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Corporate Bond Market - Feeling Good Again?
Scott B. MacDonald
was a difficult year for the U.S. corporate bond market, despite
a rally in spreads in November. What made November such a good
month was a number of factors - a 50 bps cut by the Fed, relatively
positive economic data, a decline in tensions over Iraq, short
covering and HSBC's announcement that it would purchase Household
Finance. This combination of factors helped tighten spreads. Those
sectors that showed the biggest rate of return were the same that
were earlier the most beaten up - autos, telecoms and media/entertainment.
At the same time, the new issue market reopened with strength.
Following up in December, the new issue machine produced around
$27 billion in new bonds.
What's next? We remain constructive about the corporate bond market
through the end of the year, though we acknowledge ongoing concerns
- Iraq, terrorism, the still bearish nature of the tech market,
and concerns over pension funding. The less bullish revenue and
earnings forecasts from the major auto companies (Ford and GM),
AOLTime Warner and Disney reflect that the economy and corporate
America are not completely certain of the recovery story - at
least a strong and sustainable recovery. November's 6% unemployment
number confirmed this. We also have to admit, with unemployment
likely to remain over 5.5% through mid-2003, it will continue
to feel like a recession for many Americans. In addition, it is
important to watch the housing market, which is beginning to see
what are the first signs of cooling. A major slump in this sector
would be bad news.
Yet, the U.S. economy has not experienced a double dip recession
nor do we see one on the horizon. Indeed, real GDP growth will
be around 2.6% for 2002 and we are looking to 2.4-2.8% for 2003.
U.S. worker productivity rebounded strongly in Q3, rising by 5.1%,
compared to 1.7% in Q2 and well ahead of earlier estimates. The
key strengths going into next year will be strong defense spending,
other government spending measures, and a more benign regulatory
environment (as the Republicans control both houses of Congress).
There is already a positive undercurrent of mergers & acquisitions,
asset sales, equity offerings and debt restructurings, though
the stock market will remain volatile, especially in the first
quarter of 2003. Equally important, the new issue market remains
open. Although we expect activity in the new issue market to slow
as the December holiday season begins, we would expect the market
to reopen in January (barring of course a war with Iraq).
Looking into 2003, we see the following trends - a more sustainable
U.S. economic recovery (though below the strong growth rates in
the late 1990s), a gradual return to more predictable profitability
in the corporate sector, the low point in the credit cycle in
Q1, and later in the year a rise in interest rates. Probably the
first quarter will be the most testing for those of us that do
not see a double dip recession. This largely due to the strong
possibility of a war against Iraq, mixed news from corporate Q4
results, and a hesitancy among major companies to resume capital
spending until it is certain that the U.S. economy is really on
track for a recovery. As for Iraq, we see the actual fighting
to be short-lived and decisive, allowing markets to rebound after
a temporary downturn. (We have greater concerns about what happens
in a post-Saddam Iraq due to the traditional rivalries in the
neighborhood.) We should add that if the war is prolonged and
becomes a drain on U.S. resources, this could push the U.S. back
into a recession. Nervousness about the looming Iraqi war has
been a factor in mid-December for a rally in gold and oil.
Considering that 2003 is likely to see a start-up for the 2004
presidential elections, the Republicans are going to be keen on
making the economy improve. President Bush wants to go into 2004
with Iraq settled and the economy in full recovery. The recent
shake-up in the economic team that claimed Treasury Secretary
O'Neill, White House economic advisor Lindsey and SEC head Pitt,
indicates an important shifting of the gears in Washington on
the economy. The new team of John Snow as Treasury Secretary (pending
Senate confirmation), Bill Donaldson at the SEC, and Martin Feldstein
as White House economic advisor is likely to have a better feel
for Wall Street, while having a solid understanding of the non-financial
side of U.S. business. Snow and Feldstein are also expected to
steer a new fiscal stimulus package through Congress, with a value
of somewhere between $200-400 billion and another tax cut. All
of this bodes well for the U.S. corporate bond market, underlying
our constructive outlook for next year, especially post-Q1.
We want to emphasize that while we are constructive on 2003 for
the corporate bond market, the fisrt part of the year has the
potential to be highly volatile. This is based on the uncertainty
surrounding the issue of war against Iraq. When it happens, the
Iraq war will have been one of the most advertised modern conflicts.
Yet, the very idea of war generates a high level of uncertainty,
including everything from oil prices to the potential for new
terrorist attacks on mainland U.S. targets. And we do think that
al-Qaeda, the Iraqi government and fellow travelers have cells
in the United States and Canada. Consequently, investors are likely
to hold their breath in the first part of the year. Advance with
with Yukio Iura, President & CEO of Nippon Angels Forum
Keith W. Rabin
Yukio Iura started his career as a banker at the Bank of Japan
in 1965. In 1982 he was dispatched to the I.M.F. (International
Monetary Fund). From 1989 to 1999 he worked for B.I.S. (Bank of
International Settlement) in Basel, Switzerland as a fund management
officer, in charge of managing eight percent of reserve assets
of the central banks. After resigning from the B.I.S. in 1999
he started the Smart Investors Forum from which he created a group
of more than 400 individual investors who are eager to invest
their assets in the stock or bond market. In 1999 he also started
NAF, a group of angel investors who would assist entrepreneurs
both by investing money and by providing advice. As of June, 2000
this group consists of 450 members and holds monthly meeting to
help match angel investors with entrepreneurs. He incorporated
NAIC in June, 2000, using the core members of NAF. He intends
to assist entrepreneurs more effectively and systematically. Mr.
Iura holds a Bachelor of Economics Degree from Aoyama-Gakuin University.
Thank you Iura-san for offering our readers this chance to
learn about your work. Can you tell us a little about the Nippon
Angels Forum (NAF) and Nippon Angels Investment Co., Ltd. (NAIC)
and your activities over the past few years?
Following my retirement from the Bank of International Settlements
in 1999, I enjoyed a short vacation but soon began to think about
the problems facing the Japanese economy. In time I came to view
one of the primary challenges being the need to promote entrepreneurship.
Japan lags behind the U.S. and many other economies in new business
formations. We have ample capital, but promising companies are
not able to connect with VCs and other investors who are reluctant
to invest in seed stage businesses. This is one of the great tragedies
of the Japanese economy. The consequence is that many good business
seeds are dying because they are not fed enough money to start-up.
As a result I decided to form the Nippon Angels Forum (NAF), which
facilitates matchmaking between angels and entrepreneurs.
addition, I formed the Nippon Angels Investment Company, Ltd.
(NAIC) as a means to invest in the most promising firms. The NAF
now has 450 members. Half of them are entrepreneurs who want the
support of angel investors. Through these members, we identify
promising seed stage businesses, which present themselves at our
bi-monthly matchmaking meetings. The formula is proving very successful
and as a result, we are now receiving inquiries from individuals
who are helping us to establish sister organizations across Japan.
Given current market conditions, investor interest in start-ups
and angel funding in the U.S. and many other markets has grown
very sparse and difficult. Judging from the sense of excitement
and mood of the participants and presenting companies at your
latest event in Tokyo, however, it seems very alive in Japan.
I was impressed by the wide diversity of people in attendance,
ranging from young and middle-aged entrepreneurs to private, corporate
and institutional investors. Do you view angel investing as a
growing phenomenon in Japan and if so, can you explain why this
should be the case when at least for the moment it is declining
in most other markets?
You have to remember that we started from scratch. Not many organizations
in Japan offer a platform for angel investing. Although we are
starting from a small base, Japanese angel investors have found
a place to exchange information at NAF. In U.S. and other markets,
after the IT investment boom went bust, the market was full of
suddenly empty forums. Here, we are only starting, and so the
reverse trend is seen in Japan.
Your web site (http://www.naic.co.jp)
highlights the mismatch between venture capitalists and venture
businesses and talks about your goal of providing business acceleration
and incubation services to startups and firms. It states "no
venture capital companies (VCs) are going to invest in them because
they cannot measure the potential of these venture businesses".
In the past, however, we have seen firms such as Softbank and
Hikari Tsushin in Japan and CMGI or Internet Capital Group in
the U.S., which made many, what can be termed "indiscriminate"
investments in large numbers of firms. Most of them have not performed
well from the standpoint of investors. Can you explain how NAF
and NAIC differs from these entities and why your own business
model should meet with more success?
Softbank and Hikari Tushin had abundant funds and their policy
seemed to be betting on statistics, i.e. ignoring research but
with confidence that a large net will catch a star opportunity
or two which will more than wipe out the losses incurred by the
remaining junk stocks. They had money and time, possessing young
presidents and were happy to take on big risks. On the other hand
we have very limited funding resources, and therefore choose investment
candidates very, very carefully. We have no other measures other
than a determination to make careful and sound investment selection.
Neither NAF nor NAIC can afford to make "indiscriminate"
investments because of our limited financial resources. There
seems no other way but doing extensive research work in advance
and screening carefully. This, we believe will result in successful
Can you give us some specific examples of the types of
companies who have been participating in past NAF's, how they
are selected, their success record in gaining funding, as well
as your own NAIC investments and their subsequent performance?
Our business flow is as follows: First, we organize start-up company
presentations every two months. Each time10 companies make presentations.
We choose these 10 companies carefully out of 60-70 candidates.
Second after each matchmaking session, we select the 2-3 firms
that generate the most positive reaction, who return to make what
we call "deep presentations". Here they are able to
make detailed business pitches to those angels that showed interest
at the initial presentation.
through NAIC we are able to make investments in the most promising
firms. This structure enables angel investors to make direct investments
or to participate in our special purpose funds where they are
able to gain the diversify that comes from utilizing a portfolio
approach. Through these funds we have made investments in more
than 20 companies. I'd like to mention three examples.
First, Business On Line: This company offers quick accounting
services to accounting firms. They also offer OEM services to
the U.S. firm, Intuit. After having set up their company in August,
2000, they have expanded into various small and medium sized firms
and envisage an IPO within 2 years.
Second, Oregadale: This company created a secure Internet messaging
method. They have an alliance with Japan Oracle. Their business
performance to date has been excellent.
Third, Apparel Web: Japanese apparel companies have close business
connections with China. The company helps both Japanese apparel
companies and Chinese counterparts to use Internet technology.
At the moment China takes care of the manufacturing function for
Japanese apparel companies but in the near future China will no
doubt become an attractive consumer market for Japanese companies.
The company provides useful services for both Japanese and Chinese
must have been a major adjustment to move from the Bank of Japan
where you worked for so many years to dealing with the concerns
of these smaller, privately-held enterprises. Can you give us
an idea of the challenges you have had to face?
monitoring the Japanese economy from outside of Japan for many
years, I decided that helping start-up companies and venture capitalists
is one of the most important factors needed to revitalize Japan's
depressed economy. At NAF and NAIC we are trying to revitalize
the Japanese economy from the firm level, for which many of my
colleagues at BOJ have also expressed concern. In Japan with 10
years of almost no growth, high unemployment rate and strong downward
pressure on prices, it is extremely difficult for start-up companies
to build their businesses. But Japanese individuals have huge
assets and I am trying to lead some of those assets to flow into
Your experience as a central banker combined with your
new role as a provider of advice and capital to private enterprises
give you a unique perspective on the Japanese economy. International
media coverage on the Japanese economy has been quite negative
for several years now. Is this justified and how do you perceive
the general outlook moving forward?
