For those who have received clear guidance from the corporate center, the major directive to local managers has increasingly been to limit the company’s in-market liabilities above all else. Unfortunately, this is easier said than done.

The key challenges senior executives mentioned were:

• Capping debt liabilities and continuing to supply the local market: Most corporate headquarters have put strict limitations on how much product local subsidiaries may import into Venezuela for as long as the government continues to deny foreign exchange allocations for previous imports, particularly 2013 and 2014 debts.

• Engaging the government effectively on regulations and foreign exchange allocations: Particularly for strategically important companies, developing an appropriate government relations strategy while avoiding increasing compliance risk remains a particularly thorny challenge.

• Shielding local currency assets from inflation and devaluations: Accelerating inflation and exchange rate pressures, along with restrictions on capital repatriation and FX supply, is creating greater incentive for companies to spend their bolivares quickly. However, long delays on approvals from corporate have made it impossible for local country managers to make the necessary purchases of fixed assets in time to prevent an erosion in the value of their cash assets.

• Accelerating talent flight: While companies have been reducing head count proactively given the reality in Venezuela, a very strong sense of urgency is felt by Venezuela country managers whose local teams are suffering from a severe collapse in their earning power, such that even multiple salary increases throughout the year have not been able to counteract inflation. All of which is leading talented individuals to seek employment outside of Venezuela.

• Developing realistic scenarios for 2016 and beyond: Companies are largely resigned to the fact that the situation through the rest of the year is unlikely to improve significantly, given elections scheduled for December 6. However, the outlook for 2016, while on the whole grim, remains highly uncertain, with both the corporate center and local teams uncertain over whether the government will pursue more of the same policies or begin implementing necessary fiscal, monetary and foreign exchange adjustments.

I will be exploring the solutions multinationals are implementing to confront these challenges in forthcoming reports on Managing Risk in Venezuela and Planning for an Exit from Venezuela.

To access the full Venezuela Decision Framework report, FSG clients can login to the client portal. Not a client? Contact us to learn more.

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China has experienced exponential growth in the number of outbound travelers, with 107 million trips last year. Most outbound Chinese travelers are from coastal regions where multinational corporations already have strong presence; accordingly, tailoring a retail strategy for these sophisticated customers will be critical. Multinationals should target Chinese travelers abroad by enhancing organizational synergy, using existing infrastructure to pre-empt competition and designing tailored sales and marketing strategies for specific Chinese traveler segments.

In 2014, Chinese global shoppers alone accounted for one-third of the world’s tax-free shopping, and overall disposable income levels will continue to grow throughout inland and western provinces in the coming decade. Therefore, a strategic game plan to capture those sales will be critical for multinationals targeting this emerging market segment.

But before multinationals finalize their game-plan for the emerging segments, it’s necessary to understand the key trends of these consumers:

1. APAC destinations are becoming popular: With the Asia-Pacific region home to the most popular destinations for Chinese outbound travelers, the number of Chinese tourists reached 86.51 million in just the first ten months of 2014, far exceeding the number of Chinese visitors traveling to other destinations. The boom in travel from China is effectively boosting consumption in those destination markets, especially in popular tourist spots like Hong Kong, Macau, South Korea, Japan and Thailand.

2. Most travelers are from coastal China: As most of China’s outbound tourists are currently from Tier 1 and Tier 2 cities in coastal provinces, multinationals should leverage existing infrastructure in those areas to enhance branding and refine product mix, which will provide them with first-mover advantage when targeting global shoppers from China. Companies should also use online channels for more effective marketing to reach Chinese global travelers in the emerging city clusters.

3. Affluent travelers will take the lead: This segment will contribute around 41 percent of Chinese travelers in 2020 as compared to 21 percent in 2010, while the inexperienced ratio will reduce from 56 percent in 2010 to 33 percent in 2020.

Sources: Frontier Strategy Group analysis; Boston Consulting Group

4. Understanding Chinese travelers consumption patterns is a must. Cosmetics and perfume are the most popular product categories among Chinese travelers, which is why many skincare and beauty brands have begun to target travel retail as one of their biggest market segments. Duty-free shops rank as the top sales channel for Chinese tourists overseas, as indicated by more than 80 percent of survey respondents. In addition, Chinese tourists traveling to cities in Japan and South Korea prefer to shop in large-sized department stores and duty-free shops, while tourists traveling to cities in Europe and the U.S. prefer to shop in brand franchise stores and discount stores.

