The Chinese Economy in the 3rd quarter 2012

The most recent data being released by the Chinese authorities has showed some interesting developments in terms of growth and economic expansion. As much as one would tend to regard this particular trend as positive, it is important to remain cautious and don't rush conclusions on the meaning of the latest data published.

First and foremost, we should review the overall economic performance:

A picture usually says a thousand words. The growth has slowed considerably. There are always two camps when it comes to interpreting financial and economic data. Everyone likes to add their 2 cents and give their own view. 

I will refrain from that. All I can tell in fact, is that there is a contraction. If we are reaching the point when situation will start to improve or further deteriorate, remains a question. I don't know and nobody really knows. All one can do is making an educated guess on what are the possible outcomes and the probability of such events.

Nothings is set in stone. With the China Bureau of Statistics data being questionable in many cases, one should try to look into other variables to gather a better picture of the situation.

China GDP Annual Growth Rate

The Gross Domestic Product (GDP) in China expanded 7.40 percent in the third quarter of 2012 over the same quarter of the previous year. Historically, from 1989 until 2012, China GDP Annual Growth Rate averaged 9.25 Percent reaching an all time high of 14.20 Percent in December of 1992 and a record low of 3.80 Percent in December of 1990. The annual growth rate in Gross Domestic Product measures the increase in value of the goods and services produced by an economy over the period of a year. Therefore, unlike the commonly used quarterly GDP growth rate the annual GDP growth rate takes into account a full year of economic activity, thus avoiding the need to make any type of seasonal adjustment.

The World's Supermarket

China is regarded as the main supplier of discount products in the planet. Putting it very simple, one of the main sources of revenues for China are its exports.  

 Balance of Trade

China reported a Trade surplus of 319.92 USD Million in October of 2012. Historically, from 1983 until 2012, China Balance of Trade averaged 50.56 USD Million reaching an all time high of 404 USD Million in November of 2008 and a record low of -314.83 USD Million in February of 2012. Export growth has continued to be a major component supporting China's rapid economic growth. Exports of goods and services constitute 39.7% of GDP. China major exports are: office machines & data processing equipment, telecommunications equipment, electrical machinery and apparel & clothing. China imports mainly commodities: iron and steel, oil and mineral fuels; machinery and equipment, plastics, optical and medical equipment and organic chemicals. Its main trading partners are: European Union, The United States, Japan, Hong Kong and South Korea.

Exports

Exports in China decreased to 1755.71 USD Million in October of 2012 from 1863.50 USD Million in September of 2012, according to a report released by the General Administration of Customs. Historically, from 1983 until 2012, China Exports averaged 400.88 USD Million reaching an all time high of 1863.50 USD Million in September of 2012 and a record low of 13 USD Million in January of 1984. Export growth has continued to be a major component supporting China's rapid economic growth. Exports of goods and services constitute 39.7% of its GDP. 

China's exports to Europe have declined substantially. There is an acceleration on this particular trend. France, Italy and Germany experienced severe contractions on their inflows of Chinese goods.

There were far less shipments coming into the EU from China. As the situation is unclear in Europe, with France showing some concerning sigs of weakness, one could make a case for further distress in this particular segment of the economy. 

China's ability to generate income, Credit and the trend in consumer demand are all tied to its ability to Generate income = Export goods and capitalized on its competitive advantages.

This contraction in exports should lead to decrease in capital inflows. This data is released annually. Therefore, one must use monthly adjusted data to build a forecast on what the next release could look like.

Money supply has marginally grew recently. It has a lot more to do with the decrease in Outflows - Imports - than expansion. The overall trend is contraction.

A reason for concern at this juncture is the fact that October 2012 has registered the second largest drop in M2 in the history of China. It was the second largest monthly decline ever. That is not coincidence. It reflects state of affairs.

Bank Deposits have shrunk. A fast and disorderly expansion on Bank Loans with another concerning sign matching it: Defaults in payments. The combination of factor, doesn't make the best Cocktail for success and growth.

Taking into account the fact that several countries rely heavily on China as client - Australia, Brazil & commodity exporting nations -  there are more than reasons for those nations  re-evaluate their strategies and sales forecasts for the near future.

Several firms have engaged in debt financing. Many among them are Stock listed companies, member of the composite in Shanghai. What does it mean exactly - as of now - is impossible to define. It could sign some further deterioration or it could mean the point of reversal, when companies allocate new capital to new projects and expansion. Nobody knows for sure. Are they use capital to refinance existing credit lines? are they renegotiating old debts? are they investing and expanding? It is impossible to determine with precision. All one can do is try to use common sense to assess the current and near term prospects.

