Emerging Market View: What Our Analysts Are Reading

EM View

On Friday, Iraqi Prime Minister Nouri Maliki resigned, according to the BBC. Despite hopes that a resignation would help end the political crisis in Baghdad, FSG’s Practice Leader for Middle East & North Africa says it’s not over yet.

“Iraq’s political crisis is not over yet, but Nouri al-Maliki’s decision to step aside is a critical development. Companies should watch for whether PM-designate Haider al-Abadi is able to to form a new government that promotes cross-sectarian cooperation. A new government would need to usher in political reforms that ease sectarian tensions to bring Iraq back from the brink of civil war,” says Matthew Spivack.

In Latin America, Mexico’s government has outlined a plan to open oil fields to private companies, providing opportunity for foreign investment, according to the Wall Street Journal.

“The Mexican government is quickly moving forward with the first round of bidding starting early next year, which should provide an early infusion of FDI and support higher investment growth in 2015 ,” says Antonio Martinez, FSG’s Associate Practice Leader for Latin America.

This news comes in the same week as The Economist’s story “Mexico’s minimum wage: Stingy by any measure,” highlighting the low interest in the country’s consumer opportunity over the past two decades.

“Over the last two decades the increase in earning power of Mexican workers has severely lagged most of the other large LATAM economies, and is an important reason why the consumer opportunity in Mexico has not been as attractive to B2C companies as the economy’s size would suggest,” says Antonio Martinez.

In the Asia Pacific region this week, good news for Malaysia’s economy as second quarter growth shows unexpected acceleration on exports, according to Bloomberg.

“Malaysia’s impressive Q2 performance bodes well for the country’s growth over the coming months. The government’s efforts to address bottlenecks in the economy and improve the domestic operating environment are clearly paying dividends,” says Adam Jarczyk, FSG’s Practice Leader for Asia Pacific.


FSG clients can stay up to date with analyst commentary on the latest emerging markets headlines on the client portal. Not a client?  Contact us for more information.

Mexico’s Sluggish Performance Continues

Mexico’s economy continues to struggle as Q3 unfolds, with the economy facing persistent headwinds. The prolonged weakness of the construction sector and continued fallout from tax hikes at the beginning of 2014 are limiting domestic demand. Meanwhile, the US economy’s slow start in 2014 has constrained demand for Mexican exports, though manufacturing exports have shown stronger signs of life after a strong Q2 for the US economy. Consumer spending remains sluggish, with few expectations for a rapid recovery over the short term. The combination of all of these factors has led FSG to revise Mexico’s GDP growth for the year down to 2.3% YOY, from 2.5%.

Mexico has underperformed in 2014.

The government’s ability to execute government spending and structural reforms will be vital for a recovery in the second half of 2014 and 2015. On the reform front, progress on the passage of secondary implementation reforms in the energy and telecom sectors should improve investor sentiment in Q3, while enhanced execution of government spending should boost the economy in the second half. While government spending has been underwhelming through the first half of the year with slow and ineffective execution on government infrastructure projects, other spending commitments have delayed necessary stimuli to domestic demand, derailing a recovery for the construction sector among other industries.

In our latest quarterly market review of Mexico, FSG explores three key trends that will have an impact on the business environment and corporate sentiment over the medium term:

1. The private sector is increasingly dissatisfied with Peña Nieto’s government: The private sector is increasingly at odds with the government, with tax increases and poor execution of government spending causing growing dissatisfaction within the Mexican business community

2. Higher taxes have multinationals reconsidering their local manufacturing footprints: Higher taxes and fewer incentives for export manufacturers in border states have multinationals reconsidering their manufacturing footprints in Mexico, with companies seeking to align their local manufacturing presence with the local market opportunity

3. Telecom reforms will increase productivity and investment in 2015 and beyond: Telecommunications reform will likely improve competition within the sector and increase the affordability of telecom services, which will have long-lasting effects on productivity and overall investment in Mexico


For a full report on Mexico’s performance, FSG clients can access our Mexico Quarterly Market Review on the client portal. Not a client? Contact us for more information.

