China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

This Time, You Better Listen to the BIS!

November 6, 2013

This is just a brief note I write in the last minutes before the publication of this blog. I feel strongly to point at a paper that very recently has been published by two economists from the Bank of International Settlements (BIS, which is the central bank of the central banks). Contrary to what could be read in some articles in the press, the paper – written by Dong He and Robert N McCauley – is not an official statement by the BIS. (“The views expressed are those of the authors and not necessarily the views by the BIS”).

But I am sure that many experts within the BIS share the views and the warning of the two authors.  Their concern is taking up the fact that some East Asian countries – or rather companies in these countries – more recently have been too strongly attracted by the U.S. dollar and the low-interest rate environment for private credits in USD. In other words: corporate (private) indebtedness in foreign currency (USD) has been increasing too rapidly in some Asian countries, particularly in China.

I myself take the warnings from the BIS very seriously. The BIS has a good record of giving warning signals in time, mostly expressed in the kind of working papers quoted above. Economists like E P  Davis or William White can serve as good examples.

Even if you do not believe in the concerns that are expressed above, I would like to recommend reading the analysis mentioned above. You get at least better insight into the usually not very transparent Chinese (East Asian) financial markets.

Dong He/Robert N Cauley. “Transmitting global liquidity to East Asia: policy rates, bond yields, currencies and dollar credit”. 2013. BIS Working Paper. No 431.

Furthermore, if you want to read more about the negative Swedish experience with private borrowing in foreign currency, you can look at an article of mine from last year published by the National Association for Business Economics (NABE). In this article, I also refer to the important impact of psychology on exaggerating financial markets. For this reason, I feel particularly glad that Robert Shiller this year is one of the three Nobel Prize Winners in economics. Behavioral finance can be very much applied to Chinese financial markets, too.

Fromlet, Hubert. “Predictibility of Financial Crises: Lessons from Sweden for Other Countries”. 2012. Business Economics. Vol 47. No 4, pp 262-273.

Hubert Fromlet
Visiting Professor of International Economics, Linnaeus University
Editorial board

 

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How fast can Russia grow in the future?

October 2, 2013

Boom and bust

During the boom years of 2000-2007 Russian economy grew on average by more than 7% p.a. While the global economy also expanded vigorously, Russia’s growth was boosted further by ever-higher oil prices and productivity improvements especially in the services sector.
Russia’s rapid GDP growth meant that Russians’ average standard of living also increased during this time, and by 2008 per capita GDP (at purchasing power parities) was 34% of the corresponding level in the US from 21% in 2000. Partly this rapid growth was a rebound from the economic crisis of 1998, but growth was also helped by restructuring of the economy towards services, which were very much underdeveloped during the Soviet times and early years of the economic and political transition. Moreover, productivity growth in the services was also fast, especially in the high-skill sectors such as financial intermediation and business services, which is natural given the relatively low starting level.

However, growth during the boom years was not only driven by productivity improvements. According to a recent Discussion Paper published by the Bank of Finland Institute for Economies in Transition (Marcel P. Timmer and Ilya B. Voskoboynikov: Is mining fuelling long-run growth in Russia? Industry productivity growth trends since 1995, BOFIT DP 19/2013, http://www.suomenpankki.fi/bofit/tutkimus/tutkimusjulkaisut/dp/Pages/dp1913.aspx) growth in the capital input has also accounted substantially to the growth in value-added. Moreover, growth in labor input has accounted for almost equally large share of value-added growth. At the same time many sectors where productivity growth has been very low, such as mining, have been able to increase their share of the economy, as they have been able to attract more capital and labour.

Lower growth in the future
In 2009 Russian economy suffered from the global financial crisis, but its post-crisis growth has been clearly slower than many expected, even though the price of oil soon returned to over $100 per barrel. While the average GDP growth between 2010 and 2012 was 4%, growth continued to decelerate. In late 2012 and early 2013 quarter-on-quarter growth was practically non-existent. While the slowdown in growth has partially been cyclical, it is also a sign of clearly lower growth in the potential output.
First, working-age population is already declining, and at the same time unemployment is very low. Officially the unemployment rate is around 5%, which in practice means full employment. Unless retirement age is increased soon, labor supply continues to decline, which will have a negative effect on future growth.

Second, investments are also declining. Between 2010 and 2012 the average share of gross fixed capital formation in GDP was 21.8%. This is below the average investment ratio of other middle-income countries (see Figure 1), many of which are currently growing faster. Moreover, during the first half of 2013 investments actually declined year-on-year, and especially large energy as well as infrastructure companies cut back their investments. At the same time capacity utilization rates are even higher than during the boom years of 2006 and 2007 (Figure 2). This tells us that Russian companies do not view their future prospects favorably, and the large capital outflows basically tell the same story. During the past quarters net capital outflows have averaged some 2.5% of GDP.

