Central bankers’ decisions could mean changes are in the air for the euro

President of the German Bundesbank Jens Weidmann and other countries’ central bankers made statements during the week suggesting that negative interest rates or even asset purchases (Outright Monetary Transactions, or OMT) may be considered in upcoming monetary policy announcements. These statements represent a material softening of particularly the German political stance against such measures. Any unconventional monetary policy enacted as a result of shifting eurozone economic sentiment would reduce bond yields, helping governments and banks to pay down their bad debts, and relieve upward pressure on the euro, making European exports more competitive and spurring growth.

The timing of this disruption in the consensus view on unconventional monetary action is noteworthy.  In February, Germany’s highest constitutional court criticized OMT and asked the European Court of Justice to determine whether such transactions were even within its mandate, essentially “rejecting” its validity as markets understood the ruling. However, last week the court upheld participation in the European Stability Mechanism, paving the way for further German concessions in the last pillar of the European banking union. This week’s similarly surprising change of heart prompted hopes that OMT actually could be used to support the European economy.

There are several possible reasons for the central bankers’ change of heart. The first is that a slow, incremental shift in consensus has been taking place in economic circles across Europe and is finally coming to the fore. Policymakers and business leaders alike have become less hostile towards unconventional monetary policies, and the fear of unintended consequences from QE has waned. This shift has been even more pronounced since October, when euro area inflation shrunk below 1.0% YOY, a level from which it has not returned. Price growth fell further to 0.7% YOY in February, and data released on Monday is expected to reflect the same weak inflation.

Other drivers of Europe’s re-introduction of OMT could be the result of governments bracing for another difficult year of low economic growth. Risks in Europe, and particularly Germany, are to the downside. Business confidence in CEE, but particularly in Germany, has suffered a sharp fall due to the Crimea crisis. Emerging markets’ currency devaluations have reduced demand for German exports, decreasing new orders for industrial goods. Banks are writing down massive amounts of non-performing loans ahead of ECB bank stress tests, causing a credit contraction that reduces business activity. The risk of a lash-out against austerity in southern Europe has raised fears of increasing political risk and thus higher borrowing costs for those countries, particularly Italy, which could threaten default.

ECB purchases of member government’s bonds and other assets would go far to address these issues. Reduced upward pressure on the euro would help to normalize the exchange rate, making European exports more competitive and improving growth. Lower bond yields would help banks write down bad debt more quickly, reducing the risk of bank failures. Each of these events would improve business confidence, and help bring Europe to a more sustainable recovery.

In short, central bankers’ comments bring the ECB one step closer to assisting its member governments and their banks in balanced deleveraging. This, much more than increased government spending or in lower policy interest rates, would promote growth in Europe.

Russia’s Hidden Trend: Regional Slowdown with Significant Implications

Russia slashed its long-term growth target this week, admitting that its economic slowdown is a trend that is here to stay for the next several years.

While the reasons for the slowdown have been discussed extensively, one topic has remained overlooked – the slowdown is not playing out uniformly across Russia’s geography. This has significant implications for multinationals, the majority of which are not planning to pull out of Russia, but are instead looking to allocate their resources more efficiently and to capture growth niches on a segment and geographical level.

To help our clients prioritize Russia’s geographic opportunity, we analyzed the economic health of the country’s regions. We found massive region-level variations in performance. More importantly, we found that the slowdown has been much more pronounced across many regions than the headline numbers indicate – a sign that next year’s outlook could deteriorate further.

Three trends stand out:

Trend #1: Pockets of growth are driven by one-off factors

  • Relatively fast growth in the Far East, Southern, and North Caucasus federal districts is driven by one-off projects, such as the Sochi Olympics, and federal government subsidies

Trend #2: Leading federal districts are underperforming

  • Traditional engines of economic growth, such as the Central and Urals federal districts, are stagnating because of depressed investment by large industrial enterprises in their regions

Trend #3: Slower growth is geographically widespread

  • In every federal district, there are at least several regions that are underperforming significantly, indicating that the economic slump is not isolated to a particular part of the country

The map below (click map to enlarge) summarizes our assessment of the economic health of Russia’s regions so far in 2013. We analyzed regional trends in the consumer and business sector, as well as among the increasingly-indebted regional governments, to find that demand in Russia is being driven by pockets of high growth that are geographically dispersed. This is likely to increase costs for companies looking to capture all growth pockets, and will push more multinationals to prioritize only a small number of regions, which are increasingly likely to outperform the rest. As a consequence, we are likely to see more multinationals focus on profitability and cost optimization of their local operations, rather than on making the kind of large investments that could help jump-start the country’s economy.

