Emerging Markets View: What Our Analysts Are Reading

EM View

McDonald’s restaurants in Russia came under increasing pressure from the Russian authorities this week as officials closed several outlets in Moscow and inspected 435 of the fast-food chain’s restaurants across the country, according to the Wall Street Journal. The increased checks come amid heightened tensions with the West, and FSG’s Head of EMEA research, Martina Bozadzhieva, says similar actions are likely to begin affecting other western businesses in the region.

“Regulatory checks are likely to intensify across industries, especially against American companies,” says Bozadzhieva. “It is very difficult to predict who the authorities may target next and for what, and companies should be aware that problems may arise with regional as well as federal agencies. Local teams should watch their industry regulators particularly carefully to get ahead of any problems.”

Meanwhile, Argentina’s latest plan to exit default is being met with skepticism by financial markets, as bond prices slip and the black-market peso hits a record low.

“Markets are rightful to be wary with Argentina’s proposed local law debt swap, as it suggests that, contrary to initial expectations, Argentina has no intention of reaching an agreement with holdout creditors in the near term,” says Gabriela Mallory, senior analyst for Latin America.

Thailand’s military-appointed legislature nominated army chief Gen. Prayuth Chan-ocha to become prime minister on Thursday, and FSG’s senior analyst for Asia Pacific, Shishir Sinha, says it may mean increased stability for investors.

“Thailand might be able to guarantee investors with more political stability as the ruling army chief is officially moving on to the helm of the country as its newest Prime Minister. While this move will delay truly democratic elections for quite some time to come, it is likely to help with economic growth; both consumer and investor sentiment should rise due to the expectation of stability,” says Sinha.


FSG clients can stay up to date with analyst commentary on the latest emerging markets headlines on the client portal. Not a client? Contact us to learn more.

[Video] Who is Best Positioned as Iran Sanctions Near End?

FSG’s MENA Practice Leader, Matthew Spivack, sat down with the hosts of Bloomberg’s “Countdown” Monday morning to talk risks, opportunities, and who will profit from a potential lifting of economic sanctions against Iran. View the video below and read more on investment opportunity in a post-sanctions Iran here.

Trace the Lights II: China’s 19 City Clusters by 2020

China Clusters Map by 2020

As outlined in China’s 11th five-year plan, the Chinese government has pushed for the development of regional city clusters, aiming to drive economic growth, strengthen transportation, and influence the pattern of migrants. For those less familiar, city clusters are comprised of one or two cities, considered the nucleus, and several neighboring cities with well-connected transportation facilities.  China already has several mature mega clusters such as the Yangtze River Delta centered in Shanghai and the Pearl River Delta anchored by Guangzhou, but new initiatives to continue city cluster development are underway.

Earlier this year, The Central Committee of the Communist Party of China together with the State Council released the New National Urbanization plan, a series of integrated, cooperative government initiatives to establish a more coherent city cluster plan.  According to the document, China will have 19 clusters by 2020 as illustrated in the map above. The government intends to break the constraints of administrative divisions of these city clusters, realize the integration and consolidation of social and economic activities within vast areas, greatly reduce the distance and space between people, and promote human movement and economic activities at regional and national levels.

The formations of these metropolitan areas and urban clusters are changing and will continue to fundamentally change the way we look at China’s cities. In my previous post, I discussed China’s urbanization as a major driver for the future consumption-led economy.  As China continues to urbanize, the inter- and intra-cluster’s connectivity and motilities, driven by the development of public transport infrastructure, city boundaries are increasingly blurring.

