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World Risk Developments - September 2011 (Size 3Mb)
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Resource nationalism...
Governments in a variety of countries are examining options to gain a greater share of the windfall profits flowing from strong commodity prices.
The options include greater taxes and royalties, state ownership stakes in ventures, use of state-owned mining firms, and contract revisions. In some countries the moves are consistent with healthy private investment and production; in others they threaten profitability and could force mine closures. Venezuela is causing most investor alarm, but South Africa and Zimbabwe are also being watched closely.
In Venezuela, President Hugo Chavez signed a decree last month to nationalise the gold mining industry. The main private gold miner that could be affected is Rusoro, a Toronto-listed company of Russian origin. Even before the decree, the industry was dealing with significant sovereign risk. Three companies are involved in arbitration over previous expropriations, including Canada’s Crystallex following the takeover of its Las Cristinas mine in February. Limits on exports have also been making miners unhappy, even though those limits have been relaxed recently to allow exports of up to 50% of total production rather than 30%. Meanwhile, state mining company Minerven is facing strikes that have halted operations. The move on gold is part of a wider nationalisation push by Chavez that has already targeted electricity, telecoms, energy, cement, metal smelting, food, beverages, dairy and supermarket chains.
In South Africa, there have also been calls for mine nationalisation – by the ANC Youth League – but the government has dismissed them, preferring instead to promote ‘black empowerment’ through a revised Mining Charter that encourages firms to achieve 26% black equity by 2014. The government has also revived a dormant state company called the African Exploration, Finance & Mining Corporation to do its own exploration and mining. The industry has expressed concern that this company won't compete on equal terms with private companies. Finally, there has been a call for a super-tax on profits, but the industry hopes that the government will listen to its argument that it couldn't bear such a tax because of already high costs.
In Zimbabwe, the government wrote last month to 13 foreign-owned mining, banking and tobacco firms asking how they planned to meet a September 30 deadline to transfer 51% equity to black ownership. Impala Platinum, the world's No 2 platinum producer, has said it is negotiating with the government on how to satisfy this requirement. Most foreign mining investors reportedly see their stakes in Zimbabwe as options to exercise if conditions improve. Some hope that a future democratic government will relax the current requirements.
In contrast to the situation in Venezuela, industry is reportedly comfortable with steps being taken in Peru. A new windfall profits tax has been introduced after negotiation with industry. The rate was revised down to ensure Peru kept competitive with Chile. An attractive feature of the tax is that it falls on profits, not revenue, and will be applied on a sliding scale according to price levels; so it won't threaten marginal mines. The tax will be introduced alongside legislation requiring mining companies to consult indigenous communities before operating on their land. The windfall tax and the prior consultation legislation were important items in the election manifesto of President Olanta Humala who took office in July. He criticised former president Alan Garcia for taxing the industry too lightly even while commodity prices were soaring and allowing it to ride roughshod over local communities. There have been many conflicts between miners and local communities in recent years, often over water, some turning violent.
The government also seems to be taking a measured approach in Guinea, a country attracting strong investor interest thanks to massive bauxite and iron ore reserves. A new democratically elected government led by President Alpha Conde is conducting a review of existing mining contracts and has recently announced a new mining code. The review reflects widespread public anger over a series of deals concluded by a previous military junta that ruled for two years up to December 2008 and by the government of President Lansana Conte beforehand.
Conde called in George Soros’s Revenue Watch Institute to help carry out the contract review and draft the code. The Institute is a big supporter of the Extractive Industry Transparency Initiative. The new mining code will seek to raise the state’s interest in mining contracts to 35% from 15% before. At this stage it is unclear whether this will apply to all existing concessions. The code reportedly gives the government a free 15% share with the option to buy another 20% at market value. A new state mining company has been created to hold the state’s equity.
Meanwhile, the contract review looks set to confirm concessions held by Rio and Vale in the giant Simandou iron ore deposit – as well as approve Rio's ‘Simfer’ joint venture with Chinese state-owned mining company Chinalco. As part of those arrangements, Rio agreed in April to pay the government US$700 million and to give the government the option to take a 35% stake in the project (consistent with the new mining code). In 2009 the junta confiscated half of Simandou from Rio and awarded it to a company owned by the Israeli diamond billionaire Beny Steinmetz, who went on to sell a 51% interest in its concession to Vale for US$2½ billion.
