capital market in bric economies
TRANSCRIPT
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PROJECT ON:
CAPITAL MARKET IN BRIC ECONOMIES
SUBMITTED TO
THE UNIVERSITY OF MUMBAI
IN PARTIAL FULFILLMENT FOR THE AWARD OF THE DEGREE
OF BACHELOR OF MANAGEMENT STUDIES (BMS)
SEMESTER VI
BY:
NAME: JAY.N.DHARAMSHI
ROLL NO: 30
S.K.SOMAIYA COLLEGE OF ARTS, SCIENCE & COMMERCE,
VIDYAVIHAR , MUMBAI- 400077
2012-13
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DECLARATION
I Mr JAY NITIN DHARAMSHI, the student of S.K.SOMAIYA COLLEGE,
studying in T.Y-BMS, Semester 5th course for the academic year 2012 2013
declare that, I have completed the project on CAPITAL MARKET IN BRIC
ECONOMIES in fulfillment of the course completion requirement at
University of Mumbai.
I further declare that, the information presented in this project is true and
original to the best of my knowledge.
Date: Signature of Student
Place: (JAY.N.DHARAMSHI)
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ACKNOWLEDGEMENT
First and foremost, I would like to thank Almighty God for energy, strength guidance and
help that have been with me throughout my work.
While presenting this project at this moment, I feel deeply obliged to our Mumbai University
for providing me with an opportunity to do this project.
This project could not have been light of the day without inspiring & Guidance from Prof.
Nitin Pawar sir who guided me likes a bonfire in the dark. I would also like to thank my
coordinator Prof Aparna Jain for motivating me through out.
Last but not the least; I am thankful to all my friends ans colleagues for their moral support
and encouragement.
To sum up I would like to thank all those who have helped me in some or other way in
successfully completing the project. It has been a warming experience for me, which surely
help me in future.
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INDEX
Chapter no. Topic Page no.
1 The Rise of BRIC Nations and How This Will Reshape
Worlds Geopolitics in a Near Future And Why the
United States Must Care
1 - 4
2 GROWING ISSUE OF INTER DEPENDENCY 5
3 THE PLAYERS 6-19
4 CAPITAL MARKET IN BRAZIL 20-31
5 CAPITAL MARKET IN RUSSIA 32-37
6 CAPITAL MARKET IN INDIA 39-48
7 CAPITAL MARKET IN CHINA 49-57
8 WHY THE BRICS DREAM WONT BE GREEN?58-61
9 WHY THE BRICS DREAM SHOULD BE GREEN? 62-65
10 2001:A BRIC ODYSSEY 66-67
11 CONCLUSION 68
12 NEWS PAPER ARTICLES 69-75
13 BIBLIOGRAPHY 76
14 WEBLIOGRAPHY 77
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EXECUTIVE SUMMARY
The BRIC [Brazil, Russia, India and China] idea was first conceived in 2001 by Goldman
Sachs as part of an economic modeling exercise to forecast global economic trends over the
next half century; the acronym BRIC was first used in 2001 by Goldman Sachs in their
Global Economics Paper No. 66, "The World Needs Better Economic BRICs".
The Fourth BRICS Summit was hosted in New Delhi on 29 March 2012 under the
overarching theme of BRICS Partnership for Global Stability, Security and Prosperity. The
Summit has imparted further momentum to the BRICS process.
BRICS, is a unique Grouping with shared opportunities and common challenges. Formalizedwith the first meeting of the Foreign Ministers of Brazil, Russia, India and China in New
York on the margins of the United Nations General Assembly in September 2006, in a short
span of time, the Grouping has come a long way and has evolved a number of mechanisms
for consultation and cooperation in a number of sectors. South Africa joined the Grouping at
the third Summit in Sanya, China in April 2011.
The agenda of BRICS meetings has considerably widened over the years to encompass
topical global challenges such as international terrorism, WMDs, climate change, food and
energy security, MDGs, international economic and financial situation, etc. Four BRICS
Summits and meetings of Foreign Ministers, Finance Ministers, Agriculture Ministers, Health
Ministers, High Representatives on Security and other sectoral meetings have helped further
deepening of cooperation amongst BRICS countries.
The objective of the project is to understand what BRIC is about and how the economies of
Brazil, Russia, India and China are summiting towards it. According to me, choosingbetween the opportunities is on offer in the BRIC countries is no easy matter. The economic
environment in each should encourage strong corporate growth. On one level, including
exposure to all four emerging markets in a portfolio looks like a great idea. Unfortunately,
emerging stock markets are all too prone to shocks, crises, and the inevitable flight to safe
havens such as US treasury stocks. As ever, potential higher returns go hand in hand with
potential higher risks.
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The project contains all the information on capital markets of the four economies and why
BRIC comes into picture. This project is based on secondary research and contains all the
updated information. BRICs have become popular again because the economic growth of
these countries is fast outstripping that of even the most developed of nations. This fact alone
makes BRIC mutual funds particularly attractive to investors who have a stomach for
investing in emerging markets.
BRIC mutual funds are account managed by investment professionals. The professional
investor or portfolio manager buys bulk interest in the foreign assets and pays the client-
investor a return based on the performance of the holdings.
The Delhi Declaration, capturing the essence of discussion as well as putting forth common
position of BRICS countries on various economic and political issues of global and regional
importance was issued at the end of the Summit. The Declaration included Delhi Action Plan
which highlights the activities to be undertaken under Indias chairmanship of BRICS to
further cooperation. Two agreements namely- Master Agreement on Extending Credit
Facility in Local Currencies and BRICS Multilateral Letter of Credit Confirmation Facility
Agreement- were signed by the Development Banks from BRICS countries. The Leaders
also released The BRICS Report focusing on synergies and complementarities between the
BRICS economies and highlighting their role as growth drivers of the world economy. An
updated edition ofBRICS Statistical Publication was also issued at the occasion.
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1
1
CHAPTER 1
The Rise of BRIC Nations and How This Will Reshape Worlds
Geopolitics in a Near Future And Why the United States Must
Care
A common question we hear is: why just Brazil, Russia, India and China?
The simple reason is that we think they represent the group of countries that have both the
potential to become important (largely because of their size) and a reasonable chance of
meeting the criteria. The case for China and India is especially straightforward, simply on the
basis of their massive populations. These two economies, along with China and India, have
the potential to be among the most interesting global economic stories and investment
Themes for many years to come. In addition, we now believe even more strongly that optimal
economic Policymaking cannot be undertaken without including allof the BRICs countries at
the highest level. Indonesia, Pakistan, Turkey and some of the Middle Eastern nations that
could become quite large, though may not have true BRICs potential. Estimated projections
up to 2050 to include another broad group of possible candidates, a group we call the N-
11.the Next Eleven.
It is still found that the BRICs stand out relative to the bulk of these other candidates,
in terms of the potential to be a major economic force. Mexicos favorable demographics and
scope to catch up place it among the BRICs in terms of economic size by 2050. Korea, albeit
somewhat smaller, is better placed than most others to realize its potential due to its growth
supportive fundamentals. Nigeria and Indonesia emerge as interesting prospects, but they
face serious fundamental weaknesses in the conditions that we identify as necessary. Each of
the Countries in the N-11, Korea and Mexico excluded, faces its own specific dilemmas, andperhaps unlike the four BRICs, they are not close to the heart of current and likely future
globalization developments. That does not mean that these other countries cannot achieve
their own BRICs-like aspirations. Indeed several probably will, but the probability is lower
and their potential ultimate size is smaller. For almost half a century following the aftermath
of the World War II, the global hegemony was divided between two factions:
One was the free world led by the United States and the British Empire the
western wing of the victorious Allied Powers, while the other being the Communist Bloc
spearheaded by the Soviet Union and Communist China.
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The world order as it was known during the Cold War era, however, went through a
massive amount of changes after the breakdown of the Communist Bloc and ultimately the
Soviet Union that occurred between 1989 and 1991. The Russian Federation, a non-
communist reincarnation of the RSFSR within the Soviet Union, assumed the role as a major
world power from its Bolshevik counterpart. For much part of the 1990s, the newly-born
Russian Federation attempted to recreate its image as a legitimate member of the western
world. Some of such attempts proved successful to an extent, as seen in the Russian entry in
the Group of Seven (now G8), which was initially meant to be a forum of influential nations
within the western world.
