1. Demand for commodities is still strong in China and other rapidly industrializing nations outside the core OECD countries; 2. The BRIC's, in particular, have abundant foreign exchange reserves; 3. their banks have limited exposure to the bad debt plaguing their American and European counterparts, and 4. a steadily growing percentage of their foreign trade is with each other, easing their dependence on the advanced capitalist countries. While some smaller, heavily-indebted and highly export-dependent countries could be pulled under by the financial crisis and economic downturn in the West, indications are that China and the other big new economies should stay afloat and help stave off a global depression.
According to one analyst, “...the period between 2005 and 2015 (will be) a remarkable decade – remarkable because of the transfer of wealth from developed world to developing world. In the next few years, you will continue to see the economic power shift east.”
-MG
Time to pay the bill? By David Oakley and Rachel Morarjee Financial Times August 28 2008
In the bars of downtown Moscow, there is still a buzz as if all is well in the world. At the Ritz-Carlton Hotel’s glass-domed rooftop lounge, which looks out on to Red Square, dark-suited oligarchs enjoy $50 cocktails, seemingly unperturbed by the deterioration in international relations that has followed the Kremlin’s military intervention in Georgia – even though it has made foreign investors take flight.
“We’ve been very busy in the last few days. Even wealthy Georgians who live in Moscow come here,” says Sergei Logvinov, a hotel official.
With Russian equities down by 15 per cent for their biggest monthly fall in almost eight years, foreign exchange reserves have dropped by $16bn (£8.7bn, €10.9bn), a slide not seen since Russia’s economic crisis of 1998. Yet Russia is by no means the only emerging market where confidence is on the wane. Not only has political risk also escalated in countries such as Pakistan but, across the industrialising world, inflation is dogging growth and the recent rise in commodity prices is faltering.
Sceptics wonder whether the party is coming to an end for these developing economies, after a five-year bull run.
In spite of the credit crisis, the MSCI emerging market index rose by nearly 40 per cent in 2007, prompting many investors to suggest that the developing world was insulated against the problems in the west. But these hopes that emerging markets could power ahead regardless – a theory known as decoupling – now look misguided. Since the turn of the year, emerging stocks have tumbled, most notably in China, where the Shanghai Composite index has fallen 52 per cent. Russia’s stock market has fallen by 27 per cent since January, India’s by 37 per cent and Brazil’s by 5 per cent.
As investors rushed for the exits in nearly every market, it seemed that the financial ills of the west were infecting these locations. Many analysts fear the US and European economies will continue to deteriorate, putting even greater strains on growth in the emerging world.
So what are the remaining dangers and, as some investors and analysts are starting to argue, are economic fundamentals strong enough that the torrid experience of the past few months has left valuations looking attractive once more?
Certainly, fears about a slowdown in the west co-exist with worries that the largest emerging economies are overheating. Inflation is rising across the emerging world. China’s average inflation rate for 2009 is forecast to accelerate to 6.8 per cent from 4.8 per cent this year, Brazil’s to 5.3 per cent from 3.6 per cent, India’s to 8.4 per cent from 6.4 per cent and Russia’s from 9 per cent to 14.6 per cent, according to economists at HSBC.
These rises are being fuelled not only by commodity prices that are still near historical highs but also by limits to industrial capacity. Philip Poole, global head of emerging markets research at HSBC, says: “There has not been enough investment to sustain growth, so we are seeing many economies running into capacity constraints, adding to production costs. This is putting pressure on inflation.” Of the so-called Bric nations – Brazil, Russia, India and China – only China has plenty of spare capacity, he adds.
On commodities, a further weakening in prices would undermine the revenue streams of resource producing countries such as Brazil and Russia.
Indeed, the commodity factor also raises the question of how useful the phrase “emerging market” really is. It covers more than 150 economies as different as Indonesia and Chile, some of which are rich in resources while others are not. This partly explains why equity markets in commodity producing countries have fared better this year than countries that must import resources, such as India. Even if inflation were stoking up their economies, the theory was that they were benefiting from oil and food prices, which remain high in historical terms.
However, analysts insist the outlook for many of these countries has also been helped by other factors. One is that the health of their public finances, the extent of their exposure to foreign debt and the respective monetary and fiscal management of their economies have all improved beyond recognition since the wave of emerging markets crises in the 1990s.
In these terms, the Brics read well. Banks in the big four emerging countries have not borrowed heavily overseas, curbing their exposure to the credit problems in the west. Foreign debt held by Chinese banks as a percentage of gross domestic product is only 2 per cent, for India 4 per cent and for Brazil and Russia 13 per cent, according to Deutsche Bank. These countries have also all been fairly quick to raise interest rates to tackle the inflationary threat.