I often quote from Franklin D. Roosevelt - "The only thing
to fear is fear itself." Many Japanese economists and professors
together with various media sources repeatedly make negative comments
on Japan's economic prospects. This results in a negative perception
by Japanese people on the future, letting them wait for the worst
to come. In my opinion a vicious circle of pessimism makes Japanese
people weary of taking risks in their investments. Of course the
Japanese have their own problems.
Nonetheless, I feel such problems are common in the U.S and Europe
as well. We all suffer from various problems one after another.
In the past we experienced Oil Crises, the disastrous earthquake
in Kobe, serious deflation after the bubble bust, and a lot of
large companies have been trying hard to restructure and re-organize
to maintain their integrity in a mature economy. Continuing bad
debts, deflation, deep-rooted problems in the banking system,
the weak stock market and a lack of consumer demand and confidence,
are all negative factors for the prospects of venture capitalists.
That is no doubt about it. For us, we just do what we can do with
our limited funding resources. The venture capital market is declining
in Japan. That has affected new start-up companies. We are trying
to make every effort to encourage investors as well as start-up
companies and C level companies.
In a large, complex economy such as Japan's there
are always bright spots, no matter the state of the overall economy.
In fact, some would argue these very problems are driving and
giving rise to many unprecedented and exciting opportunities.
Can you comment on whether you believe this to be the case and
talk about some of the sectors and areas that offer the most potential
to corporate and portfolio investors. If possible can you give
us some examples of specific companies that will benefit from
these emerging trends?
Currently various liquor shops and rice selling shops are beginning
to suffer from changing pricing policies by the government. A
number of these liquor shops' profits are declining sharply. In
addition, "gofuku" or "kimono" shops are suffering
from weak demand from young women. But some of them are trying
to build networks with other similar small shops. Some are converting
themselves into supermarkets or convenience stores. In the case
of "kimono" shops, some are developing brand businesses,
using their well-known names to market handbags and jewelry.
One interesting example is Suzuran International Corp. This company
is a Japanese "sake" producer in Iwate Prefecture. They
are small but produce one of the best sakes in the Tohoku region.
They established a network of small liquor shops and now their
annual sales total 250 million yen. The president of this company
founded a Japanese sake bottler in Australia, where rice prices
are 1/8-1/9 compared with that of Japan. Down there the company
can produce sake at less than half the cost in Japan. By importing
sake produced and bottled in Australia back to Japan, they are
selling via a distribution channel of networked small liquor shops
around Japan. Suzuran International has made individually weak
and unorganized small liquor shops a high performance retail network
by realizing such a unique idea. This is one of the good examples
how one can revitalize scattered and depressed small retailers.
There are various business opportunities in severely regulated
sectors including agriculture, education, and medical industries.
Mr. Taguchi, the former executive officer of Misumi, introduced
the possibility of medical doctors without hospitals. The idea
is to send doctors directly to patients' home. Visiting doctors
can save patients' time.
In Japan, there are many established firms, which are
fundamentally sound, but need to adopt more competitive financial,
marketing and other business practices. In many ways these firms,
which are not dependent on the development of new technologies
and who already possess infrastructure and customer and business
networks would seem to have less risk to investors -- who can
gain dramatic increases in valuations through standard restructuring
practices. Can you comment on the importance of restructuring
and reengineering in Japan?
In the case of Nissan, Carlos Ghosn has been very successful in
restructuring its operation and has made Nissan regenerate profits.
There are many other examples similar to Nissan type restructuring.
Especially construction companies and distribution sectors are
suffering from very weak profits base and many manufacturing companies
need to re-orient their business prospects. Now many consulting
firms are helping such large and small companies to reorient themselves.
I think Nissan is the tip of the iceberg. Gradually that trend
(restructuring and reorienting) is spreading to small companies
Foreign investors do not seem to understand the geographic
diversity offered by Japan, believing that all business is conducted
in Tokyo and perhaps Osaka. Can you talk a little about opportunities
outside of these major metropolitan areas and the attractions
offered by different local economies in Japan?
is no doubt that 25-30% of companies are situated within a radius
of 100 kilometers of Tokyo or in Kanto Plain. Many other parts
of Japan seek opportunities in Tokyo and its suburbs as possible
marketing places to raise funds. However, there is a very good
chance for various Japanese and non-Japanese firms to establish
themselves outside of Tokyo. The central government of course
helps in such efforts, and prefectures and cities are also prepared
to support those who will do business in local cities. The central
and local governments find NAF quite useful to access such private
sector needs. We hope to cooperate with such public sectors and
provide matching coordination for private entities.
Can you also talk a little about the emergence of China,
Japan's relationship with Korea, and other relevant factors as
they pertain to foreign investors that are looking to increase
their exposure in the region and with small to mid sized firms
China has a big presence in Japan and it is my belief that the
emerging China will be favorable to Japan. China and Japan have
been influencing each other through our long-term relationship,
for 2000 years or more. China has always been a good partner of
Japan. China is the main exporter to Japan and Japan exports cosmetics,
underwear, and other vital items to China. We have cultivated
a mutually profitable relationship. South Korea is also clearly
an important partner for Japan, and I hope South Korea has the
potential to become another Singapore in terms of developing a
free economic zone concept.
One major problem foreign investors have when dealing
with Japanese firms is their intense domestic focus and difficulties
in understanding Japanese business and accounting practices and
most importantly, monitoring investments after a transaction is
completed. Cultural and language differences also often represent
a real problem. Do you think that small to mid sized Japanese
companies have a capacity for dealing with outside investors -
both foreign and domestic?
Integrated and international companies such as Sony, Hitachi,
and Toyota, these companies operate internationally and domestically.
But are you aware of the "Ichiro effect", Hideki Matui
, another of our baseball stars, has just signed a contract with
the New York Yankees. Today Japanese individuals are becoming
international stars in many fields. And after the successful World
Cap Soccer Games held in Korea and Japan I feel internationalization
is beginning to penetrate into smaller companies in Japan as well.
Some of the foreign investors and financial intermediaries
we deal with are considering a funds-based approach to investing
in Japan. Through these vehicles they are seeking to achieve additional
diversity as well as the ability to rely upon professionals who
are better able to interact with, and monitor, these companies
and accelerate their long-term performance. From your perspective,
which approach makes more sense for foreign investors and are
their any particular factors, i.e. size of companies and investment,
etc. that are especially important to consider when considering
Definitely we propose a funds-based approach. Look at NAF and
NAIC. We can interact between foreign investors and Japanese companies.
We are in the same group offering various services for growing
Japanese and foreign companies, offering both direct investment
Iura-san, you clearly have come a long way in only a few short
years. What are your plans for the future? How would you like
to see NAF/NAIC develop over the next few years? Do you have any
plans to expand in markets outside Japan?
I have growing confidence in creating a new angels market in Japan
thanks to the past three years' experience at NAF and NAIC. When
the Japanese economy hits bottom, our activities will expand fairly
quickly just like a forest fire. For the moment we are not planning
on exploring other markets, say in U.S. or other part of the world
although in the long run we envisage opportunities in the U.S.
as well as Chinese and Korean markets.
Thank you so much for your time and attention. Do you have
any final points you would like to make to our readers?
Media reports are always very negative and not productive. By
activating sleeping finances, new businesses will bloom. I am
confident that there are enough business opportunities in Japan,
those areas, which Japan has neglected over the past 50 years.
CAN ANYONE TELL US WHY JAPAN'S TECH ECONOMY IS BROKEN? Is Japan's high-tech economy broken? We don't think so. Derailed perhaps. But if you understand the mechanics, you can gain access to amazing opportunities for business and technology in Japan. Nobody else knows Japan like we do. Find out what's going on, direct from Tokyo, weekly and free. Four great newsletters at http://www.japaninc.com.
- Trials and Tribulations
Scott B. MacDonald
was another difficult year for Japan. The Koizumi government's
reforms were consistently attacked and weakened by conservative
elements in the ruling LDP-led coalition, the banking sector remains
a headache, and the hope that export-led growth would trickle
down into the domestic economy and stimulate wider-based growth
appears less and less likely. The fiscal situation has not improved
and Japan's ratings took a beating. Even the opposition (that
is those opposed to the LDP outside of the government alliance)
spent the year in disarray. Yet, not all is lost.
Prime Minister Koizumi remains committed to reforming the Japanese
economy and reforms, though not as strong as originally intended,
have been passed. He still has a team of like-minded reformers
in his cabinet, including Economy Minister Heizo Takenaka, who
clearly wants to overhaul the banking and corporate sectors. Although
Takenaka's comments that no bank or company was too big to fail
roiled the markets and evoked considerable resistance, Koizumi
has remained steadfast in his support for his minister and not
entirely given up on bank reform.
One result of Takenaka's bluntness was that it appears to be pushing
Japan's major banks into reforming themselves. Japan's four major
banks - Mizuho Financial Group, Sumitomo Mitsui Financial Group,
UFJ Group and Mitsubishi Tokyo Financial Group - have all recently
announced plans to restructure and dispose of nonperforming loans.
The banks were already feeling the pressure of plummeting stock
market prices, which was raising the delicate issue of their capitalization.
Then came Takenaka. The combination of market forces and the threat
of greater government intervention helped push the banks into
what is hopefully a better approach to the bad loan problem.
Indeed, Mizuho is undergoing a substantial reorganization to create
a new structure that allows for the efficient provision of banking
and securities services to different sets of clients, ranging
from the biggest corporate customers to small depositors. While
announcing the programs is one step, the real test has yet to
come - implementation. However, there is at least some momentum
on this front, where before it was a glacial pace.
The Koizumi government has also had to deal with road rage. In
early December, there was a dramatic end to the highway debate,
which involved a government panel mandated with the privatization
of four heavily indebted public highway corporations. The four
companies together have a debt of 40 trillion yen ($320 billion).
In a heated meeting, the head of the panel, Takashi Imai, who
favored continuing certain highway projects, resigned in protest.
Imai had earlier sought to present a report that included both
a recommendation to continue road works and to discontinue them.
A clear majority -five out of seven members - objected to this
and regarded it important to send a clear message of the panel's
preference. Consequently, the five forced a vote, which provoked
Imai to resign in protest. However, the majority sent a report
to the Prime Minister clearly advocating the creation of a new
entity to take on the four corporations - debts and assets. The
report also states that the privatized companies should buy highways
back from the new ownership entity 10 years later. This would
be done to force the companies to concentrate on maintaining profitability
from their inception. The task ahead for the Koizumi administration
is to clean up the report, convert it into a bill and present
it to the Diet in the 2004 session, with a view toward privatization
Despite the symbolic importance of the reformers winning the battle
over the panel's report, the opposition to any such reform remains
strong. Influential LDP members are still pushing for new highway
projects. As in anything that threatens the old political economy,
passage of highway reform will face many trials and tribulations.
While the road reform is still moving, the government plan to
overhaul eight public financial institutions, including the Development
Bank of Japan, was shelved. The government stated that -financing
by public lenders was essential- in an environment of continued
economic deterioration. The plan was not completely abandoned,
but the timetable for reform was pushed back.