Furthermore, many Russian politicians started pointing that while Russia seemed to
pioneer a more constructive relationship with the west through its participation in the G8, the
western world in reality put effort to mount a greater geopolitical pressure to Russia, as seen
in the entry of former Communist Bloc nations (e.g. Poland, Czech Republic, and the Baltic
States to name a few) into NATO, a military alliance that was designed as the western
counterpart to the Warsaw Pact, which went defunct for nearly two decades. To counter such
pressures, Russia has aligned with the Peoples Republic of China, another non-western
member of the United Nations Security Council. At the same time, Russias economic
dependence towards the western world with its burgeoning oil industry could be alleviated
through realignment with other emerging economies across the world, as vividly seen in a
recent Goldman-Sachs thesis known as BRIC (Brazil, Russia, India and the PRC).
Russias pro-western initiatives practically began with Yeltsins takeover of power in
1991. Many speculated that such cooperation with the west was necessary, as Russia,
formerly the largest command economy in the world, was now obliged to transform itself into
a free market economy in order to survive. While the reform itself proved to be a fiasco,
Yeltsin attempted to implement yet another policy that would strengthen the ties between the
western world and the Russian Federation, namely the Russian membership in the G8, then
known as the Group of Seven. The G7, as mentioned earlier, was initially created as an
international forum between the worlds major industrial democratic politics. Henceforth, it
was viewed by many amongst both western and Russian politicians that such a transition
would accelerate the Russian effort to integrate itself into the western world, whereas the
alliance of established western industrial powers will obtain an undisputable hegemony over
the world following the collapse of the Communist Bloc.
Nonetheless, the failure of Yeltsins economic policies that was largely designed by
western economists forced many to reconsider whether the aftermath of such transition would
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be positive for Russias future. Further, the conflict of interest between Russia and the
western world with regards to many geopolitical issues surrounding the globe also played a
major role in making Russian political leaders to turn skeptical of a further collaboration with
the west. Another major concern was Russias political system, which many westerners view
as somewhat quasi-democratic or not democratic at all. While the western world has been
known for its alignment with some of the worlds most loathed dictators in necessary cases,
this clearly is an obstacle for Russia and the west to engage in a respectable degree of mutual
collaboration. These factors, I observe, are the main causes of the recent split between Russia
and the western world as seen in the Putin years, as I will clearly show during the course of
this paper.
Despite proving itself to be a formidable political and economic superpower during
the Soviet era, Russia was extremely prone to such drawbacks from rapid westernization, as
proved in the economic disaster of that happened through the grim decade of 1990s. Another
major bottleneck was a division of labor within the former Soviet Union that became null and
void since the breakdown of the Bolshevik dominion in 1991. This proved to be a disaster to
not only minor former Soviet Republics, but to many regions in the Russian Federation, as
the rapid privatization of such assets left the collapse of the countrys vast working class
populace virtually unchecked. This, in turn, resulted in the breakdown of the potential
consumer market in Russias newly operated market economy, which with the ever-growing
effect of hyperinflation caused by Yeltsins rather clumsy handling on price control plunged
Russia into an unprecedented economic depression that plagued the Yeltsin Administration
till its very end.
Despite such setbacks, Russia remained as a respectable world power throughout the 1990s,
perhaps owing to its vast nuclear arsenal from the Soviet era bolstered by its status as one of
the five permanent members of the U.N. Security Council. Thus, there was a series of
attempts to groom Russia into the prestigious Group of Seven throughout the 1990s, most
notably by the United States President Bill Clinton. The Russian Federation became an
official member of the G8 in 1997, which to an extent seemed to prove that Russia was
now a member of an exclusive group of major western industrial powerhouses. For the
western world, Russias entry into the G8 meant the expansion of the sphere of influence of
the market economy. Some even speculated that the inclusion of Russia into such an
exclusive group would lead to the emergence of the United States as a sole superpower across
the globe, as no other member of the nation did not seem to possess any chance to eclipse the
United States, which was hailed as the leader of the free world for a long period of time, in
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its military and economic powers. The age of reconciliation between Russia and the western
world fell short, however, for several reasons. These reasons are what I intend to present in
the latter part of this essay.
Russia and its leaders had intended to reassert Russias geopolitical influence in the
Soviet era once domestic affairs became stabilized. Russia also had to be cautious towards
the growing insurgency within its own borders following the independence of various ethnic
groups after the collapse of the Soviet Union, as vividly seen in the Chechnya crisis that
nearly annihilated Yeltsins image as a democratic liberator in the eyes of the western
populace. The Russian Federations skeptical attitude towards the Chechen independence and
a subsequent war, though condemned by the west, is somewhat understandable from Russian
standpoint, as a lax reaction towards such movement may have resulted in a series of violent
uprising across the country that could have transformed this minor disorder into a full-scale
chaos. Conversely, the western criticism of Russias decision to wage a war against
Chechnya which, from a Russian perspective, could be seen as a mere act to stabilize the
already fluctuating nation made many Russians question its alignment with the west, as the
western world now seemed to be a threat to Russias domestic tranquility, not a reliable
partner for mutual coexistence and prosperity.
The cases where the BRIC nations proved themselves the worlds emerging
economies could be most clearly shown in the private sector, as the BRIC thesis itself was
developed in Wall Street, not the Capitol Hill. The British Telecommunications Group, for
instance, emphasizes the potential of these countries in terms of their capability to adjust
themselves in technological progress to a greater degree than established nations, while
showing avid interest in working with these nations as part of the companys venture. The
recent outsourcing of information technology firms to India must rank high among actual
cases where the BRIC nations started playing a huge role in global economy, as an incredibly
large portion of private enterprises from developed nations flocked into India looking for an
effective, yet more affordable manpower. Outsourcing industries, most notably in the field of
information technology, is also burgeoning in Russia to a limited degree.
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Chapter 2
GROWING ISSUE OF INTER DEPENDENCY
Raisin g the issue of emerging powers and growing interdependence (economic, functional
and systemic) triggers a questioning of the structure of the world system. To be sure, the
structure of the world is extremely complex because all actors are inextricably intertwined in
multiple layers of the system. Despite this complexity, one can still identify general patterns
in the global structure. To begin with, although some scholars would argue that American
hegemony is built to last, there is a broad consensus about the fact that the American
unipolar moment has come to an end. If one dismisses unipolarity, it seems too early
nonetheless to evoke true multipolarity. Indeed, the US remains the dominant power, or the
lonely superpower, and is likely to maintain its status for years and probably decades to
come. The much-debated American decline is nothing absolute: the pre-crisis US economy
was still growing fast (and it seems to be slowly recovering from the crisis, although a relapse
is possible); the US military is more advanced than any potential competitor; and US soft
power is unchallenged even in Asia. Americas decline is not an illusion, but it must be
understood in relative terms. US global influence is fading because it contrasts with the rise
of the rest, i.e. the empowerment of other actors at the local, regional and global level. The
concept of power is relative: the power of one actor is dependent on the power of other
actors. Hence, America is declining not because it is weakening but because the rest is
getting stronger.
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Chapter 3
THE PLAYERS
The rise of a multipolar order implies the emergence of new poles. But who are the real
emerging powers? And what is an emerging power anyway? Part of the answer came from
Jim ONeill, economist at Goldman Sachs, who coined the now famous BRIC acronym
which became tightly associated not to say synonymous with emerging countries. Other
acronyms followed: BRICS (BRIC+South Africa); BRICSAM (BRIC+South Africa+ASEAN
countries+Mexico); and BIC or RIC (depending on which country is seen as the weakest link
in the BRIC). And yet, these acronyms tell us only part of the story.
