Exporting from the UK to emerging markets: Rewards and challenges
Currencies Direct March 24th 2017 - 5 minute read
What do the statistics show?
The UK currently carries out most of its export trade with developed markets. The largest market is the US, followed by a series of EU countries – the largest of which are Germany, France, Ireland and the Netherlands.
Although these are large markets, they are growing only slowly and so offer fewer opportunities to companies seeking export growth. The benefits of trading in developed markets are derived from their greater economic stability, leading to more certainty in currency rates and liquidity.
More adventurous companies can find better opportunities in emerging (sometimes called “developing”) markets, as becomes clear from the following data (CBI Global Futures Factsheet):
As the terms “emerging markets” and “developing markets” suggest, not only are these markets growing in economic significance, but they are also developing in terms of their commercial maturity, stability and strength of legal governance, meaning risks are very relevant. Based on export data, four countries already have a growing UK export presence: Indonesia, Mexico, Brazil, and Turkey.
UK exporter – things to consider
If your company is exporting to emerging markets, what are the things you should watch our for?
On a general level, there are four main categories of financial risk which are relevant when you’re considering exporting to emerging markets:
- Currency risk – This is when the currency rate that you achieve when returning your profits to your domestic currency deviates materially from your expectations, causing you to receive a lower amount than you expected. Currency risk is much greater in Emerging Markets due to the volatile nature of the currencies.
- Credit risk – This is the risk that your customers cannot pay you because their own business suffers loss or loses liquidity. Although this is always a risk in any trade, it can be more pronounced in developing economies, which can suffer from greater uncertainty and more sudden shocks.
- Liquidity risk – In some circumstances, the extreme currency deviations or major political events in a country may make it impossible to translate earnings out of a currency. This can be either for a restricted period, which can affect the liquidity and cash management plans of a company, or can last longer (as described below).
- Repatriation risk – occurs when a liquidity problem with a currency persists for more than a few days or weeks. In some situations, this can turn into a long-term problem if foreign exchange controls are introduced. Over time, this can result in profits becoming permanently inaccessible.
Indonesia is the largest economy in Southeast Asia, and has become the second fastest growing G-20 economy (just behind China). Its total imports amount to $184 billion.
Economic outlook – Its previously strong economic growth stuttered in the last couple of quarters. Forecasts, however, suggest a strong recovery in the last quarter of 2015, continuing into 2016.
Major import sectors – Indonesia is a large exporter of natural resources, including petro-chemicals and commodities. Its imports are based around fuel, machinery, chemicals and foodstuffs – making it a potentially attractive export target for engineering companies, in particular vehicle manufacturers.
Risk view – The major risk is the exchange rate. There are ongoing fluctuations in inflation, and Indonesia’s balance of payments continues to be volatile. These two factors make the exchange rate very unsettled.
Mexico is the largest North American car producer, ahead of both the US and Canada. Spectacular growth over recent years has led to predictions that it will be the world’s seventh largest economy by 2050. Its total imports amount to $400 billion.
Economic outlook – Mexico’s economy is growing, driven in part by the increase in exports to the US. Economic reforms have also boosted economic confidence.
Major import sectors – Mexico imports mainly machinery and engineering equipment, as well as oil and plastics.
Risk view – Mexico offers what appears to be a relatively low-risk investment scenario. This is supported by the close economic links it enjoys with the US. Rate, or other, risks would increase if the US economy falters or if there is a period of Mexican political instability.
The UK has a close trading relationship with Brazil; the UK is Brazil’s fourth-largest investor. In recent years, there has been a phenomenal growth in UK exports to Brazil, peaking at an annual growth rate of 23% in 2010. Brazil’s total imports amount to $238 billion.
Economic outlook – Brazil’s long period of economic growth started to slow during 2015. Some commentators do, however, expect that growth will pick up again on the back of increasing exports, which have been helped by the depreciation of the Brazil’s currency, the Real. However Brazil still faces many headwinds, one of which is the low level of investment, which is driven by the low domestic saving rate, which is in turn driven by political uncertainty and a lack of confidence in financial governance.
Major import sectors – Brazil’s imports are concentrated on machinery, engineering and electrical equipment.
Risk view – Brazil presents a huge opportunity to exporters. Along with this opportunity, however, potential exporters to Brazil should be aware of the risk that, as the government continues to encourage exports, the exchange rate may move against companies which import to the country.
In addition with unemployment, inflation, interest rates, and debt levels shooting higher and economic growth dipping into negative territory while consumer confidence remains weak, Brazil remains on fragile ground.
The Turkish Government has been progressively relaxing its controls over the last few years, with the result of an aggressively growing economy. Although the UK accounts for only 2% of Turkey’s imports, there has been steady growth in the absolute amount exported from the UK. Turkey’s total imports amount to $242 billion.
Economic outlook – Although Turkey has had a good run of growth, 2015 has been relatively disappointing. This has been mainly due to ongoing domestic political uncertainty. There are predictions of a continued recovery over the next two years, but this remains uncertain given Turkey’s geographical location and relatively high inflation.
Major import sectors – Turkey is a major importer of oil and machinery. Unlike the other countries surveyed here, its major import growth areas are in precious metals and foodstuffs.
Risk view – Currency volatility is the most significant risk at the moment, thanks to the impact of a global slowdown. Regional political challenges also loom on the horizon, raising the spectre of other major risks in the coming years.
Whatever your exposures are, start by taking a global view of financial risk across your firm’s operations. You can’t avoid risk completely, but using the right combination of approaches and instruments can produce a result which is both targeted and appropriate to the level of certainty for your firm’s business.
Currency hedging is an essential tool in managing risks in emerging markets.
To find out more about different approaches to risk and ways to manage them contact a member of our corporate team to talk about our hedging services.