Emerging Markets View: What Our Analysts Are Reading

EM View

Premier Li Keqiang delivered a speech to 1,000 business leaders at the World Economic Forum last week with the message that the China market is still open to foreign investors, according to an article in Bloomberg Businessweek. However, FSG’s Senior Analyst for China says executives should stay cautious.

“Premier Li’s statement at a recent World Economic Forum meeting suggests that Chinese leaders are cognizant of how their aggressive antimonopoly campaign is impacting multinational sentiment. Even so, executives with operations in China should remain cautious about recent policy movements in Beijing and prepare an effective government engagement strategy to mitigate the associated risks,” says Shailene Zhu.

Colombia‘s economy grew 4.3% on construction spending this quarter, showing expansion at a healthy pace despite less overall growth than expected, according to the Wall Street Journal.

“Construction spending will not only drive Colombia’s economy through the medium term, but projects such as the 4G highway network will also help Colombia overcome some of its logistical bottlenecks. Multinationals set to benefit from increased connectivity, and should evaluate how improved logistics and transportation infrastructure will affect their overall cost structure in Colombia,” says Gabriela Mallory, senior analyst for Latin America.

Russia is threatening to cap western car and clothing imports following a new round of EU sanctions that seek to block the country’s largest oil companies from raising money on European capital markets, according to The Financial Times. FSG’s Head of Research for Europe, Middle East and Africa says executives should prepare for a Russian backlash.

“The likelihood of Russian trade retaliation is high and MNCs should be prepared for the repercussions this could have for their business and customers. A car import ban could be particularly damaging not only for Western, but also for Central European markets with large automotive sectors such as Hungary, Slovakia, Poland, Romania, etc.,” says Martina Bozadzhieva.

On the global frontier, Mumbai-based transnational pharmaceutical company Lupin has entered into a long-term partnership with Merck Serono with the goal of expanding in emerging markets.

FSG’s Associate Practice Leader for Global Analytics Sam Osborn says the pact is “a great example of how partnering with an emerging-market based organization can be a mutually beneficial relationship for the multinational and local company.”

FSG clients can stay up to date with analyst commentary on the latest emerging markets headlines on the client portalNot a client? Contact us to learn more.

Emerging Markets View: What Our Analysts Are Reading

EM View

McDonald’s restaurants in Russia came under increasing pressure from the Russian authorities this week as officials closed several outlets in Moscow and inspected 435 of the fast-food chain’s restaurants across the country, according to the Wall Street Journal. The increased checks come amid heightened tensions with the West, and FSG’s Head of EMEA research, Martina Bozadzhieva, says similar actions are likely to begin affecting other western businesses in the region.

“Regulatory checks are likely to intensify across industries, especially against American companies,” says Bozadzhieva. “It is very difficult to predict who the authorities may target next and for what, and companies should be aware that problems may arise with regional as well as federal agencies. Local teams should watch their industry regulators particularly carefully to get ahead of any problems.”

Meanwhile, Argentina’s latest plan to exit default is being met with skepticism by financial markets, as bond prices slip and the black-market peso hits a record low.

“Markets are rightful to be wary with Argentina’s proposed local law debt swap, as it suggests that, contrary to initial expectations, Argentina has no intention of reaching an agreement with holdout creditors in the near term,” says Gabriela Mallory, senior analyst for Latin America.

Thailand’s military-appointed legislature nominated army chief Gen. Prayuth Chan-ocha to become prime minister on Thursday, and FSG’s senior analyst for Asia Pacific, Shishir Sinha, says it may mean increased stability for investors.

“Thailand might be able to guarantee investors with more political stability as the ruling army chief is officially moving on to the helm of the country as its newest Prime Minister. While this move will delay truly democratic elections for quite some time to come, it is likely to help with economic growth; both consumer and investor sentiment should rise due to the expectation of stability,” says Sinha.

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 to learn more.

Rising Competition from ASEAN-based Corporations

As the ASEAN region begins to mature, the power, reach and influence of its indigenous companies have begun to increase dramatically.  We’ve witnessed similar rises of local and regional companies in other parts of the world — East Asian companies in the 1980s-1990s, Multi-Latinas over the last decade and mostly recently we are seeing increasing competition from Chinese firms.

ASEAN’s resilient performance over the past decade has allowed many of its local companies to rapidly expand across the region and beyond, giving birth to numerous ASEAN-based corporations.

Asean Local Competition

Under the Radar

Companies from ASEAN often do not receive much attention from Western analysts who instead focus on China and India. However, ASEAN firms are a force to be reckoned with; keeping pace with the region’s growth, the number of ASEAN companies on Forbes’ list of Global 2000 companies has more than doubled in the past seven years. Moreover, ASEAN has more companies on the Forbes’ Global 2000 list than India, Brazil, or Russia. The region is also home to 227 companies with more than $1 billion in revenues, making it the seventh-largest host for such companies, or 3% of the global total.

