Frontier Strategy Group’s Latin American research team and expert advisory network are following the evolution of the demonstrations and would like to offer our clients analysis on how these developments have altered our FSG View on Brazil and how the events could impact our clients’ businesses.

FSG View on Brazil’s Economic Outlook:

FSG’s recently released Regional Overview for Latin America expresses our view that Brazil’s macroeconomic slowdown and generally weak business performance of the last year is due to the exhaustion of the demand-driven economic model popularized by the Lula government and employed by the current Dilma Rousseff government (see graph below).

• We caution our clients that even though this economic model is less and less effective at generating broad GDP growth, it is still effective at maintaining wage growth and high employment. Positive real wage growth and low unemployment are great news for Dilma, and until very recently her approval ratings were the highest of almost any head of state in the world.
• Our view is that low unemployment and positive wage growth should translate to a good chance of reelection in 2014, therefore little incentive for the current government to make politically painful changes to the demand-driven growth model in the short term.
• Therefore, we caution our clients to be prepared for a low-growth environment and little progress on needed reforms that would spur growth through higher productivity and a lower cost structure until at least 2014.

What Prompted the Protests?

Clearly not all of Brazil’s population is as pleased and complacent as Dilma’s recent approval ratings suggested. The protests, broadly, are a stunning manifestation of a social trend that has accompanied Brazil’s transition to a middle-class country; the demands the middle class makes of government are different from the demands the poor make. As 40 million Brazilians enter the middle class and become both consumers of government services and tax payers, their priorities and demands become more sophisticated. This is a dynamic FSG has been tracking for some time, not just in Brazil, but also in Colombia, Russia, Turkey, and many other emerging markets as this trend will have profound impact on governments’ spending priorities.

• The initial protests were over not just the price of bus fare, but the quality of service as well; essentially a question of value for money. Likewise, the subsequent demonstrations have focused on government priorities, transparency, and efficiency. No one can argue that Brazil does not devote considerable resources to social programs and alleviating poverty. Rather, the demands are for more accountability, greater efficiency, and prioritization of public investment in higher quality education and health; again, a question of value for money.

How has the Outlook Changed?

Short Term:

• Multinationals in the consumer space can expect some disruption in sales, as consumers stay home and foot traffic slows in major urban areas.
• Some businesses may experience work stoppages in the form of sympathy strikes, absenteeism, or shuttering of stores.
• Investor confidence, already sour on Brazil, will weaken, and the Brazilian real will remain at several-year lows, though the Central Bank will maintain a floor on the value of the currency to guard against excess volatility.
• Latin America and Brazil-focused executives will face tough questions on the sustainability of Brazil’s growth from increasingly skeptical corporate boards and headquarters. Negative headlines can have immediate impact on corporate sentiment towards an emerging market.

Medium Term:

• President Dilma Rousseff still has good cards to play. She is still fairly popular, her opposition is fragmented and currently lacking much leadership, and she has considerable government resources at her disposal.
  • Furthermore, while some protest language has focused on her, she has not been an explicit target of the protests. Dilma may yet succeed in harnessing some of the protest’s energy and present herself as sympathetic and aligned with the protester’s aims. That said, there is always a chance skillful opposition politician could channel the protests into electoral popularity. Yet, though the demonstrations add an element of unpredictability into next year’s elections forecast, Dilma is still in a relatively strong position.
  • Interest rates are likely to continue to rise, as inflation concerns and the political implications of inflation has the Central Bank and the government spooked.
  • Further targeted tax cuts and credit incentives to try to stimulate demand. These are increasingly ineffective measures economically, but still prove popular with potential voters.
  • Suspension of subsidy roll backs are likely. Planned hikes in gasoline prices and proposed cuts to public subsidies are likely to be delayed. This is harmful for Brazil’s fiscal position, but will keep more spending cash in the pockets of consumers.

Long Term:

• The government of Brazil will shift priorities over time. The new priorities will be improving quality and sophistication of services, rather than simply expanding access. This has profound implications for firms selling goods and services in terms of the value proposition likely to be most of interest to federal, state, and local government.
• There are potentially positive long-term benefits to the protests. Principal among them is greater accountability of government in general.
  • Similarly, greater efficiency is not just a demand, but a fiscal necessity. Brazil has deep pockets, but with citizens and corporations balking at the cost of public services, the government will be asked to do more with less. This may encourage reforms in the models employed to provide services to the public. Expect an accelerated move toward public-private partnerships and greater use of concessions in public projects.
  • Transparency will improve. Brazil has already made some inroads in prosecuting public corruption, but the demonstrations will embolden media and watchdog groups to push for greater transparency and accountability.

