High growth markets summit 2012 summary report

For many companies, high-growth markets represent their main source of global profit growth, and potentially the main source of revenue.. As developed economies stall and the investment

MarkeTs suMMiT Driving business in

The global econoMy

september 20th–21st 2012 • Park Plaza victoria, london

suMMary

rePorT

www.highgrowthmarketssummit.com

S P O N S O R E D B Y:

For many companies, high-growth markets represent their main source of global profit growth, and potentially the main source of revenue As developed economies stall and the investment risks of high-growth markets diminish, investors are increasingly looking further afield, to remoter regions within the BRIC (Brazil, Russia, India and China) economies, and to riskier frontier markets Their growing importance in the world economy means that businesses are being forced to rethink how they do business in these markets, and how to restructure global operations that can no longer impose western business models on the emerging world These profound shifts in thinking underlay the wide-ranging discussions and debate at Economist Conferences’ 2012 High-Growth Markets Summit, with a focus on the following themes:

• Why emerging economies have been better managed than developed markets;

• The implications for business in China as it stands at an economic and political crossroads;

• The relentless push of investors into tougher, “frontier” markets, especially in Africa;

• How localised thinking underpins growth strategies, talent, innovation and risk management; and

• The importance of innovation when servicing emerging middle class customers

The high-growTh MarkeTs suMMiT

Driving business in The global econoMy

inTroDucTion

The sluggishness of wesTern econoMies

“2013 will be better than 2012 for the developed world, but

not by much” said Robert Ward, the Economist Intelligence

Unit’s Director of Global Forecasting He struck a particularly

downcast note on the outlook for developed economies: the US

economy appears to be faring slightly better than the Eurozone,

and is seeing a very slow recovery A recession caused by trouble

in the financial sector, however, typically takes years to recover

from, as the experience of Japan shows US housing starts

experienced an unprecedented collapse in 2007 And there

is also the pending “fiscal cliff” for the US economy, before

investors can be sure of sustainable recovery

If the Eurozone achieves some stability, it could see 0.4% growth But Greece’s economy is set to contract by some 25% during this crisis, which arguably is the largest contraction of any developed economy in history Elsewhere, Ireland is struggling under very high debt, while in the UK, private sector debt is higher than in Spain and Portugal Eurozone collapse could usher in a depression Greece, Portugal and Italy will be the worst performing economies in the world in 2013 The performance of the Eurozone economies will be an important factor in how emerging markets fare in the coming years

Paul Collier, professor of economics at the Centre for Study of African Economies, Oxford University, noted that Germany is the best run economy in Europe, because, historically, it was once the worst In other words, lessons were learnt about profligacy, which

it would appear have still to be learnt by other Eurozone members “The euro had just two rules, one institution and upstanding members, but no critical mass of citizens who understand the institutions” Thus, there is need for leadership capacity to build that support he argued Indeed, it was these lessons that many leading emerging markets have learnt from their own difficult past, and that has served them well during the recent financial crisis One such economy is Turkey

responsible macro-economic management in Turkey

Ali Babacan, Turkey’s deputy prime minister for economic and financial affairs, who opened the summit, argued that prudent management of his country’s debts and deficits during the good times had allowed Turkey to weather the bad times with relative ease

The problem for the EU, he suggested, was that member governments had become inextricably involved in the crisis; governments may back troubled banks, but who, he asked, will back governments when they get into trouble? Fiscal and monetary expansion is simply not credible without a medium-term programme of structural adjustment The problem is also that enforcement mechanisms are not strong enough He warned that once one country exits the euro, others will follow Thus 2012 will be an important test year for the EU, as well as the US in its election year

That said, he noted that there were signs of slowdown in big emerging markets too, as risk aversion increased But many emerging markets, not least China, still had huge fiscal and monetary space in which to react to any further crisis The risk was of counter-cyclical policies becoming too tight, too soon A more accommodative approach may be necessary

