The McKinsey Quarterly: Treasury management in emerging-market banks

The Prudent Investor: This featured article is dedicated for those of you in the Treasury Departments of any Financial institutions...

Treasury management in emerging-market banks

Elevating the treasury from a support function to a bank’s primary instrument for managing market risk can have a far-reaching impact throughout the organization.

Alberto Alvarez, Hugo A. Baquerizo, and Joydeep Sengupta

The McKinsey Quarterly, Web exclusive, November 2004

Banks in emerging markets have worked hard to hone their credit-risk-management skills over the past decade, and many of them deliver credit-related services and returns on par with those of their world-class competition. Yet they lag behind their counterparts in developed markets in managing market risk and in applying this knowledge to the treasury unit.

For banks in developed markets, the treasury unit has long been a source of profit, but it remains a support function for many institutions in emerging markets. We interviewed executives at 14 banks in Latin America, the Middle East, and Southeast Asia. At 9 of them, the focus of treasury activities was short-term liquidity management: ensuring that funds are available to meet regulatory reserve requirements and the immediate needs of customers. Board members and top managers at many of these banks view certain common treasury activities—for example, trading securities and developing derivatives contracts—as forms of casino finance.

In much of the developed world, a bank's treasury, in addition to managing liquidity, is responsible for managing assets and liabilities, trading in currencies and securities, and developing new products. High-performing treasuries systematically identify, mitigate, and profit from market risk—that is, risk associated with changes in interest rates, exchange rates, and the value of securities and commodities. When board members and top executives understand market risk, they see that good treasury management is anything but a gamble. A capable treasury unit that actively manages market risk can create significant value for a bank's shareholders. To convert the treasury function into a profit center, the bank must develop a clear business plan, educate its leadership about market risk, and get treasury personnel more involved in other bank activities.

Treasury's potential

For many banks in unstable financial markets, liquidity management has evolved into a source of competitive advantage. But although these institutions can manage short-term liquidity, they fall short in other activities, such as trading, product development, and actively managing the balance sheet structure and their exposure to market risk. Without a clear understanding of market risk, managers can neither protect a bank's capital nor profit from it.¹ Several problems constrain innovation in this area: a bank's leaders may be poorly informed about the profit opportunities in treasury, local money and capital markets may be thin, and customers may not demand products available in developed markets. As a result, the treasury unit often accounts for less than 10 percent of the net profits of banks in emerging markets. For those few institutions that have turned the treasury into a profit center—primarily innovative banks in larger financial markets such as Brazil, Mexico, and Singapore, as well as local subsidiaries of global banks—its contribution tends to be much higher: from 25 to 35 percent of net profits.

Emerging-market banks with a profitable treasury function keep their strategies simple and close to home. Taiwan's Chinatrust and Venezuela's Banco Mercantil, for example, offer their large, affluent customer bases standard products such as currencies or local securities contracts, for which the treasury is responsible. These wealthy people give the banks better access to retail funds and a steady stream of income from trading, both of which allow banks to make the most of their existing customers and branch networks.

Only global players such as Citibank and HSBC have the capability to dominate all treasury segments and products. Scale advantages give these institutions superior access to markets and information, allowing them, for example, to become market makers in specific currencies. Other large banks, such as Deutsche Bank and J. P. Morgan Chase, focus on providing the full scope of treasury services to the largest corporate segments. Specialized institutions such as Goldman Sachs also serve large corporate players but aim to capture market share in specific product lines. But banks in most emerging markets, where the treasury is a support function, seldom have such explicit strategies.

Putting together a mandate

Building a treasury unit calls for an annual business plan, which includes revenue and volume targets by product line and activity—the main ones being asset and liability management, trading, and new-product development. These plans also typically include a detailed description of risk considerations, the business potential of various kinds of products, and the treasury's posture: that is, whether or not the bank should attempt to make markets and profit from price movements or simply follow market prices and fill orders from customers.

The bank's asset and liability committee should review and define the treasury's specific objectives, in what is commonly called a mandate, on a monthly basis to shape the bank's balance sheet and its exposure to market risk. This analysis examines the balance sheet with respect to target structure, short-term forecasts of interest rates, exchange rates, and the price of securities and commodities.

Managing assets and liabilities

In developed markets, treasuries act as risk managers for banks. By using internal transfers—a standard accounting practice in banks—the treasury buys and sells funds among the bank's client-facing units in order to isolate and remove maturity and interest-rate mismatches from corporate and retail business units. For the fund transfers, these banks use sophisticated pricing that allows their treasuries to account for and hedge the liquidity and interest-rate risk of each asset and liability on their balance sheets.

But most of the emerging world's banks, including 73 percent of those we surveyed, still apply a single-rate transfer price to most asset and liability contracts. By awarding the same internal transfer price to all short- and long-term funds, banks give managers no incentive to offer funds of varying maturities and repricing characteristics.² The result is an improperly structured balance sheet: since the bank can't break out the credit risk and market risk components from the net interest margin, it lacks an accurate measure of true profitability in the product or client categories.

If treasury units in emerging markets hope to compete with the local subsidiaries of global banks, it will be necessary to learn how to set transfer prices appropriately. The first step is to incorporate the maturity and interest-rate characteristics of every contract a bank holds, for both assets and liabilities.

