Steering a careful path

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A decline in oil prices and a regional economic crash should be bad news for an oil-based economy in south-east Asia. But Brunei is insulated from the worst of this economic turbulence. And this quiet country of 300,000 people is focused on the longer term. Nigel Ash reports

Words such as "crisis" and "recession" which are being hurled around much of the rest of Asia, do not seem very appropriate in Brunei's capital Bandar Seri Begawan. Riots and political unrest may be gripping its immediate neighbours, Malaysia and Indonesia, but Brunei Darussalam (The abode of peace) is living up to its name. The autumn storms can be loud and flashy but they are short-lived and the rain they bring is warm and not unpleasant. Brunei is a peaceful, very orderly city. A senior government official recently left his kerbside parking space and drove around in his car until he could find the blue uniformed lady to whom he had to pay the Br$1 ($0.57) parking fee.

The Malays who make up the great majority of this small nation of around 300,000 people which nestles into 5,765 square kilometres in the northern part of the island of Borneo, are a charming, polite and laid-back people. They have become accustomed to steady and growing prosperity since the country acquired complete independence from the British in 1984. There is no personal income tax, a relatively high per capita GDP of just over $14,700 (in 1997) and cradle-to-grave health and welfare provision.

This has all been paid for by the flow of dollars from the country's oil and gas fields. But the price of the local Tapis blend crude has tumbled almost 40% to below $13 a barrel and by this September had only recovered to around $14.85. The government's current five-year plan, which started in 1996 with a planned allocation of Br$7.2 billion ($4.1 billion) was based upon what one senior finance ministry official describes as "what we thought at the time was a very conservative and indeed pessimistic price of $18 a barrel". But at the plan's recent mid-term review there were glum faces. In addition to the fall in oil prices, official estimates of economic growth for 1998, originally scheduled to be 4%, were being revised downwards for the second time to something in the region of 1.8%. This is a shock for an economy that from official figures had been bowling along at a GDP growth rate of between 3% and 4% since 1995.

According to some observers however, anecdotal evidence suggests that growth has in fact virtually stopped, if it has not actually turned negative. New car sales are for instance about 50% down on 1997 and supermarkets are reporting a 20% drop in turnover. But this is a recession that can never really bite, because half of the workers in the kingdom are employed by the government. While state bodies may be putting off new projects or slowing down payments for work already undertaken, both of which measures have reduced liquidity for the small private sector, the government continues to pay its employees punctually.

The need for diversification

It has long been a tenet of government policy that steps must be taken to diversify the economy, in preparation for the time when the oil and gas production, which in 1997 was flowing at the rate of 163,000 barrels a day and 1,070 million cubic feet a day of natural gas, begins to run out. Oil has fallen as a contribution to GDP from 83.7% in 1980 to just 35.6% of 1997's GDP of $8 billion. Even so, as an oil specialist points out: "Brunei's oil is extremely profitable on a production cost per barrel basis. All the capital equipment has long ago been written off and the oil and gas is in fairly shallow water, which presents far less expensive technical challenges than extraction in other parts of the world. There is more revenue from liquified natural gas because it is being sold on long-term contracts which have complex structures that have an element of forward pricing."

However, the Asian economic downturn - even with its limited impact upon a still extremely wealthy Brunei - has engendered an extra sense of urgency.

"We have to open up our economy," says Hajah Rosni, deputy director at the department of economic planning and development in the ministry of finance. "Brunei is a small country which has been very much dependent on oil revenue. Since the third five-year national plan began in 1975, diversification has been our main objective. We are now on the seventh plan and we have to work harder. The impact of the Asian crisis is not so bad for us because we are not a borrower and of course our main export is still oil and gas, not manufacturing as such. So the slowdown in economic growth is related to the prudent fiscal stance which started this year."

J Keir MacKenzie, deputy CEO of Hongkong Bank adds: "The good thing about the present situation is that it has forced a serious reappraisal of economic policy in Brunei. There are various moves afoot on this. Ministers are talking about greater transparency and there is the Ministerial Economic Commission which is for the first time including business leaders in analysing the problems. This is a very positive move. Once you realize something is wrong, you can do something about it."