DeveloPeD MarkeTs versus eMerging MarkeTs

Turkey, however, had dodged the worst of the developed world problems, largely as a result of a series of reforms implemented before the 2008-09 crisis These included: price stability, social security, banking and healthcare reform, and better management of public finances After the crisis, the government announced a three-year fiscal consolidation programme It saw private sector growth of over 9% in 2010, and 8.5% in 2011 Consumer spending, bank lending and investment was also strong, while government spending made no contribution to growth The OECD expects Turkey to have the OECD’s highest growth over a five year period The country also has an increasing working age population, and is encouraging families

to have at least three children Mr Babacan pointed to rapid reductions in unemployment, especially youth unemployment The country had seen the greatest income redistribution in the OECD; the highest increases in household incomes at the lowest end (with no-one now living on less than $1 a day); and he noted that Turkey was no longer a recipient of foreign aid, indeed it was now a donor country Turkey wants Istanbul to become a financial centre, trading commodities, energy and gold, with

a new capital markets law, and the establishment of financial courts

The core of Turkey’s recent economic success has been fiscal discipline, hitting medium term deficit targets, and ensuring every Turkish bank became compliant with Basel III capital adequacy rules—all undertaken during the good economic times Household debt was low, the current account deficit peaked at 10% in 2011, and with credit growth slowing, is expected to be 7% in 2012 External demand is balancing slower domestic spending

The relatively good performance compared with that in the EU has not undermined the importance of the EU to Turkey’s future The controversial question of EU membership negotiations is important because external pressure helps Turkish governments

to implement rule of law and enhance democracy Fulfilling EU requirements represents the clearest evidence of the country’s democratic status But when Turkey joins the EU, or even what sort of EU it joins, is still open to debate

But Turkey’s economic opportunities go beyond the EU Mr Babacan noted that Russia provided excellent business opportunities, especially in tourism (with some 3m Russians visiting Turkey annually) Exports to Syria, however, are suffering Any solution to Syria civil war must be within international law, though the absence of any UN consensus on the crisis means that Turkey is now working closely with the Arab League, he says

brazil’s economic achievements

In a similar vein of responsible macro-economic management, Brazil’s minister of finance, Guido Mantega, outlined his government’s economic successes, forecasting annual GDP growth of 4-4.5% for the next few years, compared with below 3% growth in the OECD This forecast is based on solid foundations of effective economic policies, political stability, a dynamic external market, and strong demand for energy and commodities especially food

“If there is no external anchor for Turkey, then we are afraid that

momentum of the political reforms in the country will diminish…

it is still our big political will to continue the process [of EU

accession].”

Ali Babacan, Deputy Prime Minister of Turkey

Public debt has gradually declined to below 35% in 2012 which

has allowed the government to pursue counter cyclical policies

Consumer expansion in recent years has added some 50 million

citizens to Brazil’s middle class This has helped boost retail

growth to 7.5%, and create some 2.2m jobs, with unemployment

falling to 5.3%

Low interest rates (with scope for further reduction) has

boosted investment and consumption, and lowered the

currency He said that quantitative easing is ineffective if done

in isolation Taxes were reduced on payroll, eliminating a 20%

payroll tax Some 40 sectors saw tax reductions, worth R30bn

($15bn) Construction and shipbuilding are expanding Oil and

gas group Petrobras is invested some $43bn last year, and there

is a massive infrastructure programme to develop airports, rail

and roads, including concessions for 10,000 km of railways, and

8,000 km of roads Moreover, much of the stimulus plan has still

to be implemented

These policies have helped to attract some $67bn of foreign direct investment (FDI) last year, more than flowed into the UK or India Government bonds yields at 2.7% are converging with US spreads Mr Mantega agreed that high commodity prices and credit expansion had helped, but private-sector credit was still only 50% of GDP, one third of levels in the US, and oil price are expected to remain high, ensuring the sector’s profitability over the medium term

china aT a crossroaDs

slowing growTh

The biggest doubts regarding macro-economic performance was about China The country was said to be at a crossroads, with important political changes taking place in the leadership of the Communist party There is no underestimating the seismic changes happening to China’s place in the world, agreed panellists By 2020 it will be the largest economy (in PPP terms); indeed, five of the top 12 economies in the world will be in Asia But the country’s development model is outdated Its economic growth will slow to 7-8% this year, as success will depend on increasing domestic demand There are also problems with over-production, reflected in a so-called “Beijing bubble” This is the result of the extraordinary process of mega-urbanisation The country’s construction capacity could build a city the size of Rome every two weeks In addition, over the next decade, many cities will become “middle class”, in income per head terms

