All that glitters is not gold.Photo Credit: SBC9 via Compfightcc
The ECB announced recently that it’ll kick off its 60 billion euro-a-month bond purchases ($66.3 bn) today. This stimulus program, a quantitative easing, is expected to involve euro-denominated public sector securities in the secondary market, as well as securities from the corporate arena such as asset-backed securities.
Quantitative easing, not new to most Central Banks these days, although common with Japan some decades ago, is a monetary policy undertaken by Central Banks when the standard monetary policy, purchasing bonds and thereby expanding the money supply, has proved ineffective. In recent years, we have seen European countries reduce their rates to much below the lower bound, to negative values.
Why quantitative easing? As I said earlier, because standard monetary policy has failed. When Central Banks are purchasing corporate bonds and assets in lieu of its own issued bonds, the prices of those assets rise and their yields fall. The monetary base increases and thence the money supply. That means there will be much money in circulation. Many persons claim this is tantamount to printing money. It is also done to stimulate spending, discourage savings and stimulate the economy to a recovery. Eventually, all these measures prove effective when banks lend this liquid money.
Quantitative easing is also used to curtail deflationary pressures on the economy.
So, with banks having high liquidity, they’re ready to give out money both locally and globally. Africa will not be left out of the lending spree.
Nigeria, South Africa, Ghana, Kenya and other African economies that have been in favorable ratings recently will expect to receive European money as loans. Will it be free?
Even when those lending rates are low, it is not free. Like in the past, it could create a spirit of “cheap loans” amongst developing country borrowers, making them increase their debt portfolio unreasonably. To maintain or increase growth, they’d have to do with some rise in inflation. Not so bad, though.
Until European recovery occurs as expected.
Too bad if the Governors of African Central Banks are not prudent. A former Indian foreign secretary, Shyam Saran, believes most of this money flowing to developing economies will be in portfolios, and not foreign direct investments. Thence, developing countries have to anticipate distortions and manage them appropriately. Portfolio investments can take flight on a whim. African economies do not have the investment climate that fosters much confidence.
Policy responses by developing countries matter when European economies start going back to tighter monetary policies. African economies should be expecting negative spillover effects when this happens. Capital inflows will reduce. Although this might not be significant but they are cautioned to exercise prudential economic management and investment in the sectors that will best allow structural change.
So, the money will not be free after all. The ECB is looking for a way to give herself time to bounce back and be competitive again.
A prey acquired by a wolf. Credit: Mariomassone
Every industry produces according to a supply chain to increase its market share, or extend its market to overseas borders. When a firm decides to acquire another, either two of the above reasons holds, or a third - acquiring the subsidiary for purely risk reduction purposes. Mergers – horizontal, vertical or conglomerate – are the most dominant form of foreign direct investment (FDI), a sign that the international markets are confident about an economy’s ability to reward them in profits. For multinational enterprises (MNE), mergers are strategic. Understanding the behavior of mergers is really important for any economy.
It is unarguable that mergers constitute 80% of FDIs, especially for developed countries. Whether a multinational seeks to gain access to foreign markets through horizontal mergers, exploit differences in factor endowments and low wages through vertical mergers, or pursue motives related to ameliorating its financial and managerial imperfections, mergers and acquisitions affect both developed and emerging economies. Therefore, it is in their best interest to understand the wavelike behavior of mergers.
Consider an atypical MNE. Why would it decide to acquire a subsidiary in a foreign market that is in the same industry? To increase its market share, of course. What really matters to this MNE is the size of that country’s GDP. Corruption and high corporate taxes might be turnoffs, but the size of the GDP is a reflection of the size of the market. What if it decides to acquire a company that manufactures a product that is part of its production process and involves intensive labor? Then, rather than GDP, low wages and wage differences, as well as the available factor endowments in the host country, would be determining factors. Sometimes, though, M&As occur for reasons outside the normal line of activities of the MNE. It might want to please its shareholders, or buy up undervalued firms in weak markets where it sees an opportunity for financial arbitrage, or because the host country has poor shareholder protection.
According to Nils Herger and Steve McCorriston in a discussion paper titled: Horizontal, Vertical, and Conglomerate Cross Border Acquisitions, horizontal and vertical mergers are by far more stable and most prevalent, while conglomerate mergers are much more noticeable just after a financial crisis.
The wavelike nature of M&As are largely in favor of firms in markets that are unrelated to the primary business of the MNE because it is pursuing a strategy of risk reduction in lieu of a financial crisis.
CBAs over time and their composition: 1990-2011. With the amiable permission of the authors.
Two cases in point were in 2000, after the dotcom bubble burst, and 2007, the beginning of a global financial crisis. Excepting a crisis, conglomerate mergers are not too common. This might be because acquisitions are a sort of a location choice solution in the market for corporate control. If the search for a location for expansion was the problem, then horizontal mergers and vertical mergers would be the variables under consideration.
A choice for horizontal expansion is then a corporate desire to increase market share, for access to new markets and cultures. This is more noticeable in manufacturing such as food production and electrical equipment, in the services sector as in engineering and accounting firms, and also in the oil and gas extraction industries.
A choice for vertical expansion becomes a desire of possessing suppliers at the intermediate stages of the production process, especially where labor constitutes a significant part of it. The highly labor intensive manufacturing sector is a first culprit.
The wise investor seeks to understand what motivates MNEs to merge and acquire other firms in other countries, and why the international market for corporate control seems volatile, at times, with no apparent rationale. The wise investor who understands the difference between portfolio investment and FDIs and what drives both would not be taken unawares.
This article was inspired by the discussion paper from the University of Exeter, UK, titled: Horizontal, Vertical, and Conglomerate Cross Border Acquisitions..
