Emerging Market View: What Our Analysts Are Reading – 2/22/2013

Setbacks in the hopeful open sky policy for ASEAN, as well as more nervy news for Egypt’s declining fiscal health round off this week’s headlines highlighted by our research analysts:

The Wall Street Journal wrote an article on ASEAN’s open sky policy setbacks due to Indonesia:

“A good example showcasing the good intentions of the community and their positive impact on commerce in the region, but the unfortunate slow progress due to its consensus based approach of ratifying policies.”
- Shishir Sinha, Research Analyst for Asia Pacific

Arham Online, an Egyptian news website, reported currency reserves declining as Egypt’s state grain buyer steps aside:

“Egypt’s announcement that it is running out of wheat reserves is very troubling. Currency has weakened 15% since 2011 and FX reserves are down to US$13.6 billion. So it is becoming more expensive to import wheat and Egypt is running out of money to pay for it. Any significant spike in global commodity prices, a drought in Russia or Ukraine, etc. could lead to a larger economic crisis.”
- Matthew Spivack, Practice Leader for the Middle East and Africa

The Financial Times’ Beyondbrics blog, centered on emerging market news and also frequently read by FSG, posted a potential pulse in the Brazilian economy; the optimistic sentiment is not universally shared with regional executives:

“Though the Central Bank of Brazil is now stating that economic growth came in stronger than expected in 2012, this contrasts substantially from the sentiments our senior executives operating out of Brazil have expressed to FSG over the last few months. Most senior executives continue to see Brazil suffering from a sharp slowdown through the beginning of this year.”
- Antonio Martinez, Senior Research Analyst for Latin America

*Compiled by Hal Olson

Opportunities for MNCs in the Middle East & North Africa



The Middle East and North Africa’s shifting environment is making it more difficult for companies to justify investment. Several events are fueling the perception of MENA’s instability. Economic and political transitions in Egypt, Libya, and Tunisia are giving pause to foreign investors who are taking a wait-and-see approach to their entry and expansion strategies. There are serious concerns that Syria’s devastating civil war will increasingly undermine stability in neighboring markets, including Iraq, Jordan, and Lebanon. Other threats to stability, such as the fallout from a deepening eurozone crisis and the specter of a conflict involving Iran, keep corporate offices jittery about regional investment.

Despite a challenging environment, huge opportunities exist for companies operating in MENA. The MENA region’s resilient economy is expected to continue expanding steadily through 2013 and beyond. The region’s youth population has reached 200 million and it will grow significantly during the next two decades when MENA’s total population approaches 500 million. An estimated US$100 billion per year is needed for infrastructure investment to sustain growth rates and boost economic competitiveness. 

EMEA executives have a difficult time making the case for MENA, even though other regions in EMEA also have challenges. Economic growth in Central and Eastern Europe is slowing rapidly. Sub-Saharan Africa remains very risky operationally. Spending power in wealthy GCC countries is nearly 50% higher than in Central and Eastern Europe. MENA’s GDP will surpass US$4 trillion by 2015, which will be 2.5 times larger than Sub-Saharan Africa.

Even if your corporate office is not thinking about MENA investment, others are focusing on the high-reward markets. Companies will be fighting for a smaller piece of the pie due to rising competition. In a recent FSG survey of leading companies, more than 65% plan to increase their current presence in MENA markets during the next 1 to 3 years. Nearly one-third of surveyed companies expect to enter at least one new MENA market within the next 3 years.


5 Signposts to Monitor for Investing in Egypt

Foreign companies have reason for cautious optimism in Egypt after President Morsi’s stunning consolidation of power last month. Monitor economic and political signposts to anticipate the investment climate’s trajectory. If Egypt can achieve the first two signposts below by late 2012 and the other signposts by early 2013, then companies can accelerate plans to expand investment.

