Knowledge Management Initiatives in Singapore

This chapter reviews some interesting facts and analysis on international investing that I learned from the students in my masters classes at the ICMA Centre, University of Reading and the University of Cyprus in March 2012. I look at Korea, India, Russia, China and Cyprus all of which are of great interest starting from the viewpoint of the students, who represent these countries and have a unique prospective on developments there. I have supplemented their presentations with my own thoughts and research. Given the structural changes underway in the global economy, investors have to look closely at both the domestic fundamentals but also the trade and financial links across the globe. Many of these countries, despite having strong long-term growth paths, have a series of vulnerabilities, which will necessitate structural reforms to maintain and grow domestic and foreign market share in a period of global slowdown. Doing so will frame the investment opportunities.

Korea, where I am a visiting professor at the financial engineering department of the Korea Advanced Institute for Science and Technology each August is especially interesting. KAIST, which is modeled after MIT is largely located in the city of Daejeon some two hours away from Seoul. Like Tsukuba in Japan where we spent 1988-89, Daejeon has the major research facilities of the country's manufacturing and other companies. The KAIST business school is located in Seoul closer to the financial center of the country. I spoke there in 2011 and I visited both places again in 2012.

South Korea has had rapid and steady GDP growth since 1970 as shown in Figure 35.1a, total equity trading volume has also grown along with GDP, see Figure 35.1b. In contrast, North Korea has remained poor with the government siphoning off the limited resources for the military and themselves, while allowing food shortages and malnutrition. Still uncertain political environment in the North remains a major geopolitical risk both to the South, as well as to neighboring China (which fears an influx of refugees) and Japan.

South Korea's big strength has been in education and innovation, as the government, big conglomerates and households invested heavily in human capital to offset the lack of other resources. South Korea has an essentially all educated population with 80% finishing college or university. This comes from an educational system that is rigid and pushes students to their limits and the mathematics and science courses have it near the top in the world. Outstanding students can skip grades or even several years by taking exams.² There is a cost to such pressure including many suicides and other problems. Some parents send their children to Australia or other places for a more normal upbringing balancing study and other activities though without family.

South Korea has extensive research and development investment which is about 3.0% of GDP and has been outpacing GDP growth. This is similar to the US and Finland and only exceeded by Japan, Sweden and Israel and well above China at 1.4% and India at 0.9%, see Figure 35.2. This shows up in innovation index (based on things like tax policy, education, exports of high tech products) with South Korea in second place behind Singapore and above the US and Japan, see Table 35.1. This heavy investment in innovation has helped Korean conglomerates to maintain their competitiveness, even as global export growth has narrowed and they have received greater competition from Chinese producers.

Fig. 35.2 Scientists and engineers per million people versus R&D as a percent of GDP for various countries

Table 35.1: Innovation index based on a variety of inputs and performance factors. Source: Boston Consulting Group, 2009

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The stock, currency and derivative markets are very active, befitting Korea's place as a developed market (though it does retain some elements of a market that is still emerging, including a tendency to intervene in the market). After the major shock of the Asian financial crisis in 1997, Korea, like its neighbors took the lessons of cutting spending and building up FX reserves. Moreover, its domestic contraction left it even more focused on external demand, especially high-tech exports. It also reflects an expansion of financial markets. Total equity trading volume and market capitalization has also grown along with GDP, see Figure 35.1b. Although many companies finance their capital expenditures through retained earnings, they also borrow on international markets, and are still dealing with the currency mismatches that developed before the Asian financial crisis.

The main stock indices are the Kospi overall index and the technology Kosdaq index, see Table 35.2 for trading volume for 2008–2010. Most Korean companies are family dominated where the management and major ownership is common. Hence, there is a lack of transparency, but, according to UBS in February 2012, their corporate governance was ranked the best of the emerging markets (EM). Figure 35.3 shows the indices with the technology sector Kosdaq performing poorly and never recovering from the 2000-2002 internet bubble much like the US Nasdaq which it actually underperformed and which itself is also well below its 2000 peak. However, the overall Kospi index has had good performance but, like the Kosdaq, and indeed other EM Asian exchanges, it has been extremely volatile. In fact, the daily Kospi volatility in 2011 was 1.23% versus 1.0% for the FTSE100, 0.95% for the 30 stock Dow Jones average and 1.06% for the Nikkei225. Total trading volume continues to increase steadily as shown Table 35.2.

