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Recent changes in the country are visible and
perceptible
The monarchy paved the way for a parliamentary democracy
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Sourajit Aiyer - GSCGI WealthGram, Switzerland - Cracking Asia’s Final Frontiers: Case of Bhutan, Jun 2014

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Sourajit Aiyer - GSCGI WealthGram, Switzerland - Cracking Asia’s Final Frontiers: Case of Bhutan, Jun 2014

  1. 1. Gram Wealth THE IFA’s LA TRIBUNE MENSUELLE DES MEMBRES DU GSCGI wealthgram@gscgi.ch www.gscgi.ch Vol. III N°29 - Juin 2014 Groupement Suisse des Conseils en Gestion Indépendants www.gscgi.ch associations’ day at 2014 cifa forum • XIIth International CIFA Forum THE NEW PARADIGM FOR WEALTH MANAGERS 23rd -25th April 2014, Monaco, Hôtel Hermitage Social Network Platinum: Media Partners Platinum: Contributing associations: association nationale des conseils financiers
  2. 2. Recent changes in the country are visible and perceptible The monarchy paved the way for a parliamentary democracy in 2008 to institutionalize the governance system. Given its systematic planning, the economy itself has grown at rates of 7%, 12%, 9% and 5% in real terms, in the last four fiscal years. Secondary and tertiary sectors led the growth in the recent years, some large projects were initiated and public services expanded. The resultant growth in income is apparent, and Thimphu has expanded with the urbanization flow. New buildings, both residential and commercial, are coming up along the Babesa highway just before the city starts. This stretch of ~5 kilometres on the southern side of Thimphu looks a major construction site. The real estate activity is more in this part of town because this is a stretch of flat-land,whereas uphill mountains at the other end (north-west) of the city limit the scope of real estate expansion. Two senior professionals from the Bhutanese financial sector whom I met informally said some home-owners are trying out new interior designs inside the houses, an indication of changing times. While the building supply would be backed by demand, not all would have the capacity to buy new houses. It is easy to see cases of families living in strained/worn-out houses if one walks along the bylanes of the city, though its proportion seemed lower than other Asian developing countries. Nevertheless, how many of them are actual home-owners, how many are tenants on lease and how many can afford a home loan is something only the Census statisticians can say. While education enrolments have picked up, the job market has not kept speed. Employment capacity of the public sector seems to be reaching saturation and the private sector is yet to expand to that extent. There were at least 2 taxi rides where I was surprised to find that the drivers (a man and a lady of the younger Gen-X/older Gen-Y age group) were actually qualified students working in a government office on-contract for part of the week, and were driving taxis in the remaining time to supplement their income. Both said they were lucky they were able to afford car loans, as not everyone is able to do so. But there did seem a sense of despair at the general lack of full-time job opportunities. Regarding low- income labour, either the Bhutanese have not built their skills or they seem not to like getting their hands dirty - a bit akin to the Arabs in the Middle East. Most of the labour working on road and construction projects seemed to come from India, a fact made clear on hearing the music playing on their radios GramGram Wealth THE IFA’s LA TRIBUNE MENSUELLE DES MEMBRES DU GSCGI wealthgram@gscgi.ch • www.gscgi.ch Vol. III - N° 29 - Juin 2014 PLACEMENTS & TECHNIQUES DE GESTION Cracking Asia’s final frontiers by utilizing “islands of proficiency”: Case of Bhutan Groupement Suisse des Conseils en Gestion Indépendants www.gscgi.ch 1 • Frontier markets have caught remarkable attention in recent months. As an analyst is said to have summarized it during an investor roadshow in Nairobi - that everyone and their dog seems to know something about frontier markets. Improving governance, positive demographics and reforms’ initiation at one side, the large population is a major rationale to look at economies like Vietnam, Argentina, Kenya, Colombia, Nigeria, Bangladesh, Romania, Pakistan or even Myanmar. From population terms, there would hardly seem a validation to think of countries like Bhutan. After all, it has a population of just ~750,000 and does not figure in the list of typical frontier markets (hence. I have used the term ‘final frontiers’). However, every economy is still an economy. Specific opportunities can exist for those enterprising enough to invest some time to sift through its threads, identify sector-specific micro stories (‘islands of proficiency’) and place emphasis on the profitability potential of opportunities rather than just the growth potential. One needs to look at it more with a granular/micro/sector-specific mindset rather than a broader/macro/‘country-story’ mindset with which most look at the large emerging/frontier markets. In January 2014, I made a short trip to Bhutan, and took that chance to make some observations on ‘Ground-Zero’. There are three basic reasons why I think there might be some rationale to look at this final frontier market. First, Bhutan is a country which has undergone political and economic transition. More importantly, it is phasing it in a gradual, step- by-step manner. That might seem an intelligent and mature way of managing transitions, given the numerous cases where countries have simply rushed head-first and often fallen nose- first in the process. Second, the attitudes and aspirations are changing with uptick in local income and media proliferation, fuelling demand in specific sectors. The strength of the ‘demographic attitude’ in this case offers the chance to help businesses benefit from ‘islands of proficiency’, especially as the competitive scenario is still nascent and there is scope to capture the first-mover advantage. Third, the debate between chasing profitability (or ROE) or chasing growth has bitten the post- 2008 business world, especially when it comes to a new market. Thecriticalityofmaintainingprofitabilitytoavoidcapitalerosion and accumulated losses cannot be overemphasized. After all, not every venture by global businesses in the large emerging/ frontier markets has shown rapid profitability.
