First Quarter 2010

Eurasia Group Global Trends Quarterly

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Executive Summary
In collaboration with PricewaterhouseCoopers, Eurasia Group is monitoring and assessing major trends shaping the global business environment. This document summarizes the findings of four white papers. The extraordinary breadth and depth of the current worldwide economic turmoil and its gradual stabilization create new uncertainties in international and local political environments. Now, more than ever, it is crucial to understand emerging global trends.

Dollar Dynamics Economic Downturn Resource Nationalism New Capital Routes

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FIrst Quarter 2010

Is the Dollar Going Down?

Key points
The US dollar has depreciated by more than 12% since March 2009 against a basket of major trading partners currencies. However, we are not at the beginning of a dollar in decline story but rather are well into it. The dollar has fallen significantly over the past four decades. The US dollar will remain weak against currencies whose values are determined by the market, such as the eurozone and Japan, and may eventually even weaken against countries that continue to depress the value of their currencies, such as China. Such policies may, however, change abruptly. The USs trading partners are not coordinating their currency policies; each major economy is targeting its economic policies toward promotion of its own political interests. Idiosyncratic political interests are naturally a concern for economic actors, given implications for commodities, currency volatility, and the shifting costs of doing business across the globe.

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Business implications
Growth in new consumer markets: Consumer markets for US goods will expand in places where the local currency has strengthened against the dollar. Moreover, with declining US consumption, governments that had looked to the US as the consumer of last resort will increasingly look to generate domestic demand. Higher consumption in these economies could offer opportunities for US exporters. The firms that best anticipate the needs and wants of these new consumers will gain the most from these countries adjustment policies. China and India represent the largest prizes, but their relative openness remains unpredictable. Although a smaller population, Japanese consumers may also offer significant opportunities given their stronger purchasing power. Currency volatility and unpredictability: In countries that try to hold back the tide against the dollars decline, heightened currency market activity is likely as traders push back. This will show up as both short-term volatility and longer-term unpredictability about where markets will be over the course of any given time horizon. Consequently, paying attention to currency politics and trends will remain very important. Monitoring the continued availability of financial hedging strategies will also be important as the financial regulatory system is overhauled.

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Grappling with the dollars decline
Currency management Brazil China Eurozone India Japan Russia
Source: Eurasia Group

Policy responses to the weak US dollar Government Will reduce tax burden; Will offer better financing conditions Export subsidies; Promoting domestic consumption None None None Tax breaks for exporters Companies Focus on domestic market; Efficiency improvements Increased selling in domestic market Direct investment in the US None Shifting production abroad Efficiency improvements

Managed float De facto peg to US dollar Free float Managed float Free float Managed float

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FIrst Quarter 2010

glob Political Risks Challenge Economic Recovery

Key points
As 2010 begins, the global economy is showing tentative signs of recovery, with the IMF forecasting global growth of 3.1% for the year. However, while economic conditions may be improving, some of the most serious political challenges could lie ahead. Rising deficits are increasingly a significant problem for some governments and may become unsustainable in some cases, especially in western Europe. As the downturn continues, it is exacerbating the fiscal situation in a number of European countries and undermining Europes ability to coordinate policy. There are risks for countries both in the eurozone and those still in the accession process. Interestingly, eastern European countries are actually better positioned to access sovereign support in the event of a financing crisis than are current eurozone members. By contrast, across much of Asia and Latin America, governments entered the crisis with relatively healthy finances. Chinas low budget deficit, high savings, and strong financial position supplied it with more-than sufficient resources with which to counter the downturn. Brazils relatively limited macroeconomic vulnerabilities have helped the country navigate the global downturn comparatively well.

Business implications
Deficit levels risks and opportunities: Significant stimulus spending for 2010 will face sustainability constraints, particularly in the form of rising deficits. As countries meet their spending shortfalls they may turn to higher taxes or look to privatizations, which pose risks and opportunities respectively. Companies should look to historical precedent and legislative agendas to anticipate how countries are going to respond to more acute deficits.

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2010 Fiscal policy and maneuverability outlook

2009 Downturn economic impact Europe China India Indonesia Russia Brazil
Legend: Very negative Source: Eurasia Group

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Elections signal sustained spending: Governments preparing for elections in 2010 are unlikely to reduce stimulus spending. The political risk of curtailing it is simply too high for governments to undertake cuts ahead of elections. Conversely, some countries prohibit new government spending initiatives within six months of elections, so it could remain at pre-planned levels until the completion of elections. Companies would do well to monitor election schedules in order to anticipate sustained stimulus spending, as well as to gain a sense of when spending may be capped.

