Daniel Lian of Morgan Stanley: UK-Europe View of Southeast Asia

UK-Europe View of Southeast Asia
Daniel Lian (Singapore)

I spent the past week meeting more than two dozen global emerging market (GEM) and Asia-dedicated money (ADM) investors based in the UK-Europe. Below are several major topics/themes that we discussed:

(1) Overweight Southeast Asia relative to China and Northeast Asia: Most investors believe that, given uncertainty on the rate of Chinese growth and the lack of a proactive domestic demand policy response from Korean policymakers, the preferred emerging markets in Asia are the four Southeast Asian markets – Malaysia, Thailand, Indonesia and the Philippines. They also like Hong Kong and Singapore for their reflating domestic demand and stronger corporate governance and returns story.

(2) Easy money has been made and selection is becoming more stringent: Most investors recognize that the easy money has been made as the expansion of global demand from mid-2003 to mid-2004 made equities in global emerging markets an attractive investment proposition. However, investors are now slowly building varying degrees of weak global demand scenarios into their macro-portfolio decisions. Weak domestic demand almost invariably hurts global emerging market equities, particularly in Asia. This means investors will become increasingly selective, searching for either emerging economies that will provide domestic demand resilience or emerging markets that are experiencing other strong macro-micro restructuring positives.

(3) Southeast Asia has avoided the worst-case scenario: I discussed the subject of “Sino Hollow” – how much has China hollowed out Southeast Asia and how much more will it do so in future – with every fund manager I met (see “Sino Hollow”, October 7, 2004). They were impressed with Southeast Asia. Despite a decade (1994-2003) of Chinese attacks on its manufacturing sector, the region experienced a 49% accumulated increase in manufacturing output growth (vis-à-vis China’s 185%) with manufacturing output rising from 25.2% to 30.2% of its GDP. Concomitantly, Southeast Asia has preserved its 4.4% manufactured export share in the global merchandise market. While China’s manufacturing growth has outpaced that of Southeast Asia, there was a relative, but no absolute, hollowing out of Southeast Asian manufacturing.

While FDI trends suggest China is building up its manufacturing FDI substantially faster than Southeast Asia – China took in US$397 billion during 1994-2003 compared to Southeast Asia’s US$147 billion – there is increased evidence of a probable rise in urban Chinese manufacturing wages. The presence of structural reform in Southeast Asia means that it has avoided a worst-case scenario, i.e., a complete hollowing out of Southeast Asian manufacturing because of the rise of China and a lack of effective economic development strategy and positive political-economic reform.

(4) Structural upswing or mere cyclical spurt: Based on our conversations, investors see the need to distinguish between strong structural momentum and a mere cyclical spurt experienced by emerging economies. Structural momentum is attained through the removal of stubborn structural impediments – erroneous macroeconomic policy, or microeconomic inefficiency centered on the private corporate and state enterprise sectors. While some investors were skeptical, a large number we spoke to believe Thailand, in addition to Russia and Turkey, belongs to a confirmed group of restructuring GEM regimes where strong policymakers aggressively pursue removal of structural impediments to produce tangible and sustainable macro-economic growth and micro-economic efficiency gains.

These are clearly distinguishable from temporary economic gains that are tied to a cyclical spurt. Other than Thailand, they also believe Malaysia and Indonesia possess the potential to be among the “restructuring” group.

(5) Investors we spoke to approve of the new economic strategy and positive political economy changes in Southeast Asia, but would be most cheered if a structural investment boom occurs: Investors observed that Thailand has shifted to a more balanced economic strategy, emphasizing “second track” activities in rural, grassroots, agriculture-resource, SME, tourism and other service sectors. They observe Malaysia is putting in considerable effort to do likewise and are hopeful that Indonesia and the Philippines will also unleash new economic strategies to better balance their growth path.

Political-economic change is another structural shift that has won approval from investors. Singapore has a new head of government, and Malaysia and Indonesia have elected new leaders. The Philippines has renewed Mrs. Arroyo’s mandate, and Thailand will soon hold elections. Investors observed that pro-active economic management and the search for new growth engines feature prominently in these Southeast Asian leaders’ platforms.

One of the key shifts investors desired was a structural lift in investment. Since the 1997-98 Asian Financial Crisis, the investment to GDP ratio has declined substantially in Southeast Asia, but in China it has expanded. Investors believe an investment-poor Southeast Asia can now sustain higher investment rates, whereas China should guide down its excessive investment in poor return domestic ventures. The weaker growth momentum in Southeast Asia in recent years has more to do with domestic investment sluggishness than with manufacturing and export weakness (Exhibit 3). As Southeast Asia has to varying degrees repaired its bruised balance sheet since the Asia Financial Crisis period, the region is ripe for a “managed” structural lift (avoiding unproductive assets) domestic investment boom.

(6) Further discussion of investment rationale for each Southeast Asia economy/market:

Singapore: Investors have enjoyed a strong cyclical upturn, with projected 8-9% growth in 2004 making Singapore the second fastest growing economy in Asia. There has been considerable upside surprise on the corporate front as a result of the government’s restructuring efforts and improved corporate governance, which has resulted in greater corporate transparency and a steady rise in dividend yield and asset turnover.

While some investors believe the recent rise in domestic demand, consumer spending and loan growth could be sustained for longer, most agree that Singapore is a high beta Asian economy that is heavily dependent on global demand. If a dramatic slowdown in global demand were to occur in 2005, Singapore’s cyclical spurt would end. However, investors saw good prospects of micro economic and corporate efficiency gains (resulting from ongoing government-linked enterprise restructuring and its emphasis on economic efficiency), which continue to underpin the Singapore market.

Malaysia: Investors generally approved of the Badawi government and his efforts to dismantle the rent-seeking complex and diversify the Malaysian economy. However, while some expected a continued lift in Malaysia’s domestic demand, most investors believed that Malaysia, like Singapore, is a high beta economy that is highly geared towards global demand. They cited the existence of a sophisticated urban consumer culture (households are already quite geared), the strong dependence of the Malaysian economy on exports, the lack of fiscal latitude, and the uncertainty of a structural private investment upswing as evidence for this. However, because of the government’s considerable ownership of the corporate economy and its declared intention to implement corporate restructuring, we believe that Malaysia, like Singapore, could offer considerable micro efficiency gains.

Thailand: A minority of investors believed Thaksinomics has come to a dead-end, that Thai output potential is limited and that in future the economy would cease to outperform other global emerging economies. They also attribute the damage to the Thai economy from unforeseen circumstances (such as avian flu, Southern unrest and substantial oil price hikes) to Mr. Thaksin. However, the majority believe there is room for the Thai economy to grow and that if Mr. Thaksin were to be re-elected and if he continues with his dual-track policy and the “third chapter” of expanding aggregate supply potential, then the structural upswing will have a strong second leg. They see the present low forward price-earnings ratios as a good opportunity to go long on Thai equities. Investors we spoke to also generally agreed that in times of weakening global demand, Thailand would outperform most of its global and Asian emerging economic peers.

Indonesia: Most investors agreed that, in terms of a shift in economic development strategy and positive political economy change, Indonesia has substantial upside. They believed that, given Indonesia’s underdeveloped rural and grass-roots economies, as well as its significant resources and underdeveloped SME sector, it has strong prospects to strengthen its “second track” economy. They were also hopeful that the incoming President Yudhoyono would cripple the rent-seeking complex and install effective and competitive economic leadership.

The Philippines: Investors were still skeptical about the long-term restructuring prospects of the Philippines economy. President Arroyo has a fresh mandate and is likely to secure a “first round” victory in her efforts to diversify and enlarge the tax base, as well as improving tax collection. However, investors are fundamentally skeptical about her ability to tackle the larger issues facing the country’s politics and economy.

Bottom Line: Southeast Asia Has Avoided the Worst Case Scenario

In the past year, UK/Europe investors have raised their exposure to Southeast Asia’s emerging markets – Malaysia, Thailand, Indonesia and the Philippines – in preference to China and Korea, as they seek shelter from the slowdown in China’s economy and the lack of proactive Korean domestic demand policy. They also like Hong Kong and Singapore for their reflating domestic demand and stronger corporate governance and returns stories. However, investors are building weakening global demand into their portfolio assumptions and are either searching for emerging economies that will provide domestic demand resilience or other strong macro-micro restructuring positives.

We believe Southeast Asia has increased potential to fit into the above bill of domestic demand resilience and strong restructuring positives. Investors are also beginning to believe that Southeast Asia has avoided the worst case scenario (a complete hollowing out of Southeast Asian manufacturing because of the rise of China and a lack of effective economic development strategy and positive political-economic reform) as the region succeeds in preserving its global share of manufactured exports and begins to embrace economic diversification and positive political-economy reform.

Investors are distinguishing between structural upswings and mere cyclical spurts. Most see Thailand, in addition to Russia and Turkey, as belonging to a confirmed group of restructuring GEM regimes where strong policymakers aggressively pursue removal of structural impediments and produce sustainable macro-economic growth and micro-economic efficiency gains. They believe Malaysia and Indonesia could become members of the “restructuring” group.

While the new economic strategy shift and positive political-economy changes in Southeast Asia have won investor approval, investors would be further cheered if Southeast Asia were to embark on a structural lift in domestic investment. In my view, Thailand’s Prime Minister Thaksin’s plan to aggressively expand aggregate supply potential in the next few years means that Thailand, among Southeast Asian economies, has the greatest certainty of delivering a structural domestic investment boom to investors.

Fool.com: "Embrace the Unloved" Tom Garner interviews Michael Lewis

Embrace the Unloved
An exclusive interview with Michael Lewis, author of Moneyball.
By Tom Gardner
October 27, 2004

Some call it the best business book out there. Michael Lewis is the author of the best-selling Moneyball, a look into the roaring recent success of the Oakland A's baseball team gained through its contrary thinking and unconventional means. Tom Gardner found the lessons from Lewis' book quite applicable to general stock investing and very relevant in his search for undiscovered, unloved, and undervalued small-cap Hidden Gems. And since this is World Series week, we think it's a great time to share this with you. This is the third of five parts. Play ball!