During the long boom, the economy experienced both labour shortages and a shortage in the number of Bruneians with the requisite technological and administrative skills. The first of these problems was addressed by the import of up to 100,000 expatriate workers, the second by a large programme of government-funded overseas education for Brunei students.

With the government responsible for around 80% of economic activity, the private sector has been in the shade, even though officials emphasize the importance of its development. One thing that has deprived the local private businesses of bright young graduates, fresh from their overseas courses and clutching their degrees, is the stipulation that those whose foreign education has been funded by the state are obliged to spend their first five working years in the public sector. If they choose not to, they must repay the grant aid that has been provided.

According to one private-sector manager, this rule has tended to misdirect talented young people into not always fulfilling government posts, at the very time when their knowledge and enthusiasm might have been more profitably employed in the private sector.

From bricks to beef

That said, there is a limited number of private companies, many of which are involved in the service sector. Among the few manufacturers, a brick-making company, whose most sought after product is a double-sized brick, has been successful both in the local and the Singapore markets. Logging is strictly controlled in the kingdom and is confined to 38% of the total forest stock, but one timber company has built up a good business harvesting a carefully defined area of rain forest and making good with new plantings.

Concerns that imported beef has not been killed in the strict halal fashion led this summer to a ban on such supplies and saw burgers off the menu at the capital's McDonalds outlet. A hi-tech local slaughterhouse is being completed and a contract for the import of Australian cattle on the hoof is being negotiated. Some local businessmen welcome the beef-import ban as a shift from the easy-going non-protectionist policies of the past decade, and hope it will be extended to other areas where Brunei has a reasonable chance to substitute imports.

In the last few years the Brunei Industry Development Authority (BINA), the foreign investment agency that is part of the ministry of industry and primary resources, has been campaigning to attract overseas businesses, giving particular emphasis to manufacturing rather than service industries. The inducements include the kingdom's political stability and strategic location in south-east Asia; its lack of taxes on personal income, sales, manufacturing and exports, a tax holiday of up to eight years, easy import of foreign personnel from labourers to managers, the lowest utility costs in the region, excellent communications and some of the most pleasant living conditions in Asia.

Brunei has a relatively large and competitive banking community, two main ports at Muara and Kuala Belait and the international airport outside the capital which has been designed to handle 1.5 million passengers and 50,000 tonnes of cargo a year.

In the decade to 1998, BINA has overseen - or is about to - Br$490 million-worth of projects on specially created industrial parks. However, only Br$130 million ($75 million) of that investment has come from overseas, with the major investors being Malaysia (Br$30 million) and Singapore (Br$24 million). The rest has been made by Brunei investors, either as part of joint ventures with foreigners or in wholly local projects.

Companies can be up to 100% foreign-owned, but most of those that have come in have been joint ventures with local partners. Malaysian and Singaporean investors are running half a dozen highly successful garment factories at Serasa, working almost exclusively on export production. With a combined annual turnover of around Br$100 million, they are making high-value brand-name fashion garments, primarily for the US market. But this venture is unlikely to continue on the same scale when Brunei, which has no garment quota limitations into the United States, loses this advantage with the general abolition of quotas in 2003.

A British joint venture in which Semaun Holdings, a state company owned by the ministry of industry and primary resources, has a 70% stake, is about to start producing a range of solar panels at its 1,000 square metre factory at Beribi to the west of the capital. The Br$2 million company, Solartech Systems, which will eventually use locally-made aluminium profiles, plans to produce 10,000 units in its first year on a single-shift basis, employing around 20 workers. The majority of production is slated for export.

Kamis Haji Tamin, managing director of Semaun Holdings, points out that one of the important factors for Brunei in the deal is that the British partners are to be responsible for marketing. Perhaps because of their culture of politeness and good manners, the Bruneians do not generally seem to have the necessary aggression to make good salesmen.

Shortly coming on stream is Semaun Sea Food, another joint venture, this time with Singaporean and Canadian partners as well as a local fishermen's cooperative at Muara Sersa on the north-eastern tip of the country, where a fish processing and drying plant is being established. "The intention is to export most of the production," says Kamis Haji Tamin. "However there is a good local market for the product as well. Half of our fish-based products are imported and because we have an open trading system and don't use tariffs, local producers can find themselves at a disadvantage."