Although it is easy to be critical of the Prime Minister and his
team for not pressing ahead at a faster pace, it must be remembered
that the task he faces is no less than to remake Japan - to restructure
a political economy in which there are vested interests opposed
to reform - many of them within the ruling party. Ironically,
the LDP, both the backward-looking conservatives and the forward-looking
reformer, need Koizumi. While the conservative hardliners like
Taro Aso (the LDP policy chief) seek to stop reform and look to
a weaker yen to help boost exports again in the forlorn hope of
seeing some type of cyclical growth, Japan's foreign competitors
(especially China and Korea) will continue to make inroads into
their markets. Consequently, Japan is likely to have another year
of trials and tribulations in 2003 - much the same as in 2002.
If only they let Koizumi be Koizumi.
Economy Comes Full Circle: From Domestic Demand Back to Exports
Caroline Cooper, Director of Congressional Affairs and Trade Policy
at the Korea Economic Institute (KEI) in Washington
to Korea over the past year have witnessed a new phenomenon there
- a surge in domestic demand. Domestic demand, rather than exports,
sustained the Korean economy during the worst of the global economic
downturn last year and for the first half of this year. But that
trend is now changing. A recent Bank of Korea report shows that
domestic demand as a portion of gross domestic product (GDP) decreased
from 50.7% in the second quarter to 28.7% in the third quarter.
Exports as a percentage of GDP increased from 49.3% in the second
quarter to 71.3% in the third quarter. The return of exports as
the primary driver of Korea's economic growth brings with it new
challenges and opportunities. If trade is to sustain Korea's growth
over the long-term, new emphasis must be placed on importing and
diversifying Korea's export base.
Once Considered Bad, Consumption Proved Good for a Time
Despite the global economic downturn and a 6%+ drop in real GDP
growth from 2000 to 2001, Korea managed to experience positive
growth in 2001 and through much of this year. This was due in
part to pro-growth policies of the government and a surge in household
spending. The latter was the most surprising.
The Korean economy, which developed from a sustained high household
savings rate, saw that rate plummet as consumer spending and credit
card usage increased. The Korean government encouraged credit
card use, in part according to the Ministry of Finance and Economy,
"to bring the taxable income of the high-income self-employed
more into the open."
The plan worked and brought with it a new credit culture in Korea.
The majority of banks shifted their credit provision policy away
from corporations to households. Koreans - both young and old
- easily obtained credit cards and began spending. The results
were at first positive - private consumption rose to never before
seen levels, facilities investment increased, as did domestic
production. The negative result, most evident in the past two
months, read across the headlines of major global newspapers from
The Wall Street Journal to Korean dailies such
as the Chosun Ilbo: "Credit Card Usage Out of Control."Koreans,
some not yet debt-ridden, were reported as taking on personal
debt to bail out friends in severe financial turmoil - a sign
that individualistic spending habits had taken a firm hold in
Korea. According to the Chosun Ilbo, the average credit
card default ratio rose to a record 7.3% in the third quarter.
The Financial Supervisory Service has stepped in to curb defaults,
imposing caps on cash advance limits and raising the reserve ratio
for credit provision at lending institutions. But these efforts
coincide with a sharp decline in consumption, sparking fears among
analysts that trends will worsen as the government continues its
efforts to reign in spiraling household debt. A recent Bank of
Korea report shows that the consumer goods sales index (measured
year on year) declined by 25% from the first quarter of this year
to the third quarter. According to the Samsung Economic Research
Institute, the consumer expectation index and consumer evaluation
index - leading indicators of consumer attitudes in Korea - each
declined for the fourth straight month in October.
Imports and Exports are Both Good
Korea has long been fearful of an increase in imports, and that
attitude does not appear to have changed. Higher consumption over
the past year resulted in an increase in imports - both of consumer
goods and capital goods. This precipitated a rise in import prices
and fears among experts that a further increase in imports could
threaten Korea's current account balance. According to the Bank
of Korea, this reached a surplus of $459.7 billion in September.
A primary concern has been a worsening of Korea's terms of trade.
While exports - now totaling $117 billion - continue to outpace
imports, the latter grew at a faster rate than exports from the
second quarter to the third quarter. Bank of Korea data also shows
that import prices increased at a faster rate than export prices
during the first three quarters of this year.
Analysts need not be worried. An increase in imports is positive
and normal as an economy's shift becomes more fully developed,
and production focuses more on services than manufacturing. Indeed,
the government thinks that imports are positive. In a recent op-ed
piece, Commerce, Industry, and Energy Minister Shin Kook-hwan
trade policy has stressed the export aspect of trade and
overlooked the magnitude of imports - the country should
shift its trade policy toward an integrated one balancing
imports and exports. The liberalization and expansion of
imports contributes greatly to the honing of national economic
that Korea's economy is changing in the right direction can be
seen in the data. Increases in imports of capital goods and raw
materials are indicative of investment by manufacturing companies.
Minister Shin argues that "cheap, but good quality, raw materials
and machinery component imports contribute to international competitiveness."
The biggest percentage changes in imports from the second to third
quarter were seen in raw materials such as iron and steel and
chemicals (35% and 77% increase month to month), and in capital
goods (43% increase), not consumer goods.
Another positive sign that Korea's economy is changing is that
services now account for a larger percentage of Korea's GDP than
manufacturing. According to the Bank of Korea, services as a percentage
of GDP increased from 55.8% in the second quarter to 64.3% in
the third quarter. Manufacturing as a percentage of GDP now accounts
for only 38.7%.
Diversification Also Includes Services
In balancing its trade strategy, Korea needs to consider diversifying
its export base - common advice given by experts. Korea's top
exports are information technology goods (i.e., computers, semiconductors,
and wireless telephony) and old favorites - heavy industry goods
(i.e., autos, ships, steel, and chemicals). Diversifying this
export base should mean that Korea puts priority on increasing
production of more advanced IT goods and on opening IT service
As has traditionally been the case in Korea, technology is first
developed and tested in the home market before being exported.
As the first country to commercialize Qualcomm's CDMA (code division
multiple access technology) in 1996, Korea used its domestic market
to capitalize on producing wireless handsets. These are now its
top export item. Companies such as Samsung Electronics and LG
Electronics have become world-class producers of CDMA handsets.
Korean's fascination with the Internet and limited landmass provided
it with a logical testing ground to also develop a competitive
wireless communications service industry. Capitalizing on technology
already in place from fixed line broadband, Korean wireless service
providers such as SK Telecom have developed wireless broadband
products for export. But they are not looking to develop new opportunities
in the United States, recognizing that the market there is not
ripe for investment and that the economy is still in a downturn.
SK and other Korean fixed line and wireless telecommunications
service providers are heading to China - now Korea's largest export
market (including Hong Kong) - for business opportunities. They
are smart to do so, especially as the domestic market becomes
more saturated with service options, and demand in China's nascent
wireless telecommunications industry keeps growing. Other Korean
services industries would do well to follow suit, especially finance
and retail, which could profit from increased e-commerce made
available through advanced telecommunications service delivery
Cooper is the Director of Congressional Affairs and Trade Policy
at the Korea Economic Institute (KEI) in Washington. The views
expressed here are those of the author and not KEI or KWR International.
This year's exciting theme
is China Communications Define New Global Standards. Come to meet
and hear from senior telecom and IT executives in charge of Asia
and Pacific markets, and forge new relationships with domestic Chinese
partners. Supported by China Telecom, CNC, China Mobile, China Unicom
and CRC, and sponsored by Nokia, Samsung, China Putian, and Datang,
ChinaTech 2003 is the conference to gain a better understanding
of China Communications market in 2003.
(Un)Happy Birthday? China's WTO Accession One Year Later
Jean-Marc F. Blanchard, Ph.D.
year ago, China embarked on an uncertain journey when it became
a member of the World Trade Organization (WTO). Pessimists argued
forcefully that China's existing economic problems coupled with
the high demands of the WTO would cause China irreparable economic
and, in its wake, political harm.
At the time, China's economic problems included slower rates
of economic growth than it enjoyed over the past two decades,
high un- and under-employment, inefficient and unprofitable
state-owned enterprises (SOEs), a troubled state-owned banking
sector, and government budget deficits. The doubters predicted
that WTO accession would aggravate these problems by requiring
China to open its protected agricultural, manufacturing, and
service sectors, to lower tariff and nontariff barriers, and
to adhere to international intellectual property right standards.
Several analysts even asserted that WTO-fueled increases in
imports and larger numbers of foreign corporations operating
in China would bankrupt many SOEs, massively increasing agricultural
unemployment, and engendering bank runs. In tandem, these changes
would bring about severe political turmoil and perhaps the collapse
of China (see the review of The Coming Collapse of China in
this KWR International Advisor).
Earlier this month, this vision of a troubled future for China
seemed to receive affirmation when 2,000 unemployed textile
workers in China’s Northeastern Heilongjiang province
blocked a major railway line and cut off traffic to protest
unemployment, corruption, and the arrest of follow protestors.
Moreover, the economic problems noted above have not disappeared.
It is indisputable that China suffers from serious economic
and political problems, but the WTO has not yet brought China
to the brink of collapse or anything close to it. The pessimists
were wrong in their views about how disruptive the WTO actually
would be. Moreover, they incorrectly assumed that economic problems
would translate directly into political strife.
Analysts forecast job losses in the tens of millions as a consequence
of China’s membership in the WTO. In actuality, however,
many of these losses had already occurred as a result of the
Chinese government’s efforts to close unneeded factories,
lay-off surplus labor, and terminate relatively smaller money-losing
SOEs. In addition, as the economist Nicholas Lardy has observed,
China had been reducing or eliminating protectionist barriers
throughout the 1990s. This meant that WTO accession did not
produce vastly higher levels of imports and foreign competition.
Furthermore, the Chinese already had allowed the prices of many
goods sold domestically to equalize with the prices of goods
on international markets.
The WTO not only has imposed less pain on China’s economy
than the pessimists predicted, it also has brought about gains.
It has promoted greater productivity, opened previously closed
exporting and partnership opportunities, and facilitated further
inflows of foreign capital and technology. The pessimists also
seem to have neglected the fact that the Chinese government
had a variety of strategies at its disposal to counter the effect
of WTO-induced unemployment. These strategies are manifested
by its further empowerment of the private sector, the enlargement
and improvement of its financial and capital markets, and the
selective fulfillment of its WTO obligations. It also can embrace
strategies like appreciating its currency.
Forced to lend in large amounts to unprofitable SOEs, China’s
banking sector has accumulated at least a 40-50 percent ratio
of non-performing loans to assets. Since the assets of China’s
four big state-owned commercial banks run around $1 trillion,
this means that the Chinese government has about $400-500 billion
of bad loans that must be resolved. This is an incredible 40-50
percent of GDP and is sustainable only because the Chinese populace
has lacked alternatives and believes the government fully backs
their deposits. Pessimists argued that the arrival of foreign
banks would cause a huge outflow of deposits leading to a banking
crisis that would overwhelm the Chinese government.
The WTO has and need not tip the banking system from its current
equilibrium to a state of crisis. That is because foreign entrants
are and will be constrained in the amount of deposits they can
take due to regulatory requirements. It is also unlikely that
foreign banks will want hundreds of millions of small depositors.