1. Egypt secures US$4.8 billion IMF loan: This would signal the government’s ability to prioritize economic challenges. The World Bank (US$200 million) Qatari (US$2 billion) loans have built confidence already

2. A new constitution by year-end: Non-Islamists may feel pressure to compromise on the constitution, because Morsi can appoint a new body if there is no consensus. However, a national referendum is meant to ensure the constitution is a balanced document

3. Orderly currency devaluation: An IMF loan would provide positive momentum for more funds from multilaterals, Qatar, Saudi Arabia, and the US. This would position the central bank to manage an orderly currency devaluation, potentially phased over two to three quarters

4. Morsi transfers legislative power: Elections are expected 3 months after a new constitution is adopted and a power transfer to a newly-elected legislature is critical to demonstrate that decision-making will be transparent

5. President Morsi builds consensus: Morsi must convince skeptics that his agenda does not only benefit the Muslim Brotherhood. He is appointing independent figures to several posts as a result

Looming Confrontation Impacts Investment Climate in Egypt

Egypt’s military and the Muslim Brotherhood are inching closer to a direct confrontation, which has serious ramifications for the country’s investment climate. Today Egypt’s Supreme Constitutional Court rejected President Mohammed Morsi’s decree to reinstate parliament, which the judiciary dissolved in June. The Muslim Brotherhood has called for a “million-man march” to support the return of parliamentarians tomorrow.

Frontier Strategy Group warned that the parliament’s dissolution was a potential flashpoint for confrontation between the Muslim Brotherhood and the military in a June 22 executive brief for clients. Our view remains that companies should delay reinvestment due to Egypt’s increased uncertainty, which will drive economic deterioration in the short-to-medium term.

While Egypt is focused on political volatility, the economy is on the verge of a deepening crisis. Ongoing political turmoil increases the likelihood of a disorderly currency devaluation of up to 30% or more. This would significantly raise food and fuel prices, increasing social tensions.  Egypt has approximately US$15 billion in foreign currency reserves, which can only support the pound for a few more months.

Immediate investment ramifications

Demonstrations could disrupt day-to-day business, but it is unclear whether or not the Muslim Brotherhood can attract broad support that would be necessary for sustained protests. Companies should monitor the size of protests tomorrow and whether they continue through Friday at which time their size could grow significantly. A severe military or police crackdown on protesters could lead to demonstrations across the country and the MENA region.

Risk mitigation strategies

  1. Set up alternate/satellite locations for the workplace: Position your organization to overcome transportation disruptions if there is a return of demonstrations, clashes between the police and protesters, or industrial actions
  2. Focus on people for long-term sales growth: Companies can differentiate themselves as employers of choice and improve retention levels by prioritizing the safety and well-being of staff amid political and economic instability
  3. Highlight your brand’s commitment to the country through tough times: Demonstrate your support through a marketing campaign to build brand loyalty in turbulent times, which will be critical for future investment

Egypt Plunged into Crisis, Part 2: What it means for Foreign Investment

The dust has not yet settled from recent political events in Egypt.  However, it is already clear that the reinvestment timeline is delayed for foreign companies due to increased political uncertainty, which will drive short-to-medium term economic deterioration.

There is an uncertain political outlook due to several recent developments, including the military’s decree that weakened presidential powers, the judiciary’s decision to disband parliament, and an uncertain future for the body tasked with writing the country’s new constitution. While direct confrontation is not inevitable, the potential for conflict with the Muslim Brotherhood will increase as the military delays or annuls important political decisions.

Economic deterioration

There are serious ramifications for Egypt’s economy. Egypt’s efforts to secure a US$3 billion IMF loan are undermined by the absence of a parliament and ambiguity regarding President Mohammed Morsi’s powers. This could jeopardize much-needed aid from other institutions, such as the European Union and World Bank.

Ongoing political turmoil increases the likelihood of a disorderly currency devaluation of up 15% to 30%. This would significantly raise food and fuel prices, increasing social tensions. Egypt has around US$15 billion in foreign currency reserves, which can only support the pound for roughly four months.

Given the new constitutional provisions that enshrined expansive military powers, the transfer of power is purely symbolic. Decision making about the economy will be opaque, taking place behind closed doors, adding to the uncertainty surrounding reinvestment.

High risk environment

With recent events, risk will remain high, altering the risk/return profile for companies interested in the market:


This assessment is driven by several risks: 

Unclear government commitments: Without a parliament, the military may issue high-level decrees on the economy or large government projects, but these decrees may be reversed or difficult to implement.

Reputational degradation: Supporting policy decrees by the military could undermine brand equity, particularly among MENA customers. If President Morsi is able to extract meaningful concessions from the military, then this risk could be neutralized.

Currency depreciation: Egypt’s currency is extremely vulnerable to capital flight, reduced hard currency flows from tourism, and a drop in remittances due to fears of ongoing political uncertainty.