Another sea-food venture in which Semaun has a stake is a prawn breeding and growing-out facility which is currently exporting limited amounts to Osaka in Japan, using the scheduled twice-weekly flights of Royal Brunei Airlines. A further fish company is exporting grouper fish to Hong Kong.

Kamis Haji Tamin believes that by working to enter export markets, Brunei producers will be compelled to become more competitive. He emphasizes that every venture in which Semaun joins has to be viable. "We are not interested in businesses that will need subsidy," he says. "We are here as a commercial entity and we make that very clear to all our potential partners from the very beginning."

The long-term aim for all Semaun's joint ventures is, he says, that once they are established, the state company will divest itself of the majority of its holding.

Despite the official desire to attract foreign investors there are some reports of potential incomers withdrawing, largely because of long delays in the bureaucracy. The creation of BINA was designed to rectify such bottlenecks and speed up approvals by acting as a one-stop agency that could pull together the required approvals of a disparate number of official bodies into a single process.

One frequent difficulty was arranging the allocation and leasing of land for factory sites. For investors with sophisticated electronics production in mind, BINA sought to overcome delays by establishing its own Br$60 million hi-tech industrial park, with units that it could itself dispose of. However, turf disputes with the powerful Brunei Investment Agency, which believed that it could better develop the park, have led to delays and the facility remains unbuilt.

Some people talk of attracting a major hi-tech name from South Korea or Japan to set up a manufacturing base in Brunei. Such a flagship foreign investment project which, it is argued, could be heavily seeded on a one-off basis by the government, would surely attract a host of investors anxious to create support industries. But it has to be wondered what effect the arrival of a Sony or an LG would have on a society whose total population is little bigger than that of a medium-size European city. Bruneians recognize the need for changes and reforms but at the same time do not want to lose their highly valued traditions.

"In a way the delay in attracting foreign manufacturing has not been all bad," comments a local banker. "Most such investors would have been looking to export to the regional Asean market. At about this time, these companies would just be bringing their production up to maximum levels and suddenly they would be seeing their markets disappear under the weight of the regional recession. I would say that it was fortunate that they did not come in on the end of a boom and then have to ask themselves if they could afford to wait here until their export markets recovered. And Brunei has been spared the embarrassment of seeing hard-won investors packing up and going home."

But David Knight, deputy manager of Standard Chartered Bank, believes that the importance of the government sector gives Brunei some insulation from the crisis affecting the rest of the south-east Asia. "I think that what is positive about Brunei is that this is a relatively small economy," he says. "It is hugely affected by what the government does. In the short term, it would not take a very great deal to kick-start the economy back into momentum. Maybe Br$1 billion would be enough to get the place progressing quickly.

"I think that what is also positive is that there is the sense that there is a quite healthy atmosphere for change and for the introduction of some further measures to help encourage more investment and make things easier for small and medium-size enterprises and international investors.

"I would also point to the existence now of the Ministerial Economic Council. In the history of Brunei I am sure that there has never been an occasion where you have had a government initiative that has involved a very good cross-section of people both from the government and the private sector. The private sector is getting a lot more air time than before.

"On the negative side, there is still too much bureaucracy. Talking to customers that are looking to set up their business in Brunei, the bureaucracy is still a complication. But there is a receptiveness to comments about this. There is now talk about fast-tracking certain investments. It is my belief that there is a genuine momentum for change and reform of some of the previous barriers to make life easier for businessmen."

Overseas businessmen and bankers frequently emphasize the polite conservatism of the Bruneians. "They find saying no very difficult because it is impolite," says an overseas banker. "You therefore have to be extremely sensitive to their reactions to proposals."

Marked significance was attached to the installation this August of the Sultan's 24-year-old son Prince Haji Al-Muhtadee Billah as crown prince and future ruler of Brunei. The 500-year-old monarchy is held in considerable respect. Thousands of people lined the streets of the capital in spite of a heavy and prolonged rain storm to witness the crown prince's inaugural procession through the capital.

