Canadian Deals: Emerging Markets and Global Risk

Strategy Talks

Podcast Series

Canadian Deals:
Emerging Markets
& Global Risk

Vanessa Iarocci
DJ Peterson

Episode 36: Canadian Deals: Emerging Markets & Global Risk

Release date: February 7, 2011
Host: Vanessa Iarocci
Guest: DJ Peterson
Running time: 14:45 minutes

For Canadian companies, tapping into emerging world growth can offer some world-class deal opportunities. But deal-making beyond traditional borders can be difficult and fraught with risk. In this episode of Strategy Talks, DJ Peterson, a NYC-based director with the Eurasia Group, discusses some of these opportunities and risks for Canadian companies.

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Episode 36 transcript:

Announcer: Welcome to Strategy Talks, the business podcast series by PricewaterhouseCoopers Canada. Hosted by Helen Mallovy Hicks, National Leader of PwC’s Dispute Analysis and Valuations Practice, and Calum Semple, an Operations and Consulting Partner. This interview series, featuring new topics and guests every episode, is designed to valuable insight into some of today’s hottest issues affecting your business.

Vanessa: Welcome to this edition of PwC Strategy Talks. My name is Vanessa Iarocci and I am a guest host of today’s edition of Strategy Talks.

Today, we are most pleased to have DJ Peterson with us.  DJ is the director of corporate advisory services for the Eurasia Group. He manages the Eurasia Group’s advisory business serving corporate clients. DJ has more than 20 years’ experience as a thought leader and consultant on political trends and their implications for markets and businesses around the world.

Prior to joining Eurasia Group in 2006, he spent more than 15 years at The Rand Corporation. DJ has published more than 50 articles, reports, and book chapters and his work has been cited by The Wall Street Journal, The New York Times, The Los Angeles Times, and the U.S. Congress.  Welcome DJ.

DJ:  Thank you Vanessa. It’s great to be here.

Vanessa:  Wonderful. So, let’s get started. In Canada, like many developed nations, we tend to feel that our domestic strength and stability insulates us from external shocks. I wanted to quickly run through two external shocks, currently underway, to find out what your view is on our impact on Canada, specifically Deal markets.

Starting off, I’m eager to hear your thoughts on Capital Controls. Some emerging world governments are beginning to look more seriously at capital controls as a way to counter currency appreciation. Where is the risk of capital controls the highest, and how will such controls impact Canadian deal-making?

DJ:  That’s a great question Vanessa. Clearly, we’ve already seen actions by the Brazilian government to impose capital controls, and many other governments have looked to Brazil as a model. And, in fact, the actions that they have taken to date have gone fairly well, or not riled the markets too much. Many countries are looking at Brazil. Colombia, in particular, is one that we’ve highlighted. On the other hand, some countries seem to be definitely staying away from the capital controls option. South Africa is one of them. And that’s in part, because there’s a broad consensus in the South African Central Bank, as well as the policy-making community, that that’s not the road they want to go down.

To understand whether a country will impose capital controls or not, you need to look at a number of factors. One is, what role does the central bank play in the economy? Is it to manage the currency, or is it to manage inflation, for instance. And that’ll give you an indication. In the South African case, it’s managing inflation. Where, in Brazil, they’re really concerned about the currency appreciation. So, that’s how we are dividing countries and their positions on capital controls.

I think there’s another important element to raise here, and this gets to the issue of deal-making and options for Canadian companies. In fact, what Brazilian authorities are trying to do is not to restrict foreign direct investment. They’re actually just trying to control or manage the inflow of portfolio investments, or hot money.

So, for the operating companies who want to make a long-term bet, Brazil is still open for business.

Vanessa:  Fabulous. So, there are different ways to impose capital controls, and it sounds like Brazil, for example, is going about it in a manner that is not going to shut out Canadian companies from pursuing acquisition opportunities in Brazil. Is that about right?

DJ:  That’s correct. If you look at what they’ve imposed their super tax on, it is on more the portfolio investments, the so-called hot money, which it clearly is not as foreign direct investment. So, I think again, the key message is one, they want to keep the country open for foreign direct investment, and also they want to keep the country attractive as an export market. So, this is to bolster or to sustain the export industries of Brazil. So, again, you could perhaps say that capital controls are a way to preserve the attractiveness of those industries as well.

Vanessa: Right. So, they’re basically just trying to prevent excess liquidity for speculative reasons but open for business. Well, that’s good news for Canadians. I have to ask, on this point, where you see China ending up in regards to its currency and currency policy?

DJ:  It’s a wild card. The Chinese authorities clearly try very hard not to telegraph their intentions in regards to the currency to keep everybody guessing. At the same time, the Chinese authorities are very, very conservative and they do not want to rile markets or upset the global markets / financial markets through some sudden action. So, we do not see for instance, a large one offer evaluation. What we do expect to see, and which they have telegraphed, is a gradual appreciation of the currency. It has, in the last few months, appreciated moderately, and we expect that trend to continue, certainly throughout 2011.

Vanessa: Right. So, for the time being more or less still pegged to the U.S. dollar.

DJ:  That’s correct. And as many in the U.S. and around the world believe, still significantly undervalued.

Vanessa: Which, I think, some folks have a problem with that, but it’s a thorny issue that I don’t think we’ll resolve in today’s podcast.

I wanted to move on to one of the next-most talked about external shocks in Canada, and that’s the matter of the crisis in the Eurozone. And I wanted to call upon a quote that’s become somewhat famous here, and that’s a quote by Neil Ferguson. And he said “This is more than just a Mediterranean problem with a farmyard acronym. It is a fiscal crisis of the Western world. Its ramifications are far more profound than most investors currently appreciate.”