ASEAN countries and companies have continued to invest within the region at a steadily growing pace, with 2012 seeing twice the amount of intra-ASEAN FDI, in dollar terms, compared to 2008 (pre-crisis). The strengthening of intra-ASEAN investment can be attributed to a number of factors, including (a) the maturity of a growing number of companies in ASEAN who are venturing abroad, (b) regional integration, which provides future opportunities to scale, (c) improved financial capacities of ASEAN companies, and (d) home-country measures that encourage overseas FDI through institutional and informational support.

Western MNCs Should Monitor the Business Climate

Hailing from a new group of countries and leveraging competitive advantages that Western firms have not seen before, emerging-market multinationals have shaken up many stagnant, mature industries in developed countries. While not mature enough to rock Western markets, the rise of ASEAN corporations is going to lead to an increased fight for resources (both natural and human), heightened competition for several fast-growing segments, and the reduction of prices alongside faster innovation in ASEAN. 

MNCs should explore all potential partnerships with regional firms; ASEAN-based companies understand the market better, tend to have deeper distribution networks, and lower-cost operations. Emerging-market multinationals are born in a new world, one that is highly globalized and integrated, where internationalization will happen much faster than experienced by MNCs, making them much more of a threat to long-established businesses.

For more information on the rising competition of ASEAN-based corporations, FSG clients can access the full report on the client portal.

Four things MNC executives need to know about the latest sanctions against Russia

In what has been the harshest Western response to Russia’s involvement in the Ukraine crisis, the EU today imposed broad – so called Level 3 – sanctions against Russia. The US is likely to follow suit shortly.

European Parliament in Brussels (Image: Reuters)
European Parliament in Brussels (Image: Reuters)
Four things MNCs need to know about the implications of these sanctions:

1. Credit costs will increase considerably and lending will become more restricted.

The sanctions will restrict the ability of majority state-owned Russian banks to conduct long-term borrowing on European financial markets. Russia’s biggest banks – Sberbank and VTB – will both be affected, in addition to a host of smaller banks, including ones already targeted by US sanctions. Sberbank alone holds 29.0% of Russian banking sector assets and accounts for 50.0% of retail and 32.0% of commercial lending. Shut out of EU and (likely) US financial markets, these banks will see their funding costs increase considerably. In response, they are likely to reduce new lending to both businesses and consumers and increase interest rates. Importantly, however, these banks will be able to continue processing financial transactions in US dollars and euro.

2. Sanctions will have a considerable impact on investment.

Investment in Russia is already contracting – it decreased by close to 5.0% in Q1 2014. Faced with weaker demand, higher financing costs, and political uncertainty, businesses in Russia will be more likely to postpone investments and put long-term plans on hold until the situation stabilizes.

3. The Russian government may create operational problems for Western MNCs.

Russian government discussions about import substitution and re-orienting trade toward Asia have been going on since the annexation of Crimea earlier this year. The new sanctions give proponents of such ideas a strong argument for more aggressive measures to restrict Western MNCs from the market, particularly companies that sell to the government. MNCs should be prepared for a range of Russian government responses, from slightly more onerous inspections to the outright expropriation of foreign assets, although the latter is not highly likely.

4. Companies should have a plan in place that accounts for a deteriorating operating environment:

Most MNCs’s Russia plans built in 2013 or even early 2014 are likely no longer reflective of the reality on the ground. Companies need to reassess the regulatory, operational, and economic environment in which their business will be operating in the coming months and prepare their business accordingly. FSG clients can read suggested actions on building such a plan here.

Emerging Market View: What Our Analysts Are Reading

EM View

On Thursday, EU diplomats will consider increased Russian sanctions. The sanctions include a proposal to ban all Europeans from purchasing any new debt or stock issued by Russia’s largest banks, according to the Financial Times, and FSG’s Head of Research for EMEA says it’s time for multinationals to make contingency plans.

“If some or all of the proposed measures are approved by the EU, MNCs operating in Russia will be significantly affected. Executives should build a targeted contingency plan for their Russia operations to prepare. Read FSG’s report Protecting Your Russia Business for analysis and suggested actions for building a contingency plan in the case of further sanctions against Russia.” – Martina Bozadzhieva

In Southeast Asia, a rising middle class and strong demand for more expensive foods has led to increased investment by Japanese food companies, mirroring FSG predictions on the rising competition from multi-ASEAN corporations.