Mexico’s Prolonged Slowdown Continues to Rattle MNCs’ Sentiment toward the Fast-Reforming Market

The Mexican economy has continued to underperform in 2014, with expectations for 3%+ growth becoming increasingly unachievable. Q1 GDP growth came in at a weak 1.8% YOY, far below initial expectations. FSG’s forecasted 2014 GDP growth for Mexico has fallen to 2.5% YOY as domestic demand contracts and an expected recovery in exports is delayed due to US economic weakness. That said, FSG continues to expect that an acceleration of government spending and higher export demand through the remainder of the year will accelerate economic growth, however a recovery in consumer spending is likely to lag well into the second half of the year, as consumers adapt to higher taxes introduced back in January.

Mexico GDP

Meanwhile, progress on passage of key structural reforms has been slower than initially forecasted, although both telecommunications and energy reform are expected to be discussed and passed through extraordinary legislative sessions in June. Multinational sentiment remains bullish over Mexico’s long-term promise, largely as a result of these reforms, but the recent weakness of the economy and slow progress toward passage and implementation of these reforms has somewhat tempered exuberance toward Mexico.

In our latest quarterly market review on Mexico FSG explored three key trends that will have an impact on the business environment and corporate sentiment over the medium term:

  • Market liberalization will create upheaval and churn across key industries in Mexico: As the Mexican government looks to increase competition in concentrated industries, this will create new challenges for incumbent players and open up new opportunities for multinationals thinking of entering the market
  • The government’s centralization drive is transforming B2G dynamics: The government’s reform efforts, while largely supportive of greater market liberalization and private investment also seek to consolidate and strengthen the federal Mexican state against domestic interest groups, state and municipal governments, which will transform B2G sales efforts and government engagement strategies for multinationals
  • Energy costs remain the biggest threat to Mexico’s manufacturing competitiveness: Even as more companies are considering increasing their manufacturing presence in Mexico, rising energy costs remain an important threat to the cost competitiveness of manufacturing in Mexico

For more information, FSG clients can access the full report here.

Optimistic About Mexico’s Second Half Performance

While FSG clients continue to view the Mexican economy as a source of opportunity, revenue growth came in under expectations in the first quarter, and targets for 2013 reflect lower expectations than in previous years. That said, executives remain relatively optimistic about the potential for stronger growth in the second half of the year, contingent upon accelerated government spending and investment in infrastructure, progress on the structural reform front, and continued economic recovery in the US.

From a macroeconomic perspective, manufacturing exports, the troubled construction sector, and stalled government procurement proved to be significant drags on growth in recent months. Additionally, Mexican consumer and producer confidence declined during H1, and the pace of consumption and credit growth have moderated, reflecting the impact of sluggish external demand, falling remittances, currency depreciation, and inflationary pressures on domestic sentiment and purchasing power.

Broadly speaking, Mexico’s near-term prospects remain highly contingent upon US economic performance, although Peña Nieto’s commitment to accelerating investment in infrastructure and pushing through fiscal and energy reform also has the potential to drive growth and foreign direct investment in the months ahead.

It is against this economic backdrop that FSG believes multinationals should be tracking the following three trends during the third quarter of this year as an indication of how the business environment is likely to evolve over the medium term:

  • Ramping up of government spending under the new administration
    • Recent developments: During the first quarter of 2013, government expenditure fell short of budgeted amounts by 4.9% in Q1. This slowdown, while common in Mexico during periods of political transition was a key driver of Mexico’s underperformance during the first half of the year.
    • Forecast: Our expectation is that government spending will accelerate in the second half of the year. Companies in the construction sector stand poised to benefit as infrastructure projects are prioritized.
  • Near-term exchange rate volatility 
    • Recent developments: In recent weeks, the peso has depreciated sharply against the US dollar amid speculations that the Fed will begin to wind down bond purchases as the US economy continues to improve.
    • Forecast: Over the long term, recovery in the US bodes well for Mexico. As such, near-term capital outflows should be interpreted as a reaction to the shift in US monetary policy rather than perceived weakening of Mexican fundamentals.
  • Healthcare reform efforts will emphasize preventive care
    • Recent developments: In addition to pushing for reduced costs and expanded access to healthcare services, Peña Nieto has indicated that preventive care will be prioritized when healthcare reforms are rolled out.
    • Forecast: Companies in the pharmaceutical, medical device, and consumer goods spaces should consider low-cost, high impact ways to proactively align their marketing, government relations, and product development strategies with government efforts to reshape consumer behavior and promote a healthy lifestyle.

FSG clients may click here to access a full report for further reading on FSG’s quarterly market view of Mexico.

Emerging Market View: What Our Analysts Are Reading – 5/17/2013

Here are several headlines read by FSG’s regional research teams this week with their commentary below:

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


Mexico’s Near-term Slowdown Is No Cause for Alarm for Multinationals

Mexico’s economy is experiencing a pronounced slowdown across the economy, with both industrial production and consumer spending seeing more moderate growth compared to 2012. However, FSG expects growth will accelerate in the second half of 2013 as the new government’s spending plans ramp up and the US economy experiences faster growth after the one-off effects of tax increases and spending cuts work their way through the economy.

Mexico’s near-term slowdown is largely driven by short-term external factors that will lose relevance in the second half of 2013. As long as the Mexican government’s agenda remains tilted toward reform and economic growth in the United States improves, Mexico is likely to accelerate in the second half of 2013 and beyond. On the other hand, a breakdown of the reform agenda may have deleterious effects on the country’s economy over the medium term, particularly if essential fiscal and energy reforms do not pass over the next twelve months.

FSG clients have on the whole suffered tepid sales growth in the first quarter of 2013 in Mexico, as slower consumer spending, weak industrial production, and reduced government spending weigh down revenue growth. This has not translated into a reduction in interest in increasing investments in Mexico, though multinationals are increasingly cognizant of the fact that it will take time for the upside potential associated with Peña Nieto’s reform agenda to translate into real economic growth.

Trend #1: Policy Shift Toward Urbanization Is Creating Both Opportunities and Turmoil

  • Financial turbulence in the housing sector has led the government to partially bail out the major builders, and will lead to weaker overall growth of the sector. Multinationals that have builders as clients will have to reorient toward the smaller, emerging players in the industry that are better prepared for the shifting market landscape. B2C companies should expect that accelerating urbanization will make it easier for them to reach consumers, and should adapt their marketing efforts to the changing living patterns of Mexican consumers.

Trend #2: Telecommunications Reform Will Create New Opportunities for Multinationals

  • The gains for the economy from increased competition in the telecom sector would be widespread, but the success of the reform will require secondary reforms to be passed over the next few months, as well as the requisite votes in the state congresses. Even if the reforms only open up the two sectors to competition from the local giants in practice, this will still lead to higher mobile and broadband penetration, and lower advertising costs for companies due to increased competition among cable and broadband providers. If the reforms and their subsequent implementation attract foreign players to the telecom market in Mexico, this will lead to even more dynamism for the industry and consumers.

Trend #3: Industry Efforts to Increase Credit Are Falling Short, but Reforms May Help

  • While private sector initiatives from Walmart and Santander’s alliance with Oxxo may have increased access to financial services among Mexico’s emerging middle class, this has not led to a notable increase in credit growth. In response, the Peña Nieto administration has already begun pushing for improvement in the provision of credit to consumers through a significant financial reform project that would create two state credit bureaus. This would add to the information provided by commercial banks, public lenders, and other entities, and thus reduce the information deficit that is hobbling credit provision.