Check back next week for part 2 of our blog series on China’s Travel Segment.

For our latest China research, FSG clients can visit the client portal. Not a client? Email us at info@frontierstrategygroup.com to learn more.

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In fact, translation risk, or the impact of currency movements on multinational corporations (MNC) earnings, reached its highest point on record in Q1 2015. U.S. and European companies reported $31.7 billion in losses solely due to currency movements. The figure is nearly 50 percent higher than even the peak of the “taper tantrum” in 2013, during which the U.S. Federal Reserve’s announcement that it would begin to ease off or “taper” its quantitative easing program had a similar effect on corporate earnings.

Source: FiREaPPs

How it works

The current bout of currency volatility is particularly acute because of the U.S. Federal Reserve’s intentions to raise interest rates, likely this year. Interest rate increases in the U.S. prompt flight of portfolio capital from shallow emerging-market investment pools, resulting in dramatic swings in currency valuation. In an environment of slower global economic growth, underperformance in many emerging markets due to falling oil prices, and historically low developed-market interest rates, even a 25-basis point increase results in a big difference in the risk-reward tradeoffs of financial market investors.

Impact on business environment

Currency volatility is always a concern for companies operating overseas. Changes in local currency values can erode earnings in USD or other hard currency even if in-market sales targets are met. However, these impacts rarely rise above US$4 billion per quarter, making the recent US$31.6 billion figure truly significant. The result is important for companies and shareholders, but also for the markets in which they do business:

• Lower hard-currency earnings for emerging markets: rapid currency depreciation can cause country managers to miss dollar or euro targets by a wide margin, even if in-market sales targets were met.
• Slower growth in emerging markets: For emerging markets, volatile currencies can result in massive downward revisions; Argentina’s 2014 GDP growth forecast tumbled to -2.6 percent in August 2014 from 2.0 percent in January 2014, as the currency depreciated 28 percent in eight months.
• Changes in consumer preferences and behavior: Emerging markets consumers are accustomed to higher inflation, but a large change in currency values makes imported goods relatively more expensive and renders local inflation even higher than expected. The result is a reduction in purchasing power that can change consumer preferences and behavior, risking both the brand value and market share of MNC products in local markets.
• Increases in oil supply, which in turn put downward pressure on prices: As local currencies depreciate, energy exporters have an incentive to increase their exports of oil and gas. This is because oil and gas contracts are priced in dollars; every barrel of oil exported brings in more local currency than before, even as oil and gas prices fall. This additional supply puts even more downward pressure on prices, reducing overall exports earnings and foreign exchange reserves for those countries, threatening their economic stability.

Actions to take

Many companies rely on their treasury department to consider a top-level financial hedging strategy to make up for changes in local currency values. However, this strategy ignores the operational effectiveness that emerging-markets executives can bring to the table to protect their earnings. FSG identifies two main goals by which executives can consider strategies for mitigating liquidity, credit and translation risk in emerging markets.

• Improve margin by securing short-term exposures and reducing volatility to create more certainty around cash flows. Actions to achieve this strategy include providing working capital in local currency, adjusting payment terms or factoring invoices from currency depreciation by selling receivables to a third party.
• Gain market share. In an environment where MNCs have access to very low-cost financing and a strong dollar, producing locally or expanding via acquisition can be a well-timed and powerful way to gain market share.

These strategies are not mutually exclusive. Executives often combine strategies to achieve their currency volatility management goals. Perhaps most importantly, these strategies can be implemented by international and regional leaders with limited support from treasury.

As companies begin their strategic planning sessions in the fall, and as the U.S. Federal Reserve is set to raise interest rates, executives should expect increasing currency volatility to impact multinational corporations in 2015 and 2016. The stakes for executives’ targets are too high to be left to chance, or treasury.

FSG clients can access the full report, “Currency Volatility Playbook,” via the client portal. Not a client? Contact us to learn more, or follow Lauren on Twitter @LaurenElGoodwin.

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Companies should review their downside scenarios for Turkey now and assess any additional planning that needs to take place to prepare the business for increased political risk in the coming months. FSG estimates that the likelihood of heightened domestic instability substantially disrupting multinational corporations’ performance in 2015 and 2016 has increased from 25 percent to 35 percent as a result of recent events, necessitating a careful review by companies with a presence in Turkey of the risks to which their business is exposed. This applies to both 2015 plans as well as to plans under development for 2016.

