Emerging Markets: Keeping Perspective Amid the Turmoil

As the developing world faces a new set of challenges, how can global companies protect and grow their investments there?

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As growth slows in the world's wealthiest nations, many global companies are pinning their hopes on emerging markets. They're moving aggressively to source and sell more goods and services in developing countries in Asia, Africa, Latin America and Eastern Europe.

But now emerging markets are finding themselves in a perfect storm, as several economic trends conspire to dampen growth and investment. The slowdown has generated a lot of headlines, chased away some investors' capital and put up some hurdles for global companies with a presence in emerging markets. But it's useful to keep some perspective on the unique opportunities that still exist: Emerging markets are still growing faster than their developed counterparts.

HSBC projects emerging market growth at 3.9 percent in 2016, versus just 1.9 percent for developed markets. In 2017, emerging market growth is projected to rise to 4.6 percent, versus just 1.8 percent in developed countries.1 "We are still seeing companies interested in investing, particularly around production and manufacturing," says Cate Luzio, Global Co-Head of International Subsidiary Banking at HSBC. "And there are still many strategic opportunities to increase investment in emerging markets. For example, we are seeing continued investment in the apparel and transportation sectors."

Slowing Commodities

Among the reasons for the slowdown in emerging markets is slower growth in China, which became a major destination for raw materials during the early 2000s. Now, as China attempts to transition from an export-led to a consumer-driven economy, many countries are struggling to adjust.

"The Chinese slowdown has reduced demand for commodities ranging from copper to oil,” says José Rasco, Chief Investment Strategist for HSBC Private Bank, Americas. “But there's still not a lot of talk about reducing production to deal with all of the excess inventory."

Producing and delivering commodities requires a lot of capital. During the commodities boom, companies in emerging markets took advantage of low interest rates and borrowed heavily to expand production, while governments borrowed to expand infrastructure and finance public services. Now that demand has slowed, "it's getting harder to repay those debts," Rasco says.

We are still seeing companies interested in investing, particularly around production and manufacturing.

Cate Luzio, HSBC

Currency Squeeze

Another challenge faced by emerging markets began in 2013, when the U.S. Federal Reserve first signaled its intention to reduce its massive bond-buying program and raise interest rates. “This sent shock waves through the world's financial system and began the process of currency devaluation in emerging markets,” says Ivan Asensio, Senior Vice President and currency risk advisor at HSBC.

The Fed's bark proved worse than its bite: Since that announcement, long-term interest rates have remained largely unchanged and the Fed has made only one small adjustment to its short-term rate. Yet the U.S. dollar's value has risen about 14 percent.2 The stronger dollar can put a squeeze on emerging-market borrowers whose debt was denominated in dollars, Asensio says: "When the dollar rises, their liabilities become larger in local terms. This is a top concern for corporates, so we actively help manage our clients' currency risks around the globe."

The dollar's rise has also eaten into the earnings of some U.S.-based multinationals, because their revenues from overseas sales have dropped in value relative to the dollar. In the fourth quarter of 2015, dozens of U.S. companies announced that the higher dollar had reduced the value of their overseas revenues.

The strong dollar has caused some investors and corporations to reconsider their emerging market investments. Countries including Argentina, Brazil and South Africa have raised their own interest rates to prevent capital outflow and stem inflation. Interest rate increases can further dampen growth, and U.S.-owned companies in markets with high interest rates must obtain higher profit margins to succeed, Asensio says.

Plenty of Opportunity …

But all the headlines about slowing growth have obscured the many opportunities that remain throughout the developing world. Many large emerging market economies are still growing briskly and enjoy a degree of economic stability, including Mexico, India, Indonesia and the Philippines, according to HSBC projections. Even China's growth is projected at a still-healthy 6.7 percent in 2016.3

… For Companies Entering New Markets …

For U.S. companies looking to make new investments overseas, the strong dollar can be great news: It means that each dollar spent will go further than before. “There are opportunities for new investment in several countries in Latin America including Mexico, as well as in China and elsewhere in Asia, as the dollar strengthens,” says Asensio.

Many of these markets are still a good place to build new production facilities. That's not just thanks to low labor and resource costs: Countries such as China have developed infrastructure and expertise that match or even beat the production capabilities of developed countries.

China continues to strive to attract foreign investment. Leaders have recently announced “free trade” zones that lower regulatory barriers in Guangdong, Tianjin and Fujian provinces, and regulators are opening up the country's financial markets to more foreign participation.4 Southeast Asian countries are also working to attract foreign business by reducing trade barriers.

Meanwhile, Persian Gulf countries are enlisting global companies for help in massive infrastructure projects."'Free trade' zones have been established in the United Arab Emirates, Oman and Qatar," Luzio says. "There are a tremendous number of government-sponsored projects which need investment from multinational contractors. In Saudi Arabia, for example, four new metro systems are being built from the ground up."

A strong dollar is creating opportunities for new investment.

Ivan Asensio, HSBC

… And for Those Already Invested

Global companies already established in emerging countries have a variety of options for waiting out the slowdown, Asensio says. These include hedging directly with financial derivatives or using “natural” hedges in which companies pair their local-currency revenues with local-currency liabilities. For example, a company will borrow money, procure supplies or even build a production facility using a local currency to offset revenues earned in that currency.

In addition to managing foreign exchange risk, U.S. companies that do business in local currency may receive discounts from suppliers and may enjoy lower transaction costs. Making the shift to a new currency can result in considerable savings, even if it requires renegotiations with customers and suppliers and dealing with new systems, processes and regulations.

If executives believe in a country's long-term growth potential, they can take advantage of the stronger U.S. dollar by expanding or acquiring businesses within the foreign country at a relatively affordable price, Asensio says. If a company is doing business in a country with high interest rates, it can temporarily park its profits in high-interest bank accounts while waiting for a weakening in the home currency.

There are plenty of reasons to stay the course in emerging markets. In the long term, these countries harbor enormous potential as markets for goods and services. They are still expected to drive global growth, thanks largely to their younger and faster-growing populations. The world's middle class is expected to more than double to 4.9 billion people by 2030, with most of that growth coming from developing countries.5

Working with an international bank can help companies navigate the challenges and identify the opportunities of doing business in emerging markets, Luzio says. "Despite near-term challenges, there is significant growth potential in emerging markets and most executives know that to remain competitive, they need to embrace these global opportunities. HSBC is in a unique position to utilize our network and capabilities to help our clients build effective momentum and support their ambition to grow."

©HSBC Bank USA, N.A. 2016. ALL RIGHTS RESERVED. In the United States, deposit products are offered by HSBC Bank USA, N.A., Member FDIC.

This article is intended solely for informational purposes. HSBC Bank USA, N.A. assumes no obligation to update or otherwise revise this article. The information, analysis and opinions contained herein constitute our present judgment which is subject to change at any time without notice. Nothing contained herein should be construed as tax, investment, accounting or legal advice. In all cases, you should conduct your own investigation and analysis of each potential transaction, and you should consider the advice of your legal, accounting, tax and other business advisors and such other factors that you consider appropriate. This is not a recommendation, offer, endorsement or solicitation to purchase or sell product or service.

  1. HSBC Global Economics Report, Q1 2016
  2. WSJ.com, U.S. Dollar Index (DXY) *Return data from May 22, 2013 through February 8, 2016
  3. HSBC Global Economics Report, Q1 2016
  4. WSJ.com, "China to Set More Free-Trade Zones," March 24, 2015
  5. OECD Development Centre, The Emerging Middle Class in Developing Countries, January 2010

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