To a visitor, the capital is a small, well-ordered city in which most key ministries are within easy walking distance of the downtown hotels. The stilt houses of the Kampong, around which water taxis hurtle with alarming speed, might seem a mere touristic curiosity. To the Bruneians, however, they represent the important historic base refuge from which the monarch and his people only began to move to dry land at the start of this century. Nor has this area become a poor shanty town. At least one millionaire still lives in his stilt house family home and as if to reinforce their cultural importance, a new modern estate of stilt houses has been built further downstream.

Brunei: key facts
Population ('000): 314
Annual population growth (%): 3
Area (km2): 5,765
GDP: (US$ bn) 4.7
GDP per capita: (US$) 14,700
Currency: Brunei dollar
Brunei: oil and gas production
199519961997
Oil (thousand barrels/day) 175 165 163
Gas (Mmscf/day) 1,080 1,073 1,070
Source: ministry of finance

Moving Brunei offshore

"There is quite a good case for Brunei as an offshore banking centre," says David Knight of Standard Chartered Bank, "I think that there is certainly stability here and if you look at some of the other such centres around the world, it is clear that Brunei already has some of the requirements. There is an established banking community, excellent communications and a per capita income that is on a level with other centres such as Jersey. However if you think of the competition in places like Hong Kong and Singapore, it is clear that it is going to have to offer some pretty attractive proposals. Labuan in Malaysia as not been a success and I would say that Brunei has a far better presence and reputation in the international community. But this will need careful planning and very skilled marketing."

Harry Sassoon, a consultant from Business Perspectives in the UK, has been appointed by the ministry to coordinate the offshore project (draft legislation has already been presented to the ministry of finance). "The question that we have explored," says Sassoon, "is what advantages Brunei can offer as an offshore location in the Asian time zone. One of the clear advantages is that it has a highly reputable system based on English law, that goes all the way to the Privy Council in London. The will is also there. Recognizing the need to diversify away from dependency on their oil revenues, the government wishes to develop a regional role which is consistent with a very small and narrow economy."

Work on the offshore project began early in 1997. The first stage, says Sassoon, was to identify comparable offshore centres worldwide, such as the Cayman Islands, the British Virgin Islands and Gibraltar. The next step was to examine the strategic choices for offshore business. "The first is investment business, which embraces trust administration and offshore company management services," explains Sassoon. "The second is investment management, which covers offshore funds and portfolio administration services and the third is offshore banking." The two sectors that have been left to a later date are offshore insurance and offshore securities dealing. "We left these to one side," says Sassoon. "We couldn't do everything at once and the government has given us the go ahead on the first three."


Inching towards a capital market

Does a country with few investors and a limited number of companies need a securities market? If the economy is to continue to mature, it probably does

Though it has often been mooted in recent years, Brunei still has no local stock market and in the opinion of one local banker, the emergence of such an institution is unlikely at present. "I don't see that there is an immediate prospect or need," he says. "There is a very small proportion of potential share owners locally, people who will be willing to participate in shares here. Then there is the question of where the product would come from. There are very few clear candidates for privatization."

The development of a local bond market may be more likely. Issuers might include state-owned enterprises, giving these organizations access to a new source of finance. And the issuance of government debt to finance the deficit instead of drawing down on investment income, is something which is under active consideration. According to one senior source in the finance ministry there is some concern that the creation of government paper would be inflationary. But he concedes that once a debt programme was in place, it would offer a valuable tool for monetary control.

A debt market is receiving support from senior officials at the Brunei Investment Agency, though one cautions that the economy is too small to allow a market of any great size to emerge. However as the Brunei dollar is pegged to the Singapore dollar, there is an opportunity to extend the investor base to that country. But that would require the Monetary Authority of Singapore to change its rules to allow the Singapore dollar to be invested abroad.

Haji Metassan, managing director of the Employees' Trust Fund believes that a stronger local debt market would be valuable from an investment point of view. "We want our funds to be used for development here in Brunei," he says. The Employees' Trust Fund was started in 1993 with a brief to take a fixed proportion of all salaries from both employers and employees to be held until the employees reached the Brunei retirement age of 55. Haji Metassan, who joined the fund at its inception, explains that the original contribution of 5% of salary from both sides remains in place. Plans to raise it have been postponed because of the current economic downturn but in time he would like to see the figure raised.