 

Latin America’s Moment: Making the Case and Capturing Opportunity

Making the Case for Latin America Has Historically Revolved around the Region’s Untapped Growth Potential

Making the case for resources has long been a challenge for emerging markets executives—while emerging markets represent tremendous growth opportunities, they have historically been viewed as risky, volatile, and fragmented, undermining corporate willingness to commit large amounts of resources. On a regional level, many of the Latin America executives we work with have expressed frustration at having to defend the region’s potential when top-line growth has been higher elsewhere in the world, particularly in Asia.

At Frontier Strategy Group, we have long strived to help our clients overcome such skepticism and communicate upwards effectively by emphasizing the region’s hard-won macroeconomic stability, relatively under-penetrated markets, and growing middle class. While these drivers remain in place and multinationals’ growth targets for Latin America are now on par with those seen in Asia, sluggish global growth has raised the stakes, and emerging markets are increasingly expected to deliver both top- and bottom-line growth.

However, Sluggish Global Growth & Underperformance in 2012 Have Undermined Confidence in Latin America

In the wake of Venezuela’s recent devaluation and the death of President Hugo Chávez, as Argentina continues to impose heterodox capital and import controls and Brazil edges towards stagflation, it is easy to understand why multinational executives face growing skepticism from risk-averse corporate centers as they strive to make the case for resources in Latin America.

Fortunately, Executives Compelled to Reassess the Region’s Potential Can Walk Away Reassured

While we certainly acknowledge the endogenous and exogenous factors undermining Latin America’s near-term outlook, we remain bullish about the region’s potential over the medium-to-long term, and our optimism is grounded in a demonstrable belief that the region’s core advantages have in fact remained intact, and will be reinforced by positive secular trends.

Not Only Do Latin America’s Core Advantages Remain Intact…

Latin America’s core advantages can be divided into four buckets, including profitability, relative growth, stability, and concentrated financial resources. Of these four advantages, profitability stands out as the most salient given the pivot to profitability that emerging markets executives are experiencing. As growth remains stalled in developed economies and corporate places increasing pressure on emerging markets, 73% of FSG clients in Latin America have experienced or expect to experience a shift in corporate emphasis towards bottom-line growth over the near-term. With this in mind, it is certainly reassuring to consider that available data on publicly traded companies indicate that average operating margins in Latin America are 55% higher than in the BRICs excluding Brazil.

At present, Latin America derives its profitability advantage vis-à-vis other emerging market regions primarily from a host of demand-side factors which allow multinationals to sell at higher margins and maximize the gains associated with realizing economies of scale. However, these advantages have the potential to diminish over time as competition within the region increases, meaning the time to build market share and brand loyalty is now.

When it comes to GDP growth, while the pace of growth in other emerging markets is expected to decelerate in comparison with pre-crisis rates, LATAM has remained relatively resilient and will accelerate in the coming years.

If you’re tempted to dismiss growth and profitability out of fear of resurgent instability, think again. More conservative corporate centers have historically associated Latin America with hyperinflation, uneven growth, and overexposure to commodity boom-and-bust cycles. Part of the story we’re striving to help our clients communicate is that while these sorts of risks persist in specific markets, the region as a whole has progressed tremendously thanks to orthodox macroeconomic reforms.

Inflation targeting regimes, reduced deficit spending, and the liberalization of trade and capital flows have brought down inflation, empowered consumers and provided the stability necessary for sustained growth. Latin America also remains well-positioned to ride out any future global downturn, as its economy is less dependent on trade than APAC, and less integrated into the global financial system, reducing the risk of Eurozone contagion. Concentrated financial resources also bode well for B2C and B2B multinationals—per capita private consumption spending and government expenditure in LATAM outpace other EM markets including India and EMEA, and are on par with China.