Tom Gardner: My third carryover philosophy between value investing and the Moneyball take on baseball is a willingness to Embrace the Unloved. That means intentionally looking for bargains among merchandise with fixable problems or impermanent damage. Here I am thinking of the A's, as you repeatedly outlined, looking for players with something wrong with them, shopping for the secondhand engagement ring in Reno.

The great value managers pursue fallen angels, too. Think of someone looking for sound companies that missed a single quarterly earnings target. Everybody hates them the hour of the announcement and the day later. But all that negative sentiment can create opportunities. Not in every instance, but frequently. So if you methodically try to find unloved, temporarily damaged companies, mastering how to distinguish them from the permanently damaged companies, there are some beautiful investment opportunities there. Does the theory carry for you?

Michael Lewis: Yes, and you have got to accept that sometimes you're going to be wrong and you're going to mistake a permanently damaged company for a temporarily damaged one. The Oakland A's make that mistake sometimes as well. But, yes, if you can find companies or baseball players that are irrationally unloved, you'll get a great price on them. Missing earnings targets is a great example because really, quarterly targets are a very poor measure of a company's long-term viability.

So if the market is indeed punishing some company for simply missing this number, my God, that can be a huge opportunity. I don't know whether it's true that that happens. I hear it is true, but I don't know if the market behaves so stupidly.

Tom Gardner: Well, a classic example of a company that I've followed and recommended in our Stock Advisor newsletter is Trex (NYSE: TWP). They make outdoor decking out of recycled materials. After the hurricane season last year, they had a bad three-month period because, in a few primary markets, nobody was building decks in driving rainstorms. They had terrible earnings. Their stock got killed, down 30%-35% over a one-month period because short-term thinkers didn't want to wait for earnings to snap back. Classic temporary damage. I recommended it right then. It's been a beautiful performer since.

Michael Lewis: You know, that makes complete sense to me. And you know what? The other aspect of this issue is it isn't just finding companies that are temporarily unloved. The Oakland A's have found players and succeeded with players who continue to be unloved even though they've performed spectacularly by any standard. They are unloved just because of the way they look or because of the quixotic way they play the game. The rest of baseball doesn't fully understand and appreciate them, even though their performance is excellent. So, let's say this is the company that, if you can find such things, generated earnings at a remarkably steady and high level and that was forever underpriced because of something unusual in their approach to business.

Tom Gardner: Well, try this one. I really enjoyed Sam Walton's account of Wal-Mart (NYSE: WMT). And what happened there? Early on, the Wall Street analysts and investment banks just ignored them. When Wal-Mart was planning to go public, and even in the years after it went public, it was unloved -- in Walton's opinion -- because Manhattan's moneymakers concluded that these guys were just a bunch of hillbillies from Arkansas.

Michael Lewis: There you go!

Tom Gardner: Hillbillies just flipping inventory out onto the sidewalk trying to sell it. Even though their numbers were good, one of the greatest investments in history went unloved for a long time because Wall Street felt certain that retailers from Arkansas couldn't beat the veterans at Kmart (Nasdaq: KMRT), with tremendous resources back then and an enthusiasm for the superstore game.

Michael Lewis: There you go. That is a perfect example. Especially the bias against the hillbillies. That is a great example of a marketplace ignoring excellent performance because something doesn't look normal.

Tom Gardner: OK, our first three carryover theories are:

Make a Habit of Asking Why
Stop Caring About Your Reputation
Embrace the Unloved

The fourth tenet is to Figure Out What to Count. Figure out what the numbers are telling you. This applies to everything from valuation to looking at slugging percentage or on-base percentage in baseball instead of the flawed traditional measure of a player's batting average. For investors, I'm comparing that to focusing on cash flow rather than earnings. Or following rates of return on equity rather than caring about what the company's stock price is doing this month. So I think a lot of investors don't yet really know what to count, and I'm wondering if you think that carries over.

Michael Lewis: This is the thing. In most spheres of life, most people don't know what to count. In baseball, the problem isn't that people aren't counting things or that they are not quantitatively inclined. They are. It's that they are counting the wrong things. They make a fetish of certain numbers because they get told that this is important or that is important.

In baseball, people were told for generations that batting average was what was really important. Well, it turns out that when you actually ran historical studies to determine what correlated highly with a team's run totals, batting average was very low on the list. Imagine that! And that's because you have these teams that have high batting averages who never get on base with walks and who don't hit for power. Compared to a team that had a lower batting average but walked a whole lot and hit home runs, they weren't on base as much so they weren't scoring as much. A fetish was made of the wrong number. It's been that way for decades in baseball and persists even today. And this created a huge opportunity for the Oakland A's.

Naturally, there must be fetishes in the financial markets, too. Maybe they were made of either hitting earnings targets or of targeting particular price/earnings ratios or whatever it is that is fashionable and unscrutinized. Of course, there are intelligent fetishes, which help accurately measure the health of a company. But if it hasn't been scrutinized, who knows! Investors, just like baseball's general managers, have to start asking and continue asking if there is some better number, some better way to measure how a company is doing.

Tom Gardner: Time for my fifth and final tenet: Study Patterns in History. You have Paul DePodesta, now the general manager of the Los Angeles Dodgers, advising analysts to look at process rather than outcome. Study why teams win throughout history. Find the patterns that matter and emulate them.

In investing, the equivalent would be studying why companies win. Apply regression analysis and probability theory and seek patterns. Michael, I'm thinking specifically here about how difficult it can be to embrace the idea that everything is not new. We want to believe that it is.

You confess at one point in Moneyball that your problem is that you keep seeing every player and every situation as unique whereas Billy Beane and folks like him are seeing patterns that have evolved into trends over very long periods of time that enable the seer to make pretty accurate predictions about the future productivity of baseball players. There are investors using patterns as well, carrying this out methodically in a fairly private way, able to see the market as much more predictable because they have studied process in history rather than thinking that everything is new and being obsessed with immediate outcomes. Do you agree?

Michael Lewis: Yes. Let's take an example in baseball, since I just mentioned on-base percentage (which factors walks alongside hits). Two years ago, when I was hanging out with the A's, they got a guy named David Justice for a final year before he retired. All of baseball thought he was basically washed up, that he'd gotten too old. But the A's looked at him and factored in that he had been hurt the previous year. So they realized that some of the data there was possibly misleading. But then they looked at the kind of hitter he was throughout his career. He was a hitter who drew lots and lots of walks.

One of the things they found by studying process, by analyzing statistical patterns in player behavior over decades, is that that kind of hitter -- a hitter who walks a lot, a power hitter who walks a lot -- as he ages and as his career starts to fall off that cliff, yes, he doesn't hit as many home runs, but he continues to walk usually even more than he has walked before. Maybe because he can't run!

They knew they were going to get a high on-base percentage out of this guy and that that was very valuable. Whereas most baseball people just thought, "Here's an old guy with no value left." No one wanted him. But Oakland could see they could squeeze the last few ounces of on-base percentage out of him, something that would help them score more runs and win more games, which they did quite nicely. How did they find him? They found him because they didn't view him as an individual; they viewed him as a type that they recognized and valued.

So there must be, I agree, people in the stock market who think in terms of companies as a type. Sure, each company is unique in some ways, but each company is also a type. Investors have to look for the patterns. I would say the equivalent in the stock market for David Justice's final year would be companies that are going out of business but where there is still asset value.

Tom Gardner: Right. There is actually a recommendation in Hidden Gems by one of our guest analysts of a company named Arch Wireless (Nasdaq: AWIN). It's a paging business that is just gradually losing its subscribers to cell phones and other means of communication. But doctors still have uses for pagers and so they are actually very, very cash-flow positive. However, the profits are steadily dwindling. To carry the analogy over, they are still very productive relative to the average baseball player, but there aren't many years left. You can see an end point on the horizon and so the market doesn't know what to do with that valuation.

Michael Lewis: That is right. If the market doesn't know and the market misvalues it, it probably doesn't understand it and likely undervalues it. There is an opportunity for someone who understands how to milk the last few years of good earnings out of this company. So, yeah, I think there is a clear analogy there.

Oct 28 Philippine Stock Market Daily Review: Awesome Foreign Support

Oct 28 Philippine Stock Market Daily Review: Awesome Foreign Support

As we enter into the final phase of statistically weak October, we are now witnessing a vigorous rebound spurred by foreign money. The Phisix surged for the second straight session up by a considerable 33.15 points or 1.87% as portfolio investments from overseas money dictated on today’s activities. Foreign money accounted for 59% of today’s output while foreign inflows registered P 176.454 million or about 19% of the day’s aggregate turnover. These positive developments come in the light of the mostly upbeat Asian bourse with the Philippine as the third best gainer in the region following South Korea’s Kospi and Hong Kong’s Hang Seng Index.

In the most recent past while the local bears bashed the Phisix to its one and a half month low we have noted that foreign money continued to buoy the property heavyweights. Today, aside from the recovering market leaders led by key telecom issues, PLDT (+2.54%) and Globe (+1.44%), the property heavyweights represented by its index (+.7%) have provided the flanking support to the foreign bulls. Meanwhile the sanguine sentiment by overseas investors buying has likewise filtered to the Banking Issues, net foreign buying to the banking issues totaled P 26.457 million or about 15% of the day’s foreign buying activities with 5 of the 13 most liquid banking issues accounting for a positive inflow against two that posted outflows.

