The next generation of economies step onto the world stage
By Clair Spencer
A Regional Analysis of Emerging Markets
As far as emerging markets are concerned, China currently garners the most attention. It is the largest emerging economy in the Asia-Pacific region, and the second-largest economy in the world, based on purchasing power parity (PPP). It accounts for 5 percent of the world economy.
China is unique in that it comprises three disparate economies: the booming coastal region; a slowly-developing central region; and the agricultural core, which is listed among the poorest regions in the world. In recent years, its accession to the World Trade Organisation (WTO) in 2001 generated significant investor interest. In order to meet the stringent WTO criteria,China has aggressively developed a more market-focused economy and has attempted to cultivate its capital markets. Consumer spending in China accounts for 41 percent of GDP, compared to 44 percent for investment. It is highly unusual for investment to exceed spending, and if current figures dipped to normal levels of around 20-35 percent, the country could find itself in recession. The inclination of the Chinese to save rather than spend has resulted in their savings currently supporting US debt. If this balance were disturbed, it would impact many economies.
India, the second-largest Asian economy, comprises 2 percent of the world’s economy. It is currently the 12th largest global economy based on US dollar exchange-rate terms and the fourth-largest based on PPP. India and China combined represent an intimidating 40 percent of the world’s population, which offers a huge consumer base. Economic growth inIndia has been steadily improving since the mid-1980s, and is likely to continue. 2050 should see India join the US andChina as the only economies whose actions will affect all other countries. To reach this milestone, India will rely heavily upon its highly educated workforce. Skilled technology processes, service exports and consumer spending already account for an unusually large percentage of labour. Overall, India has a sound economic and political foundation, effective government policies and the ability to issue long-term debt at favourable interest rates.
As currency movements calm and many countries in the Asia Pacific region become more politically stable, foreign investors will take advantage of the large consumer base and low operational costs available. Apart from the obvious examples of China and India, M&A activity has also soared over the last few years in hotspots such as Malaysia andIndonesia, with the latter on target to rise to the ranks of the BRIC economies in the next decade or so. Many experts believe that in time, Indonesia may even become a more attractive prospect for investment than China, which many market observers fear is overheating.
Central & Eastern Europe
Russia has impressed investors of late, managing to repay almost all of its sovereign debts in less than a decade. This has contributed significantly to a rising middle class – an enticing trend for foreign investors flush with capital. However, Russiais not seen an easy market to navigate. “When coming to Russia, investors with little experience in this market are often surprised by the dynamics of the local deal environment,” says Thomas Dix, a partner and head of Transaction Services in Russia/CIS at KPMG. “In relation to strategic acquisitions or setting up a joint venture, while the Russian side may have ambitious plans to close the deal in record time, they often lack an understanding of the corporate decision processes that foreign investors must undergo. As a result, Russian vendors or potential partners’ proposed timetables are often unrealistic.”
Mr. Dix recommends the involvement of local political decision-makers and the authorities early on in a Russian transaction process. “These individuals can easily create major obstacles, such as withholding or refusing to extend licences, permits, and so on,” he says. “For example, labour law in Russia is very employee friendly but in practice easy to circumvent; it is primarily the local administration that causes difficulty in reducing staff numbers due to the social implications, not relevant legislation.” Consequently, local knowledge and ‘friends in high places’ are valuable commodities.
Looking more broadly at Central & Eastern Europe, one of the most attractive developments for investors is that some of the countries have recently joined the EU. This provides investors with access to more sophisticated legislative and regulatory systems than existed in the past, and consequently a lower risk profile. Infrastructure has improved rapidly following EU admission. Construction of numerous industrial estates has provided investors with a swift entry route into CEE and allowed them to fully capitalise on the region’s relaxed labour laws, while enjoying proximity to Western Europe. Full convergence with the EU’s labour laws is yet to occur, so labour remains cheap, and CEE member states are unwilling to negate this attraction for foreign investors until it is absolutely necessary.