The Equities Markets and its role

The Chinese stocks have performed very poorly recently. Actually is one the worse performing indexes in the world this year. Value investors would argue that here is the point where one can load on these Cheap stocks and make a fortune. Certainly, in terms of evaluation, digits are difficult to beat. Yet, things are far from being so simple. It is wise to look at companies in case by case, individual analysis. 

Not every company is a Steal right here. Many could go bust, as they have already been many cases in the manufacturing and textile sectors. One should take time to understand where Instituional money is flowing. Jumping conclusions here - even with low valuations - could prove costly if not done properly. Nobody understands China better, than Chinese  - Hong Kong and Singapore Based - investment funds. 

Each and every fund manager has its own forte and mentality. One should try to find those that match best an investor profile and investigate what this particular manager is doing. Follow the footprints of smart money saves a lot of headaches to investors.

China Stock Market (SSE Composite)

Stocks in China had a negative performance during the last month. China Stock Market (SSE Composite), declined 74 points or 3.53 percent during the last 30 days. Historically, from 1990 until 2012, China Stock Market (SSE Composite) averaged 1651 Index points reaching an all time high of 6092 Index points in October of 2007 and a record low of 100 Index points in December of 1990. The Shanghai SE Composite is a major stock market index which tracks the performance of all A-shares and B-shares listed on the Shanghai Stock Exchange, in China. It is a capitalization-weighted index. The SSE Composite Index has a base value of CNY100 as of December 19, 1990. This page includes a chart with historical data for China Stock Market (Shanghai SE Composite).

The Chinese central bank has been very accommodating in its policy. It has been lowering rates and try to make PLENTY - with capital letters yes!!!! - of capital available. They have now switched to the overall global trend of letting credit flow.  If that is right or wrong, the possible damage that such policies can generate and how the economy will react to this measures are beyond the scope of this article. However, as I mentioned in my previous China economic analysis, there are issues; and they will sooner or later weigh.

Total banking assets rose to RMB128.5455 trillion by the end of Q3, up from RMB126.7831 trillion in the Q2, and increased by 19.67% from a year early according to CBRC. Total banking liabilities rose to RMB128.2893 trillion, up from RMB118.8470 trillion.

The all important but unbelievable total non-performing loans rose from RMB 456.4 billion to RMB 478.8 billion, while NPL ratio rose from 0.94% to 0.95%.

Many investment professionals we have been quite skeptical about the true level of bad debts as opposed to the level of bad debts that are actually being recognized in the Chinese banking system. This is how such system works, as a tightly controlled banking system should play an important role in stabilizing the economy. Recently, of course, we noted that the so-called "stimulus" to counter the current slowdown is being funded increasingly by non-bank sources, which is an entirely different discussion. 

But the key, remains that if the government needs to keep credit growing, the best control the government has is to ask the tightly controlled banking system to lend, delay recognizing bad loans either by pretending that they do not exist, or to roll over bad loans indefinitely.

A case in point, is a similar occurrence in Japan during the years 90 and 94. The same pattern was experienced. The policies and negligence from policy makers also similar. It may serve as a warning and deserves a note of caution.

Chinese banks are now sitting on a tiny bit of non-performing loans which probably no one in their right mind should believe that it reflects the reality.The Wall Street Journal reports that a recent survey done by China Orient Asset Corp, one of the asset management companies which was set up to deal with a bad loan problem in the previous century, suggesting that many participants in the survey (which are the key players involved in dealing with bad loans) think that the actual level of non-performing loans are higher than it is currently being reported:

Interest rates remained the same.

Do I think the Chinese Central Bank ( People's Republic Bank) will lower rates in the near future? Yes I do. There is room to do so and they will do whatever they can to keep The Chinese Wonder Alive. It does not come as surprise the type of Fortunes being amassed by Chinese Politicians and play-makers. It serves their best interest to get that INCENTIVES or Hush money for their business connections. Therefore, my opinion. Lobbyist are doing their best to keep things going as far as they can.

BTW, such practices are not novelty in Asia. A straight forward research in countries like Thailand, Indonesia, Japan and Taiwan, can deliver a clear picture in this front. Mr. Taksin Fortune in Thailand, Soharto's and others in Indonesia, Scandals in Japan and Korea as well as the soon to become more open Burma/Myanmar will supply plenty to verify this claim. Not that I personally care, to be quite sincere. This has been part of the world history for centuries and as long as money power players can profit personally from situations, they will. It is Human Behavior.

