Lure of high-growth emerging markets is strong

For many businesses, taking the plunge into the high-growth regions of Asia, Latin America and the Middle East is a no-brainer. In March, the British Chambers of Commerce forecast that UK GDP growth for 2011 will be 1.4 percent, which compared rather unfavourably with the World Bank’s forecast that China’s growth rate will slow to 8.7 percent from 10 percent in 2010.

While not offering growth rates quite as tantalising, countries such as Russia and India do not lag far behind. With the UK and much of Europe languishing in the economic doldrums, the lure of high-growth markets is strong.

The potential of emerging markets means that 40 percent of the world’s SMEs will be trading internationally within two years – a leap of 11 percent, predicted by HSBC’s latest bi-annual business confidence monitor.

The shift towards foreign trade is put down to a decline in confidence in developed markets and an appetite to explore opportunities in new markets. During 2010, HSBC’s international trade finance lending to UK businesses was up 13 percent with the export component up 43 percent. More than 6,000 SMEs in 21 countries took part in its survey, with just 12 percent in developed countries anticipating any increase in local economic growth – compared with the 43 percent of respondents in emerging markets.

But tapping into the rich vein of opportunity these markets represent is fraught with risk for SMEs; Aon’s 2011 risk map illustrates the dangers. Events in Egypt, Tunisia and Libya highlight the threat that civil unrest can pose, while countries such as Russia and China are often at risk of political interference, and are rife with bribery and corruption, both of which are seen as an inevitable part of doing of business in those regions.

Regulators (and morals) would dictate that bribery is a scourge that needs to be eliminated, but for businesses attempting to gain a foothold in new jurisdictions, it can arguably be the grease that oils the wheels of everyday commerce. Practices considered corrupt at home may be tolerated or even normal elsewhere, and business goes nowhere unless it plays ball in some jurisdictions.

Realities on the ground

The risk of falling foul of corrupt business practices abroad has become even more fraught with the UK authorities adopting a hardball approach through the twice-delayed UK Bribery Act. Under the Act, the offence of bribing a foreign official carries a potential 10-year prison sentence and unlimited fines for directors.

Teymur Huseynov, head of Eurasia forecasting at Exclusive Analysis, which forecasts commercial political risks worldwide, warns that the new legislation in its current form will affect companies’ ability to do business in some emerging markets.

“There are objective realities on the ground,” Huseynov tells Financial Director. “There will be almost zero possibilities to do business without greasing some poles. If the legislation is adopted in its current form, it will affect business.”

In Russia and, to a lesser extent, other former Soviet Bloc countries such as Georgia, Ukraine, Azerbaijan, Kazakhstan and Hungary, these realities can be found in specific manifestations of bribery in export/import operations, public utilities, tax collection, public contracts, loan applications and judicial decisions.

Often these realities will only become apparent once the commercial operation has got to the operational stage, rather than at the initial country-entry phase of starting a business overseas. And foreign companies also face serious bribery risk from regional officials who run competing business operations.

“It is easier for companies to be targeted once they have invested money into the country,” says Huseynov. “Those running a bribery operation have confidence that a company that has money tied to the country will be more willing to pay.”

Such is the case with Ikea. The Swedish furniture giant, one of Russia’s largest foreign investors, has invested about $4bn in Russia, opening 11 stores since 2000. However, the company’s chief executive told news agency Bloomberg in March that Ikea will not build any more stores outside the Moscow region until officials stop withholding permission for two outlets in the cities of Samara and Ufa.

Ikea initially placed a freeze on expansion in June 2009 “due to the unpredictability of the administrative processes in some regions”, specifically Samara. Its store in Samara had been ready to open for more than a year, yet local government officials allegedly created artificial obstacles such as a requirement that the mall be able to withstand near-hurricane force winds, even though there was no history of such weather conditions.

Bloomberg reported that Ikea’s Russia country manager, Per Kaufmann, told German paper Handelsblatt that a Samara official had suggested a particular local construction company could “quickly help” fix the alleged deficiencies.

“The problems relate to the close connections between political officials and the power of vested local business interests,” says Huseynov. He adds that the mayor of Samara owns a furniture retailer, while there are local government interests in the construction industry.

Huseynov’s advice to directors encountering this sort of activity is to take their grievance to the mainstream media.

“You have got to speak about it on radio or TV, and let mainstream business news air the facts,” he says. “There are companies that operate in Russia bribe-free. Those companies are the ones that engaged with this type of campaign.”

It’s who you know

Business in China is predominantly conducted through personal relationships, but bribery is no less endemic for that.

In 2009, there were almost 26,000 cases of corruption by officials, half related to bribery, filed in the Chinese courts that amounted to a total value of $254bn. Of the 26,000 suspects only eight were ranked at provincial level or above, meaning most corruption cases took place at local government level.

“The systemised nature of bribery makes it hard for companies to operate unless they engage in this activity,” says Rachel Shoemaker, Asia forecasting analyst at Exclusive Analysis.

Many of the bribes are kickbacks and gifts, or facilitation payments, made to intermediaries who distribute the payments in order to win licences and contracts. But using intermediaries on the ground that can use their local experience to deliver a competitive advantage should not be viewed as inherently criminal.

Doug Alliston, MD of CFO Services Asia and former group FD for Asia and the Middle East at Interior Serverices Croup, says the ability to leverage relationships is an inherent part of doing business in the region.

Alliston refers to the concept of ‘guanxi’, which describes the dynamic in personal networks of influence and is central to Chinese society, as an example.

“Chinese businessmen will hawk their guanxi. It is important to understand this,” he says. “It does not relate to government relationships; it relates to their whole network. They are open about their relationships and prepared to market that.”

What should western companies do when confronted by it? Alliston says that performing careful due diligence on the person selling guanxi is essential.

“In other regions, where you pay a commission, it is not guanxi. If you take on a commission-type arrangement, you need good legal advice on the ground,” he says. “It is not something you can ignore. It is something you can leverage.”

One of the reasons it is so important in China to know with whom you are doing business is that when someone is convicted of corruption – which occasionally carries capital punishment – the sentence is often delayed and the person may later re-emerge in a government position.

“You have to do more due diligence on counterparties and local parties on the ground,” says Shoemaker. “You can do business in China without bribes. You may find some selective discrimination, but the environment is not completely discriminatory.”