  3. 3. GramGram Wealth THE IFA’s LA TRIBUNE MENSUELLE DES MEMBRES DU GSCGI wealthgram@gscgi.ch • www.gscgi.ch Vol. III - N° 29 - Juin 2014 PLACEMENTS & TECHNIQUES DE GESTION Cracking Asia’s final frontiers by utilizing “islands of proficiency”: Case of Bhutan Groupement Suisse des Conseils en Gestion Indépendants www.gscgi.ch 2 • when one halts beside their work sites. Most of the boys of the older Gen-Z/younger Gen-Y are increasingly sporting the ‘punk’ look and most girls are sporting generous doses of chic- fashion/accessories. An expat working with an international organization in Thimphu told me that the young Bhutanese have become big fans of Korean television programmes. People are high on aspirations and desires, reflected in changes in attitude. Those who are earning well are willing to spend on new consumption, be it clothing accessories, cars, hang-out zones or department stores. Cars are larger and in more quantum and variety, whereas they used to be smaller and fewer till the 1990s. New coffee shops and restaurants are sprouting up in the city centre, and affluent local/expat crowds are thronging at all hours. Average prices in these establishments seem on the higher side as compared to levels in Thailand, India, etc. But then Bhutan has very few such outlets, hence, some element of monopolistic-type pricing by the first-entrants might be existing. While department stores used to store mostly ‘Made in India’ products earlier, now one can see ‘Made in Thailand’ and ‘Made in... etc.’ also jostling for shelf space in most stores. What sector-specific micro opportunities do these changes spell? Following are a dozen that came to my mind based on the observations. I emphasize these are not just products for global businesses to export to Bhutan. Most are possible to be also produced locally in Bhutan over-time. That can create production-oriented jobs for locals, instead of just trade/sales- related jobs. But that depends if the country itself has the capabilities or desire to expand into ventures, albeit with foreign investment/foreign technical partnership. Some of these ideas use intellectual capital, some use physical capital, and some use a combination of the two. In most of them, I have tried to draw parallel to India using similar Indian companies as examples. Similarly, such examples of successful companies would exist globally in other countries as well: 1) Electric cars: Bhutan has been looking at electric cars sector for some time, and has recently cut a deal with Nissan for its Leaf. Despite being a hydro-electricity producer, most of its internal energy consumption is fuelled by imported fuels as most of the hydro power is exported. Apart from environmental concerns, there are other justifications for electric cars. Thimphu is only as big as an average neighbourhood/borough of a city like Mumbai, Delhi or Bangalore. Hence, intra-city driving within a small city means one is never really too far from their homes, i.e. the charging point. The Bhutanese financial professionals remarked informally that young Bhutanese increasingly preferred to drive, rather than walk short distances. While it does not mean the population is becoming lazy, it does show a shift in people’s attitude. The vertical expansion in the city is yet to occur. Most buildings have few storeys which makes wire-charging practical if batteries are difficult to detach and carry. Mahindra & Mahindra also announced plans to launch its E-20 (formerly Reva). Entry strategies by electric car makers should be more aggressive if the price differential between the various models justifies it. Mahindra E-20 costs the equivalent of ~0.6 million Indian Rupees in India. Through informal chats with local cabbies, I learnt that the average car imported from India costs about 20-25% more than its price in India. By that estimate, one can add 20- 25% over the mark-up of the Mahindra E-20 for its cost on Thimphu’s roads. Public transport of choice in Thimphu is also the taxi. Most taxis are Maruti Suzuki WagonR/Alto or Hyundai Santro made in Indian factories, which cost ~0.35-0.5 million Rupees in India. The price point of electric cars keen to enter Bhutan has to be comparably affordable; otherwise the loans might be out of reach for most buyers unless the loans are subsidized. 2) Processed-packed food products: There seems a demand for processed foods like meat products etc, as evidenced by the stocks in department stores. The population is able to pay and willing to pay. Hygiene in packaged foods might be a reason, as compared to the raw meat at the traditional shops. Another is the longetivity of the processed/packed version. Daily cooking is not practical with a working population comprising both men and women due to lack of time and lack of hands, a feature also common in India. Bhutan itself has set-up a company in the agro processing space,and there might be a rationale to invest into similar processing facilities given it has adequate supply of the raw materials. 3) Mobile V.A.S.: In a country where TV programming was banned till the 1990s, media proliferation has now grown =============================== “the average car imported from India costs about 20-25% more than its price in India” ===============================