I will not try to be the next guru or market forecaster. There are a good group of Individuals far better equipped, educated & experienced that myself, is this world that one should listen to when it comes down to forecasts. Quite brilliant Individuals with the fine knowledge to make such forecasts. An example would be Dr. Marc Faber; he is definitely one of them and personally one that I deeply admire. Therefore, I leave to Mr. Faber, a brilliant mind, the task  of giving us the hint of when and where.

I am very humble and  down to earth. I don't make secrets and I admit that instead of trying to go out of my zone and make a fool of myself, I rather pay attention to what such brilliant individuals are saying and use what  I have on my disposal to make the a sound decision. I simply listen carefully to their forecasts and follow such bright mind's.  Nothing more nor less. Listen, absorb and act accordingly.

China Retail Sales

A very interesting set of data comes from Retailing.

Retails Sales growth expanded from 14.2% YoY in September in nominal terms to 14.5% YoY in October. The results came above expectations . In Real term, retail sales were up bu 13.5%, up from 13.2% in YoY in September. 

On a seasonally adjusted month on month basis, retail sales have increased by 1.34% in October, down from the revised figure of 1.65% in September.

Retails sales have been expanding for the past five years. It is almost replicating what retail sales in the US does, which is curious to put it mildly. Another important aspect to take into considertaion, is the value of retail in China if converted to US currency.

With the current exchange rate, the sales in China represents 75% of the sales in the U.S. 
Five years ago, that represented only 25%. The power of purchase is increasing in China, meaning that the Chinese are playing a far more important role in Worldwide consumption, as well as the fact that they are being far more aggressive in their consumption pattern than counterparts.

Although the percentages have been impressive, there are some concerning issues. The contraction on real term growth once inflation is taken into consideration. That is a point to be explored. How long they can hold that growth without export expansion is the type of question one must ask itself.

Exports lead to growth in Income, that leads to Increase in Money Supply and consequently Credit expansion and Retail expansion. It is a process. Key factor: Exports.

Normally, growth in Income would also lead to increase in savings. Now, that part of the puzzle is not being filled. As that doesn't happen Export figures become central to every single other factor in the Economic Equation.

CPI

CPI inflation fell in October. Headline CPI inflation fell from 1.9% yoy in September to 1.7% yoy in October. The market was expecting CPI inflation to be unchanged on a year-on-year basis.

On a month-on-month basis, headline CPI was –0.1%, back to a deflationary territory after returning to positive month-on-month price change for the previous two months.

Looking into individual components, there is almost nothing in particular which would draw anybody’s attention. Food prices were up 1.8% yoy, lowest since late 2009, while non-food prices increased by 1.7% yoy. Thus prices of most categories of products remain largely stable.

Meanwhile, producer price index for October was –2.8% yoy, up from –3.6% yoy, but below consensus estimate of –2.7% yoy. On a month-on-month basis, it returns to positive territory at 0.2% after staying negative for 5 consecutive months.

Translating the data properly, it becomes clear that China is experiencing Price Deflation.

Short term interest rates adjusted to Inflation is increasing. There is a serious possibility for further increases in the near future - namely first quarter 2013

Conclusions

The Economic Data coming from China moves markets. It affects Equities, Commodities, Currencies and Interest Rate markets. In fact, today, professionals await Chinese data with as much intensity as they await US or European economic data or news.

On a global scale, China's importance is not going away anytime soon. On the contrary, its importance is only increasing for a couple of reasons:

- The immediate reason - need for good news somewhere - leaves no doubt that China is the place to look for. The U.S . and Europe are not being able to supply that kind of news lately. China economic data can emulate the the kind of joy that policy makers and the public in general wishes to hear. 

So, today, instead of U.S. and Europe, we look elsewhere, to a large economy with Fire Power to lift our moods. China is the immediate choice, with some other emerging economies lagging behind. Yet, China is THE REPLACEMENT by choice.

- The picture in Europe and U.S. is not very bright. Until further notice, it will remain so. Messages are always mixed, one day joy ( A speech here and there, an isolate figure somewhere....) the next day Hell! That has been the mode for quite a while. What defines Joy and Hell here is the kind of expectation the general public would like to hear. For astute enough investors, there are opportunities in this Chaos. 

- With the Panic Button at close reach everywhere, Investors, Speculators and Hedgers are again looking into Gold as an alternative. Central Bankers as well. They are now net Buyers, which is a new role. 

- The Dollar has been appreciating against all major for the last 4 weeks. Except the Chinese Renminbi. That is a factor to point out and pay attention to closely. 

- Equities markets are starting to show weakness. Commodities could suffer the same fate, as asset classes become very intertwined. Once the ball rolls in one side, it bounces immediately on the other.