3.1 INDIAS RISING GROWTH POTENTIAL
On the eve of the Industrial Revolution (around 1770), India was the second-largest economy
in the world, contributing more than 20% of total world output. By the 1970s, after two
centuries of relative economic stagnation, that share had fallen to 3%.the lowest in its
recorded history. From a long-term perspective, the post-industrial economic decline of India
(and China) is a historical aberration, driven to some extent by a lack of openness. After
independence in 1947, India followed inward-looking and state-interventionist policies that
shackled the economy through regulations, and severely restricted trade and economic
freedom. The result was decades of low growth, pejoratively termed the .Hindu rate of
Growth Reforms beginning in 1991 gradually removed obstacles to economic freedom, and
India has begun to play catch-up, steadily re-integrating into the global economy. Since 2003,
India has been one of the fastest-growing major economies, leading to rapid increases in per
capita income, demand and integration with the global economy. On the back of high
productivity growth GS baseline projections for Indias potential output growth show that the
economy can sustain growth rates of about 8% until 2020, significantly higher than the 5.7%
that what GS projected in our original BRICs paper. The key underlying assumption is that
the government will continue to implement growth-supportive policies. The implications of
this are that India will overtake The G6 economies faster earlier BRICs research. Indeed,
Indias GDP (in US Dollar terms) will surpass that of the US before 2050, making it the
worlds second-largest economy. Indias contribution to world growth will also be high and
increasing. The higher growth rate will have significant implications for Demand in India.
Comparisons with other countries that have experienced similar rapid rates of growth show
that India is firmly on the growth expressway. There is considerable scope for catch-up and,
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even with baseline projection; the speed of Indias growth transition is not implausible when
compared to the growth experiences of other East Asian countries. A turnaround in
manufacturing productivity since 2003 has been crucial. The proximate cause is the increase
in efficiency of private-sector firms in the face of growing competition. The gradual opening
up of the economy introduced a competitive dynamic, which forced the private sector to
restructure during the relative slowdown in growth and corporate profitability during 1997-
2002. After the restructuring, the private sector emerged leaner, fitter and more productive.
The underlying causes for the increase in efficiency of private firms have been trend
accelerations in international trade, financial sector growth, and investments in and adoption
of information and communication technology. These are also the cumulative effects of a
decade of reforms. The re-allocation of land, capital and especially labor from low-
productivity agriculture to high-productivity industry and services is an essential dynamic
behind sustained productivity growth. This process is being accelerated by higher returns in
industry and services due to trade openness, cheaper credit, investments in IT and
communications, and the building of highways. These processes are in their initial stages and
have substantial distance left to run. The upside to baseline projections is significant. Thus
far, the economy has logged high growth rates without significant increases in domestic or
foreign direct investment. If it can accumulate significantly more capital to add to its
favorable demographics and ongoing productivity gains, India could reach a growth rate of
10% by 2010 and sustain it thereafter. We show various combinations of factors that are
necessary to achieve this. The downside risks to baseline growth projections come from a
slowdown or reversal of reforms in part due to political or social instability, supply-side
constraints to doing business that include shortfalls in educational attainment, and
environmental degradation. Based on our analysis, FORCE Factors as critical to sustaining
growth: Financialdeepening, Openness to trade, Rural-to-urban migration, Capital
deepening, Education and Environment.
What Will It Take to Reach 10% Growth?
Indias current growth rates of around 8% have been achieved without large increases in
domestic capital accumulation or foreign direct investment, raising the possibility that
increases in investment could boost growth further. India is well below its efficiency or
productivity frontier, due to inefficiencies in production. The curve represents all optimal
points of combining inputs into output, i.e., the .production possibilities frontier. Currently,
India is at point
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A) Elimination of inefficiencies, or higher Productivity growth, would lead it to point. B) If it
can increase its input of capital, it could Move to point. C) With higher output.
Continued catch-up due to technological innovation would lead the curve to expand
outwards, Thus increasing growth output. To determine the amount of investment required to
reach 10% growth, we mapped out two scenarios based on different productivity growth
rates: either 3% or 3.5% on average until 2020. For the labor and education input, we use the
same assumptions as the baseline. Based on these assumptions, we calculated the real
investment/GDP ratio required to reach and sustain 10% growth until 2020. If we assume
more optimistically that productivity growth is sustained at 3.5%, the required increase in the
investment/GDP ratio is of the order of 16%. Thus, India would have to boost its savings rate
by roughly 16% of GDP, through a combination of domestic and foreign savings, in order to
finance the investment required for a sustained 10% growth. Below, we assess whether this is
feasible. If productivity growth were to decline to 3%, then 10% growth would be
unsustainable. The large difference in required investment in the two scenarios is due to
cumulative effects: a higher capital stock requires still higher investment to compensate for
depreciation effects.
Why Productivity Growth Is Likely to Be Sustained?
Reason 1: India opens up
With the onset of reforms in 1991, India began to unshackle its closed economy by
gradually lowering its very high trade barriers and boosting exports. Average tariffs fell to
below 15% zoom as high as 200% as the country began to re-integrate into the global
economy. The impact of opening up has been significant. Exports have risen 14 times as
India has rapidly gained trade share. This development has been most evident in the past
three years, when trade has grown, on average, 25% a year.
Indias trade/GDP ratio is still small, while average tariffs are still high by regional standards.
India currently contributes less than 1% of world trade. Assuming that trade barriers continue
to decline, productivity gains from further trade integration still has some distance to run.
Reason 2: The rise of the financial sector
Starting from a low base, the financial sector has grown rapidly in the past decade,
and especially in the past four years, and has contributed to the jump in productivity. Credit
to the private sector has grown by an average of 32% over the past two years. Increased
financial intermediation improves resource allocation by effectively channeling savings into
investment and raising productivity. Indias financial sector is still relatively small compared
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with the size of its economy, as well as with those of its East Asian neighbors. Assuming that
policies to open up the financial sector remain on track, including the entry of foreign banks
starting from 2009, we expect financial deepening to continue and to contribute to increases
in productivity in the medium term.
Reason 3: Back-office to the world
The success of the IT industry in India has had a material impact on productivity. Apart from
the direct productivity gains of the major IT firms, it has had spillover benefits through two
channels:
It has provided powerful incentives for students to invest in IT skills. This has created
a pool of technology-skilled labor that firms in other industries can tap into.
It has had a demonstration effect on other domestic firms, leading them to ramp uptheir own technology spending, thereby boosting productivity.
The rapid spread of mobile phones from a very low base provided a fillip to communications,
further boosting productivity. Today, India is the fastest-growing market for mobile phones,
with average growth rates of over 80% every year since 2000. Indias technology spending is
still low and there remains substantial scope for catch-up and productivity gains.
Reason 4: The Golden Quadrilateral
The Golden Quadrilateral Highway project is the first part of Indias most ambitiousinfrastructure project since the building of the railway network by the British in the 19 th
century. In the last 50 years, the government has built just 334 miles of four-lane roads. The
Golden Quadrilateral aims to build 3,625 miles of four- and six-lane highways. The highway
will connect the four largest cities: Delhi in the north with Kolkata in the east, Chennai in the
south and Mumbai in the west. Along the way it runs through 13 states and 17 other cities
with a million or more inhabitants, and it is expected to be fully functional by 2007. The
effort echoes the construction of a national highway system in the US in the 1920s and 1950s,
which fuelled commerce and development. We expect the new highways to help jump-start
Indias competitiveness, given that its dismal infrastructure has inhibited growth. They are
expected to reduce travel times by half, lower fuel costs and freight delivery times and enable
firms to leverage economies of scale. We expect the arteries to attract economic activity
along the way. Already, hotels, petrol stations and shops are sprouting up along the highways.
This will have implications for real estate, for location of industry and for decongestion of
crowded cities. Areas close to urban centers stand to benefit most, as activity and people fan
out of crowded cities along the highways.