Table 35.2: Kospi, Kosdaq equity trading volume and Kospi200 options trading volume, 2008-2010

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A major factor affecting the price levels and volatility of the South Korea market is the ever present tension with North Korea and war risk which followed the 1950–53 Korean War. There has been an armistice but never a peace agreement and the two countries are technically still at war. Since the Armistice Agreement of July 27, 1953, North Korea has violated the armistice 221 times, including 26 military attacks. On November 23, 2010, North Korea fired artillery at South Korea's Big Yeonpyeong island in the Yellow Sea and two marines and two civilians were killed. In March 2012, the agreement to stop nuclear tests in exchange for food was violated when North Korea planned missile testing. Figures 35.4ab attempt to measure the war risk in two ways. In Figure 35.4a the price earnings ratios of the MSCI advanced country index and that of Korea are compared. We look at equity indices not the Korean won, given that the central bank's tendency to intervene reduces currency volatility. The difference can estimate the war risk and possibly other factors. Korea considers themselves to be advanced and not an emerging market, but its market returns are more correlated with emerging markets. In Figure 35.4b the South Korean war risk is measured using a peace index. The war risk seems to correlate with the current tension in the region over time.

While it is almost as big (in terms of population) and important as China, India is less in the news and less well understood. It is a vast country of contradictions, particularly now that investment in education and services has prompted extensive business processing outsourcing. I recall on a visit in the 1970s traveling through the slums of Bombay for about three hours. There were thousands of shacks housing rather poor people. When you got on a bus there were at least two others who had the same seat assignment as you did and the bus was packed solid inside and on the roof with huge numbers of travelers. Yet the top universities in the world are full of Indian academics in very high positions and this is at places like Oxford, Cambridge, Yale and Harvard, etc, as well as outstanding places in India like the Indian Statistical Institute. A small section of Mumbai has some of the highest land prices in the world.

India is the world's second most populous country and its largest democracy. It has cheap labor and many skilled workers and professionals which is adding to inequality and in turn brings political strains and policy gridlock. Its 2011 GDP was $1.846 trillion and per capita was $1,527 with growth at 8.4%, see Figure 35.5(a). Sectoral GDP estimated for 2011 was agriculture: 18.1%, industry: 26.3%, and services: 55.6%. CPI was 6.55%, see Figure 35.5(b) and public debt 71.42% of GDP.

Enhanced liberalization policies since 1990 have attracted large foreign direct investment. The cumulative FDI equity inflows from April 2000 to December 2010 stood at US$186.79 billion. For fiscal year ending March 2011 the composition of FDI was financial and non-financial services US$2,853 million, telecommunications US$1,327 million, automobile industry US$1,066 million, power sector US$1,028 million and housing and real estate sector US$1,024 million. FDI comes mainly from Mauritius US$5,746 million (42%), which is a transit point for other funds, Singapore US$1,449 million and the US US$1,055 million. The government's ambivalence towards FDI is a constraint to India's long-term growth, as political issues limit its ability to attract the foreign capital needed to build out infrastructure, to support higher levels of growth without inflation. In recent years, growth above 8% has prompted high levels of inflation. There are two major stock exchanges in India: the National Stock Exchange of India (the index is the S'P CNX Nifty known as the NSE Nifty or NSE 50), see Figure 35.6(b) and the Bombay Stock Exchange (the index is the BSE SENSEX or BSE 30), see Figure 35.6(a). The NSE has had the world's highest yearly market capitalization growth of 30.9% followed by the BSE with 29.4%. Figure 35.7 compares these with other exchanges.

Compared to China though, India has stronger demographics, a lower number of retired people to support, and this young population, will not only keep labor competitive but suggest a pattern of increased savings going forward (if government policies permit). These savings could finance domestic investment, needed to increase potential growth rates. This however is a long-term story. In the short-term, India faces persistent fiscal and external deficits, which have contributed to an extensive slump in the rupee in the last six months. The recent moderation in the oil price, if it lasts, would be a modest reprieve for both deficits, as fuel imports deter net exports from adding to growth, while swelling government spending as the government fears passing on higher costs to the population.

Possibly the most complex of the BRICs is Russia. There is great fear of investing there following a period of resource nationalism and government encroachment on both foreign and domestic business. For example, a partner in a leading LP company said “If I bring a Russian deal to the investment committee they could fire me. And if I do not bring Chinese deals to the committee they could fire me.” So courage is needed. Yet Goldman Sachs updated their BRIC report to 2010 and Russia was rated second for attractiveness, in part due to its larger per capita GDP than other BRIC and its low government debt. Bill Gross is buying their bonds for his PIMCO bond fund (note that Russia has minimal formal government debt due to high oil spending). Jim O'Neill, Chairman of Goldman Sachs Asset Management said “Concerns about Russia are overblown and offer investors a chance to buy into booming growth stories. Contrary to the email I get every two hours about why I should drop the R from BRIC, I quite like Russia.” As with India above, we still fear there are structural issues to investing in Russia, In fact the stronger the oil price, the worse the policy making, as high oil (and gas) prices allow Russia to deter tax reforms.

