Avoiding the roadblocks to doing business in the BRICs

April 2013  |  SPOTLIGHT  |  RISK MANAGEMENT

Financier Worldwide Magazine

As the economic contagion has taken hold across much of the western world, the appeal of doing business in the world’s major fast-growing economies of Brazil, Russia, India and China (BRICs) has heightened. 

These countries are not immune to the negative effects of the financial crisis, but their ability to maintain steady economic growth despite the downturn has made them attractive locations for foreign investors looking for growth opportunities beyond their established markets.

China’s double-digit growth has slowed to more sustainable levels of around 7.5 to 9 percent in recent years, with this trend set to continue. India’s GDP growth for 2013 is expected to be around 5 percent, with Brazil and Russia at 4.5 and 3.5 percent respectively.

The BRICS therefore remain attractive to foreign investors, especially in Brazil where the 2014 World Cup and 2016 Olympic Games call for massive infrastructure developments and the chance to bid for support and supply chain contracts.

Across the BRICs, an emerging middle-class is fuelling consumer demand. India’s automotive market, for example, is one of the few expanding at a significant rate, while the opening up of India’s retail market to foreign investors is expected to provide the impetus needed to develop this sector. The other BRIC countries are also allowing foreign investors to access markets previously off limits to them. In Russia, this includes opportunities to invest in the energy sector.

Ongoing government policy initiatives to open up markets and simplify regulation suggest that the BRIC governments remain committed to encouraging foreign direct investment. But despite the many opportunities on offer, businesses expanding into the BRICs often face a number of obstacles and can find progress slow.

Bureaucracy

Bureaucracy continues to present significant hurdles to setting up operations in the BRICs. The World Bank ‘Ease of Doing Business 2013’ report ranked Brazil 130 out of 185 countries for bureaucracy, two places lower than in 2012. In Russia the investment climate is generally seen as attractive but risky, with the key areas of concern being bureaucracy, transparency of doing business and corruption.

Any new business operations in China must be in line with the government’s five-year plan. But these plans are frequently updated in an effort to meet emerging national and global trends, causing confusion and delays. Moreover, while China’s central government creates the laws and regulations that influence development and growth, implementation and enforcement are left to the local branches of the different government agencies and can result in inconsistencies. There is currently little connectivity between the information systems of the various agencies, which means any process relying on the cooperation of multiple agencies can be slow and result in different outcomes. However, China’s latest ‘Notice on Further Improving and Adjusting Foreign Exchange Control Policy for Direct Investment (Notice 59)’ is a significant step forward in this area.

Tax and regulatory environment

The Russian tax system is perhaps one of the least complicated of the BRIC countries. Tax rates are relatively low and there are no progressive rates on major taxes, such as corporate tax, VAT and income tax. However, tax accounting requires foreign investors to produce a range of supporting documents in compliance with strict requirements.

Elsewhere in the BRICs the situation is not quite as straightforward. Brazil’s tax system is often seen as regressive and burdensome, with around 85 different taxes, fees and social contributions at federal, state and municipal government levels. The tax structure is closely linked to Brazil’s financially unstable social security system and complex labour laws, all of which represent significant obstacles to growth. But only reform of the tax system is likely to be a government priority in the near future.

In India, a complete revamp of the tax system is expected, with the proposed rollout of the Direct Tax Code and the Goods and Services Act set to provide more clarity. However the situation in China remains murky. New regulation often takes effect before implementation rules and procedures have been put in place. Also, government agencies are prone to publishing notices or circulars to clarify points of law without first revoking existing interpretations. All regulations are published in Chinese and English translations are often incorrect. Therefore, effective ongoing communication with the local branch of the appropriate government agency is essential to clarify laws or regulations.

Language barriers

Overcoming language barriers is a fundamental challenge for many foreign businesses expanding overseas. A general awareness of the local language and customs can help to bridge the cultural divide and enhance relationships.

English is an official language of India, but in China, few business people are proficient in foreign languages. Young Russians tend to have strong foreign language skills, but not the qualifications and experience of their seniors. In contrast, English is spoken widely among senior business people and the professional and advisory community in the Brazilian cities of Sao Paulo and Rio de Janeiro, but this rarely extends to other parts of the country and to the management teams of small and mid-sized businesses.

Cultural differences

Understanding how business is conducted in the BRICs is critical, as cultural practices can differ widely from those of the west. In many cases, emphasis is placed on close, personal relationships, with trust seen as key to a successful business partnership. This is particularly the case in India, where many businesses are still family-owned. Indian business people like to meet often and discussions can seem protracted. However, once trust has been established, deals are likely to pick up pace.

While westerners often ‘lay all their cards on the table’ in their negotiations and business dealings, Chinese business people are more reserved and will reveal only what is necessary to negotiations. They tend to be indirect and often avoid definitive agreement or disagreement in a conversation.

Control and oversight

Maintaining effective oversight of operations in the BRICs can be challenging given the distances involved. The flying time from Europe to Sao Paulo or Rio de Janeiro is 11 hours, while Russia has eight time zones and it can take more than nine hours to travel from Moscow to Vladivostok by air and around one week by train.

Employing key local management with experience of working for internationally based businesses is therefore a key success factor and should be reinforced with clear reporting structures and formats. In China, all foreign-invested companies must appoint a legal representative to ensure that the parent company’s interests are protected. Many foreign companies also appoint board members and high-level managers who will carry out the parent company’s business plans effectively. Ultimately, however, foreign investors should visit their overseas operations on a regular basis to see first-hand how their business is performing.

Local advice

Appointing a local adviser with in-depth knowledge of the market, international experience and a successful track record will benefit any company looking to gain a foothold in the BRICs.

On a basic level, a local advisory partner should be able to communicate well in the foreign partner’s language and understand important cultural differences. Carrying out due diligence on any local adviser is crucial, in particular to determine who else the prospective partner is working with (whether publicly known or undisclosed) and if these other partnerships conflict with the aims of the overseas company. Careful and considered planning and research, along with sensible due diligence of joint venture partners, are key to success.

Manoj Gidwani is a director at SKP Group in India, Henry Tan is a managing director at Nexia TS, and Peter Thorpe is an associate director at Smith & Williamson. Mr Gidwani can be contacted on +91 22 6730 9110 or by email: manoj.gidwani@skpgroup.com. Mr Tan can be contacted on +65 6536 5466 or by email: henrytan@nexiats.com.sg. Mr Thorpe can be contacted on +44 (0)20 7131 4276 or by email: peter.thorpe@smith.williamson.co.uk. All firms are members of Nexia International, a worldwide network of independent accounting and consulting firms.

© Financier Worldwide

BY

Manoj Gidwani

SKP Group

Henry Tan

Nexia TS

Peter Thorpe

Smith & Williamson