But investment and reform are positioning the region to build on these strengths moving forwards, unlocking new opportunities for multinationals:

Most importantly, Latin America is well-positioned to build on these core advantages, and secular trends are already yielding proof points. Trends we’re tracking range from Peña Nieto’s ambitious reform agenda and the resurgence of manufacturing in Mexico to Colombia’s peace dividend and Peru’s rapid rise. On a pan-regional level, energy resources will bolster government coffers and empower investment in infrastructure and human capital, while the rise of the Pacific Alliance will provide a decidedly pro-business counterweight to the increasingly anachronistic Mercosur. The region is on the rise, and there has never been a better moment to make—and win—the case.

FSG Survey Reveals Latin America as High-Profit Region

Frontier Strategy Group’s survey of senior business executives was recently featured in a nationally syndicated article by Amy Guthrie of Dow Jones Newswire. The article, which was picked up by major news companies like Fox Business, highlighted Latin America’s high-profit performance relative to other emerging market regions.

FSG’s proprietary benchmarking data obtained from a survey of executives at multinational companies operating in Latin America’s emerging markets was highlighted in the piece as a solid indication that Latin America is well-poised for further growth.  Ryan Brier, Practice Leader for Latin America at FSG, was interviewed for the news piece and delivered further insight to the high-performing Latin America region:

“Optimism is skewed toward the region’s second-biggest economy, Mexico, aided by the country’s overhaul agenda and improved manufacturing competitiveness, as well as toward Colombia, whereas the outlook for Brazil is less certain given a slowing economy, burdensome regulation and a generally high cost of business in the region’s biggest economy. Yet executives still see Brazil’s long-term potential as promising, given the country’s large youthful population and natural-resource potential.”

 

PODCAST: MNCs Look at Mexico for Stable Growth in Latin America

EM Insights Podcast

Consistently solid economic performance in 2012 has led companies to believe that Mexico’s role within their portfolios is to offer safe, dependable top-line growth. However, progress on structural reforms and bottom-up changes to Mexico’s corporate landscape are creating conditions for the country to assume a more ambitious place in multinational’s regional portfolios. In our latest podcast, Richard Leggett, CEO of Frontier Strategy Group interviews Latin America Senior Analyst, Antonio Martinez on the business outlook for companies doing business in Mexico in Q4 2012. Martinez discusses the following three trends FSG is currently tracking:

  1. US fiscal cliff presents the single largest downside risk for Mexico in early 2013
  2. Labor legislation signals increasing consensus for reform in Mexico
  3. Multinationals have adapted to the poor security situation in Mexico

To listen to or download the podcast, click on this link to access the iTunes store.

Rising Trends for Q3 in Mexico

Mexico stepped into the spotlight in Q3 of 2012 as multinational executives began to shift their operations and increase their investments into Mexico. Reignited interest into Mexico has been largely driven by higher labor costs in China and expectations that the presidential-elect and business friendly Enrique Peña Nieto will implement structural reforms aimed at boosting long-term economic growth. A common trend in Q3 was the growing interest for companies pursuing SME customers as larger client markets became increasingly saturated. However, limited financing opportunities for SMEs is preventing multinationals from achieving additional growth. SME lending is mainly restricted by three main inhibitors: weak regulatory systems, poorly trained state development funds unable to assess credit risk, and overwhelming control of the banking sector by large foreign commercial banks in Mexico.

Multinationals may consider applying a best practices approach to SME financing. Sun Microsystems applies a credit assessment technique in another emerging market by using a quantitative and qualitative approach in order to determine credit worthiness for a potential SME client. In an attempt to assuage the multinational and lender concerns for SME financing, the Mexican government is considering an institutional reform creating a centralized development bank that will function as a main source of financing for underserved markets in Mexico. Public-private partnerships have served as an approach by commercial lenders to expand their portfolios to include SMEs as lenders provide credit lines to SMEs by partnering with a government agency that provides loan guarantees.

Antonio Martinez and Erick Soto contributed to this piece