[ Capabilities ][ Staff ][ Clients ][ Press ][ Library ][ Contact ]| KWR International Advisor #5 July, 2000 Editor: Dr. Scott B. MacDonald, Sr. Consultant Deputy Editor: Dr. Jonathan Lemco, Director and Senior Consultant Publisher: Keith W. Rabin, President Contributing Writers to this Edition: Scott B. MacDonald, Jonathan Lemco, and Keith W. Rabin of KWR International, Asian Assets Direct Staff and David Kurapka of TheStreet.com © 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. The U.S. Economy: Looking at a New Paradigm or a Return to Good Times? II. Race For the US Presidency III. U.S. Opinion Leaders See South Korea as a 'Growth Stock' IV. India's Technology Revolution: Part II V. The Right Decision in Japan - The Sogo Bankruptcy VI. China's Merging Stock Markets VII. Mixed Forecast for Korea's Investing Climate VIII. Emerging Market Briefs: Mexico: Now, the Fun Begins Brazil: Waiting for a Moody's Upgrade China and Global Commodities Israel: Growth Prospects Improving Peru: Aftermath of Fujimori Re-election ------------------------------------------------------------- I. The U.S. Economy: Looking at a New Paradigm or a Return to Good Times? By Scott B. MacDonald Only two months ago the investment environment in the U.S. could be characterized by rising interest rates, a cooling economy, uncertainty over the direction of the stock market, and the breakup of Microsoft. Now the game has changed. A new paradigm is emerging that is marked by more moderate growth (with real GDP still cooling), a possible end to the latest interest rate cycle, and prospects for new, albeit less giddy advances in the stock market. The bubble in IT stocks has not entirely deflated, but the emerging survivors will be well-positioned to ride the next waves of technological change and application. According to the Oxford American Dictionary, a paradigm is "something serving as an example or model of how things should be done." The old paradigm was defined by rapid economic growth, low inflation and a roaring stock market, driven by a flood of high tech and Internet-related stocks. The good times rolled. In March and April 2000, however, the good times suddenly stopped rolling. Free and easy money for the stock market began to dry up and office chatter about the glory of day traders disappeared. To the Federal Reserve, which appears to be getting its way, the new paradigm should be moderate real GDP growth of 3-4% and a gently upward sloping curve in the stock market. To the investor it should be strong markets, underpinned by solid economic activity and low inflation. To anyone in the high tech sector, the old paradigm is still attractive: Robust economic growth helped maintain constant demand for their services and a roaring stock market provided easy money. Obviously, not everyone is going to get what he or she wants. In all likelihood, the new paradigm that is taking shape will be a period of slower, more manageable economic growth, inflation that is containable but will continue to threaten (partially due to higher energy costs), and volatile stock markets, such as we have witnessed thus far in 2000. What this means for the IT sector is a tougher environment, with hardy survivors taking advantage of new developments, such as the mobile Web, entertainment-content on demand, and artificial intelligence-enabled electronic commerce. The bubble has not entirely deflated, but is almost out of air. According to Red Herring's Anthony B. Perkins, there are two groups that will take advantage of these new developments: the existing blue chip technology companies that have made the successful transition to the Internet and the Internet survivors, i.e. those firms that are run by sound management teams and have proven business models. Consequently, Perkins puts his faith into such companies as Apple Computer (AAPL), Cisco Systems (CSCO), Dell Computer (DELL), Palm (PALM) and Yahoo (YHOO). As for the rest, Perkins is not so positive, noting: "In the end (over the next nine months), more than 90 percent of the dot coms will die, become living dead, or get bought out for bottom-feeding prices." One sector to be hit particularly hard is that of e-tailers. KWR expects many e-tailers will fail by the end of next year because of funding problems and competitive pressures. Simply stated, there are too many companies and not enough business to go around at this stage. In its July 2000 edition, Bloomberg magazine compiled a list of companies "in jeopardy", i.e. e-tailers that are destined to run out of cash if their rate of spending does not change. Among these were such well-known names as Amazon.com, eToys.com, and barnesandnoble.com. The new paradigm accepts that old economy companies must adapt or die. Resistance is futile. Equally important, there is a growing and grudging recognition that the rate of returns on the new economy in terms of wealth generation will not be as high as before (investors will have to look outside the U.S. for big upsides in most high tech sectors). Nor will the revolutionary pace of change to lifestyles and social attitudes occur at such a breakneck speed but move in a more evolutionary pace. (We have gradually come to accept change as a constant.) This by no means infers that the pace of new technological innovation will falter, but the get- rich mentality about approaching the stock market or venture capitalists will be replaced by more sober assessments of what it will take to succeed. The vast sea of U.S. investors are not