Higher cost of doing business: Numerous fault lines threaten Egypt’s stability, which could disrupt regular business operations, especially in big cities like Alexandria and Cairo.

Risk mitigation strategies

Companies should implement risk mitigation strategies to protect investments in Egypt:

Maintain relationships with experienced bureaucrats: The bureaucratic core of the government will stay in place regardless of political upheaval. Senior executives should establish close relationships with career bureaucrats that handle product registration, taxation, and tariffs.

Leverage Saudi partners: Egypt’s stability is in the interest of Saudi Arabia, which will pour in money to support the military’s efforts to spend domestically and promote stability. This might be a good time to utilize your Saudi partners to expand presence in Egypt.

Focus on people for long-term sales growth: Companies can differentiate themselves as employers of choice and improve retention levels by prioritizing the safety and well-being of staff amid political and economic instability. This is also an opportunity to hire staff away from other multinational companies that are freezing expansion plans as a result of uncertainty.

Set up alternate/satellite locations for the workplace: Position your organization to overcome transportation disruptions if there is a return of demonstrations, clashes between the police and protesters, or industrial actions.

Uncovering opportunities

There are benefits for companies with a high risk tolerance:

Brand loyalty: Demonstrate your support by continuing some level of investment. A marketing campaign to accompany investment can build brand loyalty in turbulent times. Maintaining visibility is critical for future investment.

Undervalued acquisition targets: Assets will be trading at extremely low valuations after a currency devaluation of the Egyptian pound, which seems to be inevitable. Now may be the time to shop for companies and deepen your presence in the market.

Stronger local partnerships: Companies can strengthen relationships with partners by offering short-term financing amid tight credit conditions.

Market share gains: Multinational companies with risk mitigation plans will be positioned to gain market share while competitors are scrambling to respond to events in Egypt.

Egypt Plunged into Crisis – Part 1

This week’s dissolution of Egypt’s parliament and imposition of martial law were the first steps of a military-led coup. As a result, the ruling military council has taken over legislative powers and the committee for writing a new constitution no longer exists. The decision has plunged the political transition into crisis just one day ahead of the presidential election.

Companies should expect short-term political instability, making it more difficult to make the case for investment and delaying the reinvestment timeline for Egypt. While the Muslim Brotherhood’s initial investment policies left much room for improvement, the dissolution of parliament delays Egypt’s efforts to pass legislation that will improve the economy and attract investment.

This weekend’s presidential election will determine whether or not the military coup is successful. If former Prime Minister Ahmed Shafiq, who is backed by the ruling military authority, beats the Muslim Brotherhood candidate Mohamed Morsi, then it will be the second stage of the coup. The military is counting on Egyptians to be too disenchanted to put up a serious fight if at all. Martial law was reinstated earlier this week as a precautionary measure.

Egypt in on the Verge of an Economic Crisis

Egypt Currency

The Egyptian pound is likely to devalue by up to 20% against the dollar in 2012. The currency’s slide in value represents the biggest threat to the Egyptian economy.

  • Egypt’s government is running out of hard currency to prop up the pound, which will result in a devaluation
  • Devaluation is likely to take place following the presidential election at the end of June 2012
    • Egyptian authorities want to avoid an economic crisis that could delay elections

The currency is supported by unsustainable conditions

  • Capital flight: Egypt’s revolution drove a 60% contraction in FDI. The tourism sector, a key industry that drives foreign currency accumulation, reported a 30% reduction in revenue last year. Meanwhile, portfolio investors sold more than US$7.5 billion in Egyptian T-bills in 2011, comprising more than 25% of foreign holdings
  • Import dependence: As the largest wheat importer in the world, Egypt has a US$23.6 billion trade deficit, adding pressure to the local currency
  • Unsustainable monetary policy: The central bank spent US$18 billion, 50% of its total reserves, supporting the currency in 2011

Egypt is running out of funds to stabilize the local currency

  • The US$23 billion budget deficit will expand because of  new subsidies and weak foreign investment
  • The central bank required a US$1 billion loan from the military earlier this year, which is an unusual step that exposes a lack of funding for the institution
  • Most of the US$10 billion pledged by the G8 and GCC countries has not yet reached Egypt. Donor countries want to see a greater level of economic stability before releasing funds
  • Renewing discussions with the IMF over a US$3.2 billion loan will not make a significant difference in funding if an agreement is reached

