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Back in 2001, when Jim O’Neill of Goldman Sachs first coined the acronym, BRICs, bringing together Brazil, Russia, India and China, it was more than just a clever marketing ploy to bring investors attention to those economies. At the time, the dotcom bubble was ready to burst and augur a brief recession in the major economies. The bursting of the dotcom bubble had a bad impact on investors, especially the small retail investor, about the merits of investing in equity markets. Indeed US consumer confidence, which peaked at the time of the dotcom bubble has been in a declining trend ever since.
It is not surprising that institutional investors have been looking outside the traditional markets of the US, UK, eurozone and Japan for more exciting, better yielding investments even though in some cases, performance has been disappointing. The process of globalisation, financial market deregulation and liberalisation, the development of equity and capital markets in Asia and elsewhere have encouraged portfolio inflows into the “emerging” markets. In fact, the term, “emerging” is increasingly a misnomer. Many of these economies have “emerged” and in many cases are transitioning to “developing developed” economies. The process of modernisation and urbanisation that is taking place generally is now focusing investors’ attention on so-called “frontier” economies which includes countries in Africa and parts of Asia like Myanmar, for example.
Emerging economies in better fiscal health
Jim O’Neill was right to bring to our attention to more fundamental economic shifts that were, and still are, taking place in the global economy. The centre of gravity of the global economy has increasingly shifted from west to east. This trend has been aided by the impact of “The Great Recession” in which the major economies paid a heavy price for the credit boom which resulted in the economic and financial crisis of 2007-2009 and which has since been extended into the eurozone debt and banking crisis since 2010. As Professors Reinhart and Rogoff made clear in their outstanding research into the aftermath of financial crises, the process of debt deleveraging and balance sheet repair on the part of governments, households and the banking sector can be prolonged and take several years. The end result is sub-par economic growth, high levels of unemployment and an explosion in government debt/GDP ratios. The last few years have seen the debt-burdened major economies play out exactly in line with the Reinhart-Rogoff thesis.
The US faces the challenge of bringing its fiscal policy back on to a sustainable basis as the federal debt/GDP ratio is now above 100 per cent and at its highest level since 1950. Tackling the upward trend in so-called entitlement programmes such as Medicare and Medicaid is politically contentious given the impact of adverse demographic pressures. The ageing “baby boomers” are not going to give up their expensive health care treatment without a fight.
The eurozone faces wide imbalances between a small band of trade surplus economies and the deficit economies of southern Europe. The adjustment process of “internal devaluation” on the deficit nations is economically costly. Most of southern Europe is actually in a deflationary depression which is compounded by austerity policies which seem to be repeating the errors of the Gold Standard in the 1930’s.
In contrast, the “emerging” economies are in better fiscal shape on all counts. In the aftermath of the 1998 crisis, many countries made great progress in reducing debt levels and the average government debt/GDP ratio is at least a third of that for the “advanced” economies. Russia, is a particular stand-out in having exceptionally low levels of debt aided by a prudent central bank policy and a cautious fiscal policy in the aftermath of the elections.
The banking sectors in many emerging economies avoided the 2007 subprime lending crisis that engulfed so many US and UK banks. However, the crisis showed that emerging economies could not fully “decouple” from the slowdown in the major economies with exports and investment being particularly affected. The retrenchment in cross-border lending by eurozone banks had an adverse impact on credit conditions especially in Asia.
However, the much stronger economic growth rates among emerging market economies generally offset the slowdown in the major economies. Chinese economic growth was running at a double-digit rate courtesy of a massive fiscal expansion. For sure there have been worries of a “hard landing” during 2012 as China seemed to have its own credit bubble. The challenge for China is to transition away from the export/investment led model of growth to one based more on consumption. China will need to implement further structural reforms in order to avoid the “middle income trap” especially as “the demographic dividend” declines and the size of the labour force peaks.
Major changes ahead for world economic map
Many studies that look at future economic trends highlight that the next 50 years will see major changes in country shares in world GDP. The BRICS will play a significant role in here. The OECD, for example, envisage that faster growth rates in China and India imply that their combined GDP will exceed that of the G7 economies by 2025. PWC estimate that the world economy is projected to grow at an average rate of 3 per cent per annum from 2011 to 2050, doubling in size by 2032 and nearly doubling again by 2050. China is projected to overtake the targets economy by 2017 in purchasing power parity terms.
India should become the third “global economic giant” by 2050 with Brazil in fourth place. Russia is expected to overtake Germany to become the largest European economy before 2020.
Russia is already the world’s largest commodity exporter though the economy is not all about oil. Progress is being made on structural reforms which are gradually bearing fruit.
Bearing in mind the problems both political and economic in the eurozone, it is worth noting that the only countries that really matter are Russia and Germany which might have implications for the future shape and viability of monetary union. The McKinsey Global Institute (“Financial globalization: Retreat or reset”, March 2013) note that the share of global capital flows going to emerging economies was 32 per cent in 2012 compared to 5 per cent in 2000. Clearly, much depends on progress in terms of structural economic reforms, reform in corporate governance and development of financial markets. The worst thing that could happen for emerging markets is de-globalisation, a retreat into protectionism and currency wars which dents world trade and global economic growth.
BRICS to strengthen global GDP
History speaks for itself as to what happened. The US is under pressure as the economic superpower and the US dollar’s role as the leading reserve currency is being challenged. Many emerging economy policymakers are critical of the Fed’s monetary policy in cheapening the dollar and fuelling cross-border capital flows which can create “bubbles” in the emerging markets. The eventual exit from these policies could prove messy and inflation might start to become more of a global problem in future years. Only a few emerging economies have managed to sustain economic growth rates above 5 per cent in past decades and it will be interesting to see whether this can change.
In sum, the outlook for emerging economies is positive and the trend towards a greater and stronger contribution to global GDP growth can continue. Certainly, the longer-term investment prospects are bright reflecting progress in economic modernisation and the lifting of GDP per head. BRICS already account for 40 per cent of the world population and 25 per cent of global GDP. Christine Lagarde, the Managing Director of the IMF, recently described the outlook for emerging economies as one of “resilient dynamism”. By 2025, two-thirds of the world’s population will live in Asia. As far as Russia is concerned, the OECD’s “Going for Growth” report presented in Moscow in February 2013 noted that the potential of the Russian economy remains largely untapped and the report looked forward to increased efficiency and improved corporate governance.