More Updates: Kenya/Sovereign Wealth Funds/Emerging Economies

Stephen DeAngelis

October 23, 2009

This is the third in a series of blogs that update past posts.

Kenya

In a recent series of posts, I examined developments in East Africa, a group of countries that includes Kenya, Uganda, Tanzania, Burundi, and Rwanda. There has been some talk of forming a federation among these states (see the post entitled The Plight and Hope of East Africa). Kenya is the key to East African prosperity because it has the best access to the sea for many of the landlocked states there. In the posts about East Africa, I noted that it is a region that has not attracted much foreign direct investment. That could be changing thanks to China. China is not only interested in oil that has been recently discovered in Uganda, but also in Congo’s timber, iron ore and other minerals as well as oil coming out of Sudan. The best path for those resources to get from their place of origin to China is through a yet-to-be-developed transportation system in East Africa. Construction of the first piece of that transportation network is now in talks [“Kenya and Beijing in talks to build and transport corridor,” by Barney Jopson, Financial Times, 15 October 2009]. Jopson reports:

“Kenya’s government is in talks with Beijing over development of a multibillion dollar port and transport corridor that could provide a new export route for Chinese oil. The cash-strapped Kenyan government opened negotiations with Qatar over a potential $3.5bn (£2.2bn, €2.35bn) investment in the port project late last year, in return for a lease on 40,000 hectares of land to grow crops. But no deal was struck and Raila Odinga, the Kenyan prime minister, indicated to the Financial Times that he now viewed China as better suited to the project. ‘The Chinese offer the full package,’ he said, referring to the combination of financing and technical expertise that state-backed Chinese banks and construction companies have rolled out across Africa. A Kenyan delegation led by Mr Odinga flew to China … for talks on the project, involving the construction of a port in the tourist area of Lamu, and road and rail links to Kenya’s borders with Ethiopia and southern Sudan. China’s engagement with the continent has gathered pace in recent weeks as it has pursued a multi-billion dollar deal for oil, mineral resources and infrastructure in Guinea and a bid for up to 6bn barrels of Nigeria’s oil reserves. Kenya does not have the proven mineral resources that have attracted Chinese companies elsewhere. But China has extensive oil interests in neighbouring Sudan, it is an important lender to states such as Ethiopia, and Chinese contractors are gaining a dominant position in public works projects across east Africa.”

Despite the fact that test oil wells in Kenya have continued to come up dry, the China National Offshore Oil Corporation is going to begin drilling exploratory wells in northern Kenya. Jopson also reports that the corporation has exploration rights for a second block in the Lamu basin. The big news items, however, are the proposed port and transportation links.

“The Lamu port and the road and rail links – dubbed Kenya’s ‘second corridor’ – would kick-start the development of northern Kenya and accelerate economic growth in connected regions of Ethiopia and Sudan. It could also provide an alternative route for oil out of southern Sudan, a semiautonomous region due to vote on independence from the Khartoum regime in a referendum in 2011.”

For more on southern Sudan, read my post entitled Looking Forward to “New Sudan.” Whether or not current talks between Nairobi and Beijing bear fruit remains to be seen. According to Jopson, they are in a very early stage. The fact that Kenya continues to suffer from political turmoil doesn’t help. For more on that subject, read the post entitled Trouble in Kenya. As East Africa’s most important country, Kenya’s recovery from its political turmoil is critical for the region. Unfortunately, things are not going well on that front [“Rebuilding at a crawl,” The Economist, 10 October 2009 print issue].

“The country is suffering possibly its worst drought since 1991. Four million Kenyans depend on food aid. Hundreds of thousands of cattle have perished, leading to bloody battles in the wastes of northern Kenya. Money needed elsewhere has already been diverted to buying food and offsetting livestock losses. Growth is expected to be lower than the cautious 3% predicted by the government. Inflation is running at 18%. Frustration with the lack of progress has boiled over into unusually terse exchanges with the country’s main allies. The American ambassador was told to ‘shut up’ by a government minister after strongly criticising anti-reform Kenyan officials. The only recent success anyone can point to is the removal of the head of the country’s anti-corruption commission, Aaron Ringera, who had been reappointed to a second stint in office by Mr Kibaki despite (or thanks to) his bringing no significant prosecutions in five years. … Kenya functions best where the government does not intrude. The country has the most vibrant business sector in east Africa. The financial sector is getting leaner and smarter. Safaricom, the country’s largest mobile-phone operator, recently got permission to sell $159m of bonds to expand its internet business; KenGen, the country’s main electricity provider, announced its own $331m bond offering. Similar deals frequently come along and now pass virtually unnoticed. But private businessmen alone cannot save Kenya from a much worse outbreak of inter-ethnic violence while its politicians scheme for their own ends.”