What executives need to know:

1. The Justice and Development Party (AKP) and the main opposition Republican People’s Party (CHP) are continuing their coalition talks and have until the last week of August to form a government. If they can’t, Turkey will be holding early elections latest by end of November.
2. The Turkish government is engaged in a dual campaign against both ISIS and PKK cells within its borders.
3. The ceasefire between the PKK and the Turkish government has de facto ended, meaning the PKK has already, and could continue, to increase its terrorist attacks against Turkish government and security officials.
4. The government has and will continue to increase security measures at the southeastern border.
   • Turkish military presence as well as drones and surveillance balloons will be increased.
   • Intermittent walls of around 100 kilometers will be built along the 911-kilometer border with Syria.
5. Turkey will play an increased role in the coalition campaign (formed of 60 countries including U.S., Western and regional powers) against ISIS in Syria.
   • Its main military base Incirlik, in the southern city of Adana will be open to coalition forces in their operations against ISIS.
   • Although details and timelines have not been confirmed, Turkey is likely to establish pockets of safe zones inside Syria, which will be dedicated to various efforts including hosting Syrian refugees.

What are the implications?

1. Government spending plans for the rest of 2015 as well as the 2016 budget will allocate more resources to security institutions such as the police, military and the national intelligence service.
2. Consumer confidence, already around a six-year low of 64.66 in July, will remain muted for a longer period of time, potentially into 2016.
3. Hesitant local and international businesses will maintain their cautious stance towards new investments and likely further postpone expansion plans to H2 2016, depressing growth and demand for B2B goods and services.
4. The Turkish lira has already depreciated slightly and will continue to depreciate if early elections are announced, insecurity perceptions regarding Turkey increase, and when the U.S. Federal reserve increases interest rates.
5. Making the case to corporate for increased resources to Turkey will become harder due to a rise in insecurity concerns. However, increased focus on sales and market will be necessary to capture fluctuating demand in the country.

What should executives do?

1. Review their scenarios for the market. The likelihood for a downside scenario for 2015 and 2016 where the Turkish government mismanages domestic and regional instability, politicizes economic decision-making and postpones structural reform has increased from 25 percent to 35 percent. Companies that do not have basic plans for a downside scenario involving substantial political volatility and security threats should build one now in partnership with their local teams and distributors. Executives must monitor the following signposts to anticipate stability in Turkey:

2. Prepare for both currency depreciation and volatility for the rest of 2015. Companies, including the financially conservative ones should consider hedging, invoicing in Turkish lira, or working with fixed currencies. Multinationals should also consider how they would need to adjust pricing in the context of muted demand in the coming months combined with high inflation. We expect consumers in particular to become more price sensitive in an environment of high political and economic uncertainty.
3. Engage with local partners and distributors and determine your new plan for the next six to eight months. Ensure they are engaged in aggressive sales efforts, making necessary marketing and branding investments, working on new campaigns, or even considering temporary promotions to capture muted demand.

To learn more about FSG’s scenarios for Turkey, clients can review our reports on the short-term outlook here and the long-term possibilities in the market here. For additional support on building custom contingency plans for the market, clients should contact their client relationship director; or email us at info@frontierstrategygroup.com.

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Chile has long been perceived as one of Latin America’s most reliable economic out-performers, but on July 7, the government announced a downward revision of growth forecasts for 2015, a development which changed many observers’ perceptions of Chile’s economic health. According to official figures, Chile’s economy is now expected to grow by 2.5 percent, compared to the 3.6 percent forecasted by the government at the beginning of the year (FSG had forecasted 2.9 percent.)

While the magnitude of the reduction in growth expectations caught many by surprise, we believe that Chile is far from becoming a regional under-performer, in large part because Latin America’s broader economy is slowing, leading to downward revisions of forecasts across other regional markets.

That said, the forecast revisions for Chile were significant, and it is important to understand the reasons behind the dramatic change in the country’s growth expectations. In FSG’s view, a deeper understanding may be gained by analyzing the four main drivers of GDP growth:

1. Consumer spending

Consumption was expected to be one of the main contributors to GDP growth in 2015. The government’s effective inflation-targeting measures and the positive pass-through effect of low energy prices in the first quarter of the year suggested a positive effect on households’ disposable income and consumer spending.

