Emerging Markets Insights

Nigeria is a tale of two regions as city-level opportunities in the south overshadow widespread insecurity in the north. Companies must overcome corporate HQ fears regarding operational risks to position for long-term success in Nigeria, which remains the most attractive long-term investment destination in Sub-Saharan Africa.

Last month ethnic conflict ravaged northern Nigeria, leaving 150 dead and 100 injured. This continues a troubling trend of violence in 2012. From an investment perspective, this has rattled foreign companies that are wondering if Nigeria is becoming too risky. However, halting or drastically scaling back investment plans would be a mistake for senior executives.

Much of the violence is isolated in the economically underdeveloped north. The total GDP of 7 attack locations between April 5 and May 4 is US$25 billion, which represents less than 10% of Nigeria’s economy. On the other hand, the total GDP of 7 top investment destinations in the south is US$80 billion. This represents more than 30% of Nigeria’s economy.

Nigeria’s five largest cities, all of which are located in the south, have a combined GDP exceeding US$75 billion. This is surpassed only by Angola and South Africa.  City GDP in Nigeria’s south is set to expand significantly this quarter, even if only on paper, because the government is shifting the base year for real GDP to 2009 from 1990. The result will be an overnight gain of 40% that closes the overall economy size gap between Nigeria and South Africa to only 10%.

Southern cities represent great opportunities for companies targeting emerging consumer classes, public sector projects, and other private sector companies flocking to urban areas. Companies should establish good relationships with distributors that know the southern part of the country well. Much of your sales opportunities are likely to be concentrated in this region for the foreseeable future.

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Sub-Saharan Africa’s potential for economic growth is no longer a secret.

Some estimates show Africa having as many middle class households as China by 2020.

The region is expected to set the pace for global growth over the next five years, with economic expansion averaging 6 per cent per year. China increased Africa investment by almost 60 per cent last year, while India pledged to expand trade volume to $90bn (£56bn) by 2015.

Much of this investment will be concentrated in fast-growing sub-Saharan African markets like Angola, Kenya and Nigeria. Multinational corporations are increasingly concentrating resources on these types of markets to make up for economic volatility in Europe and political uncertainty in the Middle East and North Africa.

In a survey conducted last year, 42 per cent of senior executives focused on Europe, the Middle East and Africa (Emea) revealed that they are planning to set up a direct presence in at least one sub-Saharan African country in 2012. More than one-fifth of polled executives said they plan to establish an African managing director role within two years to oversee regional operations.

Multinationals intend to capture average profit margins greater than 10 per cent and returns on capital 60-70 per cent greater than in high-growth markets like China, India and Indonesia.

If multinationals want to capitalise on all that Africa has to offer, then a fundamental shift must take place in the way that companies prioritise markets for resource allocation decisions. Africa is far too big and complex to look at as one market, or even as a portfolio of countries. Companies must look at the African opportunity as a portfolio of cities, targeting the urban areas that offer the best opportunities for their business.

To continue reading the full article, visit the Financial Times website.

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Relatively high commodity prices are supporting government spending plans for most oil and gas exporters in the Middle East and Africa. If rising tensions involving Iran and Israel turns into a conflict, then commodities prices will climb to much higher levels and stoke inflation regionally. Import-dependent economies in East Africa, North Africa, and the Middle East are particularly vulnerable to commodity price spikes that undermine consumer spending power and make it difficult for SMEs to meet their financial obligations

Algeria: The export-oriented economy is exposed to eurozone volatility due to trade with European markets

Angola: Massive oil diversification budget spending continues this year, which means more opportunities for consumer goods and healthcare MNCs

Egypt: The country’s economy remains on the brink, though investors are hopeful that an IMF deal will provide short-term relief

Ghana: The economy remains strong due to government spending and natural resource riches, though new tax policies are a concern for investors

Iran: The local environment is increasingly precarious due to a combination of economic distress and covert military activity

Iraq: The country’s short- and long-term growth outlooks are positive, supported by increased oil production capacity and elevated global prices

Israel: Apple’s commitment to the Israeli technology sector demonstrates the attractiveness of the country’s tech industry right now

Kenya: Parliament’s bid to unseat the head of the central bank head is only the latest example of domestic political discord

Morocco: Government spending keeps growth positive, but the eurozone casts a long shadow as a fall in remittances impact Moroccans

Nigeria: Strong growth will not be derailed, though inflation and security risks pose challenges to the economy

Saudi Arabia: Economic fundamentals underpin a strong outlook, though MNCs should monitor regional tensions

South Africa: The budget offers opportunities for investment and tax relief to citizens, though alcohol and tobacco tax hikes will sting some MNCs

Tanzania: Inflationary growth continues to place pressure on consumers and the economy

UAE: Tighter Iran sanctions will benefit the UAE through increased oil demand, but a critical trade relationship will suffer