The Economist is probably correct that it will be the private sector, not the government, that will move Kenya from the brink of disaster. In the meantime, Kenya will continue to require international help in dealing with the famine caused by its disastrous drought.

Sovereign Wealth Funds

In a post entitled State Capitalism and Sovereign-Wealth Funds, written just as the current recession was really starting to exert its bite, I asserted that sovereign wealth funds would “remain viable since countries have longer investment horizons than most individuals.” A recent article reports that, in fact, “sovereign wealth funds have been on an investment learning curve that is starting to reap results with states looking beyond the US debt markets to find value [“State funds cast their nets across the globe,” by Henny Sender, Financial Times, 15 October 2009]. Sender writes:

“Last month, China Investment Corp, the Chinese sovereign wealth fund, took a $1bn minority stake in Hong Kong-based Noble Group, a big commodities shipping, trading and processing company. The move was hardly front-page news in Europe or the US. Yet it highlights a trend that could potentially have striking implications for investment flows across the western world in the coming years. Just two years ago, when CIC first sprang to life, it put most of its swelling pot of funds into financial assets in America, echoing a westward focus that has traditionally prevailed in much of the Asian sovereign wealth fund world. In the wake of the credit crisis, however, the CIC has dramatically changed strategy. Most notably, CIC, like other arms of the Chinese government and peers in Singapore and the Middle East, is becoming concerned that dollar-denominated securities, such as Treasury bonds, are no longer reliable stores of value. So, with $200bn in its coffers, CIC is now scouring the world for investment opportunities in a wide range of natural resource and energy companies such as Noble Group. It is also considering putting money into other real assets such as property, which it believes will also hold value, according to people familiar with the matter. … The shift could potentially have much bigger macroeconomic implications, not just for the outlook for the dollar and US debt markets, but a host of other sectors too.”

Sender reports that most economists expect sovereign wealth funds, especially those of Asian nations, to grow more powerful. As those funds start looking for good investment opportunities outside of the United States, it could be good news for emerging market countries desperate for investment capital. For decades the kings of sovereign wealth funds have been oil-rich nations flush with petrodollars. They are now being joined by manufacturing and financial services nations. Even though oil prices are about half of what they were at their peak last year, sovereign wealth funds whose coffers they fill remain important players on the world economic stage. Sender continues:

“There are things that the sovereign wealth funds in general are doing that will increase their clout even if their coffers shrink. For one thing, the funds are communicating more directly with, and learning from, each other. That means there is less chance that they can be pitted against each other or that some will get worse deals than others, say, from institutions seeking rescue funds. For example, when the Qatar Investment Authority is considering investments, ‘Government of Singapore Investment Corp and Temasek are our first ports of calls,’ says one QIA executive. … Moreover, these funds are becoming more discerning – since they have learned who is trustworthy, by virtue of making some expensive mistakes.”

Sender reports that although managers of sovereign wealth funds are looking more broadly for investment opportunities, they haven’t given up entirely on the U.S.

“Bitter experiences have not prompted the funds to entirely abandon their investments in the US. When Larry Fink needed to raise billions to help finance BlackRock’s purchase of Barclays Global Investors earlier this year, he was able to raise the money from GIC, CIC and the KIA in less than a day because they all know and trust him. KIA would have also happily invested in Goldman Sachs because of its high regard for the company and its chief executive, Lloyd Blankfein, according to people on both sides. But Goldman ultimately turned to Warren Buffett because Mr Buffett – unlike the funds – could move quickly and commit to a deal in a matter of hours. The SWFs are becoming much more selective in the deals they choose, however. They are also becoming more active. … ‘Sovereign wealth funds want more control,’ says Monte Brem, founder of consultancy Step-Stone, and an adviser to some of the world’s most sophisticated of these creatures. ‘They are insisting on more involvement.’ That in turn, though, creates new questions about how the funds such as CIC and others will navigate political pressures. Possibly the greatest irony facing all sovereign funds is that while they are perceived as being political, many are struggling to escape from their local political roots and political interference and make purely economic decisions. However, the more the implications of their actions on the investment landscape become clear, the more that political pressure – and scrutiny – may increase, not just in their home markets, but the US as well.”