  4. 4. GramGram Wealth THE IFA’s LA TRIBUNE MENSUELLE DES MEMBRES DU GSCGI wealthgram@gscgi.ch • www.gscgi.ch Vol. III - N° 29 - Juin 2014 PLACEMENTS & TECHNIQUES DE GESTION Cracking Asia’s final frontiers by utilizing “islands of proficiency”: Case of Bhutan Groupement Suisse des Conseils en Gestion Indépendants www.gscgi.ch 3 • leaps and bounds. Latest phones are visible everywhere, and young faces are visibly busy peering into their various gimmicks. This suggests potential for Mobile VAS providers to tie up with local networks. Mobile VAS includes mobile gaming, tones, infotainment, live streaming, m-commerce, etc. A number of mobileVAS players in India like OnMobile, InMobi, CanvasM, Mahindra Comviva etc have made this segment a success story in the Indian telecom space. 4) Solar renewable energy: The sunlight is intense and virgin when it hits people in Bhutan, which is easy to understand given its altitude and low pollution. It was enough to tan a person within 3-4 days if most of the time is spent outdoors. Conversely, the sunlight hitting flat and polluted cities is more diffused and mild. So is there a scope for solar renewable energy? Its government does seem to have upheld environmental causes. Solar power would further reduce its dependence on oil imports. Being a mountainous terrain, the country has tracts of land which are not easy for real estate or agriculture development. This is visible in the eastern parts of the city across the river, on the western part near the TV Tower, and on the southern part around the Buddha view-point. These tracts can be useful areas to set up solar photo-voltaic panels to absorb sunlight and channelize the electricity into the national grid. Today, solar panels are easily set on roofs of buildings and large-scale solar panel farms are also being set up. Logic suggests that sunlight absorption would be higher where it is more intense and bright. Nevertheless, a limitation is that the movement of shadows owing to the position of nearby mountains vis-à-vis the sun can restrict the amount of time sunlight hits a specific surface. 5) Commercial loans, boutique i-banks and online trading developers: Bhutan’s government pays for healthcare and higher education for its people in most cases - two key reasons why people globally save. Bhutanese seem more consumers by nature, rather than savers. Low interest rates historically have also not been much of a motivation. This can constrain the ability of the Bhutanese banks to lend to investible projects, if the supply of funds does not match the demand. Depending on the due diligence of local projects and regulatory requirements, there might be an opportunity for global commercial banks to look at lending to genuine, high-asset quality projects in Bhutan. To draw a parallel to India, commercial banks here have funds owing to the average Indian’s propensity to save. But the ability to lend is constrained due to asset quality concerns in the wake of the economic slowdown. The scope of capital markets also draws interesting observations. The local professionals told me the country’s stock market has only about 20 listed companies, but the appetite for those initial public offerings had been huge. One can argue the appetite is high due to the fledgling stage of the markets and novelty of the IPO product. But one can look at it from another angle – that cracking the first sale is often the toughest sale and subsequent sales get accepted more easily, more so if the money in people’s wallets is only set to grow. Potential appetite of future listings might warrant the attention of boutique investment banks for sector-specific advisory service. Online trading in shares has also picked up, and might offer scope for technology service providers to partner with the four local brokerages to enhance their online offering to clients. 6) E-commerce retail platforms: Indian e-commerce firms like Flipkart, MakeMyTrip, Rediff, Jabong, Myntra etc have garnered market share in India, and are employing large numbers of people. Bhutan has good internet connectivity and most young people are literate and computer-savvy. If investing in physical outlets poses viability concerns, then expanding the e-commerce offering might have potential,provided security of online payment gateways is maintained. There is hunger for products - evidenced by the variety of casual apparel, shoes, fashion accessories, electronic and entertainment gizmos, etc seen on the people in the high streets. Formal clothes might have a limited market, since most locals wear traditional attires at work. I do not know the penetration/ safety of online banking services in Bhutan, but there are also strategies to navigate that if it poses a constraint. For example:India’s Flipkart allowed cash-on-delivery option for clients in India who were unable to make payments online. 7) Pre-fabricated furniture: Given the real estate activity, there might be a rationale for pre-fabricated furniture. These are made from compressed ply,sawmill products,etc,and are easy to set-up/dismantle, easy to move and light-weight. They are increasingly favoured in India for its practical advantages, if the foot-falls seen in stores like Home Town or Reliance Living are an indicator. Bhutan,though being rich in timber