FSG has aligned the clusters’ definitions with the government’s plans. Of the 19 clusters, 3 super clusters have been targeted to become world-class economic zones. An additional 8 clusters are called emerging clusters, each composing as much as 3–9% of total GDP in 2013. The government aims to turn these clusters into national zones as key pillars of the Chinese economy. The remaining 8 frontier clusters are included in government’s 2020 cluster master plan but haven’t yet taken shape, each with equal to or less than 2% of total GDP. Apart from the well-known super clusters, 8 emerging clusters have already or will feature prominently in the national urbanization process. Among them, FSG has highlighted the Yangtze Mid-River cluster and the Chengdu-Chongqing cluster because we believe they are poised to be the upcoming super clusters.


This article is part two of a three-part blog series on China Urbanization called Trace the Lights. Check back next week  for part three.

For a full report on evolving consumer base and urbanization in China, FSG clients can visit the client portal.  Not a client? Contact us for more information.

Emerging Market View: What Our Analysts Are Reading

EM View

On Friday, Iraqi Prime Minister Nouri Maliki resigned, according to the BBC. Despite hopes that a resignation would help end the political crisis in Baghdad, FSG’s Practice Leader for Middle East & North Africa says it’s not over yet.

“Iraq’s political crisis is not over yet, but Nouri al-Maliki’s decision to step aside is a critical development. Companies should watch for whether PM-designate Haider al-Abadi is able to to form a new government that promotes cross-sectarian cooperation. A new government would need to usher in political reforms that ease sectarian tensions to bring Iraq back from the brink of civil war,” says Matthew Spivack.

In Latin America, Mexico’s government has outlined a plan to open oil fields to private companies, providing opportunity for foreign investment, according to the Wall Street Journal.

“The Mexican government is quickly moving forward with the first round of bidding starting early next year, which should provide an early infusion of FDI and support higher investment growth in 2015 ,” says Antonio Martinez, FSG’s Associate Practice Leader for Latin America.

This news comes in the same week as The Economist’s story “Mexico’s minimum wage: Stingy by any measure,” highlighting the low interest in the country’s consumer opportunity over the past two decades.

“Over the last two decades the increase in earning power of Mexican workers has severely lagged most of the other large LATAM economies, and is an important reason why the consumer opportunity in Mexico has not been as attractive to B2C companies as the economy’s size would suggest,” says Antonio Martinez.

In the Asia Pacific region this week, good news for Malaysia’s economy as second quarter growth shows unexpected acceleration on exports, according to Bloomberg.

“Malaysia’s impressive Q2 performance bodes well for the country’s growth over the coming months. The government’s efforts to address bottlenecks in the economy and improve the domestic operating environment are clearly paying dividends,” says Adam Jarczyk, FSG’s Practice Leader for Asia Pacific.


FSG clients can stay up to date with analyst commentary on the latest emerging markets headlines on the client portal. Not a client?  Contact us for more information.

Mexico’s Sluggish Performance Continues

Mexico’s economy continues to struggle as Q3 unfolds, with the economy facing persistent headwinds. The prolonged weakness of the construction sector and continued fallout from tax hikes at the beginning of 2014 are limiting domestic demand. Meanwhile, the US economy’s slow start in 2014 has constrained demand for Mexican exports, though manufacturing exports have shown stronger signs of life after a strong Q2 for the US economy. Consumer spending remains sluggish, with few expectations for a rapid recovery over the short term. The combination of all of these factors has led FSG to revise Mexico’s GDP growth for the year down to 2.3% YOY, from 2.5%.

Mexico has underperformed in 2014.

The government’s ability to execute government spending and structural reforms will be vital for a recovery in the second half of 2014 and 2015. On the reform front, progress on the passage of secondary implementation reforms in the energy and telecom sectors should improve investor sentiment in Q3, while enhanced execution of government spending should boost the economy in the second half. While government spending has been underwhelming through the first half of the year with slow and ineffective execution on government infrastructure projects, other spending commitments have delayed necessary stimuli to domestic demand, derailing a recovery for the construction sector among other industries.