ASIA'S IMPORTANCE AND ROLE

One cannot ignore the power and importance of this region. Asia is not a Fly by night, one time wonder; Far from That! China came to stay! Hong Kong and Singapore are now Leading financial centers. Hong Kong and Singapore will take over the role of London City by 2015. That is shocking for many, but a wake up call to what reality brings.

Singapore has taken over Switzerland as the favored location for Asset protection, and I add here WITH MERITS. It deserves that position! Service quality is second to none, friendly, efficient and above all flexible. Besides, in a region where the curve is positive still and there is far more to offer.

Professionals of every single sector and industry are being influenced by the Chinese Economy. There isn't an Industry that is immune to Asian competition.

China is the reference, however, other Asian nations also play important roles in the overall global performance. Large consumer markets, expanding economies and vast resources have to be taken seriously.

European Bailout: The facts Financial Markets are ignoring

Financial market professionals and the media are placing high bets that Germany will effectively assist financing the bond program in Europe. The program as most are aware of, is designed to assist nations in desperate need of assistance – Spain and Italy – to stay afloat for another couple of months.

One should look far deeper than the surface before starting to believe that Germany will be able to participate in the program without facing some serious criticism by its own citizens and opposition parties.

There are some facts being ignored; among the most important is the fact that in order to have a REAL PLAN implemented by the ECB; what the media doesn’t talk about or focus on is the very Harsh reality behind European Central Bank Rules.

In order to use the Financial Stability Facility there has to be a UNANIMOUS agreement between all participants.  There is one country opposing the plan without showing any signs or intentions to change its position: Finland!

As long as one participant disagrees, the ECB hasn’t got the ability to explore the facilities.

Another important aspect hardly mentioned is the fact that the ECB must respect a limit on amounts they can lend to Europeans Banks, therefore drawing a limit for funds available to European Central Banks.  If that is not an  important detail to be mentioned in terms of the entire bailout Feasibility, I don’t really know what is.

Mario Dragui – an Italian formal Italian Central Bank president - is doing his ultimate best to get funds to Italian Central Bank.  He states often that the ECB must take a Aggressive Action in terms of supporting the European Union and the Euro. Easy said, difficult done.

I have mentioned in a previous article that Germans – and the Dutch + Finnish Citizens – are very unhappy about seeing their money being use to pay somebody else’s debts.  Angela Merkel may be willing to change her views, but it doesn’t imply that it will get broad support. Elections will take place next year in Germany and she may be using an alternative strategy to gain votes but the response from the public has been far from positive.

A couple of weeks ago, The Germans & The Dutch voted against granting a Banking License to the ESM ( Bailout Bank). ECB president Mario Dragui was beyond upset and literally pointing fingers to Dutch and Germans alike stating that they were old fashioned and narrow minded.

 I guess it isn’t necessary to mention that Finland has opposed the License granting, but I am just making sure everyone knows.  To add more fire to this entire situation, Olli Rehn, EU Commission Vice President , has openly stated that as Finland will oppose any plans regarding Spain and Italy.  

Mr. Mario Monti, Italian prime minister was campaigning for support from Germany, The Netherlands and Finland early in August.  The results were far from expected. He was met with skepticism and criticism instead of support. There are sound reasons for the skepticism. Italian economic results are worsening by the day and show very little sign of improvement and efforts.

Mr. Monti’s reaction was one of retaliation: He stated that if the European Union and ECB don’t come to assist Italy, they can count on a NON-EU oriented, NON- EURO and NON Fiscal discipline oriented Italian Government.

Being very sincere, I don’t think that Germans, Dutch or Finns were surprised. Actually, for them, is just Business as Usual at this point. Put it very simply they don’t seem to be to concerned at this point. It is very bad as it is and even if they would do their best to Worsen the situation, the Italians would not do much worse.

Any changes in opinion from Germans, Dutch and Finns would come as huge surprise and complete unexpected. Fact of the matter is they are tired to pay for others mistakes. Wouldn’t anybody be quite frankly? They tighten belts, put pressure into businesses and citizens to try to get their home economies at better shapes and are dealt blows from neighbor’s sharing a complete different strategy. As I mentioned before, differences in mentality and behavior between European nations are huge. These are gaps difficult to fill and they tend to become more accentuated when things go wrong.

Financial markets are hoping that Germany Finland and the Netherlands will change their mind and will support the Bond Program and any additional Fiscal Bailouts. I doubt, but as I always say, nothing is impossible.

European Economic Figures:

The figures released earlier this month showed that Italian debt has expanded reaching almost 2 EUR Trillion. Italy's total government debt outstanding rose by + 6.637 billion EUR during the month of June and the debt outstanding increased by 21.7 Billion Euros. The situation has been accelerating since April.