However, the increasing number of corruption allegations and political scandals associated with President Bachelet and other members of her party had a negative effect on consumers’ perceptions of Chile’s political and economic stability. As a result, consumer spending and retail sales in Chile have fallen dramatically during the last three months.

Consumption is now expected to grow by 2.1 percent (The government’s previous estimate was 3.9 percent; FSG’s estimate was 2.9 percent.)

A note on currency depreciation to inflation: Despite anemic economic growth in Q2, accelerated currency depreciation in the last two months (FX: 595.7 on May 14; 651.2 on June 21) caused inflation in Chile to outpace expectations. Most recently, the consumer price index rose 0.5 percent in June, as prices for transportation, housing, and basic services increased. Accordingly, accumulated inflation for the last 12 months reached 4.5 percent, far above the central bank’s 2 percent to 4 percent target range. Inflation is now expected to average 4.1 percent this year. (The government’s previous estimate was 3.1 percent; FSG’s estimate was 4.3 percent.)

2. Government spending

A massive fiscal stimulus package that aimed to improve both consumer and business confidence was expected to be part of a historic 9.8 percent increase in government spending. However, anemic exports and investment throughout the first half of 2015 have forced the government to cut its original expectations for fiscal revenue growth by half (from 5 percent to 2.4 percent). This limited the government’s ability to implement its original fiscal stimulus plan.

Public spending is now expected to increase by 8.8 percent. (The government’s previous estimate was 9.8 percent; FSG’s estimate was 7.7 percent.)

3. Investment

Investment was expected to recover throughout 2015. However, stubbornly low commodity prices, particularly for copper, have dampened investor interest in the mining sector. Sluggish investment combined with increasing currency volatility, associated with expectations for a potential hike in US interest rates in the last quarter of 2015, has created a risky operating environment in which multinationals are hesitant to make large investments.

Investment is now set to grow by 2.3 percent. (The government’s previous estimate was 3.9 percent; FSG’s estimate was 2.5 percent.)

4. Trade

Although low copper prices have impacted Chile’s overall export performance throughout the last 12 months, low oil prices have contributed to a faster reduction of Chile’s import bill, causing an overall positive net effect in the country’s trade balance. For the last 15 months, Chile has maintained a healthy trade surplus, which, together with public spending, has been one of the main pillars of GDP growth in 2015.

It is now clear that the dramatic reduction in growth expectations for Chile was caused mainly by external factors that will also affect the region as a whole: currency volatility, US interest rate hikes, low commodity prices and low investment levels. FSG will continue to monitor the effects of these external factors on individual countries and regional economies and on the operating environment for multinationals.

For our latest Chile research, FSG clients can visit the client portal. Not a client? Contact us to learn more.

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With India’s base-case growth for the next decade to be around 7.7 percent (70 percent likelihood), it will be the fastest growing major emerging market in the world. For any multinational this is the right time to re-assess if you still need to wait and watch the reform execution, or if you need to increase the allocation for the country now to capitalize on the new opportunities and gain first-mover advantage.

The results were even more interesting in terms of checking on how India’s role will evolve within portfolios.

Some themes that emerged during our session were as follows:

1. India being a part of the Middle East portfolio: This is predominantly the reason why we witnessed a rise to 9 percent of companies that think India won’t be a part of an Asia-Pacific portfolio. An increasing number of companies have started considering if India should be embedded within the Middle East cluster because the leadership skills and consumer behavior in the regions are similar.

2. Opportunities for B2B companies: Most of the B2B companies are considering whether to increase their allocation to India given the “Make in India” campaign which will have direct/indirect benefits to all multinationals. Whether you consider manufacturing in India for India or for the rest of the world, it’s an important aspect to consider if you want to expand your product portfolio and the segments you plan to serve.

3. Make in India vs China: A deeper analysis across the board is on the rise since China’s land/labor cost is increasing and managing profitability is becoming an issue. We believe that China will continue to lead the way in high-end manufacturing. India will become a competing country only in the low-end manufacturing in the short term. The real success for the Make in India campaign is a function of the pace of new reforms to be executed.

4. Adopting a cluster-based approach: Understanding where the pockets of wealth exist in India is more crucial than in other countries. While only 30 percent of the population lives in urban areas, they account for more than 60 percent of the GDP, and the number is expected to rise to more than 70 percent by 2030. In addition, leveraging the right center/state-level incentives to build your appropriate manufacturing base is critical.

