BRICs buffeted by euro storm but stay on course

Saturday, 17 December 2011 00:00 -     - {{hitsCtrl.values.hits}}

Reuters: A sudden stop to growth in Brazil. Rising political risk in Russia. A slide in India’s rupee to a record low. A marked slowdown in growth in China.

Have big emerging markets had their day? After all, even Goldman Sachs, which coined the BRIC acronym 10 years ago, reckons the quartet’s contribution to global growth is unlikely to rise much further.

Not so fast. While all emerging markets face stiff headwinds going into 2012 as the euro zone’s debt crisis drags on, economists firmly expect them to remain the main driver of growth and to lead the world economy back to better times.

“By the second half, stronger growth across China and other emerging economies should pull up worldwide activity,” said Gerard Lyons, Chief Global Economist at Standard Chartered Bank.

“It will be a recovery made in the East and felt in the West. If ever one needed evidence of a shift in the balance of power, this is it,” he wrote in the bank’s preview of 2012.

As if to underscore the point, Fitch on Thursday became the first ratings agency to raise its measures of Indonesia’s sovereign creditworthiness to investment grade - just as financial markets are waiting for rival Standard and Poor’s to downgrade most of the 17 members of the euro zone.

“The upgrades reflect the country’s strong and resilient economic growth, low and declining public debt ratios, strengthened external liquidity and a prudent overall macro policy framework,” said Philip McNicholas, a Fitch Director.

Footloose capital

In an age of criss-crossing supply chains and instant capital movements, the notion that any country can decouple from what is happening in the rest of the world is a delusion.

When advanced economies shrank 3.7 per cent in 2009 at the height of the global financial crisis, growth in emerging and developing economies slowed to 2.8 per cent from 6.0 per cent in 2008, according to the International Monetary Fund.

Similarly, the euro zone’s woes are already having an effect far and wide as the bloc’s demand for imports sags, European banks curtail credit in non-core markets and investors who had piled into emerging markets in search of yield turn tail.

David Hauner, Head of Economics and Fixed-Income Strategy for Emerging Europe at Bank of America Merrill Lynch, said the key for investors in 2012 was to identify countries and regions that did not depend on potentially fickle foreign inflows.

“We anticipate that these capital flows will remain very scarce over the course of the first half of next year at least,” Hauner told a briefing.

Thus, the bank expects growth in Asia, a big exporter of capital and increasingly reliant on domestic demand, to slow just half a percentage point in 2012 to 7.0 per cent. And Russia should log 3.6 per cent growth as long as strong oil prices keep generating payments surpluses.

But 2012 could be crunch time for Turkey, which relies on foreigners to fund a big current account deficit stemming from red-hot, credit-fuelled domestic demand. BoA ML is pencilling in zero growth next year after more than 6 per cent in 2011.

“If the downside risks on capital inflows to emerging markets for next year materialise, it would lead growth to decline sharply and the current account deficit to shrink, as it did during the 2008 crisis,” said Erkin Isik, a Fixed-Income Strategist for TEB-BNP Paribas in Istanbul.

Policy scope

On the positive side of the ledger, the euro’s plight has inflicted much less damage on the rest of the world than the collapse of investment bank Lehman Brothers in September 2008.

Far from slumping into recession, the United States is slowly picking up, as new unemployment claims and a gauge of manufacturing in New York state showed on Thursday.

And trade finance has not suddenly evaporated, as it did post-Lehman, contributing to a 20 per cent slump in global trade.

Emerging market exports measured by value were flat in November, according to Jonathan Anderson, UBS’s Chief Emerging Markets Economist.

That implies a continued month-on-month contraction in volumes, but Anderson said the fact that trade volumes are not collapsing suggests that concerns about the wholesale withdrawal of European bank finance are exaggerated.

Also on the plus side of the ledger, many emerging markets have already started to ease policy to cushion the fallout from Europe. Brazil and Indonesia have cut interest rates.

China has reduced banks’ reserve requirements, tweaked taxes to help small businesses and made more people eligible for welfare handouts as it changes gears from fighting inflation to protecting growth. Most economists still see growth of at least 8 per cent in China in 2012 despite eternal worries about the solidity of the country’s banks and over-investment in property.

“So far, most policy moves have been slow and measured. What matters, however, is that most emerging nations are much less restricted than developed economies from using their firepower,” Pablo Goldberg and Betrand Delgado, Emerging Market Economists at HSBC, said in a report.


More broadly, looking beyond any passing hit to growth from the euro zone’s malaise, emerging markets are still a long way behind the consumption levels and technological capabilities of the West. The potential for catch-up growth is huge.

In an update by Goldman Sachs of its long-term projections, economists led by Dominic Wilson said the ascent of the BRICs has been so rapid - generating nearly half of the increase in world output in the past decade - that other emerging markets might have more scope than the BRICs themselves to increase their contributions to global growth in future.

Indeed, while the world’s centre of economic gravity will continue to shift in favour of the BRICs, the group as a whole might already have passed the peak in potential growth.

But, with other, ever-bigger developing countries taking over the baton, Wilson said global growth has the capacity to reach 4.3 per cent a year this decade.

That would not only surpass last decade’s 3.5 per cent clip, it is likely to be a high water mark for the world economy before demographics and diminishing returns gradually apply the brakes to global growth, the Goldman analysts said.