors and poorly-written English are more apt to leave a negative than a positive impression. We have seen more than one example of this in our travels within Korea and other non-English speaking countries.
8) UTILIZE SPOKESPEOPLE: Statements by local governments will be viewed with caution as investors understand the primary responsibility of a local government is to its province or municipality. While it is essential to involve government spokespeople in presentations, it is equally important to supplement their participation with third-party individuals who will be viewed as more objective and legitimate. Therefore, if a local government has had past successes attracting foreign investors, it should involve these entities in their promotional outreach. If they are promoting high-tech industries or tourism, they should utilize industry professionals or journalists who can leverage the messages of government spokespeople through comments that communicate the competitive reasons why a particular locality offers superior value.
9) LEVERAGE THROUGH MEDIA RELATIONS: Road shows visits often cost hundreds of thousands of dollars if one accounts for all the travel, planning and associated expenses. Yet local governments are often reluctant to allocate the resources needed for effective media outreach, even though the incremental costs are generally quite low. However, a highly-successful road show visit will at best attract several hundred targeted people to a particular location. A well-placed interview can be seen by hundreds of thousands, if not millions of individuals, and provide articles that can be circulated for many months or even years to come. Road shows should be viewed as a forum from which clearly-defined messages can be delivered to large numbers of individuals who live and work over vast geographic regions and whose schedules may, or may not, allow them to attend a particular event. Individuals outside the room are therefore as important as those that attend.
10) PROVIDE LOCAL, ONGOING SUPPORT: If a road show is successful, participants will have many questions and needs over subsequent weeks. Inquiries will also be generated from people who were not able to attend and still others who seek to follow-up with proposals, site visits and other requests. Local governments are rarely able to sustain the personalized, ongoing contact required to maintain continuity by themselves. The distance is too great and they do not possess the necessary expertise, localized networks and experience. Even local governments that are able to station a representative in the U.S. are able to benefit from the specialized support of an informed consulting firm. An amicable and long-term working relationship is critical in order to allow effective representation.
11) KEEP THE FIRE BURNING: Constant communication and interaction with targeted prospects, long-term contacts and existing investors is essential -- 365 days a year. Decisions to make large-scale fixed investments can require millions or even billions of dollars. They involve many people and are made over long periods of time. While road shows and seminars offer an excellent vehicle to open doors and entice potential investors, they are unlikely to generate tangible results in and of themselves. The best one can hope for are intent letters or memorandums of understanding, which do not generally create any legal obligation and are therefore essentially meaningless documents. Follow-up must be sustained to maintain continuity and the growing interest and participation needed to transform an initial interest into a real transaction.
12) MAINTAIN FLEXIBILITY: Government agencies budget far in advance. They are therefore often unable to respond to attractive opportunities that may arise unpredictably over the course of a year. Local governments must, however, try to leave themselves open to change and are advised to retain a portion of their allocated funding so that they can respond quickly and proactively, so that they will not have to wait for an entire year before initiating needed changes.
Every province and municipality is unique and the points noted above address just a few of the many issues KWR International utilizes when it works with a client to develop an investment promotion program.
Book Review by Scott B. MacDonald, Senior Consultant, KWR International
Sidney Weintraub, Development and Democracy in the Southern Cone: Imperatives for U.S. Policy in South America (Washington, D.C.: Center for Strategic and International Studies, 2000), 95 pages.
Anyone looking for a readable, yet pointed overview of U.S. policy vis-Ã-vis South America, in particular the Southern Cone countries of Argentina, Brazil, Paraguay and Uruguay, will find Sidney Weintraub's Development and Democracy in the Southern Cone essential. Weintraub, the holder of the William E. Simon Chair in Political Economy at the Washington, D.C.-based Center for International and Strategic Studies and a veteran Latin Americanist, focuses on the interplay between market economics and political democracy in this important region and how it interfaces (or doesn't) with U.S. policies.