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Reason 5: The great migration
The 21st century is set to become Indias .urban century, with more people living in
cities and towns than in the countryside for the first time in its history. India has 10 of the 30
fastest growing cities in the world and is witnessing rapid urbanization. The growth ishappening not in large cities, but in small and mid-sized towns. In 1991, India had 23 cities
with a million or more people. A decade later, it had 35. According to our projections, other
140mn rural dwellers will move to urban areas by 2020, while a massive 700mn people will
have moved to urban areas by 2050. Indias current urbanization rate of 29% is still very low
compared with 81% for South Korea, 67% for Malaysia and 43% for China. Rural-urban
migration in India has the potential to accelerate to higher levels as, judging by the
experiences of other countries, the pace of migration tends to accelerate after a critical level
of 25%-30% urbanization is reached, and due to faster economic growth. Urbanization is
spurred by both push and pulls factors. Deteriorating agricultural productivity, caste barriers
and unemployment in villages push rural inhabitants out, while better opportunities in cities,
very high growth in the construction industry and demonstration effects from other migrants
pull rural workers into urban centers. The implications for productivity growth are
significant. Our estimates show that movement of labor across sectors, primarily from
agriculture to manufacturing and services, adds 0.9ppt to GDP growth a year. This process is
likely to continue, if not accelerate, as urbanization continues. Demand for urban housing and
infrastructure such as electricity, health care, sanitation and education is set to jump several-
fold. Policy will, however, need to address basic infrastructure shortfalls in order to take
advantage of the .urbanization bonus.
Reason 6: The land factor
The imminent shift in land from agriculture to urban use and industry constitutes
another source of potential productivity gain. Land is a critical input needed to keep the
development process moving, allowing for the shift of people from the rural to the urban
sector. Access to land is needed for factories and housing projects, and to create tens of
millions of jobs in construction in the short run, as well as longer-term employment. When
land moves from low productivity agriculture to urban use and higher productivity sectors,
overall productivity improves. However, India will need investments in agriculture to boost
productivity, especially in rural connectivity, storage, etc., to improve the yield of remaining
agricultural land. The creation of new Special Economic Zones (SEZs) has the potential to
transform the Productivity of agricultural land. Ideally, India should develop economy-wide
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infrastructure and the necessary investment climate to enable the move from agriculture to
industry and services. In the absence of governmental resources (or the ability) to do so, the
SEZs will attract private-sector as well as foreign investment, thus helping to develop much-
needed infrastructure, generate employment and facilitate urbanization. Productivity gains for
the economy tend to be a cumulative process. Higher productivity leads to more confidence
and increased openness, which means more technology and investment and sustained
productivity growth. The building of highways will not only lower costs for companies but
also enable rural-urban migration, the development of cities and the process of moving land
from agriculture to industry and services. These in turn attract more investment through
agglomeration effects, and thus sustain growth.
3.2 RUSSIA: A SMOOTH POLITICAL TRANSITION
On October 1, 2007, Russias President Valdimir Putin announced that he would lead the
party list of the pro-Presidential United Russia party in the upcoming parliamentary elections
and said that it was entirely realistic. That he could become PM after the elections. At a
stroke, he has both confounded and confirmed the consensus view of how Russian politics
would evolve over the coming years. On the one hand, very few observers had anticipated
that Putin might move into the PM.s seat after relinquishing the presidency next year but, on
the other hand, the statement lent strong credence to the widely-held view that, regardless of
where Vladimir Putin sits after the inauguration of the next President in May, he will
continue to play a central role in the countrys political life We review the record of the Putin
presidency, and argue that the Putin era is likely to continue for the foreseeable future, quite
likely for another 5-10 years or more. Putins continued presence on the political stage would
all but eliminate the risk of the kind of political disorder and policy gridlock that Russia
suffered in the 1990s.and that continues to hamper reforms and macroeconomic stability in
neighboring Ukraine and some other emerging market democracies.
Decentralization under Yeltsin
The lack of any perceived alternative is in large part the result of a re-centralization of
power over the course of the last eight years, reversing the chaotic decentralization that had
occurred during the turbulent 1990s. During his rule, President Yeltsin variously shared and
fought over power with a number of other state and non-state actors, including his opponents
in the federal legislation; directly-elected regional governors; a new oligarchy that controlled
large parts of the bureaucracy, courts and legislature through corruption; managers of state-
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owned firms who turned them into personal fiefdoms; and media chiefs who at times used the
threat of negative coverage to put pressure on or even extort money from the state. By 1999,
with the state bankrupt and the ailing Presidents approval rating in single digits, the Kremlin
was directly controlled by a small group of business oligarchs. It was they who identified
Vladimir Putin, at the time the obscure head of the Federal Security Service, as someone who
would be electorally viable but who would not seek to reverse the privatization process of the
1990s. Putin appealed to the patriotic electorate but also had an understanding of the
workings of the market economy. In Russian terms, the oligarchs saw Putin as apreemnik(a
successor) who would ensurepreemstvennost. (Continuity) rather than a reversal of Yeltsins
unpopular and incomplete market reforms.
Re-centralization under Putin
After taking power in 2000 with a strong popular mandate, President Putin proved far
less pliant than the oligarchs may have expected. He immediately began to reverse the
political pluralism that had frustrated many of his predecessors efforts at reform and had
contributed to the breakdown of central state authority. His supporters forged a majority in
the previously fractious Dumas, and he has taken steps to eliminate independent deputies and
small parties from the legislature. In effect, the Dumas have been transformed over time from
a staunch opponent of market reforms into a body that approves all of the Presidents
initiatives with minimal debate. Putin also eroded the power of regional governors, ultimately
reducing them to the status of Presidential appointees. Finally, he reasserted government
control over state-owned companies, either replacing the management with close allies or
appointing senior administration officials to their boards.
External surpluses past their peakThe ongoing increases in oil prices have caused the current account and fiscal
surpluses to expand. The current account surplus averaged over 10% of GDP between 2004
and 2006, while the budget surplus was 7.5% of GDP in 2005 and 2006. As oil price growth
has slowed, rapidly rising imports and government spending have begun to catch up. Even
using the Goldman Sachs Commodities teams bullish forecasts of oil price reaching $90/bbl
by 2009, we expect the current account to fall to 6% of GDP this year, and possibly to go into
balance by 2010-11, while we expect the budget surplus to fall to 4% of GDP in 2007 and to
be essentially in balance by 2010. In 2007, for the first time in more than five years, Russia
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growth suffered crises, Chinas story seems abnormal (or accidental), and has elicited
periodic predictions of an upcoming crash. All such predictions have proved wrong, but the
longer the story lasts, the more people forecast a bad end. For me, there is nothing more
abnormal about Chinas unbroken pattern of growth than effective macroeconomic
intervention in boom times. To be sure, both economic development and institutional reforms
may cause instability. Indeed, the type of central government inherited from the old planned
economy, with its over-stretched growth plans, causes fluctuations, and contributed
significantly to instability in the early 1980s.But the central government must be responsible
for inflation in times of overheating, lest a bursting bubble fuel unemployment. Local
governments and state-owned enterprises do not necessarily have those concerns. They want
high GDP growth, without worrying much about the macroeconomic consequences. They
want to borrow as much as possible to finance ambitious investment projects, without
worrying much about either repayment or inflation. Indeed, the main cause of overheating in
the early 1990s was over-borrowing by local governments. Inflation soared to 21% in 1994
its highest level over the past 30 years and a great deal of local debt ended up as non-
performing loans, which amounted to 40% of total credits in the state banking sector in the
mid-1990s. This source of vulnerability has become less important, owing to tight
restrictions imposed since the 1990s on local governments borrowing capacity. Now,
however, the so-called animal spirits of Chinas first generation of entrepreneurs have
become another source of overheating risk. The economy has been booming income has been
rising, and markets have been expanding: all this creates high potential for enterprises to
grow; all want to seize new opportunities, and every investor want to get rich fast. They have
been successful and, so far, have not experienced bad times. So they invest and speculate
fiercely without much consideration of risk. The relatively high inflation of the early 1990s
was a warning to central government policymakers about the macroeconomic risks posed by
fast growth. The bubble bursts in Japans economy in the early 1990s, and the Southeast
Asian economies later in the decade, provided a neighborly lesson to stop believing that
bubbles never burst. Since then, the central governments policy stance has been to put brakes
on the economy whenever there is a tendency toward over-heating. Stringent measures were
implemented in the early 1990s to reduce the money supply and stop over-investment,
thereby heading off hyperinflation. In the recent cycle, the authorities began cooling down
the economy as early as 2004, when China had just emerged from the downturn caused by
the SARS scare in 2003. In late 2007, when GDP growth hit 13%, the government adopted
more restrictive anti-bubble policies in industries (steel, for example) and asset markets (real
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estate), which set the stage for an early correction. Economic theory holds that all crises are
caused by bubbles or over-heating, so if you can manage to prevent bubbles, you can prevent
crises. The most important thing for ironing out cycles is not the stimulus policy
implemented after a crash has already occurred, but to be proactive in boom times and stop
bubbles in their early stages. Chinas unrivalled economic growth over the past quarter-
century has surpassed all records and created a new standard in the history of economic
development. With an average annual real GDP growth rate of 9.6% from 1978 to 2004,
Chinas pace of growth is faster than that achieved by any East Asian economy during their
fastest-growing periods. Nonetheless, demographers have warned that rapid ageing will limit
Chinas future growth prospects and that the demographic tailwind will turn into a significant
headwind. China has benefited from strong raw labor growth from the late 1970s until now,
but the future demographic outlook suggests that the growth of the labor force will slow and
ultimately decline after 2030.