The number of high-quality lending opportunities in China also
will serve to restrict the amount of deposits that foreign banks
China’s banking woes are daunting, but the government
has been addressing them. Increased economic growth has helped
as have requirements for the Big Four to set aside increased
loan loss reserves. Going forward, China can sell stakes in
the Big Four, tap into international capital markets to recapitalize
and restructure the Big Four, sell off larger stakes in SOEs
that burden its banks, and collect special taxes to stabilize
its banking system.
Even if the WTO increases unemployment or banking difficulties
over time, the Chinese government can move to reduce unemployment
and stabilize the banking system. Although it is unlikely they
can eliminate these problems, it is another matter to conclude
this will mean the collapse of China or even significant political
The domestic tranquility the U.S. enjoyed during the 1930s Great
Depression highlights that more than unemployment is needed
to foment major political instability. Political fallout from
unemployment in China has and is likely to be controlled as
the government can directly aid, albeit in limited ways, the
unemployed with welfare schemes. It will be very difficult to
organize the unemployed for sustained action as they partly
blame “the market” for their unemployment. The government
can also enact political reforms to allow the unemployed to
vent their anger, and can also utilize coercive tools to repress
The political consequences of banking crises are more uncertain
since a nationwide banking crisis would present more severe
management problems than a local or regional crisis. In any
event, Turkey’s recent banking crisis and South Korea’s
banking woes in the late 1990s demonstrate that banking crises
do not necessarily translate into political crises. Before that
stage is reached, the government can pay individuals whose money
is at risk, or has been lost. They can also ease credit, or
take steps to deflect blame.
There is no doubt China has real economic problems and that
the WTO has presented new challenges and intensified others.
It is unlikely, however, to bring about an economic catastrophe.
Furthermore, it is fallacious to assume that China’s economic
problems will lead to significant political turmoil. Doubters
raise the possibility of unforeseen events such as a war over
Taiwan to challenge more sanguine assessments. Nevertheless,
it is hard to envision many of these “unforeseen”
scenarios. Furthermore, the Chinese leaderships’ intelligence,
willingness, and desire to tackle these problems bode well.
Dreams of a vast China market may be unfounded, but a paralyzing
fear of economic and political chaos is equally unwarranted.
Economic Sustainability Remains on the Agenda
Russian economy has picked up somewhat following a decade-long
decline. However, economists warn that a lot must be done to secure
the country's sustainable development. In 2002, annual growth
of Russia's Gross Domestic Product (GDP) is expected to reach
4 percent -- a drop from the 5.5 percent it achieved in 2001,
which itself was substantially lower than 2000’s 10 percent
Despite this slowdown, Russia outpaced many other nations in GDP
growth for the second year running. However, last year the Kremlin
went ahead with daring reforms, notably implementing a new Land
Code and restructuring the pension system. Moreover, high prices
for gas and oil exports had boosted Russia's revenues. In 2002,
Russia expects its foreign trade surplus to exceed $30 billion
- still lower compared to the $65 billion it generated in 2000.
Correspondingly, according to the Central Bank the nation's gold
and hard-currency reserves rose to nearly $48 billion, almost
quadrupling the level of late 1998.
Riding on top of commodity exports, Russian government officials
have depicted a rosy picture of the country's booming economy.
However, experts warn that continued over-reliance on oil and
gas, may eventually push the nation into a vicious circle of debt
crises and an increasing dependence on commodity prices, a pattern
well known among developing nations.
Russia's financial health has improved significantly since the
1998 crisis, largely due to high world market prices for its main
energy and commodity exports. Its performance since the crisis
has been impressive. However, Nobel laureate Joseph E. Stiglitz,
professor of economics and finance at Columbia University, estimates
that the country's GDP still remains almost 30 percent below where
it was at the beginning of the 1990s. Stiglitz notes that at 4
percent growth per annum, it will take Russia another decade to
get back to where it was before the beginning of transition.
Furthermore, another potential challenge to Russia's sustainable
development is the country's foreign debt level. About $140 billion
is owed to Western governments and banks, the World Bank and International
Monetary Fund. Although Russia has managed to reduce its debt
over the last three years, this debt still represents $1,000 per
Russia is sitting on the world's richest natural wealth, priding
itself with an impressive ranking in the oil and commodity ratings.
It is the world's biggest natural gas producer and exporter, producing
some 550 billion cubic meters (bcm) a year -- pumping over 200
bcm abroad. With the country's proven 12 billion metric tons of
oil deposits, Russia is the world's second biggest oil producer,
generating more than 7 million barrels per day (bpd).
However, most of Russia's oil and metals industries were sold
to well-connected tycoons at dirt-cheap bargains. Oil and metal
magnates have opted to siphon their cheaply-acquired assets out
of the country via obscure off-shore entities – instead
of investing in actual production. Now the top 65 private companies
in Russia are controlled by no more than eight holding companies.
This concentration of ownership rights, the attendant small numbers
of new firms entering the market and the lack of economic diversification
all suggest that, despite its considerable achievements, there
is still much reform work to be done, argued Christof Ruehl is
World Bank chief economist for Russia.
In fact, Deputy Economic Development and Trade Minister Arkady
Dvorkovich warns that the economy will start shrinking as early
as 2004 if the pace of reforms is not accelerated.
If the governmentit wants sustainable growth, argues President
Putin's top economic adviser, Andrei Illarionov, it must cut expenditures
by nearly a third, . He said the government should cut spending
to 25 percent of GDP from the current 35 percent. If the ratio
remains at its present level, economic growth will average 2.9
percent a year through 2015, according to Illarionov's Institute
for Economic Analysis. But if spending drops to 25 percent of
GDP, he believes growth would average 8.9 percent.
President Putin has pledged that the average Russian will "be
happy" by 2010. However, that date is well after the expiration
of his maximum constitutional presidential term.
In 2002, Russia still seemed to be heading toward the light at
the end of the tunnel. Favorable economic factors gave athe Kremlin
yet another chance to secure the country's sustainable development.
On the other hand, Russia faces a problem of the uncertainty over
oil prices, fueled by worries of possible U.S. military strikes
against Iraq. Since Russia is still dependent on oil, it remains
a matter of debate whether the country can sustain its current
level of growth with potentially lower commodity prices.
the Rounds: ASEAN's New FTA Commitments
years of warnings that they were failing to capture the attention
of a foreign investment community increasingly fascinated with
China as a market and production base, the members of the Association
of Southeast Asian Nations (ASEAN) may now stand accused of doing
too much. At an early November summit in Phnom Penh, Cambodia,
the leaders of Thailand, Laos, Cambodia, Myanmar, Vietnam, Indonesia,
Singapore, Brunei, Malaysia and the Philippines not only pledged
to boost intra-ASEAN cooperation - in the areas of tourism and
counter-terrorism in particular - but also committed themselves
to closer economic linkages with the meeting's three guests -
China, Japan and India.
On the surface, the summit was hailed by Cambodian Prime Minister
Hun Sen as "historic" it does indeed appear to have
produced some impressive results. Chief among these is the "Asia-China
Framework Agreement on Economic Cooperation," designed as
a blueprint for the creation of an ASEAN-China Free Trade Area
(FTA) within the next decade. Under the framework pact, negotiations
will begin on the elimination of tariffs on a range of agricultural
and livestock products earmarked for an "early harvest"
program next year. This is seen as a preliminary step toward free
trade and investment in "substantially all" products
and areas by 2010. The pact was particularly kind to ASEAN's newer,
and less developed, members – Myanmar, Laos, Cambodia and
Vietnam – who will be given an extra five years to prepare
their fledgling markets for the initiative. They were also granted
special trade concessions by the Chinese government.
The agreement was far-reaching enough for ASEAN Secretary-General
Rudolfo Severino to tell the press shortly after the summit that
ASEAN had shown, once and for all, that it was taking concrete
action to address the issue of China grabbing an ever-larger share
of the region’s foreign direct investment flow – apparently
by adhering to the old adage that “if you can’t beat
‘em, join ‘em.” Severino argued that the creation
of an ASEAN-China free trade zone would encourage foreign firms
to use ASEAN as a production center and “gateway”
to China’s billions of consumers, while the ASEAN business
community would have free access to the world’s most potentially
That ASEAN firms would stand to gain at least some degree from
China’s elimination of tariffs on their products is difficult
to contest. Trade between the two sides has already evidenced
steady growth, reaching US$38 billion in the first three quarters
of this year, a 27 percent increase on the same period in 2001.
But it may prove more difficult to reap other promised benefits.
The region's firm belief that signing on to an FTA with China
will increase its luster as a production center seems misplaced.
Two factors have driven much of the recent rush to establish manufacturing
facilities on Chinese shores - market access and cost. While theoretically,
ASEAN could indeed act as a "gateway"to the mainland
in an FTA situation, especially considering Beijing's recent ascension
to the WTO, most firms determined on doing business with China
will no doubt elect to set up shop there. The current trend of
shifting production to China has already demonstrated that the
often superior infrastructure and comparatively friendly investment
environments that ASEAN’s more developed members possess
have done little to convince companies that Southeast Asia is
the best place to be based.
In addition, while countries like Malaysia may be able to compete
with China for some time yet as manufacturing centers for high-end
goods such as computer parts, automobiles and electronics, those
that have established themselves as outsourcing centers for more
basic goods such as food and textiles - including Thailand, the
Philippines and Indonesia - will still find themselves unable
to compete with China's skilled labor costs, FTA or no FTA. Even
the members of ASEAN able to compete with China on the pricing
front – Cambodia and Vietnam, for example, both of which
possess burgeoning textile industries – seem set to fall
behind in terms of infrastructure and human resources. This is
to say nothing of the region’s perceived instability, which
could again be highlighted if the Bush administration launches
an attack on Iraq, angering Southeast Asia’s millions of
Muslims in the process.
Less obvious, but still far from addressed, are concerns that
despite the agreement, an ASEAN-China FTA may not arise by 2010
- or at least not in the shape so ambitiously laid out in the
framework pact. Negotiations will commence with agricultural products,
perhaps because consensus on these may be hardest to reach. While
Singapore, unable to produce enough food of its own, may have
no problems slashing excise taxes on Chinese vegetables, the other
nations of ASEAN will no doubt find the process more trying. Farmers
in Northern Thailand are already up in arms over an influx of
cheap Chinese garlic and mushrooms, a situation that their leaders
will no doubt capitalize upon come election time. This pattern
is likely to repeat itself throughout ASEAN as heavily agriculture-based
economies prepare themselves to deal with sudden onslaughts of
Chinese goods. Past experiences in the implementation of the ASEAN
Free Trade Area (AFTA) itself have shown that when the time comes,
certain nations simply refuse to discard sensitive aspects of
their import tax regimes, regardless of their past promises –
witness Malaysia's reluctance to liberalize its auto sector and
the Philippines' backpedaling on its commitments to drop duties
on petrochemical products. What may emerge from the China-ASEAN
FTA, if the 10-year deadline is to be adhered to, is an agreement
so hobbled by compromises and "exceptional cases" that
it does not resemble an FTA at all.
Another potential difficulty is the fact that ASEAN may simply
be too busy – given the likelihood that negotiations on
a FTA with China will be time-consuming and fraught with obstacles
– to give the framework pact the attention it deserves.
