Are corporate growth expectations for 2012 unrealistic?
Despite the uncertainty and volatility surrounding the 2012 economic environment, corporate expectations for emerging market business units remain high, across regions and industries. Companies such as Heinz (NYSE: HNZ-P) and BlackRock (NYSE: BLK) are expecting emerging markets to continue to drive growth, but Frontier Strategy Group has observed two potential red flags that emerging markets executives should consider as they look to 2012:
FSG has surveyed senior executives running emerging markets business units to collect detailed insights into growth targets and strategies, hiring, salaries, organizational structure, and more.
The Sovereign Debt Crisis in Emerging Markets (Part II)
What can your business do?
Most companies react to crises by cutting costs and strengthening cash positions. These companies fail to separate from the pack during the inevitable recovery that follows every crisis. Leading companies:
- Plan opportunistically – Build acquisitions target lists ahead of downturns. Companies that want to be in emerging markets for the long term correctly identify environments with low valuations and favorable exchange rates as strategic entry points. Other companies pursue Greenfield strategies to the same ends. Going local can mitigate currency risk and pricing strategy disruptions as both inputs and outputs are denominated in one currency. Companies that go local during downturns, inorganically or organically, capture market share from competitors who import into the market because depreciating local currencies price local customers out of the market for imported goods.
- Mitigate risk while positioning for recovery – Selectively extend financing to suppliers and distributors to ensure that ecosystems remain liquid and can survive a downturn. Rebuilding supply chains and indentifying new distribution partners is more expensive than providing support during tough times.
- Prioritize markets to identify winners – Rigorous data-driven prioritization is paramount when there is increased competition for investment dollars. Leading companies quantify the size of the opportunity, the growth trajectory of the opportunity, as well as the individual risks present in the marketplace before making the case for resource allocation.
Identifying emerging markets winners
We can determine the emerging markets that will outperform and underperform by the level of trade exposure a market has to the center of the crisis. Broadly, emerging markets can be broken into three groups: markets that have a high linkage, a medium linkage, and a low linkage to the center of the crisis.
Low linkage:
The clear outperformers in the short term are India, Indonesia, and Sub-Saharan Africa. These markets are characterized by rapidly growing domestic demand and diversifying economies that are creating middle class growth. These markets have limited trade relationships with Europe. As a result, multinationals are gearing up investment plans across these regions, hoping that ensuing growth makes up for losses in Europe.
China is an exception. It is linked to the crisis in Europe but has built enough savings to weather a downturn in manufacturing exports. However, China has a domestic credit bubble that makes its economic outlook less clear. That said, multinationals will continue to invest in China as historic performance has been robust.
Medium linkage:
The Middle East and Latin America are linked to Europe because of trade in commodities: oil from the Middle East and foodstuffs from Latin America. In the Middle East, reduced European demand for oil will impact state revenues, but most markets have more than enough reserves to weather a crisis. As a result, we expect Middle Eastern markets to continue to grow and invest in long-term projects that will help maintain stability and diversify the economy.
While commodities play a role in Latin America, the real driver of growth there is domestic consumption and a growing middle class. A slowdown in Europe may shave a few points off growth in the region, but it will not stop the secular trend of robust middle class growth that is driving the market.
High linkage:
Russia is positioned to be the biggest underperformer. Oil exports to Europe are driving Russian GDP growth more than ever before. Russia emerged from the 2008 crisis weakened as much of its hard currency reserves were spent placating the population while no meaningful diversification of its economy was achieved. As oil prices fall below the $110 per barrel built into the Russian budget, Russia will enter deficit. It has already borrowed from capital markets for the first time in years.
Turkey will be another underperformer, although the demographic and economic fundamentals in Turkey are so strong that a downturn there will create excellent buying opportunities for companies planning to be in Turkey for the long term. The crisis is already impacting the lira, which has depreciated rapidly against the dollar as Turkish exports to Europe slow.
Central and Eastern European (CEE) markets will suffer for the same reason as Turkey – increased reliance on manufactured exports to Europe. In CEE, Poland stands out as the strongest market.
Contingency planning is key
The crisis will create risks and opportunities for businesses. Leading companies will distill the fundamentals, develop contingency plans, and communicate those plans throughout their organizations ahead of the crisis.
The Sovereign Debt Crisis in Emerging Markets (Part I)
What happened?
In 2008, banks stopped lending as they were forced to use capital to absorb losses from deteriorating investment portfolios. When lending dried up, business struggled, industrial production contracted, and jobs were lost.
Job loss drove the consumer into a deep recession. When the consumer lost its means to spend, banks found themselves in more trouble. Consumer-related debt securities holding everything from mortgages to credit cards to auto loans began to default, driving the deepest recession since the 1930s.
Governments stepped in as lenders of last resort to break the vicious cycle, but many governments were already overleveraged. As bad credit worked its way through the system, markets ultimately turned on indebted governments believing that governments would not be able to repay debt.
Enter the sovereign debt crisis
Markets revolted first against governments on the periphery of Europe because it was clear that those governments would run into solvency issues with no credible plans for economic growth. Ireland, Greece, and Portugal subsequently received bailouts but are still in trouble. Italy is on the brink and there is not bailout package on the table large enough to solve that crisis. Spain is next.
The crisis is not a Greek problem or an Italian problem. The crisis is a problem that impacts all of Europe as well as markets globally. Leading European banks based in Germany and France hold tremendous amounts of bad sovereign debt as well as derivatives on that debt. Much of this is not marked to market, so banks currently do not have to recognize losses. However, the event of a technical default will force banks to recognize losses that they are not capitalized to absorb.
