China: the ultimate value investor?

The US has been called the world's largest venture capitalist. Should China now be considered its largest value investor?

For a look at the implications of Chinalco's proposed investment in Rio Tinto, check out my recent piece at zzzeitgeist.

On South Africa and the ANC

On Monday morning, it seemed as if the long leadership/personal battle between ANC factions had been settled. South Africa's dominant political party, led by supporters of Jacob Zuma, succeeded in forcing the resignation of President Thabo Mbeki, the man who has run the country since Nelson Mandela left office in 1999. Jacob Zuma would almost certainly assume the presidency in 2009, after a brief care-taker run by Kgalema Motlanthe, deputy leader of the ANC and Zuma loyalist.

By Tuesday afternoon, the country was in the midst of a full-scale political crisis (and possibly on the brink of a financial crisis). 14 ministers resigned over the manner of Mbeki's ousting, including Trevor Manuel, the world-respected finance minister who is widely credited with South Africa's macroeconomic success. So spooked were the markets by Manuel's reported departure, that the Rand sank 3% in less than an hour. When Manuel's press secretary publicly stated his willingness to serve on, the Rand bounced back. But the shock of his departure illustrated just how unstable South Africa's macro success is. It also signalled a period of political instability in Africa's largest economy.

The ANC has dominated South Africa's political scene since the fall of apartheid. Under Mbeki's leadership (which to many extends back well into Mandela's presidency- Mbeki essentially ran the economy as Mandela's deputy), the party embraced liberal macro policies and fiscal discipline. Manuel's stewardship of the economy isolated the influence of the trade unions and old revolutionary communists that dominate the ANC's rank and file, satisfying foreign investors and an emergent (but tiny) black middle class.

But Mbeki's ANC has always been an uneasy alliance. Zuma's resurgence has been driven by a revolt of sorts by the trade unions and rural base. He carries the torch for the old school ANC, concerned with equity and workers rights rather than macro stability and foreign capital. Mbeki and his liberal policies had become so detached/isolated within the ANC, that his ousting was probably inevitable. While he was playing peace-maker in Zimbabwe, Zuma loyalists were orchestrating his demise. Unless the legal proceedings against Zuma return with a sense of legitimacy, he will assume the presidency next year, and the party base will expect a return to the ideological roots of the revolutionary years.

Zuma will have to be attendant to the interests responsible for his rise to the presidency. They want greater spending (difficult given ZA's already troubling deficits and reliance on foreign capital), a renewed focus on jobs and equity (desperately needed), and the abandonment of an inflation-targeting monetary policy (potentially disastrous). But few doubt he will fully reverse Mbeki/Manuel's macroeconomic policies. Zuma himself has been at pains to assure foreign investors and business leaders of his commitment to austerity and monetary discipline.

The real risk to South Africa is a political split within the ANC. This is more likely than it was last fall, when the party seemed united behind Zuma. While woefully unpopular, Mbeki's ousting reeked of revenge and opportunism, and the resentment over this spread beyond the former president's allies. Archbishop Desmond Tutu (Nobel laureate and South Africa's moral authority) was widely quoted as warning, "The way of retribution leads to a banana republic". The mass resignation of ministers was largely protocol (and a show of loyalty to Mbeki), but the former president's allies are unlikely to passively fall in line behind Zuma.

More importantly, the ideological split that has festered beneath the surface of the ANC has now burst into the open. This may be harder to reconcile than old grudges.

Whatever the ultimate outcome of this leadership struggle, South Africa's post-apartheid stability is in real trouble.

On Russia, Part I: investment climate

As readers of IPE Journal will know, I am fascinated by Russia (see here). The geopolitical and economic implications of Russia’s rise are immense, and its actions are both bold and confusing. This is the first in a series of pieces on the implications of Russia’s resurgence. Part I: Russia’s investment climate.

The Russian investment climate has been shaped by a number of startling developments over the past five years. The Yukos affair, re-nationalization of strategic industries such as energy, questionable legal proceedings against foreign energy companies operating Russian oil and gas fields, and most recently the deterioration of the TNK-BP joint-venture have all increased uncertainty over the integrity of Russian contracts and vulnerability of assets to expropriation. The 2005 “gas war” between Russia and Ukraine signalled to many the political levers behind the commercial actions of state-run companies like Gazprom. Prime Minister Vladimir Putin’s verbal assault on Mechel Co. (the Russian steel maker) last month knocked $6bn off of its market cap in mere hours of trading. And just last Monday, Russian authorities formally sanctioned the British Chief Executive of the TNK-BP joint-venture.

However, Russia has been a top destination of foreign direct and portfolio investment. FDI has grown over 800% since 2002. By 2006 it accounted for over 3% of GDP (comparable to China). From 2005-2006, net capital inflows rose sharply from $300m to $40bn.

There are a number of explanations for the increase in capital inflows in spite of rapidly rising political risk. Russia’s economic fundamentals are sound, growth large, external debt low, and foreign exchange reserves the third largest in the world ($58bn). Additionally, its capital markets (particularly corporate bond markets) are underdeveloped, and thus foreign investors provide the bulk of corporate finance to Russian companies. Finally, low real interest rates in the U.S. and Japan have driven capital into emerging markets in search of higher returns, and Russia has been among the best performing markets in recent years.

But Russian military action in Georgia appears to have finally reversed investor sentiment. Chris Palmer, head of emerging markets at UK fund manager Gartmore, says, “Absolutely the worst thing that can happen to a political economy is that it is involved in any kind of military activity”. Since the beginning of August, the RTS index (Russian benchmark equity index) has fallen 18.2%, including a 6.6% drop on the day President Medvedev recognized the breakaway provinces. Russia’s central bank reports that the country lost $16bn in foreign capital following the incursion into Georgia, the largest and most rapid withdrawal since the 1998 crisis. August also brought the largest monthly decline in the ruble in almost a decade. Perhaps most important to the real economy, Fitch said last week that rising tensions between Russia and the West could significantly undermine corporate borrowing conditions.

This dramatic reversal signals that foreign investor perceptions have finally converged with the actual level of political risk in the Russian economy. According to Keynes, investor confidence is largely based on the assumption that present circumstances will continue unchanged into the future. In other words, perception (not probability) drives the risk tolerance of foreign investors. For years investors have been willing to swallow a higher risk premium because Russian performance was high. But Russia’s military actions have altered this risk calculation, and the potential for political isolation has injected even greater uncertainty into capital allocation.

The negative impact of declining investor sentiment on Russian growth is likely significant. Deteriorating corporate borrowing conditions will hit Russian companies hard. As Patrick at Zeitgeist noted yesterday, the financial interests of the Russian elite are not served by poor corporate performance. However, the Kremiln has yet to demonstrate a willingness to adjust policy in reponse to declining investor sentiment. Even in the energy sector, where foreign capital and expertise is critical to upstream production, the Kremlin has pushed ahead with its aggressive expropriation and nationalization agenda.

Therefore, with the stand-off between Russia and the West unlikely to diminish any time soon (more on this to come), the Russian investment climate will be among the more immediate casualties of the escalating tensions. It will be interesting to see if Russia turns East for long-term corporate finance (to SWF’s and Chinese banks), and whether the economic policy divisions between the liberals around Medvedev and the Silvoki under Putin will burst into the public. Russia’s vast foreign exchange reserves will undoubtedly cushion it from any short-term risks. But the lack of a developed corporate finance market and banking sector will heighten the long-term impact of capital outflows. While the West has struggled to respond to Russia’s resurgence, foreign investors have cast their judgment.