Two forces drive these changes:
1) Increased longevity, which is raising the number of elderly, and
2) The one-child policy, which has slowed the growth rate of young adults in the population.
The implication for workforce growth is immediate and significant. When more workers
reach retirement age and growth of the young adult population slows, the dependent per-
worker ratio will increase and the .demographic bonus Will end. Many observers are thus
concerned that .China may get old before it gets rich. Ageing has been perceived almost
exclusively as a problem for industrialized economies, following years of urbanization and
industrialization. Fewer people have associated ageing with a developing Country where
labor is often ample and the cost of child-raising inexpensive. China may be an exception.
Although it is still considered a developing country by many standards, China has the fastest
ageing trend among the 14 developing economies in the BRICs and the N-11.analysis
suggests that by the time China becomes an aged society. In 2027, it will probably be
considered a developed country, although it will still be considerably poorer than the US or
Japan on a per-capita income basis. We believe the rapid build-up of human capital and the
continued release of surplus labor from the agriculture sector will mitigate the negative
influences on the labor supply from ageing. Despite the slowdown in labor force growth,
improved labor quality is likely to help sustain .quality-adjusted labor supply. Growth
Chinas economic growth has coincided with a tremendous boost in human-capital
accumulation. In addition to advances in education from improved living standards, the one-
child policy has led to increased human-capital investment on a per-child basis. As public and
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private education expenditure has per person increased, the education attainment of the labor
force has boomed. Smaller family Sizes have helped China to achieve great success in
promoting higher education and producing college graduates. This accumulation of human
capital contributed 15% of overall growth between 1979 and 2004, while labor force growth
only contributed 13%. Further educational improvement should continue to support quality-
adjusted labor growth. The release of rural laborers into the industrial and service sectors will
also augment the available supply of labor. The ongoing gradual relaxation of the household
registration (hukou) system should facilitate this.
Rich but Not Richest
Together, these results suggest that by the time China becomes old, it should be fairly
developed, but still not richer than the US or Japan in terms of per-capita income. Richness is
usually defined in relative terms, while economic development is both an absolute and
relative concept. Generally, an economy is considered to have achieved developed status
upon its accession into the OECD. An effective rule of thumb has put per-capita income of
$10,000 as the threshold of developed country status. Economies above this line are fairly
developed, and are often consistent in sectoral composition of output, urbanization, life
expectancy, national wealth, capital stock per labor hour, education and service-sector
development, etc. For China, this day may not be too far away. Our analysis shows that by
the time China becomes an aged society in 2027; its per-capita GDP should have surpassed
$10,000 (in 2005 terms) in all scenarios.
3.4 B. IN BRICS: UNLOCKING BRAZILS GROWTH POTENTIAL
Average labor productivity has declined since the 1980s but has recovered somewhat
since the Real plan. This is in part because Brazil is inefficient at spending on education and
because its labor laws are outdated. Brazil spends almost twice as much (4.1% of GDP a
year) on education as China, but even so, it ranks poorly in terms of the average number of
years spent in school. Trade liberalization has exerted a strong positive influence on TFP, and
thus has been a key driver of growth. Although Brazil has recently reduced trade barriers and
opened up the economy to trade, it remains too closed to trade when compared with other
fast-growing emerging markets. In fact, the share of Brazilian exports and imports in total
world trade has plunged to less than 2.0% from a peak of 4.3% in the 1950s. Since the 1990s,
as macroeconomic policies have improved, Brazil has gradually reopened its economy to
trade and lifted trade barriers. The large devaluations of 1999 and 2002 also helped to make
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the BRL more competitive. Together with the boom in the global demand for raw materials,
this has increased the degree of openness, with the sum of exports and imports reaching
24.2% of GDP in 2006 from 11.1% in 1990. In all, we believe it is unrealistic to expect that
Brazil will once again grow as quickly as it did during its miracle years or at the same rate as
the Asian economies. This is simply because this phase of rapid growth propelled by a high
level of investment, rapid population growth and easy jumps in growth rates resulting from
the elimination of stifling economic distortions. Is over it isreasonable to expect Brazil to
grow once again at its secular growth rate of about 5.0%. To this end, the government will
have to implement policies that would raise savings and investment, by improving the quality
of fiscal policy, and increase the contributions to growth from TFP, through better education,
trade openness, investment in technology and institutional reforms. Fiscal policy is a key
reason why investment, savings and growth have declined in Brazil. This is because the
government has built an onerous welfare state, which has led to ballooning total spending, an
increased tax burden and public indebtedness. Fiscal largesse and its associated inefficiencies
have crowded out the private sector, ultimately stifling growth. Over the past seven years,
Brazil has tightened fiscal policy to rein in inflation and reduce the stock of public debt.
Since 1999, the government has raised the primary surplus of the consolidated public sector
to a peak of 5.0% of GDP in 2005, though it reduced the target to 4.25% in 2006. The
adjustment has reduced the nominal fiscal deficit to 3.5% of GDP, from Almost 7% in 2003,
and reduced the stock of net public-sector debt to 49.5% of GDP in 2006 from a peak of
65.5% in 2002. Although Brazil has tightened fiscal policy and improved its debt dynamics,
fiscal policy Have two big problems. The primary fiscal surplus is not high enough to reduce
the debt ratio more quickly. The fiscal adjustment has been achieved solely by raising taxes,
while real primary public spending continues to grow at double-digit rates. Rather than
attacking the roots of the structural fiscal problems, the fiscal adjustment has only mitigated
their effects on macroeconomic stability and debt dynamics. The main casualty of this
approach has been growth. The structural fiscal problem has five main causes: the generous
welfare state, which in aggregate is in deficit to the tune of 4.5% of GDP; the system of
revenue earmarking, which makes fiscal policy highly pro-cyclical and resistant to spending
cuts; the loss of the (regressive) tool of using high inflation to balance the budget; ongoing
growth in the civil service, resulting in federal wage costs averaging 5.1% of GDP in 2001-
2006; and higher current spending to combat poverty, with social assistance spending
currently rising by 20% per year in real terms. In all, since 1990, primary government
spending has increased by almost 11 percentage points of GDP, raising total nominal and
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primary government spending to 42% of GDP and 34% of GDP, respectively. In order to
finance such high levels of spending, during the same period, the government raised the tax
burden by roughly the same amount, to 38% of GDP in 2006 higher than in the US and close
behind France and Italy. As a result, the tax system is complex and highly distortionary it has
crowded out the private sector; and it increases informality by encouraging firms and labor to
move underground. Informality reduces TFP, because it influences a firms decisions about
size and markets, precluding them from fully benefiting from returns to scale. In order to
finance higher current spending, the government has also cut public investments, reducing the
effective ratio of public investment to 0.5% of GDP from 1.0% since 2002. This has
accelerated the depreciation of infrastructure, which has also weighed on TFP. The fiscal
imbalances also help to explain why real interest rates are so high: (1) The stock of public
debt is large relative to a small stock of private financial wealth (2) The markets demand a
high risk premium because of contractual uncertainty; and (3) Heavy taxation and high
reserve requirements on sight and time deposits discourage financial intermediation.
Expansionary fiscal and wage policies have increased the risk that the central bank may not
meet its inflation target of 4.5%, preventing it from cutting real interest rates faster.
