Newsletter 3

THIS ISSUE
Italy, the next victim? p.2

Dear Friends
Time has flown with the speed of light and so it is the moment for the third iFund Newsletter which is devoted to two economies that currently find themselves in two completely converse economic situations. With no further ado, comments and suggestions are more than welcome, so with high expectations and little sense of criticism, lets proceed. The BRIC countries have been lately referred to as the countries with the highest growth potential which mainly derives high labour availability and low expenses, favourable conditions for investment as well as presence of natural resources. Hence, they are frequently called the next future big deal as people readily invest there for the hope of future growth. At the same time there are the so called PIIGS, which currently experience a state of negative or virtually no growth as well as suffer from severe problems due many fiscal and financial flaws. In this issue we will try to shed light on two representatives of each of the two groups, what problems they face and what are their growth prospects in the future. Yours financially, iFund

Since 2009 I doubt if there was a single day without appearing the word PIIGS in biggest media channels and newspapers. We are terribly sick of hearing anything from Greece about its sovereign debt. By investigating this issue we would like to shift your attention from medias beloved Greece to Italy. The Brazilian Miracle p.3

The second article is devoted to the an emerging giant of Latin America Brazil, which despite multiple economic mishaps has established a strong and vibrant economy which is bound to be one of the leading forces in the forthcoming decades. Board updates Upcoming Events p.5 p.5

Who will be the second one of PIIGS after Greece: Italy?

Italians have always been a laid-back, open nations, yet such openness sometimes can lead to negative consequences. We give a detailed coverage on why that could happen

Since 2009 I doubt if there was a single day without appearing the word PIIGS in biggest media channels and newspapers. We are terribly sick of hearing anything from Greece about its sovereign debt. By investigating this issue we would like to shift your attention from medias beloved Greece to Italy. Though it is easy to poke fun at Italy, with its sometimes silly politics, archaic economic structure, low productivity and poor competitiveness, the government nevertheless should be praised for its sound financial management. Italy's government debt level has not spiked upwards like it has in so many other developed economies in recent years, and it is roughly the same today as in the late 1990s. Nor did the government blow out its budget during the financial crisis. But markets have punished Italy anyway. More than 6% yield from European countrys bond sounds impossible to be true? To our biggest surprise, Greece was able suggest even more, since this country has had 98% chance of default recently. Needless to say, that the question whether Greece will default or not is senseless. Who is the next one and what is going to happen? Ciao Italy, we havent forgotten you.... There is no doubt that Italys governments debt is considered to be the key problem, projected to reach 120 % GDP this year (the second biggest after Greece) and is directing the country to follow the way of Greece. Italian politicians are perfectly aware of ongoing issues and seemingly some ices might be broken. Silvio Berlusconi, who obviously has been paying more attention to reviving his cranky image after all sex scandals than solving countrys fiscal troubles, deserved some credits, as long as Italy's much-altered austerity package is approved and strictly followed. Italy may sell municipal utilities and real estate as part of a plan to dispose of state assets valued at as much as 500 billion EUR. Nevertheless the European Commission

does not think that Italy's fiscal consolidation plans are supposed to have negative impact on growth for this year. Finally, we all perfectly know that ECB is buying Italian bonds and all those steps are supposed to be the way out of this gruel... Believe or not that is far away from enough and the government is turning to cash-rich China in the hope that Beijing will help rescue it from financial crisis by purchasing Italian governments bonds and making investments in strategic companies. The CEBR said it had modelled good and bad scenarios for the two countries and Italy could not support its debt even if rates fall back unless the euro-zone's third-largest economy sharply increases growth."Realistically, Italy is bound to default, but Spain may just get away without having to do so," said the London-based consultancy. The CEBR said the situation is better for Spain as its debt is much lower, and calculates that even under its bad scenario Madrid's debt ratio would climb to no higher than 75 per cent of national output. "Fingers crossed but there is a real chance that Spain may avoid default and debt restructuring unless it gets dragged down by contagion," said the consultancy. It calculated that the maximum sustainable bond yields for weaker southern European countries whose competitiveness has been hit by staying in the euro is really 4-5 per cent, rather than the 6-7 per cent advanced by many analysts and the markets. Unfortunately, it is getting more and more complicated to pursue borrowing for Italy. In any case if the yields of government bonds will begin its climbing to hill, no one is considered to be having such large funds for rescuing Italy arrivederci, Italia!!! By Liudvikas Galvanauskas