To put things into perspective government Debt is 125% the size of GDP. If that doesn't come as Bad News, I don't really know what is...

Industrial Output does look any better:

and last but not least

The figures are dismal and provide little comfort for those willing to SUPPORT Italy’s spending.  If we translate that into layman terms, it is fair to say that Germans, the Dutch and Finn’s must work “Very Hard” to pay Italy’s bill? Is that fair? I don’t think that they agree and it is showing.

Germans are well aware that their support elsewhere is having a direct impact on their domestic economy. Below an extract of the latest press release from the Zew Report:

-          The erosion in business confidence comes on the heels of the

seventh consecutive fall in Germany's composite PMI to its lowest level

(47.0) in over three years.

     "August PMI data highlights the weakest German private sector

performance for over three years, with a return to falling services

activity offsetting an easing in the manufacturing downturn," said

Markit Economics senior economist Tim Moore.

     "Overall, the latest survey indicates that the German economy is

sailing into greater headwinds as the third quarter progresses, with PMI

readings slipping deeper into territory normally associated with GDP

contractions," he added.

     The Bundesbank warned last week that the risks to Germany's

economic outlook have "increased notably" for the second half of 2012,

given the recent escalation of the Eurozone sovereign debt crisis.

There is deterioration on the 5 and 10 year Bond Yield Spread express clearly what the expectations are for the near future. 

Here is the Graph from the 10 year Bund:

GERMAN INDUSTRIAL OUTPUT 2004 to 2012

GERMAN Debt to GDP

How Markets interpret data stays completely detached from the current situation. Markets are discounting mechanisms. While situation in Europe has not improved - actually it has worsened if one reads economic data across Europe, the Euro has reached 8 week highs yesterday. 

Certainly for the public, it is difficult to follow this mechanic. It leaves people rather confused and  asking themselves what defines the value of investment instruments. In short, what the latest appreciation of the Euro represents is nothing but the perception of market participants that the European Central Bank will intervene and find solutions for the current situation.

The speculation is based upon the promises made by the ECB president as well as the overall perception that the Europeans HAVE TO DO something about it. Now, the HAVE TO is just a perception; by law they are not obliged to intervene. In fact, they don't have to do a single thing. 

Market valuations today express the view that member countries will support the members with problems and the situation will improve in the future. That is far from clear, however being as it may, the market has a BID tone and the Euro is appreciating against other currencies. Helping the cause is the fact that the Federal Reserve should engage again on further monetary easing, therefore depreciating the dollar and automatically appreciating the euro.

Making it far more clear, the Euro is a single instrument created to facilitated trade and somehow set standards for those willing to participate. If the regulations would really apply, many countries would have already been  sanctioned or expelled from the Euro Economic zone due to their economic results. 

The Debt as ratio to GDP, Budget deficits, low inflation and interest rates have all been breached by several member countries. So far, there have been no sanctions. Exceptions are being made and most likely the ECB will continue to do so for the foreseeable future. 

The euro was established by the provisions in the 1992 Maastricht Treaty. To participate in the currency, member states are meant to meet strict criteria, such as a budget deficit of less than three per cent of their GDP, a debt ratio of less than sixty per cent of GDP (both of which were ultimately widely flouted after introduction), low inflation, and interest rates close to the EU average. In the Maastricht Treaty, the United Kingdom and Denmark were granted exemptions per their request from moving to the stage of monetary union which would result in the introduction of the euro.

The situation has not improved; The European economy is not expanding and the countries aren't facing brighter futures. All that is at this point are promises - in my opinion difficult to be fulfilled - and hopes that things will turn around elsewhere. If that Elsewhere would be China, I think everyone should reevaluate their priorities, simply because things are far from Rosy in China. 

But, living in a world of hopes and promises, principally when we approach elections, reality has been placed second for the time being and will remain so until further notice.

The reality behind Brazil’s infrastructure WONDER plans and stimulus

Brazil was again In VOGUE last week when the government announced the new stimulus plan.  Reactions were mixed: Enthusiasm and optimism from some and skepticism and a wait and see stance from others.

The initiative is good and the plan makes sense.  Improving infra-structure is essential for the further growth and expansion on industrial sectors.  It would improve Brazil’s competitiveness and provide great relief to exporters. However, in my opinion, these plans are again promises that most likely will remain unfulfilled.

I don’t want to be labeled a pessimist. I wish I could come here and be able to talk about plans that were implemented and dutifully revised and maintained. That doesn’t happen often in Brazil. We don’t have to look deep nor have to dig for facts to see that plans – in the majority of cases – remains plans.