Trading and holding positions in currencies, securities, and derivatives

Large banks in emerging markets usually generate 5 to 35 percent of their total treasury revenues from trading. The actual percentage depends largely on a bank's ability to benefit from its customer relationships. Credit-related products in foreign currencies, such as working-capital lines of credit and trade-financing letters of credit, often generate the majority of foreign-exchange trading business for corporate clients. Banks that derive a relatively high proportion of their revenues from trading rely on the treasury and their client-facing units, such as the corporate-banking group, to develop a clear understanding of their customers' needs. Product-development managers in the treasury of such a bank have developed skills in structuring contracts, and corporate-account executives know best what their clients want. Thus, when the treasury and client-facing units collaborate more closely to plan accounts and set sales strategies, it's much more likely that the bank will create attractive products for its clients and generate more revenue.

The most successful investment-driven banks in emerging markets generate up to 60 percent of the treasury's total revenue by holding inventories of, or positions in, currencies, securities, and derivatives. For maintaining profitable positions, access to information and the ability to liquidate positions are crucial. Banks in emerging markets are usually well acquainted with trading and holding positions in local and sometimes regional securities markets. Since these banks lack the experience and resources to research other markets adequately, they often delegate investing and taking positions in global securities markets to third parties. When a small or midsize bank in Dubai or Riyadh, for example, needs to purchase US Treasury bills and bonds, it may delegate the task to a large institutional investor with better market access.

Developing new products

In general, bank treasuries in the emerging world don't create and market new products themselves, since a relatively unsophisticated local customer base doesn't push them to develop a wider variety of offerings. In some markets, top corporate customers structure their own products and use the banks merely to execute transactions.

Most often, treasury products are associated with the credit and cash-management needs of corporate customers—off-balance-sheet and tax-efficient loans or project finance, for example. To sell new, more sophisticated products, banks should involve the treasury in segmenting corporate clients and in creating tailored offerings based on the needs and behavior of customers.

The treasury can also play an important role in structuring products to hedge the bank's own capital. These products—typically derivatives contracts—protect the bank's capital exposure to a particular currency or to market factors such as changing interest rates and commodity prices.

Taking the treasury seriously

To build an effective and profit-oriented treasury unit, the leadership of banks in emerging markets must develop a better understanding of and appreciation for market risk. This cultural shift must start with board members and top management and continue through the treasury organization and the rest of the bank. Implementing an effective decision-making culture means making everyone understand how the bank manages and profits from market risk.

The creation of a treasury unit that follows global best practices—with clear treasury and market-risk-management roles—is a critical step in gaining this understanding. Centralizing the treasury unit and streamlining business, support, and control processes are also vital to building a profitable treasury. For many banks in emerging markets, market risk management and activities such as liquidity management and the holding of currencies and securities are conducted in an uncoordinated way outside the treasury: It may handle foreign-exchange trading for only, say, traditional retail and corporate clients, while other business units might trade for corporate and commercial clients that demand trade finance products (import and export financing, such as letters of credit, for example). Or perhaps the treasury manages local-currency liquidity while the international-banking unit handles liquidity for foreign currencies. In such cases, it's far more difficult for the bank to monitor and manage risk, since decision making is decentralized.

Banks can better manage and profit from risk by making the treasury the lone department with access to the financial markets and the single repository for currency and securities inventories. One Latin American bank, for example, was dominant in its market but had a relatively unsophisticated and decentralized treasury unit. The bank consolidated its liquidity-management operations for all currencies under a single money-market desk and created a clear distinction between the trading and sales functions. It also adjusted its asset- and liability-management processes and tools to help the treasury take a more active role in handling market risk and in developing new products. In just 18 months, the treasury unit's contribution to the bank's bottom line increased to 25 percent, from 12 percent.

How to proceed? In our judgment, hiring experienced traders and product developers allows both frontline and top managers to build new skills in less time than would be needed if they merely watched and learned from the market itself. In addition, many banks that lack skills at the top of their treasury organizations would be wise to recruit new treasurers from global banks. For most banks in emerging markets, developing and implementing a new treasury model takes three to five years. When top management is committed to the new goals, and the bank's competitive position in the market is favorable, the transition can be completed much more quickly. Two banks in Latin America, for example, achieved significant benefits—increased profits from the treasury unit and better risk management—just 18 months after launching their transformation effort. An efficient, committed management team can increase the treasury's contribution to net profits by more than 20 percent.

The most critical aspect of the evolution of the new treasury is ensuring that the board and the top-management team are committed to it. Other key stakeholders—such as traders, account executives, and branch managers—must learn how it operates. But unless the board is well educated in the advantages of the new model and has confidence in it, all may be lost. The board must develop an understanding of market risk management in order to provide direction, while top executives must acquire a new mindset as well as the tools to implement it. The risks and rewards—increased vulnerability to the vicissitudes of the market, on the one hand, substantially higher profitability, on the other—are too large to ignore.

About the Authors

Alberto Alvarez is an associate principal in McKinsey's Caracas office, Hugo Baquerizo is a principal in the Bogota office, and Joydeep Sengupta is a principal in the Delhi office.

Notes
¹ For a broader summary of channel options, see John M. Abele, William K. Caesar, and Roland H. John, "Rechanneling sales," The McKinsey Quarterly, 2003 Number 3, pp. 64–75.
² The frequency with which a price can change, regardless of the fund's maturity date. The contract for a three-year loan, for example, might stipulate that the loan be repriced every 90 days.