Learn more about the topic

In spite of having the same leading EU countries who are ready to bailout Italy, China also expressed a huge interest in Italy bonds. Could it be the particularly needful remedies? Be careful, once China was interested in investing Greece and Spain..it didnt work out: http://www.cnbc.com/id/44490774 Seemingly, Italy has a blindly smoldering hope having present levels of Italy bonds ~5% the government would be able to rollover this debt: http://video.cnbc.com/gallery/?vide o=3000045151#eyJ2aWQiOiIzMDA wMDQzMTc5IiwiZW5jVmlkIjoiTDdE cmpkL1lFYTMrR25McVE5Y2hjdz09I iwidlRhYiI6ImluZm8iLCJ2UGFnZSI6 IiIsImdOYXYiOlsiwqBMYXRlc3QgV mlkZW8iXSwiZ1NlY3QiOiJFVVJPUE UiLCJnUGFnZSI6IiIsInN5bSI6IiIsInN lYXJjaCI6Ikl0YWx5In0= Those who might be of interest in more detailed Italys comparison to Greece: http://seekingalpha.com/article/199 875-is-italy-the-next-greece Whats going to happen next? Dont ask us, even investment genius Warren Buffett is not sure: http://www.youtube.com/watch?v=f d_ihO28pgU Apparently investing in cash is the clearest opportunity for the Nobel Prize winner Nouriel Roubini: http://www.youtube.com/watch?v= S56g53CaZBo&feature=related

Learn more about the topic:

Our reckonings seem to fulfill, at least they comply with the views of many analysts that Brazil is the best representative of all the BRIC countries: http://businessnewsexpress.com/inves tors-see-brazil-as-most-attractiveemerging-market/8777558/

The Brazilian miracle

The Brazilian economys consistent and solid performance during the financial crisis and its strong and early recovery, including 2010 GDP growth of 7.5%, have contributed to the countrys transition from a regional to a global power. Expected to continue to grow in the 4% to 5% range in 2011-2015 according to the IMF, the economy is the worlds eighth-largest and is expected to crash into the top five most powerful economies of the world in several years. During the administration of former President Lula, surging exports, economic growth and social programs helped lift tens of millions of Brazilians out of poverty. For the first time, a majority of Brazilians are now middle-class, and domestic consumption has become an important driver of Brazilian growth. President Dilma Rousseff, who took office on January 1, 2011, has indicated her intention to continue the former presidents economic policies, including sound fiscal management, inflation control, and a floating exchange rate. The markets also pose a largely supportive view of the prospects of the Brazilian economy. Even though the country has far fewer inhabitants than India or China, it is the leading constituent of the MSCI Emerging Markets Index, and has retained this position since 2008 outperforming the abovementioned countries plus a series of other fast-growing economies (Egypt, Mexico, Poland, South Africa, South Korea and so on). Believe it or not, the country has numerous reasons for that. Brazil supplies the world with commodities and natural resources such as lumber and petrochemicals. Extensive deposits of iron, manganese, nickel, tin, uranium, bauxite, beryllium, copper, lead, tungsten, zinc, gold, and other minerals are important sources of industrial raw materials and account for a significant portion of export earnings. The strength of Brazil is also associated with its oil reserves, thus it is widely regarded as the new Persian Gulf or Oil superpower. Newly discovered offshore oil deposits further brighten the countrys prospects going forward as foreign oil producers strive to enter this market and set their own oil platforms. In March 2011, the notorious British Petroleum entered a 7 billion deal with Devon to conduct field research and create oil platforms in the pre-salt regions of Brazil, which by 2020 would yield 1.82 million barrels of oil a day. Exxon Mobil and Petrobras now share the Santos basin, which contains more than 8 billion barrels of oil. From an economic perspective, feeding foreign oil giants with such an important resource is certainly unwise in the long run because of foregone profits to locals, and perhaps stricter government surveillance like in Russia or Venezuela should be undertaken Brazils economic policies generally favor foreign investment. In fact, Brazil is the largest recipient of foreign direct investment in Latin America, with the United States as the top foreign investor The country boasts one of the most advanced industrial sectors in all of Latin America. Industrial operations account for one-third of the nations GDP, with a diverse manufacturing base that includes automobiles and parts, machinery and equipment, shoes, textiles, cement, computers, aircraft, and consumer durables. Brazils sophisticated and diverse services industry includes sectors such as telecommunications, energy, banking, commerce, and information technology. Brazil also prides itself on being a leader in science and technology in South America. Local universities spend a great deal of money by attracting foreign PhDs to conduct research in fields such as biofuels, agricultural research, deep-sea oil exploration, and remote sensing, where Brazil enjoys international recognition for its scientific contributions. The country has also emerged as a leader in IT outsourcing in Latin America. Close time zones, physical proximity to the U.S., cultural compatibility, and cost savings on labor all make Brazil very attractive to companies

A nice and objective evaluation of why Brazil is a perfect subject for investment: http://www.investingdaily.com/id/18 382/brazil-is-the-best-emergingmarket.html Shoul Brazil follow Chinas case of astounding growth. This article finds the similarities between China and Brazil as well as gives an evaluation of whether one can expect convergence between the two countries: http://www.investmentu.com/2011/ March/china-brazil-emergingmarkets.html Another amusing piice of news regarding China and Brazil: http://dailyreckoning.com/emerging -market-growth-and-prosperityfrom-brazil-to-china/ Brazil and the other economies are said to set the tone in the world economy, as said by the World Bank. Check out the complete coverage on that: http://web.worldbank.org/WBSITE/ EXTERNAL/COUNTRIES/LACEXT/B RAZILEXTN/0,,contentMDK:229160 98~menuPK:322347~pagePK:1497 618~piPK:217854~theSitePK:32234 1,00.html

zones, physical proximity to the U.S., cultural compatibility, and cost savings on labor all make Brazil very attractive to companies looking to outsource tasks such as web design and programming. Serious flaws on the way The largest overhang to the Brazilian economy has been systemic inflation and structurally high interest rates. The current benchmark government-lending rate, the Selic, is yielding 12.50%; with inflation running around 6.9% that translates into 5.6% real rate of return. Far greater than almost everywhere except Greece and Portugal, yet the bewildering 12% interest rate is honestly a sign that the economy may be outpacing normal growth.