Figure 1 Share of fixed capital investments in GDP and per capita GDP (middle and high-income countries
(Click the image to zoom in)
Source: World Bank World Development Indicators database

It is noteworthy that even relatively high oil prices have not been enough to boost Russia’s growth in the recent quarters. It seems that the uncertain global environment and Russia’s own well-known problems with business environment are hindering investments. It is especially noteworthy that Russian companies and investors are deeming investments into Russia lacking when taking into account the expected profits and perceived risks.
The aforementioned factors have led many analysts inside Russia and outside it to drastically reduce their estimates of Russia’s long-term growth potential. Many of the estimates seem to cluster between 2.5% and 3% p.a. While this is still quite respectable in comparison to many EU countries, it will mean substantially slower increase in incomes and delayed convergence with the OECD countries. Also, slower growth may at some point be in conflict with the many fiscal responsibilities of the public sector.

Figure 2 Capacity utilization rates in manufacturing industry
(Click the image to zoom in)
Source: Rosstat

 

 

 

 

 

 

Iikka Korhonen
Head of Bofit (Institute for Economies in Transition) at the Bank of Finland

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Spread Your Eggs, and Do It Quickly! A note on the internationalization strategy of SMEs and their performance in times of market turbulence.

In 2007 the world economy faltered. The economic crisis that struck the globalised economy spread rapidly across country borders and caused the most severe and globally spread recession witnessed in almost a century. This global recession affected international business all over the world. Empirical reports have shown that small and medium-sized enterprises (SMEs) in general and those with international operations in particular were most affected by the recession. One reason for this might be that SMEs in general possess fewer resources and have more limited international experience and managerial resources compared to large multinational corporations.
In a recent publication of mine at the Center for International Business Research in Emerging Markets (CIBEM), Linnaeus University, interest was turned to the performance of SMEs and to examine whether the internationalisation strategies of SMEs can contribute to explaining the firms’ performance in the market turbulence caused by the recession.
The article addresses three shortcomings in the existing literature on the relationship between firms’ internationalisation strategies and their performance.

First, the main body of research reported has focused on MNCs, thus our knowledge is still limited when it comes to SMEs. This is an intriguing shortcoming as SMEs, in comparison with their larger counterparts, have to be more conscious, careful and selective when making decisions about their international or global activities. This is because SMEs are generally constrained by a limited resource base and hampered by a limited pool of international experience.

Second, most studies have examined the effects of a firm’s degree of internationalisation; in contrast, this study seeks to separate the scope and the scale of internationalisation while at the same time including the dynamic speed dimension.

Third, and most importantly, the reported studies have been undertaken in times of market stability. Less is known about the validity of these findings under market turbulence.In light of this background, the article addresses these shortcomings by seeking an answer to the research question: In times of market turbulence, what are the performance effects of a SME’s scale of internationalisation, scope of internationalisation and speed of internationalisation?

To answer the research question, the research model is theoretically derived from international business and strategy literature.
The research model is confronted with a unique dataset integrating data collected in an on-site survey covering the firms’ internationalisation strategies until 2007 with objective and publicly available performance data for the period 2007-2011. This strategy allows us to test whether the internationalisation strategies in place prior to the recession have an effect on firm performance during times of market turbulence. Three hypotheses are posited:

The greater the scale of SME internationalisation, the stronger the firm performance in times of market turbulence.

The broader the scope of SME internationalisation, the stronger the firm performance in times of market turbulence.

The higher the speed of SME internationalisation, the stronger the firm performance in times of market turbulence.

From the analysis and discussion it can be concluded that the strategy of firm internationalisation is a relevant predictor of performance in times of market turbulence. In this research it is shown that the scope as well as the speed of firm internationalisation positively influences performance in times of market turbulence. Thus, firms that are able to balance their sales between different markets as well as to establish first mover advantages internationally will experience a positive performance in times of market turbulence. Conflicting the hypothesised model, however, the analysis revealed that the scale of internationalisation did not significantly affect SME performance in times of market turbulence. Thereby it seems as if the share of the sales exported is less important than the number of markets exported to in order to be resilient in times of market turbulence.

These conclusions should be of interest to managers of SMEs. The findings suggest that managers of internationalising SMEs should spread their risk between different countries in order to reduce sales fluctuations and gain flexibility of market activities in times of market turbulence. This research shows that the geographical scope of the international activities of the firm is a more important predictor of SME performance in times of market turbulence than the scale of internationalisation. Furthermore, this study has shown that managers in firms starting to internationalise their activities should seek to exploit potential first-mover advantages in different countries by realising a strategy of internationalisation at a high speed.

Thus, it has been shown that SMEs should not put all their eggs into one basket. When market turbulence arises, as witnessed in the last five years, firms that have spread their risks have experienced stronger performance. This analysis shows that it is not the share of the eggs that are put into the home market basket in relation to the international one that is the main predictor of performance in times of turbulence. Instead, it shows that what matters is the number of baskets used for the eggs and the speed at which the eggs are spread between the baskets. Thus, it has been shown that the number of baskets used renders a positive performance effect. The same holds true for the speed at which the eggs are spread. Based on this research, it is argued that we should drop the assumption that internationalisation is a risky strategy. This research has shown that it might be more risky for firms not to internationalise activities than it is for them to do so. In times of market turbulence, internationalisation should be seen as a risk-reducing strategy rather than an instance of risk taking.

Thus, we are confident to suggest for managers of SMEs to spread your eggs, and to do it quickly!

The full version of the paper can be accessed online at the website of International Small Business Journal: http://isb.sagepub.com/content/early/recent

 

Mikael Hilmersson
PhD, Assistant Professor of International Business, Linnaeus University
Editorial board

 

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