Weintraub argues persuasively that the primacy of economics, begun in Argentina under Menem and Cardoso in Brazil during the early 1990s, is likely to remain as a central track of policies in the four Southern Cone countries that make up the Mercosur trade bloc -- Argentina, Brazil, Paraguay and Uruguay. Surprisingly, at a time when this part of Latin America has embraced democratic-capitalism and is seeking greater regional and extra-regional economic integration, U.S. policy has become somewhat ambiguous or detached.
U.S. policymakers dealing with Latin America have a more narrow focus. Although broad U.S. policy objectives are supportive of the advancement of democracy (including human rights) and market reforms (good for foreign investment), the core issues boil down to stemming the flow of illicit drugs and immigrants into the United States, which elevates the importance of countries such as Colombia, Mexico and Haiti. Equally important, Mexico has a special relationship based on a shared border and membership into the North American Free Trade Agreement (along with Canada). It is one of the U.S.' major trade partners. Cuba also has importance as it has consistently been a vocal ideological opponent of the United States in Latin America.
Although Brazil and, to a lesser extent, Argentina have been significant places for U.S. business and investment, they fall considerably further down the list of priorities in terms of U.S. policy -- except in times of acute economic crises that threaten international finance. Weintraub observes of U.S. policy-makers: "As a consequence of the generally pervasive neglect, the most senior U.S. officials are not as well as informed about the Southern Cone as they are about the more incandescent trouble spots around the globe. Given the media's similar focus on the world's flash points, the general public receives limited information about developments in the Southern Cone."
Despite all this, Weintraub comments: "This volume's main conclusion is that the geoeconomic and geophilosophical basis for U.S. relations with the Southern Cone will endure." There is a lot to be said for the commonality of interests -- democratic governance, economic growth, expanding trade, and ongoing flows of investment capital.
Weintraub also does an excellent job of capturing some of the challenges of maintaining a unified Mercosur. Although Mercosur commenced as a trade organization, it soon assumed a political component in that its members must be democratic -- as in the case of the European Union. This helped contain the more coup-related elements of the military in Paraguay. Keeping democratic goverance on track, though challenged by a long tradition of military intervention, has become important to the region's ruling elite and populations.
While the democratic element of Mercosur helps bind the four nations together, Brazil's aspirations as a regional power have at times complicated matters. The 1999 Brazilian devaluation wrecked havoc on the Argentine and other economies, clearly putting the organization under considerable stress. Brazil's unilateral approaches to other countries about new free trade agreements (FTAs), without consultations with fellow Mercosur members has also strained relations. As Weintraub notes: "All four core countries seek a coherent integration process, but with different degrees of intensity. The economic aspects are most important to the smaller countries, while the political objectives play a larger role in Brazil's thinking." Nonetheless, he also assures us "that the forces pulling the countries together are more powerful than those separating them -- but the duality exists."
At the end of the day, the Southern Cone is a region on the move economically, in the process of developing further economic integration and politically consolidating democratic rule. That combination should elevate the Southern Cone countries as a group that have greater importance to the United States. U.S. detachment to the region could have a cost as the European Union is negotiating a free trade agreement with Mercosur, having successfully recently completed one with Mexico. European competition is on the rise: in 1999, European investment in Latin America was greater on a whole than that of the U.S. The case is clear - Washington's detachment from the region and the narrow vision of those members of Congress opposed to providing the President with fast track authority to negotiate FTA s with Chile (or other Latin American countries) could result in an erosion of opportunities for U.S. business. This would be a situation from which the rest of the U.S. economy could suffer. Weintraub puts all of this into context in this well-argued book.
KWR International, Inc. (KWR) a firm specializing in the delivery of research, communications, consulting and advisory services to a wide range of public and private sector clients.
KWR can provide support throughout all stages of a program/project cycle. We draw upon analytical skills and established professional relationships to design, implement, manage and evaluate programs all over the world. These range from small, targeted projects within a single geographical area to large, long-term initiatives that require on-going global support.
In addition to serving as a primary manager, KWR also provides specialized support to principal clients and professional service firms who can benefit from our strategic insight and expertise on a flexible basis.
Drawing upon decades of experience, we offer our clients capabilities in areas including:
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