Wednesday, May 13th, #845

Will the Nuclear Bomb testing in India affect investment there?

In order to judge the situation, it is necessary to understand India's motivation. The tests were primarily for internal consumption rather than the world stage. Flexing nuclear muscle is a popular act - look at the reactions of Indian citizens featured in the world press. The current Hindu Nationalist government (BJP) is a coalition government and like most coalition governments, it is weak and has been very careful in its moves.

While essentially a market-friendly government, it recognizes the frustration of its citizens that India has never been accorded the importance in the world councils and among the nuclear powers that might be warranted by the size of its population.

Longtime, an opponent of nuclear arms, India had been forced to negotiate from a position of weakness. Now that the BJP government has succeeded in obtaining the support of its citizens by making India a force to be reckoned with, it is probable that it will sign the non-proliferation treaty and more importantly, will also be able to effect internal changes which are badly needed, i.e. war on rampant corruption and over-blown bureaucracy, privatization of insurance, enabling of joint ventures and partnerships with foreign companies. This will make investment much more attractive.

The timing however, might have been better if the testing had been postponed until after the upcoming meeting of the G-8 leaders, a forum where this event will almost certainly be discussed and deplored. The United States is furious as there was no fore-warning from the intelligence community. Some feel that it is a major foreign affairs blunder, but the testing indicates how determined India is to be taken seriously. In the light of commercial interests, however, any sanctions applied will be mild as there is a growing resistance within the G-8 nations to trade sanctions as a policy tool.

Pakistan may feel that it is a target, but this is not the case. The situation with Pakistan will resolve itself. China is a greater threat to India.

The probable bottom line is that India, very conscious of the importance to that country of international trade, has taken a calculated risk and most probably has emerged much stronger in many ways than it was before the nuclear testing.

Southeast Asia:

Indonesia, a country of some two hundred million people, reflects what is happening in all of Southeast Asia. Here, the current unrest is a troublesome effect of last year's financial crisis. The Chinese community which is small, but controls a high percentage of the wealth is serving as a scapegoat. The banking system is in disarray, with a large bad debt to capital ratio. Interest rates in Indonesia are 60% per month. Inflation is at an annual rate of 30%. Many of the important companies, controlled by a small number of family members and cronies of Suharto, are protected by tariffs.

As elsewhere in the world where there is suppression of freedom of expression, it is the students who take up the struggle at great social cost. The most recent important event in China was the student protest in Tianamin Square.

The future of President Suharto is very dependent on the army which is generally perceived as the protector of the people. Whereas the older officers who have had the experience of dipping into and sharing in the corruption are likely to forget their perceived role, the younger officers who have not yet experienced (benefited from) corruption may split from their superiors, ultimately overthrowing Suharto.

The economy in Asia will decline by twelve percent this year.

The main difference between the financial problems in Asia and Mexico is that debt in Asia is largely private rather than government, the result of systematically shoring up and protecting inefficient business. This must end.

Solutions to the area's problems lie with Japan but Japan's economy is in serious trouble. Some (canny) investors have been out of the region since last summer. The weakness of the yen weakens all currencies in the area. Japan should recover in three to five years perhaps as many as ten (opinions varied). Meanwhile, there are still some good buys in stocks, mostly in global and export-driven companies (Toyota, Sony). Changes are occurring. An example is Nomura, now run by Chicago-trained economists. Some financial services will be taken over. Requirements that insurance companies purchase domestic stocks make them less attractive. There will be survivors. For the investor, the game is to identify the survivors as candidates for investment. One investor stated that he is glad to see optimism about Japan, but we may see more washouts in Asia. He prefers to purchase stocks whose biggest risk is time.

Meanwhile China is a problem. Chinese banking is primitive. $500 billion is the loan default figure and U.S. banks are exposed to Chinese bank defaults. The Chinese are very aggressive in swap and forward markets and will deal with U.S. institutions. China has indicated its intention to hold its future foreign reserves in euros rather than in U.S. dollars. Even if this occurs, it is not believed that this will affect the U.S. dollar as a currency of refuge. (Bringing us to the next topic)

Europe and the Euro:

It will take a long time for the consolidation of European countries, but Europe has changed during the past ten years, made careful preparations for the future and has recovered to the point that permits governments to adhere to the Maastricht criteria. European nations now appear to be prepared to surrender more of their sovereignty.
(Editor's Note: the discussion on this topic was considerably more bullish than that generated on the same issue last week - change in attitudes or change in discussants?)

North America:

Labour costs are under control. There is little or no chance of Canada raising interest rates this year. Inflation in the U.S. will be 2%, but there will be a modest increase in American interest rates in the second half of this year to keep the economy sound. The Canadian dollar remains weak for several reasons. The Canadian dollar is not a currency of refuge. We have begun to retire our debt and borrow less, which has had an impact on the value of our dollar, as well as on the differential between U.S. and Canadian interest rates. As soon as the Canadian dollar shows strength, this differential increases so as to stimulate the economy. As a general rule, the value of any currency is based only on supply and demand.

Québec Real Estate:

There is a phenomenal boom in real estate in Québec, undoubtedly more related to economics than politics. A U.S. vulture fund and an insurance company have taken two buildings off the market for the right reasons. Crescent and Mountain streets are indicators of strong up-scale boutique renewals. Higher-end housing is beginning to move. See L. IAN MACDONALD: It's coming back. , Friday, May 15th

While opinions were divided on Asian economies, the main topic of the evening , the concluding note of optimism regarding Montreal's economy was widely shared. In this regard, we call to your attention an idea advanced by Michel Vastel of Le Soleil as quoted in Gretta Chambers' column May 15th.

"If Lucien Bouchard has the time of MNAs to waste and wants to test the new Liberal leader, let him take up a real plan to boost Montreal. Let him debate a solemn declaration signed by all his colleagues in English Canada stating what makes the character of Quebec unique, which is the vitality of its metropolis, the flourishing of its English-speaking minority, the safety of its districts and streets. This is not a bad joke. It is the core of what the 1996 Task Force on reviving Montreal (led by the president of the Banque Nationale, Andre Bérard) had to say. Here is what the Montreal Declaration would say: Montreal is unique because of its exceptional quality of life, notably in the area of safety. Government leaders, who love spending the weekend and visiting our restaurants, bars and stadiums, will willingly endorse this assertion. Montreal is a unique city because of the languages used in its business community, universities and colleges, hospitals, everyday life, radio stations and television networks…. Montreal is unique because of its laws and courts which allow for contracts to be drawn up in English. Montreal is unique in that its labour force is 50-per-cent bilingual and 30-per-cent trilingual."

Reported by Herbert Bercovitz and Michael Judson Edited by Diana Thébaud Nicholson

This Wednesday Chill Heward of C.F.G Heward Investment Management, Ltd. introduced an International Investment Manager an expert on Asian economies and markets Richard Gabbay of Lopresti Gabbay & Associates, Inc. Jacques Clément ex the Bank of Canada and Dr. John Shingler of Brockhouse Cooper who introduce George Archer of BCA also an expert on Asia.