Unless there is the heavily participation and support from the private sector (without Excessive CORRUPTION) this time around, these plans are once again noting more than media and PR plays to boost morale and improve/ polish the country’s image. It sounds good, looks good, but in fact they are nothing more than drafts that remain on the draw board.  They are plans that will never have continuity.

One needs not to look too far behind in time to be confronted with reality and question the government’s ability to deliver. It doesn’t take a genius:  It takes only asking serious questions regarding plans that sound great and find out that they failed. Case in question: the AIRPORTS! In less than 12 months what once sounded like the solution for a below par, very chaotic infrastructure and logistic in airports has completely stalled. It has been delayed, forgotten, or ignored. The real reason doesn’t really matter; what it matters is that the M.O. hasn’t changed.

Ok, Let’s look at the some recent news and articles regarding Brazil’s Airports  to better evaluate the situation:

-        -   Lula’s administration promised to invest 5,5 billions Reais in airports in the 12 world cup hosting cities where there will be World Cup matches in 2014. Untill the end of his admnistration  roughly 300 millions Reais were allocated and around 154 milllion Reais executed.

A recent article on published by the BBC news expressed the international community concerns. Here is an extract of the article:

-       " According to a recent report published by Brazil's audit office (TCU), just 4% of the $3.1bn of funding set aside for transport has been invested to date.In 2011, 179 million passengers travelled through the 67 airports run by the government aviation body, Infraero - 108 million more than in 2003. The result has been queues, delays, poor services and overcrowding: at São Paulo's international airport, it can take up to two hours to pass through immigration.

Carlos Campos, a senior researcher at the Institute for Applied Economic Research (Ipea) in Brazil, says most of the scheduled improvements will not be ready for the World Cup."

Eight airports where improvements are planned in the terminals are still in the initial phase, he says.

"That means that the government might have to build temporary structures to meet the additional demand."

Final dream

Costs will rise as the government spends more to meet the deadline requirements, says Prof Rezende: "We will end up paying a high price for hosting the World Cup."

Official reports don’t bring any relief to the situation. It is definitely not news for travelers in Brazil, but an official report by Brazilian IPEA reveals that 17 out of the 20 main Brazilian airports are either on a “worrying” or “critical” situation: Maior parte dos aeroportos brasileiros está em situação crítica, diz Ipea. The study quotes the economic growth of the last decade and the lack of investment on the field.

The report quotes the examples of Guarulhos international airport in São Paulo, operating at 121% of its capacity or Congonhas domestic airport, also in São Paulo, operating at 141% (does anybody recall the promises made after the tragic accident of Tam’s Airbus at Congonhas airport?).

The Investment Opportunity

In February  the government awarded concessions to 3 investment concerns. They paid premium for the concessions and did so expecting to yield returns from the venture. The consortia are largely Brazilian owned by Brazilian capital, with some international participation.

At 16.2 billion reais ($9.4 billion), it was nearly 4 billion reais more than the second-highest bid, and 12.8 billion reais above the government-specified minimum. On offer was 51% of a public-private partnership with Infraero, Brazil's lumbering state-owned operator. The partnership will have to pay the sum in inflation-linked instalments over 20 years, and also give the government 10% of its turnover. From what is left, money will have to be found for investment of more than 4.5 billion reais fixing up decrepit, overcrowded terminals. A third of that sum must be spent before crowds of football fans arrive for the 2014 World Cup.

Controlling stakes in two more of Infraero's 66 airports were also on offer. Viracopos, 100km from São Paulo, needs huge investment to cope with overflow from Guarulhos, which has no room to grow. Brasília's airport is to be expanded as a hub for domestic flights. All told, the government pocketed 24.5 billion reais.

Some 30% of the country's air passengers and 57% of its air cargo pass through the three airports. The firms bidding are well aware of that and realize that if all goes with a certain degree of normality, They should be gold mines.

Passenger numbers in Brazil have doubled in a decade and hectic growth is expected to continue. Since Infraero is heavily overstaffed and travellers have few opportunities to spend money, costs can be slashed and revenues rose.  With all that said, one has to wonder why they paid such a high premium for the venture. Indeed, it leaves us normal mortals wondering what kind of plan these consortia have in mind…

Questions that remains unanswered:

-          Why companies with more expertise in the sector where unwilling to raise bids?

-          What kind of future cash flows they expected?

-          Are they planning to create new cash flows from diversified operations within airports?

