Investing in Uncertainty: Best Practices for Mitigating Emerging Market Risk
The attack on Israel by Hamas. An earthquake in Morocco. Presidential coups in Niger and Gabon. These are just a few examples of low-probability, high-impact events that rocked emerging markets around the world in 2023.
Few seasoned international political experts predicted any of these events, despite early warning signs in some of these countries.
Let’s face it: emerging markets are unpredictable and can be difficult to navigate for companies, governments, economists, NGOs, and organizations of any size.
Complicating things, it’s impossible, and would be irresponsible to paint all developing economies with one broad brush of “emerging.” Each continent, nation, and even region within a given political boundary may have drastically different economies, political systems, regulatory frameworks, and so on.
As we assess risk and attempt to mitigate it, we are looking at commonalities and warning signs.
Common Characteristics of Emerging Markets
Most developing nations have only been self-governed since the mid-20th century. Many lack mature political institutions and are often characterised by elevated corruption risks, regional and ethnic tensions, ineffective bureaucracies, skills shortages due to brain drain and poor education systems, and immature political-military relations.
The most defining characteristic of an “emerging economy”—as “emerging” implies a low-to-middle income of $15,000 per capita GDP or lower—these countries have large (and in some cases swelling) numbers of people in impoverished conditions who are increasingly pressuring their governments for reform.
Assessing Risk vs. Reward for Market Entry
The unique challenges of market entry in any specific emerging market make it difficult to prioritize where to focus, what the real vs. perceived risks might be, and how to best factor these variables into a business risk assessment.
That said, companies must also keep in mind the big picture: emerging market GDP growth has long outpaced that of developed economies, while population growth is far more robust (important for any company manufacturing goods or providing services to local markets).
In short, emerging markets are appealing because they offer dramatic upside and opportunities that developed markets cannot.
Still, too many decision makers in small- and medium-sized businesses (particularly in the United States) often dwell on the risks without properly considering the rewards.
How To Conduct a Comprehensive Risk Assessment
This leads to the key question: how can SMEs—with limited budgets, international experience and/or staff to make comprehensive assessments—make effective risk evaluations to determine whether investing in an emerging market is the right choice?
Every situation is different of course, but the following tips are worth keeping in mind:
Do your homework
Corporate decision makers often dismiss investment opportunities based on negative perceptions of countries or regions as a whole. Africa is probably at the top of the list, with investors ignoring the fact that the continent consists of 55 drastically different countries and many more sub-markets within them. This is a huge mistake.
A Japanese company would not make a decision about an auto plant in Madrid due to instability in Bulgaria; or about investing in Milwaukee due to concerns about crime in Albuquerque. So why ignore an opportunity in Rwanda, one of Africa’s most welcoming business environments, over worries about stability in neighboring DR Congo? Or in Lagos, Nigeria’s bustling economic capital, because of unrest in the northeast, hundreds of miles away?
The economic microclimates matter more than that of the country or region as a whole.
Think Locally
Investors often focus heavily on the macro-level picture, looking at economic growth rates, conflict prevalence, government stability, and terrorist threats.
However, developing economies often have huge regional disparities, notably around the business climate and the quality of infrastructure, particularly transport and power.
Furthermore, local culture can have a huge impact on management practices and how businesses operate.
Common examples include a greater emphasis on relationship-oriented (a more time-intensive approach), over results-driven management, as well as greater acceptance of uncertainty and higher risk tolerances.
These characteristics are not unmanageable, but they do often surprise Western investors who have not prepared.
Engage on the ground
Part of the homework mentioned above is local engagement, and this is probably more critical than any other element. While investors should by all means meet and interact with national and state/provincial political leaders, regulators, and other officials, the key to success or failure depends on local communities.
Meet with local politicians, religious leaders, chiefs, headmen—anyone who has sway in the community in which you are investing.
Listen to their concerns and desires, particularly in situations where construction might disrupt a community.
Early engagement will mean fewer headaches later on, especially regarding construction and local labor. It may be slow and deliberate, but it’s essential.
Ask the right questions
Investors often ask questions about the big, national issues rather than practical, local issues.
Nigeria is a great example. Most Westerners have heard of the Boko Haram terrorist group, which has devastated northeast Nigeria for more than a decade. However, Nigeria is a geographically vast, ethnically and religiously diverse state of more than 100 million people, and one of the most important economies on the continent. Boko Haram’s activities impact only a small portion of them in the country’s most economically disadvantaged region.
In Mozambique, a country destined to become a major oil & gas economy in the coming years with recently discovered reserves, there is an insurgency in Cabo Delgado, a province 1,000 miles from the capital of Maputo.
So these macro pictures have little relevance for local investments. Investigating in local business climates and examining infrastructure (particularly power and transport) are all more worthwhile questions to focus on.
Read “official” sources with a critical eye
I would argue that no information source does a better job dissuading investors from emerging markets than the travel guidance published by the US, UK, EU, and other government bodies.
Africanists tend to chuckle at the “critical” crime and terrorism designations of many African capitals, descriptions that seldom reflect reality.
To their credit, Western governments have a duty to protect their citizens, and they generally take the stance that providing too many warnings is preferable to too few, but prospective investors should get the lay of the land themselves, through visits, partnerships, consultants, and discussions with local experts.
Once in-country, investors are likely to find a far different environment than the one described by the State Department.
Vet any local partners intensively
I’ve been approached on several occasions about business opportunities in Africa that have come about because the executive “knows a guy in country X who is well-connected and can get things done.”
Yes, there are local partners around the developing world who know the markets and political decision makers intimately, allowing them to cut through red tape and get results.
However, the vast majority of these self-declared miracle workers are simply hustlers, perhaps with a few useful connections but generally without the clout they claim.
Even then, what accounts for their “magic touch”? Is it a well-developed network and excellent local knowledge, or is something more nefarious involved, such as paying bribes? The bottom line is that any local partner or key management hire should be rigorously vetted, preferably by an outside evaluator. Engaging the support of a firm with experience helping other companies in your industry in the market or region, is the safest bet to get results and to ensure your company is compliant with laws including U.S. Foreign Corrupt Practices Act (FCPA) and the U.K. Bribery Act 201 (UKBA).
Of course, with any change and growth in any situation, something unexpected might happen. Pandemics come. Civil unrest happens. things can and do go wrong, often beyond anyone’s control.
However, I can guarantee that a business is likely to falter or fail altogether unless investors do their homework: ask the right questions, make visits, talk to people, and engage outside experts if you cannot get proper advice internally.
Be prepared to walk away if the fit is not right. But if you take away one piece of guidance from this piece, it is to not dismiss emerging markets out of hand.
Risks exist, but with the right advice, an investment in Lagos should be no less manageable or marketable than in Milwaukee!