Businessweek: The Economy Five Wild Cards For 2005

The Economy: Five Wild Cards For 2005

What could throw the economy for a loop? Here are some threats worth watching

There's an old saying in economic forecasting: The consensus is always wrong. That's why the key to investing wisely in 2005 may well lie in considering how the economy will stray from expectations. To evaluate the risks and possibilities for 2005, BusinessWeek asked the economists in our annual outlook survey to think outside the box of their basic forecasts by identifying the wild cards that could have a positive or negative impact on the outlook. That's not to say consensus forecasts are useless. Far from it. They provide an important baseline for judging the economy's performance as it plays out. For 2005, the 60 forecasters we surveyed expect, on average, that the economy will grow 3.5% from the end of 2004 to the end of 2005. That's a bit below the 3.8% pace expected for 2004. The consensus view is that profit growth will slow to 6.7%, and inflation will fall, as oil prices slip to $39 per barrel by the end of 2005. The Federal Reserve will keep lifting the federal funds rate, to nearly 3.5% by yearend, from 2.25% now, and the yield on 10-year Treasury bonds will increase from 4.3% to 5.1%. In general, economists see the dollar slipping at a gradual pace of about 10% against major currencies and 5% vs. all currencies. The jobless rate should fall from 5.4% to 5%.

All in all, that's not too shabby. But what could throw the consensus for a loop? Here are five economic wild cards for 2005 that bear close scrutiny as the year progresses. They're especially important because they are interrelated: A surprise in one area could generate unexpected consequences elsewhere. These wild cards are the most credible threats to the general forecast -- and to the value of your portfolio.

WATCH OUT FOR FALLING DOLLARS

A possible crash in the U.S. dollar surpassed even oil prices as the biggest question mark on economists' minds for 2005. "This has been my worst nightmare for some time," says Nicholas S. Perna of Perna Associates in Ridgefield, Conn. The growing concern is America's ability to attract the massive amount of foreign capital it requires to finance both private and public investment. The trouble: A rising federal budget deficit subtracts from the available pool of domestic savings, even as the widening trade deficit adds to the financing needs.

The danger, says Perna, is a loss of confidence in the U.S. economy and those running its economic policy that could play out in a rerun of the 1980s. Early in that decade, the stimulative effects of budget deficits helped to push up the dollar and the trade deficit. But in 1985-87 the dollar plunged 40% vs. major currencies, yields on Treasury bonds jumped two percentage points, and stock prices plunged 30% in October, 1987.

Economists already see some increasing reluctance by both private investors and central banks to hold U.S. Treasury securities. But if the greenback really tanks, "the primary effect will likely be on the U.S. corporate bond market, where overseas investors -- largely Europeans -- account for about half of new-issue buying," says Vincent Boberski at RBC Dain Rauscher in Minneapolis.

Sharply higher interest rates would be especially damaging to a frothy housing market, the stock market, and heavily indebted consumers. More ominously, higher rates would increase the risk of an outright recession.

AVOIDING ANOTHER OIL SLICK

Unlike the dollar, oil is a wild card that could swing either way. On the negative side, another spike in oil prices could slow consumer demand just as it did in 2004. "If oil remained at $50 to $55 per barrel, it would lower gross domestic product growth next year by about one percentage point," says Richard D. Rippe at Prudential Equity Group. Other economists worry that, given the right geopolitical upheavals or supply disruptions, oil could hit $60 or $70, a shock that would further crimp household buying power and pummel corporate profits. "Oil prices at $80 would undermine business and consumer confidence sufficiently to cause a mild recession late next year," says Kurt Karl of reinsurance firm Swiss Re.

But economists see an equal, if not greater, chance that oil prices could fall, perhaps to $25 per barrel. That could be precipitated by several factors, including an expected slowdown in global demand, a mild winter, or an easing of Mideast tensions either in Iraq or between Israel and the Palestinians. Cheaper oil "would spark a period of very strong growth in the U.S. as consumers and companies respond to the cash flow gains generated by the drop, pushing growth towards perhaps 6% for a time," says Ian C. Shepherdson of High Frequency Economics in Valhalla, N.Y. Stock prices would benefit handsomely, and the wealth effect would support consumer spending. However, don't expect falling oil prices to keep rates down. "The Federal Reserve would probably continue to raise interest rates with the economy growing above its potential," says Lynn Reaser at Banc of America (BAC ) Capital Management in St. Louis.

INFLATION BREATHES FIRE

Oil and the dollar have one thing in common: the potential to affect inflation. That may well explain why our survey's inflation forecasts vary more than usual, from 1.2% to 4.4%. Consumers and businesses could easily adjust to a return of low inflation after 2004's oil-fueled rise. But if prices pop up 4%, that would send both bond investors and the Fed scrambling. "We believe there is a significant risk that inflation will be higher than expected," says Lynn O. Michaelis at Weyerhaeuser Co. (WY ), noting that the dollar's drop and higher commodity prices are just beginning to wend their way into final goods prices. Matters could be worse if China revalues its currency higher. "This would result in revaluations of other Asian currencies and allow U.S. businesses to become more aggressive in their pricing," says Mark Zandi at Economy.com Inc.

Bear in mind that many of the factors that held inflation down during the 1990s are reversing. And it's not just the weaker dollar or costlier energy. First, productivity growth is slowing, as it does when a recovery matures. That, together with a tightening job market, will push up unit labor costs. Second, factories are busier. "The Fed's capacity numbers understate the true capacity utilization rates," asserts Robert Shrouds at DuPont (DD ). "Based on the experience at my company, utilization rates are high across a broad range of products." Lastly, monetary policy is still unusually accommodative, with the Fed's target interest rate still close to zero after adjusting for inflation. An inflation surprise would cause the Fed to lift rates more and faster than expected.

POP GOES THE HOUSING BUBBLE

If rates rise faster than the consensus expects, housing is especially vulnerable, say some economists. "Houses that look affordable now would not look so with mortgage rates two percentage points higher," says Nariman Behravesh at Global Insight Inc. in Waltham, Mass. If mortgages rise to 8%, many buyers would have to scale back their aspirations, and some homebuyers would be priced out of the markets, causing a downshift in home demand.