Looking at the main components of the Phisix, only two of the eight Phisix heavyweights recorded net foreign sales, namely Metrobank (unchanged) and San Miguel B (unchanged) while the rest were receptacles to overseas portfolio investments and closed mostly higher, specifically Ayala Corp (+3.17%), Ayala Land (+2.85%) and Bank of the Philippines Islands (+2.17%). Only SM Prime (-2.59%) seems to be the outlier defying the current bullish sentiment today while being defiantly bullish when the market was sold down.

I would also like to particularly point out that Banco De Oro (+1.13%), which of late had posted large cross trades, has seemingly been the object of foreign accumulations. The Henry Sy owned Banco De Oro whose stock languished since its IPO (still trading below IPO price of P 20.5) could possibly be the next target by foreign investors maybe due to its aggressive corporate maneuvers to expand its market share through mergers and acquisitions. A breakout from its IPO price could possibly indicate for a buy.

Finally, definitely the euphonious blathers by our media grandstanding colleagues would probably say that today’s positive action has been triggered by the massive rally in the US financial markets and the steep correction in oil prices, while they may be partially true I stand to say the current rally is part and parcel to the unfolding cyclical shifts, historical patterns, seasonal strength and a vibrant technical picture which represents the underlying psychological positive shift of mostly foreign investors to the Philippine equity assets, as well as, macro development undergirding such paradigm shift. Local investors, as usual, being outrightly fickle and of the speculative propensities have always been the laggards. A case in point is Philippine Realty up 50% today and 400% over the week. According to the PSE, Phil Realty is "undergoing judicial proceedings for corporate rehabilitation" (read: to sell assets to pay off debts). Nice recovery huh.

Matthew Lynn of Bloomberg: Europe's Non-Fossil Fuels Receive Boost From Oil

Europe's Non-Fossil Fuels Receive Boost From Oil: Matthew Lynn

Oct. 27 (Bloomberg) -- Non-fossil fuels are finally getting the boost they need to become a feasible long-term solution to the world's dependence on oil.

Surging crude prices won't wean Europe or the U.S. off their addiction to imported oil in the near future. Yet they will help redirect capital to other energy sources for the next generation.

Last week, Electricite de France said it would build a new type of nuclear reactor in Flamanville, France. According to Pierre Gadonneix, the chairman of EDF, the plant will ``contribute to ensuring Europe's energy independence in the coming decades.''

In Finland, work has already started on a new nuclear power station, which will be the first completed in Europe since the Chernobyl disaster in 1986. The plant is scheduled to start operating in 2009.

Britain is thinking about whether to build a new generation of nuclear stations to replace three-decade-old plants that are nearing the end of their useful lives.

Nuclear energy accounts for 32 percent of the European Union's electricity production. That figure is bound to rise over the next few years. After a decade during which nuclear energy was considered too expensive or environmentally unsafe, it has now forced its way onto the agenda.

And it's not just nuclear power. Capital is pouring into companies that are developing any kind of alternative to pumping lots of black, sticky stuff out of the ground.

IPO Rush

``High oil prices increase the attraction of non-conventional energy sources,'' said Credit Suisse First Boston in a recent note to investors. ``These include heavy oil, gas to liquids, and liquefied natural gas, as well as alternative energy sources such as fuel cells, solar and wind power.''

In London, there has been a rush of initial public offerings by alternative-energy companies.

ITM Power Plc sold shares in June to develop its fuel-cell technology. Fuel cells generate electricity by combining hydrogen and oxygen, producing only steam or water as byproducts.

Ocean Power Technologies Inc., which makes equipment to generate power from waves, listed its shares in London last year.

And D1 Oils Plc this month announced plans for an IPO. It hopes to raise 13 million pounds ($24 million) to make diesel fuel from vegetable oil -- the money will be used for plantations of Jatropha Curcus, a tree that produces oil-bearing seeds.

Investors have started to take notice. ``A lot of companies had promised a lot and not delivered,'' said Charles Hall, a director of London-based Westhall Capital Ltd. who specializes in alternative-energy companies, in a telephone interview. ``People were starting to lose faith. Not until this summer did they start to get that back again.''

Canadian Flop

Investors have also been burnt. Take Ballard Power Systems Inc., which also makes fuel cells. The Burnaby, British Columbia- based company's shares soared to C$189 in 2000 as investors got excited about the prospect of the big carmakers using Ballard's equipment. The stock now trades for less than C$10.

That's in the nature of the investments. These are all technology companies, which are always risky.

And oil prices prompt serious questions, too. Is almost $55 a barrel a speculative bubble? Or does it represent a permanently high price that consumers will have to adjust to? Many alternatives look appealing with oil at current levels. At $30 a barrel, people would stick to the black stuff.

Nuclear energy has a bad image because it can be expensive and is seen as dangerous. France's Areva SA, the world's biggest maker of nuclear reactors, has to battle constantly with protesters who obstruct its plutonium shipments.

Nuclear Energy

Yet, it is a well-established technology with a stable cost base. And, with the exception of Chernobyl, none of the reactors have caused a disaster, even after 30 years of operation in some cases. That's enough of a track record to suggest they aren't as unsafe as some people imagine.

Wind and solar power are more environmentally friendly, though there is scant evidence that either can be a major alternative. Fuel cells powered by hydrogen are the big hope. Nobody has made them cheaply or efficiently enough yet -- but that doesn't mean they won't soon.

Expensive oil will lead to more exploration and efficient exploitation of resources. Yet it will also encourage investors to hand over money to any bright scientist who can think of another way to make energy. And it is prompting smart young entrepreneurs to move into the area.

Capital is shifting into the alternatives to oil. As long as crude prices remain at current levels, other energy forms will be attractive for investors.

To contact the writer of this column:
Matthew Lynn in London at matthewlynn@bloomberg.net.

Financial Times: Cuba to end circulation of US dollar

Cuba to end circulation of US dollar

By Reuters

October 26 05:36

Cuban President Fidel Castro, seeking to rid his country of the currency of his arch-enemy, said on Monday Cuba was ending circulation of the U.S. dollar as of Nov. 8 in response to tightened American sanctions.

Cubans, foreign residents and tourists will have to use locally printed convertible pesos, equal in value to the dollar, for all cash purchases, a Central Bank decree said.

“As of Nov. 8, the dollar will not be accepted in our shops, which will only take convertible pesos,” it said.

A 10 percent commission will be charged for changing dollars into the local currency, according to the decree read on a special television broadcast attended by Castro.

Appearing on television in a sling only five days after falling and fracturing a knee and an arm, Castro said the issue was so important that he had to be there despite Wednesday’s accident that left his left leg in a plaster cast.

“The empire is determined to create more difficulties for us,” he said, referring to Bush administration steps to restrict travel and cash flows to the island nation.

The dollar was legalized in Cuba in 1993 after the fall of the Soviet Union plunged the island into deep economic crisis and forced it to open up to tourism and foreign investment.

Dollars became the dominant currency and are used to buy most consumer goods in dollar stores that will now only accept the local currency.

The decision will effect cash remittances from the United States, a major support for the cash-strapped Cuban economy that amount to an estimated $1 billion a year, unless they are sent in other currencies.

The government encouraged Cubans living abroad to send remittances to their relatives in Cuba in euros, British pounds, Swiss francs or Canadian dollars, to avoid exchange costs.

NO DOLLAR BAN

Castro, wearing his trademark military uniform, said his communist government was not banning possession of dollars, just their use in the economy.

“We are not restoring the penalization of holding dollars; it will not be a crime,” he said.

The move to eliminate use of the greenback was prompted by U.S. moves to squeeze Cuba financially, the decree said.

A four-decade-old U.S. trade embargo against his communist government prohibits the use of dollars in transactions with Cuba unless they are licensed by the U.S. Treasury.

Foreign banks were put on guard in May when the Federal Reserve fined UBS, Switzerland’s largest bank, $100 million for illegally transferring freshly printed dollar notes to Cuba and three other countries subject to U.S. sanctions, Libya, Iran and Yugoslavia.

Foreign bankers in Havana said this had created serious problems for Cuba to deposit its dollars abroad and renew bills in circulation.

Existing dollar accounts will be “totally guaranteed” and their funds can be withdrawn in the U.S. or local currency at any date with no charge, the decree said. Dollar bank transfers will be also be accepted, but not cash deposits.

Foreign companies operating in Cuba, as well as Cuban state enterprises, will not longer be able to make dollar bank deposits in cash.

Cuba’s tourism is based on the dollar, though euros are accepted as currency in some resorts. Tourists will have to exchange their currency into convertible pesos, though the 10 percent charge will only apply to dollars, the decree said.

The commission will not affect credit cards payments. Cards issued by U.S.-based banks are not valid in Cuba.

Cuba took the first step to curb dollar circulation last year when it banned state corporations from using the U.S. currency in their domestic operations.

U.S. President George W. Bush launched a strategy in May to undermine Castro’s government by tightening restrictions on travel from the United States and the amount of dollars licensed visitors could spend on the island.

Castro, who has outlasted nine U.S. presidents and survived the demise of the Soviet Union, said his socialist system will prevail.

“The destiny of this country was decided long ago and nothing can intimidate us,” he said.

Business Report: World trade to grow 8.5%, says WTO

World trade to grow 8.5%, says WTO
October 26, 2004
By Jonathan Fowler

Geneva - Global commerce was expected to grow 8.5 percent by the end of this year despite record oil prices, the World Trade Organisation (WTO) said yesterday.

Oil prices might dampen growth in trade and overall output in 2005, but at present the effects of the rise were being outweighed by economic revival, the WTO said in its annual International Trade Statistics report.

The WTO stopped short of predicting a dollar figure for the value of world merchandise trade for all of 2004, but said it would be 8.5 percent higher than the $7.3 trillion (R45 trillion) recorded for 2003.

Michael Finger, of the WTO's development and economic research division, said the percentage increase was based on constant dollars.

