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Transparency ...

Global commerce and market interconnectivity have revealed how much one country can differ from another in their capital markets and business environment. Some countries offer relatively transparent economic environments:

– Corruption on a broad scale is rare– The rule of law is well developed and enforced– Government economic and fiscal policies are openly

debated and decided– Accounting and corporate reporting standards are

comprehensive and prudent– Regulatory authorities operate by clear and publicly

debated criteria

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…and Opacity

Other countries are relatively opaque in one or more of these dimensions.

– They may be emerging economies and still developing their market environment.

– They may be following another vision of sovereignty, business practice, or management of the national economy.

– They may be experiencing a turbulent period in their national life.

Whatever the reason, the commercial and capital market environments are lacking in transparency.

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Opacity Hinders Economic Development

Opacity impedes economic progress—seriously enough that it needs to be measured, better understood, and brought into focus as a world-wide debate.

Who should care?

– Executives– Government officials– Diplomats– Regulatory authorities– Leaders of finance– Business journalists– The common citizen who looks to his or her country for

economic progress.

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Defining Opacity

Opacity is the lack of:

Clear, accurate, formal, easily discernible, and widely accepted practices in the world’s capital markets.

These practices are shaped in the broad arena where business, government, and regulatory authorities interact

The practices are domestic, but subject to global influence and pressure

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The Causes of Opacity

The Opacity Index integrates five related measures that each affect the cost and availability of capital

Corruption

Legal system opacity

Economic and fiscal policy opacity

Accounting standards opacity

Regulatory opacity

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CLEAR

From these elements emerges the acronym

CLEAR

A means of keeping in mind the multiple aspects of opacity/transparency in capital markets

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Why the CLEAR Dimensions Matter

There may be corruption in government bureaucracy that allows bribery or favouritism

The laws governing contracts or property rights may be unclear, conflicting, or incomplete

Economic policies—fiscal, monetary, and tax-related—may be vague or change unpredictably

Accounting standards may be weak, inconsistent or unenforced, thus making it difficult to obtain accurate financial data

Business regulations may be unclear, inconsistent, or irregularly applied

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Are There Any Heroes?

A high degree of opacity in any of the CLEAR dimensions will raise the cost of doing business and curtail the availability of investment capital.

– Yes, some countries are more transparent overall than others. But no country is likely to earn a perfect score.

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Basic Features of the Opacity Index

The Endowment assembled a team of senior economists, survey professionals, analysts, and distinguished advisors to explore the development of a world-wide Opacity Index.

– The Index is a set of well-founded estimates.

– This first report estimates the adverse effects of opacity on the cost and availability of capital in 35 countries.

– The Index offers a composite O-Factor for each country.

– The O-Factor score can be used to develop other “views” of capital markets.

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The Opacity Index is Not a Ranking Among Countries

The Opacity Index is not yet a ranking.

Some countries score well in one or more of the five CLEAR dimensions, less well in other dimensions.

The Index correlates with other indices, but it is a genuinely new measure.

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How Will the Opacity Index Help?

Businesses can make better informed investment decisions

Governments can more clearly assess strengths and weaknesses, and track change over time

Governments will better see where to revise their legal, regulatory and policy frameworks to achieve greater economic progress

The Index estimates the costs of certain behaviours, without imposing political or ethical judgements

The value of transparency in world-wide capital markets will be reinforced

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Our Operating Principles

To be fully transparent

To involve a broad breadth of stakeholders

To create partnerships between civil society, governments and the private sector

To enable public comment on the Index via our website

To make the Index a public good full accessible to everyone for their use

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Methodology

The Opacity Index scoring is survey-based

– Survey population: corporate leaders, banking executives, equity analysts, in-country staff of PricewaterhouseCoopers

A team of economists generated individual scores for the five CLEAR dimensions to create the O-Factor, for each country in the sample

– They used the opacity score with other data (FDI and portfolio flows) to determine the economic impact of opacity on the cost and availability of capital in the 35 countries

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Three Data Streams

This overall exercise created three streams of related data:

1. O-Factor scores

2. Measurements of the risk premium due to opacity when countries borrow through sovereign bonds

3. Calculation of the effects of opacity as if it imposes a hidden surtax on FDI

A fourth data stream will follow soon: estimates of the extent to which opacity deters FDI