FSG Index for General Health of Russia's Regions


FSG clients can access the full report here.

Russia: Slowing Despite High Oil Prices

The most obvious risk to Russia’s performance in 2013 is that a sharp decline in oil prices will result in a rapid deterioration of the country’s macroeconomic environment. Foreign multinationals operating in the market, however, have a much more immediate issue to deal with – the Russian economy is slowing, even as Brent prices remain above US$110.

Demand from business customers, consumers, and the government will be trending down in the next several months and continue in 2013; the timelines, however, will differ depending on the customer. Demand for business products and services is already slowing significantly as a result of stalling investment by Russian businesses. Consumer demand started to decelerate in late summer and will continue to weaken over the next several months as inflation, a weak currency, slowing salary growth, and the anticipation of a deterioration of the macroeconomic environment in the country weigh on consumer confidence. Finally, the Russian government plans to cut spending in 2013, including in sectors such as healthcare, education, and infrastructure. As a result, multinationals selling to the government can expect reductions in public sector demand starting from next year, or at best a slowdown in the implementation of existing public commitments.

Together, these trends will contribute to a slowdown in the Russian economy in H2 2012 and 2013. However, Russia’s slowdown has a broader set of implications for multinationals. As growth in many multinationals’ core markets – particularly in Western Europe – slows, companies are increasingly turning their attention to emerging markets as a source of growth that would compensate for Europe’s weak performance. Russia is high on the list of markets where multinationals will increasingly seek to grow their presence. As a result, multinationals operating in Russia will be facing increasing competition in the context of slowing market growth. Capturing opportunity in this environment will increasingly require a commitment of greater resources to the market, as well as excellence in execution through superior logistics, distribution, and marketing, among others. Thus, Russia’s slowdown should be a wake-up call for multinationals that taking advantage of Russia’s opportunity will increasingly require a sophisticated strategy and best-in-class execution.

2013 will not be a year of recovery in CEE


Companies need to prepare for a continued deterioration of the macroeconomic environment in Central and Eastern Europe through the end of 2012 and at least the first half of 2013. Demand from both the business sectors as well as the consumers in the region will slow, and public spending cuts will limit opportunity for companies selling into the public sector.

Several drivers are contributing to this bleak picture, all of them linked to the eurozone crisis.

Exports are the main culprit as most CEE economies are highly dependent on export-driven growth and the majority of their exports are destined for the eurozone. In addition, a dependence on lending from the local subsidiaries of eurozone-based banks is leading to a tighter credit market across the region and depriving already struggling local businesses from access to capital. Adding to this, the deeply depressed consumer sectors across CEE further exacerbate the slowdown in regional economies. Finally, regional governments, eager to cut public debt and budget deficits in the face of the sovereign debt crisis, are cutting spending and raising taxes, further depriving their economies of much-needed growth. Together, these trends reinforce each other, creating a perfect storm of weak growth in the region. Because regional governments are unwilling, and some are also unable, to increase spending to break this vicious cycle, CEE’s recovery is largely out of the region’s hands and instead depends on how and when European leaders find a sustainable solution to the eurozone crisis.

While these trends apply broadly to the region, there are differences. Russia, Turkey, and Poland are benefiting from the size of their economies and resilient consumer demand which will support a softer decline in growth. Russia, Kazakhstan, and, to a small extent, Ukraine will also benefit from commodity exports. However, both consumer demand and energy exports stand substantial risk of rapid deterioration of the eurozone crisis, such as may be triggered by an exit by Greece and/or Spain. In this case, no CEE economy will be spared and the starting point of the recovery will be delayed even further.

Recession in Europe, Driving Risk of Breakup – FSG Analyst Insights


Interview with Matt Lasov, Head of EMEA Research for Frontier Strategy Group

“The risk of default and devaluation in Europe is still high. Bailout discussions focused on Spanish banks buy time and businesses should use this time to set plans in place to protect themselves against a Spanish exit from the euro.

So what’s changed in Europe since the last update? Not much. The crisis is playing out exactly as anticipated. The likely scenario remains deep recession. The risk of eurozone break up remains high and businesses should continue to plan for this. Greece is off the rails, waiting for elections in the middle of June to determine its fate inside or outside the eurozone. Meanwhile, Spain entered a full-fledged banking crisis that requires a coordinated European bailout.

The bailout for Spanish banks should buy time and avoid a run on banks in the immediate term. It will not fix the structural issues that will plague Spain in the medium term.

It is important to note that the bailout deal is not done. Spain will still have to accept the terms of the agreement, which will require harsh austerity and a transfer of fiscal sovereignty to Germany. Can the Spanish government force this on its people, especially when Prime Minister Rajoy ran on a platform guaranteeing that this would not happen? If Rajoy can push it through, how long will Spain be able to weather a cycle of harsh cuts to public services while unemployment remains at record highs?

