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 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
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.”
Trend
The ruble is depreciating against the dollar as markets anticipate Russia will run a deficit in 2012. We expect the Russian government to intervene in the foreign exchange market in Q1 2012, but a significant decline in oil prices could lead to rapid ruble depreciation as Russia would lose the hard currency necessary to support the ruble
Drivers
- The eurozone crisis is driving investors away from emerging markets currencies, including the ruble. The result is a stronger dollar which will put downward pressure on oil prices. Low oil prices will in turn weaken the ruble in H1 2012
- Weak exports combined with Russian demand for imports (see Trend #2) are also contributing to a weaker ruble
- Large capital outflows, expected to reach over US$70 billion for 2011, are putting downward pressure on the ruble. The outflows will continue to impact the exchange rate at least through the March 2012 elections
FSG View
- We expect the ruble to remain weak through H1 2012 and to depreciate significantly when the eurozone crisis leads to a decline in oil prices
- The Central Bank of Russia is able and willing to intervene to keep the ruble from depreciating significantly and will do so increasingly as elections draw near. However, it does not have the firepower to offset the effects of a sharp decrease in oil prices
- A weak ruble will contribute to the gradual deterioration of Russian consumer outlook in late Q1 2012 and negatively impact B2C companies and MNCs importing into Russia. Companies producing locally will be well-positioned to take advantage of consumers switching to cheaper, domestically-produced goods
- The weaker ruble will strengthen the position of Russian exporters but will not compensate for the decrease in demand from European markets
- MNCs need to factor a weaker ruble and higher volatility in their planning for 2012 and consider forward-pricing and hedging strategies to limit the impact of a weaker ruble on their business
As Western Europe continues to struggle with the sovereign debt crisis and currency depreciation, declining exports, and lower 2012 growth prospects engulf Central and Eastern Europe, the outlook for Russia seems surprisingly solid. Despite a slow downward revision of 2012 growth forecasts from earlier this year, Russia is still projected to grow at about 4% in 2012.
However, the 2008-2009 crisis made it painfully clear that Russia is not and cannot be an island of stability when European and potentially global markets are in turmoil. Since 2009, Russia has grown even more dependent on energy exports, with its 2012 budget balancing at oil price of over $110 per barrel.
In the short term Russia is growing on the back of strong consumer demand, but this in no way eliminates the significant downside risk of an oil price decline. With the Eurozone already heading into a mild recession and the possibility of global financial market contagion, a significant decline in oil prices is a real possibility. A drop in oil prices could unleash a chain reaction (see graph) that would undermine Russia’s economy and, at best, depress Russia’s GDP growth.
For MNCs, this means having contingency plans for a significant downturn in Russia over the next 6-8 months to address ruble depreciation and declining demand on the domestic market.
On the positive side, MNCs should also be prepared to take advantage of M&A opportunities as attractive local assets will be priced at a discount.
In the long term, the Russian market continues to hold significant opportunity for foreign companies, especially after the country joins the WTO later this year. However, MNCs need to account for the significant risk the Eurozone crisis is posing to Russia’s performance in 2012 and be prepared to respond to rapid changes in the market.
Despite the uncertainty and volatility surrounding the 2012 economic environment, corporate expectations for emerging market business units remain high, across regions and industries. Companies such as Heinz (NYSE: HNZ-P) and BlackRock (NYSE: BLK) are expecting emerging markets to continue to drive growth, but Frontier Strategy Group has observed two potential red flags that emerging markets executives should consider as they look to 2012:
1.Expectations are aggressive, but strategies are conservative
–Profitable growth is the priority in 2012. Most executives are emphasizing conservative methods for expansion over riskier and more resource-intensive options
–Companies are expecting to achieve targets by taking market share, rather than entering new markets, launching new products, or M&A
2.Strategies may be undermined by the tactics used to implement them
–Despite the emphasis placed on profitability, a majority of companies plan to compete on price, lowering the prices of their existing products developed for Western markets, rather than adjusting product features, which would allow them to reduce costs while increasing value
–Margins will be further squeezed if deteriorating market conditions cause customers to be increasingly price sensitive
FSG has surveyed senior executives running emerging markets business units to collect detailed insights into growth targets and strategies, hiring, salaries, organizational structure, and more.
