Burmese business returns to the fray

CFA Magazine, July 2012

To look at Myanmar (Burma) now is to watch a recluse returning to the fray. Isolated for decades, globally loathed, every passing day brings the country closer to international – or western – acceptance, and as it does so, the world’s investment community is quickly positioning itself to benefit.

That’s the popular view, anyway; that a once repugnant government is seeing the error of its ways, embracing the advantages of the world community, and promising a future that benefits not only its economy but its citizens. But as with all complex transitions, it’s more nuanced than that: firstly in terms of the likely pace and direction of change, and secondly in terms of the business opportunity people are going to find when it’s finally considered acceptable to go back in.

Background

First, the background. It seems remarkable to look back and realise that, not so long ago, Burma provided the Secretary-General of the United Nations: U Thant, who held the post for a decade from 1961. After independence from Britain in January 1948, it had a bicameral parliament and regular multi-party elections. That changed when General The Ne Win seized power in a coup in 1962, and the military has never ceded power since.

A military leadership is not, historically, all that unusual in the Asia Pacific region – it certainly didn’t stop people doing business with Indonesia, for example – and the history of sanctions against Burma date not from the coup, but what happened more than two decades later. In 1988 the public began to express frustration at a leadership that had made it one of the world’s poorest countries. In 1988 thousands of demonstrators were killed in the so-called 8888 uprising, followed by a declaration of martial law the following year – this was also when Burma’s name was changed to Myanmar.  The USA, for example, put its sanctions in place after this uprising. In May 1990, the government held free elections for the first time in nearly 30 years, which was when Aung San Suu Kyi became a household name: her National League for Democracy won 392 out of 489 seats, but the military refused to cede power.

After that, Burma disappeared from view as a member of the world economy, although it was admitted to the Association of Southeast Asian Nations (ASEAN) in 1997. The capital city moved from Yangon (Rangoon), the bustling city of Colonial architecture and extraordinary Buddhist stupas, to an odd and barely populated city called Naypyidaw three hours up-country. As well as the US, the European Union and Australia largely shunned it, with sanctions covering visas, financial services, imports, investments and assistance [see box]. According to the Congressional Research Service, issues with Burma “include the use of child soldiers, drug trafficking, human trafficking, money laundering, failure to protect religious freedoms, violation of workers’ rights, and threats to world peace and the security of the United States.”

It’s quite a list. So what changed? In 2008, a new constitution, promising a “discipline-flourishing democracy”, was enacted, to general scorn. Elections were held in 2010, and although they were peaceful they were considered fraudulent. Nevertheless, there was a sense of slow progress, starting with the release of Aung San Suu Kyi from house arrest, the release of at least 1,000 political prisoners, some new labour rules, and a relaxation of restrictions on the media. Cautious but encouraged, western nations have gradually been taking a closer look. In December 2011 US Secretary of State Hillary Clinton became the first person in that role to visit the country in more than 50 years. Most significantly, a by-election on April 1 2012 appeared to be run legitimately – international monitors were allowed to watch – and Suu Kyi won 43 of the available 45 seats.

What next?

And so to this new mood of rapprochement. The European Union has suspended most of its sanctions for one year as a gesture of good faith; the US, while ruling out an immediate end to its sanctions, has applauded progress and will send a US ambassador to the country (and welcome a Burmese one in Washington) for the first time in 21 years; UN chief Ban ki-Moon has urged Western nations to drop more sanctions; and Suu Kyi herself has called for the suspension of sanctions.

Hence the growing interest of western businesses. “It is a very exciting story,” says Andrew Swan, head of equities for Asia at Blackrock in Hong Kong. “There are still substantial risks associated with it: there is no infrastructure in terms of legal, accounting and finance. But so far the policies are heading in the right direction.” And in certain areas, the opportunities for investment are very clear. “It is a large country in terms of people, the cost of labour there is a fraction of what it is in China, and it is abundant in arable land and natural resources,” Swan says. “And that is where the medium term opportunities will be found: basic commodities, agriculture and some infrastructure.”

Let’s quantify some of those numbers. We don’t know exactly what the country’s population is since there hasn’t been a census for nearly 30 years, but estimates range between 44 million and 62 million – so a mid-size southeast Asian nation, smaller than the Philippines or Thailand but bigger than Korea or Malaysia. It is also helped by geography, partly because it is surrounded by nations that have grown rapidly to developed status (which presents a clear opportunity for trade) and partly because it is one of the few nations that borders both India and China (as well as Thailand). As Credit Suisse analyst Dan Fineman notes: “In the early stages of development, where Myanmar now finds itself, it seems that all an East Asian nation needs to do to generate rapid growth for three to five years is: 1) establish internal peace, 2) open up to foreign investment and 3) allow their acquisitive population the freedom to pursue their dreams. We would be surprised if Myanmar did not witness at least a short period of surging GDP.”