In Conclusion:

The slow death of Brazil’s demand driven growth model is coinciding with the growing assertiveness of the middle class. The government has been very slow to respond to either phenomenon. The short term chaos of the protests will disrupt some economic activity, while the mid-term economic doldrums will continue. The political picture becomes more volatile, yet Dilma is still in a relatively strong position and is unlikely to try to upset her political coalition or potential voters with radical reforms that won’t bear immediate fruit. Long-term, a political awakening could increase accountability and efficiency of government.

As a long term investment opportunity, FSG remains optimistic and convinced of the attractiveness of Brazil’s fundamentals. The case for continued prioritization of investment in the market, however, becomes more difficult with each day of negative headlines. For this reason, FSG is releasing a new “Making the Case for Brazil” report and presentation materials at the end of June. The materials are designed to help senior executives focus stakeholders on long term opportunities in the market and reaffirm the underlying potential of Brazil’s future.

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Listen as FSG CEO Rich Leggett moderates a discussion on strategic planning with FSG’s expert advisor, Jeff McLean. Topics covered include economic health of China and the ASEAN community, as well as strategic workforce planning in the region.

The full podcast is available for download here.

______________________________________________________________________________________________

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Another red flag will be exports. China’s export numbers in the first four months of 2013 have come under scrutiny as concerns have been raised about their accuracy. China’s export growth to developed markets—the US, EU and Japan—remains lukewarm (see graph below).

Export growth to developing markets in ASEAN and Africa are strong but start from a lower base. Questions have been raised in particular about the extraordinary growth of China’s export to Hong Kong, which stands at 69% in the first four months based on official numbers indicated in the graph here:

We also believe slower growth at home will drive more Chinese investment overseas. Traditionally, Chinese outward FDI is state-led and resource driven. If we look at the geographical distribution of Chinese FDI overseas in last few years, they were focused on resource rich regions like Africa, Latin America, Oceania and some Asian countries like Indonesia.  But with the economy slowing, we see that trend changing. We expect more participation of private Chinese companies who are investing for pure business purposes rather than national strategic reasons. And these private companies have the potential to pose a real challenge to multinationals, starting in the Chinese market, but increasingly in markets outside of China as well.

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Google To Build Wireless Networks in Emerging Markets – Wall St. Cheat Sheet

“Google’s push into emerging markets could be a paradigm shift for the viability of e-commerce.”
-Sam Osborn, Senior Analyst for Global Analytics

 

The Miserable Plight of China’s Millennials – CNBC

“Difficult job market this year is another indication of a worse than expected economic slowdown in China.”
-Shijie Chen, Practice Leader for Asia Pacific Research

 

Russian pharma giant to invest in Turkey – The Republic of Turkey Prime Ministry

“Despite continuing pricing pressures, interest in Turkey’s healthcare market remains strong. R-Pharm’s investment highlights growing emerging-market competition within Turkey.”
- Martina Bozadzhieva, Associate Practice Leader for Central and Eastern Europe

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Outlook for China’s Economy Just Keeps Getting Worse - CNBC

“Macroeconomic outlook in China continues to worsen. Though most economists still predict a gradual slowdown rather than a sudden deceleration, companies need to be prepared for a worse-than-expected 2013.”
-Shijie Chen, Practice Leader for Asia Pacific Research

Brazil oil licenses raise record R$2.8bn - Financial Times

“Some good news for Brazil’s long term outlook; long awaited oil license auctions went smoothly and raised $1.4bn USD. The auctions are necessary for opening vast oil fields for exploration and exploitation. The development of these fields could provide a major boost to Brazil’s long term economic outlook.”
-Clinton Carter, Director of Research and Product Development for Latin America

UAE benefits from influx of capital from emerging markets – The Economic Times

“Political stability in the UAE amid regional instability has led to increasing proportions of capital inflows compared with the rest of the MENA region.”
-Sam Osborn, Senior Analyst for Global Analytics

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Having spent here now a couple of days meeting with a variety of stakeholders and seeing the capital, my first impression has given room to a more nuanced picture.