We had my own experiences there in 1992 when our family traveled from Helsinki where I had been speaking at an international Informs conference to St Petersburg. Among other things we wanted to see the Pazryryk carpet. This famous carpet of high quality with reindeer on the borders was made in the 5th century bce and survived frozen in Siberia until it was unearthed in 1949 from a burial site with many other objects including felts. Since the next high quality carpets are the 13th century Seljuk ones found in Konya, Turkey, now residing in the Turk ve Islam museum in Istanbul one wonders what happened in these 18 centuries. Since the Pazryrk is of high quality, carpet production must have been going on for some time before. Though it is not known where it was made, there is no shortage of countries claiming that the carpet was made there and these include Turkey, Iran, and Russia. After considerable inquiry at the Hermitage Museum, we found it in a basement glued to a fabric on a wall. It was rather dusty and experts and amateurs were allowed to snip away little souvenir pieces for study. Wow - if they only knew the true significance of this carpet! But there are experts in St Petersburg and chief among them is Elena Tsareva. She is the curator of the Peter the Great Museum of Anthropology and Ethnographics of the Russian Academy of Science collection of Turkmen carpets and a world renowned rug scholar. In 1992 when we went, the salary was $10 a month and rarely paid; she had to sell jewelry she collected to visitors like us, at possibly inflated prices, to survive. At that time in the universities, $20 a month got you a professor, $40 a star and for $60 one of nobel quality.

In Chapter 26 we discuss the risk management failure of Long Term Capital Management, the MIT led group that was too smart to lose. Among other things, they got wiped out by the August 17, 1998 Russian ruble devaluation. We were guests of Professor Zari Rachev, an expert in stable and other heavy, fat-tailed distributions. On arrival Bill gave him a US$100 and he in turn he gave a four inch wad of 25 ruble notes. Our dinner that night cost two inches for the four of us with drinks extra in hard currency. Well times have certainly changed. For example, in 2012 Russia has more billionaires than any other country. Some facts about Russia are in Table 35.3.

Figure 35.8 shows the close relationship between Russian stocks measured by the RTS index and energy prices measured by the price of oil. Although the hydrocarbon sector's contribution to output has been limited (oil output has increased only gradually over the last decade), the increase in value has led to a massive increase in per capita income, fuelling consumption and inflation. Still, like India, Russia has under invested and its corporations, and infrastructure are in need of an upgrade. Regarding economic recovery, see Figure 35.9 for the RTS index versus IPOs, new car sales and consumer loans. We see some modest signs that the new Putin administration will need to deal with some of these aging structures, but we expect that these measures will be slow - and state-led. Putin finds the Chinese model very enticing (as do many EM governments) so it is fitting we move on to the biggest EM next).

Table 35.3: Russia is still very attractive

#2 MCap growth

10.2% forward 20-yr CACR (#1 is China with 11.5%)

#2 Allocation growth

From 1% to 3% in MSCI in 20 years

#6 GDP

Bigger than Germany and France in 20 years

#11 GDP growth

But at least 30% GDP/Capital higher than in countries with higher GDP growth

#5 Strategic investors target

According to UNCTAD survey after China, Brazil, India and US

46% of wannabe entrepreneurs

Among people 20–29 years compared with only 29% for 30–47 years

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Fig. 35.8 Russian stocks and energy prices are closely correlated

China is very complex, and like Japan in the late 1980s, is feared as well as admired. Figure 35.10 has Chinese growth rates. I do not really expect them to blow up the way Japan did as the management seems much sharper and focused and can more or less make their own rules. A major part of the Japan demise was their investment behavior. According to the 1992 book Power Japan that Sandra and I wrote, they only invested about 3% of their assets abroad - overpaying for most purchases which were of the luxury variety. But the rest was invested in two things they already owned - their own land and their own stocks (which were highly invested in the land). Then when the stock market began to crash in 1990 an the land market in 1991, it was all basically lost. Poor policies kept the bad time continuing and still now in 2012 more than 20 years later the Nikkei stock average is about a quarter of where it was in late 1989. But, of course, the composition of the index has changed.