The rate of increase would be even higher if the depreciated dollar and higher oil price were used, he said.

"Growth in world trade in 2004 will not be adversely affected by higher oil prices to any great extent because we are seeing good growth in trade and output in China, Latin America and Africa," said Supachai Panitchpakdi, the head of the WTO.

"We have also seen stronger-than-expected economic recovery in Japan. Strong demand is behind rising prices for oil and other commodities," he said.

WTO said it would release its full statistical report next month.

Initial figures showed that world merchandise trade grew 4.5 percent last year to $7.3 trillion compared with 3 percent growth in 2002 and a decline in 2001, the WTO said.

The recovery was sustained by stronger economic activity in manufacturing and mining, and strong expansion in agriculture, it said. Merchandise trade expanded faster than output.

Demand for foreign goods in the US helped sustain output in other regions, and the US trade deficit continued to rise despite the weakness of the dollar.

The WTO said that strong US demand had helped the global economy, and that a sudden reduction could have "strong repercussions" on world trade.

Trade in the EU was stimulated by its expansion in May to 25 from 15 members. Asian growth in exports and imports was fuelled by China.

"With its rapidly expanding economy, China has become a major trader," the WTO said. "Its surging demand for oil, copper, soybeans and many other primary commodities contributed significantly to higher prices."

"In 2003, as in the second half of the 1990s, China's merchandise export growth was twice as high as that of world trade."

Latin America, which had recorded 12 years of successive deficits, registered a merchandise trade surplus in 2003, with China a major customer.

Some industries did particularly well. Trade in chemicals has accelerated in tandem with a surge since 2000 in pharmaceutical products, with 2003 world chemical exports rising 19 percent to $794 billion and accounting for nearly 15 percent of global trade in manufactured goods.

Bloomberg: Chinese Tourists `Flood' Abroad, Spending $48 Billion

Chinese Tourists `Flood' Abroad, Spending $48 Billion

Oct. 26 (Bloomberg) -- Like almost all of China's 1.3 billion people, Jiang Liang has never been a tourist in Italy. Next month she'll spend $6,000, almost half her annual wage, to visit Venice during a 10-day honeymoon tour.

``It's our dream to go to Europe,'' says the 26-year-old Shanghai accountant, who married a mobile-phone salesman last month. ``I want to see historic buildings and experience the lifestyle. It'll be very romantic.''

Jiang was able to book her trip because on Sept. 1, China's National Tourism Administration added 26 European countries to the 26 mainly Asian destinations it lets tourists visit. Seven years ago, leisure travel was forbidden. Last year, 20 million travelers from China spent $48 billion on items such as Louis Vuitton bags and Accor SA hotel rooms, according to travel researcher IPK International and the Chinese government.

The Chinese may dominate world tourism in coming years, says Nigel Summers, a director at Horwath Asia Pacific Ltd., one of the region's two largest hotel consulting firms. Tourist departures from China will expand 12.8 percent on average a year -- triple the world rate -- to about 100 million in 2020, according to the World Tourism Organization, a Madrid-based United Nations agency.

The new travelers, sparked by a 40 percent increase in urban incomes since 2000, already account for 9 percent of the world tourism total.

``The numbers have grown substantially, and that's with a lot of travel restrictions in place,'' says Summers, who is based in Hong Kong. ``Wherever they are allowed to go, they'll go, and in big numbers.''

Airlines Add Flights

Intercontinental Hotels Group Plc, Accor and Best Western International Inc., have boosted marketing in China in a bid to increase brand loyalty as more Chinese travel.

Air China, the nation's largest international carrier, is ferrying most tour groups to Europe because European airlines have only limited flights from China.

Beijing-based Air China plans a $500 million initial share sale this year to buy more planes. It placed a $360 million order for seven 737-700 jetliners from Chicago-based Boeing Co. on Sept. 2, according to Boeing.

Cologne, Germany-based Deutsche Lufthansa AG, Paris-based Air France-KLM Group and Stockholm-based SAS AB say they will increase flights to China.

Only Hong Kong-listed China Travel International Investment H.K. Ltd. among non-Chinese-owned travel agencies can arrange outbound tours. The agency is 59 percent owned by China's largest travel operator, state-owned China Travel Service, according to data compiled by Bloomberg.

Las Vegas-Bound

Chinese travelers managed before the restrictions were lifted to find their way to one U.S. tourist destination: Las Vegas. That's where about 90 percent of the 250,000 Chinese who visited the U.S. last year went, according to the Nevada Commission on Tourism. It opened a Beijing office in June.

Those visitors had to have either public or private passports, issued only to businesspeople, students or those with relatives overseas willing to sponsor them.

Now the Public Security Bureau, which controls private passports, can issue travel documents to those joining tour groups. Approved travel agents in turn can organize group visas to so-called Approved Destination Status countries, cutting costs and bureaucratic delays.

Only Croatia, Germany, Hungary, Malta and Turkey among European countries had group visa arrangements with China before Sept. 1. Germany got the go-ahead from the China National Tourism Administration in February 2003. It's since hosted 100,000 Chinese in tour groups, says Xu Shengli, a Beijing-based spokesman for Germany's National Tourism Office.

Fifth-Largest Spenders

Added to the list Sept. 1: Austria, Belgium, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Greece, Italy, Iceland, Ireland, Latvia, Liechtenstein, Lithuania, Luxembourg, the Netherlands, Norway, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and Switzerland.

``With the pent-up demand from the last 50 years, the flood of outbound travelers will be massive,'' says Bernard Bialylew, the Shanghai-based director of Gulliver Travel Associates of London, the world's largest tourism services provider.

Chinese travelers already are the world's fifth-largest spenders, according to Falls Church, Luxembourg-based IPK International. Last year Chinese paid $2,967 on average for a European tour package, sightseeing and shopping, compared with $3,870 for U.S. tourists and $3,616 for Japanese.

The U.S. and Britain so far are missing out. U.S. security concerns mean tour-group visas can't be negotiated by travel agents, according to the U.S. State Department. The U.S. in any case has not applied for Approved Destination Status.

Response `Amazing'

Britain hopes to be an approved destination soon, says Jonathan Simpson, a London-based spokesman for Visit Britain, the marketing arm of the British Tourist Authority and the English Tourism Council. ``The British and Chinese governments are in talks,'' Simpson says.

At China CYTS Tours Holding Co., China's second-largest travel agent, the first 10-day tour from Shanghai to France and Italy was fully booked about a month before the Sept. 1 departure.

``The response has been amazing,'' says Wang Peijun, director of CYTS Tours' Shanghai office. ``We only advertised in the local newspapers for about two weeks.''

Ten-day tours cost about 14,000 yuan, Wang says. France, Switzerland and Italy dominate bookings.

Shanghai China Travel Services Co. expects to send 10,000 travelers to Europe before year-end -- triple the 2003 total, says Yu Weihong, the general manager.

``People are more keen to travel to countries that have just opened up,'' says Yu. The company runs tours for about 200,000 Chinese each year.

Congee for Breakfast

Berkshire, England-based Intercontinental, the world's largest hotel operator by rooms, opened a Chinese-language booking Web site in February.

It also added Chinese-language signs and menus at some European hotels, says Patrick Imbardelli, the company's Asia- Pacific managing director. About 8 percent of the company's guests worldwide, excluding China, are Chinese nationals.

Accor's European hotels with Chinese tour groups now provide Chinese-language satellite TV and newspapers, as well as congee, or rice porridge, for breakfast, says Reggie Shiu, who heads the Paris-based company's Chinese unit.

``At our hotels worldwide, for every 100 room nights occupied, two are Chinese guests,'' Shiu says. ``Our objective is to double that in the next year.''

Best Western, the world's largest hotel group by number of properties, is promoting mid-price rooms that appeal to more than 80 percent of China's tour-group market, says William Dong, the company's spokesman in China. Rooms cost $80 to $150 a night.

Credit Cards

European tourism authorities are gearing up, too. France expects 1 million Chinese tourists by 2009, said Junior Tourism Minister Leon Bertrand, who greeted the first Chinese tourists at Paris's Charles de Gaulle airport Sept. 1. About 400,000 Chinese visited France last year -- 1 percent of the 75 million total, according to the Tourism Ministry.

About 85 percent of China's tourists chose an Asian destination last year, including Australia and New Zealand, according to the London-based World Travel and Tourism Council. Favorite vacation spots were Thailand, Taiwan and Singapore.

San Francisco-based Visa International Inc., the world's largest credit-card company, says Chinese cardholders touring in Asia spend $253 on average for each transaction, compared with $135 for U.S. tourists and $141 for those from the U.K.

Luxury Brands Expand

In Hong Kong, a special administrative region of China, 60 percent of the record 2.1 million tourists in August came from mainland China, the Hong Kong Tourism Board reported -- a 31 percent increase from 2003. Chinese tourists still need visas to visit the former British colony.

The influx has prompted luxury retailers such as Paris-based LVMH Moet Hennessy Louis Vuitton SA and Geneva-based Cie Financiere Richemont AG to expand in duty-free Hong Kong. China levies duties of as much as 35 percent on imported goods and a 17 percent sales tax.

Jiang, the Shanghai honeymooner, visited France for three days in 2001 on a business visa that took her a month to get. Her tour-group visa for next month's trip to Italy and France was approved in two weeks.

Now Jiang is plotting her next jaunt -- to the U.K. ``It has a lot of history and culture,'' she says.

To contact the reporter on this story:Jasmine Yap in Hong Kong at jyap5@bloomberg.net.

CGES: OPEC pushing limits of oil production capacity

CGES: OPEC pushing limits of oil production capacity
Paula Dittrick
Senior Staff Writer

HOUSTON, Oct. 21 -- Most members of the Organization of Petroleum Exporting Countries are pushing the limits of their oil production capability, and some probably are finding that their sustainable capacity is not as high as originally thought.

