Author: Philip Baillie

The course is more than 20 million square kilometers, and covers 15 percent of the world’s land surface. It’s not a new event in next month’s IAAF World Championships in Moscow but a long-term project to better integrate emerging Eurasian economies.

The eventual aim of a new economic union for post-Soviet states, known as the Eurasian Economic Union (EEU), is to “substitute previously existing ones,” according to Tatiana Valovaya, Russia’s minister in charge of development of integration and macroeconomics, at a media briefing in London last week.

That means new laws and revamping regulation for “natural monopolies” in the member states, streamlined macroeconomic policy, shared currency policy, new rules on subsidies for the agricultural and rail sectors and the development of oil markets.

Kazakhstan and Belarus are the two other members of what is known as the Single Economic Space (SES), that is, the existing economic partnership between the three bordering countries established in 2012. So far Kyrgyzstan and Tajikistan  are co-operative members, Ukraine, Armenia and Moldova have been given observer status.

Since 1995, the SES3 and observer states have been moving ever closer to a shared set of structures under the EEU umbrella.

For Kyrgyzstan, accession depends on the fate of Tajikistan in terms of its accession. Once the blueprint is in place for Tajikistan, that should prepare the ground for Kyrgyzstan’s integration within the EEU.

In theory, economic integration brings improvements in institutional quality, better understood contracts and a reduction in the cost of trade. The World Trade Organisation in a recent report outlined some of the challenges and some potential responses to the global challenges, from agriculture and global climate change to the auto sector.

Russia perhaps sees its part in the acceleration of global trade as developing a fresh perspective on existing post-Soviet ties, moving ever further away from the stigmatic blow-out of the financial crisis.

“The global economic crisis made us realise that we needed to do something about integration because it is the only way which would allow us to find an input for growth,” Valovaya added.

The idea of the revamp of existing partnerships, which have been developing more closely since the new millennium, is to lower the cost of trade through the removal or reduction of trade tariffs, not dissimilar to the Free Trade Agreements (FTAs)  the United States has initiated and the Trans-Pacific Partnerships (TPP). Negotiations are ongoing for many emerging nations to play a larger part in customs unions, not solely in the post-Soviet bloc in central Asia.

Twenty five members have applied to join a free-trade zone with Russia, with the country having a particular interest in forming new links with New Zealand and Vietnam.

“Trade with the EEU is only about 30 percent with Europe…the idea is to create an economic union from Lisbon to Vladivostok.,” Valovaya said.

The outcome of post-Soviet integration depends on a vote on around 90 competencies, as rigorous as a political decathlon. Voting rights of the nations that will oversee the transformation of the EEC to the evolved EEU are as follows:

The Russian Federation – 40 votes

The Republic of Belarus – 20 votes
The Republic of Kazakhstan – 20 votes
Kyrgyz Republic – 10 votes
The Republic of Tajikistan – 10 votes

What is the benefit of a new customs union?

The auto sector, for example, will reap rewards. Gains are set for domestic-focused companies, according to research from the Boston Consulting Group.

Further integration internally may boost Kazakhstan’s application to join the WTO, which will be submitted by December according to the organisation’s website on June 5.

China’s inflation print for June at 2.7 percent, a four-month high, was higher than forecast, but part of the picture could be obfuscated by a lack of accounting for the ever-growing online retail sector.

Gross domestic product figures have been consistently revised down this year from 8 percent to around 7.4 percent by July, with significant doubt over the reliability of official data. Some analysts forecast the more likely GDP print is around 5 percent, given the lack of punishment for falsifying local data and incentives for better growth figures for regional prints.

With an increasing share of shopping carried out online through websites such as Taobao, Tmall and Paipai, there is an increasing argument for online retail numbers -which had lifted one metric of inflation  closer to 7 percent in April –  to be included in the headline CPI. That metric is the retail sector’s internet shopping price index (iSPI).

This includes (based on the compilation of Taobao sales data) food, tobacco, liquor, clothing, household equipment and maintenance services, health care and personal products, transport and communications, entertainment and educational products and services including residential and office supplies. If inflation were calculated on this basis, it could be more accurately computed at 3.15 percent today.