the same ready fish in the sea willing to bite at every hook with a juicy worm on it. In a sense, the "go-go" days of the bull market have ended and we have entered a more cautious period. The guideposts ahead include the pace of the U.S. economy, U.S. interest rates, various economic data releases (PPI, unemployment, new home sales, etc.) and how Europe and Japan react to all of this. Europe has already been in the mode of raising interest rates. Concerns about a potential slowdown of the U.S. economy have already spawned the release of Wall Street research pieces with such titles as "Should Euroland Fear a US Slowdown". Of course, what happens in the U.S., Europe and Japan, has an impact on Latin America, the Middle East and Canada. So what does KWR expect in the next few months? As higher energy prices filter into the economy (we look to $27-28 a barrel for West Texas Intermediary on average for the year), the Fed will probably move again, most likely in November by another 25 bps, bringing Fed Funds to 6.75% by year-end. This should be enough to contain inflationary pressures and keep U.S. growth in a soft landing mode of 3.0-3.5% for 2001. If Fed measures fail to contain inflation and rates climb higher in 2001 (of which there is a chance of 20% according to the KWR model), the U.S. economy could be heading for a hard landing. We take to heart the recent commentary by Goldman Sachs economic research: "·the more resilient the U.S. economy remains to the Fed's efforts at slowing it down, the more force the Fed will use, and the higher the risk is that the eventual slowdown will be severe." With the new U.S. economic paradigm in mind, we expect that Europe will weather a soft landing in North America relatively well. Global economic growth for 2000 will come in at 4%, with a little over that number expected for 2001. Economic growth is picking up in Europe and the European Central Bank is aware that substantial increases in interest rates could brake growth and result in a negative trend in employment. The most significant risk in Europe would be an inappropriate monetary tightening because of a collapse of the dollar related to concerns over U.S. private sector debt or the large current account deficit. If the European Central Bank perceived conditions threatening monetary tightening, it could dry up credit in Europe and run the risk of stalling economic growth. The new U.S. paradigm is not entirely good news for Asia nor is it all bad. Although the new paradigm entails a slowdown, not a recession, it means that consumption levels in the U.S. are likely to decline. Over time, this could bite into Asian exports into the North American market. Economies such as Japan, China, Korea, Taiwan and Singapore will have to adjust to the possibility of lower US import levels. We do not expect this to put Asia back into a recession, but it takes some of the wind out of Asian growth prospects and makes the need to press ahead with structural reforms that have been postponed or slowed down all that more necessary. Latin America is probably one of the most vulnerable regions in the new U.S. economic paradigm. We are not predicting major economic crashes, but the mountain of external debt the region has accumulated, in particular with Argentina and Brazil, is a point of concern in a higher interest rate environment. To their credit, the governments in both Latin American countries have made substantial efforts at structural reforms over the last two years to avoid another meltdown. Despite these efforts, Latin American countries remain dependent on the U.S. market for the bulk of their exports and most of their external debt is dollar denominated. Any increases in U.S. interest rates will hurt. However, while a soft landing in the U.S. will hurt, it is probably manageable. A hard landing would press the region hard. Argentina and Brazil are particularly vulnerable, considering their need to access international capital markets to repay their external debt obligations. Mexico is considerably better placed to ride through the new U.S. economic paradigm due to its extensive structural reforms, its completion of financing for 2000, and its proximity to the U.S. market. Moreover, Mexico's fundamentals are solid: Inflation is already below the target for 2000, oil prices are above the budget's estimate, the imbalance in external accounts is modest, and foreign investment rose to $3.1 billion in the first quarter of the year. NAFTA should help Mexico ride through a soft landing in the U.S. relative to the rest of Latin America. The new government of Vincente Fox, the leader of the PAN, represents a new direction for Mexico, ending 71 years of PRI rule. However, the PAN government will have many challenges, which will dent some of the current excitement. That stated, we expect that Mexico will continue to experience relatively strong economic growth and inflows of foreign investment. The new U.S. economic paradigm is still in the stage of formulation. For corporate managers in the United States, it means that greater attention is required in regard to debt management, revenue enhancement and acquiring market share. For Internet companies, in particular, it means more difficulty in raising capital. Substance is now in fashion, not normative ideas. For investors it means less money to put to work in the market and more precise questions about revenue streams, profits and the assumptions behind such numbers. In the second half of 2000, the new U.S