Eurozone and the global economy: Place your bets

Finally…positive news from the Eurozone

With GDP growth of 0.3% in the quarter to June 2013, the Eurozone has finally emerged from  recession. The outlook remains challenging however, with GDP likely to fall, despite the positive second quarter, by 0.5% in 2013 overall and to grow by only 1% in 2014 according to the EY/Oxford Economics September 2013 Eurozone forecast.

Time to invest in the Eurozone?

So how should business respond to this first sign of improvement in the Eurozone? Is now the time to look to increase exposure to the currency zone?

The situation reminds me of a recent conversation I had with an American auto industry executive. He described the relocation  of manufacturing activity  from Northern to Southern Europe by his competitors as the “least bad option available” – hardly a ringing endorsement. He was saying that while business recognises the potential value of the European market, change is happening too slowly and only in certain markets, and so businesses are making the best of the situation, but much more structural economic reform is required.

The same logic applies when we place Europe in a global context. The Eurozone economy is improving slightly at a time when the growth prospects for previously fast growing markets are weakening. In recent weeks, the challenges facing emerging markets in particular have become clear with and world GDP is now likely to grow at a little over 2% in 2013 according to Oxford Economics. Set against this, Eurozone growth of 1.5% by 2015 looks relatively less weak than it previously did. Recent outbreaks of political and social tensions in some emerging markets in recent months have further increased Europe’s relative attraction, but enthusiasm should be tempered: Europe is gaining from declines elsewhere rather than as a result of major steps forward in the Eurozone.

Businesses should now be re-evaluating their geographic portfolios. Many corporate strategies reflect assumptions formed in 2005 to 2008 when emerging markets were growing at what, is now clear, were unsustainable rates. The world is now a more uncertain and volatile place and business leaders now have to make their capital allocation decisions on the basis of their assessment of the ability of national governments to implement economic reform.

The restructuring challenges in the Eurozone are clear, but we can also see reform agendas across the globe such as China trying to rebalance its economy towards more consumption, India, Brazil and Russia all looking to restructure key elements of their economies and Japan embarking on a radical reform agenda. The list goes on and the question for business is clear: where should we allocate resource in a changing environment that will be shaped as much by politics as by economic reform?

A framework for decision making

In comparing opportunities in the Eurozone to those elsewhere, a business must evaluate what it wants to do (sell, create, innovate) across its operating matrix (sector, segment and geography) against its view of how economic reform will change its markets. As an example, we can consider the issues that are relevant when assessing the impact of the changes ongoing in China.

China is transforming its economy from one dominated by exports to an economy with more balance between domestic consumption, business investment and trade. The earliest sign of change is a reduction in the rate of GDP growth from the 9-10% we have become accustomed to each year to something in the range of 7-8% growth. This will clearly have implications for suppliers to China, commodity providers in the first instance will see a reduction in demand. Over time, as consumer wealth grows so there will be increased opportunities for consumer goods companies. However, to date western brands have been more successful at the high income end of the market in China than in lower income bands and so it will be important to assess the scope for profitable market entry in other segments.

Then business needs to understand the knock on effects. Germany is currently a major exporter to China. As China changes, what will this mean for Germany? If Germany is unable to maintain its export performance as China’s import demand shifts from industrial to consumer goods, will this lead to reduced  spending in  the German domestic economy? It could mean a fall in demand but it might also spur faster reform in areas in Germany, such  as the services sector, which could boost GDP dramatically in both Germany and other European markets.

Companies should therefore be evaluating how economic changes will impact:

– Demand: Manufacturing, Utilities and Communications are expected to lead the growth in the Eurozone, especially in the North, overall consumer spending will recover relatively sluggishly;

– Supply:  improvements in productivity in Southern Europeare are starting to emerge but much more remains to be done but over time, the South of Europe may become increasingly attractive as a production base, more work is needed on services liberalisation across the Eurozone however; and

– Finally what the changes mean for the most appropriate business model. Should the portfolio be rebalanced to reflect shifting supply and demand conditions? Is the cost base fit for purpose? Is the business flexible enough  to respond to change in an uncertain world? Is now the time to look to divest non-core activities or is it time to look to acquire to consolidate and drive synergies or to add new capabilities?

The long wait is ending

Sitting and waiting has been a sensible approach in recent times for business in respect of the Eurozone. The world is changing and positive engagement is now required to identify the appropriate strategy for the coming years.

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