The consumption of Brazil is a large 63.1% of GDP, essentially unchanged over the latest decade. And for a developing economy, the investment share is remarkably low in levels, 16.4% of GDP in 2008 (compared to Indias 32.2% share). Brazil in particular must re-arrange its consumption/savings relationship, as the share of investment as a percentage of GDP has changed little over the past decade. Brazils experience is in sharp opposition to India, which continues to increase overall investment, primarily through increased FDI. All in all, the saving and investment story adds up to a level of productive capital stock. Without investment, there is no capital stock growth. And without capital stock growth, there is little productive GDP growth. Actually this relationship can be clearly seen by comparing Brazil with other emerging economies, where the level of capital per worker is not increasing for 30 consecutive years. This implies that the production in the country is clearly extensive but not intensive as opposed to India and China. Hnce, there is no wonder why the country is facing such rapidly growing factor prices, as surging wages push up both consumer and production prices (PPI exceeded 7% y-o-y in July).

Performance of some important economic indicators of Brazil

GDP Growth (y-o-y), 2002-2009

10-year government bond interest rates. Source: tradingeconomics.com Given that Brazil has sound banking, monetary, and fiscal policy (in fact it has a reserve surplus) in addition to its strong export economy, it seems strange that Brazil has historically and perpetually carried a huge premium in its real rates compared to similar emerging markets such as India and Turkey. Brazil has had three distinct periods of hyperinflation: the 30s, the 70s, and most recently in the early 90s. The traumatic impact of facing a 100% inflation rate is manifold; internally it decimates the savings rate and impetus for investment. Brazilians have been conditioned to not save and have little incentive to invest. In short, both countries need to increase their savings rates in order to boost overall investment and, in turn, worker productivity. The lack of savings has led to little capital available for lending. This in turn has led to extremely high lending rates. If you thought that 12.5% on a basic government bond was high, what do you think about paying 30% to 40% for an auto loan or 25% for a five-year mortgage? The reasons for these blowout rates are twofold: lack of capital available (see above about low savings rate) and the historical volatility of inflation and interest rates. This makes it a necessity for banks to require a risk premium when making loans.

Price ndices (Red Producer Price Index, Blue Consumer Price Index) 2002-2009

Exchange rate (Real/USD), the upward trend until 2007 denotes depreciation (Real losing value, but Brazil as a whole gaining competitiveness)

Capital per worker across emerging economies 1980-2009. Source: newsneconomics.com Conclusively, although the prosperous Brazilian economy brings about several signs of future unsustainable growth, it is certainly a deal-breaker in the short run, especially given its non-capital investment in people and large openness to FDI. If the latter is to be fixed through more liberal reforms and more stable prices levels, the economy is still possesses undiscovered potential for years to come. By Igors Pauks

Brazilian Balance of payments: The blue line denotes current account (inflow and outflow of goods and services, transfer payments, and participation fees) The read line denotes capital account (inflow or outflow of cash, financial assets, etc.) Note that normally current and capital accounts are inversely related: whenever there is a current accounts surplus (because of, say, positive net exports) then the country is basically a lender to other countries, meaning that its capital account will be negative.

Board updates
Here the iFund board posts weekly updates on what has been done or achieved during the week by the board: 1. Linedata Services is to become the Technological Partner of Investment Fund Agreements were reached with the American Embassy in Latvia for monetary support in providing a data feed for S&P 500 and NASDAQ 100 companies Thomson Reuters (the big financial news agency) has agreed to support us by providing a free data feed on the quotes of the largest financial markets during the Investment Game The negotiations with Finasta and PwC have entered a deadlock and it seems that the outcome will be quite unclear A detailed plan, vision and for this years Investment Game has been created and the main work will be commenced soon.

2.

Upcoming Events
Guest lecture: Striving Towards Success: the Story of Vadims and His Way to Barclays Capital M&A Division in the United Kingdom
September 20, 16.00 17.00 in 303

3.

Seminar 2: Introduction to Financial Markets II

September 29, 16.00 17.00 in 303

4.

Movie night: Wall Street

October 9, 17.00 19.00 in Soros

5.

Seminar 3: Introduction to Financial Markets III

September 16, 12.00 13.00 in 303

SSE Riga Investment Fund

Strlnieku iela 4a, Rga LV-1010, Latvia Ifund.sseriga@gmail.com http://www.ifund.lv