Balancing risk and reward sustainably in the BRICS

Investors must consider the short-, medium- and long-term issues.

As the world slowly emerges from the global economic and financial crisis, businesses and governments are realising that the global economic and financial landscape has changed and that they must adapt to this new environment. As consumption in advanced economies remains stunted, increasing attention is focused upon the potentially vast consumer market in the BRICs, which many are hoping will play a key role in driving global demand and pulling the world out of recession. While the long-term rewards are evident, there are significant risks to investing in these economies short- term. However, with sound risk management strategies in place, supported by ethical business principles and environmental and social policies, foreign companies working in the BRICs, and in partnership with domestic companies overseas, are poised to benefit from their projected phenomenal growth over the next decade. Even before the global economic and financial crisis, the growth potential of the BRICs – Brazil, Russia, India and China – was luring investors from across the globe. In 2003, two years after the concept was founded by Goldman Sachs chief economist, Jim O’Neill, economists were predicting that by 2040 the BRICs economies together could be larger than the G6 in US dollar terms.By early 2009, as many advanced countries were still languishing in recession, some economists were arguing that the BRICs, who were already seeing positive indicators, had the potential to lead the rest of the world out of the quagmire. Significant growth in the domestic consumption of the BRICs would exert a positive influence on global demand. Goldman Sachs consumption growth forecasts imply that, by 2010, the BRICs will contribute almost half of global consumption growth. These headline figures suggest that for western businesses, there is a growing imperative to operate in, procure from and distribute into the BRICs, and the emerging economies where the BRICs’ capital is deeply integrated. Take, for example, the size of China’s automotive market – which became the world’s largest earlier in 2009 – as an indication of the potential business opportunities that the growing consumer market of the BRICs. Last year, Chinese vehicle sales reached 13.6 million, comfortably higher than the 10.4 million equivalent vehicles sold in the United States in 2009. Only 33 years ago, there were only one million privately owned cars across the whole country. Of course, the BRICs are a very diverse group of countries and headline growth projections disguise variations
between them, and even between their internal economic zones and poorer rural hinterlands. A stable political and economic environment is crucial to domestic growth and to productive investment by foreign companies. The immediate political environment in all of the BRICs is relatively stable, meaning that businesses in these countries are not at imminent risk of a sudden change in government, which could bring policy changes and political violence. For Russia and China, regime stability stems from the authoritarian nature of the regime and the lack of political alternatives. By contrast, Brazil and India are both more established democracies that ensure in principle popular representation and smooth transitions. While both Brazil and India have coalition governments, which are often associated with instability, Lula’s coalition is strong and stable, while the 2009 Indian parliamentary elections saw a resounding victory for the ruling Congress party, whose mandate had previously been hampered by volatile coalition partners such as the Communist Party. However, both Russia and India are vulnerable to terrorism. In Russia, terrorist activities are concentrated in the North Caucasus, including Ingushetia, North Ossetia, Kabardino-Balkaria and Ingushetia, which has emerged as the most violent of the North Caucasus regions with 146 terrorist attacks recorded in the first nine months of 2009, leading to 106 deaths. In recent weeks suicide bombs in Moscow killed 23 people. In India, although al-Qaeda related incidents occur, the risk from Maoist terrorism is a more pervasive one, especially in North-Eastern parts of the country. Over the last year or so, the risk of conflict in Chinahas increased following unrest in Xinjiang province although this is very unlikely to have a major impact on stability over the medium term. It is also imperative for responsible businesses to identify and mitigate longer-term structural risks affecting the business environment. While these risks may not affect the day- to- day operations of businesses, they will affect the long term opportunities and profitability of an investment.

“A stable political and economic environment is crucial to domestic growth and to productive investment by foreign companies.”

For businesses operating in China and Russia, a key risk stems from complicity with governments that restrict fundamental freedoms and the democratic process. The recent dispute between Google and the Chinese government over censorship demonstrates the kind of dilemmas businesses operating in such countries face. Across all of the BRIC countries, labour rights violations are a major risk to doing businesses as it increases foreign companies’ risk of complicity in the actions of local business partners and suppliers. In addition, in harnessing the consumption power of the BRICs, labour rights are crucial in providing income security to workers who in turn feel more confident to spend, and ultimately to buy consumer goods. Businesses in India, and to a lesser extent China, face the greatest structural challenges to growth.
Levels of poverty, income disparity, literacy, education and basic transport and communication infrastructure are extensive in India. In particular, poor energy infrastructure has been a major constraint on businesses in the country, which face persistent power shortages. Limited purchasing power of Indians will limit their consumption of goods and services by produced by western companies. While Russia’s infrastructure readiness and education capacity may currently outperform some of the other BRICs, in the longer term, ensuring sound public finances in order to maintain roads and schools will require diversification of the economy away from oil and gas. Especially in areas such as poverty and income disparity, businesses need to consider not only the differences between each of the BRICs, but also the differences within each of the BRICs. Wide and growing regional disparities in income, for example, exert a negative influence on overall growth levels of the country. And such regional disparities will have political ramifications. Take India, for example, where four states containing the majority of the country’s poor – Bihar, Madhya Pradesh, Orissa and Uttar Pradesh – account for a major proportion of seats in parliament, thus exerting significant policy-making influence. In these states, support is higher for the country’s extensive subsidies, which are increasingly a drain on resources. Such expenditures have contributed to limiting the much- needed investment in infrastructure. Soundenvironmental policy, geared towards improving efficiency, can promote a reduction in resource input costs, whether energy or water. However, energy and water security are key issues in China, whilst in India, water and food security are critical for social stability and reducing risk of unrest and in turn political violence and repression. For China and Russia in particular, one of the key longer term risks to growth are demographic changes. Due to its one-child policy, China is the fastest aging country in the world and by 2030 the country’s working-age population is expected to have grown by just 1%, while Russia’s population will see a 16.8% decline between 2010 and 2030. Perhaps more significantly, this demographic decline will translate into an increase in the dependency ratio of over 20% for Russia and China, putting a major strain on the labour market and on social service provisions, and hence government finances. Despite these risks, for foreign companies working in the BRICs, and in partnership with domestic companies elsewhere in the world, there is great potential to benefit from their growth. In order for businesses to benefit from this growth, there is an imperative for them to put in place ethical business principles and basic environmental and social policies, not least to meet growing regulatory requirements of western home governments and stakeholder, including shareholder and investor requirements for good governance.

Professor Alyson Warhurst is the CEO and Founder of Maplecroft (the global risk advisory firm and issue mapping specialist). She was Chair of Strategy and International Development, Warwick Business School (1999 to 2009) and Honorary Professor from 2010. Rebecca Jackson is a senior political risk analyst at Maplecroft.
www.maplecroft.com