London-based Centre for Global Energy Studies reached that conclusion in its Global Oil Report Market Watch for September-October.

"Indonesia and Venezuela cannot meet their quotas, while Nigeria—which produced at surge capacity earlier this year—finds it must now lock in production at many of its aging fields, proving that its stated capacity is not sustainable," CGES said.

OPEC members have frequently talked up their production capabilities with a view to increasing their allocated quotas within OPEC, but only recently has this capacity been tested.

CGES expects that there will be little more than 1.5 million b/d of incremental oil production capacity by the end of 2005.

OPEC's production currently is estimated at just over 30 million b/d of oil, and its current level of spare production capacity is believed to be about 1.4 million b/d of oil at most, representing only 5% of its aggregate output, or 1.7% of estimated world oil demand for the fourth quarter, CGES said.

Algeria and Indonesia

Algerian Oil Minister Chekib Khelil said that his nation's oil production, excluding condensates, is about 1.35 million b/d. CGES estimates the country's oil production at closer to 1.28 million b/d; however, condensates—which do not make up part of the OPEC quota—bring total production of liquids to about 2 million b/d.

Khelil said Algeria's oil production capacity will rise to 1.5 million b/d in 2005 after new fields are brought on stream. Algeria is planning to boost oil production capacity to 2 million b/d by the end of the decade.

Indonesia's oil production has continued to slip this year. CGES estimated oil output in September at 963,000 b/d, 436,000 b/d below the country's OPEC quota. The country became a net oil importer during the second quarter, and production capacity shows little sign of recovering any time soon.

CGES said that Indonesia's oil production capacity looks set to continue to decline next year.

Iran, Iraq, and Kuwait

Iran currently produces about 3.98 million b/d of oil, which appears to be a sustainable capacity level. National Iranian Oil Co. (NIOC) repeatedly has said it plans to raise capacity by 5 million b/d during the next 15 years—well beyond the peak levels achieved before the 1979 revolution.

"By the end of 2005, the [Iranian] oil ministry hopes to have reached a total sustainable capacity of 5 million b/d, but with an annual reservoir depletion rate of about 200,000 b/d offsetting any gains made by multiple active projects, this now looks highly optimistic," CGES said.

Much work has been done to arrest oil production decline as well as upgrade existing fields, CGES noted. Upgrading offshore fields Sirri and Soroush-Nowruz already stemmed a decline in oil production capacity. Major fields that NIOC is looking at upgrading during the coming year to boost capacity include Aghajari, Masjid-e Suleiman, and Zagros.

Iraqi oil production capacity, meanwhile, currently is fluctuating at 2.8 million b/d.

"While plans are afoot to increase this production beyond 3 million b/d by the end of 2005, production capacity will remain constrained by the security situation and the infrastructure available to export this oil," CGES said.

In Kuwait, bureaucracy and politics have hampered efforts to increase its production capacity much beyond the current level of about 2.4 million b/d, which includes production from the Neutral Zone.

"Continuing doubts over the opening up of the Northern oil fields to international consortiums—dubbed Project Kuwait—has led to abandonment of short-term capacity targets in favor of a longer-term goal of 4 million b/d in 15 years," CGES said.

Until international players are granted access to Kuwait's expansion projects, CGES does not expect much of a boost to Kuwaiti production capacity; it should increase by roughly 100,000 b/d by yearend 2005, it said.

Libya
Libya is rushing to add new oil production capacity and is planning to raise the volume of oil it can produce to 3 million b/d by 2010. The Libyan Oil Ministry now claims an oil production level of about 1.7 million b/d.

An official of Libya's National Oil Co. (NOC) claimed during OPEC's recent conference in Vienna that Libya could add 300,000-350,000 b/d of new oil production by mid-2005, raising its oil production capacity to 2 million b/d well ahead of schedule, CGES said.

"However, he gave no indication of where this new capacity might come from. This latest assessment represents a significant acceleration from plans reported as recently as April, which saw production capacity reaching 2 million b/d in 2008 and 3 million b/d by 2014," CGES said.

A number of oil fields operated by international oil companies are expected to begin production, or see significant increases in output levels, in the near future.

There also are hopes that the "Oasis Group" of US oil companies—ConocoPhillips, Marathon Oil Co. and Amerada Hess Corp., which was forced out of Libya by the US government in 1986—will be able to boost production from its former fields by 100,000-200,000 b/d of oil within 2-3 years.

Nigeria
Nigeria's oil production capacity, which the CGES currently estimates at 2.55 million b/d, is expected to reach 2.6 million b/d by the end of the year, possibly rising a further 200,000 b/d in 2005.

"However, it must be asked whether this capacity is sustainable. August saw 250,000-300,000 b/d shut in just to protect the aging onshore oil fields and infrastructure after production reached surge capacity levels in response to high prices, although Presidential Advisor Edmund Daukoru has promised this capacity would be restored by the end of 2004," CGES said.

Daukoru recently was quoted as saying there is a current limit of 2.5 million b/d for Nigeria's capacity.

"While civil unrest in the region and a national workers strike have yet to affect total oil production so far, Nigeria may have its work cut out simply holding on to its current production capacity in the short-term. Increments in production capacity will almost certainly arise from offshore fields, unaffected by unrest and growing maturity," CGES said.

Qatar, Saudi Arabia, and the UAE Qatar currently produces about 800,000 b/d of oil of its estimated 950,000 b/d production capacity. The CGES sees little change in production capacity over 2005, with small incremental additions contributing only 20,000 b/d to overall capacity.

Saudi Arabia's production capacity, including that from the Neutral Zone, currently is about 10.5 million b/d of oil, which is expected to rise to more than 11 million b/d by yearend as Abu Safah and Qatif fields start to make an impact.

Production from these fields is expected to reach 800,000 b/d of oil from the 150,000 b/d they collectively produced during September.

Saudi Arabia has been unable to use its spare capacity to take advantage of high prices and record demand because its oil is heavy and sour. For this reason, a number of projects have been lined up to expand production capacity of Arab Light.

Saudi Arabian officials maintain that the kingdom's spare capacity of 1.5-2 million b/d of oil is a matter of policy to retain its position as "swing producer" and that there is no need to alter their longer-term plans to do this. CGES estimates that by yearend 2005, the kingdom could reach a sustainable oil production capacity of about 11.5 million b/d and a surge capacity closer to 12 million b/d.

In the UAE, Abu Dhabi National Oil Co. has suggested that the emirate's sustainable output capacity could reach 3.6 million b/d of oil in 2005 from its present level of 2.7 million b/d.

CGES estimates that current sustainable capacity is at 2.55 million b/d of oil—about the level at which the UAE is currently producing—and this is set to rise to only about 2.6 million b/d by the end of 2005 as small gains are offset by declining production in Dubai. However, the UAE's capacity increases are due by 2006-07.

Venezuela
Venezuelan production capacity stands at about 2.7 million b/d of oil. The nation struggles to maintain its capacity because of aging oil fields and a lack of qualified workers with experience in working with these fields after the mass cull of state-owned oil firm Petroleos de Venezuela SA's technical staff.

Venezuela's Hydrocarbon Law and its recent hike in royalties due from heavy oil projects are unlikely to have an immediate impact on oil production because of high oil prices, CGES said.

"But unless conditions for foreign investment are made much more stable and favorable, Venezuela under President [Hugo] Chávez will struggle to maintain its present oil production capacity, let alone reach its [oil production] target of 5 million b/d by 2009," CGES said.

October 25 Philippine Stock Market Daily Review:Talk about absurdities

October 25 Philippine Stock Market Daily Review:

Talk about absurdities.

Locals whom have been stampeding out of the market for vacuous reasons once again have plagued the Philippine Market with excuses for a selloff. Oil, inflation, MPC, US markets have prompted locals to take profits after the Phisix’s sensational run up in September. Naturally, the so-called experts are quick to attach bunkums on the after-the-fact events.

As discussed in my newsletter, the ‘October Effect’, which means that the market tends to be soft during this period, has been reinforced by the fact that in the past ten years, October has produced 7 years of losses against only 3 years of gains. This indicates that October presents a statistical probability of 70% that the market will head lower, even as the recent October started at a high of 1,865. This phenomenon could be what is now unfolding right before our very eyes.

Again the local investing mindset manifests its puerile nature in treating equities investment. Had fundamentals such as oil been the factor in today’s market activities apparently we should be seeing rotations to the defensive sector. Oil as of this writing trades above $55 and looks poised for another leg up for another record price high; ironically oil related issues have been even sold down by nincompoops. Gold is likewise $2 dollars away from its decade year high levels (currently at $428 per oz!! bye bye bye US dollar~Bush or Kerry), yet mining issues are sold down, as if the prices of these metals have no relevance to the financial valuations of these exploration and milling companies.

The Phisix closed lower by 26.5 points or 1.5%, the fourth biggest loser in a region haunted by losses for the day. Among the industry indices only the banking and financials index defied the tide up by a scanty .22% largely on Metrobank’s (+1.81%) advance. The Commercial Industrial was the day’s biggest loser down on the country’s duopoly, PLDT (-3.24%) and Globe Telecoms’ (-3.43%), price declines, followed by the OIL index (-1.75%-hahahaha!!!), the mining index (-1.70%-more hahahaha!!!), the foreign supported property index (-.49%) and lastly the ALL index (-.31%). Naturally when locals are bearish the market breadth manifest these; declining issues beat advancing issues 14 to 65. Ugh.

We are seeing continued accumulations by foreign money on the local’s dampened sentiment. Foreign trades accounted for almost 56% of today’s trade while flow of funds to the local equity market registered a positive P 83.150 million worth of inflows. Moreover, overseas investors bought twice more issues than it sold today. Hmmm.