Gerard Lyons, chief economist at Standard Chartered Bank, believed that China was concerned about inflation pressures, and export problems spreading to the domestic market China’s outgoing premier Wen Jiabao, in a recent speech, offered relatively little in the way of economic growth for the Chinese, who had perhaps become “spoilt” by recent high rates The economy, however, was not collapsing, just cooling, he reckoned, and said that there was lots of room for policy manoeuvre True, gloom seems to have spread, but this amounted to uncertainty not pessimism This is a middle income rapidly trying to become a high-income country, he said, and it will take more than a 5 year plan to raise domestic spending that far

“The big challenge is that China is a middle income country and

wants to become a high income country and that is a very big

task … The three most common words in the last decade were

‘made in China’; in the next decade it will be ‘bought by China’”

Gerard Lyons, Standard Chartered Bank

Eswar Prasad, professor of trade policy at Cornell University, focussed on the country’s internal and external imbalances A current account surplus of some 10% of GDP had created an external imbalance, though this was expected to be only 3% this year But investment led growth had created an internal imbalance, and this was still a problem Spending had been effective in the wake

of the crisis, but it was now hard to get the policy mix right for the longer term Certainly, there was a need to retain some policy flexibility should the US, or Eurozone economies create more problems

He noted that it was hard to talk about “good” or “not good” performance What rates should investors be expecting anyway, he asked A sustainable rate of 7-8% over the medium term is certainly not bad

Mr Lyons added that it was also important for investors to understand what was behind these headline GDP numbers Regional differences are huge The authorities’ main policy hope was for wages to rise as the economy moved up the value chain and for investment and production to shift inland China has moved from “made in China” to “bought by China” But the country still needs better skills, which will take a lot of work and time And there are also demographic pressures to consider, such as low birth rates, ageing, and a gender imbalance

Political uncertainty

The economic outlook, however, rested upon certain political assumptions, and these outcomes were less clear The leadership struggles in the Communist party were hard for outsiders to read For example, it is still not know when the important party congress will be held, or who will get appointed But the assumption that incoming party leaders are not reformers is not necessarily correct The big economic issues are discussed openly by Chinese academics and think tanks The views of external organisations were also deemed important: it was important for the government that, for example, the 12th Five Year Plan obtained some kind

of independent endorsement from the World Bank The government takes seriously comments and advice that calls for greater innovation in the economy Current policy plans are unlikely to change significantly, and reformers saw opportunities to influence policy It was noted that China’s Five Year Plans are not something that get casually abandoned, but get implemented with great effort If the plan calls for 7% growth, then there’s a good chance that this target will be met, said a delegate New provincial heads will also push to achieve regional targets One might even argue that the lack of democracy might help the government hit its growth targets

Nevertheless, one cannot be complacent about reaching growth targets The economy is still run from the centre, and the financial system is repressed It was argued that the system works well for big banks and politicians, who are powerful, and resist radical change Implementation, even without the democracy, continues to pose problems There will be setbacks along the way It was noted also that the government wasn’t entirely unshackled by popular opinion Twitter is spreading, and even the President reads influential blogs China is much more transparent than it was, say, 15 years ago

Tense international relations

China’s foreign relations also present an important dimension to the growth story Alejandro Jara, deputy director general of the World Trade Organisation (WTO), said that China still had some way to go in its economic reforms in the world trading environment The country was the object of most trade complaints in the WTO, which is not entirely surprising – the more trade, the more disputes,

he noted Much of the problem lies in implementation of rules China’s appetite for globalisation is strong, but it was approaching trade deals bilaterally and regionally This makes it hard to align a patchwork of such trade relations with WTO arrangements, and as such was suboptimal, but at least the country is moving in the right direction of freer trade