Of particular interest to foreign investors are the country’s gas reserves; production today is not high – well below Indonesia, Malaysia and Thailand – but the potential for development is great. A new pipeline to southern China should open in 2013, while another to Thailand is underway. Analysts Wood Mackenzie expect production to peak in 2016 at over 2,100 mmcfd (million cubic feet per day), close to double today’s levels. Gas is enormously important to Myanmar: Credit Suisse says it accounted for 43% of total exports in 2010.

And gas reserves are not the whole opportunity. Teak is another, infrastructure too, and tourism represents great opportunity potential. Then there are the wholly untapped markets that tend to thrive in a newly opening market. In March, Nomura put out a report on telecommunications in Myanmar called: “The appeal of 60 million people but less than three million mobile users.” Myanmar has 4% wireless penetration, 3% fixed. Nomura believes a new telecom law, to go alongside reforms on labour and media law, is in the works, allowing for up to five licences and either direct or indirect foreign operator participation. “The telecom sector in Myanmar is likely to be on the radar for most telcos for incremental investment,” says the report’s author, Sachin Gupta. “We think there is legitimate cause for fresh optimism on possible political and economic reforms in Myanmar,” although the military’s continuing heavy influence will make decision-making and implementation “challenging,” he says.

Comparing the neighbours

It has become commonplace for people to look at Myanmar and draw comparisons with other Asian nations, and in particular Vietnam and Indonesia. Vietnam is the most obvious comparable because it is the most recent significant-population East Asian state to make the shift from being cut off to embracing the free market. Interestingly, though, Vietnam has done that without making the slightest step towards democracy – like China, it remains proudly communist and no citizen has a vote. So from the political perspective, it is interesting to look at Indonesia, which for many years was under military dictatorship before entering a gradual and initially somewhat painful transition to democracy. It really took 10 years for Indonesia to find its feet in this model, but today the country is touted (by the US in particular) as a role model of emerging democracy and a light for others to follow.

Following that comparison through, it’s also useful to note that although Indonesia is unquestionably now a functioning democracy, it is still run by a former general, President Susilo Bambang Yudhyono. The military remains exceptionally powerful. One western ambassador privately says that people should be realistic about what is likely to happen in Burma’s political transition, and that the idea that the army will step aside tomorrow and let Aung San Suu Kyi lead a glorious new democracy is naïve; instead, a series of steady progressive steps should be encouraged, which is pretty much what is happening now. This commentator notes that even free-market Singapore is still governed by a man with Brigadier-General in his title (Prime Minister Lee Hsien Loong). In any event, the prize is potentially exceptional: Indonesia, having an economy built largely on domestic demand, is arguably the nation that came through the financial crisis in the best shape of them all, and has been upgraded to investment grade by two of the three international rating agencies.

The promise of a Vietnam, Indonesia or Thailand-like path for Myanmar is a large part of the attraction to international investors. And it is no surprise to see private equity firms already looking to move in. Earlier this year, Patricia Higase – who is half-Burmese and half-Japanese – established a company called Link Road Capital Management as a vehicle through which to launch private equity funds in Myanmar on behalf of global institutional investors. It can’t move until US sanctions lift – this is a common impediment to new funds like this – and also needs the new investments law to pass through Naypyidaw’s parliament. But she calls it “too compelling an opportunity to sit out.” She, like other private equity professionals, expects Myanmar to start as a centre for low cost labour, then to follow the same trajectory up the value chain as its neighbours have done. If Myanmar follows the Vietnam pattern of development, then one of the first things that will happen will be a return of Burmese expatriates with international experience who want to come home and build business where they came from.

So far, so good. But there are some important footnotes to consider about Myanmar.

Too much hype?

In April, Credit Suisse’s Thailand team put together a detailed study of Myanmar, and its conclusion is reflected in its single word headline: “Overhyped.”

While its authors found developments in the country to be exciting, they noted just what an exceptionally low base it was starting from. “Although impossible to determine with any accuracy, Myanmar’s GDP is probably only 14% the size of Thailand’s,” says Dan Fineman, the report’s principal author. “It takes only 1% of Thailand’s exports. Most of the population is too poor to buy anything other than locally-produced subsistence goods.” On top of that, Fineman finds “the country’s human capital is arguably the weakest in Asia outside East Timor. The currency is likely overvalued. The military consumes as much as two thirds of the budget, leaving little for infrastructure and education. Inflation is structurally high.” And, naturally, political risk will be an enduring concern. “The 2015 general election seems an especially risky event, as only then will the military be faced with the prospect of losing control of the government.”

It is also, at this stage, a considerable distance away from being a theme that many investors can play.  “It’s going to be fairly limited in terms of what it means for equity markets in the region,” says Swan at Blackrock. “There really is no stock market. They’ve only just created a real exchange rate.”