2010 Fiscal policy trend Tough fiscal situations compounded by complex political debates Stimulus spending will mean a slight deficit, but a growth lull could drain more resources than expected Expansionary fiscal policy, although facing spending constraints

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Negative Minimal

Fiscal maneuverability if needed, but overwhelming approach is conservative Relatively conservative fiscal approach, with sufficient maneuverability Fiscal policy will remain expansionary

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Working with Rising Resource Nationalismglob

Key points
Resource nationalism has been building steam in recent years. In many of the countries that have chosen to pursue resource nationalism, most of the labor, financial, and technological resources that are devoted to the energy sector are brought to bear through large national oil companies. For some countries, this model has worked. Notably, each of these countries companies is more and more noted for technological sophistication, particularly in deepwater production. For other countries, the model has been less successful. If successfully implemented, resource nationalism can help create a positive political legacy for governments. However, if they lack the capacity to continue to develop their domestic potential post-nationalization, political support can quickly falter. Other governments with more autocratic structures do not face significant domestic political risks in pursuing resource nationalist policies. These governments are perhaps most vulnerable if mismanagement of the oil and gas sector leads to revenue losses for prominent elites.

Business implications
Understanding host country leverage: The above analysis shows that some governments are better positioned than others to sustain state-centric policies guiding foreign investment in their domestic energy sectors. Some elements of resource nationalism are cyclical such as the popularity and political capital of elected governments and fiscal stabilitywhile others are more structural. The latter would include the scale of hydrocarbons potential, legacy aspects of resource nationalism embedded in political culture, and to some extent, industry costs. Industry costs can also be cyclical and fluctuate according to technological breakthroughs. Breakthroughs in deepwater drilling, for example, have unlocked the potential for the Brazilian pre-salt. It is crucial for foreign investors to understand which factors drive government resource nationalism and to structure their response (exiting, waiting, renegotiating, finding a partner, etc.) accordingly. Limitations on government response: Recent cases suggest that foreign investors face significant challenges when, after encountering resource nationalism, they turn to their home governments for diplomatic assistance. Companies should be prepared to rely on their own capabilities for managing resource nationalism, most importantly through pre-transaction planning, risk management, and partner selection.

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Credit default swap spreadsSovereign debt major oil producers

3,500

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Venezeula Saudi Arabia Russia Mexico Kazakhstan Brazil

3,000

Millions of dollars

2,500

2,000

1,500

1,000

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1 7/3 /20 08 08 08 008 008 08 09 09 09 09 09 09 09 09 09 09 09 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /2 /2 /20 /20 /29 9/30 0/31 1/30 2/31 1/31 2/28 3/31 4/30 5/31 6/30 7/31 8/31 9/30 0/31 1/30 8 1 1 1 1 1

500

Source: Bloomberg

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First Quarter 2010

glob New Paths for Capital: Emerging Markets Flows

Key points
While emerging market (EM) economies traditionally have been a destination for financial flows, years of manufacturing and commodity export-led growth is increasingly turning key states, such as China, the Persian Gulf states, and India from importers into exporters of capital. Capital flows between EM nations have expanded rapidly in recent years, a trend that is likely to accelerate. In doing so, it will radically reshape global capital markets and the business opportunities and risks associated with EM nations. Four factors will primarily drive capital transactions between developing countries: New capital increasingly originates in EM countries; EM nations continue to offer investors attractive rates of return compared to developed markets; EM nations have strengthened their financial markets infrastructure and grown more sophisticated; and as a whole, large EM nations are waking up to their newly-found economic power and using it to further their political interests. competition. Most of this competition will probably come from companies within the region, such as occurred when local airlines in South America (Chiles LAN and Brazils Gol) undercut efforts by US-based airlines to boost their business in the region. Western entities must increasingly establish regional presences in order to effectively compete with EM firms, and must devote resources and time to understanding how to operate in different cultural, social, and political environments. As a case in point, marketing to retail clients in India could be easier for an Indian or South Asian bank than for a Western institution.

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Business implications
EM corporations and financial services firms will have a significant competitive edge in their own regions: As more EM corporations seek investments abroad, corporations from developed countries will face greater

Geographical distribution of the 50 largest banks by market capitalization

2006
8% 3% 3% 9% 2% 4% 23% 16% 4% 6% 9%

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2009
13%

EMs still look to developed countries: EM countries will continue to want and need to interact with developed states; some will be probably continue to welcome access. Brazil, India, and South Africa will be more important destinations for both developed and developing world capital. Other states, such as Singapore (which is trying to develop as a financial center), will welcome Western participation and cooperation. Some EM countries, especially those that are importers of capital, such as those in eastern Europe, will be increasingly tied to US/EU capital flows, given their political orientation.

Source: Financial Times Global 500

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US Japan OECD Europe Other OECD BRICs Other emerging markets

Photo credits: Reuters This material was produced by Eurasia Group in collaboration with PricewaterhouseCoopers.This is intended as general background research and is not intended to constitute advice on any particular commercial investment, trade matter, or issue and should not be relied upon for such purposes. It is not to be made available to any person other than the recipient. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic or otherwise, without the prior consent of Eurasia Group. 2010 Eurasia Group
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