Before the ink had even dried on the China-ASEAN agreement, ASEAN
leaders signed on to a Comprehensive Economic Partnership (CEP)
with Japan, which also commits both sides to work toward a FTA
in the next decade. Just a day later, the leaders of ASEAN and
India released a statement after their Phnom Penh meet that claimed
they would also explore the possibility of creating an India-ASEAN
free trade zone by 2012. Add to this the US’s recent unveiling
of the “Enterprise for ASEAN Initiative,” under which
Washington plans to establish FTAs with ASEAN nations meeting
certain economic conditions, and the host of bilateral trade agreements
that individual ASEAN countries have already or are striving to
seal. This includes Singapore with the US and Japan and the US
with Thailand and the Philippines. The result is a host of programs,
dialogues and deadlines that will no doubt tax the region’s
severely limited manpower. Secretary-General Severino himself
has admitted that there are “valid concerns” surrounding
ASEAN’s capacity to juggle so many obligations at once.
The effort to forge partnerships with nations outside ASEAN’s
borders may also take a toll on AFTA itself, which is set to come
into full force in the new year. While many intra-ASEAN tariff
cuts have been implemented successfully, heavy duties on politically
sensitive products remain squarely in place, customs procedures
are still disjointed, and trade in services is no freer now than
it was a decade ago. ASEAN leaders would do well to remember that
their work within the grouping itself is not done – and
plan carefully their efforts to establish FTAs with other countries,
or risk losing the credibility they are fighting so hard to gain.
- Passing An IMF Test
Scott B. MacDonald
early December the International Monetary Fund completed its seventh
review of Indonesia's performance under a SDR 3.638 billion (about
US$4.8 billion) Extended Fund Facility arrangement. This paves
the way for release of a further SDR 275.24 million (about US$365
million), bringing the total amount drawn under the arrangement
to SDR 2.262 billion (about US$3 billion).
The key points of the IMF’s report were that Indonesia’s
macroeconomic developments in 2002 were favorable, with steady
economic growth, moderating inflation, and a strengthening balance
of payments. The IMF report did, however, note that the economic
outlook deteriorated as a result of the recent terrorist attack
in Bali in November. As the IMF stated: “The attack poses
new challenges, which must be met, on the economic front, through
the continued firm implementation of the government's reform program.”
Indonesia was given credit for the important progress achieved
during 2002 in laying the foundation for a durable improvement
in macroeconomic fundamentals, including generally prudent policy.
The recently-approved 2003 budget is regarded as striking the
“appropriate balance between ensuring further fiscal consolidation
to reduce the public debt and providing support for the economy
in the aftermath of the Bali attack.” The terrorist attack
in Bali will clearly have a negative impact on tourism, a significant
source of income for the local economy. The budget also preserves
development and social spending as well as eliminating remaining
fuel subsidies with the exception of those on household kerosene.
The budget also targets an appropriately ambitious non-oil and
non-gas revenue increase through improvements in tax administration
and additional tax policy measures.
The IMF also gave Indonesia a positive nod for the continued recovery
of bank and state enterprise assets. This is important in reducing
public debt levels. IBRA's broad-based loan sale program has been
successfully concluded, with the new priority being the sale of
IBRA's remaining assets and to collect payment from cooperating
debtors under the revised terms of the bank shareholder settlement
agreements. The IMF did note that it was necessary to take enforcement
actions against debtors who remain noncompliant with their settlement
agreements. This remains a problem, especially if Indonesia wishes
to attract greater foreign investment. It also cuts to the heart
of what kind of Indonesia the new democratic government wants
to create. A more sustained effort will also be required to consolidate
the momentum of the government's privatization program, which
was reinvigorated with the sale of a small stake in PT Telkom
and the intended sale of a strategic stake in Indosat. The momentum
of bank divestment has been restored with the sale of Bank Niaga
despite some degree of protests. The focus has now shifted to
the sale of a majority stake in Bank Danamon, to be followed in
2003 with the sale of Bank Lippo and, thereafter, the remaining
The IMF report concludes: "Accelerated progress in implementing
legal and judicial reform and establishing the rule of law is
critical to improve governance and strengthen the investment climate,
which continues to suffer from the widespread perception of judicial
corruption and weaknesses in the legal framework. Establishment
of the Anti-Corruption Commission, ongoing reform of the commercial
court, and revisions to the bankruptcy law will be important milestones
in this effort."
- Big Strikes Weigh Heavily on the Country
Scott B. MacDonald
has become the major political flashpoint in Latin America. Despite
the ongoing civil war-like conditions in Colombia and the long
downward economic spiral in Argentina, Venezuela has come front
and center as leftist President Hugo Chavez is seeking to cling
to power in the face of a determined opposition that wants elections
in early 2003, well before the end of the presidential term in
2006. Outright civil war or a military coup cannot be ruled out,
considering the highly polarized nature of the country’s
political arena. Although we remain hopeful that there can be
a negotiated settlement through the good offices of the Organization
of American States, tensions run high and hardliners on both sides
increasingly lean in the direction that power grows out of the
barrel of a gun.
The opposition to President Hugo Chavez initiated a large strike
in early December, which eventually came to include the country’s
oil industry. The strike at the state-owned oil company, PDVSA,
has in effect taken more than 2.5 million bpd of crude and refined
product out of circulation in international markets. The strike
is also disrupting daily life in most of the major cities and
towns in Venezuela as food and other basic staples of life are
only reaching markets with difficulty.
Venezuela remains a highly polarized political arena, with an
opposition of big business, labor unions, the middle class and
parts of the armed forces favoring an early referendum on whether
President Chavez should leave office. They also expect to win
such a vote, considering that Chavez’s popularity has fallen
from 80% to around 30% in opinion polls. There is a strong feeling
within opposition circles that Chavez and his leftwing civilian
advisors want to take Venezuela through a Cuban-style revolution.
This view has been bolstered by Chavez’s close personal
relations with Fidel Castro, the appointment of a number of leftist
intellectuals to government posts and a foreign policy clearly
geared to anti-U.S. forces in the global arena. Chavez has also
managed to ruffle relations with the country’s oil industry
leadership, claiming that the top executives lived in “luxury
chalets where they perform orgies, drinking whisky.” Rounding
things out, he also has been critical of the Catholic Church.
While poking at the U.S. and the old order in Venezuela, Chavez
has mismanaged the economy. For an oil-rich country, the last
couple of years of higher oil prices have not translated into
a boom. Instead, the economy is in shambles, with real GDP expected
to contract in excess of 8% for the year. The 4th quarter could
see a contraction of 10%, considering the damage to the national
economy from the strike. Complicating matters, the government
is seeking to bridge the fiscal deficit and Venezuela has no access
to international capital markets. President Chavez’s ordering
the army to break up the strike in the oil industry on December
5 only reflects the dire nature of the confrontation Venezuela
faces. The military is seeking to restart the shipment of oil,
but this is proving to be a difficult process.
Chavez, the promoter of his own hazy Bolivarian revolution, maintains
the support of the country’s lower classes, left wing intellectuals
and elements of the military. Having already survived one coup
attempt in April 2002, which briefly ousted him from power, he
is showing little inclination to be caught unaware a second time.
However, Chavez can take little comfort when leaders of the opposition,
such as Carlos Ortega, president of the largest labor union federation,
the Confederation of Venezuelan Workers, states: “The active
national strike continues until the resignation of Chavez.”
The scenarios ahead for Venezuela are either a slow-moving slide
into civil war, another coup, or a negotiated settlement leading
to early elections, probably in August 2003. The ongoing political
uncertainty, of course, is not good news for the Venezuelan economy
or foreign investors. Venezuela has a little over $12 billion
in foreign exchange reserves. This is enough to keep making its
payments on its external debt - in the short term. However, if
the political crisis continues through 2003 and oil exports are
negatively affected, there could be problems on the repayment
front. Above all else, Venezuela depends on oil to generate capital.
The oil industry accounts for around 75% of GDP.
An additional factor concerning Venezuela’s political and
economic crisis is what role Washington want to play. U.S. policy
has been keenly focused on the Middle East. A war against Iraq
could disrupt oil prices and flows from the Persian Gulf. It is
in the U.S. national interest to have some degree of stability
in Venezuela before a new Gulf War, possibly as early as January.
Venezuela accounts for 13-15% of U.S. oil imports and is one of
its major sources in the Western Hemisphere. Having no oil flowing
from this South American country would be bad news with a war
in the Middle East, as it would no doubt push oil prices up even
higher. In turn, higher oil prices could hurt the U.S. economy,
which is in the midst of a sluggish recovery. Consequently, we
see greater U.S. pressure on all the actors, both in the opposition
and in the government. It is not in the U.S. interest to have
Venezuela in the middle of a civil war.
Venezuela has some dark days ahead. The struggle between the Chavez
government and the opposition is now a bitter affair in which
it is difficult for either side to compromise. However, considering
the stakes for the United States and other Latin American nations
as well as the country’s population, a negotiated settlement
could produce results, creating a timetable for an early election.
Getting to the point where a compromise can take place will be
difficult. Until then Venezuela will continue to be Latin America’s
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A Stable Credit in an Unstable Time
an investor's point of view, Mexico has made tremendous economic
and political strides in recent years. Economic growth has surged,
in part because Mexico has benefited from its membership in
the North American Free Trade Agreement. Mexico's crippling
debt load of the 1980s and early 1990s has been reduced substantially.
Employment is at an all time high with unemployment at only
a 3.1% level in September. Inflation has been contained at approximately
4.9% year-on-year. Education levels are slowly improving. And
President Fox was elected in the freest vote in Mexico’s
As a consequence of this improvement, Mexico’s interest
rate spreads have narrowed throughout 2002, unlike several other
Latin American sovereign credits. Furthermore, the credit rating
agencies rate Mexico at investment grade levels (Baa2 with “Moody’s”
and “BBB-“ with Standard & Poor’s). As
of December 2002, only Chile is higher rated in the entire Latin
American region. As its credit fundamentals have improved, Mexico
has become an investor darling, and has issued well-received
debt throughout this past years. We expect the sovereign, Pemex,
Telmex, Cemex and other Mexican issuers to return to the marketplace
Of course, there are problems along the way. Mexico's economic
future, more than ever before, is intimately tied to the United
States. As the US economy slows at year-end, so has Mexico's
and earlier growth economists' forecasts for the year have been
recently reduced from 1.7% to 1.2% GDP growth. This deceleration,
not surprisingly, is directly related to a decline in export-oriented
industrial production. Ironically, one of the consequences of
the improvements in recent years is that Mexico is now having
trouble competing with certain lower wage economies. Most notably,
there have been several media stories recently noting how Mexican
industry and jobs in selected low-tech industries are leaving
for lower wage China. We think this is a natural development
in a rapidly modernizing economy, however, Mexican industry
will have to adapt to worker demands for higher wages and improved
benefits, but there will be an economic cost to this as lower
wage countries continue to compete effectively.
It is also worth noting that the structural reform agenda of
the Fox Administration is hindered by a tense relationship between
the executive branch and the PRI, the main opposition party.