The fund began operations covering only government employees but its remit was extended to cover everyone. Compulsory deductions from wage packets began a year later in 1994. It currently has Br$262 million of funds and its contribution receipts are now some Br$5 million a month.

"Until 1997 we kept all our money with the banks," explains Haji Metassan. "We were very cautious, but we saw that there was a need for us to diversify our portfolio." In 1997 the fund began to use the Brunei Investment Agency to manage part of its portfolio.

A government paper programme would permit the fund to participate at second hand in development projects. "In the past we have been approached to help fund projects," says Haji Metassan, "but because there was no mechanism by which we could put money in and take it out of a project, we have always said no, because there was no liquidity. However if you look at the experience of provident funds in other countries, they are a key source of capital."

An overseas banker sees arguments for and against a government bond market. "One of the main benefits would be that it would establish a cost of capital for assessing government projects," he says. "It would also provide an alternative for banks such as ourselves to invest money back into the economy. At present surplus funds are going into Singapore, which doesn't benefit Brunei at all. If the money from any government bond issues were invested back into the economy, then the banks would benefit. The fundamentals of Brunei government bonds would be quite attractive for foreign investors. It would also I believe encourage the government to take a longer-term view of investment rather than funding investment in infrastructure out of short-term income."


Comfortable market for banks

Accounting practices in Brunei may be less-than transparent, but this is a country where a businessman's reputation is valued highly. That makes life easier for corporate bankers

There are nine banks in the Kingdom, three of which, Baiduri Bank, the Development Bank of Brunei and Islamic Bank of Brunei (IBB) are locally incorporated. Baiduri Bank is a joint venture with local government, private investors and Banque Paribas, which holds a 15% stake. The foreign banks are Hongkong Bank and Standard Chartered, which were established in the kingdom during the British colonial period, and Citibank, Sime Bank and the Overseas Union Bank.

David Knight, deputy manager of Standard Chartered Bank is a member of the banking and finance sub-committee of the working group of the Ministerial Economic Commission. "We are producing a series of working papers and we will have to have finished our final submission by the end of November."

The inclusion of foreign bankers in the work of the commission is seen as highly positive. It is enabling them to bring up a number of issues which have inhibited banking business. One such, says Knight, is an updating of the commercial code, which is based on 1929 British legislation. "At present," he says, "it is difficult to effect a proper security over land. The legal process is very time consuming and there is clearly a risk in accepting it. The commission is enabling us to bring this up along with a number of other operational matters."

Referring to the liquidity squeeze which has lately affected the local banking sector Knight comments: "We are finding that as a bank we are not really financing contracts directly associated with government work, but we are involved with customers two or three tiers below that level. These customers are waiting for money to come down from the primary contractors, who may well in some case have had the money. We are seeing a lot of customers whose activities are currently non-existent and there is not a lot of new work coming into the system, which is a concern for these businesses. As a bank, we have always been very conservative towards property developments and our credit policy has always tended to be against funding it."

Given the considerable dependence of the private sector on government contracts, the reported changes to ministerial budget allocations, which were first cut back severely and then partially reinstated, have deprived companies of the ability to make any long-term plans. But competition among the banks for corporate business remains relatively fierce. "This is a very comforting market in which to operate," explains one banker. "The business community is small and a crook is easily exposed. There is also a very strong business ethic here. Businessmen value their reputation. This is an important consideration because the tax legislation is so drafted that company accounts can quite permissibly be drawn up which show that sound companies are in fact hardly making a profit at all. When you look at a balance sheet, the risk may not be clear. Therefore you tend to lend based on your knowledge of the person."

Knight admits that the opacity of balance sheets makes credit risk analysis difficult but explains: "I am more interested in cashflow and forecasts and evidence of financial skills within a company. Our corporate banking portfolio is more diverse than those of our competitors. It is focusing on the automotive sector here. We have quite a few trade lines to the main dealers here and we also have quite a cross section of SMEs, including distributors and some of the supermarkets. We are much more of a consumer bank than a corporate.

"In consumer banking, the delinquency rate is certainly not outside that which we accept and until recently it was in fact minimal. Among our most prominent products is auto finance, which is largely on a hire-purchase basis though there is a small leasing portfolio as well.