economic paradigm will prove to be a test for U.S. economic managers as well as their counterparts around the planet. Hopefully, everyone has woken up and smelled the coffee. II. Race For the US Presidency by Jonathan Lemco The race to be President of the United States is in full swing, although most Americans seem bored with the whole affair. At the moment, election polls reveal that Governor Bush of Texas may be as many as ten percentage points ahead of his rival, Vice President Al Gore. Bush has cleverly positioned himself as a moderate, as evidenced most recently by his commutation of the pending execution of a Texas death row inmate to a life term. But the Presidential election is too early to call. In fact, a survey of prominent US political scientists, who have a track record of forecasting presidential elections, reveals that if history is any guide, Gore should be elected easily in November. The reasoning is that with a strong economy, low unemployment, negligible inflation, and a country at peace, most voters will vote for the perceived lesser of two evils, Vice President Gore. This is despite the fact that the Democratic nominees' campaign has been lackluster and uninspiring thus far. >From an investor perspective, it should be stressed that both candidates are ardent free traders and supportive of further globalization efforts. Both face opposition to these positions within their parties, trade union and environmentalist opposition within the Democratic Party and Pat Buchanan-like "America First" opposition within Republican ranks. However, both of these opposition positions are minority views within their respective parties. Vice President Gore is more knowledgeable about international politics and economics than his Republican challenger. In particular, he is quite expert on European and Canadian affairs and the implications of broadening the NAFTA throughout the hemisphere. Texas Governor Bush is well-versed in US-Mexico relations and speaks Spanish fluently. Presumably, he will be dependent on his foreign policy advisors for fuller policy positions as the campaign continues. That being said, most Americans will vote on the basis of their pocketbook or on intensely felt domestic political issues. Historically, most voters do not cast a ballot on the basis of a candidate's foreign policy positions. Contrary to the expert opinion cited, we think that the race is too close to call. III. U.S. Opinion Leaders See South Korea as a 'Growth Stock' By Asian Assets Direct Staff (Originally published - June 2, 2000) WASHINGTON - In the minds of U.S. opinion leaders, South Korea can be roughly equated to a highly-promising "growth stock," according to a new survey commissioned by the Korean Chamber of Commerce and Industry in the USA Inc. and the New York office of the Federation of Korean Industries. However, this means that "even a small disappointment in performance can have dramatic repercussions over the short term;" the report says. It was prepared by KWR International, Inc., a New York consulting firm, and released Friday. KOCHAM and FKI have commissioned the annual survey since 1996. The latest one reaffirms earlier findings of a growing gap between Korea's economic achievements and the perceptions of U.S. audiences. Korean firms and institutions must strengthen their efforts to engage in the "corporate diplomacy" needed to manage the expectations of foreign audiences in a realistic manner, according to the report. It argues that "this will serve to minimize market and perception volatility and to maintain an equilibrium between these expectations and Korea's future economic performance." Whether those expectations and perceptions are fair or realistic "is beside the point," the report argues. "They clearly exist in the mind of U.S. opinion leaders and therefore affect Korea's cost of capital and its ability to maintain its global competitiveness." 'Outdated' business model In particular, U.S. opinion leaders regard Korea's business model -- forged by government and large conglomerates and honed during years when manufacturing boomed -- as outdated. The report quotes a New York-based senior attorney as saying, "The chaebols must decide how to advance beyond a strategy that seeks to do business globally from a Korean base to make the concerted global acquisitions of financial, human and other resources needed to become competitive multinational corporations." Seventy-four unidentified opinion leaders took part in the survey. They urged that:
Respondents acknowledged that Korean firms have demonstrated impressive efficiency, many recovering from near-death, but argued that labor protections, or rigidities, will thwart competitiveness in the long run. "While favorably crediting Korea's remarkably rapid recovery from the 1997 financial crisis, U.S. opinion leaders now judge Korean businesses with higher standards than in the past," KOCHAM President Young Man Kim said in a statement. "They stress that ...Korean companies need to adopt a higher benchmark if they are to maintain their long-term competitiveness." The sentiments and recommendations in the report echoed calls made by the American Chamber of Commerce in Korea earlier this year and, this week, by the Organization for Economic Cooperation and Development. The U.S. Treasury had lobbied for Korea's OECD membership as a way to encourage capital markets liberalization in the country. Survey respondents included executives (11 percent), journalists (22 percent), academics (5 percent), attorneys (14 percent), government (5 percent) and nonprofit officials (3 percent), consultants (5 percent), financial professionals (16 percent), engineers (3 percent) and analysts (16 percent). All the respondents were Americans working in the United States, Asia or Europe or English-speaking foreigners working for western firms. Reprinted by permission of Asian Assets Direct, http://www.asianassetsdirect.com A summary of KOCHAM/FKI's "U. S. Opinion Leader Perceptions Report: Comparative Impressions Concerning Economic Trends and the Investment Potential of Korea" can be viewed at: http://www.kocham.org/english/act1.htm IV. India's Technology Revolution: Part II By Scott B. MacDonald and Keith W. Rabin In our last KWR newsletter of April 2000, Jonathan Lemco, covering the fundamentals of the economy, reported to you about India's technology revolution. In this issue, we take a closer look at the companies involved in the Internet and B2B commerce. India is identified as one of the major growth markets within Asia. It has a large base of knowledgeable workers, a relatively cheap cost of labor, and a local network of suppliers. Although India has lagged in terms of incentives and infrastructure, the government is now aggressively moving to address these issues. There appears to be a consensus among the major political parties that the Internet and related high tech companies are an important national asset, especially if India is to compete in international markets. For India to compete it needs considerable capital, much of it from outside the region. Capital is required to achieve a convergence of voice and data technology and to upgrade telecom infrastructure. These capital needs cannot be met from Indian sources, hence the interest in IPOs in the United States. Four Indian companies that have been issued on U.S. stock exchanges are: Satyam Infoway Limited (SIFY): Satyam was the first Indian company to gain access to the American stock market (the NASDAQ). It is the second leading internet service provider (ISP) in India, behind the state-owned former monopoly VSNL. Satyam created the country's first private Internet protocol network, with points of presence in 25 major Indian cities. It offers dial-up Internet access, as well as dedicated access for businesses, and has about 130,000 subscribers. The company operates one of India's leading portal sites (satyamonline.com), plans to acquire portal IndiaWorld, and has launched e-commerce site serwiz.com. Satyam Computer Services owns nearly 60 percent of the company. Market capitalization is $467 million and its stock last traded at around $22 per share. Its 52 week high was $113 per share. Infosys Technologies Limited (INFY): Infosys was founded in 1981 and develops customized software products and performs a variety of software services for business around the globe. The company's BANCS 2000 system automates banking operations; other products and services assist with inventory and distribution management, warehouse management, and Internet-based electronic commerce. Infosys services clients, such as Aetna, Visa, EC Cubed, and Sportsline.com, through development centers and marketing offices in Asia, India and North America. Infosys has a market capitalization of $20.4 billion and its stock lasted traded around $154 per share on the NASDAQ. It is down from its 52 week high of $375 per share. ICICI Limited (IC) and ICICI Bank Limited (IBN): A financial services firm, ICICI is increasingly moving into providing Internet services. It currently has two listings on the New York Stock Exchange, IC for the holding company and IBN for the bank. The commercial bank operates more than 70 branches in 40 cities on the subcontinent. Business is divided into three segments: corporate banking, the largest, provides lending and deposit services to business customers; retail banking offers deposit accounts, loans and credit cards to individuals; and treasury handles the bank's investment portfolio. Working capital finance loans for corporate clients make up nearly 70% of ICICI Bank's loan portfolio. The bank has a market capitalization of $1.5 billion and its stock last traded at $13.75 per share. The 52 week high was $18.75. Over the past year the holding company has launched internet sites allowing on-line trading, bill payment, and "Cafemumbai.com", the first in a series of Cafe India Series portals. It has also been active in introducing WAP technology into India and recently teamed-up with Yahoo! India, to offer co-branded Yahoo-ICICI pages featuring financial information including commentary on equity markets, stocks, news analysis and special features related to the financial sector in India. It has also announced partnerships and acquisitions in media and technology consulting. It currently trades at 17 5/16 per share. The 52 week high was $46.00. In June, two new companies issued IPO's in New York - Rediff.Com, an Internet company, and Silverline Technologies, a software house. Behind these companies is a growing pipeline of Indian firms that wish to issue shares on either the New York Stock Exchange or NASDAQ. The NASDAQ even sent over a team to India earlier in 2000 to explore the possibility of opening an office in Bombay or Bangalore to help process Indian high tech companies for entry into U.S. markets. Although the market downturn in April appears to have postponed this development, Indian companies are ready to issue. The following companies have either