Most people I have so far spoken to confirm that Angola is an extremely difficult place to do business. Laws and regulations change constantly, it is very bureaucratic, the country has a major talent gap, and corruption (fondly called ‘gasosa’ by the locals) is publicly accepted and openly discussed. It is incredibly expensive and challenges abound. One executive I met, a veteran of setting up factories in difficult markets, summarized this fittingly: “Nigeria is junior school, while Angola is university.”

However, what strikes me more than all the challenges I have heard about is the opportunity that one can literally find on every corner of the street. Yesterday, I visited the national registry of companies, a place bustling with activity. It registers 30 local and international companies on an average day and a total of 4,000 in the first four months of this year!

The roads are filled with large 4x4s, mainly Hyundai, Toyota, Mitsubishi, Mahindra, some Chevrolets and to a lesser extent Land Rovers and BMWs – the latter being driven vastly by government representatives. Portuguese brands and companies are dominant, building on long established trade routes and cultural proximity. Modern retail outlets are primarily Portuguese, with the exception of South African Shoprite. A 1-bedroom apartment in downtown Luanda costs between 5,000- 10,000 dollars a month and you have to pay 1 year rent in advance.  Meanwhile, a Hugo Boss and Nike shop caters to Luanda’s affluent consumer class.

But it is not only the rich. Despite its many faults and flaws, the government is actively pursuing a policy that will see wealth trickle down in the next few years. Initiatives have been rolled out to allow the informal economy be included into the formal sector. Companies doing business here are obliged to commit resources for training local Angolans. An array of protectionist measures are being put in place to protect those that want to produce locally and add value to the country. The government’s motivations are, of course, ambivalent. A country born in times of the cold war as a communist regime (a fact today largely downplayed by Angolans) has embraced capitalism. But the ideology of today’s government is difficult to grasp and requires some further studies.

Despite the country’s incredible development in the last ten years Anglo-Saxon MNCs are not yet widely present here. And if they don’t move quickly, they will miss out on all the opportunities that still exist in pretty much every sector.

Stay tuned for more valuable insights as I meet more companies on the ground…

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I recently noticed that a number of big department stores have been closed or scaled down, primarily due to the increased competition coming from the Internet (as compared to the number of stores which I observed several years ago).  Social media is expanding its penetration of Chinese Internet, which is already the largest in the world. Many companies have started thinking about how to build social media into their business strategies, similar to what many MNCs did for the Internet 10 to 15 years ago.

Chinese social media platforms are generally more interactive and users can share content in a greater variety of formats to a wider audience, therefore drawing more user contributions. Sina Weibo, a Chinese mircroblogging platform, is more user friendly and contains more features than Twitter to attract new users, retain elite users, and encourage all users to contribute more content, leading the platform to be more interactive.

Home grown platforms like Sina Weibo, Wechat, Qzone, Renren and Kaixin have dominated the social media space in China. Most were started as imitations of similar platforms in the West but over time have evolved into something quite different with unique product and service offerings specific for Chinese users.

A company’s social media strategy could be rendered obsolete very quickly as the market is ever-changing, with new companies, business models, and user features continuously mushrooming . FSG has built a simple 5-step process for B2C companies to build an effective social media communication plan.  Social media is also not exclusive to B2C companies.  B2B companies can leverage social media in an indirect way to build positive brand image, enhance internal communication, and even drive recruitment efforts. This is definitely a space where the marketing heads need to zoom-in on now to ensure they capitalize on the opportunity.

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Cultural notions of time and reliability are different and as a result it is a challenge to schedule meetings. Calls are by far the preferred method of communication as people like the human interaction. On the upside, time is fluid and people are generally flexible. If they are late, they smile – no need for an excuse. But overall, this attitude makes it a challenge to commit to a time and date though, let alone keep a tight schedule.

But the Western business traveler (myself included) needs patience. After all, the country only emerged from a traumatic civil war a decade ago. Today, this is most obvious in the labor force where an entire generation did not receive the most basic schooling. This of course, presents various obstacles in everyday life.

Luanda’s skyline has changed dramatically in the last ten years

But Angola’s pace of change is nothing less than remarkable. The city is bustling with commercial activity. Everywhere you look there are huge construction sites and office towers are rising into the sky.  Local bank branches are on every other corner.  The roads are packed at most times of day with a considerable amount of expensive cars. There are business people of all colors and races, with a definitive majority of Portuguese, Brazilian and Chinese. People are very friendly and approachable. They like to enjoy life, to celebrate. And so I was warned before coming to Luanda that I would get little sleep because at nighttime, “that’s when the real business deals are struck.”