Moreover, high real interest rates have attracted large capital inflows, forcing the central bank
to continue to buy international reserves to avoid a further appreciation of the BRL. While
campaigning for his second term, which begins in January 2007, Brazils President Lula da
Silva promised to implement economic policies that would boost GDP growth rates to 5.0%.
This growth target sounds ambitious given that, since we published our first BRICs studies in
2003, Brazil has grown only at a disappointing 2.7% a year on average, compared with the
3.7% that we had estimated its long-term growth potential to be. Brazil has underperformed
not only relative to our expectations but also compared with all the other BRICs.
Brazils growth potential, at least in terms of what we have envisaged in our BRICs
studies. The main reason for Brazils underperformance is that, until now, the government
had been in the process of implementing a stabilization programmed, with a view to
achieving macroeconomic stability. This is a key precondition for growth. Thanks to these
adjustment efforts, macroeconomic conditions are more favorable now than they have been
for decades. The large balance of payments surpluses have been used to prepay external debt
and accumulate reserves, while a credible central bank (BACEN) has reduced inflation to
3.0% in 2006. Brazil saves and invests too little. To address this issue, the government will
have to deepen and improve the quality of the fiscal adjustment.The economy should be
opened to trade. The government must improve the overall quality of education. The
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government should implement structural reforms to improve institutions, with a view to
increasing total factor productivity. The Lula II administration and Congress will be
ambitious enough to implement this politically difficult agenda. Therefore, while Brazil has
the potential to grow at or above 5.0%, this is unlikely to happen during the next four years.
Nevertheless, Brazil will remain a valuable out of the money option on growth. In the
meantime, it will be an important destination for fixed income and equity inflows, given the
high carry trade, the embedded growth option for equities and the reassurance of stable macro
policies and sound external credit fundamentals.
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Chapter 4
CAPITAL MARKETS IN BRAZIL
4.1 REACTION OF BRAZILIAN STOCK MARKETS TO POSITIVE
AND NEGATIVE SHOCKS.
Introduction
Many empirical attempts to consistently encounter the efficient markets hypothesis in
different markets have failed. The implications of new information on financial assets are
often exaggerated and therefore time for adjustment is required to equate the price levels with
the mean rate of returns. However an alternative version to the EMH has been pointed out to
be more realistic and capable of explaining some apparent anomalies without actually
violating efficiency. Making use of event study the examination traces the effects of passage
of time on stock returns following favorable and unfavorable news. The benchmark adopted
for generating abnormal returns for Brazilian stock exchange is the down Jones stock index
which is associated to the New York stock exchange the returns of the Brazilian market
index is then regressed on the returns of the Dow Jones index to generate events. The
Brazilian stock market is virtually represented by a single stock exchange i.e. Sao Paulo stock
exchange which was founded in the year august 23,1890.up to the mid sixties Bovespa and
other Brazilian exchange
The Brazilian Stock Market
The Brazilian stock market is virtually represented by a single stock exchange Bovespa (Sao
Paulo Stock Exchange) which was founded on August 23, 1890. Up to the mid sixties,
Bovespa and other Brazilian exchanges were official entities linked to finance departments of
state governments, and brokers were appointed by the public sector. After the enactment of
the Securities Act in 1965, the Brazilian financial system and capital market underwent a
series of reforms, which provided the institutional character the Brazilian stock exchanges
still have today The Brazilian stock exchanges became non-profit self regulating institutions,
with administrative and financial autonomy. Brokerage firms replaced the traditional
individual government securities brokers, and firms were established as joint stock companies
or private limited liability companies. Located in the City of Sao Paulo, Bovespa is a self-
regulating entity operating under the supervision of CVM Comissao de Valores
Mobilizations, the Brazilian equivalent to the SEC - Securities and Exchange Commission in
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the US. In 1972, Bovespa implemented automated trading sessions with information
displayed online and in real-time via a computer terminal network and in the late 70s,
Bovespa introduced the options market in Brazil. By using electronic technology', Bovespa
has expanded the potential information processing volume and has consolidated its position
as the most important trading center in the Latin American market. The Bovespa Index
(Bovespa) is the oldest and most traditional indicator of the average stock-price behavior in
Brazil. In terms of liquidity, the stocks that integrate Bovespa theoretical portfolio represent
more than 80% of the number of trades and the financial value registered on Bovespa cash
market and in terms of market cap. Firms with stocks included in the Bovespa are
responsible, in average, for approximately 70% of the sum of all Bovespa firms cap. To
ensure the representativeness of Bovespa indexes over time the stock exchanges indexes
portfolios are recalculated at the end of each four months. At the rebalancing, the changes in
the relative participation of each stock in the index are identified, as well as their maintenance
or exclusion, and possible inclusions of new papers are defined. Thus, Bovespa theoretical
portfolio is valid for four months, for the periods of January to April, May to August and
September to December.
4.2 THE ROLE OF INSTITUTIONAL INVESTORS AS A PROVIDERS
OF LONG TERM FINANCING IN BRAZIL
Introduction
This paper analyzes the role of institutional investors as suppliers of long-term capital
resources in the Brazilian capital market. For firms in general, corporate finance theories
sustain that fixed assets should be financed by long-term liabilities and equity. The search for
long-term resources in the capital markets leads to icy and long-term debt security issues. In
order to achieve liquidity and equilibrium in the market for long-term capital, it is necessary
that the supply of these securities match a demand specialized on these types of financial
assets, which is exerted by long-term investors. On this field, institutional investors, grouped
as investment mutual funds, pension funds, insurance companies, capitalization firms, and
open social security funds stand out. Institutional investors develop and program their ink
element policies with longer time horizons than individual investors and, in general, they
employ a buy-and-hold strategy i.e, they purchase an asset and maintain it in the portfolio for
a long period. Hence, they are capable of making feasible large projects that are necessary for
the survival and growth of large corporations and that would not be attractive for short-term
investors. Considering that since the 1980s the Brazilian state lost its capacity to invest in
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large-scale projects as it had done in the past the long-term capital resources supplied by
institutional investors have acquired strategic importance to the country's economic
development. There is, of course, the extremely important role played by the National Bank
for Economic And Social Development (BNDES), as provider of long-term capital rescue
Brazilian-based firms, but BNDES financing is mostly focused on I loans and its capacity of
granting resources is certainly insufficient for the economy as a whole. One of the most
serious obstacles hampering institutional investor contributing more effectively to the long-
term capitalization of Brazilian the market for government bonds. In the economic literature,
the term crowed out represents the economic externality where government debt securities
with equity and debt corporate securities issued by the private sector governments with the
dual purpose of refinancing its debt and controlling - sets high interest rates, so that investors
become keener on buying low government bonds rather than relatively more risky private
corporate bands. This, of course, dampens the development of the private capital gain
Another factor that has affected negatively the Brazilian pension-fund is political
interference, which derives from the fact that state-owned maintain some of the country's
largest pension funds. During these terms, political in was used either to influence the
outcome of certain dramatization auctions raise illegal financial resources for the
government's political party as published on the Brazilian press and the academic literatures.
The international literature reveals that the participation of institution investors in the
accumulation of domestic savings across countries has extraordinarily during the last
decades. Besides, these investors have crucial role in the development of the capital markets,
both on developed emerging countries. Brazil, despite the problems pointed out above, is not
different in this respect.
The role of institutional investors in Brazilian economy
The growth of institutional Investors in the Brazilian Economy the growth of
Importance of Institutional investors the Brazilian economy is significant - In particular, the
real asset growth of pension funds during the last ten years overcomes economic growth in
real terms. The total of rs 270 billion in investment assets of funds, as of July 2005, there is
only Rs.52 billion directly invested in financial assets representing equity or debt of Brazilian
firms. Considering the regulatory limits for fixed income and variable income portfolios
previously mentioned, we can see that the investments of pension funds both in corporate
bonds and stocks are still very modest. With respect to investment funds, one can see that
their growth in Brazil over the last ten years, when measured by their net worth, was well
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above that of the pension funds and very superior to the average real growth of the Brazilian
economy as a whole, with an accumulated real growth rate of 152% from December 1996 to
July 2005, corresponding to an annual real average rate of 11.5 the major part of the
investment funds portfolios has been invested over the last years in fixed income, whereas
investments in the stock market have remained around 7%.We can also verify here the
preponderance of fixed income and public bonds Assets. Actually the investment of these
institutions in public bonds is much larger then what it seems since inside the fixed income
portfolio there is a large amount of investment fund share backed on public bonds.