Structural reforms in the areas of electricity, labor and education
are needed to improve competitiveness and to promote economic
In the next month, investors should pay attention to the political
wrangling associated with the next federal Budget. We think
that the Budget, when it is finally passed by year-end, will
include fiscally prudent provisions. Although President Fox’s
administration is assuming a 3.0 % growth rate in Mexico in
2003, it is also proposing a modest 1.9 % real increase in expenditures.
Overall revenues are expected to outpace expenditures slightly.
Also, projected oil revenues, which are critical to the Mexican
economy, are based on a $17.00 per barrel price for the Mexican
oil basket. This is almost $5 below the estimated average for
2002. Currently, the Mexican oil mix is hovering near the $20
level. Unless prices collapse, which is unlikely given the uncertainty
surrounding a potential war in Iraq, it is difficult to imagine
the average oil price in 2003 will be substantially below the
Furthermore, we think the 2003 Budget will include a provision
whereby the deficit target will be increased to 0.65% from 0.5%.
This slight increase should not be alarming to investors. Away
from the budget, investors will also be focused on electricity
reform negotiations. If these discussions go well in the next
few months, it will send a very positive sign to the financial
In short, we expect that Mexico will continue to grow at a steady
pace while maintaining fiscally prudent policies. President
Fox will have to expend political capital to pass much needed
structural reforms, but we think he will be able to do so. The
2003 Budget assumptions are conservative and achievable. At
a time of economic and political uncertainty in much of Latin
America, Mexico stands out as a positive model.
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Banks - Tough Times
Scott B. MacDonald
banks are an important part of the international financial system.
They are critical to the European economy and have been a relatively
sound investment in the past. The relative safety of investing
in German banks, however, is over. The sector is grappling with
difficult structural problems, ratings are under pressure and
spreads are generally wider. We expect things to get worse before
they get better. HVB Group, Dresdner Bank, and Commerzbank will
remain challenged into 2003. Deutsche Bank is in comparatively
better shape, but even Germany’s largest private sector
bank faces a difficult business environment, especially as the
global securities industry has yet to recover. Although we do
not expect any of the country’s major banks to fail, we
have concerns the sector will end up muddling through the next
few years, badly in need of structural reform and growing less
competitive with other European and international institutions.
In late October 2002, chairman of the supervisory board of Deutsche
Bank and president of the German banking association, Rolf E.
Breuer, denied his country’s banks were in a crisis. He
stated “’Banking crises’ is a very risky expression,
because usually people think of 1929. We’re not talking
about a liquidity problem. We’re not talking about a credit
crunch. What we are talking about is a lack of profitability.”
While Mr. Breuer is correct that profitability is a major problem
facing German banks, the crisis aspect of the matter can be
debated. The situation facing German banks is challenging. The
German economy remains troubled, corporate bankruptcies are
on the rise, and investors are clearly worried. HVB Group, one
of the country’s major banks, recently sought to issue
bonds in the U.S. market, but finally balked at the pricing
– equal to where many high yield bonds trade. In addition,
the equity shares of another of the country’s largest
banks, Commerzbank, plunged in October to their lowest level
since 1996 in October. At the same time, the rating agencies,
Moody’s and Standard & Poor’s have downgraded
the credit ratings of most major German banks. If not a crisis,
it certainly feels like one.
The worrisome thing is that banking conditions in Germany are
set to deteriorate further before they get better. On October
22, regional head of corporate clients at Commerzbank, Berkhard
Leffers, stated: “We haven’t seen the worst yet;
insolvencies and risk provisions are likely to keep rising in
2003.” To this he added that the outlook for an economic
recovery in the world’s third largest economy is “very
pessimistic.” Indeed, German banks have suffered as a
loss of investor confidence due to the increasing risk of deflation,
low capital levels, weak core earnings and concerns over the
impact of declining equity markets. Real GDP growth is now expected
to be around 0.4% for 2002 and a little over 1% in 2003. This
is hardly the robust momentum needed to pull the German corporate
sector from its doldrums.
The root of the problem for German banking is structural –
the vast majority of banks are not in business so much to make
a profit, but as to provide credit. The country has over 500
Sparkassen (savings banks), which are largely owned by municipalities
and the 12 Landesbanken, regional banks owned by state governments
and savings banks associations. Together these institutions,
along with a number of other smaller lending institutions, account
for 39% of domestic retail and corporate deposits and 35% of
bank lending. In contrast, the country’s Big Four –
Deutsche Bank, HVB Group, Dresdner Bank and Commerzbank –
account for only 14% of deposits and 15% of loans. While the
public sector banks benefit from state guarantees, which helps
them to contain borrowing costs and lending rates, the Big Four
have no such support and consequently see their profitability
In addition to the public sector vs. private sector mismatch,
German banks are not the most cost-efficient, leaving them with
bloated operating costs. There are also too many of them. Germany
possesses some 2,700 lending institutions. It also has 42,350
branches -- more than any other major industrialized country
Germany’s private bankers increasingly see the need for
change. Commerzbank’s CEO Klaus-Peter Mueller said during
a conference in London in early December that he would welcome
domestic bank consolidation. The statement fueled investor speculation
that the troubled bank may partner up sooner rather than later.
The bank is currently in the process of eliminating more than
6,000 jobs to cut costs and boost returns. Commerzbank reported
a 3Q02 loss of €129 million.
Pressure is also coming from the European Union and the Basel
Committee, a body of major economies that functions as a guide
to international bank regulation. Although Germany’s public
sector banks are being pushed to reform and are phasing out
a number of the state supports, including the guarantees, this
is a multi-year process. There is no quick leveling of the playing
The danger going forward is that what is required to turn German
banking around is likely to take several years and is greatly
complicated by domestic politics. Change means consolidation,
introducing greater cost-efficiency and trimming personnel.
It means charging off a growing pool of bad loans. Consolidation
also means vertical integration between the Sparkassen and Landesbanken.
Politicians from various regions do not wish to surrender their
banks, many of which make critical loans to struggling corporations.
With unemployment at 10%, pulling critical credit lines can
lead to greater joblessness. This is something that does not
win elections for those already in office. Moreover, the closing
of bank branches would only add to the ranks of the unemployed.
Is Germany becoming Japan, where many banks are close to or
are already insolvent and kept alive by injections of public
money and the forbearance of bank regulators? Although deflation
is emerging as a major concern and there is a closer relationship
between the private and public sector than with Anglo-American
economies, Germany is not yet Japan. But, the preconditions
are there, including a slowness to act, political resistance
from elements of the ruling elite, eroding loan portfolios and
steep declines in the value of stockholdings. All this points
to the risk of a self-fulfilling prophecy, in which the fears
of a crisis grow with the slowness of response and bank counterparties
begin the add costs to doing business with what they regard
as troubled institutions. This, in turn, raises obstacles to
accessing international capital markets, which may need to be
tapped to top off capital adequacy ratios.
We return to Mr. Breuer’s denial of a crisis. It is fair
to state that German banking is not in a crisis – along
the lines of 1929. Support from the German government should
prevent that, while pressure from the European Union helps push
reform. However, until local political support for the public
banks is curtailed and reforms are pushed in a more meaningful
fashion, there is a risk that German banks will head into a
crisis. If the banking system of the world’s third largest
economy slips into a crisis, it would be only one more force
pulling the global economy toward a potentially lengthy recession.
In contrast, a German banking system on the mend would have
much to offer in helping drive the European economy and reducing
the current heavy dependence on the U.S. economy as the sole
engine for global .
Buyside Magazine reaches active institutional investors monthly with news and analysis of the equities markets. Buyside takes readers beyond news of the current business climate to report industry and market trends that are crucial for investors to understand -- not simply the latest business trends or product releases. Buyside and BuysideCanada are available in print, and online at www.buyside.com. Subscriber information is available on Buyside's home page.
issue of pension fund shortfalls was given considerable media
time in October when General Motors (GM) declared that its pension
plan may be under funded by as much as $23 billion by year-end
2002. This prompted Standard & Poor's to downgrade GMs
BBB+ ratings to BBB. GM is hardly alone. Over the past couple
of months, a number of major companies have indicated that pension
shortfalls are a growing concern Ford, Maytag and Whirlpool
to name but a few. Pension funding shortfalls are the next issue
which have the potential to disrupt the stock market, due in
large part to the complex nature of funding and accounting rules,
the large size of numbers involved and rating agency reactions.
We would add that although this may cause spread widening, equity
price volatility and negative ratings actions, not all companies
have this problem. Some of the companies with pension plan shortfalls,
like IBM and Boeing, are in much better shape to make up any
differences compared to AMR and Delta, which will be hard-pressed
with a multitude of other problems. The bottom line is that
companies that are already on the margin with their ratings
(for other reasons) are very likely to be negatively impacted
by this issue. Our recommendation is that with any company
that you are examining, take the unfunded portion of pension
plans and treat that as debt. If the impact on leverage is significant,
you should be concerned.
The roots of the pension shortfall are to be found in the excesses
of the 1990s. Many companies used gains from pension investments
to inflate profits. They were allowed to do this by accounting
rules that permitted corporations to mingle pension income with
operating earnings. While this worked well in an upwardly mobile
stock market, it has hurt when the same market has had two consecutive
years of steep declines and 2002 looks like it could be year
number three. This is painfully evident by Standard & Poor's
500 Index of companies with defined benefit plans, which indicates
that there will be a $243 billion shortfall in 2002, the first
The critical issue for many companies is that if the stock market
does not recover, a number of companies will be forced to divert
earnings and cash to make up the difference. This takes capital
away from capital spending at a time when capital spending is
already tight. It also reduces the availability of funds to
help the process of reducing debt. Moreover, the pension funding
issue is a bigger concern to the industrial sector of the economy
than it is to financial services.
We see three major trends emerging from the pension funding
Investors will avoid companies with large gaps in pension
funds unless those companies can clarify that they have
the means to deal with the situation. We have already seen
this in the case of the autos;
Rating agencies are looking more closely at the issue and
are likely to downgrade those companies that are unable
to satisfactorily demonstrate that they can handle the situation
without resorting to a further buildup of debt. S&P
already downgraded GM and placed Ford and auto-parts maker
Delphi on watch for possible downgrades. (Delphis
unfunded pension obligations increased in 2002 to $3.5 billion);
Pension shortfalls can become a political issue if there
is enough pain from the workers and if taxpayers dollars
must make up the difference. This could result in accounting
changes as well as greater regulatory oversight. Pension
shortfalls in the United States do not mean that retirees
stop receiving benefits. Ultimately, benefits are backed
by the Pension Benefit Guaranty Corp (PBGC), a federal agency,
which guarantees benefits for around 44 million U.S. workers
in 35,000 pension funds. The PBGC is paying benefits for
624,000 workers of 2,975 under-funded plans that have been
terminated since the agency was created in 1974.
are seeing companies respond to the pension fund issue. IBM
has stated that it will add as much as $1.5 billion a year
to its pension fund in 2003 and 2004 because it expects declines
in the value of the plans assets. United Technologies
also announced that it would put another $500 million in cash
into its pension plan, taking total contributions in 2002
to $1 billion. Boeing announced that it expects no pension
income in 2003 after getting $500 million in 2002. However,
the lack of pension income in 2003 contributed to a cut in
the aerospace companys 2003 profit forecast.