“The increasing sophistication of regional firms and growing demand is attracting several global players to partner/acquire ASEAN firms. MNCs should explore all types of partnerships with such regional firms; they understand the market better, tend to have deeper distribution networks, and lower-cost operations.” – Shishir Sinha, FSG’s Senior Analyst for Asia Pacific after reading this WSJ article.

Good news for Argentina this week. Last Friday, the Latin American country struck a deal to borrow $7.5 billion from China for power and rail projects, according to Reuters.

“Argentina has reached a deal with China to borrow US$ 7.5 billion to finance energy and railway projects, and the two countries have also signed a three year, US$ 11 billion currency swap, in which Argentina will receive Chinese yuan that it can then use to finance Chinese imports or exchange to USD to bolster reserves. This news is welcome given Argentina’s balance of payment concerns.” – Christine Herlihy, FSG’s Senior Analyst for Latin America.

FSG clients can keep up to date with the latest emerging markets headlines and exclusive analyst commentary on the client portal.

Multinationals must build contingency plans for Russia

European foreign minister
European foreign ministers gathered in Brussels on Tuesday. Associated Press

The EU has decided to impose more sanctions on Russia. For now, these fall short of the so-called Level 3 sanctions that could be against whole sectors of Russia’s economy and crucially, its banking sector. However, the international fallout from the downing of flight MH17 and the growing tensions between Russia and the West mean that Level 3 sanctions are increasingly a possibility.

For an MNC executive, this means that it’s time to plan. Level 3 sanctions would dampen Russian growth further, reducing demand across industries; they would cause significant problems for customers and distributors to access finance, affecting operations; and are likely to be met with Russian retaliation that could make it more difficult for MNCs (especially American ones) to do business in Russia. All of this will have an impact on a company’s customers, finance, supply chain, people, and marketing strategy and MNCs should be building step-by-step play books on how to respond to spillover across their Russia operations.

martinachart2This is not to say that MNCs should be pulling out of Russia. In fact, planning is so important because of the significant role that Russia plays in many MNCs’ EMEA and even global portfolios. Companies that have stuck with Russia through crises have historically reaped significant benefits and this could be an opportunity for MNCs to strengthen partner and customer relationships and to make low-cost investments.

Meanwhile, larger strategic questions are looming in the background for EMEA and global leadership teams. With the likely opening of Iran for business, a Russia that is increasingly closing in on itself could lose out in the competition for corporate investments.

For a full report on Russia contingency planning, FSG clients can click here. A full report on preparing for a post-sanctions Iran is also available.

What the Latest Sanctions Against Russia Mean for MNCs

The latest rounds of EU and US sanctions against Russia fall short of imposing restrictions on entire industries, but they do have a number of hidden spillover effects for Western multinationals operating in the market. Beyond the obvious impact on MNCs selling to the energy and defense companies directly targeted by sanctions, a broader set of MNCs operating in Russia should be concerned about the banks that have been included in the sanctions list.

Impact on MNCs:

MNCs selling business goods and services are most likely to be indirectly affected by the sanctions, because some of their customers may face a higher cost of credit. Beyond businesses that directly work with the sanctioned banks, Russia’s financial market as a whole is likely to see more expensive credit as more international banks try to restrict new lending out of cautiousness. In the long term, higher lending costs contribute to the contraction in domestic investment, which will prolong Russia’s economic stagnation and reduce demand across all industries.

Actions for executives:

Executives whose business may be affected should speak with their local teams and identify key customers who may work with the sanctioned banks. Such customers may face the risk of rising borrowing costs, particularly if their credit lines need to be rolled over in the near future.

Three consequences of the new round of sanctions:

  1. They could reduce demand from small and medium enterprises.

Both the European Bank for Reconstruction and Development (which the EU will ask to halt new lending in Russia) and VEB, a bank sanctioned by the US, lend extensively to small and medium businesses. A cut in their lending will result in reduced investment and demand for B2B goods and services at a time when investment activity is already deeply depressed.

Chart: VEB will be prohibited from borrowing at maturities longer than 90 days on US capital markets

  1. Multiple industries could be see more expensive credit.

VEB and Gazprombank, the two banks the US sanctioned, lend extensively to the corporate sector, including industries such as oil and gas, metallurgy, machine-building, chemicals, and others. 40% of VEB’s lending in 2013 was for infrastructure. Interest rates for corporate customers of both banks are likely to increase, hitting multiple industries at once.

  1. Lending in Belarus could also be hurt.

Subsidiaries of VEB and Gazprombank hold almost 10% of the Belarussian banking market and are largely dependent on parent-bank financing. Their lending activity and cost of credit is likely to be negatively affected by the US sanctions, affecting some MNCs’ corporate customers in Belarus.