More important, a weaker housing market would prick any bubble in prices, deflating household wealth. Consumers would have to save more and shop less. And with mortgage rates up, refinancing would dry up, also crimping spending.

AS THE WORLD CHURNS

Another wild card foremost in our economists' minds is a sharp slowdown in global growth. "The euro area is weighed down by currency appreciation and the absence of any domestic demand dynamic," says Bruce Kasman at JPMorgan Chase & Co. (JPM ), "and Japan's recovery could prove disappointing." If China's efforts to cool off its economy rip its fragile financial fabric, that could have global repercussions. The risk is that weak demand would cut into U.S. exports, thwarting the chances for a lower dollar to help stabilize the trade deficit.

Not surprisingly, the threat of terrorism looms over all. "A terrorist strike in the U.S. or marked escalation of the conflict in the Middle East could result in an attendant drop in business confidence that would undermine the expected recovery in investment and employment," says Tim O'Neill at BM Financial Group/Harris Bank in Toronto. Another attack could hasten the dollar's decline, roil the financial markets, and harm the economy.

The problem is that terrorist attacks are impossible to forecast. But that only illustrates how one day's events can derail a yearlong consensus forecast. If all goes according to the forecasters' plans, 2005 should be a decent year for both the economy and a well-balanced portfolio. But investors should heed the lesson of recent years: Expect the unexpected.

By James C. Cooper & Kathleen Madigan

Japan Times: China's power prevents Japan from invading Asia again: Lee

China's power prevents Japan from invading Asia again: Lee

SINGAPORE (Kyodo) Japan is unlikely to again go down the militarist path and invade its Asian neighbors as it did before and during World War II because China's growing economic prowess has created a new balance of power, according to Singapore's elder statesman.

"I do not see a return to a situation the Japanese were in during the 1930s and 1940s. That Asia will not come back," Lee Kuan Yew, 81, told a dinner organized by the Foreign Correspondents' Association on Monday.

"We have an Asia now that is completely different with China . . . economically growing 8 to 9 percent. So I don't see a repetition of the old behavior, but an evolution into a new balance."

In response to a question, Lee said Prime Minister Junichiro Koizumi's visits to Yasukuni Shrine, the dispatch of ground troops to Iraq and preparations for a more significant role for the Self-Defense Forces reflect a "gradual evolution" that could turn out to be positive.

"I see this as a development that the U.S. would be happy with and will fit in with the balance that eventually must be established between the U.S. and Japan on the one, and China on the other," he said.

He said the United States needs Japan to continue as a partner.

"A U.S. without Japan would be at a great disadvantage in Asia," he said.

Lee was Singapore's first prime minister, holding the reins for more than three decades until 1991. In the 1990s, he quipped that allowing Japan to rearm would be like giving liquor chocolates to an alcoholic.

In his memoirs, published in 1998, Lee says 50,000 to 100,000 mainly Chinese people in Singapore were massacred by the Japanese military during the 1942-1945 occupation.

On an East Asian economic community, Lee said: "If we want an economic community, I think it is possible, but it will take many years. But to be an East Asian union, that is different. To have one currency, that will take many decades."

The Japan Times: Dec. 22, 2004
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New York Times: China in Line as U.S. Rival for Canada Oil

China in Line as U.S. Rival for Canada Oil

By SIMON ROMERO

CALGARY, Alberta, Dec. 21 - China's thirst for oil has brought it to the doorstep of the United States.

Chinese energy companies are on the verge of striking ambitious deals in Canada in efforts to win access to some of the most prized oil reserves in North America.

The deals may create unease for the first time since the 1970's in the traditionally smooth energy relationship between the United States and Canada.

Canada, the largest source of imported oil for the United States, has historically sent almost all its exports of oil south by pipeline to help quench America's thirst for energy. But that arrangement may be about to change as China, which has surpassed Japan as the second-largest market for oil, flexes its muscle in attempts to secure oil, even in places like the cold boreal forests of northern Alberta, where the oil has to be sucked out of the sticky, sandy soil.

"The China outlet would change our dynamic," said Murray Smith, a former Alberta energy minister who was appointed this month to be the province's representative in Washington, a new position. Mr. Smith said he estimated that Canada could eventually export as many as one million barrels a day to China out of potential exports of more than three million barrels a day.

"Our main link would still be with the U.S. but this would give us multiple markets and competition for a prized resource," Mr. Smith said. Delegations of senior executives from China's largest oil companies have been making frequent appearances in recent weeks here in Calgary, Canada's bustling energy capital, for talks on ventures that would send oil extracted from the oil sands in the northern reaches of the energy-rich province of Alberta to new ports in western Canada and onward by tanker to China.

Chinese companies are also said to be considering direct investments in the oil sands, by buying into existing producers or acquiring companies with leases to produce oil in the region. In all, there are nearly half a dozen deals in consideration, initially valued at $2 billion and potentially much more, according to senior executives at energy companies here.

One preliminary agreement could be signed in early January. A spokesman for the Department of Energy in Washington said officials were monitoring the talks but declined to comment further.

China's appetite for Canadian oil derives from its own insatiable domestic energy demand, which has sent oil imports soaring 40 percent in the first half of this year over the period a year ago. China's attempts to diversify its sources of oil have already led to several foreign exploration projects in places considered on the periphery of the global oil industry like Sudan, Peru and Syria.

In Calgary, however, the negotiations with China have focused on the oil sands, an unconventional but increasingly important source of energy for the United States. Higher oil prices have recently made oil sands projects profitable, justifying the expense of the untraditional methods of producing oil from the sands. Large-scale mining and drilling operations are required to suck a viscous substance called bitumen out of the soil.