The U.S. corporate sector has been through a succession of
tough challenges in 2002. Corporate scandals, an anemic economic
recovery, and concerns over a host of geopolitical issues
have created a difficult business environment. Now as Q3 earnings
have a better tone, we have pension fund shortfalls. In reality
this is not a new problem, but something that has been quietly
building up as the stock market has deflated. However, as
the economy remains weak and companies still lack traction
for stronger growth and earnings, the financing of shortfalls
in pension programs will be a major issue. And, like all the
fear and loathing over scandals and the state of the economy,
the scare over pension fund shortfalls has the potential to
Scott B. MacDonald
asbestos issue is not likely to go away any time soon, but there
is some good news. Recent announcements of settlements in asbestos
cases for Sealed Air Corp., Halliburton and Honeywell indicate
there is a positive trend in this direction. Although the settlements
have large price tags, they begin to quantify the costs related
to the issue and start to remove some degree of the uncertainty
that has been hanging over a number of companies and their employees
many of whom were threatened with job losses related to possible
bankruptcies. Equally important, the push on the part of the
companies, with their insurance companies in tow, puts more
pressure on the U.S. Congress to pass reform legislation on
In early December, Sealed Air Corp., maker of Bubble Wrap, agreed
to pay $856.3 million in stock and cash to settle asbestos and
bankruptcy-fraud claims connected with its 1998 purchase of
W.R. Grace & Co.,s food-packaging unit. Grace creditors
and asbestos-injury claimants sought to prove the chemical maker
fraudulently transferred assets before filing for Chapter 11
protection in 2001. What was regarded as positive from the settlement
was that it was well below expectations in terms of cost. Stated
in another way - Sealed Air can afford the settlement.
The news concerning asbestos settlements continued into mid-December
with the announcement that Halliburton, an oil services company
with 85,000 workers, has offered to pay about $4.2 billion to
settle more than 200,000 claims and create a trust to handle
future claims. It was also announced that Honeywell, a diversified
manufacturer with 115,000 employees, agreed to settle a similar
number of claims against one of its subsidiaries and ensure
that all claims against the unit are paid.
Related to these recently announced settlements is the expectation
that the new Republican-dominated Congress may finally reform
U.S. tort law, under which asbestos litigation falls. Both U.S.
business and labor are growing more concerned that asbestos
will be increasingly more damaging in terms of lost jobs. A
recent report commissioned by the American Insurance Association
noted that so far 60,000 jobs had been lost due to asbestos-related
bankruptcies. In addition, the report noted that worse is yet
to come if there is no reform as only about a quarter of the
costs of asbestos claims have yet been paid. The eventual price
tag is expected to range between $200-275 billion. This has
gotten the attention of Congress.
Over the last several years, Congress has considered a number
of bills aimed at creating a system for resolving asbestos claims
outside the judicial system. The Democrats, backed by trial
lawyers, have consistently blocked any changes in the law. The
recent settlements could represent an important breakthrough.
In the Sealed Air case, approval of the settlement is required
from the judge overseeing Graces Chapter 11 case, filed
in U.S. Bankruptcy Court in Wilmington, Delaware and several
creditors committees. If the judges approve the settlement,
there is a strong possibility that other companies in similar
cases will follow suit, seeking to settle out of court. This,
in turn, could provide additional pressure on the Congress to
reform tort laws, which would make sense out of a judicial system
that is largely stacked against the companies. If nothing else
the threat of legislative reform of the tort code could force
12 -14 February
2003 - United Nations Conference Center, Bangkok, Thailand
Small to Medium-Sized M&A Opportunities in Japan
Andrew Thorson, Partner, DORSEY & WHITNEY LLP (Tokyo Office)
in the world and Japanese domestic economy have resulted in
increased opportunities, not only for large but also for small
and mid-sized foreign companies seeking financial and strategic
opportunities in Japan. Foreign investors, once scared off by
linguistic and cultural barriers, the high cost of doing business
and a lack of market access, are now taking a second look.
Distressed assets and strategic tie-ups are hot. In the wake
of Japans so-called Big Bang financial reforms,
investment barriers are slowly loosing ground to market realities.
Nonetheless, closing cross-border acquisitions in Japan is not
easy. Foreign investors must understand the local dynamics.
Here are some tips they should keep in mind:
Find the right advisors. Japan has a rich and complex
business environment embracing both traditional and modern aspects
of business culture. As the sophistication level of M&A
has risen in Japan, so has the importance of in-depth experience
with sophisticated structures and transactions. More importantly,
taking advantage of recent deregulation and newly opened doors
for state of the art transactions in Japan demands that the
acquisition team and its advisors have in-depth experience utilizing
cutting edge tools.
Examples of such opportunities include recently adopted laws
facilitating M&A techniques such as MBOs and the new
shares reservation right (shinkabu-yoyakuken) which has
a function similar to that of an option. To name only a few
of the other significant advances, the Japanese Commercial Code
has been revised to: permit a two-tier governance structure
similar to the U.S. model comprised of directors and officers;
prescribe stock-for-stock acquisitions; and relax burdensome
restrictions on contributions-in-kind, stock options and the
issuance of preferred and other types of stock. Most notably,
Japan has also enacted a new Civil Rehabilitation Law, which
can expedite the restructuring of debt-ridden companies. Recent
changes in accounting rules are also anticipated to facilitate
This new environment provides opportunities for foreign investors
to engage in creative strategic and financial investments. Optimizing
the acquisition possibilities requires a team, which is equipped
to think outside the traditional box in Japan. Unfortunately,
such professional advisors in Japan are not inexpensive, and
there is a shortage of qualified, experienced and bilingual
service providers. Accordingly, it is important for small to
mid-sized investors to consider potential transaction costs
in the planning stages.
Communicate on a business level. It is said that Japanese
executives prefer to do business with people that they know.
During business negotiations, the Japanese negotiating team
will often try to establish direct personal ties with foreign
counterparts. If foreign negotiators fail to engage in effective
personal interaction, Japanese counterparts might doubt their
sincerity. Worse, they may be reluctant to provide frank information
to the acquiring company.
In addition, Japanese companies also tend to rely less on outside
attorneys and advisors. As a result, phrases like our
attorneys or our advisors will be contacting you
regarding this are heard less often. The hurdles to closing
a deal are often overcome without lawyers present in a less
formal setting outside of the conference room. In practice,
deal-killer issues are often resolved informally by smaller
groups over a discrete dinner or whisky and water.
Effective communications requires establishing personal ties
at not only the executive, but also the managerial and operations
levels. There is no substitute for an acquisition team, which
can expedite person-to-person contacts with, and learn first-hand
knowledge from, the target company itself. This is one aspect
of doing business in Japan in which small to mid-sized companies
that have a "hands on" management might find they
have a natural advantage.
Keep concepts simple. Japanese executives often disdain
complex, legalistic proposals. Instead, one often hears Japanese
executives state we should work things out together
as Japanese do. Typically, this requires compromises together
with a deference to trust and pre-existing relationships.
The emphasis in Japan on informality and simplicity in cross-border
M&A arises from both practical and cultural causes. On the
practical side the parties often negotiate in English. Like
international executives from most countries, many high level
Japanese businesspeople are fluent in English. However, negotiations
are more manageable when the documentation and proposals are
in plain English and do not include convoluted provisions
and concepts. Quite often the Japanese team faces a greater
disadvantage than might the typical European or American negotiators
when having to deal in the English language.
More than likely, the transaction will be reviewed at various
levels by senior executives within the Japanese corporation.
These executives may be unfamiliar with and even suspicious
of Western ways of dealing. And it is quite likely that they
will be unfamiliar with the mechanics of Western-style mergers
and acquisitions. Senior Japanese executives are more likely
to okay a transaction if it is as straightforward as possible.
Understand the dynamics of your counterpart. Some Japanese
companies are trying to encourage greater flexibility in decision-making.
But many large Japanese companies still operate under a burdensome
managerial hierarchy. While Western companies give mid-level
executives discretion to negotiate deals based on their independent
judgment, Japanese negotiators may be expressly or implicitly
required to consult closely on minute details with senior executives
before accepting any proposal.
Negotiating in this environment is usually challenging for Western
executives. In addition to patience, a few simple techniques
may minimize frustration.
Western negotiators should put their proposals on the table
early to allow a timely response by their Japanese counterparts.
Western negotiators also should avoid surprises. That will help
their Japanese counterparts, who must achieve consensus among
senior executives. Reaching a new consensus often requires time.
Worse yet, going back to the executives provides them an opportunity
to raise additional new issues.
For the reasons above, the Japanese negotiating team itself
may also seek to minimize the involvement of its executive decision-makers.
This urge to avoid senior executives may lead Japanese negotiators
to reject even reasonable requests out of hand. Surprises can
kill a deal.
On the contrary, it is not uncommon for a Japanese negotiating
team to raise untimely last minute demands based upon suggestions
by executives who have not been involved in the transaction
to date, but who also cannot be ignored once they become involved.
Sometimes Western negotiators misinterpret these untimely proposals
as a bad faith change in the deal terms. Quite often it is simply
a matter of poor management of the negotiating process.
Understanding the source of a counterparts reactions to
proposals and untimely demands requires patience. It is also
an essential requirement for determining appropriate responses.
Understand the inter-company relationships. In Japan,
companies in certain industries often form a tight web of relations
with affiliates, customers and suppliers. Such networks are
loosely referred to as keiretsu. In cases where
suppliers and customers own stakes in each others companies,
these ties are obvious. But companies often maintain less obvious
ties by sharing technology, production and management. Inter-company
debt guarantees are also common.
Commonly, ongoing transactions and other important relationships
within networks are poorly documented or not documented at all.
Nevertheless, investors should strive to evaluate and clearly
understand these relationships and the inherent liabilities
early in the acquisition process. Otherwise, foreign investors
may learn about such issues only at the last minute when closing
appears inevitable. Such untimely disclosures do not necessarily
indicate bad faith. Often, it reflects the complex nature of
the Japanese keiretsu. Even the target company itself might
fail to understand or appreciate the impact of keiretsu relationships
on the proposed deal.
Accordingly, early clarification of these relationships is absolutely
crucial. Investors must confirm transactions that are not at
arms length, insider deals, and inter-company guarantees, etc.
Unfortunately, Japanese companies also provide notoriously conservative
and vague disclosures. To avoid misunderstanding and stonewalling
later, investors should consider walking the target companys
management through due diligence requirements in the planning
stage. Management interviews are also an important means for
understanding the target company and for finding any hidden
land mines not disclosed in documentation.
Japan is truly a complex blend of the traditional and modern
and often defies Western attempts to fully understand it. Nevertheless,
the right team and knowledge of the basics can help ensure that
valuable transaction time is not wasted and that deals that
should have happened are not lost. Hopefully, this article has
offered a useful guide, but these are only generalizations.
Each situation must be evaluated first-hand by qualified individuals
with extensive knowledge of Japanese language, culture and business
Emerging Market Briefs
Scott B. MacDonald
Passing of an Era: General Ne Win, long time dictator
of Burma and then power in the shadows, has finally died at the
age of 91. He rose to power as one of a group of former students
who fought with the Japanese against the colonial British during
World War II. Joining the Burmese military in its early days,
he became one of the key players in Burmas politics. In
1962 he took power and quickly moved Burma into many decades of
self-imposed international isolation. The Ne Win regime used a
blend of socialism and Buddhism as an ideological fig leaf, while
the top-ranking members of the military pursued their own set
of development activities. Ne Win developed his own reputation
for liking good food, gambling and women. This was a sharp contrast
to the long-term downward trajectory of the Burmese economy and
difficult living conditions faced by most Burmese.