Even if the bailout goes through, and we expect that it will, Spain will still require cost cutting of 30-40% to compete globally. This will be immensely painful whether it is done slowly over a decade, as every labor and government contract is renegotiated at competitive rates, or through a quick but highly disruptive devaluation. As cost cutting continues, the economy will shrink, and more debt will go bad because there are fewer available revenue streams that can be used to pay it off. Another bank bailout will be required to clean up the remainder of the debt overhang and the cycle will continue. Some estimates show an additional $300bn euro gap in the medium term. The current package amounts to $100bn euro.

We have seen this movie before. The cycle playing out in Spain is exactly what happened in Greece. Europe stepped in with bank bailout money to avoid imminent implosion of the member state. In exchange for funding, Greece accepted austerity measures which reduced the size of its economy. While the economy shrank, the debt burden with long term maturities stagnated. Debt to GDP ratios soared and Europe called for further austerity. The result for Greece is higher unemployment and extreme social pressures that are leading to an exit.”

Time to Prepare Your Business in Russia for Crisis

Russia Oil

Russia has been one of the few CEE markets with strong growth as the eurozone crisis drags Eastern Europe into recession. Russia’s GDP expanded 4.9% YoY in Q1 2012 and the economy seems set on a stable trajectory for the rest of the year. This stability, however, is illusionary.

Russia’s growth is already slowing down compared to 2011, a trend that plays out both in the consumer and in the industrial sectors. This is not surprising – both the IMF and the Russian government itself have already warned that Russia’s ability to grow on the back of high oil prices has reached its potential. The economy is set to grow at a sluggish 3-4% per annum unless there are major structural reforms to reduce red tape and improve the business climate in the country.

With Putin back in the Kremlin, none of these reforms are likely to materialize. The recently-announced new Russian government, dominated by Putin loyalists and weak bureaucrats, is unlikely to be a major driver of policy change. Putin’s agenda remains heavily centered on the energy sector, maintaining a large public sector, and sustaining high social spending. His program will only increase Russia’s dependence on oil prices.

In the near term, significant external risks loom over the economy. Global oil prices are unsupported by demand-supply fundamentals and are already on their way down; a deeper eurozone crisis will lead to their further decline. Brent prices declined by 25% in the last three months and the worst of the eurozone crisis is still ahead of us. As Russia’s dependence on oil prices has increased since the 2008-2009 financial crisis, the impact of an oil price bust on the economy will be severe – S&P estimates that Russia will enter recession if oil prices fall below US$80 per barrel.

As a result, Russia’s prospects should be a source of concern, rather than optimism: in the short term the economy is slowing, in the medium term the eurozone crisis poses a significant risk of recession, and in the long term there is little reason to expect growth to improve significantly. While none of these risks have fully materialized yet, companies with significant exposure in Russia need to prepare now to respond to them.

How MNCs can Benefit from Growing Political Instability in CEE

Austerity ahead

The fall of the Romanian provisional government on April 27th was the latest indication of rising anti-austerity sentiment across Europe. In the past several months, just in CEE governments have fallen in Slovakia, Slovenia and Romania, with the disintegrating Czech governing coalition barely surviving a no-confidence vote last week. However, these are not the only countries where popular dissatisfaction with the deteriorating macroeconomic environment is on the rise. The incumbent government in Croatia lost to the left-leaning opposition in the latest elections, while the pro-European Serbian government stands the real possibility of being voted out of office in favor of the leftist and nationalist opposition in next week’s elections. The Party of Regions in Ukraine, facing elections in October, is already increasing public spending to stave off its sliding popularity. Even Poland’s just-reelected government has taken a significant popularity hit in response to the austerity measures it introduced immediately after returning to office.

As CEE voters are making their preferences for less austerity clear, the resulting political instability is not all bad news for MNCs in the region. First, the political instability in CEE is giving local consumers breathing room by delaying the introduction and implementation of higher taxes that would reduce consumer spending power. Coupled with weakening inflation, this creates the opportunity for moderate improvement in consumer growth in CEE that would benefit MNCs in the FMCG space.

Second, anti-austerity sentiment in CEE is part of a broader European backlash against belt-tightening. CEE’s new governments are more likely to push for a strategy of growing out of the eurozone crisis, the only viable way for Europe to break the vicious circle of high debt and low growth in which it has been trapped. In giving in to their populist tendencies, CEE’s new governments may well push Europe toward the most viable way out of protracted recession.