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Turkmenistan: A closed, state-controlled economy undermines potential opportunities for investment in the market. Oil and gas production, plus investment in infrastructure and construction are the main growth drivers. This is very visible in Ashgabat, the capital, a city re-built in white marble to dominate the surrounding desert (see photo). Despite the wealth that the capital city tries so hard to demonstrate, opportunities for multinationals are limited by a small domestic market, high level of government control of the economy, opaque political decision-making, and import restrictions. Because of this, the country is unlikely to present significant opportunity for multinationals in the medium term.

Turkmenistan: Turkmenistan’s capital, Ashgabat, is impressive in its white marble buildings, but seems to be largely populated by policemen, rather than by regular Turkmen

Uzbekistan: With its 30-million-strong population and a history of industrialization, Uzbekistan should be the economic driver of the region. Instead, it is struggling with a barely-contained economic crisis. Hidden inflation makes the black-market exchange rate 30% higher than the official one, getting access to foreign currency is extremely challenging, and in some cases, illegal, and shortages plague the economy. A policy of import substitution means that getting goods into the market could involve working with corrupt individuals or breaking the law, and repatriating earnings can be next-to-impossible. Not to mention the very real risk of government expropriation. Not surprisingly, this is resulting in deep poverty visible at every step in the country. Whether social dissatisfaction with the economic failures of the government will ever turn into a push for political change, and whether such change will come peacefully or result in violence, is one of key questions facing Uzbekistan in the medium term. In the meantime, Uzbekistan will present an opportunity only for companies with an extremely high risk appetite.

Uzbekistan: Economic mismanagement has spurred poverty in Uzbekistan. Thousands of Uzbeks seek to work in Russia every year in search of higher salaries with which they support their families back home

Kazakhstan: The economic leader in the region, Kazakhstan is a natural extension of multinationals’ Russia presence. Its membership in the Customs Union with Russia and Belarus and its relatively open operating environment (Kazakhstan ranked 49^th in the World Bank Doing Business Survey in 2013) attract a growing number of Russian and multinational players. Almaty, the biggest city, is brimming with flashy shopping malls and a middle class that is not unlike the one you may encounter in Russia’s biggest provincial cities. Yet, Kazakhstan’s relatively small (16 million) and dispersed population and large territory drive up transportation costs. Beyond Almaty and a few other big cities, average incomes are low, and the real addressable market may be as small as 5 million people. This makes it critical for multinationals to think carefully about the most efficient way to capture Kazakhstan without overspending in the market.

Kazakhstan: Demand for luxury goods is thriving in Kazakhstan’s biggest city, Almaty

To find out more about each of these markets, including which foreign companies are most advanced in Turkmenistan, what it takes to buy a car in Uzbekistan, and whether Kazakhstan can be a viable hub for Central Asia, listen to our podcast Notes From the Field: The Central Asia Business Landscape by clicking this link to access the iTunes store.

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Czech GSP: it gets worse - Financial Times Beyondbrics

“The Czech economy is unlikely to recover considerably until German growth picks up. The Czech Republic’s problems highlight the growing division between markets driven by domestic demand vs. by exports, with the latter likely to underperform. For more details on this trend, see FSG’s report Global Performance Drivers – Q1 2013.”
- Martina Bozadzhieva, Associate Practice Leader for Central and Eastern Europe

Joko Aims for June MRT Groundbreaking - The Jakarta Globe

“Companies should monitor the Jakarta MRT project since it will serve as a good proxy for Jokowi’s ability to get things done in the capital. If he cannot hit his self-imposed deadline for breaking ground in June or July, it will bode ill for the implementation of other difficult policies in Jakarta.”
- Adam Jarczyk, Associate Practice Leader for Asia Pacific Research

Mexico: Uphill battle joined in effort to restructure oil industry - Financial Times Beyondbrics

“This article illustrates the major hurdles president Peña Nieto faces in pushing through reforms to open the oil sector to foreign investment and private capital. Nevertheless, the article details the apparent resolve of the government to pursue the needed reforms.”
-Clinton Carter, Director of Research and Product Development for Latin America

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