Although Ne Win kept his country non-aligned during the Cold War
and avoided embroiling it in any major conflict, there was a significant
price. On the economic front, Burma missed the boom starting in
the late 1970s that lifted the economies of most of Southeast
Asia and made substantial improvements in daily life. On the political
front, Burma long remained a bloody arena of contending regional
and ethnic factions, some of whom relied heavily on the international
drug trade for funding. Ne Win frequently purged his regime. Despite
the brutal approach to any opposition (real and imagined), his
regime was unable to completely control the country. By the time
Ne Win resigned in 1988, Burma was regarded as one of Asias
most backward countries and the country was strongly identified
as a core part of the infamous Golden Triangle for the global
heroin trade. Since his resignation, Ne Win and his family sought
to maintain some control over the military junta and he is regarded
as an obstacle to opening up the political system. Recently, members
of Ne Wins family were arrested, indicating that old dictators
actually due fade away.
Chile Finally a Free Trade Agreement With the
United States: After more than a decade of trying, Chile and the
United States finally appear to be on track for a free trade agreement.
It was announced on December 11th that the two countries had reached
an agreement. If approved by the U.S. Congress, the agreement
would eliminate tariffs immediately on 85% of goods traded between
the countries and tariffs on all goods within 12 years. This is
positive news for Chile. The North American country is Chiles
major trade partner, with the total of goods and services traded
between the two standing at close to $9 billion.
China Industrial Production Up: Chinas industrial
production rose 14.5% year-on-year in November. It is expected
this strong performance in manufacturing should ensure that China
finishes 2002 with real GDP well above 8%. This is far above most
other Asian nations. Real GDP has benefited from steady domestic
demand and recovering exports.
China Big Time Entertainment Goes to China: On December
6, it was announced that Universal Studios plans an $870 million
amusement park in Shanghai. The park could open as early as 2006,
spanning a two-square-kilometer patch in Shanghai's booming Pudong
development area. The move comes after months of negotiations.
Universal is expected to invest less than $100 million on the
Shanghai park as it has partnered with the logistics company Waigaoqiao
Group and developer Shanghai Jinjiang Holding Co., which will
together own a majority stake in the project. Universal would
retain around one-third of the project and supervise its operation.
Disney is also in talks to build a park in Shanghai, a move that
is likely to upset officials in Hong Kong. Disney is already constructing
a Disneyland on 310 acres near the Hong Kong airport. That park
is due to open in 2005. The Hong Kong government awarded Disney
substantial incentives to come to Hong Kong, counting on a HK$148
billion ($19 billion) boom in tourism, particularly from China.
Disney, however, did not sign an exclusivity agreement, meaning
it can also build copycat parks in the mainland.
These developments come amid a development boom in Shanghai. Hong
Kong-based Sun Hung Kai Properties said this week it will spend
HK$8 billion ($1 billion) to develop a project in Pudong. Universal
is also in discussions to build a park in Beijing.
Saudi Arabia Feeling the Heat: The Saudi government
is increasingly under pressure about its ability to deal with
Islamic radicalism. The latest flap came from revelations that
money donated by a Saudi princess possibly ended up in the hands
of an Islamic charity that helped finance one of the 9/11 terrorists.
Although the Bush administration officially claims that Saudi
Arabia is still a good ally, tensions have risen since 9/11 between
the two countries. In particular, the high number of Saudi nationals
involved in the 9/11 attacks (a clear majority), the track record
of Saudi money going to radical Islamic groups outside of the
country and a rising number of attacks on Westerners inside the
Kingdom have fueled Western criticism of Saudi Arabia for turning
a blind eye to the rise of anti-Western groups. Now, German
prosecutors are investigating possible links between the alleged
al-Qaeda terrorist on trial (Moroccan Mounir al-Motassadeq) and
diplomats and Islamic activists from Saudi Arabia. The Saudis
find themselves in a difficult situation as they are caught between
Western pressure to clamp down and domestic discontent with the
U.S. push to go to war with Iraq. In addition, many Saudis see
the ruling royal family as corrupt and unable to manage the economy.
This is compounded by the lack of political freedom, which has
pushed tensions just beneath the surface. Saudi Arabia will be
a country worth watching in 2003, especially if the U.S. goes
to war with Iraq.
Singapore Cutting its Growth Forecast: Singapore remains
highly vulnerable to the ups and downs of the international economy.
Along these lines, 2002 was a trying year as export expansion
did not meet initial expectations due to the sluggish nature of
the U.S. economy. In addition, the regions growing political
worries related to rising activity by radical Islamist groups,
including the bombing in Bali, have put a dent in the city-states
tourist trade. Many travelers use Singapore as a hub from which
to visit Indonesia, Malaysia and Thailand. Exports to the U.S.
shrank by 5.7% in October. Considering all this bad news, the
Government of Singapore has cut its real GDP growth forecast for
2002 from 3-4% to 2-2.5%.
Coming Collapse of China, by Gordon Chang (New
York: Random House, 2002) 368 pages. $26.95
by Jean-Marc F. Blanchard, Ph.D
Click here to purchase
Coming Collapse of China,
directly from Amazon.com
is at stake in Chinas future: huge foreign investments,
billions of dollars of trade, the global energy equation, the
lives of more than a billion people, and the geopolitical situation
in the Asia-Pacific region. It is not surprising, therefore, that
policymakers, academics, and writers devote so much attention
to this topic. What is surprising, however, is how individuals
looking at the same facts can arrive at such diametrically opposed
conclusions. On one hand, some envision a bright future. On the
other, some see a looming disaster on the horizon.
In The Coming Collapse of China, Gordon Chang forcefully
argues the pessimists case. For Chang, glitzy Shanghai,
increasing foreign trade and investment, and a developing high-tech
sector do not represent the real China. Instead, the real China
is characterized by increasing unemployment and underemployment,
massive banking problems, failing state owned enterprises (SOEs),
corrupt and repressive Chinese Communist Party (CCP) rule, dissident
movements like Falungong, and separatists in Tibet and Xinjiang.
Indeed, the situation is so critical that Beijing has about
five years to put things right. Unfortunately, he believes,
the shock of Chinas WTO obligations, the governments
lack of fiscal resources, the straitjacket of Communist Party
ideology, the Partys lack of ideological authority, and
the power of the Internet mean there is no hope. China is a lake
of gasoline and one individual will have only to throw a
Before taking the money and running, however, businesspeople and
policymakers need to consider the following. Chinese leaders and
bureaucrats are not hamstrung by ideology and are well aware of
the problems they are confronting. Second, Chinese elites are
moderating the effects the WTO has on the country. Third, however
gradual, China truly is reforming its SOEs, establishing social
safety nets, and changing the political system (e.g., by incorporating
private entrepreneurs into the Party). Fourth, the Party retains
solid control over all the instruments of coercion. Fifth, although
the outside world in the form of the WTO will pressure China,
the outside world in the form of international investors and financial
institutions, and neighboring countries also will help.
As for the merits of Changs analysis, it is important to
remember that multiple and potent domestic and international factors
have to come into alignment for states to collapse or regimes
to fall. In addition, unemployment, even massive unemployment,
or dissatisfaction with the CCP does not necessarily translate
into revolutionary political action. Moreover, the existence of
fiscal deficits does not mean the Chinese government has run out
of policy options for reflating its economy. Finally, it is true
that Marxist-Leninism cannot provide any legitimacy for the CCP,
but there are other factors such as nationalism and performance
legitimacy that can.
The Coming Collapse of China is repetitious and contradictory
at times. It does not offer much new information, and contains
some noteworthy factual errors. Nevertheless, I still recommend
its purchase for three reasons. First, it is an entertaining book
full of colorful anecdotes and quotable statements. Second, it
highlights, in one place, all the major challenges that now confront
Chinas current leadership. Third, it forces us to think
about the effect that Chinas WTO admission will have on
the country. The Coming Collapse of China may not be an
apt title, but A Dramatically Changing China would be a
hard title to dispute.
Eye of the Storm by Owen Bennett Jones, (New
Haven: Yale University Press, 2002) 328 pages $29.95.
by Scott B. MacDonald
here to purchase Pakistan:
Eye of the Storm directly
was long a forgotten backwater in global politics and this was
amply reflected by a sparse literature concerning the country.
The Soviet Unions invasion of Afghanistan in 1978, however,
changed this. Afghanistan soon became a center of attraction
for both academics and journalists. Having the Taliban in power
only helped this, considering the quirky and ruthless nature
of the regime. Now, it would appear it is Pakistans turn.
Long the realm of a handful of academic works and a rare journalistic
sortie, Pakistan is becoming a topic. Indeed, it
is important to have a better understanding of this strategically
located country in South Asia which borders Afghanistan, Iran
and India. Owen Bennett Jones, a journalist who has worked for
the BBC, Financial Times, and The Guardian, has written what
is likely to be one of the better new books on Pakistan. Pakistan:
Eye of the Storm is well-written, thoughtful, and thought-provoking.
While critical of much of what he sees, he clearly is not anti-Pakistani,
making his book credible.
The fundamental thrust of Jones book is that Pakistans
creation as a country was done so in such a fashion that its
insecurity would remain a central preoccupation of the ruling
elite. This insecurity is broadly defined as a long and vulnerable
border with India (especially for East Pakistan which became
Bangladesh), the frequently fractious nature of its ethnically
mixed population (divided between Punjabis, Baluchis, and many
others), and lack of strong institutions beyond the military.
The overwhelming military threat from neighboring India, with
its longstanding dispute over Kashmir, clearly helped maintain
the Pakistani militarys central and usually dominating
role in its nations politics. Hence, the arrival of General
Pervez Musharraf upon the scene in 1998s coup was no surprise
nor was it a departure in the countrys political tradition.
The other related thread running through the book is the battle
over Pakistans soul fought between those who envision
a modern country and Islamic radicals, who would prefer a hardline
Muslim state, governed by sharia.
Within this complex country, the forces of Islam are having
their own civil war. On one side is Musharraf, who has clearly
sided Pakistan with the West and a more tolerant world order,
and the Islamic radicals on the other. In a sense, Huntingtons
clash of civilizations is fully believed by the radicals. As
one Islamic radical leader stated: We believe in the clash
of civilizations and our Jihad will continue until Islam becomes
the dominant religion.
Jones concludes that Pakistan is likely to remain in search
of a national unifier. Neither Islam nor Urdu has brought greater
national cohesiveness. Musharraf does have a vision of a more
modern, developed Pakistani nation, less divided by ethnic and
religious strife. Yet, Jones ends his book: If General
Musharraf is to transform his vision of Pakistani society into
a reality he will need great reserves of political will, and
a more effective bureaucracy. He has neither. And while he still
believes that the Pakistan army is the solution to the countrys
problems, he shows no sign of accepting that, in fact, it is
part of the problem.
Pakistan is an important country in what has become a critical
region in international relations. We strongly recommend Jones
Pakistan: Eye of the Storm.
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