In our latest quarterly market review of Mexico, FSG explores three key trends that will have an impact on the business environment and corporate sentiment over the medium term:

1. The private sector is increasingly dissatisfied with Peña Nieto’s government: The private sector is increasingly at odds with the government, with tax increases and poor execution of government spending causing growing dissatisfaction within the Mexican business community

2. Higher taxes have multinationals reconsidering their local manufacturing footprints: Higher taxes and fewer incentives for export manufacturers in border states have multinationals reconsidering their manufacturing footprints in Mexico, with companies seeking to align their local manufacturing presence with the local market opportunity

3. Telecom reforms will increase productivity and investment in 2015 and beyond: Telecommunications reform will likely improve competition within the sector and increase the affordability of telecom services, which will have long-lasting effects on productivity and overall investment in Mexico


For a full report on Mexico’s performance, FSG clients can access our Mexico Quarterly Market Review on the client portal. Not a client? Contact us for more information.

Tragedy in Brazil: Presidential candidate Campos killed in plane crash

Eduardo_Campos_Bloomberg

Brazilian presidential candidate Eduardo Campos (PSB) was tragically killed in a plane crash yesterday, throwing Brazil’s October presidential election into disarray and causing big swings in local financial markets. Campos’s running mate, Marina Silva, was not onboard the plane, according to party officials.

Campos was in third place in recent polls with the support of about 10 percent of voters. While he was not expected to win the October 5 vote, he was perceived as a market-friendly alternative to President Dilma Rousseff, and his death will set off an intense scramble for his supporters in an increasingly-contested election. While it is too soon to draw a definitive conclusion about the impact of this event on the shape of the presidential race, FSG believes that Campos’s demise is likely to improve Rousseff’s chances of re-election in the first round. This is because:

1. Rousseff was already hovering around 50% of total valid votes in the latest pollsRousseff only needs to receive just over 50% of the valid vote to win in the first round, and according to IBOPE’s election poll from August 7, Rousseff would get 50% of valid vote despite obtaining only 38% of total vote. This is because blank and null votes do not count toward the total vote.

IBOPE Voting Intention Poll – August 7 2014

IBOPE Voting Intention Poll

2. A portion of Eduardo Campos’s votes will go to Rousseff in the first round: Regardless of who becomes the new candidate for the PSB, it is expected that at least some of Campos’s supporters will shift their support to Rousseff, which would provide her with the extra votes she needs to be the first-past-the-post in the first round. The fact that Campos served as a minister under PT president Lula, and that his political party (PSB) was part of Rousseff’s governing coalition until 2013, puts him in the orbit of the PT in the eyes of many voters. Some Lula supporters had shifted their support away from Rousseff to Campos only because they were disappointed with Rousseff’s execution of PT’s policies, but now that Campos is no longer in the race, they might shift their support back to Rousseff.

3. The proportion of null and blank votes could increase: By the same token, Campos had also gathered the support of disaffected voters from other political parties other than the PT, namely the PSDB. In the absence of another solid candidate that represents “the option for change,” the percentage of voters that vote in blank or null could increase. Additionally, a significant chunk of former PT voters supporting Campos might not be willing to shift their support back to Rousseff, or any other candidate. This would automatically increase the percentage of valid votes obtained by any candidate in the first round, including Rousseff, facilitating her re-election as president of Brazil without the need of a second round.

One factor that could disrupt this outlook would be the selection of Marina Silva to replace Campos as the PSB candidate, and her subsequent rise in the polls. Given Silva’s strong national brand, and the potential for a robust sympathy vote, there is a good chance that she could syphon votes away from both Rousseff and Neves to force a second-round vote. If this were to happen, the potential for Silva to endorse either Rousseff or Neves in a runoff election could prove to be a significant wildcard.

