Sustainable development: twin engines of growth

3 Apr 13
Sustainable development often hinges on the strength of the private sector in emerging economies. With the right investment conditions leading to poverty alleviation and job creation, two key success stories are the examples of Brazil and Russia, both of which have proved rare beacons of growth in a fragile global economy, says Alexis Karklins-Marchay

By Alexis Karklins-Marchay | 3 April 2013

Sustainable development often hinges on the strength of the private sector in emerging economies. With the right investment conditions leading to poverty alleviation and job creation, two key success stories are the examples of Brazil and Russia, both of which have proved rare beacons of growth in a fragile global economy, says Alexis Karklins-Marchay

Brazil and Russia. Forming half of the famed “BRIC” economies, their rapid growth and future potential has long been established. Expanding middle classes, natural resources and continued industrialization and urbanization are just some of the factors that have sheltered them from the worst of the global financial crisis. But how do foreign investors view these countries? Will they continue to attract investment into the future?

Ernst & Young has recently investigated the foreign direct investment (FDI) performance of both Russia and Brazil. These attractiveness surveys — which used a two-step methodology that analyzed both the reality and perception of FDI — found that despite the global economic uncertainty, investors continue to remain positive about the attractiveness of both countries as investment destinations. Challenges remain, however, and policy-makers will need to redouble their efforts in order to safeguard continued development.

Russia, for example, has seen a 50% increase in FDI project numbers over the last decade, with 83 in 2002 increasing to 128 in 2012. Russia also remains in the top 10 investment destinations in Europe coming in seventh place and is the premier destination for investment in Central and Eastern Europe. Our report included a survey of more than 200 global executives on their views about how and where global investment will take place in the next 10 years. Although concerns remain around bureaucracy and infrastructure, a large majority of investors believe that Russia has made a step forward in closing the gap with other rapid-growth markets. The country’s attractiveness has grown by eight percentage points over 2011, the largest increase of any region.<%$Image: ext-gen1301 61 0 /EasySiteWeb/EasySite/SupportFiles/ExtJS/4/resources/themes/images/default/s.gif 0 0 0 false false false false%>

Brazil, too, is a priority for foreign investors. From a country with bleak economic prospects in the 1970s, it has become a formidable force thanks to its stable economy, a burgeoning domestic market and huge untapped reserves of natural resources. Despite the unsettled world economic outlook, Brazil saw a record number of FDI projects in 2011, establishing it as the second most popular global destination in terms of FDI value, and fifth in terms of number of projects. The value and number of inward investment projects to Brazil has tripled since 2007 from US$19b to US$63b and from 165 in 2007 to 507 last year respectively.

We also spoke to 250 global executives to gather their views on Brazil as a potential place to do business both now and in the future, and 78% of respondents rated the country as the most attractive location for future FDI in Latin America. In addition, 83% believed that Brazil’s attractiveness as an investment location will improve over the next three years in comparison to just 38% who believed that Europe’s attractiveness will improve over the same period.

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Where has the investment come from?

Both Russia and Brazil have succeeded in attracting investment from countries near and far. The US remains Russia’s primary investor with 122 FDI projects between 2007 and 2011 (16% of the total), but 8 of the top 10 source countries are from Europe. European countries established 343 FDI projects in Russia from 2007 to 2011, 44% of the total. Following Russia’s recent accession to the WTO, the Russian economy should push toward attracting a larger share of investment from its leading source regions such as the US and Europe. FDI into Russia from emerging countries remained low between 2007 and 2011, however. India and China each accounted for less than 2% of FDI projects and Brazil originated just two projects in the same period.

Brazil, meanwhile, continued to be a huge recipient of investment from the US (up 43% to 149), value (US$12.4b) and jobs created (35,195). This is largely explained by the geographic proximity and the development of trade agreements between the two countries. The UK jumped from being the fifth-largest investor in Brazil in 2010 to second in 2011 by project numbers with 45, and the total value of UK investment was nearly on a par with the US at US$12.2b. Although UK companies have been present in Brazil for many years, they are now looking to expand their investment across a wider array of sectors, including business services, manufacturing, mining and metals and ICT.

And China has emerged as the fifth-largest investor in Brazil in terms of value of FDI with investment increasing six-fold since 2010 and a 70% increase in project numbers. The recent boom in the Brazilian consumer market has also led to an increase in investments by small and medium-sized Chinese companies in the country’s manufacturing sector. In the future, Chinese investment is expected to be directed at the areas of technology, logistics and infrastructure. The overall momentum across all sectors is also expected to increase as a result of a joint communiqué signed in 2011 to promote cooperation in trade and investment.


Boosting growth

It would be mistaken to assume that these positive results mean there is no scope for improvement. On the contrary, meeting the future needs of investors will require substantial changes to take place in both countries. Russia offers investors a high-growth economy, a large domestic market and highly skilled labor at moderate cost, but its enduring reputation for difficult business conditions deters investors. Doing business there is fraught with challenges associated with corruption, government bureaucracy, complex regulatory requirements and a lack of transparency. Some 53% of investors cited improving the effectiveness of the rule of law as a key way to Russia’s investment appeal. Alsopopular was reducing bureaucracy (47%) and improving the transparency of business regulations (37%).

Overdependence on the oil and gas sector is another key challenge that the Russian economy faces today. As a result of this focus on oil and gas, there is a large mismatch in Russia between the attention that other strategic industries receive from investors and their real potential. Among the most attractive sectors, investors highlight ICT (20%), agriculture (13%), consumer goods (13%) and transport and automotive (11%) as the keys for growth in the next couple of years.

The steady growth of Brazil, on the other hand, has amplified the requirement for a qualified and productive workforce. There is now a shortage of skilled labor, which has meant that there is now a higher labor cost in the country compared with other rapid-growth markets. Nearly a third of our survey respondents, when asked how Brazil could improve its attractiveness, highlighted

the development of education and skills. On the regulatory side, they also expressed concerns about rigid Brazilian labor regulations.

Other improvements that would enhance the attractiveness of Brazil include investment in major infrastructure and urban projects, which was cited by 29% of respondents, closely followed by incentives to lower corruption (24%), an improvement in urban security (23%) and a more transparent tax system (17%). Brazil’s high corporate tax rate of 34% was also cited as unattractive especially when compared with rates in other Latin American countries, such as Chile (18.5%) and Mexico (30%).


But a positive outlook remains

Increasing global competition, not to mention the fragile global economy, means that securing sustainable growth won’t be easy. But despite their respective challenges, there is little doubt that Russia and Brazil are both well placed for continued expansion. In addition to the advantages of their natural resources and fast-growing middle classes, both countries will host a FIFA World Cup and Olympic Games in the near future. These events will deliver a significant infrastructure boost as well as offering a tremendous opportunity to showcase their respective strengths to a global audience.

But with Brazil having even seen a decline in FDI value in the first half of this year, this is no time for complacency. While the long-term fundamentals are secure, it is now up to policy-makers in both countries to respond quickly and effectively to any concerns of global investors and entrepreneurs. If they do so, their rapid growth of recent years will continue long into the future.

Read more at www.ey.com/attractiveness

Alexis Karklins-Marchay is Co-Leader of the Emerging Markets Center at Ernst & Young.

This article first appeared in the Devember edition of  Ernst & Young's Dynamics magazine

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