On the connection between the iSPI and the CPI numbers, analysts at ICBC have said:

Network retail price index (iSPI)…  should generally reflect changes in the general price of the domestic online retail channels, which is ultimately the formation of a national network of retail price index and even the formation of the first stepping stone in the CPI process of covering the online retail channels.

Take a look at this chart for a closer look at the level where inflation could be more accurately estimated. In recent months, the gap between the internet shopping index and official CPI data has started to converge, to around 3.65 percent today from as wide as 11.9 percent in May last year.

Online retail holds opportunities for the investor too. According to McKinsey & Company research in March,  the online marketplace ecosystem in China accounts for 90 percent of transactions, though covers only 70 percent of investment. The current level of online market activity breaks down on a GDP per capita basis.

The world’s largest car market, China, with a population of 1.3 billion people and an emerging middle class, holds great potential for investors and consumers alike with annual growth rates in the auto sector expected to hold at around 23 percent to 2017, according to Alliance Bernstein Asset Managers.

Joint ventures (JV), the most popular structure for foreign firms investing in the automobile sector in the world’s largest car market, are set to capitalise on a growing consumer base in a country with 3.3 million kilometres of asphalt. Traversing the so-called ‘mother’ road 312 (China’s route 66) is becoming more of an attainable dream for the Chinese consumer.

VW has a JV with Changchun-based FAW, Dongfeng with Nissan, GAC with Toyota and  Honda. There are many investment opportunities, though a constantly changing sectoral environment and risks of mechanical recalls can cause sharp fluctuations as in any market, according to Bernstein Research, a subsidiary of Alliance Bernstein holdings.

China now has some 21,100 dealers nationwide, more than the United States (17,500), Germany (12,900), and the UK (4,700) in absolute numbers. Domestic dealers are overshadowed by international brands in the larger cities. The next step is for the international JV-backed dealers to make regional expansion where domestic dealers are currently concentrated.

Tassos Stassopoulos at Alliance Bernstein said:

The place we currently expect companies to generate most value in China is in the SUV and luxury segment. Land Rover is in a sweet spot to cover both and for luxury BMW and Audi. This is all contingent on them not messing up their product cycle, which is hard to predict.

There are some warnings, however, according to the authors of the Bernstein Research report.

We believe Chinese car sales growth is set to run at a slower pace going forward and will collide with large increases in production capacity. Direct government financial assistance appears to be playing a role in China’s fast increasing capacity, which will ultimately lower returns. Our framework takes account of technology, R&D competence, growth and cash valuation. We rate Brilliance (HK$13 price target) and Dongfeng (HK$17) outperform. We rate Great Wall (HK$36) and GAC (HK$7) market-perform. We rate Geely (HK$3) underperform.

Elsewhere in the  BRICs, Russia’s government announced a new subsidy programme in July for Russian citizens wanting to buy a car, helping to boost the likes of Avtovaz. Tata Motors in India has also found SUVs a bright spot, though sales to March were lower than expectations.  In Brazil the world’s fourth largest car market, auto sales hit record levels in May as car makers took advantage of tax breaks for domestically manufactured vehicles.

If there is still doubt about the market in China, it is clear that it has more dealers in absolute terms and still sells more per dealer than major developed markets.

China tops the list for sales per dealer

This is a reference when the People’s Bank of China makes big decisions.

Source: Flikr creative commons

Problems are found at a local level too, however. While the current system sets local government officials’ bonuses for better GDP growth, there is no penalty for supplying incorrect data, neither are local government officials assessed on the jobs they create but via a points system. Instead local governments have ‘soft’ and ‘hard’ targets to attain, according to the panellists, some of which include environmental targets.

Then there is the issue of language. Some say data is more detailed in the Chinese language than in English, though official translations help bridge this gap. Quandaries remain, the resolution is still far from clear.