Finally, CEE’s political turmoil is weakening local currencies, creating opportunities for cheap investment. With local valuations depressed due to the eurozone crisis and CEE governments aggressively seeking to attract foreign investors, MNCs are well-positioned to acquire local assets at a discount that will be compounded by currency depreciation in response to CEE’s turbulent political landscape.

As CEE Economies Slow, Governments Seek to Attract Foreign Investment

CEE Overview

As regional economies continue to slow down, CEE governments seek privatizations and public sector restructuring in order to increase revenues and attract foreign investment. Russia, Turkey, and Poland remain the region’s most resilient economies and offer opportunities for MNCs, particularly in the consumer goods sector

Bulgaria: Despite a slowdown in growth in 2012, Bulgaria remains one of the region’s most macro-economically and politically stable markets

Croatia: Croatia is in for a challenging year that will bring austerity measures, pain for local consumers, and possibly a recession

Czech Republic: As growth continues to slow, the government plans to support local producers exporting to non-eurozone markets

Hungary: The government’s disagreements with the EU negatively impact its ability to stabilize the economy

Kazakhstan: Plans for new infrastructure building and technical upgrades create opportunities for B2B MNCs

Lithuania: As eurozone export demand declines and the Lithuanian government seeks to cut spending, the economy will grow more slowly this year

Poland: Positive economic sentiment and a stabilization of the currency improve the outlook for Poland; credit crunch remains a downside risk

Romania: Despite the change in government, Romania still has to implement painful austerity measures this year

Russia: High energy prices and consumer confidence sustain solid growth

Serbia: The government will struggle with a deteriorating macroeconomic environment and pre-election pressures through H1 2012

Slovakia: The consumer outlook remains negative through 2012 as any new government would have to cut public spending

Turkey: Turkey’s growth remains resilient on strong consumer demand and public investment plans

Ukraine: The government will continue to avoid prudent economic policies that could cost it the elections this fall

Austerity Measures, Weakening Growth in Central and Eastern Europe in 2012

CEE View

As exports and consumer demand slow and regional governments seek to reduce spending, growth is weakening across the region and a difficult year is ahead for both B2B and B2C MNCs. GDP growth forecasts will likely be revised further down as CEE economies struggle with continuing volatility and recession in the eurozone. Kazakhstan and Russia continue to benefit from high energy prices, but remain vulnerable to an oil price decline

  • Bulgaria: The economy will slow in 2012, but a conservative budget will act as a buffer against an external macroeconomic shock
  • Croatia: Croatia is in for a challenging 2012 that will bring austerity measures, pain for local consumers, and possibly a recession
  • Czech Republic: Avoiding a deep recession in 2012 is possible if there is clear progress on the eurozone crisis and the German economy remains strong
  • Hungary: The government will struggle to regain investor confidence as its controversial policies are undermining market trust in Hungary
  • Kazakhstan: MNCs can expect continuity in government policies and populist measures in 2012
  • Lithuania: The liquidation of a major local bank threatens to offset the budget this year and may mean more austerity measures
  • Poland: MNCs pursuing investments in Poland are well-positioned to capitalize on the country’s undervalued currency
  • Romania: Romanian consumers remain deeply pessimistic about the economy’s prospects, a trend that will impact consumer goods MNCs
  • Russia: Economic performance will slow only moderately as the government will support high consumer spending ahead of the elections
  • Serbia: The key driver for Serbia’s growth this year remains the economic performance of the eurozone
  • Slovakia: The consumer outlook remains negative through 2012 as any new government would have to cut public spending
  • Turkey: Economic growth will slow gradually over the next several months
  • Ukraine: Growth will slow this year and could decline sharply if commodity prices drop as a result of the recession in the eurozone

Russia’s WTO entrance redraws global resource map – MarketWatch

Full article on MarketWatch

Russia’s acceptance into the World Trade Organization last month didn’t just mark an end to nearly two decades of negotiations, but opened a door to free up global trade with a nation that is one of the world’s largest oil producers and home to the globe’s biggest natural gas reserves.

And if the impact on the last large economy to join the organization — China — offers any clue, the outlook for Russian trade and its economy has much improved.

On Dec. 16, the World Trade Organization approved Russia’s membership. WTO trade ministers have said Russia’s accession to the organization will bring the nation more firmly into the global economy and make it a more attractive place to do business.

“Russia took 18 years to complete its WTO negotiations, but in the end it walked away with a great deal,” said Martina Bozadzhieva, senior analyst for Central and Eastern Europe (CEE) & Russia at Frontier Strategy Group. “Over the long term, WTO accession will increase the competitiveness of the Russian economy and [foreign direct investment] inflows.”