"The prime rate is 7%. It is set by the Brunei Association of Banks. We build the rates around the size and tenor of the loans. Up to Br$100,000 we have an agreed range of rates; thereafter it is a free for all. On the deposit side we are paying 4%. Banks are required to keep 6% of the balance of their deposits liquid."

Brunei's bank assets 1997
Br$%
Cash 99 1
Amounts due from bank 3,380 36
Loans and advances 5,219 56
Investments 51 1
Other assets 529 6
Total 9,276 100
Source: ministry of finance

New broom at the BIA

After being drawn into the scandal surrounding the collapse of a prominent local business group, the Brunei Investment Agency has placed a new focus on its core business - managing the kingdom's wealth for future generations

The Brunei Investment Agency (BIA), the main investment vehicle for managing the kingdom's surplus oil wealth does not give details of its total funds. Estimates range from $70 billion to $110 billion. Whichever sum is nearer the truth, given 1997 oil and gas earnings of $1.26 billion, it seems likely that investment income, which the IMF reported as $2.7 billion that year, now easily outstrips hydrocarbon receipts.

The agency has suffered from its association with the collapse of the Amedeo group of private companies run by Prince Jefri Bolkiah, the Sultan's brother. Although there is apparently no formal link between the Amedeo companies and the BIA, Prince Jefri was head of the agency as well as finance minister. The accountancy firms KPMG and Arthur Andersen are investigating the possible misuse of the BIA's funds.

Amedeo is believed to have had substantial overseas holdings, including a clutch of luxury hotels. The projects that the group undertook in Brunei itself, through some 20 different subsidiaries, are very visible and impressive. Rising above the capital is a series of neo-classical buildings and luxury condominiums built by Amedeo companies but never occupied.

The area to the west of the capital was extensively developed by Amedeo interests, with an international school, a luxury hospital and a five-star hotel. The company was also upgrading the road to this development. But now all work has stopped on this and other projects and the machinery lies neglected at the side of the road.

When Amedeo was forced to close earlier this year, something in the region of 30,000 expatriates from labourers to skilled technicians and senior manager and consultants were left without work and within a few weeks had left the sultanate.

Whatever else the Amedeo debacle has done, it has generated a new mood of openness at the BIA, following the replacement of the entire board and senior management. The new managing director, Haji Syaippudin, was one of the first executives of BIA in July 1983 and was head of foreign exchange when he left in 1992. After working a year for Citibank in New York and studying at Harvard, he returned to Brunei, working in the ministry of finance and overseeing the creation of the Development Bank of Brunei.

Haji Syaippudin explains the BIA's philosophy: "Our job here is to make sure we invest all our money in a prudent manner so that at the end of the day we ensure a safety net for future generations. We are quite comfortable that the funds that we are managing now will be able to cope with the change in the oil and gas revenue."

The BIA manages its own foreign exchange out of the modest BIA headquarters in a ministry of finance building, where the majority of its 175 employees work. "We have strict guidelines on currency management," says Haji Syaippudin. "We have a limit on overnight exposures. The FX is run out of BIA in Brunei. We don't speculate on currencies."

The BIA also has a specially ring-fenced portfolio designated for domestic investment. "These funds are meant to complement the assets that are managed by our portfolio managers," explains Haji Syaippudin. "I cannot say what proportion of our portfolio is involved here but it is quite a significant amount."

Of the overseas investment, Haji Syaippudin says: "We have quite a number of portfolio managers. But the core people are Citibank, JP Morgan, Daiwa, Nomura and Morgan Grenfell. These are the five core portfolio managers We use Citibank as our clearing account. We don't have a main broker."

Will the new management be reviewing the existing fund management arrangements? Haji Syaippudin says: "Since I'm pretty new here, that is something that we will look at but there is not really a review under way other than the normal performance review of our portfolio managers, which we have on a quarterly basis. As far as we are concerned, we are quite happy. We need to introduce new ideas and guidelines to match our needs. We are trying to review the guidelines on asset allocation in terms of liquidity. We are trying to enhance our presence in the international markets and we want to review the image of BIA as the main investment arm of the government of Brunei. We are confident that given time, the new management will be able to perform to the expectations of the government."