Coups can be good for business

Small coup in Bangkok; not many investors hurt.

The military takeover in Thailand is actually the second bit of political unrest this week that has struck what the financial services industry dubs the emerging markets.

The unrest in Hungary may well unseat another elected representative, whose crime has been lying to the electorate about the state of the economy.

The two events remind us that emerging markets are inevitably less stable politically than established ones, even if in both these cases the incumbents rank as less-than-optimal leaders.

But just how much this matters is an open question.

It is hard to argue in favour of military coups but some might think that taking to the streets because politicians fail to tell the truth would be a useful tactic to apply in the UK.

The Hungarian unrest seems an understandable and healthy reaction.

As for Thailand, while the world of business and finance hates uncertainty, it also ranks economic competence higher than legal niceties.

In any case, the military leaders have evidently committed to getting a new civil government in place in two weeks.

Thus the immediate reaction yesterday to the Thai coup was that on balance the events might well turn out eventually to be positive for business and investment in Thailand.

Nor does there seem likely to be any regional contagion.

Economic woes and successes cross national boundaries, but political tussles do not.

It is just 10 years since the 1990s Asian financial crisis, which at the time caused huge economic disruption.

Bangkok was full of "see-through" buildings where construction had been abandoned, leaving the steel and concrete shells unclad.

Part of the reason for the crisis was a sudden withdrawal of Western speculative funds, and Malaysia made itself very unpopular at the time by blocking such outflows.

But in terms of subsequent economic development it is hard to deduce any lasting damage either from the crisis itself or from the different national reactions to it.

Thailand has grown strongly.

So too has Malaysia.

Indeed, the whole region remains in economic terms one of the most vibrant parts of the planet.

The problem of investment in emerging markets is less a political risk and more one of finding appropriate entry points.

The boom of the east Asian "tiger" economies predates the sudden growth spurts of China and most recently India - and the coining by Goldman Sachs of the expression "Brics" to describe the growth of these two countries, plus Russia and Brazil, vis-a-vis the Group of Seven.

If it is hard to find entry points into relatively small countries such as Malaysia, it is also tough to find ways into the Brics.

That practical difficulty is the focus of a study by Goldman Sachs out this week.

It looks at what outside investors can buy through the public markets, starting with the general valuation of quoted shares vis-a-vis the size of the different economies.

In the bottom graph you can see that, compared with the US, the eurozone and Japan, the market capitalisation of all four Brics is still much lower.

Typically in the developed world the value of a country's businesses is something close to the GDP.

Russia, India and Brazil are all about half that level, while China's companies are valued at a quarter of GDP.

The gap has been closing, most notably in the case of Russia, but it still exists.

This does not necessarily mean that shares are cheap.

It means that for various reasons the output of the economy is not fully reflected in the value of its companies.

That could be because of a lack of transparency of markets or simply that a large part of the economy is not in the quoted sector, as is the case in China.

But the effect is there is not a lot of stuff to buy.

This becomes clearer when you look at the sectors that are represented (next graph).

In the group as a whole, some 30 per cent is in energy and commodities.

The proportion in Russia and Brazil is higher still.

In the other parts of the world the proportion is less than 10 per cent, much less in the case of Japan.

If you look at concentration in terms of the numbers of companies whose shares you can buy, there is another abnormality when compared with the developed world.

You would expect the top five companies to be worth less than 10 per cent of the market total and the top 25 to be worth perhaps 30 per cent.

In the most extreme case, Russia, the top five are worth 65 per cent of the total and the top 25 worth 90 per cent.

So if you try to buy into the Brics, you find yourself not really buying the economy but rather the shares of a tiny number of companies.

If you buy shares in the British market you can in effect buy into the British economy, though much of our companies' profits come from overseas.

But you cannot buy the Russian economy as such.

All you can buy are a handful of commodity-driven companies.

This comes from a study of the Brics rather than emerging markets as a whole but actually in some smaller countries the problem is just as apparent: there is a tiny handful of companies whose shares you can buy.

All this will gradually change; it is already changing as new shares are issued.

These markets (except Russia) are much less dependent on a few companies and a few sectors than they were five years ago.

But for the time being there are still these practical barriers to portfolio investment in emerging markets.

Does this matter? Well, this depends on your view of the value of cross-border portfolio investment.

Until recently the popular wisdom was that direct investment - where a foreign company built a plant in another country - was more valuable than portfolio investment, where foreign investors bought shares in existing businesses in another country.

The first, it was argued, brought new investment and access to markets, whereas the second simply enabled the buying country to get dividends and maybe allow existing local shareholders to sell at a profit.

That view has I think now shifted.

Direct investment does bring direct rewards in the sense that output is increased, people get jobs, exports rise and so on.

But portfolio investment also brings rewards in that companies acquire an international investor base.

They can then go to foreign markets to raise capital on better terms, they have a local investment lobby that can be marshalled to represent their interests.

And crucially, having to deal with a global shareholder base puts a discipline on companies they would not have were they only dealing with the locals.

More than this, international investors now are pretty experienced, pretty mature.

They know they will not get Western standards of corporate governance, or Western quality accounts - though post-Enron maybe we should not be too confident about our own standards on those counts.

It is true that at a national level they are much more interested in good administration than in the niceties of electoral process - though again we have our own weaknesses on that score.

But I think the messageof the past few days is toreinforce the positive message from emerging markets in general.

Eastern Europe remains the most vibrant part of the European economy, notwithstanding lying politicians.

And east Asia remains the most vibrant part of the world economy, notwithstanding military coups.

- INDEPENDENT