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4.3 CAPITAL MARKETS FOR SMEs IN BRAZIL
Between 2004 and 2006, Brazil experienced a significant expansion of Initial Public
Offerings (IPO) on the Brazilian Stock Exchange (Bovespa). The 40 new entrants raised
approximately US$10 billion. While this came somewhat as a surprise after years of ashallow IPO market, it has also marked the existence of a new breed of financial
intermediaries in Brazil, the Private Equity and Venture Capital (PE/VE) firms.PE/VC firms
are financial intermediaries that perform investments eat in equity or quasi-equity instruments
of unlisted companies and projects. It has been used around the world to finance privatization
of government-owned firms, infrastructure development buyouts, and specially the creation
and expansion of high-growth Small and Medium-sized Enterprises (SMEs).Different from
most sources of financing, PE/VC firms provide more than money after a careful screening
process; they usually require a seat on the board of directors of the companies in which they
inset during the long-term relationship PE/VC managers provide portfolio companies with
strategic advice and access to their valuable business network. Due to the rigor of the PE/VC
investment and monitoring. Process, which includes detailed due diligence and the adoption
of serious corporate governance, PE/VC recipients have a stamp of approval that reduce the
risks vis-a-vis their suppliers, customers. External finance providers and employees. After a
maturation period, PE/VC firms seek to exit their investments by selling shares to strategic
buyers, external investors or even to existing shareholders, in order to obtain significant
capital gains. Sometimes, exits take place in the stock exchange, indicating that the invested
company has successfully graduated to the stage of receiving investment from a great number
of institutional investors and individuals. IPOs on Bovespa between 2004 and 2006. It reveals
that 19 lPOs were made by companies that received PE/ VC financing, representing US$4.59
billion in new funds raised, or close to half the total amount raised in that period. In 2004,
PF/VC-backed companies represented 76.7% of total.
Turning SME into Publicly Listed companies
There are two companies - Odontoprev and totus - that provide some Insights into how a
small and a medium size enterprise become larger to the point of posing the stock markets
after receiving a few rounds of PE/VC Investment. These cases illustrate the positive Impact
of PE/VC Investment in Brazilian SMEs to face difficulty in raising capital to undertake
ambitious growth plans. Furthermore they show how the external finance provider can help
the SME circumvent the initial skepticism of new clients about their ability to provide high
quality and reliable services, especially those that are most critical to financial Institutions.
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Concluding Remarks
In the end of the 1940s, a new type of financial intermediation emerged in the US named
private and venture capital. It has quickly become an important segment of capital marketsin that country responsible for successful investment cases in entrepreneurial ventures and
undervalued corporations that because leading companies. From 1970 to the beginning of the
l990s, the world has witnessed a silent globalization of PE/VC International management
firms started to investments emerging markets. Local executives with financial expertise and
managed experience opened their own independent PE/VC firms. Investment banks with the
legal environment is Inefficient, making It difficult to enforce business and Investment
agreements, and foreign competitors with strong brand names represent a real and constant
threat. At the same time these successful Investment cases reveal the existence of well-
managed Brazilian SMEs with good products and seduces that-are both credit constrained
and apt to receive PE/VC Investment. The lack of governmental investment in fundamental
sectors (e g , health) represent opportunities for the private sector, and fragmented markets
makes it possible for SMEs to grow following acquisition strategies These companies have
shown that It is possible to succeed in a challenging environment and transform small and
medium-sized businesses into leading corporations In turn, the PE/VC firms that Invested in
them have proved the catalytic role of PE/VC. It also shows that privatization of formerly
state-owned Industrial companies and public service providers contributed to the formation of
the layout segment and to the entry of PE/VC firms of bigger size and scope. finally the
reopening of the market for IPOs is now facilitating exists which attracts new entrants and
promote the restart of a new and prosperous investment cycle In addition to the changes in
the macro environment, the actions taken by governmental bodies legislators, Most of these
actions took place during the downturn of 2001-2003, thus contributing to the survival and
the sustainable development of this Industry. Given the continuous Improvement in the
regulatory and legal aspects, the emergence of PE/VC success cases, the consistent market
for IPOs, the lowering interest rates, It is expected that PE/VC will grow In this country to
become an integral part of its capital markets, granting financing to Innovative SMEs and to
non-listed companies In sectors of high-growth expectations with the prospect of long-term
economic development in the BRICs the PE/VC Industry is well-positioned to allocate
resources within the economy for the ever-greater number of companies that are not yet ready
to access the stock markets or traditional sources of debt Acknowledgement.
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4.4 BRAZILS HEDGE FUNDS: A BREAK THROUGH
Brazilian hedge funds
In October 2005 Latin America hosted two hedge funds conferences simultaneously
within a gap of one week 1st in Miami and then in Geneva .Both events attracted the best
American hedge funds managers to converse about the prospects of investing in the region. It
was not strange in handling two events that discussing the US hedge fund industry just seven
days apart downturn of 2001-2003, thus contributing to the survival and the sustainable
development of this Industry in Brazil Now, other countries In Latin America are
Implementing PE/VC development programs similar to those implements in Brazil Given the
continuous Improvement in the regulatory and legal aspects, the emergence of PE/VC
success cases, the consistent market for IPOs, the lowering interest rates, It is expected that
PE/VC will grow In this country to become an integral part of its capital markets, granting
financing to Innovative SMEs and to non-listed companies In sectors of high-growth
expectations with the prospect of long-term economic development in the BRICs the PE/VC
Industry is well-positioned to allocate resources within the economy for the ever-greater
number of companies that are not yet ready to access the stock markets or traditional sources
of debt Acknowledgement but this is the first time for Latin to reflect a growing interest in
the hedge fund sector. Miami and Geneva are better homes for potential investors; so the
events were held there, as the Latin 'hedge funds were focusing on the foreign investors.
Looking for better yield Brazil remains remain focus for such investors, as the Latin
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American economy'' accounts for the majority of that region's hedge funds. As per the given
data of Eureka hedge, there are 109 Brazilian domiciled funds (that can only invest Inc
Brazil's securities) of which 97 are based offshore. The funds in Latin funds posted healthy
performances. Average annualized return for onshore funds posted 26.44% and for offshore
vehicles, it is 17.78%. In total 75% of $23.7 ban of these funds is invested in offshore
vehicles Compared to onshore funds, the offshore funds face fewer regulations Offshore:
funds are normally dollar denominated while the onshore funds are open to all foreign and
local investors, which could expose foreign investors to risks such as.- Interest rate and
currency risks. Both funds have been emerging from the past, three years, but the huge
development has been seen in the offshore funds, where in more than $8 ban was raised in
2005, which is $600 man higher than the previous year. The US and European private banks,
high-net-worth individuals and fund of, funds investors, which have been sniffing around
sago Paulo and Rio de Janeiro seeking investment opportunities, have approached most of the
Brazilian hedge' funds. Funds were invested in Asia and Latin America through global
emerging markets, as investors did not have exposure to local Latin America. Earlier, there
were not even two international investors in the Latin American market; but now there are
five to ten international visits per month. Even hedge funds are reassessing their approaches
that are more reliant on local clients. Renate Abu ham, a hedge fund manager claims that
their biggest challenge is not to build a global client base. They are waiting for investors from
London, Geneva and the US, wherein they have already received visits in Sao Paulo' from
foreign investors. This is never contacted before Fama Invrstimentos, in Feb. so far the funds
has $10 mn assets under management although the goal is to raise $200mn with the road
show to be held by the fund managers in Miami, London, New York.