"China's gone after the low-hanging fruit so far," said Gal Luft, a Washington-based authority on energy security issues who is writing a book on China's search for oil supplies around the world. "Now they're entering another level of ambition, in places such as Venezuela, Saudi Arabia and Canada that are well within the American sphere."

Canada's oil production from the sands surpassed one million barrels a day this year and was expected to reach three million barrels within a decade. The bulk of output is exported to the Midwestern United States. That flow pushed Canada ahead of Saudi Arabia, Mexico and Venezuela this year as the largest supplier of foreign oil to the United States, with average exports of 1.6 million barrels a day.

Even so, there is the perception among many in Alberta's oil patch that Canada's rapidly growing energy industry remains an afterthought for most Americans. That might change, industry analysts say, if Canada were to start exporting oil elsewhere.

"A China agreement might serve as a wake-up call for the U.S.," said Bob Dunbar, an independent energy consultant here who until recently followed oil issues at the Canadian Energy Research Institute.

Executives at energy companies and investment banks in Calgary say an agreement with the Chinese could materialize as early as next month. Ian La Couvee, a spokesman for Enbridge, a Canadian pipeline company, said it was in talks to offer a Chinese company a 49 percent stake in a 720-mile pipeline planned between northern Alberta and the northwest coast of British Columbia.

The pipeline project, which is expected to cost at least $2 billion, would send as much as 80 percent of its capacity of 400,000 barrels a day to China with the remainder going to California refineries. Sinopec, one of China's largest oil companies, was said by executives briefed on the talks to be the likeliest Chinese company in the project.

A rival Canadian pipeline company, Terasen, meanwhile, has held its own talks with Sinopec and the China National Petroleum Corporation about joining forces to increase the capacity of an existing pipeline to Vancouver. Richard Ballantyne, president of Terasen, said it had supplied almost a dozen tankers this year to help Chinese refineries determine their ability to process the Alberta crude oil blends.

"There's been significant interest so far, but the way I understand it, their refineries are still better suited to handling Middle Eastern crude than ours," Mr. Ballantyne said. "That has to change if they're intent on diversifying their sources of oil."

Separately, Marcel Coutu, the chief executive of the Canadian Oil Sands Trust, a company that owns part of one of the largest oil sands ventures in the tundralike region around the city of Fort McMurray in northern Alberta, said he had recently met with officials from PetroChina, one of China's several state-controlled energy concerns, and had agreed to send it trial shipments of oil.

In an interview, Mr. Coutu described PetroChina's interest in a deal as very serious, but he declined to say when one might materialize. "China can become one of our capital sources, enabling us to go a bit further afield than the New York market for our financing," Mr. Coutu said.

Additionally, Chinese companies are also said to be considering investments in smaller Calgary-based companies, like UTS Energy, that have approved leasing permits for parts of the oil sands. Officials from the Chinese companies said to be negotiating in Calgary - PetroChina, Sinopec and CNPC - did not respond to requests for comment.

Wilfred Gobert, vice chairman of Peters & Company, a Calgary investment bank, said Canada's main attractions for the Chinese are the stability of its political system and its sizable reserves. Canada ranks behind only Saudi Arabia in established petroleum reserves, now that its oil sands are included in international estimates of Canadian oil resources.

Before prices rose and the United States expanded its calculation for estimates of reserves, oil sands were often scoffed at as an uneconomical way to produce oil. They still involve risks not normally associated with conventional oil exploration.

Large amounts of capital are necessary to produce oil from the sands, with companies having to acquire large shovels, trucks, specialized drilling equipment or supplies of natural gas to make steam before producing one barrel of oil. So, the price of oil needs to remain elevated, at a level of $30 a barrel or so, for ventures to remain profitable.

[Oil prices for February delivery slumped 3.3 percent, to $44.24 a barrel, in New York on Wednesday, the biggest slide in two weeks.]

An entry into Canada would assure the Chinese of a steady flow of oil, even if the profit margins from the activities were to pale in comparison to what the international oil companies expect from their investments, said Kang Wu, a fellow at the East-West Center in Honolulu who follows China's energy industry. "For China it is foremost about securing supply and secondly about profits," he said. "That explains the incentive in going so far abroad."

China's growing demand for oil is responsible for much of the increase in worldwide prices in the last year. Mr. Kang of the East-West Center estimates that demand in China could grow from 6 million barrels a day to as much as 11.5 million barrels within a decade. China's domestic production is expected to remain nearly stagnant, Mr. Kang said, resulting in aggressive efforts to import more oil from sources like Canada.

"China needs oil resources and has a big market," Qiu Xianghua, a vice president at Sinopec, said in a speech in Toronto this month. "Canada needs markets."

Alberta, a province of 3.1 million people, is keenly aware of the potential for Chinese involvement even as American companies like Exxon Mobil, Burlington Resources and Devon Energy remain prominent in its energy industry. Ralph Klein, the premier of Alberta, traveled to Beijing in June to drum up investment in the tar sands.

And yet officials and authorities on Canadian energy supplies are cautious not to suggest that Canada will ever turn off the spigot to the United States. At a time of a highly competitive market for global oil, in fact, some analysts see greater interest in Alberta's oil reserves as a healthy avenue for China to explore, even if it were to push the United States to seek an even greater diversity for its own energy needs.

"The pipeline system that connects Alberta to the U.S. isn't going to be lifted out of the ground and put into the Pacific," said Daniel Yergin, chairman of Cambridge Energy Research Associates. "The flows to the U.S. will continue, but it should be expected and welcomed for China to meet the challenge of its growing dependence on imported oil."

Still, the prospect of dealing with China has many here pondering relations with the United States. The last time any significant oil-related friction arose between the nations was in the 1970's, when Ottawa became concerned over what it perceived as too much American control over Canadian oil, leading to greater federal involvement in the oil industry.