announced their intention to issue equity shares in the U.S. or have been identified as possible candidates: Zee Group: Zee Group is one of India's major media companies, with such holdings as SitiCable (a $3.5 billion cable distribution firm) and, Zele Telefilms. It has announced that it is planning to issue ADRs to raise $1.5 billion for expanding its Internet service provider and portal business ZeeNext. Wipro: A computer and consumer durables firm that has tied up US Internet software maker Open Market Inc. (NASDAQ: OMKT), to provide systems integration services for e-businesses. Wipro management has hinted that it is looking to the NASDAQ. Mahangar Telephone Nigam Ltd. (MTNL): MTNL is a state-run phone company (56% state ownership) that offers fixed-line phone and Internet access services in New Delhi and Bombay and enjoys a stronghold of about 4 million telephone service subscribers in two cities. It also has launched a partnership with MasterCard International for payments of bills through the credit card and MTNL plans to launch its GSM-based cellular phone services by the end of June. It has already completed its filing with the SEC and expects to list its shares on the NYSE in late June. Videsh Sancahr Nigam Limited (VSNL): A former government monopoly in the ISP market and still a monopoly on Internet gateways, VSNL has announced that it will issue shares on the NYSE. It remains India's largest ISP and has a subscriber base of 300,000 customers. Its core business is international telephony. It is also diversifying into other areas, such as satellite mobile phone services, Internet, and direct-to-home satellite platforms. It also plans to position VSNL as a global and regional player through the creation of a regional hub in India. We suspect that, as a former state monopoly VSNL is being pushed hard by new private sector companies and is scrambling to remain competitive. MphasiS-BFL: One of India's e-business solutions providers, MphasiS-BFL has decided to issue ADR's worth $50-100 million. The transaction will enable MphasiS-BFL to become a significant participant in the high-value "interactive architect" IT segment that specializes in Internet-based solutions for established firms as well as new dotcom companies. Other companies that have been mentioned include Indya.com, Indiainfo.com, Indiatimes.com, 123india.com and BusinessIndia.com. Indian Internet companies are also thinking about listing on the London Stock Exchange. Aptech, a Bombay-based IT company, will lead the new wave of companies when it makes its debut later in July. Aptech will join 17 old economy Indian companies and two other IT companies. According to our sources, London Stock Exchange officials are talking with Wipro, India's largest software house by market capitalization. India Internet and high tech companies are also receiving attention from large foreign companies. Intel has announced that it would increase its venture capital investment in India to over $100 million in Internet startups in 2000, which is a tenfold increase over the previous year. Last year it put money into Rediff, Cyber India Online, Indus Media Cable, Network Solutions, Eastern Software, Ritesource, Bharati, and Silicon Automation Systems. In addition to Yahoo's alliance with ICICI, AltaVista has also announced its entry into India, with Lycos and Microsoft Network expected to launch in the near future. Conclusion: India is finally emerging as a heavyweight in the IT business. Although problems continue to persist with inadequate infrastructure (especially in the telecom area) and bureaucratic red tape, the business environment is gradually improving. The BJP government is attempting to address many of the problems and is indeed promoting the IT sector as an engine of growth for the country. This means that India Internet companies can be expected to approach US markets in larger number for capital. Many of these companies will be well be worth considering for investment purposes. V. The Right Decision in Japan - The Sogo Bankruptcy By Scott B. MacDonald Japan has made the right decision in not bailing out the ailing Sogo department store chain. Although the company's bankruptcy will have a negative impact on its 151 financial institution creditors and will result in additional people entering the ranks of the unemployed, Japanese taxpayers have avoided putting their money into a failed company in a non-strategic sector. Moreover, the decision helped reinforce Japan's creditworthiness with both Moody's and Standard and Poor's, both of which are carefully looking at Japan's current ratings. Japan continues to have a number of large corporations that are struggling to survive, in particular in the domestic sectors such as retail and construction. One of the larger companies struggling to stave off bankruptcy was Sogo, a 170-year old nation-wide department store chain. Sogo had accumulated combined liabilities of $18.5 billion. The department store appealed to its main bank, Shinsei (formerly Long Term Credit Bank and now owned by Ripplewood, a U.S. investment firm) for help. As part of an earlier agreement in acquiring Shinsei, the Japanese government promised to buy a portion of ex-LTCB's loans at book value in case they declined in value by more than 20% within three years. Accordingly, Shinsei sold its 198 billion yen Sogo debt to Japan's Deposit Insurance Corp., which in turn accepted Sogo's request to forgive 97 billion yen of that amount. Public response to the