The South African rand has lost most ground amongst emerging market currencies, according to Reuters data, falling almost 10 percent so far this year to hit 4-year lows against the dollar.

That is perhaps not so surprising given the country’s high level of dependence on the minerals and mining sectors, which have been disrupted by labour strikes along the same lines evident in the summer of 2012. Lonmin, the world’s third largest producer of metal, said it stopped its production of its Marikana mine near Rustenburg following strikes over wages.

Net commodity exports – Morgan Stanley and UNCTAD

With the metals and mining sectors accounting for 60 percent of South Africa’s exports, the strong relationship between these sectors and the rand is not surprising. A falling currency has a knock-on effect of facilitating inflation, especially as imports grew faster than exports for the first quarter of 2013. Meanwhile platinum prices have been in a gradual downwards trend since February.

The currency could be in for a deeper slide if mining companies’ wage negotiations are not made within the July 1 timeframe, while the central bank is not expected to act. According to Phoenix Kalen, CEEMEA Economist at RBS:

The central bank of South Africa trusts that the currency will eventually stabilise. I don’t think they will intervene in the currency via interest rates hikes, and furthermore, rand weakness is a consideration against cutting interest rates.

RBS added in a note:

We believe that the SARB will keep interest rates on hold at 5 percent for the remainder of the year.

Amplats, a unit of Anglo American and the world’s biggest platinum producer, said last week it would cut 6,000 jobs from its mines near Rustenburg, less than the 14,000 originally planned.

Mining-related strikes last year that resulted in the death of 34 workers reduced growth at the country’s factories and lead to credit rating downgrades. More unrest will be most unwelcome for the country’s economy. But with falling platinum prices and persistent inflation. the rand could be in for more of a slide.

Emerging markets may not have all the technological know-how in civil aerospace, but from China across the world to Brazil, they do have the cash.

The civil aerospace sector performed well in 2013, according to Societe Generale data, trading at a 4 percent premium over the MSCI world index, while the defence sector has steadied, and in the medium to long term civil aerospace should be supported by strong orderbooks from emerging economies.

Research from PwC shows the global aviation industry is set to increase by 3.3 percent to 68 billion by 2022, driven by an increase in fleet size.

Last month China decided to ease a boycott of $11 billion in Airbus jet orders. A letter seen by Reuters gives a breakdown of the A330 orders, the details of which have been mostly kept secret awaiting final approval from the Chinese government.

They include 10 aircraft for Air China, 10 for Hainan Airlines, 10 for China Southern and 15 for China Eastern. The letter said first deliveries were tentatively scheduled for mid-2013.

China has already become the largest maintenance repairs and operations  market in Asia-Pacific and is expected to grow 9 to 10 percent annually, to reach $70 billion by 2015.

On Tuesday, Airbus results showed a sharp rise in first quarter core profit, with revenues rising 9 percent, though the aerospace group said it had consumed a significant quantity of cash to boost inventories for new projects.

Research from Societe Generale shows the largest order backlog for the industry comes from the Latin American share of the market, with an increase in aviation orders to 37 percent of the market in 2011 from 3 percent in 2000, a general trend that is set to grow given rising fuel prices.

Higher fuel prices means airlines will look to replace their fleet with more fuel-efficient aircraft and growing populations will bring increasing numbers of passengers. An increase in passenger traffic for the 2014 Football world cup championships in Rio de Janiero and the Olympic games in 2016 will fuel part of this.

SocGen has this:

With emerging economies now accounting for almost half of new orders, and Airbus and Boeing boasting eight-year backlogs, large jet delivery growth looks well set for the medium and long term.

Compared to last year EADS, the parent company of Airbus, Bombardier aerospace and Boeing are set to increase deliveries of commercial aircraft while revenues are set to grow at Boeing. EADS will see its orders drop for 2013 but the sector is due to see resilient earnings, research shows. Soc Gen has ‘buy’ ratings for EADS, Safran, Megitt and MTU as a result.

