The Future of the BRICs: Are they headed for a comeback?
The term ‘BRIC’ economies – Brazil, Russia, India and China was introduced in November 2001 by Jim O’Neill at Goldman Sachs, to distinguish the four countries from the host of other emerging nations as the engines of global economic growth in the future. As predicted, for most of the last decade the growth in the world economy was led by the BRIC economies that accounted for about 18% of the global GDP growth.
However, post the 2008 financial crisis the situation seems to be changing. Growth in these economies was interrupted and a downward trend began over the past couple of years owing to the fall in demand from advanced economies, a threat of capital outflows due to “tapering” by the Federal Reserve, and the structural deficiencies in these economies. This has forced the central banks to keep interest rates high to attract capital flows.
Morgan Stanley recently introduced the term, the “Fragile Five” to describe Turkey, Brazil, South Africa, India and Indonesia as economies vulnerable to a crisis given the weakening investor sentiment and heavy reliance on foreign capital.
However with the majority of the emerging markets underperforming as compared to the developed markets, this nomenclature seems a bit fuzzy. In my opinion, every journey entails short pauses or stumbles but the long term trajectory remains unchanged.
Lets us take a look how these countries have fared in terms of macroeconomic and social indicators to see why these economies still have the potential to grow back and power the global economy.
The Golden Period
From 2000 onwards, Russia’s per capita income has increased from 33 to 51% of the OECD average. Growth during this phase was led by a trade surplus given the spare capacity in production and the ever rising oil prices. In Brazil these years saw a sustained increase in consumption, especially private consumption which was the major contributor to growth. The rapid absorption of the rising population in the labor force has also led to growth in the Brazilian economy. The growth in China was driven by an increase in productivity, government reforms and a competitive export base. The low cost of capital has provided people the incentive to over- invest and at almost 50% of GDP, investment seems to be the growth driver for the economy. India’s growth was led by the impact of economic liberalization of the economy post 1995.
The phase of slowdown
Recently there have been doubts about whether Solow’s hypothesis of convergence will be proven true given the recent slowdown in the BRIC nations. The BRIC countries have been battling challenges both on the external and internal front. The interlinking of economies exposed the BRICs to the global market dynamics. The slowdown of advanced economies eroded the value of emerging market currencies. This was followed by falling investor sentiments further driving the BRIC economies further down. Adding to these are problems inherent in the economies.
While the downward trend in oil prices and the narrowing output gap has troubled Russia, Brazil now suffers due to the low level of investment as a result of low level of domestic saving and structural barriers. The investor confidence in the Brazilian economy is falling as shown in the figure.
FIG :Falling Business Confidence, Brazil
Source- IMF Data (Trading economies)
For the Chinese economy, the capacity utilization has fallen from the pre-crisis figure of 80% to around 60% currently.
FIG : Falling Capacity Utilisation, China
The increased state bank lending to the commercial sector has rendered a high amount of loans unproductive. Increase in shadow banking also remains a concern. Indian Economy has to bear with a high fiscal deficit and growing dependence on external loans for investment. The investment climate is also plagued by governance issues.
Why the story is not over yet
Implications of a Growing Middle Class
Source- Goldman Sachs
The rapid economic growth and demographics of the emerging countries have elevated people out of poverty and have given rise to a growing middle class (especially in India and China). An emerging middle class promises a positive future for the BRIC countries owing to its long term implications for these economies.
The growth of the middle class will lead to a dramatic increase in domestic consumption demand. It will also encourage the growth of small-scale businesses and entrepreneurs which will drive the modern economy.
Falling Public Debt Ratios
One major positive for the emerging world is the there has been a significant drop in the public debt ratios as compared to the advanced world. This will help enable fiscal policy in the developing nations to focus on the structural and infrastructure gap.
Implications of the Kuznet’s Inverted U-curve
While a major concern lies in the rising Gini Coefficient in the emerging nations, however, this concern is addressed by the application of “Kuznets’ inverted U shaped curve of inequality” . This curve predicts the growth to be more equitable with increasing economic development.
Increase in Research and Development in the BRIC countries
Schumpeter in his book “Capitalism, Socialism and Democracy’1943” stresses the importance of the process of creative destruction (innovation), which “incessantly revolutionizes the economic structure from within, destroying the old one, incessantly creating a new one”, as a growth driver.
India, China and Brazil account for most of the increase in investment in science research and scientific publications. The global spending on R&D has increased by 45% since 2000 to more than $1 trillion. India, China and Brazil almost doubled their spending on R&D in the past decade raising their contribution to global research expenditure from 17 to 24%. China’s future plan focuses on development of a number of scientific fields like clean fuel, rare earth and environment friendly transportation.
China and India have steadily increased the share of medium-high, medium-low and high technology goods exported. The other economies however need to follow the example.
FIG : Exports by technology intensity
The BRIC growth story may have gone sour but it has definitely not come to an end. Growth in the past decade has been tremendous but the countries now face challenges due to heavy interlinking of economies. However these challenges are only temporary obstacles in the path of the emerging countries. The abundant natural resources and a favorable demographic situation will ensure that growth is not halted. Economic and regulatory reforms however are necessary to kick start the economies all over again. Heavy reliance on the global economy might prove to be harmful for any nation as it is exposed to exchange rate risks and risk of spillover of slowdown from the rest of the world. The BRIC nations should focus on reducing their dependency on the export sector and strive to diversify their economy and encourage bilateral currency trading.