  5. 5. GramGram Wealth THE IFA’s LA TRIBUNE MENSUELLE DES MEMBRES DU GSCGI wealthgram@gscgi.ch • www.gscgi.ch Vol. III - N° 29 - Juin 2014 PLACEMENTS & TECHNIQUES DE GESTION Cracking Asia’s final frontiers by utilizing “islands of proficiency”: Case of Bhutan Groupement Suisse des Conseils en Gestion Indépendants www.gscgi.ch 4 • resources, restricted the export of timber to India few years back to maintain its ecological balance and prevent excessive deforestation. In this context, the demand for furniture fuelled by the building boom might mean demand for more timber, something which the nation might want to avoid in order to maintain its ecology. Hence,usage of pre-fabricated furniture might actually serve a broader national interest. 8) Chic hang-out zones: Growing consumption and changing lifestyles mean changes in the way people spend their leisure time, be it in shopping plazas or socializing in ‘chic’ public spaces like coffee shops and restaurants. These are the current hang-out zones for the affluent locals, and the 1990s western music playing in some of them seems to target the younger Gen-X/older Gen-Y age group. There might be more appetite for such outlets if the quantum of high-income earners grows further, coupled with the fact that the number of such chic outlets is still limited in the city. 9) Vocational/professional courses in higher education: Constructions of the Knowledge Park on the Paro- Thimphu highway and the IT Park in Thimphu are evidences that the government is taking the objective of higher education and creating further jobs very seriously. But apart from universities/colleges,higher education also includes professional and vocational courses focused on specific streams which help build expertise in that specific area and make the students job-ready. It helps create ‘employability’ of the students. Successful examples in India are software/IT institutes, hotel management colleges, graphics designing, media and mass communication colleges, industrial training institutes etc. After all, there is only a limit of engineers, doctors and lawyers a country can employ. Every country also needs professionals in other work areas as well, otherwise it needs to import that talent. Investing into education is also akin to investing into the country’s future, since the skills of its people are its biggest asset against competing nations in the global arena. India’s leadership in the global ITES and software sectors are classic examples. 10) Online newspapers: Local newspapers were not really impressive, with dimensions of an afternoon tabloid paper and just a dozen pages. The small population size poses a constraint to set-up the full fledged newspaper since the readership base is limited. So it might be worth looking at a digital/online newspaper with both news and infotainment content, which makes its revenue from either the advertising or subscription. There might be such products already existing in the country, unfortunately I did not spend much time in ‘Bhutanese cyberspace’. 11) Online travel booking platforms, budget hotel chains: Tourism is a major draw. But what is really missing is a good online booking platform if one is not travelling as part of large, package groups. Using my own experience,it was difficult to book Druk Air’s tickets online, and it has a limited number of travel agents. It was also tough to book hotels through phone/email. Of the dozen hotels in the Ngultrum 1,200-2,000 range whom I contacted, only two acknowledged. It was not the most streamlined booking experience. Hence, there might be scope for online booking platforms which make it convenient for individual budget travelers, like MakeMyTrip or Yatra in India. However, the number of tourist arrivals may not grow exponentially - the small tarmac bay of Paro airport can only fit a limited number of aircrafts, road travel is time-consuming, Gelephu airport development is delayed, and the government itself is keen to limit the tourist inflows to maintain the ecological balance. Hence, service providers need to manage costs within limited tourist volumes. Budget hotel chains might take a look at Bhutan. Why not 5-star chains? Most foreign visitors apparently pay a per-day fee which limits the number of days spent, most of the time in Bhutan is spent outdoors in day-trips, there is limited time to spend in the hotel to use its luxury services and the existing 5-star TAJ property might just be sufficient for the quantum of high-end tourists. Resultantly, the numbers might warrant the attention of only budget chains like Ibis, Ginger Hotels or Lemon Tree. 12) Fitness centers: From the above observations, it is apparent that the Bhutanese society might be on the eventual path where people are walking less, not always eating healthy foods,too busy at work to take time off,etc. Such examples of societal transformations abound globally,where a proportion of the people fall prey to lifestyle issues like obesity,‘bulging- =============================== “Bhutan, though being rich in timber resources, restricted the export of timber to India few years back to maintain its ecological balance and prevent excessive deforestation.” ===============================