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For Those Who Think Mathematically…

The composite O-Factor is calculated by averaging (on an equally weighted basis) the various components of opacity for each country:

Oi = 1/5 * [Ci + Li + Ei + Ai + Ri],

Where i indexes the countries and:O refers to the composite O-Factor (the final score)

C refers to the impact of corrupt practices

L refers to the effect of legal and judicial opacity (including shareholder rights)

E refers to economic/policy opacity

A refers to accounting/corporate governance opacity

R refers to the impact of regulatory opacity and uncertainty/arbitrariness

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A Key Chart

Exhibit 1Scores for O-Factor and Components(higher numbers indicate more opacity)

Country C L E A R O-FactorArgentina 56 63 68 49 67 61Brazil 53 59 68 63 62 61Chile 30 32 52 28 36 36China 62 100 87 86 100 87Colombia 48 66 77 55 55 60Czech 57 97 62 77 62 71Ecuador 60 72 78 68 62 68Egypt 33 52 73 68 64 58Greece 49 51 76 49 62 57Guatemala 59 49 80 71 66 65Hong Kong 25 55 49 53 42 45Hungary 37 48 53 65 47 50India 55 68 59 79 58 64Indonesia 70 86 82 68 69 75Israel 18 61 70 62 51 53Italy 28 57 73 26 56 48Japan 22 72 72 81 53 60

Country C L E A R O-FactorKenya 60 72 78 72 63 69Lithuania 46 50 71 59 66 58Mexico 42 58 57 29 52 48Pakistan 48 66 81 62 54 62Peru 46 58 65 61 57 58Poland 56 61 77 55 72 64Romania 61 68 77 78 73 71Russia 78 84 90 81 84 84Singapore 13 32 42 38 23 29South Africa 45 53 68 82 50 60South Korea 48 79 76 90 73 73Taiwan 45 70 71 56 61 61Thailand 55 65 70 78 66 67Turkey 51 72 87 80 81 74UK 15 40 53 45 38 38Uruguay 44 56 61 56 49 53USA 25 37 42 25 48 36Venezuela 53 68 80 50 67 63

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Country C L E A R O-Factor

Singapore 13 32 42 38 23 29

Chile 30 32 52 28 36 36

Argentina 56 63 68 49 67 61

Peru 46 58 65 61 57 58

Thinking About the Numbers

Singapore—with O-Factor 29—is the benchmark

Chile scored a comparatively lower O-Factor than its neighbours

Lower opacity on every CLEAR dimension

Targets of opportunity exist for all three on E dimension

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Still Thinking About the Numbers

In comparison with India, Indonesia scores significantly higher levels of opacity on almost every dimension

…but scores rather well with regard to accounting standards

Similarly, in comparison to Pakistan, Indonesia’s opacity levels are higher

Such findings can show governments and businesses where to target efforts to reduce opacity and, as a consequence, the cost of capital

Country C L E A R O-Factor

Singapore 13 32 42 38 23 29

Indonesia 70 86 82 68 69 75

India 55 68 59 79 58 64

Pakistan 48 66 81 62 54 62

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The Tax-Equivalent “View”

Opacity has the effect of a surtax imposed on foreign direct investment (FDI) through an increase in the corporate tax rate

– The number 30 would indicate opacity in that country equivalent to levying an additional 30-percent corporate income tax

– Singapore is the benchmark

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The Second Key Chart

Exhibit 2Economic Cost of Opacity: “Tax-Equivalent” Estimates(Singapore is the benchmark)

Country O-Factor Tax-Equivalent (%)

Argentina 61 25

Brazil 62 25

Chile 36 5

China 87 46

Colombia 60 25

Czech Republic 71 33

Ecuador 68 31

Egypt 58 23

Greece 57 22

Guatemala 65 28

Hong Kong 45 12

Hungary 50 17

India 64 28

Indonesia 75 37

Israel 53 19Italy 48 15Japan 60 25

Country O-Factor Tax-Equivalent (%)