A big issue is the massive foreign exchange reserves which exceed US$3 billion. As shown in Figure 35.11 these reserves are growing at a fast pace that is now slowing much. We will see how much the economy and prices slow in 2013 given a possible soft or hard landing as many predict.

Some facts concerning Chinese real estate: Price increase for renting have exceeded inflation. In part this reflects downside pressure on other goods. For example, in Shanghai in 2008, rents increased by 25% more than inflation, but incomes are rising. In Shanghai the average monthly income in RMB rose from 687.75 (in 2007) to 1174.92 (in 2008) and 1682.17 (in 2009). This income increase did outpace housing prices so that the price/income ratio fell from 34.35 (in 2007) to 22.70 (in 2008) and 17.14 (in 2009), but the housing price growth rate in 2008 and 2009 was over five times the GDP growth rate.

Figure 35.12 shows the RMB versus the US dollar. While many argue that a higher Chinese currency will lower the trade surplus, this is a bit unclear since the J-curve effect that a higher price will lead to higher costs and less competitiveness unless demand falls as the currency rises. Given that much of the demand in China is by US companies for sales in the US, it is not clear that they can quickly move production to other currency regions.

Shanghai followed by Beijing is the most expensive Chinese city. Figure 35.13 shows that in Beijing the average salary has climbed more or less linearly from 2000 to 2011. However, the housing prices, especially in the city center but also in the entire city, have risen at a much faster rate, especially in the 2008-2011 period. There is a bit of cooling off of the market prices recently with 2011 showing a decline in prices. Chendu, a city I visited twice, which is a western provincial capital, has much lower housing prices so that the housing price over income ratios are only about four times compared to Shanghai's over 17 and the housing price growth rate is similar to the GDP growth rate.

Fig. 35.13 Housing price vs average salary in Beijing measured by RMB per square meter

In Cyprus, a divided country of about 900,000 people with the south Greek and the north Turkish, there is political tension which aflects the economy. In the South, the yearly CPI was 3.4% in March 2012, up from 3.1% in February and 2.8% in March 2011 according to the Cyprus Weekly, April 16-22, 2012. So there is not much inflation which is partly form the VAT which increased to 17% from 15% on March 1, 2012. Moreover, Cyprus' financial sector is far far too linked to Greece, with Greek banks present in the South, and local banks heavily exposed to domestic and Greek debt. A Greek exit from the eurozone, more likely after the results of the recent election that ended in stalemate, would bring costs to Cyprus, which would accentuate its home-grown competitiveness issues - and likely lead it closer to ties with Russia.

The US unemployment rate has been high since 2007. In April 2012 it was 8.3%, the lowest in three years. The situation is similar in the UK. However, these rates are well below those in Spain and Greece. A comparison of the unemployment rates in Greece, Spain, Cyprus and Italy for 2003–2010 is shown in Figure 35.14. Females and youth have the highest unemployment rates.

The unemployed as those actively looking for work; the total workforce then is the sum of these plus those actively working; the rate of unemployment is the unemployed divided by the total workforce. These official numbers, of course, underestimate true unemployment as discouraged workers do not count and those who take jobs below their aspirations and skills just count as employed by underemployed.

Fig. 35.14 Unemployment in Greece, Spain, Cyprus and Italy, 2003 to 2010. Source: Kasapis et al. (2012)

In the south, the labor market in 2012 is the worst since the 1974 hostilities with Turkey with an unemployment rate of about 10%, about double the usual 5%. To try to isolate the factors affecting unemployment, the following ordinary least squares regression model was run with eleven (0,1) variables and 3230 observations of random people from the population using statistics from the Economics Research Centre at the University of Cyprus. The regression equation is:

Fig. 35.15 Unemployment in Cyprus by factor, 2002 to 2011. Source: Kasapis et al. (2012)

The last four variables are regional which have little effect. More important variables are unemployment by gender (females are more likely to be unemployed), education and skills reduces unemployment and youth are more likely to be unemployed.

Figure 35.15(a) has total unemployment which has greatly increased since 2008. Figure 35.15(c) shows the dramatic age difference effect with the youth under 25 having four times as likely to be unemployed. The Paphos area, heavy on tourism, has the lowest rates of unemployment but all regions have suffered since 2008. Education does help as Figure 35.15(d) shows. Finally, the length of time unemployed is increasing, see Figure 35.15(e).

Conclusion: Cyprus is in a poor economic state and could have a financial crisis similar to Greece and Spain.

²I had one student in my essentially PhD level class at KAIST who looked young. When I asked his age, he replied “16”. He told me he skipped junior high and high school via examinations.