And, we should not forget that if all else fails, they could still resort to the same old strategy of pleading Poverty and ask for relief when plans fail and situation turns out different than expected. It such common practice in Brazil to renegotiate terms and re-restructure contracts and terms to find a leeway to sort out problems, that firms have the luxury to be wrong and still come out ahead. Of course, someone will profit and lobbyists must do their best.  All in all, nothing new here; actually, this is Business as usual.

Corruption, Red Tape, fund misallocation and other recurrent problems

Brazilians have learn how to Swallow – like it or not –  problems including endemic corruption, red tape, insufficient funds and -- above all -- a glaring lack of leadership and know-how.
Government representatives keep on reassuring the world that all will be fine and that all is going according plans. Off Course they take the opportunity to express clearly that they might need SOME help in order to get there!. Now, that is really comforting!
 I think that only fools could believe that. It is really absurd to try to convince the world that all is under control when single visits prove the contrary. By some independent estimates, fewer than half of the major projects planned nationwide will be done on time.
If Stadiums, the central focus of the world cup, are suffering from rampant delays, costs inflation and logistics problems, what could we expect from Infrastructure and facilities? Not Much! So, contrary to what we are being told, things are not going well.

Infrastructure in Brazil

Airports, Roads, Railroads in Brazil are nothing more than SHAMEFUL!  It is a Disgrace! For those who doesn’t agree here are the figures:

ROADS:           

6% of roads in Brazil are paved.  The Other BRICS nations have the following percentages: India 63% of roads paved, Russia 67% and China 87%.

PORTS:                       

According to the Containerisation International Yearbook, average time of permanence of containers before leaving port gives a good idea of where we stand in terms of efficiency in Brazil. 

Our largest Port in SANTOS takes 17 days handle a container while the world average is 5 days. These are incomprehensible facts. An exporting nation with impressive outputs suffering from outdated logistics and absurd costs.  

Cost of Handling is ranks among the most expensive in the world, with services lagging in quality and efficiency.

ELECTRICITY:              

Brazil has some the most expensive Electricity costs in the planet. It stays only behind a few countries in developed economies: Namely Denmark, Italy and Slovakia in developed countries.  So in that ranking we rank number 4! Not bad, isn’t it?! Jokes aside, it is astonishing the overall scenario. Electricity costs in countries such as Germany and The Netherlands are 20% cheaper than Brazil’s current rates.  

AIRPORTS:      

I guess the few paragraphs above summarized the state of affairs…No need to elaborate any further!

RAILROADS:   

The average speed of cargo trains worldwide is 55km/h. In Brazil the speed is 20 km/h. Another problem is railroad’s coverage. In a country where GDP has grown consistently a fractional of revenues was reinvested in infrastructure and in the particular case of Railroads, the percentages where dismal.

I honestly would like someone to come up with sound arguments to convince us that the situation is somewhat manageable. A country that has grown exponentially the last decade, has left its infrastructure on Shambles, to put it very mild.

Some firms have resorted to intelligent solutions to remain competitive. They have built their own ports and cargo facilities.  Such infrastructure and operations are expensive; they are exceptions not the norm. The majority of firms must rely on the public services and networks and in a raw material/commodity exporting economy; they are without a shadow of doubt integral part of company’s competitiveness.

What casts shadows and doubts on the latest developments are a combination of timing and the approach.  

ROAD & RAILWAY REVIVAL

This week Brazil's president Dilma Rousseff announced a $66.0 billion stimulus plan intended to revive the country's road and railway systems and to help bolster the economy. It is the fourth time that the country has tried to revive and stimulate private investments on its Road and Railway networks.

The announcement’s timing gave the impression that the government came swinging in order to reassure the world that it can deliver on commitments.

Our Economy is facing some significant adjustments. The continuous growth is receding and the pace of expansion slowing considerably. The latest economic figures reflect the reality.
GDP showed a very shy recovery (0.20%q/q in Q1 2012 and Q4 2011) after a small contraction of 0.15%q/q in Q3 2011. GDP data for the second quarter of the year has not yet been released, but high-frequency indicators are suggesting further weakness. The latest round of companies’ earnings reinforces the trend. It would be a surprise to see a very strong shift in trend. It is possible, but unlike.

The government can always try to justify and adjust as it see fit. However, the reality comes when the private sector present results and they come far below expectation. Can we blame only Europe and China for our problems? I don’t think is fair. It would not be fair to say that when things go well that we are doing fantastic and when they don’t we blame everybody else in the planet. Now, I don’t think that it is fair to put things that way.

They had to find an alternative way to finance these projects in time for the world magnitude events that will take place in Brazil. The current model is slowing considerably and with the current world economic situation, we can’t rely on revenues from export as we once did.

THE AUCTION RULES

The government announced the rules under which it intends to auction a proposed 511 km high-speed rail link between São Paulo and Rio de Janeiro next year.  

