Broadgate: Weekly Briefing 6/9
6 September 2013
Rising Demand Adds to Evidence World Growth is Picking Up – Euro zone businesses had their best month in over two years in August as orders increased for the first time since mid-2011 while growth in China’s services sector hit a five-month high, underpinned by new orders and business optimism. Pockets of weakness remain across the world, however. Data on Wednesday showed Indian services activity shrank in August at its quickest pace since the depths of the global financial crisis. Italian services also contracted more than expected and the downturn continued in France. “The advanced economies have clearly picked up, China is the exception among the major emerging economies but the other emerging economies are still struggling and India in particular,” said Andrew Kenningham, senior global economist at Capital Economics.
Emerging economies are particularly vulnerable to a tightening of United States monetary policy, the International Monetary Fund warned in a note prepared for the Group of 20 meeting in St. Petersburg this week. Markets are preparing for the Federal Reserve to begin slowing down its huge bond-buying program this month as the US recovery remains on track.
The US Institute of Supply Management is due to publish its PMI for US services on Thursday and a Reuters poll predicted a dip to 55.0 from July’s 56.0. A sister survey on Tuesday covering factories showed a surprise upturn. Markit’s Eurozone Composite Purchasing Managers Index (PMI) rose to 51.5 last month from 50.5 in July, its highest reading since June 2011. The headline figure was revised down a touch from a preliminary reading of 51.7. Anything over 50 indicates expansion.
But there are still major differences between Europe’s two most important economies. The composite PMI for Germany, the euro zone’s largest, jumped to a seven-month high of 53.5, but the French PMI dipped to 48.8 from 49.1. Across the channel, a rush of new business last month drove the fastest growth in Britain’s services sector for more than six years, challenging the Bank of England’s cautious outlook for the economy. It’s services PMI beat forecasts with a rise to 60.5.
Led by firm US growth, the outlook is gradually improving for advanced economies and even crisis-weary Europe is at last joining the recovery, the OECD said on Tuesday, but warned a slowdown in many emerging economies meant global growth would remain sluggish.
The Chinese Markit/HSBC Services Purchasing Managers’ Index (PMI) climbed to 52.8 in August after seasonal adjustments, up from July’s 51.3 and the highest since March. Qu Hongbin, an HSBC economist, cited new business growth as the key driver of the PMI and expected the momentum to be sustained. “A rebound in manufacturing output is expected to support service industry growth in the coming months,” Qu said.
Any improvement will cheer investors as fears of a sharp slowdown in the world’s second largest economy had kept markets in check but the good news will be tempered by a slowdown in India, Asia’s third largest economy. Having fallen below the 50-mark in July for the first time in nearly two years India’s services PMI slipped further last month and with a survey of factories published on Monday showing activity shrank for the first time since early 2009, the picture is grim.India’s economic growth has almost halved in the past two years and the economy grew 4.4 percent in April-June, its slowest quarterly growth rate since early 2009. The weak run is set to continue with macroeconomic uncertainty and tighter financial conditions weighing on growth,” said Leif Eskesen, HSBC’s chief India economist.
Emerging Nations Save USD 2.9 Trillion Reserves in Rout – Developing nations from Brazil to India are preserving a record USD 2.9 trillion of foreign reserves and opting instead to raise interest rates and restrict imports to stem the worst rout in their currencies in five years.
Foreign reserves of the 12 biggest emerging markets, excluding China and countries with pegged currencies, fell 1.6 percent this year compared with an 11 percent slump after the collapse of Lehman Brothers Holdings Inc. in 2008, data compiled by Bloomberg show. The 20 most-traded emerging-market currencies have weakened 8 percent in 2013 as the Federal Reserve’s potential paring of stimulus lures away capital.
After quadrupling reserves over the past decade, developing nations are protecting their stockpiles as trade and budget deficits heighten their vulnerability to credit-rating cuts. Brazil and Indonesia boosted key interest rates last month to buoy the real and rupiah, while India is increasing money-market rates to try to support the rupee as growth slows. Central banks should draw on stockpiles only once currencies have depreciated enough to adjust for the trade and budget gaps, according to Canadian Imperial Bank of Commerce.
“If fundamentals are going against you, it’s not credible to defend a currency level – investors would rush for the exit when they see the reserves depleting,” said Claire Dissaux, managing director of global economics and strategy at Millennium Global Investment in London. “The central banks are taking the right measures, allowing the currencies to adjust.”