The issue of trade is increasingly tied up with relations with the US, especially the impact of the close US presidential race With

US unemployment at 8%, and slow job creation, China will remain a potent issue during the election campaign and beyond US Republican presidential candidate, Mitt Romney, has suggested strongly that China was a “currency manipulator”, and should be confronted on this However, it is a hard case to make given China’s falling surpluses, and the appreciating Renminbi closer to fair value There doesn’t seem to be huge market pressure on the currency to appreciate Over the long term, it will continue to rise gradually over the next few years, simply as a result of growth differentials, anyway Financial inflows are probably a more important factor on its current rate Broadly speaking, the currency is more or less fairly valued

“China’s currency is like a dog you take for a walk on a leash,

sometimes the dog is ahead and sometimes it lags behind.”

Alejandro Jara, WTO

As well as trade relations, it was also said that the impact of international events, climate change or security issues should not be ignored Tensions in the South China seas could get out of control Politics could spill over to affect production For example, a threat to the supply of rare earth products could harm companies reliant on vertical supply chains in China

nexT wave oPPorTuniTies: china’s ciTies, vieTnaM anD The nexT 11

For investors wary of China’s rising costs or competitive market, they have the option of moving to inland cities, where “tier 3” or

“tier 4” cities are relatively unserved and growing at around 13% They remain some 5-10 years behind eastern seaboard centres Consumer tastes don’t always derive from 1st tier cities, and there is some variations that are not always visible to western eyes, according to Stuart Ferguson of the China-Britain Business Council Less obvious advantages – such as a nearby specialised technical institute or certain natural resources—should also not be overlooked Patience is required when dealing with less experienced officials, and firms can be offered investment incentives that are at odds with central government policies, which can create legal problems later on, says Tracey Wut, a partner at law firm Baker McKenzie

An alternative is to move to lower cost countries, such as Vietnam Truong Chi Trung, Vietnam’s vice-minister of finance, presented his country’s macro-economic achievements Average GDP growth over the past half-decade had been over 7%, although it had recently slowed to 5.5% FDI amounted to 18% of GDP Inflation had slowed from 14% to 6%, and the authorities expect to keep annual price rises in single digits Macro-economic stability, in the post-crisis period, was deemed a priority, achieved through fiscal discipline Spending has been boosted but the government deficit has fallen from 6.9% in 2008 to 4.9% today and will be 4.5%

by 2015 A tax-friendly environment, regarding corporation, consumer and environmental taxes will help, as will export promotion efforts

The government wants to access international markets over the next decade Of some 10,000 state-owned enterprises, there are now only 1,300 in government control The government will retain stakes of 50% or 55% in some of these, with state control focussed on defence and public utilities Eventually, it envisages having just three or four very strong state enterprises FDI is seen

as being very good for the economy by helping to restructure industries, so privatisation will involve foreign investors, he said As for state-owned commercial banks, the government will restructure these operations, before deciding their future The government also want to preserve a social safety net, providing the poorest some healthcare, income support, job training and credit for small businesses

Vietnam was one of several next wave markets that were on investors’ radars, according to Katie Koch, managing director and senior strategist at Goldman Sachs The bank’s “Next 11” (or N11) emerging markets (comprising Mexico, Indonesia, Turkey, South Korea, Bangladesh, Egypt, Iran, Nigeria, Pakistan, Philippines and Vietnam) had as a group outperformed any other category of frontier markets over any period in equities, she claimed Goldman’s was particularly bullish about the first four countries for, amongst several reasons, their strong demographic, health and taxation profiles She believed that these markets would help push global growth above 4% once conditions in developed economies improved

There was some debate about what constituted a “frontier market” They were often characterised by high state interference, commodity reliance, poor governance, weak democracy and corruption They were also hard to access for portfolio investors The big corporations such as Unilever or Coca-Cola were the best vehicles for success in these markets Financial investors would also face poor liquidity and a risk of hubris that would misprice risk Charles Robertson, global chief economist at Renaissance Capital reckoned that frontier markets will rapidly follow a similar path of earlier reforming nations over the past centuries He noted how, for example, a simple “ease of doing business index” produced by the World Bank had, by ranking countries, spurred reforms to the business environment, and allowed these economies to access a huge global market As Julian Mayo of Charlemagne Capital, noted, it’s the rate of change rather than the current state of affairs to which investors should pay attention And nowhere is the impact of reforms more remarkable than on the African continent

