Sourcing in Emerging Markets

Emerging markets represent both opportunity and challenges for pharmaceutical companies. Risk management is an important component of any sourcing program, but with rising trade tensions and geopolitical uncertainty, managing supply lines and products in emerging markets has become even more challenging. What should be on your radar?

The macro factors: economic outlook

An overarching issue is global economic performance, including trade patterns. Global economic growth remains strong, but has passed its recent peak and faces escalating risks, including rising trade tensions and tightening financial conditions, according to the latest analysis (November 2018) by the Organisation for Economic Co-operation and Development (OECD), an intergovernmental economic organization with 36 member countries. Growth forecasts for next year (2019) have been revised down for most of the world’s major economies. Global gross domestic product (GDP) is now expected to expand by 3.5% in 2019, compared with the 3.7% forecast in the OCED’s May’s outlook and by 3.5% in 2020.

In many countries, unemployment is at record lows and labor shortages are beginning to emerge, but rising risks could undermine the projected soft landing from the slowdown, according to the OECD analysis. Trade growth and investment have been slackening on the back of tariff hikes. Higher interest rates and an appreciating US dollar have resulted in an outflow of capital from emerging economies and are weakening their currencies. The report says that monetary and fiscal stimulus is being withdrawn progressively in the OECD area.

The shakier outlook in 2019 reflects deteriorating prospects, principally in emerging markets, such as Turkey, Argentina, and Brazil while the further slowdown in 2020 is more a reflection of developments in advanced economies as slower trade and lower fiscal and monetary support take their toll, according to the report.

“Trade conflicts and political uncertainty are adding to the difficulties governments face in ensuring that economic growth remains strong, sustainable and inclusive,” said OECD Secretary-General Angel Gurría in commenting on the organization’s latest outlook. The OECD outlook says trade tensions are already harming global GDP and trade and estimates that if the US hikes tariffs on all Chinese goods to 25%, with retaliatory action being taken by China, world economic activity could be much weaker. By 2021, world GDP would be hit by 0.5%, by an estimated 0.8% in the US, and by 1% in China, estimates the OECD. Greater uncertainty would add to these negative effects and result in weaker investment around the world. The OECD outlook also shows that annual shipping-traffic growth at container ports, which represents around 80% of international merchandise trade, has fallen to below 3% from close to 6% in 2017.

Inside trade patterns

The report points out that amidst rising trade tensions, global trade volume growth (goods plus services) has slowed this year (2018), with particularly weak outcomes in the first half of the year. High frequency indicators, such as export orders and container-port traffic, suggest that the prospects for future trade growth remain modest. A series of new tariffs and retaliatory counter-measures have already come into effect this year, and there is a risk that more may be implemented next year, according to the OECD report. New restrictive trade policy measures have resulted in marked changes in trade flows and prices in some targeted sectors, particularly in the US and China, with some transactions being brought forward ahead of announced tariffs. Policy announcements are also affecting business sentiment and investment plans, especially in manufacturing, and have added to uncertainty, according to the report. Financial conditions have tightened this year, with rising long-term interest rates, particularly in the US, triggering repricing across many asset markets and significant turbulence in a few emerging-market economies. The associated shift in risk sentiment has contributed to sizeable currency depreciations against the US dollar in many emerging-market economies, especially ones with large and rising external imbalances. “An additional weakening of market sentiment towards emerging-market economies would cut their growth further and place renewed downward pressure on their currencies,” concludes the report.

Another macro factor relates to higher and more volatile oil prices over the past year, which have added to the challenges for oil-importing economies. Oil prices have been over 30% higher this year (as of mid-November 2018) than in 2017. The OECD report notes that production in the US and Russia has risen to record levels, but continued uncertainty about potential supply disruptions in some OPEC economies, particularly Venezuela and Iran (who collectively account for around 4% of global supply at present), and expectations that demand growth might slow are resulting in considerable price volatility. “The rise in prices over the past year is already having a mild negative effect on global growth and adding to inflation,” says the OECD report. “This could intensify if further supply disruptions materialize,” says the report.