The South African rand, real, rupee, rupiah and lira, dubbed the “fragile five” by Morgan Stanley strategists last month because of their reliance on foreign capital for financing needs, fell the most among peers this year, losing as much as 19 percent.
Foreign reserves in the 12 developing nations including Russia, Taiwan, South Korea, Brazil and India, declined to USD 2.9 trillion as of 28 August, from USD 2.95 trillion on 31 December and an all-time high of USD 2.97 trillion in May,. The holdings increased from USD 722 billion in 2002. The figures don’t reflect the valuation change of the securities held in the reserves. China, which holds USD 3.5 trillion as the world’s largest reserve holder, is excluded to limit its outsized impact.
Spotlight On: Indonesia Loses its Allure as Prices Chill Buyouts
Indonesia has lost much of its allure for private equity as steep valuations restrain buyouts in a country that two years ago was, in the words of one investor, “probably the sexiest destination in the emerging markets.”
International private-equity firms have acquired stakes in four Indonesian companies this year, down from 10 in 2011 and seven last year, according to data compiled by Bloomberg and the Asian Venture Capital Journal. Total transaction values fell from USD 649 million for the nine deals in 2011 where terms were disclosed to USD 324 million for the six deals last year for which prices were available, the data show.
Deals have fallen precipitously this year, to USD 87 million for three of the four announced deals. “Expectations have been high over the past two years for private-equity deal making in Indonesia,” said Nicholas Bloy, Kuala Lumpur-based managing partner at Navis Capital Partners Ltd., which oversees USD 3 billion in public and private equities in Asia. “But many players in the industry had a sobering reality check and now need to be more realistic in their return expectations, as they are facing inflated valuations by sellers.”
Even after its 22 percent decline from its all-time high on May 20, the Jakarta Composite Index (JCI) has surged 75 percent over the past four years, compared with a 11 percent increase in the MSCI Emerging Markets Index. The companies in the Jakarta index are trading at 17 times earnings, compared with 11 times earnings for companies in the MSCI Emerging Markets Index, according to data compiled by Bloomberg. “Value expectations have been at record highs,” Bloy said. “Cautious investors are looking at valuations in a different way than bullish entrepreneurs.”
In addition to valuations, deal making is being chilled by shifting government regulations, which complicate market assumptions for acquirers, and competition from strategic buyers.
Growth in private equity in Indonesia has turned out to be “lumpy” rather than “a straight line,” said Juan Delgado-Moreira, a Hong Kong-based managing director at Hamilton Lane Advisors LLC, which invests in private equity. “There is a bid-ask gap to bridge” because of high prices in the stock market, “which some would say is overheated” despite the recent drop, he said. Delgado in January 2012 had said that “Indonesia is probably the sexiest destination in the emerging markets now,” calling it “one of the key long-term investment destinations in Asia.”
Large global private-equity firms this year have been selling more than buying. Deals in Indonesia have failed because of unrealistically high valuation expectations by sellers. One consumer company seeking a valuation at 12 to 14 times earnings before interest, taxes, depreciation and amortization for a private-equity stake should have been priced around eight times Ebitda based on comparable public companies, according to Navis Capital’s Bloy. “When you have a slight divergence you can adjust, but here you can’t bridge the gap,” Bloy said. “Someone has to give.”
If the selloff in share prices as well as Indonesia’s rupiah continues, it may improve opportunities for private-equity investors, according to Sebastien Lamy, a Singapore-based partner at management consultancy Bain & Co.
The rupiah has plunged 13 percent this year to the weakest level in four years, making it the worst performer among Southeast Asia’s currencies, according to data compiled by Bloomberg. “If the stock-market adjustment lasts, it will also have an impact on private-equity valuations, and those lower valuations would mean that private equity deploys more capital in the country,” Lamy said. “A lasting devaluation of the rupiah will have the same effect.”
High asking prices have also been bolstered by the prospect of increasing economic expansion. Growth rates in Indonesia, Southeast Asia’s largest economy and home to 249 million people, are forecast to increase from 5.8 percent this year to 6.4 percent in 2015, according to the median forecast of 24 economists surveyed by Bloomberg. That’s higher than projections for neighboring Malaysia and about double the growth expected for the global economy.
Economic growth of about 6 percent a year would mean Indonesia’s economy will surpass Germany and the U.K. in size by 2030, according to a report last year by consulting firm McKinsey & Co. By 2020, the number of middle-class and affluent Indonesians may double to more than 141 million, Boston Consulting Group said in a March report. That’s greater than the population of Japan, and almost that of Russia.
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