Research shows China accounts for 7 percent of Boeing’s sales. Outside the BRICs, demand for western aviation technology is evident. Oil-rich Kuwait is looking at plans by its state-owned airline Kuwait Airways to buy 25 new Airbus jets, a source told Reuters, a deal that could be worth up to $3 billion dollars.

Indian aerospace is also enjoying a round of investment through a series of joint ventures.

Source: PWC

For those curious about the global aviation industry’s outlook, the Paris airshow on June 18 should leave clear a slipstream.

The world’s leading ad agencies are positioning themselves  in Brazil, Russia and China — countries that are expected to provide almost a third of the growth in global advertising over the next three years. That’s according to a report by S&P Capital IQ Equity Research, a unit of publishing giant McGraw Hill.

Most major advertisers already have a foothold in these BRIC economies, where the advertising market is projected to grow by an average 10.7 percent  a year over the next three years — more than three times the growth rate in  the developed world.  Over the next 15 years,  big emerging markets will add $200 billion to the global ad spend, S&P Capital IQ reckons.

Hopes, unsurprisingly, are pinned on the soccer World Cup in 2014 and the 2016 Olympics, both hosted by Brazil. Russia hosts the 2014 Winter Games in Sochi and Football World cup in 2018 and both these events are expected to boost ad spending. The behemoths of the ad world have prepared for this, says Alex Wisch, an analyst at S&P Capital IQ:

    The global agencies have already developed a solid foundation in the BRICs, so the heavy lifting on the investment ramp is largely behind them.

(Graphic under creative commons)

Accordingly, S&P Capital IQ has a ‘buy’ recommendation on advertising agencies Publicis, Interpublic and Omnicon while advising a “hold” on WPP.

Emerging markets currently account for a small proportion of the global ad market which is estimated to be worth more than $500 billion. Despite faster growth that will remain the case, S&P Capital IQ says, noting that in absolute spending terms, North America will contribute as much to global advertising expenditure as China, Brazil and Russia combined over the next three years.

While Europe looks set for more disappointment, the report predicts faster momentum in North American markets as economic recovery gathers steam. One reason is digital advertising — internet advertising, digital marketing and data services  –which is better established in the United States.

The outlook is  ‘cautiously optimistic’ for global advertising agencies, driven by further expansion in higher growth markets, the report concludes.

Watch that ad space…

The ability of Brazil, Russia, India and China to support their leading banks is tightly correlated to the credit rating on the banks, according to ratings agency Moody’s. The agency compares the ratings of four of the biggest BRIC banks which it says are likely to enjoy sovereign support if they run into trouble.

China’s Industrial & Commercial Bank of China (ICBC) tops the list of BRIC lenders with a rating of (A1 stable)  thanks to the central bank’s $3 trillion plus reserve stash.

Brazil’s Banco do Brazil  (Baa2 positive) is in investment grade territory but it still fares better than the State Bank of India (SBI) (Baa3 stable) and Russia’s Sberbank (Baa3 stable) at one notch above junk status.

That gels broadly with credit ratings for the underlying sovereigns — Brazil for instance is rated Baa2 while India has a Baa3 rating (it is in danger of losing its investment grade rating however). Russia’s sovereign rating though at Baa1 is two notches higher than Sberbank’s Baa3.

The Moody’s report found that all of the four banks had seen creditworthiness improve in recent years. But those in Brazil and China benefited from the stable domestic environments while SBI and Sberbank ratings were constrained by the more challenging operating conditions in India and Russia.

In a self-perpetuating cycle, ratings will be higher because governments are prepared to provide high levels of support to the banks, reflecting the lenders’ systemic importance and in some cases government ownership.

Credit default swaps (CDS), the cost of insuring debt on all four banks show a correlated fall from 2008′s peak with sovereign debt CDS (see graphic below)

Moody’s said:

Top BRIC banks’ deposit ratings  are very closely aligned to their governments’ debt ratings, because Moody’s considers that BRIC governments will provide very high systemic support to these banks, reflecting these banks’ very high systemic importance and government ownership.

Moody’s expects that the deposit ratings of large BRIC banks will remain closely correlated with their government debt ratings.