decision to bail-out Sogo was highly negative, as it was seen as an unjustified use of tax money for saving a private company. The idea that the government should write off debts incurred by a department store held out a substantial risk of moral hazard and unlimited guarantees for the long list of other terminally-leveraged companies. The chorus of those opposed to the Sogo bail-out included the opposition parties, members of the three ruling coalition parties, and businessmen. Additionally, Standard & Poor's criticized the bail-out decision, noting that the action could have a "hazardous" effect on the country's efforts to reform the financial system, and put Japan's AAA rating at risk. Moody's already downgraded Japan's Aaa rating to Aa1 and currently has its domestic Aaa rating on review for a possible downgrade. Considering the strong public opposition to bailing out Sogo, the government indicated to the department store that the better path to follow was for it to declare bankruptcy, which it did on July 12. As Koichi Kato, a member of the ruling Liberal Democratic Party stated: "I think that this outcome was inevitable. It's the only one that will ease concerns about moral hazard and reduce the general feeling of helplessness among the public." The Sogo case was an important test for Japan in terms of the reform process. If Japan is to leave behind the old structure of company-bank relations and cross-share ownership and allow market forces to work, Sogo had to fail. Otherwise the door would be open to the long list of troubled domestic sector companies seeking the same redress at the hands of the Japanese taxpayer. The next test for Japan will be when some of the larger and deeply troubled construction companies seek help from their banks. The Sogo decision indicates Japan's commitment to continuing economic reform is not transitory and that a new Japan is slowing emerging. VI. China's Merging Stock Markets: By Scott B. MacDonald China is facing daunting changes. It is set to join the World Trade Organization (WTO), is seeking to develop a new trade pact with the European Union, and must deal with pressing internal economic changes. Addressing the need to consolidate the financial system is part of that internal economic change. A step in that direction would be the merger of the Shanghai and Shenzhen stock exchanges, which is now under construction. As China faces globalization it must strengthen and streamline its securities markets. Consequently, Chinese authorities are discussing a plan that will have stocks listed on the Shenzhen bourse shift their listings to Shanghai. There is also a proposal for a second board for start-up companies to be opened in Shanghai. This idea has obviously been influenced by the revolution in start-up companies in the United States as well as with the success of Hong Kong's Growth Enterprise Market (GEM). The path to a single, regulated national stock market in Shanghai has already taken steps in this direction. The central authorities have consistently blocked a campaign by the small Wuhan exchange for recognition as a third official stock market. They have also dismantled numerous over-the-counter trading centers around China. Moreover, the once-sprawling commodities futures trade has been reduced from fourteen to three exchanges to cut down on overlap and tighten regulatory control. The benefits of merging Shenzhen and Shanghai would be considerable. Together they would have 964 publicly traded companies valued at 3.66 trillion yen ($422 billion) at the end of the first quarter of 2000. At the same time, the two stock markets boasted of 89 stock brokerages. According to Xinhua News Agency, institutional investors had only 0.4% of the 47.5 million trading accounts. A consolidated market would provide a greater scope for institutional investors, ease demand on scarce resources and boost trading liquidity. This would be especially useful as China seeks to float larger corporations, like its sizeable financial institutions. A merged stock market based in Shanghai would also bolster that city's bid to regain its standing as one of Asia's premier financial and commercial banking centers, a position it held in the 1930's. This, of course, puts Shanghai in a more competitive position vis-Ã-vis Hong Kong. Other measures are being undertaken to consolidate and improve China's financial system with an eye to WTO entry. In May it was announced that foreign financial firms will be allowed to participate in the underwriting of China's treasury bond sales. Like the idea of stock market consolidation, this measure also seeks to make China's markets more global. At the same time, Chinese authorities indicated that the process of opening the treasury bond market to foreign managers will be gradual and selective. China will commence over-the-counter trading in treasury bonds by domestic corporate investors in the second half of 2000. For China to be a bigger player in the global economy, its financial sector must be brought up to international standards. This is one of the country's most difficult challenges. The failure of Hainan International Trust and Investment Corp (HITIC) to make a Yen 14.5 bn ($138 million) payment on its Japanese Samurai bond in June 2000 indicates that serious problems continue to dog the sector. The points of difficulty facing the financial sector stem from the heavy burden of reforming the country's banks, the related issue of State Economic Enterprise reform (as many such