Given this potential runoff scenario, FSG will be monitoring the following factors in the weeks ahead:

  • Nomination for Campos’s replacement: The PSB has 10 days to nominate a new presidential candidate, and initial reactions within the PSB suggest that Campos’s running mate Marina Silva will become PSB’s new candidate.
  • Potential for Silva to issue an endorsement: Assuming Silva is the candidate chosen to replace Campos, there is a lot of uncertainty as to who she might support in a second round. In fact, during the 2010 presidential elections, when she was the third-place finisher in the first round with her own political party (Green Party), she decided not to endorse neither Rousseff nor José Serra (PSDB).
  • Where Silva’s supporters might go in a runoff: Assuming again that Silva is PSB’s presidential candidate the precedent we have from 2010 is that 50% of her votes went to Rousseff and 50% to Serra. What her voters would do this time around is hence very unclear.

In summary, although Rousseff’s re-election in the first round on October 5 seems be the most likely scenario, we still need to wait for new polling data and for the definition of the PSB’s internal political transition to have a clearer sense of the impact of Campos’s death on the presidential elections.


FSG clients can access all research on Brazil through the client portal. Not a client? Contact us for more information.

Trace the Lights: 5 Key China Urbanization Stories for MNCs

nasa earth at night
Source: NASA Image

Take a look at this famous NASA image, a satellite photo of the Earth at night. This map shows the geographic pattern of night time electricity consumption, but it also clearly shows the geographic distribution of cities and population. Lights are bright in South Korea, but most places are in dark in North Korea; within the US, the east coast is brighter than the rest. Likewise, the lights are brightest around Paris and London in Europe. While there are still lots of dark places in China, we must ask ourselves, as urbanization continues in the country, what will this map look like for China in 2020, and where will the brightest lights be?

1. Strategic plan for China 2020 should incorporate future urbanization landscape—“go deep” vs. “go wide”

Every Western multinational needs to ensure they look at China’s urbanization as a major driver for the future consumption-led economy. FSG’s analysis is a starting point to assess the clusters in which multinationals already operate, and more importantly, what the best plan for the future should be—“going deep” vs. “going wide.” A clustering approach uncovers synergies, which are necessary given the scale in China and therefore an important input into the game plan for China 2020. My next blog will provide more details on which clusters I’m referring to.

2. Managing profitable growth in China

Concentrating resources on certain clusters brings the opportunity to exploit scale more quickly, because companies can leverage the synergies in sales force, distribution partners, supply chain, and marketing efforts across a wider geographical scope than by managing on a single city basis without sufficient regional scale.

3. Future organizational design is tilting toward decentralization

Multinationals will have to assess the possibility of decentralizing their Chinese sales headquarters by branching out sales centers to other hub cities to get closer to local business—for instance, using Beijing as the northern China headquarters, Guangzhou as the southern China headquarters, and Chongqing as the western China headquarters. MNCs can also consider breaking down functional responsibilities into different clusters by leveraging the clusters’ specializations—for instance, building a logistics center in Wuhan because of its favorable geographic location, establishing an e-commerce hub in Chengdu, and incubating R&D innovation in Suzhou.

4. Western multinationals need to monitor the industry clusters very closely

The government is and will continue building numerous industry clusters across the country that will help build the ecosystem around them. High-skilled and high-tech industry value chains are gradually taking shape. For example, a few biotechnology companies set up their administrative operations and R&D centers in Shanghai, while locating manufacturing in neighboring cities such as Suzhou or economic zones such as Kunshan or Zhanjiang Industrial Park. MNCs can leverage the formation of mature industry clusters to screen out horizontal suppliers and customers, as well as monitor the vertical competitive environment.

5. Multinationals need to keep an eye out for key signposts that will evolve over time; everything may not be rosy

China’s urbanization program will cost approximately US$ 6.8 trillion. From 2015 to 2020, more than US$ 100 billion of new, related professional services and biddable infrastructure contracts are estimated to be available every year. However, local governments are already deeply debt-ridden, given that China’s total local government debt in mid-2013 ballooned to 17.9 trillion RMB. The gap between the urbanization rate and urban “hukou” rate has widened over time. The high levels of local government debt will make it difficult to provide provisions for adequate public services, including healthcare and education, to new migrants.