Inside emerging markets

Growth prospects in the emerging-market and developing economies collectively appear steady over 2018-2020, says the report. GDP growth in China is projected to ease slowly to 6% by 2020. Infrastructure investment and credit growth have both moderated, the working-age population is declining, and trade tensions are likely to slow export growth. Recent policy measures have improved financial conditions, and scope remains to expand fiscal support if required, but this could delay the necessary deleveraging of the corporate sector and aggravate risks to financial stability, says the OECD report. 

Strong domestic demand growth in India, boosted by new infrastructure programs and recent structural reforms, is projected to keep GDP growth close to 7.5% in 2019 and 2020. Growth in Brazil is projected to strengthen gradually to between 2% to 2.5% in 2019-20, with lower inflation and improving labor markets supporting private consumption. “Political uncertainty remains high, but restarting reforms, particularly the pension reform, would help to improve confidence,” concludes the report.

Overall global trade growth is projected to remain moderate, easing from around 4% in 2018 to 3.75% in 2019 and 2020, on the assumption that trade tensions do not worsen. At this pace, trade intensity would remain mild by pre-crisis standards, but would be broadly in line with the average pace achieved over 2012-2017, according to the report. Trade growth is projected to slow relatively sharply in China and other Asian economies, in part reflecting the likely impact of the tariff measures included in the projections and the potential disruption to regional supply chains. A further intensification of trade restrictions between the US and China in 2019, or in other countries, could reduce global trade substantially further by 2020.

In the major economies, the number of new trade restrictive measures has risen in 2017-18 on balance, with a substantially broader coverage than in 2016-17. In particular, a significant number of new measures have been taken by the US and China on their bilateral trade, with a risk that these continue to intensify in the coming months, according to the report. An initial set of new tariffs were imposed by the US on imports of solar panels and washing machines (February 2018) and steel and aluminum (March 2018), with the latter having some exemptions. Imports of these goods into the US were worth around $60 billion in 2017. Retaliatory tariffs have been imposed by some countries affected by the steel and aluminum tariffs.

The US has subsequently imposed additional tariffs on a range of imported goods from China. Tariffs of 25% were imposed on $50 billion of imports in July (2018) and August (2018), and a 10% tariff was imposed in September (2018) on another $200 billion of imports, with the latter rate potentially rising to 25% from January 2019. The baseline projections here incorporate the 10% tariff from September, but assume that the increase scheduled for next January is not implemented. There is also a risk of tariffs up to 25% being imposed on the remainder of US merchandise imports from China (worth around $260 billion in 2017). This would increase tariffs on a broad range of consumer goods as well as the intermediate goods that were the primary focus of the tariffs introduced this year, according to the OECD report. In turn, China has announced a set of higher tariffs on $110 billion of imports from the US, but has offset this in part by lowering tariffs on imports from other countries. Additional US measures could result in China either raising the tariff rates further on these categories of imports from the US or imposing additional tariffs of up to 25% on the remainder of Chinese merchandise imports from the US (worth around $40 billion in 2017), according to the OECD report. The European Union, Japan, and many other economies in regional supply chains, including commodity exporters, are also affected by these bilateral tariffs and the associated trade diversion effects, especially if additional tariffs were to be imposed on imports of cars, trucks and auto parts, notes the OCED report.

The report also shows that growth in China has eased over the course of 2018 amid tighter rules on what it terms as “shadow bank” financial intermediaries outside the formal banking sector, a more rigorous approval process for local government investment and new US tariffs on Chinese imports. “Stimulus measures and easier financial conditions by the central bank may help to bolster slowing growth and help engineer a soft landing, but could also aggravate risks to financial stability,” says the OECD outlook. “A much sharper slowdown in Chinese growth would damage global growth significantly, particularly if it were to hit financial market confidence,” says the report.

Looking ahead

With very low interest rates in many countries, particularly in the euro area, and historically high debt-to-GDP levels (both public and private), flexibility for policymakers in the case of a more marked global downturn is limited. The report says it is important to maintain the capacity for tax and spending policies to stimulate demand if growth weakens sharply.

“There are few indications at present that the slowdown will be more severe than projected,” said Laurence Boone, OECD Chief Economist, in commenting on the association’s recent report. “But the risks are high enough to raise the alarm and prepare for any storms ahead. Cooperation on fiscal policy at the global and euro level will be needed.”

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