Russian aluminium producer Rusal and the China International Fund (CIF), a member of the 88 Queensway Group, look to be two prominent companies that may not fare so well under the review. Rusal owns the Friguia aluminium refinery and has interests in the Dian Dian bauxite deposit. A local court ruled in 2009 that Rusal had provided an inadequate payment of only paid US$22 million in 2006 for Friguia, an asset valued at around US$250 million. In turn the government has described the deal as illegal and lodged a claim for nearly US$1 billion in taxes, penalties and compensation for environmental damage, a claim Rusal contests. Conde is reportedly also irked at how slowly the development of Dian Dian is proceeding. For its part, CIF signed a controversial US$7 billion 'Angola mode' resource-for-infrastructure deal with the junta in 2009 and has also agreed to fund US$2.7 billion worth of infrastructure to support another large iron ore deposit being developed by the Australian AIM-listed company Bellzone. According to the Financial Times, CIF funded the audit of Rusal that led to its large tax and compensation bill. But it and Rusal could now see their contracts reviewed.
The government is also revising the mining code in Mozambique against a background of criticism of the tax take from mines. It reportedly favours increased royalties and taxes on new mines, a 10-20% stake in 'strategic' projects for the state mining firm, and licence cancellation for firms that fall behind with their agreed development schedule. It apparently has no plans for a windfall profits tax.
In Tanzania, the government has announced that it is looking to raise taxes and royalties to fund a five-year development plan. A windfall profits tax is reportedly one option under review. Tax revenue from mining has remained flat at around US$100 million a year for five years, so some review is hardly surprising; indeed, the IMF recommended it. Any higher taxes that result will probably be applied only to new mines; existing ventures with tax stabilisation agreements are likely to be shielded.
Apart from a handful of countries, most seem intent upon not carrying resource nationalism to the point where it 'kills the goose that lays the golden eggs’. Few are resorting to nationalisation; most seem content to increase taxes and royalties, or buy into resource ventures, or both. The wisdom of states buying equity in projects can be questioned, but it does not seem to be making the stakes of private investors unprofitable.
India’s supply side challenges
India’s supply side challenges continue to crimp the economy’s growth potential.
Growth moderation. Indian GDP growth slipped to an 18-month low of 7.7% (annualised) in the June quarter, compared with 8.8% growth in the same period a year before. The slowdown follows aggressive monetary tightening by the Reserve Bank of India in response to persistently high inflation – the Bank has now raised rates 12 times since March 2010 – and will probably continue to raise them, particularly since, as we noted in March, base (benchmark minimum) lending rates (now 9½%-10¾%) are out of step with nominal GDP growth.
Supply side issues. The persistence of high inflation points to serious supply side issues. India’s infrastructure deficit and other structural challenges, notably in the labour market, are well documented. Recent media attention has also focused on problems of corruption and land acquisition.
These concerns could lie behind a slowdown in FDI (Chart 1). Such a slowdown is worrying for two reasons. First, FDI is crucial to government plans to achieve $1 trillion in infrastructure development over the next five years. Second, the country runs a current account deficit and needs non-debt creating foreign capital inflow to fund it.
Reform progress? The government has sought to answer long standing complaints about the difficulty of acquiring land for factories and other developments through a land acquisition bill. This seeks to codify a country wide approach to government land acquisition and ensure the government pays market prices. Popular resistance to land acquisition has delayed numerous government infrastructure projects and thwarted the development of industrial projects.
Indeed, an official 2009 review revealed that as many as 70% of 190 delayed projects were victims of problems in land acquisition. Delayed projects included nearly 60 railways, 40 highways and 20 power stations, as well several large private industrial projects, including POSCO’s planned US$12 billion steel plant in Orissa and Reliance’s US$8 billion gas power station in Uttar Pradesh.