Political and social factors undermine the currency’s outlook

  • Political uncertainty is undermining the outlook for the currency as investors, both domestic and foreign, do not want to hold Egyptian pound-denominated assets
  • To reduce uncertainty, Egypt must achieve several political milestones this year, including presidential elections and the writing of a new constitution
    • The constitution will define the military’s future role in Egypt
    • An unclear transition timetable from military to civilian rule could deepen local tensions
    • The same underlying factors that led to the revolution, such as high inflation and unemployment, are still serious concerns and may be drivers of continued instability


Outlook for North Africa Post Gaddafi

The death of former Libyan ruler Muammar Gaddafi marks the symbolic beginning of a new era in North Africa and transitioning states are keen to attract foreign investment. Companies should avoid being paralyzed by uncertainty, and must begin planning to re-engage and expand in the region to capture medium to long-term opportunities.

Investment opportunities exist across sectors though key considerations differ by country

  • Consumer Goods: Egypt’s market size and strong sector growth, especially in cities, make it an attractive investment, while relative stability in Morocco and Tunisia will support a healthier outlook (see MarketView screenshot above)
  • Industrials: Ongoing public and private investment in oil and gas will support Algeria’s desirability as an investment destination in related sectors. Rebuilding opportunities and an effort to bring oil production back online will mean strong growth in Libya
  • Technology/Telecommunications: Size and growth underpin the outlook in Egypt, where plans could be revisited to become an outsourcing hub, while ICT services make Algeria’s B2B market an attractive investment target
  • Healthcare: Tunisia’s market does not offer robust size or growth, but it is a safe bet due to previous investment in the healthcare sector. Conversely, Libya’s healthcare infrastructure suffers from years of neglect, but the country is a wildcard for future growth due to high GDP per capita among a small population

Threats and Opportunities Await MNCs in Turkey

Explosive deterioration of its relationship with Israel. A trip of the post-Arab Spring Middle East. Turkey’s foreign policy is generating quite a lot of attention in the Middle East these days.

Beyond its political implications; however, the policy of courting key Middle Eastern countries like Egypt also has a serious domestic driver: Turkey’s economy is charting precarious waters.

Turkey has been struggling with a rising current account deficit driven by strong domestic demand. The rise in household consumption has been financed by capital from Europe, making Turkey increasingly vulnerable to an outflow of short-term capital as European economies continue to struggle.

The other pillar of Turkey’s economy – exports, is also threatened by the potential of a Eurozone recession. With over 50% of Turkish exports going to the EU, Turkey is particularly vulnerable to a drop in demand from such key countries as Germany, Italy, and Spain. FSG Monitor estimates that a US-EU recession would lead to a 2% drop in Turkey’s GDP in 2012. The projected decline may not be as dramatic as in other countries in the region, but compared to Turkey’s Q1 2011 11.6% GDP growth, followed by 8.8% for Q2 2011 (Turkey had the highest H1 2011 GDP growth in the world), it’s very significant.

In this unstable environment, the Turkish government has announced it will seek to promote export-oriented domestic production. But this strategy will only work if there is enough demand for Turkey’s increased exports. With the European economy in a shaky state, Middle Eastern markets will be increasingly instrumental to Turkey’s economic stability. Currently, the Middle East is the second biggest regional market for Turkish exports, accounting for 20% of the country’s exports, plus another 4.9% of exports going to North Africa.

Turkish businesses are clearly seeing the writing on the wall and are aggressively seeking expanded influence in the Middle East, as evidenced by Prime Minister Erdogan’s large business delegation on his recent trip to Egypt and his promise to increase trade between the two countries to US$5 billion.

In this context, MNCs should expect Turkish competitors to aggressively pursue opportunities in the post-Arab spring markets. As we already discussed, MNCs with overly risk-averse strategies in the region can fall behind regional competitors with a greater risk appetite. It also means, however, that MNCs with Turkish partners can use these relationships in support of strategic expansion in the MENA region, benefitting from the good will Turks are enjoying among the region’s populations and leadership.

In this context, the role of Turkey as a manufacturing hub for the Middle East and North Africa region is becoming increasingly attractive, not just to MNCs but also to the Turkish government itself. As a result, MNCs with local production facilities meant for export to the region are well-positioned to lobby the Turkish government for additional incentives and support.