entities owe the banks money), the weakness of many of the international trust and investment corporations and the pressing need to imbue the system with greater transparency and disclosure. Consequently, the push at stock market consolidation is a step in the right direction, but the road ahead is a long one. VII. Mixed Forecast for Korea's Investing Climate By David Kurapka, Senior Writer, TheStreet.com (Originally published - June 30, 2000) NEW YORK -- Former U.S. Ambassador to Korea Donald Gregg can't contain his enthusiasm for the country. Gregg, who now serves as president of the Korea Society, is effusive about his faith in the nation's possibilities. He thinks Korea's economy is poised for a long run of strong growth following an amazing turnaround from 1997's financial crisis. And he thinks the possibility of peace between the communist North and democratic South lays the groundwork for security and prosperity throughout the entire region. Speaking at a road show put on by the Korea Securities Dealers Association, Gregg said he couldn't give investment advice, and then did exactly that. "It's a good place to be," he said. Apparently, Gregg didn't listen to the conference's other presenters. They painted a much murkier picture, one of an economy that is essentially strong, but with disturbing weaknesses. They described excruciatingly slow restructuring and a highly volatile stock market. Nonetheless, there was considerable agreement among both presenters and participants that the Korean markets would rally this year, around the beginning of the fourth quarter. That admittedly unscientific sampling of investor sentiment is important because confidence is extremely important to the Korean market. (Sentiment is a key factor in any market, of course, but it is especially crucial in emerging and less-developed markets). Last year, Korea's stock markets -- both the main Kospi stock index and the tech-heavy Kosdaq market -- could do no wrong. Investors viewed the country as having undergone fundamental economic restructuring following the crisis of 1997-1998, which set it on track for a return to strong economic growth. Consequently, the Kospi rose by roughly 50% and the Kosdaq nearly tripled in value. This year, that confidence has swung the other way. Investors have looked with disappointment on stalled restructurings at some major conglomerates, known as chaebol. That restructuring slowdown is seen by most observers as an obstacle to efficient economic activity. They see a government that has slowed its economic reform efforts because of an election season. They see the near-bankruptcy of the investment trust corporations, institutional investors that have been hit hard by the collapse of the Daewoo chaebol. In addition, the fall in U.S. stock markets has hurt Korea. Thus, the Kospi and Kosdaq have both fallen well off their peaks. However, election season is over, ITC problems are nearing resolution and U.S. markets appear to have a floor beneath them. For Charles Kim, vice president for Asian equity sales at Flemings, Korea is the place to be in Asia for the next few months. Kim also likes the looks of Taiwan. U.S. retail investors have a number of ways to play the Korean market as a whole. The Matthews Korea Fund is an open-end single-country fund with a minimum investment requirement of $2,500 and an expense ratio of 1.77%. It is down 24% for the year, but up 13% the last month. There are four closed-end Korea funds: the Fidelity Advisor Fund (FAK:NYSE - news), which is basically flat since the beginning of the year; the Korea Investment Fund (KIF:NYSE - news), up 23% the last month; the Korea Fund (KF:NYSE ADR - news), also up 23%; and the Korea Equity Fund (KEF:NYSE - news), up 26% the last four weeks. In addition, the iShares MSCI South Korea (EWY:AMEX - news), an exchange-traded fund indexed to the Morgan Stanley Capital International index for the country, trades for a little more than $21 a share, very near its price when it was first offered last month. Listening to speakers at this conference, a paradox for the Korean market became clear. The companies that are likely to interest investors mostly are the smaller, more entrepreneurial tech companies listed on the Kosdaq. Yet the volatility in that market is immense. It's fueled by enormous online trading, which represents 85% of the trades that occur on the market, and much of that is day trading, according to Nam Park of Hyundai Securities, who spoke at the conference. "What happens on the Kosdaq is not investing. It's not even speculating," says James Rooney, a governor at the American Chamber of Commerce in Korea. "It is recreational gambling." Meanwhile, many of the companies on the Kospi still are in the corporate web of chaebols. Nonetheless, there are enormous bargains there. In fact, Rooney sees bargains in the Kosdaq too, although investors have to surf carefully. He's bullish on Korea -- assuming a lot of pieces fall into place, such as the expected profit growth being real, economic reform continuing and the financial system strengthening. "The real economy is solid," he says, "but it is built on a financial system made out of jelly." The presenters at the conference, Donald Gregg excluded, succeeded in painting a picture of a market that, while bright, has a number of clouds. Like the meteorological legerdemain of The Perfect Storm, it is hard to tell whether the clouds foretell a brief shower or a monstrous hurricane. Reprinted by permission of