The greaT african renaissance

It was the outlook for sub-Saharan Africa that captured

greatest interest throughout the summit (accounting for

almost half of the plenary sessions) Several perspectives on

the continent’s future were presented, including that of the

academic, the development agency, the foreign investor and

local entrepreneurs

legacy, transition and potential

Once regarded as “the hopeless continent” after two lost

decades, Africa has enjoyed 10 good years Sub-Saharan Africa

will be the fastest growing region in the world, according to

EIU forecasts Wolfgang Fengler, lead economist at the World

Bank, referred to the four “Y”s of demography, geography,

policy and technology that have transformed much of the

continent Demography includes rapid population growth,

declining mortality, urbanisation (cities, as engines of growth,

will account for over half of the population by 2023) Others

had noted that the average age on the continent is only 18,

compared with 32 in Asia and 39 in Europe, which will have

major business implications Telephony has become much more

prevalent in recent years, and not just for making voice calls

The economic policy environment has also improved radically,

which (with the exception of Zimbabwe) has produced good

growth performances

Paul Collier, economics professor at Oxford University, argued

that our assumptions about risk and return in the three key

blocs, OECD, BRICS and frontier economies, had now changed It was a fantasy, he said, to expect 12% returns in the OECD, and that there is no advantage to be gained in the BRICs - everyone knows about them already Even frontier markets don’t provide very high returns, (in the mid teens or possibly 25%) The interesting story, he asserted, was about the risk side of the investor’s equation

It is wrong to think that OECD is safe, as stagnant economies cannot be bailed out by growth And firm level risk is high too, with many so-called zombie firms But risk assessments of frontier economies are also misunderstood Zambia’s first sovereign bond was oversubscribed, offering only 5.6% - lower than bond yields in Italy or Spain Zambia is quite representative of African risk: a “so-so” democracy, with natural resources” (in Zambia’s case, copper)

One indication of Africa’s potential lies in the fact that its subsoil assets per square mile are $60,000, about one fifth of that

in the OECD, which indicates huge amounts yet to be discovered, especially oil Growth in Africa is much safer With significant improvements in governance, and prudent macro-economic management, the continent was resilient in the global financial crisis Africa was “the dog that didn’t bark”, he noted With a strong commodities export sector, non-tradeable capital goods demand will be very high, especially in construction, which is growing faster than natural resources Others also noted that there are huge productivity gains to be had in consumer goods and retailing, commercial agriculture, and transport infrastructure Light manufacturing is already moving out of China to low wage Asia (such as Bangladesh) and will move to coastal Africa, not least because of its good access to both OECD and China China will not have the field to itself Its biggest advantage in Africa has been speed But Canada, Europe and Brazil are also becoming big on the continent Much land acquired by foreign powers simply as a geo-political insurance policy in a crisis, was “a big stupid play”, Mr Collier said

“Africa weathered the macroeconomic shocks of 2009 very

resiliently because cumulatively they made little steps towards

prudence… The dog that didn’t bark, internationally, was that

Africa didn’t fall apart.”

Paul Collier, Professor of Economics, Oxford University

Simon Susman, non-executive chairman of Woolworths, believed that the legacy of colonialism persisted in many countries, and the more recent it is the harder it is for a country to move on But investors should look for those countries that have shrugged off their Marxism for market thinking, are less xenophobic, and accept a free press, he said Another good sign is the returning diaspora, which include many top people This is a continent where a modern, savvy consumer is emerging It points to an aspirational tipping point, a feeling that: “I want it and I can get it” amongst new consumers, said Mr Susman

investing and exit strategies

Many new competitors are entering the market to capture this new consumer Zain Latif, founder of TLG capital, is already invested

in Africa His focus is on healthcare, given the high proportion of disease in Africa, including cancer, AIDS and malaria He confirmed worries about the difficulty of accessing frontier markets through private investment portfolios While it’s always possible to find something to invest in, it’s very difficult to create shareholder value and exit, which is why the private equity structure doesn’t work well there Local banks lend at 30% because of inflation, making it hard to build a business within fixed timelines Many smaller funds entered in 2005-08 but managed only a couple of deals