A technical default is the worst-case scenario because it will disrupt the banking system, dragging Germany, France, and the broader global economy into recession. The only way to mitigate the impact of an EMU breakup is if the European Central Bank (ECB) preemptively recapitalizes banks, something Germany is opposed to because it fears inflation.
Regardless of the scenario that plays out, Europe is headed for recession and a breakup of the EMU. The only potential solution is a massive debt monetization program that would be led and funded by Germany through the ECB. However, this is becoming increasingly unlikely as policy heads the opposite way. On Monday, November 14th, German Chancellor Merkel’s party voted to allow EMU members the right to remain in the EU free trade zone; even they left the monetary union. This is a critical first step in preparing the mechanisms necessary to support a breakup of the EMU.
In Nigeria Oil is King, but the Consumer is a Restless Prince
Growth Beyond Oil
- Real GDP growth is projected at 7.4% in 2011. At this rate, Nigeria’s economy will double in the next 10 years
- Nigeria depends on oil exports for more than 80% of government revenue and 95% of foreign-exchange income. The government has recently announced a 10-year plan to cut oil dependence
- Nigeria’s non-oil sector continues to be a major driver of the economy, largely driven by improved activities in wholesale and retail trade, finance and insurance, telecommunications, and building and construction. The non-oil sector is projected to grow at 8.8% in 2011 compared to 8.5% in 2010
Nigeria’s Bullish Consumer
- Plentiful: Nigeria is the world’s 8th largest country by population. In the next 5 years, Nigeria will increase its population by the size of Romania
- Urban: Lagos (GDP $37bn), Kano (GDP $5.5bn), and Ibadan (GDP $9.5bn) are three of Africa’s largest cities
- Optimistic: Nigeria is ranked as the most optimistic consumer market in Africa
FDI in Nigeria
- Recent FDI in Nigeria includes investments by NSN, Google, Diageo, and Nestle (US$94.4m plant) as well as the construction of the Lekki Free Trade Zone (LFTZ)
Argentina Faces Looming Economic Challenges in 2012
Argentina’s economy is at a crossroads with high inflation, an overvalued currency and an increasingly unfriendly policy regime. The greatest risks to the business environment come from capital controls, trade restrictions, and currency devaluation. The situation is unsustainable, making a reckoning likely in 2012.
Signposts for a Reckoning:
- President Fernandez’s selection for Economic Minister
- Inability of the government to reign in spending
- Labor unrest and discord between the unions and government
- Worsening capital flight
According to Frontier Strategy Group’s on-the-ground advisers, the majority believe that the business environment will worsen during President Fernandez’s second term. They also feel that trade restrictions, capital controls, and currency depreciation are of top concern for multinational corporations operating in Argentina.
The Problem in Italy Lies in Politics, Not Economics
Berlusconi’s exit may mark the beginning of the breakup of the European Monetary Union (EMU), changing the business environment in Europe and markets globally. The problem in Italy lies in the country’s politics, not its economics; if the political class demonstrates they will do what is necessary, catastrophe can be averted. And over the past half century, Italy has often done the right thing (usually after exhausting all other options). The country’s politicians turned a ruined country into the world’s 8th largest economy, outwitted the most powerful and genuinely popular communist party in the western world, and entered the Euro, to name just a few accomplishments. Unfortunately, the challenge before them today is far greater and far less conducive to political machinations. The country has to decide whether it will be a competitive and dynamic economy or a larger version of Greece; the health of the world economy, and the future of the Euro, hang on the balance.
India’s Growth to Exceed China by 2014
Frontier Strategy Group appeared in yesterday’s Financial Times in an article titled, Gems: Making the case for Gems
According to the Frontier Strategy Group, while China’s growth may be slowing down, India’s is increasing, and by 2014, India’s growth rate will outstrip China’s, at 8.6 per cent compared with 8.2 per cent. This has prompted fears of a hard landing for China.
For much of the past year, China’s policymakers have been grappling with how to temper sharply rising asset and consumer prices and dampen the ill-effects of an unprecedented economic stimulus following the global financial crisis – without torpedoing strong economic growth.
China first set about reining in credit in April 2010, following a record RMB12.2trn (£1.1trn) surge in bank lending since the start of 2009, according to China Economic Research.
The Frontier Strategy Group predicts that China will have trouble in tackling its public debt and its debt to GDP ration will rise from 16.2 per cent in 2011, to 16.3 per cent in 2012, 2013 and 2014, before going back down to 16.2 per cent in 2015.
Germany Structuring Path to Euro Exit for Italy, Greece
German Chancellor Angela Merkel’s party voted today to provide a means for Euro-zone markets to voluntarily exit the Euro without losing access to the EU’s free trade zone. This move confirms that Germany is not willing to save the Euro in its current form and will begin to put in place additional mechanisms that will lead to exits from the Euro.
Retaining free trade with the rest of the continent is the key issue for markets like Greece, Italy, Portugal and Spain who would become more competitive overnight with a devalued currency and access to open borders.
If accepted by the broader EU, the move will make an exit easier for troubled markets, but it may also put undue pressure on the banking systems in Germany and France. Any exit would cause default, meaning that German and French banks have to absorb losses on bad debt and associated derivatives. A preemptive strategy to recapitalize banks will be required if Germany is to protect itself while paving the way for weaker markets to leave the Euro.