  6. 6. GramGram Wealth THE IFA’s LA TRIBUNE MENSUELLE DES MEMBRES DU GSCGI wealthgram@gscgi.ch • www.gscgi.ch Vol. III - N° 29 - Juin 2014 PLACEMENTS & TECHNIQUES DE GESTION Cracking Asia’s final frontiers by utilizing “islands of proficiency”: Case of Bhutan Groupement Suisse des Conseils en Gestion Indépendants www.gscgi.ch 5 • waist’, etc. This might just interest fitness chains like Fitness First, etc. Is it justified to look at these opportunities, given it is a small market? Here I would like to draw the attention on the profitability vs. growth debate highlighted in the initial paragraph. The market might be small, but one needs to look at it from the perspective of a correspondingly lower capital outlay and the profit potential. For example, I might need 100 dollars of capital to set up 10 outlets in a large market where I might earn 20 dollars profit. A small market like Bhutan might warrant only 1-2 outlets, i.e. a limited outlay of 10-20 dollars. But as long as the project earns a profit of 2-4 dollars, the ROE is maintained. It has some ‘margin of safety’ since the absolute amount of capital is committed to an unknown market is lower. Even expansion into small areas within a large country requires breaking up of the larger business plan to examine the viability per location. Hence, one can compare a small market like Bhutan to a sub- portion of a larger economy. But it assumes the 2-4 dollars profit factors in the additional compliance/regulatory cost,given it is a separate country. The potential to earn that profit fast seems to exist because: (a) Competition is still limited and the first-mover advantage exists, to some extent. In comparison, competition is already high in large emerging/frontier markets. Bhutan might not be a demographic story, but it seems to hold potential to realize profitability faster vis a vis larger markets, which hold higher growth potential but are challenged due to sheer number of players competing, leading to capital erosion, delayed break-even and unrealistic price wars. (b) The government will also have to think about increasing economic opportunities for its jobless youth, otherwise restlessness and impatience will eventually rise as the supply of qualified youth increases each year. The monarchy seems pro-people, and its popularity amongst the local/foreign residents is clearly visible. The commitment of the establishment to create opportunities for its people seems to be concrete. The government has to delve how it can manage the economic needs of its youth within its much admired Gross National Happiness objective. Does this mean there are no challenges? The government has faced criticism in the international media foritshandlingofthesituationoftheBhutanesepeopleofNepali origin who could not prove their residency as per the 1958 law, rendering them homeless in camps in Bhutan and Nepal. There have been some incidents of violence and situations of unrest associated with this issue. Any situation causing heterogeneity/ ghettoism of population segments is best avoided, especially in a small country like Bhutan where any demand leakage should be a concern. Also,when people and lifestyles mix,it is good for business as it enhances scope for products that one might not otherwise have demanded. Another is the vacancy rates in the newly constructed buildings. If the demand continuously falls short of supply and prices do not reconcile, then vacancy rates will move northwards and remain sticky. This can eventually lead to a bubble and loss in invested capital. The supply of educated youngsters is only going to increase each year. Controlling the impatience and frustration of its educated yet jobless youth is a socio-economic challenge, especially to avoid those ill feelings getting targeted towards the government. Lastly, while some steps of the government might seem restrictive (like restricting car imports, etc.), they were good from ensuring the nation’s long term sustainability. But such uncertainties worry those who have committed capital. Conclusion There might be some opportunity to extract profitability even in the ‘final frontier’ markets, despite the population size not being significantly large. One needs to look into the viable sector-specific micro ‘islands of proficiency’, study the strength of the ‘demographic attitude’ rather than just the ‘demographic quantum’, the existent competitors and scope of the first-mover advantage. At the end, profitable growth makes a valuable and sustainable business. In this case, the absolute value of potential profitability is low owing to the lower capital outlay in a small market. But the chances of achieving the potential profitability faster seem bright, especially when one recalls that a proportion of new businesses in large emerging/frontier markets are still struggling to achieve profitability due to the old adage – too many cooks spoiling the broth. Sourajit AIYER sourajitaiyer@gmail.com ____________ This article was originally published (in abridged form) in The Straits Times, Sin- gapore The author works with a leading capital markets company in India. Views ex- pressed are entirely personal and do not represent those of any entity.

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