That said, it’s important to publicise success stories, so investors see beyond the traditional view of the region as an oil and gas opportunity – which can be hard for investors to get exposure to anyway—and see its burgeoning middle class, which is easier

to access There is also a tendency to balk at political risks He mentioned Uganda which presents many good opportunities, but mainstream investors won’t go there (perhaps deterred by news stories of Joseph Kony and the LRA) and will wait until someone else shows that it can be done

He noted that it can be hard to capture a market when people don’t have bank accounts Nevertheless, African consumers will spend on healthcare, housing and education So investors may see good returns in those sectors Even insurance can be profitable: Nigerians spend only US$0.05 per capita on policies, so there’s scope for life insurance, especially as premiums can be reinvested

Diversification is essential, as at least one market will be in a crisis at any time It is also important to be country focussed, rather than vaguely referring to “Africa” It’s a hugely diverse continent in many ways One might also apply such distinctions to cities rather than countries, according to a panel on African cities Rapid urbanisation has made Lagos, Johannesburg, Nairobi, Kigali and others important business centres in their own right, and led to opportunities in services, retailing and property, as well as excellent opportunities to invest in infrastructure The future may lie in public-private partnerships to get key infrastructure built Despite the influx of the young into urban areas, skills shortages, and the lack of flight or rail connections between African cities was seen as among the biggest frustrations for investors

The african entrepreneur

Probably the biggest success story in Africa is Nigeria’s Aliko Dangote, founder, president and chief executive officer of the Dangote Group Titled Africa’s richest man, Aliko Dangote explained how to be an entrepreneur in one of the most promising markets in the world He began trading in 1978 in Nigeria A family loan which he repaid in three months allowed him to trade in sugar, rice and commodities during the 1980s, then textiles and banking His 13 factories produced a range of products, including flour and pasta, and also a joint venture with Coca-Cola

Around 2005, the company attempted to work with cement giant Lafarge, but couldn’t agree terms, so he took a bold leap to compete, opening a cement factory in southern Nigeria It acquired over 40% of the market in two years The company quickly expanded across Africa, investing in and upgrading old processes, for example in Liberia, Sierra Leone, Cameroon, Gabon, Congo, Tanzania and elsewhere The company expects to produce 60m tonnes in sub-Saharan Africa over the next couple of years Cement now accounts for some 80% of Dangote’s business The group is moving into agriculture, encompassing vertical or backward integration including irrigation It is linking up with expert partners, in Asia to acquire refining businesses Faith in the African market is evidently stronger than ever, with huge investment plans, including some $7.5bn for petrochemicals projects There are significant resources of limestone, near Abuja to exploit The company expects returns on investments of at least 30%

But there are challenges Lack of infrastructure is one The company plans to build west Africa’s first, 18-metre, deep-sea port, and will venture into logistics—it already owns 6,000 trucks—while lack of reliable power supplies means that the company needs to become a power producer too The company’s interest in steel and gas pipelines also require that adequate infrastructure, especially ports and roads, be in place

Corruption is another problem Western governments are helping to clamp down on dishonest officials The company also sponsors seminars and advises governments on reducing corruption It is possible to do business without being corrupt

Good government relations are important, but you don’t need political connections

to do business There are one-stop shop investment bodies, for example, to help investors Governments can make life easier for big investors, especially when trying to resolve problems For example, investment in agriculture is deemed vital for the continent’s development, so many governments in the region will compulsorily purchase private land

if seen to be in the public interest of developing agriculture A government crackdown on the Islamist terrorist group Boko Haram, which may have been responsible for a 3% drop in turnover, has helped suppress unrest

A good name is also vital When Dangote proposed a $600m investment in Tanzania, for example, officials assumed it was a scam, until the investor’s reputation and its $2+bn net