This article is part one of a three-part blog series on China Urbanization called Trace the Lights. Check back next week for part two.

For a full report on evolving consumer base and urbanization in China, FSG clients can visit the client portal.  Not a client? Contact us for more information.

Erdogan victory shouldn’t overshadow MNC priorities in Turkey

On Sunday, Turkey completed the second of the three milestone elections on the country’s political agenda between 2014 and 2015. Recep Tayyip Erdogan’s victory did not surprise anyone and is not likely to have a major impact on the Turkish market. In the meantime, currency volatility and persistent inflation are emerging as the real sources of concern for companies operating in Turkey. So, what should executives do?

1. Don’t count on political stability until the parliamentary election in June 2015. Erdogan’s victory supports stability for now, but political tensions could rise leading up to the June 2015 Parliamentary Election. Companies should keep track of three factors to anticipate whether the business climate will be hurt by political instability: 1) Who the Prime Minister will be, 2) Whether Erdogan will try to change the constitution before the June 2015 elections, and 3) What the new AKP and the new government in June 2015 will look like.

  • Watch who the new PM will be to anticipate the balance of power between the cabinet and the president: If Abdullah Gul makes a strong claim to the AKP and challenges Erdogan’s desires to control the party from afar, this could lead to a political crisis. If a passive member of the AKP is brought to the head, this may mean that Erdogan will continue to retain authority over the party.
  • Monitor how quickly Erdogan will move to increase his powers: Executives need to be aware that rapid and bold efforts may lead to heightened instability before the parliamentary elections. Currently, the AKP does not have the majority in parliament to change the constitution and expand the powers of the president. While the leading opposition parties CHP and MHP will oppose an Erdogan power grab, monitor whether Erdogan is able to gain support from pro-Kurdish parties in parliament to make amendments to the constitution.
  • Understand that the upcoming parliamentary elections have two implications for businesses: 1) Erdogan will be able to consolidate his power easier if AKP wins majority seat in parliament, which is required to change the constitution; and 2) New policies may be implemented as the AKP will replace 70 MPs including well respected Deputy PM for economy Ali Babacan.  Companies may be faced with opportunities for establishing fresh relations with the government or with new challenges.

2. Focus on what really matters to your business.

  • Plan for continued volatility in the Turkish Lira: Due to its dependency on foreign capital inflows, especially short term portfolio investments to finance its growing trade deficit, Turkey is especially susceptible to currency volatility. Domestic developments such as the December 17 corruption probe or the March 2014 local elections have proven that the lira can rapidly fluctuate with each event that alters perceptions of political stability in the country.  Executives must also watch regional developments especially in Iraq and Ukraine, as the Turkish lira has been highly reactive to the events in those countries. On August 6th, Turkey’s currency depreciated to reach TRY 2,17 against the USD, its highest since March 2014, when aversion over Ukraine increased risk perceptions in emerging markets including Turkey. Meanwhile, the Turkish Lira had depreciated by 1% on June 11th when Islamic State militants kidnapped 49 Turkish citizens in Iraq.

Suggested actions: 1) Prepare for fluctuations in costs due to weaker lira  when importing intermediary goods to Turkey, and 2) Expect a fall in the demand for final imports as the currency depreciates in the short term

  • Expect persistent inflation and high interest rates: Persistent inflation is a leading concern for economists and businessmen as July’s annual consumer price index (CPI) reached 9.32%. After a peak of 9.38% in April, the central bank has been expecting a downward trend from June onwards, to culminate in a 7.6% end of year inflation. However, the July CPI defied the downward trend of May and June, increasing worries of sustained inflation in the Turkish market.  As the high price of food and basic goods put pressure on household budgets, consumer spending levels may show slight decreases. MNCs can expect high borrowing costs and a slight slowdown in consumer demand as interest rates are likely to stay high in the next few months to combat persistently high inflation.