It has tried, and failed, to find bidders three times in the recent past. Most companies with experience in high-speed rail say that that the current cost estimate for  the line—34 billion reais ($17 billion)—is far too low, and that ridership predictions—33m journeys in the first year of operation rising to 100m by 2050—are out of contest. They are far too optimistic.

The cheapest tickets will cost 200 reais one-way and assuming that the railway intends to entice the low/middle classes to travel, the fares are far too high for those earing low wages to effort.

Business travelers fly between São Paulo and Rio in large numbers, and would presumably be willing to spend the money to travel by railroad. The savings would be considerable, the question remaining is: would they be able to sacrifice the time and accept a Downgrade?  Tickets between Rio and SP are the most expensive in the world for city to city flights.  They can reach 700 dollars when booked short term; but with all that said, being a Brazilian, it seems hard to believe there are enough travelers willing to make the sacrifice and generate the desired passenger turnover.

The auction may go ahead this time, because the government has changed the rules since the previous failed attempts. Earlier this year it accepted that taxpayers, not contractors, would have to bear a good chunk of the risk of cost over-runs, low demand and sharp currency movements.  For those who aren’t very aware, current exposure hedging isn’t really a widespread practice in Brazil; only look at the current exposure of several stock listed companies and their quarter results to get a crash course on currency exposure in Brazil.

For the Railroads project, Brazil must rely on international players. Simply put, Brazil has never developed a single High Speed railway project.  It known factor in Railway projects is that they always EXCEED estimations and budgets.  It happened in Korea, in Japan, Taiwan and Europe. In many cases  costs were double the estimates. Given the challenges in Brazilian topography, one can assume that it won’t be different here. The Mountains and Valleys between Rio and São Paulo will be certainly a challenge to overcome and costs will exceed forecasts.

NEW CRITERIA

On August 23^rd, in order to attract investors, it implemented new criteria in the efforts to attract the best candidate: Those with the lowest estimates are most likely to win the concession. This change implies, at the very least, that the government has finally accepted that its own cost estimates are perhaps not the last word.

Also new, is the fact that Brazilian taxpayers will have to participate on the venture. They will have to carry some of the burden.

Most of Brazil's roads are unpaved. Some important routes—including some interstate highways—are single-lane and extremely dangerous.  They are dark and poorly signaled.

Half the population is not connected to the sewage system. There are few (ordinary) commuters or freight rail lines, and they are mostly in very poor condition. Urban mass transport is grossly deficient: São Paulo, a metropolis with almost 20million inhabitants, has a mere 71km (44 miles) of metro/ underground transport, plus a few overland urban rail lines, which at peak hours are all overcrowded.

The Government is planning to start take measures to tackle this backlog, but even if it goes full speed ahead, catching up will take years, maybe decades. It is so easy to think of a long list of more worthwhile infrastructure projects in Brazil (i.e. Sewage systems) that it is hard to understand why this one is not dismissed out of hand.

The only plausible reason one can think of is that of providing some relief to the international community reassuring them that we will be ready for the events ahead.  Is that Pride? is that Vanity?or maybe,  Despair?   Maybe it’s a combination of all elements.

 It may seem outrageous to many what I am about to say, but from Brazilian’s perspective at that stage, the need to show that we can deliver gives us hope that these projects may somehow be completed. Even if they come at high costs, they will fall in the hands of international players doing business with the intent to generate profits (not bleed funds into private bank accounts) and commited to the completion of tasks at hand. 

Plans normally ended in shelves, funds into corrupt politician’s pockets and the costs on the hands of Brazilians paying taxes. That is the sad reality in a country with vast potential and resources, but with a peculiar mentality in regards to projects and funding.  For those doubting my words, just spend few minutes reading about the list of political and financial scandals implicating businessmen, politicians and important personalities.  Most lead to no arrests, impunity and complete disregard to laws and regulations.

Politicians have a license to abuse and steal whenever it pleases. That dictates the mentality in brazil. Schemes are the norm not the exception. With all due respect, when Brazil was nominated to hold the World Cup 2014 and the RIO Olympics, several well placed people were wildly celebrating the inflow of cash that would be coming their way. (Here read Bribery: favors, licenses, votes and nominations for projects all have a price and the highest bidders get those projects).

So, with all sincerity, the only thing that could be relevant and make a difference this time around would be the participation of international firms, willing to do business with an intent to generate real profit. That would be a start.That could be a stone in the right direction. Only time will tell though.

Links below

http://www.guardian.co.uk/world/2012/may/15/brazil-bribery-scandal-politicians