Capital Market in Bric Economies

7/29/2019 Capital Market in Bric Economies

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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

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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


19/81


20/8114

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


21/8115

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


22/8116

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


23/8117

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


24/8118

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


25/8119

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.


26/81

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


27/811121

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


28/81

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


29/81123

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.


30/8124


31/8125


32/8126

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.


33/8127

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.


34/81

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


35/8129

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.


36/8130

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

Documents

Capital Market in Bric Economies