Kenya 69 32

Lithuania 58 23

Mexico 48 15

Pakistan 62 26

Peru 58 23

Poland 64 28

Romania 71 34

Russia 84 43

Singapore 29 (benchmark)

South Africa 60 24

South Korea 73 35

Taiwan 61 25

Thailand 67 30

Turkey 74 36

United Kingdom 38 7

United States 36 5

Uruguay 53 19

Venezuela 63 27

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Country O-Factor Tax-Equivalent (%)

Singapore 29 (benchmark)

Hungary 50 17

Poland 64 28

Romania 71 34

Thinking About the Tax-Equivalent Numbers

Were Hungary to reduce its O-Factor score to the level of Singapore, this would be like eliminating a 17% hidden surtax on FDI

Hungary’s tax-equivalent score is half that of Romania, where a hidden “surtax” on FDI of 34% is estimated

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Why the Tax-Equivalent “View” Matters

Many countries are eager to cut tax rates in order to boost investment, often by offering tax concessions to attract foreign investment.

A reduction in opacity can essentially substitute for a tax cut.

Domestic reforms that reduce opacity may be as effective as a tax cut—without sacrificing tax revenues!

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The Risk Premium “View”

National governments often obtain funding from domestic and international capital markets in order to meet their spending needs

– The risk premium “view” estimates the increased cost of borrowing faced by countries due to opacity, expressed in basis points (100 basis points = 1%)

– A score of 900 would estimate that the country needs to pay investors an extra 9% on sovereign debt, due to opacity

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Three Caveats

Some governments have deep pockets in terms of accumulated foreign currency reserves (the calculations allowed for this).

Countries issuing dollar-denominated bonds may enjoy lower risk premiums than estimated, but pay higher rates on bonds denominated in local currency.

When actual rates in domestic markets are lower than estimated opacity-based risk premiums, this may be a symptom of what economists term “financial repression.” The end cost of such policies is borne by individuals who save money.

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The Third Key Chart

Exhibit 3Risk Premium Due to Opacity(Singapore and USA serve as benchmark)

Country O-Factor Opacity Risk Prem.(Basis Points)

Argentina 61 639

Brazil 61 645

Chile 36 3

China 87 1,316

Colombia 60 632

Czech 71 899

Ecuador 68 826

Egypt 58 572

Greece 57 557

Guatemala 65 749

Hong Kong 45 233

Hungary 50 370

India 64 719

Indonesia 75 1,010

Israel 53 438

Italy 48 312

Japan 60 629

Country O-Factor Opacity Risk Prem.(Basis Points)

Kenya 69 848

Lithuania 58 584

Mexico 48 308

Pakistan 62 674

Peru 58 563

Poland 64 724

Romania 71 915

Russia 84 1,225

Singapore 29 0

South Africa 60 612

South Korea 73 967

Taiwan 61 640

Thailand 67 801

Turkey 74 982

UK 38 63

Uruguay 53 452

USA 36 0

Venezuela 63 712

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Thinking About the Risk Premiums Numbers

The benchmark, Singapore, pays virtually no risk premium due to opacity

The risk premium due to opacity in Chile is 3%, particularly on Peso-denominated bond issuances

By way of comparison, the risk premium due to opacity in Argentina is estimated at approximately 6.4% on domestic bond issuances

Opacity contributes to the inability of some countries to borrow in their own currencies

Country O-Factor Risk-Premium (%)

Singapore 29 (benchmark)

Chile 36 3%

Argentina 61 6.4%

Peru 58 5.6%

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Drawing Some Conclusions

The Opacity Index charts structural elements in each nation’s economic make-up which, if made more efficient, can help countries grow more quickly and soundly.

The mathematics and methods underlying the Index are neutral—but the results argue for greater transparency as a means of accelerating growth.

The Index has further applications. Look for our calculation of “FDI deterred”—a controversial and important view of how opacity reduces foreign direct investment.

Look also for the next release of the Opacity Index, with many additional countries included.

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Available for Your Use

The Opacity Index is a project of the PricewaterhouseCoopers Endowment for the Study of Transparency and Sustainability

www.opacityindex.com

DRAFT

The Opacity Index: a project of the

PricewaterhouseCoopers Endowment for the

Study of Transparency and Sustainability