Among the heavyweights only PLDT and San Miguel (-.69%) posted outflows while the most inflows were seen in SM Primeholdings (unchanged), Bank of the Philippine Islands (unchanged) and Ayala Land (unchanged). Other issues as International Container Terminals (-1.96%), DM Consunji (-1.72%), Equitable Bank (unchanged), Filinvest Land (-1.58%) and other second line issues recorded inflows. If these funds from abroad come from institutional investments then what does these entities see in the Philippine market that prompts their accumulations? I thought oil was ah....

Notice too that most of the heavyweights supported by foreign money closed unchanged. The biggest losers among the most active issues are noticeably the ones whom had been the erstwhile market darlings MPC (-5.0%), ELI (-5.88%) and PLTL (-2.54%). Except for MPC the rest looks like a buy buy buy.

Techni-speak, today’s activities brought the Phisix towards key retracement levels. At today’s low, the Phisix corrected by some 43% from its peak while compared to the closing prices at 1,735.69, the Phisix yielded 40% of its current gains.

Robert Feldman of Morgan Stanley: Oil and Water, Japan and China

Oil and Water, Japan and China
Robert Feldman (Tokyo)

No, this piece is not about how Japan and China do not get along politically. Rather, it is indeed about oil and water — or more precisely about how the competition for resources will shape the world in which Japan and China interact over the next decades. This piece is inspired by a recent book by Michael Klare entitled Resource Wars (Owl Books, 2001). In the book, Professor Klare makes the important (but also somewhat obvious) point that the combination of geography, economics, and politics will create intense competition for scarce resources, especially oil and water.

How will Japan and China interact in this world? Are they competitors or allies? Will the competition be diplomatic, negotiated, and peaceful, or will it be military?

The answer depends on the specific resource involved, and the geography (and politics) of the resource. However, fortunately, the details suggest that Japan and China (along with the United States) have much more to gain by cooperation than by competition, especially military competition. This conclusion is clearly good news for financial markets. Even better news is the opportunities that joint development will hold for business. Industries of particular interest include plant engineering and suppliers for energy development projects and trading companies or storage facility providers for agricultural trade in the region.

Oil

Most oil analysts are now convinced that the world does face high oil prices for at least a few years, even if speculative excess and weather-related distortions abate. There is virtually no spare capacity to produce more oil, but global demand will continue to increase. So the equilibrium price will be higher. The question for all countries now is how to find new energy sources and to promote conservation.

For Japan and China, the closest potential sources of new energy are oil from the South China Sea, and oil and/or natural gas from Siberia. In light of competing claims to exploitation rights, the South China oil will be the most contentious. China has claimed vast stretches of the South China Sea as an exclusive economic zone, while other countries do the same. So far, military conflict has been limited. The only direct confrontation between Japan and China concerns the Senkaku (Diaoyu) Islands, where nationalistic groups (from both Taiwan and China) have tried to occupy the islands. The incidents so far have been handled deftly, diplomatically, and with little disruption by the Chinese and Japanese governments — which have many more important problems (such as North Korean nuclear weapons) to handle.

The South China Sea issue for Japan involves two separate questions: passthrough access to sealanes bringing energy from the Middle East, and exploitation of resources that are believed to lie under the ocean floor. The passthrough question is both military and economic. Unsure of how China and other nations will resolve the issue of economic rights, Japan is rightly worried that sealanes could be disrupted. Hence, some military presence is needed. However, to the extent that China and Japan can reduce the need for such military protection of the sealanes, both countries will benefit. (The same is true of the US, which will continue to have a role in defending Japan.) The balance of methodology for dealing with the sealane issue is likely to remain firmly diplomatic and legal, rather than military.

The exploitation issue is harder, because of the many competing claims and lack of clarity in international maritime law on how to resolve the claims. So long as the claims are unresolved, there is very little likelihood that major companies would invest any significant amounts in resource exploitation. Hence, all parties have an interest in creating a stable legal environment for development. The risk is that energy prices climb high enough, and potential users of energy become desperate enough, to occupy territory militarily. I doubt that energy prices could trigger such action, because the economic losses from unilateralism would likely outweigh any benefits. The challenge for countries in the region, therefore, is to work out a rights-sharing arrangement as soon as possible. Oil at $50/bbl is certainly an incentive to cooperate.

Other oil projects are more straightforward. Siberian exploitation will involve negotiation with Russia, and with countries through which pipelines might pass. Ironically, this factor might aid a solution to the problem of nuclear North Korea. A pipeline passing through North Korea could pay access fees to that country in the form of a portion of the energy that passes through, thus providing effective aid to North Korea, and obviating the need for nuclear facilities — the justification for a nuclear program.

Farther afield, China has an interest in building pipelines from Central Asian countries to serve western China, but Japan has little interest in such projects, except as a potential investor or provider of equipment. Such projects would benefit Japan to the extent that they remove pressure on global oil prices.

My reading of the oil situation is that both Japan and China view economic and political stability at home as requiring a cooperative solution to the oil / energy problem. Neither country has either the resources or the military power to pursue a unilateral solution. Hence, there appears to be a bright future for Japan-China cooperation in the energy field.

Water

The other major source of potential conflict that Mr. Klare discusses is water. In particular, he focuses on the scarcity of water, and control over the Nile, Tigris-Euphrates, and Indus river valleys. Obviously, none of these issues has any direct relation to either Japan or China (except to the limited extent that the Indus initially arises in western Tibet). But water is an issue, especially for China. As living standards rise, China will need more fresh water and the products thereof, but sources are limited. Moreover, as my colleague Andy Xie points out, agricultural land in China is under pressure from industrial development projects. How can China raise living standards when water and land are becoming scarcer?

The answer is to import the products that require land and water. Already, China is a huge importer of agricultural products from the US. However, as water becomes scarcer in the US as well, alternatives must be found. Japan is a good candidate. Indeed, water is the one natural resource that Japan has in abundance. Moreover, as Japan's population ages, it will require less food. In addition, the inefficiencies of Japanese agriculture suggest that much improvement in output is possible. Already, Japan supplies limited amounts of high-grade rice to some Chinese cities as a luxury item. The factor endowments suggest that there is more such trade in Japan's and China's futures.

Other Resources

There are many other resources in which Japan and China have common interests in ensuring stable supply. Among these are minerals from Africa, fish from the oceans, and uranium in particular — a source of energy that may well come back into fashion as high oil prices persist. None of these resource issues can be settled in a unilateral way. Rather, China and Japan must cooperate in creating a strong Asian voice for peaceful exploitation. It is in this context that the proposals to re-organize the United Nations’ decision-making structure are key. So are regional initiatives, such as Japan-ASEAN cooperation and regional Free Trade Agreements.

Investment Implications

Investors in Japan will likely be paying more attention to the energy and water issues over the next few years. Japanese companies stand to benefit from new energy projects, not only as suppliers of machinery and materials (e.g., high-grade seamless pipe) but also as designers and implementers of projects. While currently still troubled by balance sheet difficulties and cash flow problems, the Japanese plant engineering companies have much expertise in these areas. Moreover, transportation of energy, particularly natural gas, will require increased fleets of LNG tankers and port facilities. The latter must be constructed some distance from large urban areas, in order to ensure safety, and thus some rather large projects could become necessary.

The implications of the water issue are somewhat different. Japan has no major agribusiness sector, but the imperatives of food supply for the region suggest that such firms could emerge. For this to happen, however, major deregulation would be needed, particularly an expansion of corporate ownership of farmland. In addition, the efficiency of distribution of agricultural products needs work. These inefficiencies are the raw material of business opportunities. Ironically, such a turn of events would reverse the trade flows of the last decade, in which China has become a major supplier of fresh vegetables to Japan. However, as China's needs grow, and as the resources for producing such crops in China dwindle, Japan could help fill the gap, first by replacing China's exports to Japan, and then by exporting to China itself. Trading companies are likely to be major beneficiaries of trade pattern changes, in light of their expertise in project investments and in distribution. Moreover, as agricultural trade grows in the region, the need for storage facilities could help the manufacturers of machinery for this sector.

New York Times: Private Investors Abroad Cut Their Investments in the U.S.

Private Investors Abroad Cut Their Investments in the U.S.
By EDUARDO PORTER
The New York Times

Published: October 19, 2004

The flow of foreign capital contracted in August as private investors lost some of their appetite for American stocks and bonds, underscoring the United States' increasing dependence on financing from central banks in Asia.

The Treasury Department reported yesterday that net monthly capital flows from the rest of the world fell for the sixth time this year, declining to $59 billion from $63 billion in July.

Private investment from abroad fell by nearly half - to $37.4 billion in August from $72.9 billion the month before. Investors appear to be concerned over cooling growth and a rising American trade deficit.

The only reason that the contraction was not more pronounced was that official financing, mainly from Asian central banks, jumped to nearly $23 billion in August from just over $6 billion in July.

Washington has demanded that China end a policy of buying dollars to reduce the value of its currency, the yuan, and make its exports more competitive in American markets. But the new data accentuated how dependent the United States has become on purchases of dollar securities by the Chinese and other Asian governments with links to the dollar.

"Foreign central banks saved the dollar from disaster," said Ashraf Laidi, chief currency analyst of the MG Financial Group. "The stability of the bond market is at the mercy of Asian purchases of U.S. Treasuries."

Net foreign purchases of United States Treasury bonds fell 35 percent, to roughly $14.5 billion, an 11-month low. Foreign governments left a particularly large footprint in this market, stepping up their net purchases to about $19 billion even as private investors sold about $4.5 billion worth.

Holdings of Treasury bonds by Japan, where the central bank has also been intervening to keep the value of its currency from rising, increased by $26 billion in August, to $722 billion. Chinese official holdings rose more than $5 billion, to $172 billion.