Understanding how the new US sanctions work:

The banks sanctioned by the US – VEB and Gazprombank – are among the largest in Russia. They lend primarily to corporate customers across multiple industries and much of their portfolios consist of long-term loans. To finance these loans, they need to borrow at long maturities on international financial markets, which is exactly the kind of borrowing that US sanctions have restricted. Their alternative sources of long-term capital are notably more expensive and would require them to increase lending interest rates, hurting the businesses to which they lend. Because of the size of these banks, increases of their interest rates are likely to have a spillover effect across the Russian banking sector as a whole.

View the video below to see FSG’s Martina Bozadzhieva discuss investing in Ukraine and Russia on CNBC yesterday.

Escalation in Crimea: Impact on MNCs Operating in Western Europe

As MNC executives responsible for Western Europe dissect the events unfolding in Ukraine’s Crimea region, they will fall under more pressure to digest mounting media news and interpret current events’ impact on their business. To address the localized impact of increasing hostilities in Crimea, our latest podcast, introduced in the preceding blog post, focuses on the factors that will impact multinationals’ Ukraine and Russia business regardless of the scenario that unfolds in Ukraine’s Crimea region.

However, the impact of Ukraine’s crisis is extending to the regional level, and could impact European recovery. Executives should act now to consider how the following possible impacts will affect their ability to meet targets in 2014:

  • Any disruption in gas lines will push up prices in Europe. A Gazprom (Russia) decision to cease gas flow to Ukraine would disrupt gas flows to Europe, which only has 18 days of gas reserves and easily could be outlasted by a political crisis. Decreased gas flows would thus increase energy prices and hurt any chance of recovery as consumers focus on inelastic energy costs and away from elastic purchases of goods and services. Europe is Russia’s largest export market, creating disincentives for a gas cutoff that would leave a large hole in the government budget. The Russian government, however, has often put political concerns ahead of economic ones
  • Germany could be the worst hit. Most of Germany’s gas supply flows directly through Ukraine, and constitutes about one-third of its energy mix. German consumers also suffer from the highest electricity prices in Europe, meaning that the country’s exposure to increased energy prices would force the government to abandon its new energy rebalancing policies in favor of keeping prices manageable for its citizens and industry. The result would be increased short-term energy costs and a return to government deficit. Furthermore, Germany’s reliance on exports means that lower demand due to regional volatility would reduce its prospects for outperforming the eurozone in 2014
  • Even European bank exposure to Ukraine could reduce lending activity in Western Europe. While the Ukrainian credit market is almost entirely dominated by local players ─ only Raiffesen of Austria is heavily exposed ─ the European banking system is so sensitive that one bad bank could accelerate the credit contraction already taking place in Europe
  • Continued crisis in Ukraine could disrupt supply chains, which would increase costs. Companies should consider what disrupted supply chains would mean for getting their products to market, and include distributors in the conversation to gain local knowledge and buy-in, and ensure adherence to any contingency plans

Now is the time for executives to build contingency plans, particularly focusing on what increased activity in Ukraine would mean for pricing. Companies that are able to course correct strategic plans and allow for increased costs will be better-equipped to address regional volatility, meet their 2014 targets, and gain market share.

Escalation in Crimea: What it Means for MNCs

With all eyes on Ukraine after Russia threatened military action, MNC executives are under more pressure than ever to rise above the media noise and assess what current events mean for their business. Even though the situation is evolving by the minute, executives’ time is better spent focusing on the factors that will affect their business under any scenario, rather than trying to decipher the multiple directions in which the crisis may evolve.

In our latest podcast (client portal) on Ukraine and Russia, we highlight what executives should focus on:

  • Companies need to have contingency plans for both Russia and Ukraine; any existing plans likely need to be revised in light of events during the weekend
  • Under any scenario, Ukraine is in for significant economic pain in the short term. Targets and plans should reflect that. Pricing may also need to be adjusted
  • Managing corporate’s perceptions of the situation is critical given the flood of media coverage on Ukraine. Executives need to control the narrative on Ukraine and Russia with HQ to ensure that their business is well-positioned to take advantage of any opportunities that the crisis may present
  • 2014 Russia plans need to be revised. Russia is likely to underperform in what was already a poor economic environment. Companies should in particular make sure they have a plan in place to respond to the currency depreciation which threatens to hurt both revenues and profits this year

For a detailed discussion on these and other steps executives should take in response to tensions between Ukraine and Russia, listen to FSG’s podcast (client link) and read our report (client only) on how to protect your Ukraine business from the worst fallout from the crisis. You can download the podcast here (public) or subscribe to our Emerging Markets Podcast Series.

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.