South Africa is the continent’s progressive economic leader. It offers a unique combination of developed and developing characteristics, and its large consumer base and advancing infrastructure is appealing to emerging market investors. “South Africa has a very sophisticated banking, legal and regulatory system which, in combination with a relatively stable political environment and the opportunities that come with a resource rich country presents a lot of scope for investment,” explains Morne van der Merwe, a director at Werksmans Inc.
Marc Kemp, a director at Edward Nathan Sonnenbergs, notes that M&A activity is increasing for a number of reasons. “Some of the factors include infrastructural development in anticipation of the 2010 FIFA World Cup, the interest of foreign private equity players in making South African investments and the general strength of the country’s equities market,” he says. “Notable deals include the acquisition by Barclays Bank of South Africa’s largest retail bank, and the recent endeavours of large private equity firms including Blackstone, Permira and Actis. South Africa’s anticipated strong growth should see the trend continue.”
Africa as a whole is benefiting from newly gained stability and government investment initiatives. One such initiative is Black Economic Empowerment (BEE) in South Africa, which was introduced to reverse the imbalance in the corporate structure that resulted from apartheid. But such innovations can complicate the process for foreign investors, according to Mr. van der Merwe. “Foreign investors take some time to get a proper handle on the black economic empowerment statutory and regulatory environment in South Africa. Also, the country is subject to exchange control regulations, which weighs on the ability of parties to structure their transactions. The tax regime is particularly complicated, and the labour laws could also, in certain instances, be seen as a deterrent.” Yet the outlook is particularly bright for South Africa, and its development appears to be, at least for now, sustainable.
Brazil, as Latin America’s primary economy, and the world’s ninth-largest based on PPP, is appealing to foreign investors due to its consumer base and its ability to fulfil the commodity needs of other large emerging economies, particularly Chinaand India. Investors have also been drawn in by its economic rebound and ability to issue long-term, local currency debt. However, as is the case with a number of other Latin American countries, acquirers find that headcount reduction strategies are made difficult by notoriously pro-employee labour laws, which diminishes the appeal of Brazil against the other BRIC nations.
The recent economic rebound in Chile, and reformations regarding trade policies and corporate governance, have encouraged investors to take more interest in Latin America, particularly for its large, young, consumption-driven population and low production costs. Although its attraction lags other emerging markets, Francisco Acuña,managing director atManatt Jones Global Strategies, LLC, believes the possibilities are promising. “In certain sectors and regions, Latin America offers some of the best investment opportunities and margins for foreign investors. There are many areas, such as real estate, tourism, private equity and others, that are more attractive than elsewhere,” he says. Mexico, in particular, may soon join the BRIC economies, while Chile and Argentina are rising in prominence.
But complicated tax laws, inefficient bureaucracies and unfriendly foreign investment laws taint the picture and suppress activity. Mr. Acuña believes that for buyers to successfully tackle the region’s considerable risk profile, intelligent target identification is necessary. “One of the most common challenges is finding the right partner to do business. This is the key to big returns in Latin America. As long as this issue is taken care of, other issues are relatively minor and can be handled with a good team of experts in the region,” he says.
The next decade will see the combined middle classes of the BRIC nations reach a total of 800 million, one-quarter of which will form an upper-middle class. Tinamarie Feil, co-founder and president of Legal Services at BMC Group, believes that investors and companies looking to expand their operations are attracted to the sheer volume of opportunities in markets such as China and India. “The rate of economic growth is staggering, and the utilisation of technology makes it possible for companies to run operations on a global front,” she says. In addition, the recent surge in liquidity, combined with an ever-deepening pool of managerial talent and legislative reform, is causing many professionals to predict that BRIC counties will outperform Europe in the near future.
Contributor: Francisco Acuña
As published in the Financier Worldwide’s Opportunities in Emerging Markets Special Report 2007. For more information about the Financier Worldwide, please visit their website at www.financierworldwide.com.