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On January 1, the Nigerian government removed the long-standing subsidy on fuel, increasing prices from 65 to 150 naira per liter. Following local protests and negotiations, President Jonathan reduced the increase to 97 naira per liter, a 50% increase

While some view this as a clever strategic move, the haphazard implementation (including using the military to quell protests) has called into question the government’s ability to implement other much-needed reforms

Drivers

Reduced Political Capital: The new president’s “honeymoon” has officially ended. The president can no longer count on broad-based political support, and has recently been stymied by state governors, unions, state legislators, and religious leaders

Poverty and Inequality: A perception that reforms favor elites and businesses will continue to plague the president. Critically important will be future implementation of the president’s “jobs agenda” for generating employment, especially among youth

Fighting Corruption: Recent anti-corruption moves, such as dismissing state governors, are largely symbolic and the president’s policies must succeed where others have failed

FSG View

The fuel subsidy removal is unlikely to be repealed. Higher local fuel prices and reduced consumer discretionary spending should be priced into operating budgets immediately

The next three months will be critical to bolstering government credibility and preparing for upcoming economic improvements

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Country and regional heads are increasingly turning their attention to their government engagement function. Government decisions, from regulatory issues to government sales, can deeply impact the bottom line.

Companies wrestle with a variety of questions when it comes to running successful government engagement functions. These questions can be broken down into three principal challenges:

1. Ensure the company invests the right amount in government engagement.

2. Generate positive engagement when government actors are initially unreceptive.

3. Capitalize on the abilities of third parties without putting the company at risk.

In response to these challenges, most companies resort to a reactive, problem-solving approach. In order to succeed, the government engagement function should reframe traditional ROI evaluations to embrace the broader goals of government engagement, thus creating a proactive decision framework. This new ROI approach applies to each of the three major challenges companies face:

1. Justify Your Investment – First understand how to tailor your investments to the realities presented by each country’s business and political environment.

2. Earn Your Influence – Make sure you time the ―I‖ well in ROI.

3. Discipline Your Delegates – Do not take short cuts with third parties. A low ―I‖ does not guarantee high ROI if the ―R‖ turns out to be negative.

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Nigeria’s government must walk a tightrope to successfully implement its reform agenda and satisfy angry citizens who are feeling the pain of fuel subsidy rollbacks. However, a resolution to the current political impasse is likely so any major changes to your strategy is a mistake

• Fuel subsidy rollbacks caused gasoline prices to rise by more than 100% to US$0.94 per liter. As a result, Nigeria’s two largest unions called indefinite strikes that could threaten the economy if a compromise is not reached and work stoppages spread to the oil sector
• President Goodluck Jonathan is framing the rollbacks as critical for the economy, which was burdened by the recurrent costs that total more than US$6 billion annually or roughly 25% of the budget
  • The government claims it will reallocate the cost savings to spend on education, healthcare, and the energy infrastructure. However, the public is skeptical due to past wasteful spending and a draft budget that allocated more money to security than health, education, and energy combined

Three ways you can respond to the latest developments in Nigeria

• Diversify your production toward more high-margin products
• Leverage Frontier Strategy Group’s making the case materials and city-level data to quantify ROI in Nigeria
• Consider forward-buying key imported raw materials with cash-flow management tools as price pressure is likely to maintain upward momentum

Three ways fuel subsidy rollbacks impact Nigeria’s investment climate in 2012

• More competition for the purse: B2C companies will face more cross-sector competition to capture discretionary spending from cash-strapped Nigerian consumers
  • The rollbacks will stoke food and fuel inflation, which impacts most Nigerians whom live on less than US$2 per day
  • Heightened price sensitivity may cause consumers to trade down for value in the short term
• Difficulty in making the case: Nigeria’s medium-term growth potential remains the best among African peers, but negative headlines will raise doubt among some risk-averse corporate centers 
  • The strikes coupled with a recent spike in sectarian violence will scare away some investors
• Higher cost of doing business: All companies with local operations should brace for higher costs as instability weakens the naira and increases the likelihood of a currency devaluation
  • Strikes amid ongoing sectarian violence, mid-teens inflation growth, and depleted currency reserves raises the specter of a devaluation
  • A silver lining of a currency devaluation would be to make Nigeria a more attractive regional export hub

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Original Article in MarketWatch

Matt Lasov, director of global research at Frontier Strategy Group, said the emerging markets’ performance in 2012 depends on their relationship to the euro zone.

“The euro zone is in a recession that is likely to get worse,” Lasov said. “We see a two in three chance that there is a breakup of the euro zone in 2012 — most likely Greece leaving.”

And “success for emerging markets will be determined by linkages to the euro zone,” he said.

“The clear outperformers in the short term are India, Indonesia, and Sub-Saharan Africa,” according to a research note from Frontier Strategy Group, referring to those markets as having “low linkage” to the euro zone. “These markets are characterized by rapidly growing domestic demand and diversifying economies that are creating middle class growth” and they have limited trade relationships with Europe.