China’s foreign exchange reserves, excluding gold, are forecast to stand at $1,900bn this year, India’s $330bn and Brazil’s $205bn, HSBC’s projections show. Even Russia, in spite of the conflict in Georgia, is forecast to have reserves in excess of $500bn by year-end. As some analysts put it, the countries all have money in the bank should things grow even more ugly in the financial markets and global economic climate.
On top of this, Brazil and Russia have assets in the ground. Russia, for example, produces more than $1bn a day from its vast oil reserves, while Brazil is a big producer of corn, wheat, sugar and oil. Many Latin American and African nations are also rich in resources and showing signs of improved political and economic stability, while the Middle East is awash with oil.
Commodities provoke the sharpest divisions of opinion. Already down more than 20 per cent, should commodity indices suffer further significant falls, it would take the steam out of inflation but at the same time hit exporters’ coffers. However, analysts note that even an oil price of $100 a barrel would provide substantial sums for countries such as Russia.
Another plus for the Brics is also a central plank of the “decoupling” thesis – that they have a diminishing reliance on the developed markets as a destination for their exports. They export more to other emerging markets than ever before, while their economies are increasingly boosted by domestic demand rather than by the vagaries of the US or European consumer. They are also spending heavily on infrastructure.
In Russia’s case, barely 5 per cent of its exports go to the US, although Brazil at 14 per cent, India at 15 per cent and China at nearly 20 per cent would be more affected if US growth, after its strong second quarter performance, turns weaker again. The strengthening of the dollar will also help these and other emerging economies, particularly those in the Middle East and Asia that have currencies pegged to the US unit and have suffered extra inflationary strain because of its weakness.
Yet some of the other developing nations will come under pressure as financial conditions worsen and inflation rises. Kazakhstan, with foreign debt equivalent to 71.4 per cent of GDP, is one example of a country that enjoyed the good times perhaps a little too much, borrowing heavily to fund expansion in its property sector. Mexico is highly exposed to the US economy, relying on it for 85 per cent of its exports, while many of the central and eastern European economies depend on the eurozone for export earnings as well as running large current account deficits.
In short, the outlook is varied for the differing emerging nations, depending on political and domestic economic factors. The next few months will be rocky for foreign investors in Russia and eastern Europe. “In a nutshell, this is a short-term problem for Russian markets. Fundamentally, nothing has changed in Russia,” says Vladimir Savov, Russia strategist at Credit Suisse.
But for most emerging markets, the long-term prospects are arguably rather brighter than the recent turbulence might suggest. There are reasons to hope that they can continue to outperform their western rivals in terms of growth – and benefit from wealth transfers from the advanced to developing nations. Nigel Rendell from RBC Capital Markets says: “In terms of years rather than months, the emerging market economies are looking in good shape. They are likely to continue growing strongly, more strongly than the western economies – [particularly] the US and the eurozone.”
Since 2000, emerging nations have contributed an increasing amount to the world’s output. The International Monetary Fund estimates that these economies will provide more than 80 per cent of global growth this year – up from less than 50 per cent at the turn of the millennium – as they now make up $18,100bn of world GDP, a 30 per cent share. The IMF forecasts that this proportion will grow to 35 per cent, or $28,850bn, by 2013.
What of their stock markets? During last year’s burst of optimism over emerging equities, these commanded a higher multiple of earnings than developed market stocks, according to MSCI indices. This has now reversed and emerging markets trade at a substantial discount to the developed world once more. That could encourage bargain-hunters who believe in their long-term growth prospects.
But overall, if the four Brics are anything to go by and if growth is the right benchmark to measure the health of an economy, analysts generally expect them to weather the present difficulties.
Consensus forecasts indicate that China’s GDP growth is expected to slow to 9.2 per cent next year from a peak of 11.9 per cent in 2007, Brazil’s to 3.8 per cent from a high of 5.4 per cent in 2007, Russia’s to 7 per cent next year from its 2007 peak of 8.1 per cent, India’s to 7.7 per cent from 9 per cent last year.
These growth levels are still relatively strong and will certainly outperform the west, suggesting a soft rather than a hard landing and a bright long-term outlook.
“By 2015, today’s current emerging markets will be a much larger part of the world economy,” says Dalinc Ariburnu, head of emerging markets at Deutsche Bank.
“I am sure that when we look back in years to come, we will say the period between 2005 and 2015 was a remarkable decade – remarkable because of the transfer of wealth from developed world to developing world,” he adds. “In the next few years, you will continue to see the economic power shift east.”