Risk Round-up

At the risk of tempting fate, the early indications are that the storm clouds of the recession are clearing and the worst of the economic crisis is behind us.

Several economists have revised upwards their growth predictions for the developed world. Japan, Germany and France all released figures recently that indicated they were technically out of recession. And the International Monetary Fund predicted global economic growth of 2.5% in 2010.

The recovery is likely to be sluggish, however. Unemployment continues to mount up and, as a result, advanced economies as a whole are not expected to see a sustained improvement until the second half of 2010.

Consequently, companies are looking at the emerging markets commonly referred to as the BRIC countries (Brazil, Russia, India, and China), as the key to their growth strategies for the future. It was once hoped that consumption in these regions, particularly China, could assuage the worst effects of the recession, although this seems to have proven overly optimistic.

This viewpoint isn’t a new phenomenon. For a long time, Western companies have gazed enviously at China’s double-digit growth rates. What has changed, however, is the standing and influence that these parts of the world now command in economic world affairs.

While the financial crisis is not responsible for this evolution, it has flagged the drawbacks of a free market economic system and soft-touch regulation. Policymakers around the world may be looking at China’s centralised and tightly controlled economy in a new light.

Building BRIC

This new world order represents a huge challenge for the West (Europe, America and Japan) in two ways. First, companies based here need to learn how to exploit the opportunities presented by a new and potentially lucrative consumer market. Secondly, they are now required to engage with these nations and react to the new competition that they represent.

“The growth of the BRIC is fundamentally changing the patterns of economic and political international relations,” Goldman Sachs’ chief economist, Jim O’Neill, says. ‘This will become increasingly evident over the next few years. As the economies of the US and Europe struggle to recover, those of the BRIC will prove to be more robust, and will be instrumental in pulling the world out of recession.”

O’Neill also believes that, by 2027, the BRICS (including South Africa) economies together could be larger than the Group of Seven (Canada, France, Germany, Italy, Japan, the UK and US), although much of this growth will come from China alone.

No longer can the West claim the top perch in international economic matters. And their dominance in terms of intellectual, human resource, technological and financial capital is undisputed no more. In Europe and America, the financial system is only just beginning to stagger back to its feet.

Meanwhile, although not totally insulated, sovereign wealth funds, mainly based in Asia and the Gulf states, have become key players in global capital markets. These funds have an estimated $3,000bn of assets under management, and shifts in their investments could have a major impact on global financial markets.

China in particular is beginning to flex its muscles in international affairs. US President Barack Obama said recently: “The relationship between the United States and China will shape the 21st century.” For example, China is expected to soon get greater voting rights in the International Monetary Fund (IMF). And, in June, it agreed to buy up to $50bn of bonds from the IMF to boost the fund’s capacity to tackle the financial crisis.

“China is already too important to the global economy not to have a full seat at the international table,” Timothy Geithner, US Secretary of the Treasury, said in a recent speech on co-operation and recovery at Peking University.

Consumer forces

Since 2000, 600 million people have reached middle-class status in Asia, Russia, central Europe, Latin America and the Gulf region. In India, there are over 50 million people who are considered middle class, and predictions put this figure at 580 million by 2030. This booming consumer class represents a huge opportunity. But the emerging world also presents a challenge to Western hegemony.

It is not just a question of economic competition but a battle for hearts and minds too. As living standards rise in the emerging world, many of the smartest students educated in the West will decide to return home. This reverse brain drain could have serious implications for research and development and technological innovation in Europe and America.

As the flow of human capital reverses, local competitor companies are increasingly germinating in the emerging markets. The BRIC nations make four of the top five countries playing host to the most reputable companies in the world, according to a recent Reputation Institute survey. Admittedly, the US tops the list by a country mile, but the rest of the developed world is eclipsed by BRIC.

The survey also indicates that the largest companies based there enjoy a much stronger emotional connection with consumers than the largest companies in the industrialised world. Perhaps developed market companies can look to the emerging market for models to build stronger relationships with consumers.

“The evolving patterns of integration suggest that, as the BRICs gain momentum in the global economy, Western business will benefit from seeking out opportunities for innovative collaboration,” says Rebecca Jackson, an economic analyst with global risks specialist Maplecroft.

Making connections

Considering the complexity of the global regulatory environment, it may be easier for multinationals to partner with established and reputable local companies rather than suffer the compliance burden of establishing their own presence in overseas markets. This could lead to a process of deglobalisation.

The shifting balance of power also brings with it new risks. As emerging powers integrate themselves into the economies of other countries, Western companies could miss out on investment opportunities.

Increasingly, the BRIC nations are investing abroad with countries who are at an early stage of development. Traditionally, these are the countries – many of them ex-colonies – that were the playground of European and American investors.

“As Western investors get more risk-averse, Chinese and Indian companies appear to be using their extensive foreign exchange reserves to obtain cheap investments overseas,” Maplecroft’s Jackson explains. In 2008, overseas direct investment (ODI) fell globally, while China’s ODI increased by 64%. And, at the end of 2008, it promised Cambodia unconditional development assistance of US$257m for 2009, more than that offered by Europe or Japan.

As the BRIC countries increase their level of investment, their leverage over these developing countries increases, and it could be at the detriment of companies based elsewhere.

Much is made of the problems associated with development aid from the emerging powers, not all of which is sour grapes. “BRIC nations do not insist on the conditions that accompany commitments of Western development assistance,” Jackson says. “Increased dependence on the emerging powers could have negative consequences for governance.”

For example, in Zambia, after trying to find alternative investors, the government finally announced that a Chinese firm would be running the Luanshya copper mines, despite disputes with the government over Chinese working practices. “As countries increasingly come to rely on development assistance from the BRICs, there is a risk that poor governance will become entrenched,” Jackson warns.

Challenge for the industry

The insurance industry has a key role to play in helping companies take advantage of these new opportunities. As the new business centres increase in importance, businesses will require innovative products to cover new and emerging liability regimes, and they may increasingly require assistance in some far-flung places.

This could be challenging for some insurers, who may not have the international network and expertise to follow their clients everywhere that they need to go. In some instances, it may even be impossible to offer clients financial protection. Certain parts of the emerging world, including parts of Pakistan, Burma, Lebanon, Syria, Iran and other political hotspots, are blacklisted states, where firms are prohibited from offering financial assistance. IT

Nathan Skinner is associate editor of Strategic Risk, sister title to Insurance Times.