Moreover, there aren’t so many stocks with exposure to Myanmar – partly because no western country has been permitted to have any. Asian countries have never had any qualms about investing in Myanmar, but even then there are few listed stocks with much meaningful exposure. Credit Suisse identifies just three: Italian-Thai Developments, PTT Exploration & Production, and PTT Public Company, all of which are listed in Thailand. ITD has by far the greatest potential – its investment in the Dawei project, which would involve building two deep sea ports, three industrial zones, residential areas and a commercial complex, eventually to be followed by oil and gas pipelines, would be “a potential game-changer,” Credit Suisse says. But it doesn’t like the stock. The PTT group, which dominates upstream and downstream resources in Thailand from exploration through to petrochemicals, is a widely admired stock, and has done business with Myanmar for over 20 years, but the country will always be a relatively small impact for such a large-cap (by local standards) stock: Myanmar accounted for 8% of PTTEP’s sales in 2011, although 30% of its reserves.

Neighbouring Thailand apart, the country that has long taken an extremely close interest in Myanmar is China – which has not been deterred from investment through any moral objections. “China is taking an enormous interest in it,” says Swan. “It’s already got the freeways, the oil and gas pipelines, the ports and rail infrastructure nearing completion. The implications for getting energy from the Middle East to Central China can save five or six days by going through Burma.”

Indeed, there is a sense among some westerners that when they get the go-ahead to invest, everything they might want to invest in will already have been snapped up by the Chinese. Talking to a representative of an Asian sovereign wealth fund, CFA wonders if we should all be buying property in Yangon/Rangoon. “You’d be much, much too late,” he replies.

There is, clearly, a long way to go for Myanmar: convincing the west not just to suspend sanctions but to lift them; building a soft infrastructure to accommodate foreign interest; somehow building an educated workforce capable of embracing new opportunity; the list goes on. But we are likely to look back on the last two years as an historical event, the period in which the last East Asian pariah bar North Korea was welcomed back into the fold of the world community.

BOX: The currency

Until recently, Myanmar had two exchange rates: an official one and a market one. This is not wholly unusual, particularly in states that have been in isolation for some time, but the big problem in Myanmar was that the official rate was about 100 times higher than the market one. This has made foreign investment deeply impractical and allowed for widespread corruption (Transparency International once ranked Myanmar the most corrupt nation in its ranking).

However, in April the IMF, which has renewed links with the country on the back of apparent political and economic reform, helped Myanmar to move the official rate close to the market rate. This ought to help. “It is not entirely clear how the new currency mechanism will work,” says Dan Fineman at Credit Suisse, “but a managed float like China’s appears most likely.”

Fineman, who is otherwise a little cynical about the hype around Myanmar’s liberalisation, is encouraged by this. “We believe that the government is not only eager to jump-start the economy, but that it is getting good advice,” he says. “The government is consulting closely with the IMF on currency unification and other issues, and listening carefully to the recommendations of private economists and think tanks. This government gets it on the economy, in our view.”

BOX: The moral question

In 2010, ahead of the landmark but controversial elections, I visited Myanmar in order to get a sense of local and international views on sanctions and engagement – in particular around the tourism industry.

The local perspective was extremely interesting. Local people wanted tourists to come; not only would they be benefited by the dollars they brought, but they also felt there was safety for them in foreigners being in the country.

“If tourists do not come, it costs the government very little. They can get what they need from teak and gas,” one member of the local tourism industry told me. “But it costs me everything.” And foreigners, he said, were “like a protection for us.  If tourists do not come there is nobody to see what happens.”

No doubt not everyone in Myanmar would have agreed with him; someone in the tourist industry, with a vested interest in foreign money, might have a quite different view to a political prisoner, for example. But tourism demonstrates how tricky the sanction debate can be. Prior to recent liberalization, there was widespread agreement in the west (companies like France’s Total apart) that engagement in the oil and gas sector would be akin to funding a brutal military regime and should not be done. To an extent, tourism had the same effect, since visa fees fund the government. But the counter-argument is that tourism, practised carefully, puts money directly into the hands of ordinary people and funds the vital private sector, as well as deterring abuse on the ground and creating a positive image of foreign countries.

The travel guide Lonely Planet, which publishes a Myanmar/Burma edition, prefaces it with a detailed 14-page analysis of the engagement argument, entitled “should you go?”, and makes that available for free on its website before anyone buys the book. I met Tony Wheeler, the founder of Lonely Planet, who has visited the country about 15 times. “There’s no question that if you spend money in the country then some of it is going to go to the government,” he said. “But not much, and you can minimize that. I can think of numerous ordinary people I have met there over the years where the money you spend goes straight into their pockets then back out again at the markets, or to repair a roof that leaks. They’d be amazed if you said you thought this money was going somewhere to support the military.”

Upon her release from house arrest, Aung San Suu Kyi changed her position on tourism and encouraged people to visit. And if sanctions are lifted, the arguments around them will become academic. But one mistake is to see the engagement argument in black and white terms. “When you first go there you think you have an understanding of the place,” Luc De Waegh, who runs an advisory firm called West Indochina, told me. “Those who have been there four or five times get confused. Those who live there are very confused. In fact the only people who think they have a very clear understanding of the place have never been there.”