TheStreet.com, http://www.thestreet.com. Editors Note: More information on the recent Portfolio Korea 2000 Road Show can be obtained at http://www.ksda.or.kr/portfoliokorea . Mexico: Now, the Fun Begins: Mexico's July 2 elections brought about the unexpected victory of opposition candidate Vincente Fox, of the center-right PAN, ending the 71-year rule of the PRI. Fox won 43.8% of the total vote over PRI candidate Francisco Labastida with 36.7% and center-left C. Cardenas with around 16%. The elections are regarded as the fairest in Mexico's history and were marked by a high voter turnout. The PAN also won the biggest bloc of seats in the Senate and Congress, though not a majority. The challenge is now multiple. Fox must form a cabinet, begin the process of a transition from 71 years of PRI government to a new era, and make certain that he can live up to some of his campaign promises. He faces high expectations, a pro-PRI bureaucracy and entrenched interests, some of which are highly corrupt and willing to use bribery and strong arm tactics to maintain their niches in the power structure. Corruption represents Fox's biggest challenge. To move the economy to the next stage - that of a more equitable and efficient system - the hold of corruption on a number of institutions in the country must be broken. Failure to do so, will complicate Fox's ability to create a new, fair and open Mexico. Brazil: Waiting for a Moody's Upgrade: There is considerable debate on Wall Street whether Standard and Poor's is moving to upgrade Brazil's B+ foreign currency rating to BB-. Earlier this year the rating agency provided a list of targets required for such an event. This included the passage of the Law of Fiscal Responsibility (done); the meeting of fiscal and inflation targets (on track); expansion of exports (up); economic growth should continue (3.5-4.0% real GDP growth expected); privatization should advance (mixed results); and comprehensive tax reform (minimal progress thus far). Considering that the Brazilians have either met or are moving on all conditions, the reasoning is that S&P will have to make the upgrade. Although privatization remains a sore area, that situation could improve with the sale of Banespa, set for July 18. So keep your eyes on Brazil's ratings over the next few months. We still think that the country requires considerable improvement and have concerns about the impact of a slowing U.S. economy on the Brazilian economy. Then again, should Brazil be rated the same as Papua New Guinea, Kazakhstan and Bulgaria? China and Global Commodities: The Chinese economy appears to be back in a strong growth mode. It was announced on June 8th that China's value-added industrial output rose at a faster rate than expected, 11.5% on year in May to 196.3 billion yuan. That is compared with a 9% increase last year. What was important was that this acceleration in growth drew heavily on raw materials. This is good news for world commodity prices. China remains a key industrial workshop for the global economy, and its use of a wide range of imports is critical for various commodity markets from Latin America to Central Asia. The trend is currently very positive, with at least one Wall Street firm projecting 11% industrial production for 2000. Considering the cooling nature of the U.S. economy, one of China's major export markets, this will have to be watched closely. Thus far, China's industrial exports are up 23% year-on-year for the January-May period. Israel - Growth Prospects Improving: Although Israeli politics remain tumultuous, the economy continues to expand at a healthy pace. In early July, the Ministry of Finance announced that it adjusted its real GDP forecast for 2000 from 4% to 4.5%. The expansion, following growth of around 2.2% in both 1998 and 1999, indicates that Israel's recovery is firm and becoming broader based. Unemployment is expected to fall to 8.5% this year from 8.9% in 1999. One of the reasons for stronger growth has been the relatively positive performance of Israeli high tech companies, a number of which are traded on U.S. stock exchanges. Israel's finance ministry is currently discussing tax reform proposals, including lower income taxes and imposing new taxes on savings and investments. Peru: President Alberto Fujimori's re-election on May 28th in Peru is likely to continue to cause problems for that country and complicate its relations with its neighbors and the United States. Asking for a postponement to allow for new measures to be implemented to guarantee a fair election, Toldeo, Fujimori's opponent, stepped out of the 2nd round election.,. Fujimori refused and ran virtually unopposed, creating considerable discord in Peru. The Organization of American States, the European Union and the United States have all criticized Fujimori for the fraudulent nature of the elections. Yet, for all of the rumblings, we do not expect that any type of meaningful punishment will be imposed against Peru. Considering the near-chaos in neighboring Ecuador, the nasty civil war in Colombia, and the frothy nature of Venezuela's electoral politics, U.S. interests would not be well served if Peru were to become destabilized. Moreover, the Peruvian economy is gradually recovering, which could provide one bright economic spot in an otherwise struggling Andean region. ---------------------------------------------------------------------------------------- KWR International, Inc. 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