Suggested actions: 1) Consider lower priced products and services as consumers face lower purchasing power of the lira and higher interest rates, and 2) Track the effects of inflation on business demand, as the failure of lower interest rates to manage inflation in the last two months may be a sign of higher production costs

Pre-election coverage was detailed in our Turkey Quarterly Market Review, available on the client portal. Not a client? Contact us for more information.

Emerging Market View: What Our Analysts Are Reading

EM View

After defaulting on some of its restructured debt on July 30, Argentina has petitioned the International Court of Justice to hear a lawsuit against the U.S. According to the Wall Street Journal, the South American nation claims that decisions by the U.S. courts in the legal battle between Argentina and some of its creditors have violated its sovereignty, but FSG’s senior analyst for Latin America research says it’s merely a stalling tactic.

“Argentina’s lawsuit against the U.S. is a stalling tactic intended to bolster the Argentine government’s political rhetoric. Most likely, its main result will be a further delay in negotiations with holdout creditors,” says Gabriela Mallory.

On Tuesday, South African publication The Daily Maverick asserted that “corrupt, incompetent governments and their repeated failure to protect their citizens” was more to blame for the Ebola outbreak than the disease itself. FSG’s Sub-Saharan Africa analyst Alexa Lion agrees, adding that the virus will have little affect on Western businesses involved in the region.

“Ebola is scary but is fairly isolated from Western economic interests. Its spread speaks more of government inability to contain the virus rather than high risk of contagion. MNCs must be vigilant and articulate health precautions to their partners, but also remain aware that it is business as usual in West Africa’s largest hubs,” she says.

In Indonesia, members of losing presidential candidate Prabowo Subainto’s political coalition are planning to form a special committee, or pansus, in the House of Representatives, claiming electoral fraud. Despite Prabowo’s large presence in the legislature, FSG’s Adam Jarcysk says it is unlikely the court will rule in his favor.

“The Prabowo camp’s decision to begin saber-rattling now about launching a pansus in October suggests that the Constitutional Court is likely to support Jokowi in its ruling later this month,” says Adam Jarczyk, FSG’s Asia Pacific Practice Leader.


FSG clients can stay up to date with analyst commentary on the latest emerging markets headlines on the client portal. Not a client?  Contact us for more information.

Beyond Beaches: The Caribbean’s Role in Latin America Business

The Caribbean offers a small but potentially significant and diverse set of markets for companies looking to expand and deepen their presence in Latin America. Indeed, in many cases the Caribbean presents opportunities that have been neglected by the competition. FSG has recently released a Caribbean Regional Overview to provide companies with an in-depth understanding of the region’s most significant growth drivers while assessing the comparative economic and operating environments that each of the major markets in the region offers.

CaribbeanOutlook_piechart


Caribbean_barchart

Representing only 5% of LATAM’s GDP, the Caribbean is characterized by a diverse range of economies with relatively small populations whose growth rates diverge significantly on a market-by-market basis. While some of the more commodity-based economies in the region are experiencing relatively robust growth, many markets in the region, including Jamaica and Puerto Rico, are suffering from severe fiscal strains that leave limited room for higher growth.

Multinationals tend to take an opportunistic rather than strategic approach to developing their Caribbean presence by striving to find the right distribution partner, or building on either global or regional relationships with key customers, instead of developing a specific Caribbean market entry and penetration strategy. As they expand their presence and seek to expand their market share and revenues from the region, companies tend to find managing the diverse range of political, economic, linguistic, and legal environments challenging, particularly as developing an on-the-ground presence across most of the region is generally not feasible.

This report should help align your team around the markets that provide the greatest risk-adjusted opportunity, and understand the key risks and scenarios for the Caribbean region.


For FSG clients interested in learning more about the Caribbean region, the full report is available here. Not a client? Contact us for more information.