The decline in foreign investment seems to have unsettled some investors in the bond and currency markets, who have been on tenterhooks as the American trade deficit has soared to nearly 6 percent of the nation's economic output, requiring foreign investment to finance it.

Through the first quarter of the year, financial flows into the United States exceeded the trade deficit by well over 50 percent. Last month, they barely covered the $54.2 billion deficit.

As private capital flows declined, the American financial balance has been poised precariously. As private financing dwindled, most of this coverage has been provided by foreign government finance.

"If all we have funding our current account imbalance is the good graces of foreign central banks, we are on increasingly thin ice," said Stephen S. Roach, the chief economist at Morgan Stanley. Of Washington's call for China to stop interfering in currency markets, he cautioned, "That could come back and bite us."

Not all economists are that worried about the growing shortfall in the current account, the broadest measure of trade, pointing out that it is sustainable as long as Asians continue on a path of export-led growth that requires cheap currencies against the dollar.

Many economists stress, however, that this symbiotic balance between Asian and American economies will eventually come to an end.

Jeffrey Frankel, an economics professor at Harvard University, said: "The Asians are going to go on buying Treasury securities for a while, preventing the dollar from depreciating and helping keep U.S. interest rates low, which is a good thing. But not forever."

Morris Goldstein of the Institute for International Economics remarked, "This can be a story for one year or two years, not for 10 years."

If the United States were to temper its appetite for foreign money, the Chinese and Japanese could curtail their purchases of American securities without causing financial havoc. The dollar could then drift lower against Asian currencies, benefiting American exporters and manufacturers that compete with Asian imports.

But this would require Americans to increase their rate of savings. Household savings have plummeted to only 1.5 percent of personal income, from 11 percent 20 years ago. With the federal government running a budget deficit of 3.5 percent of the nation's output, the public sector hardly contributes to savings.

A disorderly situation would occur if foreign money dried up suddenly when the United States still needed it. Then, the adjustment in American savings might happen involuntarily. Interest rates would rise sharply, and the dollar could fall abruptly. This could induce a sharp economic contraction, even stagflation.

"The longer we wait," Mr. Goldstein said, "the more likely we'll have the adjustment anyway. But the adjustment will be more chaotic and sharper."

Peter Cooper:Linking gold and oil prices

Linking gold and oil prices

Peter Cooper

Ameinfo.com

What do the price of oil and the price of gold have in common? At the moment, both more and less than you might think.

A crisis in the Middle East, an American president who did not inspire confidence overseas, rising economic powers in Asia and instability in global monetary policies.

In the early 1970s, these destabilizing factors combined to helped to push gold prices steadily upwards towards the peak price of more than $800 per ounce that was reached by the end of the decade.

Today, in a world that seems in many ways to mirror that of three decades earlier, gold prices are hovering in the $400 per ounce range. By some standards that price is quite high; by others, though, the precious metal is a relative bargain - especially compared to oil prices, which are a traditional indicator of the value of gold.

Historically, the ratio of the price of oil to the price of gold has been relatively fixed: the number of ounces of gold required to buy a barrel of oil has averaged .06 ounces. As oil prices soar past the $50 mark, however, gold prices have not kept pace. For gold to reach the historical standard - with oil prices at a more modest price of, say, $42 per barrel - the precious metal would have to trade at $700 per ounce. Put another way, by historical gold-price standards, oil should be selling at just $24 per barrel. By most measures, then, buying gold is currently a smart investment. Which would make Kuwaitis the savviest investors in the Middle East. In terms of value, the emirate saw the greatest surge in gold consumption in the second half of this year, recording growth of 28 percent. Saudi Arabia, the largest market in the Gulf, saw growth of 23 percent, followed by the UAE at 21 percent, Bahrain at 20 percent, Oman at 18 percent and Qatar at five percent.

Overall, second-quarter demand in the region was up by eight percent. Not everyone who buys gold, of course, is concerned with historical standards - or, for that matter, with any standard beyond their latest bank account balance. And the seemingly inexorable rise in oil prices means that, across the Gulf region, those balances are currently looking very, very healthy.

Hedging bets

So will the regional buying trend continue at least for the rest of the year? That seems likely, although the end of the summer tourist season will result in an inevitable short- term decline.

Worldwide, Goldman Sachs argued recently that buying by hedge funds and an expected continued decline in the dollar against the euro means that gold prices will continue to inch up for the rest of 2004. (Investors historically purchase gold as a hedge against declines in US assets when the dollar is falling.)

Its worth recalling that, barely 18 months ago, the outlook for the gold market was extremely bleak, with merchants at Dubais gold souk lamenting a 50 percent drop in sales. Many shops, despite running any promotion they could think of, were reportedly on the brink of going bust.

Our business has shrunk substantially, Joy Alukkas, managing director of Dubai-based Alukka Jewelry, told Arabies TRENDS in March 2003. There is no hiding the fact that the gold jewelry business this time around is very poor. At the time, there was hardly a consensus about the direction gold prices would take.

Some industry analysts argued that prices would inevitably decline, as speculative investment dried up and what they saw as a price bubble finally burst. A rapid sell-off would result in a drop as large as the increase we have seen, said the chairman of one gold trading group in Dubai at the time.

Paradigm shifts

Others analysts strongly disagreed. Leonard Kaplan, a gold analyst with Prospector Asset Management, told Arabies TRENDS more than a year and a half ago that a drop in gold prices was out of the question.

As the US dollar continues to falter, as the equities markets continue their slide, as the paradigm shift from paper assets to hard assets builds a bit of momentum, as the budget deficits of the United States swell - it becomes apparent that gold must rise in response.

At the time, there were fears among some regional bankers of gold hoarding - driven by instability surrounding the war that had just been launched in Iraq - leading to a cash-flow crisis, a proposition that seems laughable today. But in March 2003, despite the fighting in Iraq, oil prices remained well below $30 per barrel, and there was no way to predict the surge that would take prices above the $50 mark.

So what to make of all this? Is the current gold-buying boom in the Gulf a sign of increased or decreased confidence in the future? Are regional shoppers hoarding hard assets based on a fear of future instability, or does the trend simply indicate that so many people have so much money to burn?

The latter is far more likely, of course. But the real test wont come for Gulf consumers until the gold:oil price ratio finally settles to its historical levels. After all, the last time the world looked like it does today, gold prices were on their way to $800 an ounce.

Financial Times: India in plea to investors abroad

Financial Times: India in plea to investors abroad

By Ray Marcelo in New Delhi

Published: October 20 2004 03:00

Last updated: October 20 2004 03:00

Manmohan Singh, India's prime minister, urged foreign investors yesterday to contribute to $150bn worth of planned infrastructure spending, an appeal likely to strain relations further with his government's communist allies.

Mr Singh told a business summit between India and the Association of South East Asian Nations (Asean) that the country's economic growth relied on substantial increases in domestic and foreign investment in physical infrastructure.

"We believe the Indian economy can absorb up to $150bn (£83bn) of foreign investment in infrastructure over the next 10 years. There is therefore a large opportunity for Asean businesses to invest in India," he said. India's ailing airports and railways needed more than $55bn in capital investments, alongside $75bn in power and $25bn in telecommunications, Mr Singh added.

"We will make every effort to promote such investment and to create a climate conducive for investors and entrepreneurs," he said.

Such statements are a further sign of the government's resolve to pursue economic reforms despite opposition from communist parties, which support Mr Singh's multi-party coalition from the outside.

Relations between the government and the communist bloc appear increasingly tense.

Both sides clashed last week over plans to raise the foreign equity ceiling in the telecoms sector from 49 to 74 per cent, part of several industry reforms championed by P. Chidambaram, the finance minister.

Communist parties have opposed raising foreign direct investment (FDI) levels in telecoms, citing concerns over national security. They have argued for a "Chinese strategy", insisting that foreign telecom carriers enter into local joint ventures.

In response, India's pro-reform finance ministry has revealed data showing local telecoms carriers have already exceeded current FDI limits.

Oct 21, 2004 Phisix Crumbles Under the Weight of Local Selling

Philippine Stock Market Daily Review: Oct 21, 2004

Phisix Crumbles Under the Weight of Local Selling

No, I certainly would not ascribe to any particular event solely responsible for the current drag in the Phisix, down 18.33 points or 1.03%, which has broken from an important support level. The 1,770-level served as its platform to establish its most recent record high. The motley reasons that you can expect from mainstream analyst to cite for the recent string of declines would be overnight decline of the US markets, oil (again!! No rotation to oils), local political developments as coup fears arising from corruption crackdown on military hierarchy, economic data, Metro Pacific-driven et. al. and a whole lot of crap.

While these experts presume knowing the mindsets of the market, what we can deduce from the market is what the market internals show. And today’s activities manifest glum outlook by locals responsible for the recent declines.

The Phisix has retraced by more than 23.6% and could probably test the 1,740 level for a 38% correction/retracement from its recent highs before moving higher.

Today’s action was centered on the sell off in the telecoms sector with key heavyweights (PLDT down 2.13% and Globe lower 1.9%) and attendant second liners taking the most damage, Piltel fell 2.41% and Digitel declined 4.34%. The Mining sector was the biggest loser (-1.4%) even as metal prices underpinning the corporate fundamentals such as gold and silver are currently approaching their record highs in dollar terms. The financial sector (-1.33%), weighed by losses from its heavyweights Bank of the Philippine Islands (-2.12%) and Metrobank (-1.8%), came second while the telecom led Commercial Industrial Index (-1.22%) was third. The All Index posted the least decline down by .32% as its heavyweights Sunlife and Manulife were untraded today. The foreign supported property sector (+.4%) defied the market sentiment and posted slight gains for today largely on SM Prime’s advance (+1.38%).