Since sovereign wealth funds are controlled by national governments, they will never be able to escape entirely the political implications associated with their investment strategies. If sovereign wealth funds follow Norway’s example, they can do a lot of good in the world. For more on that subject, see my post entitled Norway: Proof (or not) that Oil Need Not be a Curse for Developing Nations. That’s a good segue into my final update on emerging market countries.

Emerging Economies

I’ve written a number of posts about emerging market economies including The Future of Emerging Markets, Emerging Market Recovery, and Emerging Markets — Room to Grow. In those posts, I have been very optimistic about the future of emerging market countries. Antoine van Agtmael, who coined the phrase “emerging markets” in 1981 and is chairman and chief investment officer of Emerging Markets Management LLC, agrees with my assessment and argues that “the recent global crisis did not derail the rise of emerging economies, it accelerated it” [“The attractions of emerging economies are no passing fad,” Financial Times, 15 October 2009]. He writes:

“Investors were too quick to conclude the crisis was global as doomsday scenarios proliferated. It turned out to be only ‘half-global’ because most emerging economies started out with resilient banking systems and prudent macro-policies. In contrast to the Mexican and Asian crises of the 1990s, this time the crisis was imported and not of their own making. Unlike the US and much of Europe, emerging economies passed the financial crisis with flying colours. The greatest corporate victims of the Great Recession were developed-market icons such as AIG, Citigroup and GM rather than China Life, Itau-Unibanco, or Hyundai Motors. Sales and profits of emerging multi-nationals suffered temporarily but most escaped the crisis without the need for intervention and are getting ready for a post-crisis world in which the American consumer is no longer king.”

Van Agtmael notes that “emerging markets were first in and first out” of the current recession. He singles out China for its “intervention through feverish bank lending and front-loaded fiscal stimulus”; but he claims that “policymakers in other emerging economies also stepped in decisively where needed.” As a result, “emerging markets are coming out of the crisis with greater respect and they now account for one third of the world’s gross national product.” He continues:

“If growth in developed countries starts to look like a ‘U’, in emerging markets it is already a ‘V’. Their economies and markets initially had a steeper drop (after a five-year rise) but they came out of the global recession about six months earlier than the developed world and their equity markets have jumped more than 100 per cent from their trough last October, outperforming developed markets by more than 50 per cent. No wonder investors have flocked back after a few months of panic. Stock markets are often ahead of economic turning points as investors begin to sense that the next batch of economic and earnings reports are likely to surprise on the upside. … There are reasons for short-term caution. But it would not be smart for investors to ignore the rise of emerging markets, led by the four Bric countries – Brazil, Russia, India and China – and their long-term potential. Most of the growth in the global economy came from emerging markets even before the crisis. Outsourcing of manufacturing, IT and even research is no longer a passing fashion but an integral part of the global production chain. One billion new consumers will double the existing consumer base within the next decade. Roads, rail and ports are improving rapidly – and not just in China. Most oil and gas now comes from outside the developed world. Each year more emerging multi-nationals join the 75 that are already on the Fortune 500 list (there were only 19 in 2000) and second-rate producers of cheap goods are becoming world-class companies. The world is not flat, it is actually tilting and that is true not only for opportunities but also for risks. Emerging markets now own $5,000bn in foreign reserves and are much less dependent on foreign loans. They have fewer budget and current account deficits than their western counterparts while governments, corporations and consumers carry a much lower debt burden than found in much of the developed world. There are plenty of reasons to be optimistic on the longer-term outlook for emerging markets for the next three, five, 10 and 25 years. And there are fewer and fewer reasons to be afraid.”

As the chairman and chief investment officer of a company that manages investments in emerging market countries, one would expect van Agtmael to recommend investors to put their money in emerging market equities. Regardless of his bias, I continue to share his long-term optimism about the opportunities that can be found in emerging market countries.