MENA Instability is a Wake-Up Call for Companies to Engage Governments

After months of turmoil and civil war, the precipitous fall of the government of Muammar Gaddafi has re-ignited the momentum behind the so-called “Arab Spring.” Escalating violence in Syria, transitions in Egypt and Tunisia, and tensions throughout much of the region will ensure political uncertainty for the remainder of 2011 and quite possibly well into 2012.

Amid all of the ambiguity, one fact remains certain:  more change is on the way and global companies need to prepare for it. Outcomes will vary from country to country, as will the groups impacted, and timelines for transition. Years of endemic corruption that benefitted small segments of the population have led to a pervasive sense of injustice and huge gaps in employment and education.  For many years, governments have been unwilling or unable to 1) control high food and fuel prices; 2) curb unemployment and underemployment especially among young people; and 3) establish viable and forward-leaning education systems. The governments must address these root causes of societal conflict while also trying to attract FDI— a tough balancing act. All of this will lead to an unpredictable manner in which citizens will interact with their government and in the way that governments interact with external actors, including foreign MNCs.

Given the shifting landscape, foreign MNCs see potential for new challenges in the region. In a poll that Frontier Strategy Group conducted at the end of July, nearly 80% of executives identified external factors as the biggest challenge facing their businesses in MENA. This new regional reality has raised pertinent questions for businesses that are unsure how to engage new and transitional governments: How can companies mitigate risks through government relations? Should companies take a wait-and-see approach in the region or build government relations networks that will assist them through these transitional years?

Mitigating risk through government relations

Foreign MNCs have a variety of tools that they can utilize to mitigate risks associated with ongoing changes in governments. Judith Barnett, principal for the Middle East-focused consultancy The Barnett Group, sees several concrete steps that companies can take to reduce risk:

“There will be more changes, but the core of the governments will stay. Executives should visit these markets and establish close relationships with career people who handle product registration, bans, taxation, and tariffs. Being aligned with some of the local business organizations and federations is very important during this transition.  MNCs also need to organize a strategy that allows them to invoke a range of relevant ministers who could play a substantial role in establishing new government processes by the time they leave office. Coordinating with a relevant embassy can be important because in most, but not all of these discussions with local government officials, the Ambassador and her staff can be very helpful in assisting companies to reach out to local governments and most importantly, to conduct follow through activities.”

While senior executives in Latin America are awash in funding and senior executives in Asia have high growth markets like China and India, EMEA executives must contend with an atmosphere in which they are expected to do more with fewer resources. This presents challenges for obtaining internal buy-in for a government relations unit in the region. However, failing to devote the appropriate resources to government relations in MENA can result in tens of millions of dollars in losses.  “An internal government relations program is actually inexpensive to establish. With a set of priority issues (trade barriers your Company is confronting), a strategic plan, focused meetings with government officials, and intense follow-through, you can resolve expensive problems and make 2011 and 2012 market-building years.  You need to build your brand’s name, but you also need to protect it. That is where government relations can be critical. All you need is one tariff increase, product ban, new tax, or problem with registration to throw off your entire year,” Ms. Barnett adds.

Wait-and-See approach is the wrong one

In markets plagued by political and economic turmoil, conventional wisdom for many Western firms is to take a wait-and-see strategy before unfreezing projects, increasing investment, or expanding operations. This type of risk-averse policy leaves an opening for Chinese, Gulf, Turkish, and other international companies to gain significant market share in a very short period of time. Judith Barnett comments that there are long-term ramifications for this approach:

“Wait-and-see is the wrong strategy. When I visited Egypt over the summer, companies were talking about US$150 million investments, US$1 billion investments. These are smart companies that are moving forward at this time of opportunity. The more you continue to support these countries, the more that people will remember it. There is a great deal of brand, and inter-personal loyalty in the region.”

There is no doubt that MENA markets will present challenges to businesses in the short to medium term. Democratic transitions are not usually a smooth process. For example, unemployment historically increases as the economy is transformed. This will exacerbate political stability. Still, the investment opportunity is undeniable in the region. Right now 200 million people in MENA are under 29 and that figure will rise significantly over the next 10-15 years when the population surpasses 500 million. Regional GDP will surpass US$3 trillion next year, which is 30% higher than the rapidly growing African continent is forecast to reach by 2020. The MENA figure is expected to more than triple to US$10 trillion by 2030. A robust government relations strategy is critical for capturing this growth opportunity.

“Candidly said,” states Ms. Barnett, “If you don’t take care of your customer, someone else will!”