The Lens: From London to Lesotho, a tough week for corporate strategy

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In this week’s edition, our analysts provide our view on the UK political deadlock, Brazil’s growth forecast, and NAFTA 2.0.

The Lens: April 4, 2019

UK political deadlock has increased chances of No-Deal Brexit

• The UK Parliament again failed to achieve a simple majority on any option that could break the gridlock over Brexit.
• After years of Brexit negotiations, the Conservative party finally tried to engage with the Labour leadership to generate consensus on an approach that would prevent a no-deal Brexit, but this approach has also not worked.
• Amid Brexit uncertainty, UK manufacturing output as well as business and consumer confidence continued to slide in March.

Our view

FrontierView has raised the likelihood for no-deal Brexit, a variant of our ‘Hard Brexit’ scenario, to 25%. The April 12 deadline is fast approaching, and there are Brexiters who would prefer a no-deal Brexit to a long extension that could lead to a second referendum. We still believe a long extension and/or a transitional deal remains the most likely outcome, as there is broad political and public awareness of the massive costs of a no-deal Brexit.

Business implications

Multinational companies should continue to execute on their contingency plans until the UK government legally rules out no-deal Brexit and reaches an agreement on the withdrawal terms with the EU. As part of their contingency plans, firms need to calibrate their supply chains, sufficiently stockpile their factories, and communicate the operational impact of Brexit to their clients, partners and employees to safeguard their businesses from the adverse implications of no-deal Brexit.

Turkey supports currency in lead-up to local elections

• After a few months of stability, intense Turkish lira volatility returned in late March.
• The most likely driver was local residents panic-buying US dollars ahead of elections, though there are also geopolitical concerns stemming from Turkey’s potential acquisition of a Russian missile system.
• To prop up the currency, the central bank spent large quantities of reserves and took controversial steps to prevent off-shore trading in Turkish lira.
• In last weekend’s local elections, Turkish President Recep Tayyip Erdoğan’s Justice and Development Party (AKP) had a poor showing. The AKP and its coalition partner won a narrow majority with 51.67% of the total vote. However, they lost in the critical cities of Ankara and Istanbul.

Our view

Local elections have little impact on economic policy, and the next national election is not until 2023. But the Government needs to implement serious macroeconomic reforms to regain exchange rate and inflation stability. When the Government announces its new economic plan on April 8th, we expect the government to announce spending cuts. We also expect the central bank to maintain tight credit conditions. Both of these moves will hurt domestic activity, and we expect Turkey will remain in recession in 2019.

Business implications

Multinational corporations across industries will see contracting demand as Turkey remains in recession in 2019. Managing eroding margins and receivables risk will need to remain a key priority. The competitive landscape will shift as strategies and investment propensity diverges across firms based on their risk appetite and long term commitment to Turkey.

Zeynep Kosereisoglu, Director for the Middle East and Africa

FrontierView clients: See our more recent Istanbul Executive Breakfast for further insights

Brazil growth forecasts lowered after weak start to 2019

• We revised down Brazil’s growth for 2019 following contractions in manufacturing output in December and January.
• Retails sales underperformed in the second half of 2018, leading to rising inventory builds. Local industry responded by scaling back production.
• Weaker production has spilled over, and reduced the outlook for job creation and new investments in capital equipment.
• Concerns that pension reform will stall has kept down confidence.

Our view

We expect Brazil to rebound from early weakness. The downward forecast revision reflects the impact of the early adjustment by local manufacturers in late 2018 and early 2019. Lingering questions around pension reform, which is now being debated in the lower house of Congress, will hold back confidence during the first half of the year. But we expect pension reform will pass in the third quarter of 2019.

Business implications

The overall adjustment seen in the industrial sector and the impact on the labor market outlook, in addition to short-term purchases of capital equipment, will reduce realized customer demand in the market during the first half of 2019. But with pension reform still expected for the third quarter of 2019, companies should see a stronger acceleration of market growth.

Alec Lee, Practice Leader, Senior Brazil analyst

FrontierView clients: See our Brazil Quarterly Market Review for further insights

Time is running out for the USMCA

• The new North America Free Trade Agreement (NAFTA) deal, officially called the United States-Mexico-Canada Agreement (USMCA), was signed by the presidents of the US, Canada, and Mexico back in 2018. However, the deal has not been ratified by any of the legislatures.
• Neither Canada nor Mexico are likely to ratify the USMCA until the US-imposed steel and aluminum tariffs are lifted. However, Trump recently told a senior senator that he doesn’t plan to lift those tariffs in exchange for USMCA ratification.
• In the US, the Democrat-controlled House has a strong incentive to deny President Donald Trump a symbolic victory ahead of the 2020 US presidential elections. Though the election is more than a year out, Democratic presidential candidates have already begun the campaign season.
• In response to the USMCA being stalled in Congress, Trump may follow up with his threat to pull out of NAFTA. This would drive significant investment uncertainty prior to the 2020 presidential election and lead to a legal battle over presidential authority.

Our view

In the US, the USMCA is unlikely to pass until after the 2020 US presidential election. Democrats have almost no incentive to pass the deal, and many reasons to deny Trump a victory on trade. But Trump remains unlikely to pull out of NAFTA. He is keenly aware of the need to maintain a strong economy in the lead-up to the 2020 election. The most likely outcome is that we remain in the original NAFTA regime for the foreseeable future.

Business implications

The risk of a ‘NAFTA Exit’ continues to feature in our Events-to-Watch for 2019 due to the broad ramifications for North American supply chains. Trump is unpredictable, and has broad executive authority to complicate business operations in the short-term. Even Trump’s threats have led to periods of intense exchange rate volatility. Businesses should continue to implement strategies to mitigate the impact of exchange rate volatility for operations and maintain contingency plans in case Trump decides to pursue a NAFTA exit.

Ryan Connelly, Senior Analyst for Global Economics and Scenarios

FrontierView clients: See our Mexico City Breakfast Presentation for our most recent 2019 NAFTA scenarios updates

Cyclone Idai damages supply chains, ports, and electrical grids across Southern Africa

• The UN estimates infrastructure damage from Cyclone Idai at US$ 1 billion, including destruction of the critical port of Beira, and damage to roads and bridges in Mozambique, Malawi, and Zimbabwe.
• Electrical transmission lines between South Africa and Mozambique have been affected, worsening electrical outages that have been plaguing South Africa since February.
• About 500,000 hectares of crops were destroyed due to severe flooding, which has forced many to evacuate to overcrowded areas. There are cholera outbreaks and food supply shortages in impacted areas and evacuation zones.

Our view

Economic growth across the region will suffer due to lower exports and weaker private sector activity. Food prices will likely spike due to crop damage, reducing consumer spending power. Electrical blackouts in South Africa will persist, weighing on an economy that has just recovered from a recession.

Business implications

Distributors in markets reliant on the port of Beira will need to need to make alternative logistics arrangements. These include pushing up transport costs, or face running down inventories. Companies operating in Sub-Saharan Africa need to prepare for continued power outages and decreased demand due to the fall in consumer spending.

William Attwell, Practice Leader Sub-Saharan Africa

FrontierView clients: See our more recent SSA Regional Outlook for further insights