"Watch the Americans have a hissy fit if a Chinese incursion materializes," Claudia Cattaneo, a Calgary-based energy columnist for The National Post, recently wrote. "So far, the Americans have taken Canada's energy for granted."

Prudent Investor Debates: Philippines in a State of Anarchy?

From this week's newsletter: Prudent Investor Debates

Philippines in a State of Anarchy?

Early last week I read an article by a local political analyst Mr. William Esposo of the Inquirer-GMA 7 website and found it initially repugnant. Since your prudent investor analyst do not want to succumb to confirmation biases, with an opened mind I digested the thesis that the Philippines is in an advance state of anarchy let me quote some important quips of Mr. Esposo’s arguments:

“The lethal combination of the most extreme poverty and runaway consumer prices, graft and corruption, public disillusionment over the political system coupled with the total absence of an inspiring leader-model and topped with an all-encompassing fiscal crisis lead to only one conclusion: we are headed for a period of anarchy…

“I’ve said in previous columns that this nation is already in revolt, in the psychological sense. In contrast to our previous political crises, people have become too disenchanted to even see hope in the changing of the guard. The people want a system overhaul. The yearning to change the system becomes even more intense as the pressures mount….

“More and more people I talk to have told me that they find an authoritarian regime an acceptable alternative to the present system. In his column several weeks back, my friend and Inquirer columnist Randy David wrote about Washington Sycip and F. Sionil Jose expressing support for an authoritarian regime and a revolution, respectively. Five years ago these mild-mannered gentlemen would have found these radical views unthinkable.

Writing as an investor, for a state that is on an initial phase of ‘revolt’, as Mr. Esposo suggests definitely is unworthy of investments. But is the country truly in a state of anarchy? Or is anarchy simply confined to the mindsets of political analysts with blinders and experts banking on controversial hugging headlines? While it is true that problems such as extreme poverty graft and corruption, public enchantment does exist, does this suggests that the Philippines must undergo a violent cleansing process to uplift its economy and its people? Will a change of political system guarantee the amelioration of the economic health of the country?

Well for Mr. Esposo arguably it is, hence their radical call for an authoritarian regime. This is sharp contrast to what foreign analysts think of our economic health as I have shown you lately. Warts and all analysts from Credit Lyonnais, Morgan Stanley, Goldman Sachs, the Economist and independent market maven the preeminent contrarian and my personal favorite thinker Dr. Doom or Marc Faber are economically bullish on the Philippines. So why these extreme nuances?

“Wealth distribution in Asia has been heavily skewed and has benefited relatively few. Second, poor governance suggests the danger of the collective wealth being squandered by rent-seeking and systemic financial risks. In addition, it is possible that inflation will be raised in the US to ease the debt burden of future generations, which could impair Asia’s inheritance.” notes Daniel Lian Southeast Asian Economist for Morgan Stanley. Wealth distribution (poverty levels), inflation (high prices) and rent seeking (patronage ‘palakasan’ culture, cronyism) and systemic financial risk (fiscal crisis) are well identified and similar to the observation of Mr. Esposo. In other words, these foreign analysts are fully aware of the disequilibrium in the economic and political structure. However unlike Mr. Esposo he identifies the risks of US inflationary policies from which Mr. Lian posits “may impair Asia’s inheritance”.

On the plus side Mr. Lian cites of a possible domestic investment boom which is of course is virtually impossible to the likes of Mr. Esposo. Mr Lian says, “Both Malaysia and the Philippines also have considerable scope for lifting investment. Malaysia has consistently generated very high savings (44% of GDP) and the Philippines has plenty of room to raise its savings rate to at least the low 20%s, if the present round of revenue-enhancement efforts, coupled with structural fiscal reform, result in a significant reversal in the government’s deficit trend. Raising the investment rate to the low-20% area COULD TRIGGER A SIGNIFICANT RISE IN INVESTMENT IN THE REPUBLIC. However, in the case of Malaysia, there is some uncertainty about the investment outlook due to the government’s attempt to reduce its investment role. In the Philippines, the battle in the current round of revenue enhancement moves and structural fiscal reform is far from over.”

Morgan Stanley is bullish on Asia and the Philippines not only in its outlook but it puts its money where its mouth is according to Bloomberg’s Hui-yong Yu “Morgan Stanley, raising $3 billion for its fifth global real estate fund, got a commitment of as much as $440 million from Washington state’s pension fund to invest in Asia and Europe… Morgan Stanley…is betting on economic recoveries in Asia and Europe to lift property values.”

In addition the latest news is the mining front is that Dr Marc Faber who sits in the board of Canadian Mining Ivanhoe Mines is in talks with local mining heavyweight and Philippines’ largest gold producer Lepanto Mining. According to the Philippine Daily Inquirer, “CANADIAN mining firm Ivanhoe Mines Ltd. is considering investing in mining projects of the Lepanto group Lepanto group chairman Felipe Yap said Thursday…Yap said he met with Ivanhoe Mines founder and chairman Robert Friedland to discuss the potential investment of the Canadian firm. “I am excited to look at investment opportunities here in the Philippines,” a Yap associate quoted Friedland as saying.” Money invested represents votes of confidence.

Now if the Philippines simmer into a revolutionary phase obviously this would be felt by these investor/analysts. Either these investors stall their investments or sell out. Apparently based on market data, manifestations of these conditions have not yet emerged. But Should it?

