Managing Contract Risk in High-Growth Markets
Throughout 2015, several emerging markets, including China, Greece, and Puerto Rico, suffered financial woes. In 2016, many emerging markets, particularly the BRIC region, continue to experience a long list of economic problems and slower economic growth.
To compensate for the slowdown in emerging markets, many investors are looking for investments and business opportunities in frontier markets. In this article, we will analyze what is the appeal of frontier markets for enterprises and what steps can enterprises take to manage the inherent higher risk of these regions.
Economic Outlook of Frontier Markets
While there are many lists of countries that are considered frontier markets, the one from MSCI is the most commonly used by analysts and investors. Frontier market nations, including Argentina, Croatia, and Nigeria, have less developed economies than those from emerging markets and are experiencing such explosive economic growth that are poised to become part of the set of emerging markets.
For example, in the 2016 World Economic Forum, Argentine President Mauricio Macri indicated that the South American nation would receive a potential $20 billion in potential foreign investment throughout 2016. Among the foreign investors, the Coca-Cola Company pledged $1 billion in investments over a four-year period and the group formed by Total SA, Royal Dutch Shell Plc, and Dow Chemical Co. pledged “hundred of millions of dollars each.”
In Asia, Vietnam is a focus of attention for investors seeking growth in that region. Back in 2012, Coca-Cola invested $300 million in Vietnam. By 2015, the drink company reported that Vietnam has been “one of the world’s fastest-growing markets for brand Coca-Cola across.” Apple is another company highly interested in the Southeast Asian nation and set up a subsidiary with a $672,194 investment there.
Besides Argentina and Vietnam, other frontier markets have the potential to continue growing at an accelerated rate throughout and beyond 2016.
Risk Management in Frontier Markets
The higher potential for growth in frontier markets comes with a higher risk. To mitigate risk related in frontier market investments in your contracts, here are several factors to consider:
- Currency exchange rates: Over the period April 2014 to April 2016, the U.S. dollar has appreciated 17% against the Kenyan shilling. However, in during a one-month period in 2015, the U.S. dollar drop 4%. Frontier markets are characterized by volatile currencies so make sure to include clauses that hedge both parties against dramatic movements in exchange rates.
- Benchmarks: To establish interest rates and target return rates, enterprise can use exchange-traded funds (ETFs) targeting frontier markets as useful benchmarks. For example, the iShares MSCI Frontier 100 ETF trading in the NYSE Arca provides a guide of equity market performance of set of frontier market economies. Additionally, the MSCI tracks standalone market indexes, including Jamaica, Ukraine, and Palestine.
- Verbal agreements: In many Asian and African frontier markets, some business agreements are made without formal written contracts. An expert in international negotiations and professor at the INSEAD School of Business, Erin Meyer points out that in countries with less reliable legal frameworks, business relationships may have more weight than contracts under several scenarios.
- Liquidity issues: Unlike nations with more developed financial systems, frontier markets may have legal or technical issues to move funds from and outside the country.
- Cross-cultural negotiations: Meyer provides also several tips to improve cross-cultural negotiations. Depending on your target frontier market, your enterprise may need to add additional processes or take out irrelevant ones. Having an enterprise contract management system that allows you to customize your contract lifecycle is key to adapt to the local customs and document all processes for future reference.
To business people willing to take the additional risk, frontier markets offer an opportunity to make potential high profits. However, business transactions in frontier markets have many risks, including liquidity restrictions and dramatic currency fluctuations. Enterprises looking to do business in these nations need to account for the additional risk.