The Middle East and Latin America are linked to Europe because of trading in commodities, the note said, referring to these markets as having “medium linkage” to the euro zone. “Reduced European demand for oil will impact state revenues, but most markets have more than enough reserves to weather a crisis.”

Russia, meanwhile, is “positioned to be the biggest underperformer,” the note said. “Oil exports to Europe are driving Russia GDP growth more than ever before,” and as oil prices fall below the $110 per barrel built into the Russian budget, “Russia will enter deficit.”

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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 8^th 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)

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In my last post Weeding out corruption critical to African growth prospects we looked at the current state of corruption in Africa and its impact on conducting business on the continent. Below are four tips for an anti-corruption strategy in Africa:

#1 Recognize nuance: corruption varies by country, sector and type of interaction (both public and private sector) – risk assessments and due diligence to highlight ‘red flags’ associated with important transactions are always worthwhile investments and should be built into the deal cycle accordingly

#2 Training and messaging is invaluable: consistently repeat the mantra to staff in-country, to management at HQ, to suppliers and other service-providers, and to government and wider stakeholders that the organization is not prepared to involve itself in illegal or unethical practices

#3 Uncover wrong-doing proactively: prevention is cheaper than cure, but self-diagnosis is also preferable to external investigation; publicizing whistle-blowing channels and regular self-auditing are invaluable tools in this process

#4 Prepare for the worst: even with the best intentions, and policies, wrong-doing will still be a realistic possibility somewhere in your business footprint in Africa; the worst time to be crafting a coping strategy is on the fly so proactively prepare a corrupt incident crisis management and business continuity strategy to cover for that eventuality

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(A sign promoting the fight against corruption in Zambia - author's photograph)

From examinations of malpractice in South Africa’s police service, via investigations into grand larceny perpetrated by the recently toppled Gadhafi and Mubarak regimes in North Africa, to debates about new anti-graft bodies in Kenya and Zimbabwe, a cursory glance at media stories from the past seven days illustrate that corruption is rarely far from Africa’s headlines. Nor is it often absent from lists of investors’ most common complaints about, or reasons to delay, committing funds to the continent. With the business opportunity in the region proving increasingly difficult to ignore, and legislation governing Western companies’ ethical conduct tightening, developing holistic and effective corporate strategies to avoid entanglement in illegal activity has arguably never been more important.

Shifting sands, but still quicksand

Africa’s changing demographic and governance profile – generally younger and more democratic – is gradually changing its transparency outlook. Observing events in Tunisia and Egypt from close quarters and fearful of similar mass protests mobilized within their own increasingly connected societies and maturing civil society institutions, fewer governments south of the Sahara feel they can be seen to be tolerant of corrupt activity. However, as powerfully illustrated in a compelling recent book about the root causes and impacts of corruption in Kenya, the incentives that drive malfeasance including inter-ethnic competition and poor bureaucratic pay remain strong across most of the continent. The recent experiences of Nigeria, Senegal and Kenya amongst other countries highlight that all too often political movements that surf an anti-corruption and good governance wave to power all too often themselves succumb to temptation once entrenched in government.

Recognizing that transforming a vicious circle – where citizens, bureaucrats and businessmen all feel it is in their immediate personal interest to prolong corrupt practices – into a virtuous one is far from an overnight project, Western governments are increasingly seeking to rupture that co-dependency through extra-territorial legislation in their home countries. Until recently, the US Foreign and Corrupt Practices Act has been the trailblazer in this regard, ensnaring a who’s who of major corporations in its investigations – many of them with a footprint in Africa. A newer kid on the block, the UK Bribery Act, was only enacted on 1 July this year – it has raised eyebrows by outlawing smaller so-called ‘facilitation payments’ or small bribes made by UK entities – the grinding, every day variant of the corruption blight – as well as the large payments intended to skew business outcomes that usually attract the main focus of investigators.

(Percentage of users who report paying a bribe to at least one of nine service providers in the past year; source: Transparency International Global Corruption Barometer, 2010)

Short term pain, long term gain

The howls of protest that greeted the UK legislation – that it’s impossible to do business in places like Africa without paying bribes, that zealous enforcement of its provisions will render UK businesses uncompetitive against less scrupulous competitors – underline the sort of short-term thinking that continues to define the intractability of the problem in the region. In fact, growing numbers of corporations are finding out that taking a zero-tolerance approach even in the most murky and problematic jurisdictions does eventually pay dividends. A short-term opportunity cost – of tenders lost or delays to processes previously greased by bribes – is rapidly replaced by a reduction in demands and enhanced status as an employer and partner of choice. The contribution to overall societal transformation may be more modest, but the benefits in terms of litigation and compromising commercial entanglements avoided are generally a more than sufficient ROI.

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