To suggest the likelihood of the return of authoritarianism is equally revolting. Name me a Latin American country (which has patently a similar culture to the Philippines than that of the rest of Asia) that has prospered economically out of dictatorship? Not Brazil, Argentina, Chile, Ecuador, Peru, Bolivia and Nicaragua. Some of our Asian neighbors had their encounters with Dictatorship and/or statism but has returned to the fold of democracy. You’ve got the likes of India, Indonesia, Thailand, South Korea and Malaysia. Myanmar (Burma) nor North Korea are no Thailand and is hardly your economic paragon. In fact both China and Vietnam are now gradually phasing in market based economies that are unlikely to prosper under a dictatorship, I believe that the Political transition would follow soon.

The usual argument for a return to authoritarianism is predicated on virtuous of discipline and central control. And this is premised largely on model leaders that would be ideal or in Mr. Esposo’s words ‘inspiring leader model’. And in most occasions, the premier model would be Mr. Lee Kwan Yu of Singapore. Singapore’s 8 million people is largely a homogenous society and could be easily controlled. The Philippines is a technically heterogeneous considering that it has more than 172 dialects, 7,100 islands, and 15 regions including National Capital Region (NCR), Autonomous Region of Muslim Mindanao (ARMM)and Cordillera Autonomous Region (CAR). Hence even amongst ourselves unity can hardly be attained, simply observe the Philippine organizations abroad, as much as the local political butterflies, Filipinos abroad could hardly foster unity.

The best parallels could be seen with Indonesia which also underwent a plentiful horrid years of Dictatorship (1967-1998), yet if one notices in economic terms according to World Bank 2002 the Philippines ranked 133^rd against Indonesia’s 145^th based on GNI Atlas methodology per capita income, as measured in Purchasing Power parity the Philippines ranked 126^th against Indonesia’s 140^th.

In terms of corruption according to Transparency International the Philippines ranked 77^th in 2002 against Indonesia’s 96^th place. Moreover according to the same corruption watchdog, President Mohamed Suharto ranks as the most corrupt leader with an ill-gotten wealth estimates of around $15-35 billion, our own Ferdinand Marcos was ranked second with an estimated stash of about $5-$10 billion. Of course there would be an update on these as Iraq’s deposed despot Saddam Hussein and his cronies were reportedly able to skim over $21 billion out of the UN Oil for Food scandal which were originally intended for food and medicine provisions for the Iraqi people.

The additional list of most corrupt leaders includes Mobutu Sese Seko of Zaire, Sani Abacha of Nigeria, Slobodan Milosevic of Serbia/Yugoslavia, Jean Claude Duvalier of Haiti, Alberto Fujimori of Peru, Paulo Lazarenko of Ukraine and Arrnoldo Aleman of Nicaragua. Now note, most of these most corrupt leaders were tyrants. In other words, authoritarianism breeds corruption rather than slays them. Corruption under an authoritarian regime is and has been the rule and their much touted Singapore’s Mr. Lee Kwan Yu is an exception to the rule which means that in context of probabilities, under an Authoritarian regime the likely outcome would be a more corrupt government. So be careful of what these analysts wish for.

In terms of Business conduciveness, World Bank’s Doing Business shows that the Philippines has a more attractive business environment COMPARED to Indonesia it takes 25 procedures 380 days and costs about 50.7% as percentage to debt to set up a business in the Philippines compared to the Indonesia’s 34 procedures 570 days and 126.5% of costs. So if there was any country that needed a revolution it would have been Indonesia.

And for one to believe that a country can emerge as immaculate is delusional according to Director of Global Governance at the World Bank Institute, Daniel Kaufmann, “there is no such thing as zero corruption, even in countries that rate at the highest levels in terms of ethics and the control of corruption.” This not to mean that your analyst would be tolerant of these malfeasance this is to say that reforms are required and not some iconoclastic actions that would exacerbate rather than alleviate our present predicament.

But of course, these local revolution inciting analysts have their self-serving agenda, either they bear an irresolvable personal difference with the present administration or they seek other agendas such as outmoded left leaning political paragons or have personal interests on an alternative government or are simply dolts engaged in oodles of tarradiddles.

Finally I would like quote Mr. Lew Rockwell of the Ludwig Von Mises Institute about the corruptions of governments, “In a free market, big isn't the same as corrupt or inefficient. Bigness is the reward of market success. If you give the consumers a good product or service at a price better than the competition, your business tends to grow. No matter how large the firm, its managers are always accountable to the public. Moreover, no market position, however exalted, is permanent. Private business must earn its keep every day, or suffer losses and even bankruptcy. This is what makes market institutions accountable; the watchdogs of the system are investors and consumers with their own property at stake.

“In government, the opposite is true. Big and corrupt go hand in hand. The worse the government is, the more it grows at public expense. So long as the coerced revenue pours in, government can disregard the public interest, and go about its usual business of rewarding its friends and punishing its enemies. Rules, regs, and whistle-blowing that attempt to keep conflicts of interest at bay work about as well as prison bars of thread. For mankind has never discovered a method for keeping the robber state from acting according to its nature.”

To diminish corruption we need less government not more.

*****
For a sample of the horrors of Authoritanism read the Economist article about Myanmar "Forced and other customs"

Mineweb: They love gold and they’re trading gold – but will they buy more?

They love gold and they’re trading gold – but will they buy more?
By: Rhona O'Connell
Posted: '21-DEC-04 12:00' GMT
© Mineweb 1997-2004

LONDON (Mineweb.com) -- The gold market has long been seen as global, in the sense that gold can be totally anonymous and has been traded either as a commodity or a currency the world over for thousands of years. The recent proliferation of “formal” gold trading is a not a modern day phenomenon, as there have been commodities exchanges, on and off, going right back through history, with Commodities Exchanges in Amsterdam in the Middle Ages. This year, however, has seen a proliferation of announcements of planned new formal exchanges or trading centres.