Decliners led advancers by 53 to 15, as foreign money remained bullish on local equity assets particularly on the property sector to register P 111.868 million worth of inflows. Foreign trades accounted for only about 37% of today’s trades, meaning that the psychology of the local investors dictated the tempo of the trading activities in today’s market. ERGO Locals are selling for whatever reasons, Foreign are buying for reasons stated previously in our newsletters.

The September-October period statistically speaking has been one of the weakest period on a month on month basis aside from the July-August and June-July time frame since 1997. Five out of seven months in the past 7 years or a probability of 71.4% showed that the September-October period is predominantly a bear’s lair, although month to date the Phisix is barely up by 5.03 points or .3% which simply means that it is natural to expect the Phisix to head lower because of seasonality factors paving way for strengths in the coming months. Take these indications of weaknesses as opportunity to buy on dips, as I believe that the cyclical shifts, seasonality factors, historical patterns and the technical picture remains tilted in favor of the bulls.

Business Times Asia: Radical Delhi plan to fund infrastructure

Radical Delhi plan to fund infrastructure
Use of US$120b of reserves may have consequences for US budget deficit

By ANTHONY ROWLEYIN TOKYO

INDIA'S plan to use up to US$120 billion of its foreign exchange reserves to help fund domestic infrastructure projects signals a radical departure that could influence the way other developing countries in Asia and beyond finance infrastructure, and could also have an impact on foreign exchange markets.

It comes at a time when the International Monetary Fund and the World Bank are considering fiscal incentives to get developing nations in general to spend more on infrastructure.

The move by the new Congress-led coalition in Delhi is designed to help India overcome serious infrastructure deficiencies in its road, railway and power sectors that could hinder economic growth.

It marks the boldest step so far by any Asian government (which collectively hold nearly US$2 trillion in reserves) to deploy its reserves actively in the domestic economy instead of keeping them invested in US and other foreign government securities.

China has diverted some US$45 billion of its reserves to dealing with its banking sector problems but India's initiative is much bigger.

Analysts say the move could have considerable significance for the funding of the US budget deficit, as well as for the exchange rate of the US dollar, if other countries opt to use their reserves more actively in their domestic economies.

India has not so far been able to attract foreign investment in basic infrastructure on anything like the scale that China has. At the same time, the Indian banking system has proved incapable of providing long-term bank loans for infrastructure on the scale needed, while the domestic bond market is also underdeveloped. Recently the Asian Development Bank issued its own rupee bonds in India to help bridge the infrastructure gap.

According to a report in Saturday's Financial Times, critics of the government plan say it would be an inappropriate use of India's foreign exchange reserves and would add to the already high fiscal deficit.

But Indian officials argue that the country's foreign exchange reserves have tripled in the past three years and are now high enough to cover almost 20 months of imports - far higher than the IMF-recommended minimum ratio.

The fiscal deficit issue may not prove to be a problem for India or other countries that opt to spend more money on infrastructure development. This is because at their annual meetings in Washington this month, the IMF and the World Bank decided to examine the idea of giving developing countries more 'fiscal space' to deal with their infrastructure funding needs.

According to an IMF spokesman, developing countries that invest in infrastructure, and thereby add to a nation's income-generating potential, would be able to deduct such spending from their budget, for the purposes of achieving the 'primary balance' which is regarded as the good housekeeping seal of fiscal management.

Debt services payments on infrastructure loans from multilateral development banks would also be deductible.

This would be a significant concession to emerging market economies at a time when there has been a massive shortfall in hoped for private sector investment in infrastructure, leaving governments bearing around 70 per cent of the total burden.

Those governments that invest most claim they are penalised in terms of the way their primary budget balance is calculated by the IMF.

World Bank president James Wolfensohn estimated in Washington that developing countries need to double infrastructure investment to around 7 per cent of GDP if they are to meet economic growth and poverty reduction targets.

Copyright © 2004 Singapore Press Holdings Ltd. All rights reserved.

New York Times: Insurance Investigation Widens to Include a Look at Costs

Insurance Investigation Widens to Include a Look at Costs
By JOSEPH B. TREASTER
New York Times

An investigation into the insurance business is expanding, investigators said yesterday, as Eliot Spitzer, the New York attorney general, increasingly turns his attention to whether American corporations and their employees are paying more for life, disability and accident insurance than they should be.

In California, John Garamendi, the state insurance commissioner, said last night that he, too, was concerned about extra costs to individuals for life, disability and accident insurance and that he was considering legal action against at least one broker and several insurance companies that sell what are known as employee benefits.

While the current focus of the New York investigation is on bid-rigging and price-fixing among commercial insurance brokers and insurance companies, investigators say Mr. Spitzer is also pursuing reports of payoffs that may increase coverage costs for tens of millions of individuals.

"Eliot Spitzer's interest is in the retail stuff, the effect on regular people,'' said David D. Brown IV, the chief of the state attorney's investment protection bureau.

"Our investigation is broadening and deepening,'' Mr. Brown said. "We are going to look across product lines, across insurers and across brokers, the big and the little."

The insurance controversy became public last week, when Mr. Spitzer sued Marsh & McLennan, the world's biggest commercial insurance broker, accusing the broker of rigging bids from insurance companies and fixing prices for corporate customers in exchange for fees from the insurance companies.

Three insurance companies have entered guilty pleas to rigging bids, and more criminal charges are expected, perhaps as early as this week.

Such bid-rigging schemes, investigators contend, have indirectly increased the costs of everything from houses to toothpaste as corporations pass along the expense. The bid rigging was discovered, Mr. Spitzer said last week, during an investigation into incentive fees insurers pay to insurance brokers.

But there are other potential conflicts of interest in insurance that may have a more direct impact on consumers. Investigators in New York and California are now examining whether brokers and consultants are demanding extra fees for favored treatment in the sale of employee benefits like group life and disability coverage.

Like the investigation into commercial insurance brokers, this inquiry began when Mr. Spitzer's office received a tip. In this case, an industry executive, upset by deals involving brokers and employee benefits insurers, telephoned the attorney general.

In June, subpoenas were issued to Aetna, Cigna and MetLife, some of the biggest sellers of what the industry calls group benefits.

These include life, disability and accident insurance bought for workers by businesses and nonprofits, who often allow employees to add to their coverage if they dip into their own pockets.

"We're very interested in health-related lines and auto insurance,'' one investigator said, "because those are the ones that affect consumers the most.''

In California, Mr. Garamendi said he had been discussing with his staff and other California officials either filing a lawsuit or joining in with others in a lawsuit on employee benefits. He said he planned to announced his decision later this week.
"We are on the verge of taking legal action,'' he said.

The California commissioner said he also planned to draft new regulations that would require insurance brokers to disclose all compensation from insurance companies and explicitly prohibit brokers from steering business to insurers in exchange for payoffs.

The role of insurance brokers is to obtain the best coverage for corporate insurance clients at the best price in exchange for a fee. They are supposed to deal with insurance companies at arms length. Long ago, however, they began collecting fees from the other side of the deal, from the insurance companies, creating a conflict of interest, some industry experts said.

In the field of employment benefits, brokers and consultants often receive two kinds of special payments in their dealings with insurance companies, according to an executive who works in the field.

The most widespread form of payments is a reward to the broker or consultant from an insurance company for a certain volume of business and for business that is expected to have few claims and therefore be especially profitable. This kind of payment, investigators and industry executives said, is the same as the kind widely used in commercial property and casualty insurance; in property casualty insurance, it raises the cost of insurance generally.

These arrangements are known as contingency fees, placement service agreements and market service agreements, just as they are in property casualty insurance.

But an additional form of payment that is absent in property casualty transactions results in higher individual costs for corporate employees who choose to buy life, disability or accident coverage beyond the amount provided by employers.

In those transactions, the executive said, the insurance company tacks on an additional annual fee of perhaps $5 to $15 for every worker who increases coverage.

While the extra money is collected by the insurance companies, the executive said, it is passed on to the brokers. Sometimes, the executives said, employers are aware of the extra charge, sometimes not.

In any case, the executive said, because of the hidden fees on workers, the corporation gets the services of a broker for less in direct costs than otherwise.

The degree to which incentive fees were important to Marsh was illustrated late yesterday, when the company said that it took in $843 million in such fees last year, or about 12 percent of its brokerage revenue of $6.9 billion. The disclosure was the first time the company had outlined the financial impact of the payments.

Marsh said on Friday that it was halting the incentive payments. Yesterday, the company said that the decision would "negatively impact near-term operating income.'' The payments represent 7 percent of its overall revenue. (Marsh's other main businesses are Putnam Investments and Mercer Consulting.)

Mr. Spitzer said on Thursday that the incentive payments could represent more than 50 percent of the parent company's income of $1.5 billion last year.

But Marsh said last night that it could not be sure how much income it earned through the payments because it was unable to determine the expenses associated with them. Marsh said, however, that it paid at least $340 million in expenses in connection with the payments in 2003.

Jeffrey Greenberg, the chief executive of Marsh & McLennan, had previously said that it was company policy not to break out either the revenue or the profits from the payments in its financial statements.

Two rating agencies, Fitch Ratings and Moody's Investors Service, lowered their estimates of Marsh's ability to repay debt and said further downgrades were possible.

Earlier yesterday, shares of Marsh & McLennan fell for a third day. The stock closed down $3.63, at $25.57. Since Mr. Spitzer announced the lawsuit on Thursday, the shares have tumbled 45 percent.

And the investigation is gathering speed. Already, Mr. Spitzer has 20 lawyers investigating the insurance industry, or nearly double the number involved in the investigation into mutual funds.

"This is a much bigger team,'' Mr. Brown said, "and it's much more interdisciplinary. The other cases were largely investor protection. This one involves people from our consumer fraud unit and antitrust as well as from criminal prosecutions."

Referring to Marsh, Mr. Brown said, "The first place we looked, we found massive issues.

"We're going to keep pounding on this,'' he said.