FSG’s proprietary analysis suggests that all multinationals need to consider the seven mega clusters, nine emerging clusters and 24 frontier clusters. The fundamental question remains where multinationals need to “go wide,” or “go deep,” or both. All FSG clients can access the report through the FrontierView platform.

The most important action that a lot of regional multinationals and country GMs need to take is to initiate making a case for India to their corporate teams. Providing a clear and deeper analysis on the true opportunity is a must since, historically, lack of profitability, infrastructure bottlenecks and bureaucracy have been big hindrances, and many executives don’t have the appropriate patience to wait for scaling the right business in India.

This update is the first of a series of insights on how and what you need to plan for success in India. In my next blog, I’ll be sharing the top actions all multinationals need to plan for as they scale up operations in India.

FSG clients can access our latest India research via the client portal. Not a client? Contact us to learn more.

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Ever since Chinese President Xi Jinping proposed to build a cross-regional economic plan in 2013 to strengthen trade and investment partnerships across Asian, European and African markets, China’s “One Belt, One Road” initiative has been attracting worldwide attention with its massive scale and immense potential economic impact.

China’s Master Plan for Global Integration

The Belt and Road blueprint consists of two main routes. The Silk Road Economic Belt focuses on enhancing economic engagement with Central Asia via land transportation and expanding the influence onward to Europe; while the 21st-Century Maritime Silk Road is aimed at bringing together China’s coastal hubs and Europe, which starts from the South China Sea and will help develop China’s economic ties along the sea route with multiple key players in the Southeast Asian, South Asian and African regions.

Covering regions with around 60 percent of the global population and 30 percent of the world’s GDP, the China-initiated project is poised to become the world’s largest economic development plan. It has recently been placed under global spotlight again, as China’s top officials made visits to global partners and settled long-term bilateral deals with substantial economic weight, including major infrastructure and financial contracts finalized with Russia, Pakistan and India.

Proposed Routes for China’s One Belt, One Road Initiative

Image Source: Wall Street Journal

Impact on multinationals operating in China

1. Solving industrial production overcapacity: Besides facilitating regional commodity trade flows, one of its most critical and straightforward impacts domestically is to create an outlet for the country’s industrial production overcapacity. With a weakening manufacturing sector and dwindling demand at home, the world’s largest emerging market is aggressively seeking to develop new export markets for its construction materials and manpower.

2. Urbanization on western and central clusters: The New Silk Road strategy, especially the land route, will be offering abundant opportunities for China’s western and inland areas to glean benefits. All provincial governments along the routes are proactively working on obtaining incremental financial support for local infrastructure projects, and setting up logistics centers and cultural expos in preparation for strengthened global economic interactions.

3. Internationalizing the renminbi: As fifty founding members joined the Beijing-led Asian Infrastructure Investment Bank, the synergy between the financial institution – which aims to close Asia’s infrastructure gap – and China’s One Belt One Road plan is likely to further bolster the utilization of renminbi in cross-border trade transactions and loan settlements.

Impact on multinationals operating in Europe and Central Asia

Outside of China, the New Silk Road land route will have multiple economic repercussions in Central Asia and Eastern Europe. Most notably and immediately, China’s infrastructure development strategies in these areas will offer much-needed investment assistance and economic stimulus to economies struggling from depressed energy prices, the regional fallout from the Ukraine crisis, and weak global demand.

Central Asian nations, reeling from low oil prices and the collapse of the Russian ruble, and Eastern European countries, managing slowed growth on account of weak Eurozone demand, will benefit considerably from the inflow of billions towards the construction of previously-unaffordable railways, roads, and ports.

Likewise, western multi-national firms should be aware of the opportunities made possible by the New Silk Road program. In the short- to medium-term, one of the main beneficiaries will be construction and logistics firms seeking to invest in these new infrastructure projects. Over the longer-term, companies should recognize the potential for both an increase in the size of these countries’ addressable markets as well as the possible liberalization and diversification of these economies, which is a fundamental aspect of the New Silk Road development model. Should these factors in fact materialize in the coming years, the opportunity for exports, investments, and selling into these markets could rise substantially.

This blog post is the first of a four-piece series on China’s “One Belt, One Road” initiative, during which we will be sharing FSG’s view on this influential regional partnership plan and its further implications for China and the global economy.

For more information on FSG’s China, EMEA or Global view, clients can access the research section on the client portal. Not a client? Contact us to learn more.

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