We have already outlined the plans for the Dubai Commodity Exchange and its intention to commence gold futures trading in the first half of 2005. The National Multi Commodity Exchange of India is already operating gold futures contracts (fully computerised and online rather than open outcry). Now hard on the heels of these developments in Dubai and India come two more countries announcing plans for formal exchanges, in the shape of Pakistan and Vietnam. While these two countries are not among the world’s largest consumers in terms of overall tonnage, they are nonetheless enthusiastic for gold investment, being among the world’s heavier consumers of gold on a per capita basis.

The accompanying table shows overall tonnage in jewellery and bar hoarding form recorded by GFMS Ltd for 2003 in these countries (and for the world as a whole) and how they compare on a per capita basis. It shows quite clearly that the UAE, of which Dubai is an important part, is by far and away the heaviest consumer of gold on a per capita basis with a hefty 23.9 grammes, or 0.77 ounces, in 2003 (on a more comprehensive analysis, only Saudi comes particularly close, with 6.1g per capita). The world average, by contrast, is a mere 0.44g or 0.014 ounces while it the US it worked out at 1.21g per capita. These number s should be interpreted with caution, as some recorded UAE demand will be tourist purchase, as is also strongly the case in Turkey. Even so the fact that UAE offtake is more than 50 times he world average does talk to the love of the Middle East fro gold.

Country	Exchange	First Trading Date	Jewelry Demand	Bar Hoarding 2003 (source:GFMS Ltd)
			tonnes	Per capita
USA	COMEX	Dec-74	348	1.21
JAPAN	TOCOM	Mar-85	84.5	.66
TURKEY	ISTANBUL	Aug-97	155.8	2.24
CHINA	SHANGHAI	Oct-02	203	.16
INDIA	MCEX	2003	547.5	.55
UAE	DMCC	First half 2005	90.9	23.92
VIETNAM	HANOI, HO CHI MINH	Early 2005	58.8	.73
PAKISTAN	NCEX	Early 2005	59.5	.41
World			2715.1	.44

World Bank: Corruption - What Can be Done to Fight It?

World Bank: Corruption - What Can be Done to Fight It?

The global cost of corruption tops a trillion dollars a year in bribery alone. Corruption drains treasuries, delays development and is even linked to high rates of infant mortality. All of which makes fighting corruption a top priority around the globe, writes the Voice of America (12/17).

General Suharto of Indonesia... Ferdinand Marcos of the Philippines... and Mobutu Sese Seko of the former Zaire... they represent some of the most corrupt leaders in recent history. Global governance expert Daniel Kaufmann of the World Bank calls them 'kleptocrats' who ravaged their nations. But he says the face of corruption is changing. "There are many countries nowadays where, thanks to a move towards democracy, the leader has integrity, and the problem of corruption is still absolutely enormous." For example, in Nigeria, democratically elected president Olesegun Obasanjo and his cabinet face political constraints in an environment where corruption is deeply ingrained. And using traditional methods to attack the problem just don't work.

Kaufman says that is a waste of money. "You have a big corruption problem in a country, (so) throw another institution (at it) and start an anti-corruption commission, anti-corruption agency; a lot of funds have gone to that. We do not see major positive fruits out of that."

At the World Bank one new idea is to 'name and shame' companies that don't play by the rules. "It is no secret that we have made mistakes in the past and some World Bank funded projects have been tainted," said Kaufman. "There is a much tougher approach now." The World Bank sponsors an anonymous phone line to take tips. Then it bans companies found guilty of wrongdoing and posts their names on the Web.

The Internet and technology can also help nations create transparency. Kaufman provided an example. "In Chile, 80 percent of individuals are filing their tax returns on line -- probably the highest in the world nowadays." That means the government picks up more money to spend on development. But Kaufmann adds that fighting corruption is not just a job for governments or the World Bank. It's up to every exporter, business owner, judge, and citizen to build a world of integrity.

Yahoo News: Global Mining Firm Eyes Philippines

Prudent Investor Says: Welcome Dr. Marc Faber!!!

Global Mining Firm Eyes Philippines

MANILA, Dec 20 Asia Pulse - The Ivanhoe Capital Corporation (ICC), one of the world's leading mining companies, has expressed interest in the possibility of investing in the country after the Supreme Court recently decided to allow foreign companies to explore and develop the country's mineral resources.

President Gloria Macapagal-Arroyo welcomed ICC Chairman Robert Friedland and ICC legal representative Edward Rochette during a courtesy call at the Malacanang's Music Room on Friday.

Accompanying them were Trade and Industry Secretary Cesar Purisima and Philip Romualdez, who represented the local mining chamber.

ICC's Ivanhoe Mines, with operations in the Asia Pacific region, is a producer of copper, gold and iron ore products. The company's sales revenue in 2003 was US$89.7 million.

Purisima said ICC would likely tie up with Lepanto and Benguet Mines in exploring mineral deposits and promoting mining entrepreneurship in the country.

Purisima said Friedland, who was due to proceed to China on Saturday, would be back in Manila next year for a mining conference scheduled from February 2 to 4.

Purisima said ICC has discovered the largest copper deposit in Mongolia and the largest nickel deposit in Canada.

Currently, Ivanhoe Mines is evaluating coal, copper and gold discoveries in central and southern Mongolia and exploring for copper and gold in the Chinese province of Inner Mongolia and in Australia.

A study conducted by the National Economic and Development Authority (NEDA) has placed the potential mining wealth of the Philippines at $840 billion (P47 trillion), or 10 times the country's annual gross domestic product (GDP), and 15 times more than the total foreign debt of $56 billion.