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Structural Changes
For long/short equity funds, even structural changes are giving a boost. Hedge fund
managers could short individual stocks more easily than before-with the developments in
corporate governance and liquidity. There would be more shorting opportunities in die
market there is greater transparent Increasing the number of stock listed the companies are
looking more readily at the equity markets to raise cash In the last two year, there were 24
initial and secondary offerings in Bowama (so Paulo stock exchange). however there would
be more opportunity to profit from shorting, as there is lets correlation between individual
stocks and the overall index an investor could make money on both the long and short sides,
as he could find stocks that considerably underperform or fall in value. Now the industry has
evolved and the fund managers are analyzing specific company risks. This evolution has
allowed young and sophisticated to succeed now; hedge funds are borrowing stock from
pension funds and have $3 ban of shorts outstanding that could be an important source of
income for hedge funds. One more advantage for the Brazilian short sellers is that there is no
uplink rule as in the US. The process to short shares is relent on the fund manager actively
looking for shares and organizing the operational aspects of renewing contracts and assuring
accessibility to avoid a squeeze.
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Conclusion
Fund managers have to adopt considerable resources and time to manage the procedure and
build relationship with different brokers. Another general Issue Is many investment managers
do not leverage their funds but try to have a hedged position with the risk associated in the
country with the economy on track and with regulations and infrastructure improving
communally the potential is great compared to the other emerging economies the derivative
volumes are relatively high in brazil the industry's growth could be rapid if the local pension
funds learn to trust their hedge funds more and breaks free from their conservative market
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Chapter 5
CAPITAL MARKET IN RUSSIA
5.1 CORPORATE BOND MARKET
Introduction and summary
The Russia financial market of 1999-2006 is one of the most dynamic markets In the world
It produces high risks and is one of the most liquid of emerging markets, yet It offers
Investors the full package of traditional financial Instruments and techniques on electronic
basis According to estimates over 30% of Investors In domestic market are non-resident (in
2003-2004 all restrictions for their entrance into the market were cancelled) He modern
infrastructure of the Russian financial market was created m the 1990s There was formed an
electric market model combining advantages of universal banking and benefits of
specialization of securities companies Over 1300 commercial bank about 700 brokerages,
over 1200 Insurance companies, several hundred investment and pension funds make its
institutional basis. The system of financial market regulation is formed in analogy with
developed markets models. It is focused on protection of Investors and maintenance of
Information transparency in 1994 was created an Independent securities commission, aims to
reduce information barriers concerning entrance into the Russian corporate bond market, InRussia, first of all such as an ownership structure and investors preferences, showed the scope
of development of the rouble bond market In 1999-2005, Including its physical growth
(number of Issuers and traded Issues, value of initial offerings and outstanding debt, turnover
indicators and strengthening of its qualitative characteristics diversification of product lanes,
Improvement of term structure, risk and yield profiles, sophistication of market's industrial
structure)
1. Debt Preferences of Investors
Structure of investors demand also drives the capital market to debt model the
commercial banks (by nature are focused on debt investments) generate over 95% of
financial assets in Russia. Institutional investors are unable to create significant demand for
shares. Households prefer either hard currency in cash holdings or simple debt products bank
deposits or debt securities) as means of savings. The reasons are social and cultural-
adherence of retail investors to lower risks, than in the countries with Anglo Saxon culture
(wide-spread risk aversion); extremely sizeable expectations of Russians concerning the
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proper depth of social protectionism social market'' economy in its excessive manifestations);
absence of any market experience for three generations economic - massive losses of
households as concerns their investments in stocks in the 1990 financial pyramids of 1993-
1996, negative influence of voucher dramatization on welfare of households, crises in the
securities markets of (1997-1998) ultra high volatility of the Russian stock market as one of
the 6-8 most risky emerging markets in the world; low level of dividends in Russia due to
absence of interest of controlling owners to pay dividends; wide-spread practice of under
declaration of profits as a tax and dividend base; insignificance of shares as assets of minority
shareholders, lack of influence on decisions are made by stakeholders and managers.
2. Corporate Bonds: Current Situation and Development2.1 Volumes of Corporate Bond Market
2.1.1 Initial Offerings and Repayments of Corporate Bonds From start of
Russian corporate debt market
In 1999, and up to the end of the 3rd quarter of 2005, 233 non-financial issuers of various
industries placed 381 issues of corporate bonds, for total face value of about 15.7 billion USD
During this period. Financial institutes including banks non banking credit organizations and
their subsidiaries placed 122 issues for the face value of 3.83 billion USD Data analysis
shows that corporate bond market is dynamically growing. Thus it developed mostly in 2002-
2004 when 95 96 and 91 issues were placed.
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2.1.2 Market Capacity and Number of Traded Issue:
Dynamical growth of number and volumes of issues with excess of number and
volume's of placed Issues over those of redeemed issues in most quarters of the period under
analysis caused of such important Indicators of corporate bond market as its capacity (totalface-value of traded bonds and number of traded Issues large increase in volumes of initial
bond offerings by non-financial organization determined the meaningful acreage in market
capacity m 2004-2005: the cumulative gain made 4.02 and 4.09 billion USD during 2004 and
9 months of 2005 accordingly or 81% and 45% of the value of this indicator as of the end of
the previous period In the sector of non financial Issues, these parameters made 3 25 and 3 12
balloon USD or 85% and 44% accordingly similar to the above mentioned trend the number
of traded Issues was characterized by essential Increase achieved basically due to Increase in
numbers of Issues placed by non financial organizations which made 77% of total traded
issues by 10/01/2005.
2.2 Structure of Corporate Bond Market
2.2.1 Maturity Structure of Market
As Issues of corporate bonds are traditionally considered as an instrument used for financing
of long-term Investment projects aimed at modernization of equipment. development oftechnologies, mergers and acquisitions and other capital intensive growth strategies, the
question of bond maturity is crucial A large part of Issues registered in 2000-2005 contained
options for pre-scheduled early buy-back, structured as a contractually binding commitment
of the Issuer to make an offer to buy back the bond from the current holder at pre-set time
points through the life of the bond at prearranged prices (Bermudan-style putt able bond).
Accordingly when analyzing risks Involved in the purchase of such security an Investor could
consider it as a bond with maturity equal to the first date on which the attaching option can be
executed From the Issuers point of view, however, the actual maturity of these bonds was
longer. The buyback did not signify the final redemption of the bond, but merely a temporary
transfer from the market to the asset side of the Issuers balance sheet, that would shortly be
followed by the re-sale.
2.2.2 Structure of Corporate Bond Market by Volumes of Issues
The size of individual bond issues is an important subject to analyze because it
highlights a comparative advantage of bonds over bank. Credits in that the size of an
individual bond issue tends to exceed the size of a typical bank credit. The share of small
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issues (with value below 10 million USD, referred to as non-market as it is impossible to
create a liquid secondary market in them) significantly decreased from 50.00% of total
number of issues in 2000 to 14.29% in 2004 and 9.09% as of 3 quarters of 2005. In terms of
volumes of registered issues, dynamics of share of small loans was less clear cut: in general it
did not exceed 16%, as of 9 months of 2005 it made 10.7%, however in 2001-2002 it was
rather high - 13.5 and 15.6%, accordingly. In 2003-2005 the role of large issues (over 1000
million roubles or 35.5 Million USD) in the total value of registered issues increased greatly
in comparison with 2002. So, in the sector of issues by financial organizations their share
increased to 89.20% in comparison with 28.21% in 2002, by non-financial organizations -
83.43% in 2004 and 70.86% .in 2005 in comparison with 45.56% in 2002, and across the
entire market' to 80.23% in 2004 and 78.81% In 2005 in comparison with 41.24% in 2002.
Thus, such a substantial increase in the share of large issues took place die to increase in their
volumes from 730 million USD in 2002 to 4 762 million USD as of 9 months of 2005,
coupled with stable value of average issues (within the limits of 764-1216 million USD
during the period under analysis). Mirroring the direction of trend for illiquid loans reduction,
the share of small Issues in the total number decreased from 55% in 2002 to 9.09% in the first
9 months of 2005.
2.2.3 Industrial Structure of Corporate Bond Market
The industrial structure of corporate bond issues underwent certain changes in 1999 - 9
months of 2005 In 1999-2000, the market was focused on key industries, but their share was
decreasing (in 1999 the share of issues by oil and gas refinery companies accounted for
67.09% of the total amount, energy - 23.78%; in