However, the draft bill faces a long legislative road. It is likely to face resistance from farmer’s lobbies, real estate developers, and some state governments. The Associated Chambers of Commerce and Industry estimate that the bill may increase land acquisition costs by 60-80%.
Rising rice prices
A rice price support scheme from the new Thai government will increase world rice prices and add to regional inflation.
To boost rural incomes the new government of Yingluck Shinawatra has pledged to pay Thai farmers Bt15000/t for unhusked rice beginning with the November harvest. Because this is equivalent to US$800/t, well above the current world market price (Chart 2), it will prompt farmers to switch sales to the government and away from export markets. This diversion will in turn squeeze internationally traded supply and raise the world price (Chart 3) – after all, Thailand is the world's No 1 rice exporter, supplying 30% of total world exports.
Rice prices are already rising in anticipation of the policy change. The price of 100% B-grade Thai rice (the international benchmark) hit US$629/t in early September, up 25% from May. On the supply side, Thai and Vietnamese producers are already delaying exports in anticipation of the Thai policy changes and higher prices. In 2008, rice prices surged to a record US$1000/t after Vietnam and India banned rice exports in a bid to contain rising domestic prices. According to Bloomberg, analysts expect the rice price to reach US$750/t by December. No doubt on the demand side of the market as well, people are stockpiling rice.
The rise in rice prices will add to inflationary pressures in Asia and restrict the flexibility of the regions’ central banks in the event of a renewed slowdown in the North Atlantic. Rice accounts for 10% of the CPI in Philippines, 5% in Indonesia and 2-3% elsewhere. Rice was one of the few food commodities whose price has been stable in 2011. Higher prices will also act as a drag on the incomes on net importers – Philippines, Bangladesh, Malaysia, and the Middle East.
Emerging market FDI
UNCTAD’s latest World Investment Report highlights the growing importance of emerging markets as both source and recipient of foreign direct investment (FDI).
Inflows. For the first time, FDI into emerging markets in 2010 represented more than half total FDI (Chart 4).
In dollar terms, China and Hong Kong were the largest FDI recipients in the emerging world, and the second and third overall after the US. In 2010, China and Hong Kong absorbed 14% of total FDI. Other major recipients were Brazil (4%), Russia (3.2%) and Singapore (3.1%).
Scaling inflows by GDP tells a slightly different story. FDI into North Asia has actually slowed (Chart 5). Inflows into India have also trended down – FDI into South Asia (India, Pakistan, Bangladesh and Sri Lanka) was just 1.3% of GDP in 2010, below the average in the developed world. In contrast, FDI into ASEAN boomed, reaching 4.4% of GDP in 2010. Several ASEAN countries have liberalised their FDI regimes in recent years. Indonesia and Vietnam are also becoming attractive for low-end manufacturing due to rising costs in China.
Outflows. Emerging markets are also becoming a key source of FDI (Chart 6). In 2010, their share of worldwide FDI was 30% – up from 16% in 2007. The majority of this investment is from Asia – particularly China. Offshore investment from China has risen ten-fold over the past five years to reach US$68 billion in 2010, exceeding Japan’s outward FDI.
UNCTAD estimates that 70% of FDI from developing economies goes into other developing economies (Chart 7). The majority is intra-regional, though a growing proportion is extra-regional. In 2010, for instance, Asian companies accounted for over 60% of the cross-border M&A in Latin America, largely focused on resources.
Investment restrictions. According to UNCTAD, new policies that liberalise or promote FDI continue to outnumber policies that restrict it (Chart 8). But the gap is narrowing. Many of the restrictive measures are focused on mining and agribusiness. In the mining industry, 93% of new policies were restrictive in 2010. According to UNCTAD ‘this trend is part of a broader development in industry policy, characterised by an extension of protective measures to ‘national champions’ and ‘strategic industries’ and the intrusion of national security concepts into industry policy.’
Roger Donnelly, Chief Economist
rdonnelly@efic.gov.au
Dougal Crawford, Senior Economist
dcrawford@efic.gov.au
Ben Ford, Senior Economist
bford@efic.gov.au
The views expressed in World Risk Developments are EFIC's. They do not represent the views of the Australian Government.