So, what are your thoughts on the ramifications of the Eurozone crisis on Canada, specifically from an M&A perspective?

DJ: That’s a great question. First of all, Neil Ferguson’s a pessimist, so we need to take his views with a grain of salt.

Is this a fiscal crisis for the Western world? I don’t think so. The Western world is a very robust group of countries. Yes, there are significant issues facing a number of countries. But, for instance, if you look at the United Kingdom, their political system is moving very aggressively to manage the situation, to get a bunch of deficits under control, to cut spending. And there seems to be a broad political consensus in the U.K. that they do not want to go back to the troubles that that country saw, say in the 1970s. So, there you see actually the political system reacting pretty firmly to try and get a hold of the challenges they face. Similarly, in Spain, you see the government very aggressively working to avoid having any tinge or possibility of default. So, again, the political system reacting. Even if you looked at the United States and you listened to the State of the Union address recently that President Obama gave, again trying to send messages that the U.S. is going to get its house in order.

So, I think that, in terms of a profound crisis that is going to shake the Western world, I don’t see it that way. But I think for investors there are certain very important issues. Clearly, in the distressed countries, in Europe, there’s going to be significant volatility. There are going to be very severe budget cuts, and this is going to have a very serious impact on various sectors. So, if you’re looking at infrastructure investment, for instance, government funding, government spending on infrastructure is going to be cut back severely. If you’re looking at healthcare or R&D, again, areas that are likely to experience significant budget cutbacks. Also, there will be cuts backs in budgets and pensions and welfare which can have a negative impact on households. So, if you’re in the retail and consumer sector those, over time, could be impacted.

What we’re expecting, is what you’re seeing now in 2011 is just the beginning of this. That these cuts will take place over several years and they are actually going to get more severe. So the real effects won’t be sensed or seen probably until 2012 or 2013.

Vanessa: Interesting. So, in your view, we’re not looking at a cataclysmic default or breakup of the Eurozone; you see more of a long period of slow growth perhaps in Europe?

DJ: Yes. Default is still a possibility out there and, in fact, many investors have already baked in to their expectations that there will be at least a technical default in a number of countries. But the long-term prospects for Italy, Greece, Ireland, economically are going to be very challenging and, in fact, I tell clients to think of these as perhaps the new emerging markets of the world.

Vanessa: That’s an interesting perspective. So, we’re somewhat moving backwards.

DJ:  They will be. And if you think about the difficult political pressures when households see significant, say, cuts in pensions, there could be political volatility that goes along with that.

Vanessa: Interesting. That dovetails in to our next question, which is: we at PwC in Canada have been advising some of our clients to consider doing deals in emerging markets because of these expectations of slow growth in the so-called developed world. What are your views? I know Eurasia Group recently released a paper in the Harvard Business Review about investing in a post-recession world. So, where do you see the new areas of deal-making growth to be?

DJ:  Well, clearly, we see the bricks in particular in India, China, and Brazil continuing to be favourable. They’ve received a lot of foreign investment in the past, and we expect that to continue, in part because we also expect their strong economic growth to continue. The political fundamentals are in place to support that, and that’s how we look at it. So, for instance, in India we expect the reform movement to continue and that will continue to create new economic opportunities, especially for foreign investors.

Similarly with China. Broad consensus. Again, very conservative economic decision making. We expect the policies in place today to continue for the near future. And similarly with Brazil. Though with a recent election we see a continuation of their pragmatic policies. The challenges are, that because they’ve received so much foreign investment, that we’re also seeing rising costs. Asset prices are appreciating significantly. So, from both a short-term perspective and as well as a long-term thinking about, for instance, labour costs also moving up in these countries. Long-term currency appreciation. So you need to balance both the opportunities and the risks of investing in these countries.

One other though to add is, because these countries have become so popular, you’re also seeing – and the growth has been so fast – you’re also seeing bottlenecks in the system, particularly in Brazil and in India, whether it’s transportation or electric power.  And so, when making deals and looking for opportunities, you also need to think of these other factors; the environment that might shape the investment and operating environment in these countries.

Vanessa: Right, and on the matter of emerging market economies, how do they differ from the West in terms of their political stability? So, if you’re going to be doing a deal in Brazil or India – I know Eurasia Group has an extensive framework for evaluating political risk, but – is that a critical aspect of deciding whether to move forward with a deal?

DJ: It should be. At the end of the day, though China is a very large economy and has shown sustained growth for decades now, it is still a political black box. We really don’t understand what the decision-marking priorities are and how they might change. In 2012, there will be a new leadership and the country will be moving in new directions. And in various sectors, in economic sectors, that’ll have significant implications. One area that we see significant uncertainty, for instance, policy and regulatory uncertainty in China is around their policy of indigenous innovation and the requirements for technology transfer from foreign invested firms, which could present significant challenges, especially for firms that have significant intellectual property.

Vanessa: Thank you DJ. I found that quite fascinating and I’m sure our listeners did as well. For more information on Emerging Markets, and for thought leadership on political risk visit

Announcer: This concludes this episode of strategy talks. Thank you for listening. We hope you will join us again soon for another episode. To download or to subscribe to this podcast series, or to find more information, please visit The information in this podcast is provided with the understanding that the authors and publishers are not here and engaged in rendering legal accounting, tax or other professional advice or services. The audience should discuss with professional advisors how the information may apply to their specific situation. Copyright 2009 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario Limited liability partnership or as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each is which a separate and independent legal entity.

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Hosted by Helen Mallovy Hicks, a Partner and National Leader of the Dispute Analysis & Valuations Group, and Calum Semple, a Partner in the Operations and Consulting practice, Strategy Talks is a series of audio podcasts that explore key issues affecting businesses in Canada, and share strategies that companies can use to help address them.