Top leaders tend to focus more on status updates than on contingency planning. They devote far more time to internal execution and competitive risks than to external risks that can change the playing field. This means that many emerging market risks get cut from the senior leadership agenda.
At Frontier Strategy Group, we observed that in 2017, executives and boards paid the most attention to risks that dominated global headlines: Brexit, the Trump administration’s trade policy, cybersecurity, and, more recently, North Korea. They did not spend as much time thinking about local events that have implications for their emerging market operations.
Each year, FSG evaluates more than 100 scenarios that could disrupt our economic forecasts for 73 countries. We identified three emerging market risks that are top multinational leaders should be paying more attention to this year:
- the election of populists in Brazil and Mexico increasing the cost of doing business
- conflict in the Middle East or Africa renewing the migrant crisis in Europe
- maritime confrontation between China and its neighbors disrupting trade routes
If these events occur, they would severely disrupt multinationals’ market strategies, supply chains, and exchange-rate assumptions.
Latin America: Potential Populist Backlash in Mexico and Brazil
Latin American subsidiaries are being held to more-aggressive sales and profitability targets in 2018, given a rebounding 2.7% real GDP growth rate for the region, but there is more business risk than many expect. Mexico and Brazil alone account for over 60% of Latin America’s GDP and most regional revenue for multinationals. Both countries have presidential elections in 2018, with frontrunners advocating populist-nationalist platforms that would damage investor confidence and financial market stability.
When it comes to risk in Mexico, companies are paying attention to the fraught NAFTA negotiations, but not the domestic politics that could damage business plans far sooner than any NAFTA changes. Leftist presidential candidate Andrés Manuel López Obrador is well ahead in the polls. He pledges to reverse reforms that improved labor-market flexibility and private-sector participation in formerly protected industries like energy. The cost of doing business — and especially the cost of local production — would go up, and budget-busting government spending increases would erode long-term business confidence despite short-term stimulus. We believe that business-friendly candidates could win, but companies should make sure that their Mexico investments have an acceptable rate of return even under this populist scenario.
When it comes to Brazil, the economy is picking up. In our survey of 30 Brazil country managers in October, 20 reported increased revenue growth, despite the country’s dysfunctional, scandal-ridden politics. Unfortunately, the business outlook could change if ex-president Luiz Inácio Lula da Silva returns to office and fulfills his pledges to cancel pension reform and budget constraints. Da Silva could be disqualified due to a corruption conviction, but he maintains a strong lead in the polls, and the far-right candidate Jair Bolsonaro is currently in second place. Either candidate’s success could cause sufficient uncertainty for Brazilian businesses to put the brakes on investment plans.
In both Mexico and Brazil, companies that sell to businesses and the public sector — from health care to construction to IT services — are particularly vulnerable, as populist election outcomes would likely trigger a stall in purchasing. Companies should be prepared to significantly reallocate sales targets across customer segments as the programs of the new administrations become clear.
Middle East and Africa: Migrant Crisis Redux May Reignite European Populism
Europe’s migrant crisis illustrates how events in developing countries create ripple effects that ultimately affect global business. Millions in the Middle East and Central Africa fled conflict, drought, and economic stagnation, and their arrival in Europe transformed Western politics. Anti-immigrant political movements swelled, helping to push Britain out of the European Union and bringing right-wing populists to power across Central Europe.
The flow of refugees has slowed, but this is largely due to a pledge by the European Union to provide Turkey with €6 billion in aid to prevent 3.6 million mostly Syrian refugees and asylum seekers from moving onward to Greece and beyond. However, relations between the two countries have been deteriorating over the last year, due to friction between a Turkish government looking to consolidate power and European governments attempting to support human rights and democratic norms in Turkey. If, for example, the EU chose to suspend payments or impose sanctions on Turkish entities and individuals, Turkey could retaliate by voiding the migrant deal.
This would come at a delicate time for the European economy, making it more difficult for leaders to assemble coalitions to back complex EU reforms to put European finance on sound long-term footing. Italy could become an epicenter of volatility if it has a sudden surge of Arab or African refugees and sees a coalition of populist and right-wing parties following the March elections. An anti-immigrant, Euroskeptic Italian government could spook investors, dragging down the shares of bad-debt-laden Italian banks and weakening the nation’s sovereign debt.
Any of these political outcomes would devalue the euro below 2018 corporate budget assumptions and diminish a European economic upswing that had boosted many companies’ revenues. Multinational companies should pressure-test 2018 sales targets and currency hedging against this scenario.
Asia-Pacific: China Sea Flashpoints Could Obstruct the Global Supply Chain
While North Korea tops most foreign observers’ Asia risk list, China has been laying the groundwork for superpower confrontation in the South China Sea. In 2017 China constructed 290,000 square meters of dual-use civil-military facilities on the Spratly and Paracel Islands, which are also claimed by Malaysia, the Philippines, Taiwan, and Vietnam. What might seem to be a local dispute over fisheries and oil fields has much broader implications.
Each year, $5 trillion in commerce — nearly one-third of global trade — passes through the South China Sea. China’s military buildup now allows it to project power across those sea lanes, challenging the freedom of navigation guaranteed by the U.S. Navy for the better part of a century. China could not exert unilateral control of these critical trade routes today, but expanded military traffic raises the chances of an unintended clash that would greatly disrupt commerce.
Accidents like a collision, whether between fishing vessels or fighter jets, could provoke a spike in nationalist confrontation. The United States military would face pressure to support Southeast Asian allies and to preserve the principle of free commercial navigation. Without a code of conduct or an established mechanism for de-escalation in place, saber-rattling in the South China Sea, or between Japan and China over the Senkaku/Diaoyu islands in the East China Sea, could spiral into full-scale conflict. Korea- and trade-related tensions could make it even harder to de-escalate an unintended clash.
What would be the practical effects for business? A large-scale standoff between the Chinese and American militaries would immediately disrupt the international supply chains on which modern manufacturing depends, causing shortages for many companies. Consumer and business demand in Asian markets would also face a shock as deep or deeper than the 1997 Asian financial crisis, prolonging inevitable volatility in currencies and financial markets. Longer term, China-led regional integration efforts like the Regional Comprehensive Economic Partnership trade deal and the Belt and Road infrastructure initiative could stall, dampening investment and productivity growth.
To mitigate this risk, companies should assess the resilience of their Asia supply chains, inventories, and distribution against a sudden and sustained disruption. Leaders should also reduce third-party risk by assessing value chains for excessive dependency on particularly vulnerable partners in the countries bordering the South China Sea.
Emerging Markets Require a Risk-Reward Balancing Act
We expect greater investment from multinational companies in emerging economies as consumers, business, and governments accelerate spending and emerging markets overall accelerate to 4.9% growth in real GDP. But this healthy forecast should not encourage complacency about risk. Events like the three we highlight above often precipitate global shocks to currencies, financial systems, and commodities, causing serious disruption to business plans.
Our research has found that few multinational firms conduct structured reviews of local economic conditions in between annual planning cycles. To ensure that 2018 results exceed expectations regardless of local surprises, corporate leaders should work with regional teams to monitor and assess these risks and put contingency plans in place.
from HBR.org http://ift.tt/2BhzQmx
