WHAT ARE WE TO DO By TAN SRI LIN SEE-YAN
THE term BRIC (Brazil, Russia, India, China) was first used in 2001 by economist Jim O’Neill (Goldman Sachs) to call attention to four rapidly rising large emerging economies considered able to play a significant role in global affairs, championing the interests of developing nations. Very much like what G-7 does for the developed world.
For years since, it was treated by investors and journalists as a shorthand for the big emerging markets. Adding South Africa to the group widens its focus to include more from outside fast-growing China and India.
The BRICs held its first summit in 2009 in Russia, discussing issues on international monetary reform, including the possibilities of a new dominant reserve regime to replace the US dollar-based system. This year, China played host and invited South Africa to join, formally naming the group BRICS. Together they exceeded three billion people, nearly 45% of the world, and about 25% of the world’s 2011 gross domestic product (GDP) based on purchasing power parity.
China’s total output is bigger than the other four put together. The economic clout of the BRICS is now growing as the developed world struggles to expand and pare debt. Indeed, they are starting to operate as a common bloc in the G-20, providing a counterpoint to the United States and Europe.
But the group is vastly different. India, Brazil and South Africa are vibrant democracies in contrast to the more authoritarian Russia and China. They need to balance the interests of its members: three large commodity exporters and two huge commodity importers. For sure, they have to get used to obeying rules they played little part in shaping. China’s economy, the world’s second largest, is nearly three times the size of Brazil’s, close on four times that of Russia and India, and 16 times that of South Africa.
They also differ on exchange rate policies. Brazil is vocal against China’s tight management of the yuan’s value, keeping its exports relatively cheap. China is becoming prominent in BRICS’ trade already it is Brazil and South Africa’s largest source of imports. Be that as it may, the group shares strong macroeconomic fundamentals going into 2012.
China and India will grow 8.5%-9% this year; Russia and Brazil, 4%-4.5%; and South Africa, 3.5%. Their structural budget deficits are well contained, with low debt/GDP ratios, highest being in India (68%) and South Africa (65%).
China continues to have a current balance of payments surplus (5.7% of GDP), while all the others’ deficits are each less than 5%. But they share a common problem inflation: 6.5% in China, 9% in India, 9% in Russia, 7% in Brazil and 6% in South Africa. Containing inflation remains a top priority of public policy. Still, they continue to struggle to deal with this threat.
The 2nd BRICS Summit held in April 2011 reaffirmed the group’s determination to transit from global pax americana to a new order in the “development of humanity.” The BRICS’ emphasis on co-operation in their call for reform of the US-dollar dominated international monetary system and for tighter supervision of commodity derivatives and markets, and capital flows show the group is seeking to refrain from too much assertiveness. Still the desire to shake off the old hegemony is there; it calls for a larger role in international fora.
It condemns “the inadequacies and deficiencies” of global finance and the “excessive volatility in commodity prices.” The Sanya declaration underscored their concerns about underlying factors that fuel inflation and currency volatility in many emerging economies, as well as their strong desire to shift away from reliance on the US dollar.
“We call for more attention to the risks of massive cross-border capital flows now faced by the emerging economiesExcessive volatility in commodity prices, particularly for food and energy.”
The BRICS took a new step towards cementing their global influence by: (i) calling for a broad-based reserve currency system “providing stability and certainty”, one that is more reliable and stable; (ii) welcoming discussion about the global role of Special Drawing Rights (SDR), the International Monetary Fund (IMF)’s in-house accounting unit but a global reserve asset, and on the SDR’s basket of currencies (now comprising the US dollar, the euro, yen and pound sterling); (iii) establishing mutual credit lines denominated in their home currencies among the state development banks of the group. To start the ball rolling, China Development Bank will issue loans worth 10 billion denominated in yuan this year to other BRICS nations, mostly to fund oil and gas projects; and (iv) forging a common emerging market negotiating stance on issues from climate change to world trade, and to act as a credible counterweight to the West in settings like the G-20.
BRICS & Asia
The Asian Development Bank (ADB) expects Asia to grow 7.5% this year (against 9.2% in 2010) and 7% in 2012. “If anything distinguished the region from the rest of the world, it is its strong macro fundamentals.”
However, a dark cloud in the horizon is the slowdown in exports to its traditional markets in the United States, Europe and Japan. Against this is the region’s potential for rapid expansion in intra-regional trade, amid signs of rising domestic demand in Asia.
True, manufacturing and services-related activities stalled across much of the world in August, raising fears of another global downturn. True also, factory and services output throughout Asia, including China and India, slackened in August, pointing to growing evidence that weaker demand in the United States and Europe is weighing on Asia’s export-driven economies.
Moreover, investor confidence dropped to the lowest in two years in September in the eurozone and the United States, and consumer confidence, already fragile, weakened further. Unfortunately, the United States’ anaemic growth and Europe’s worsening debt crisis have prompted governments to deepen budget cuts, undermining consumer demand and clouded growth prospects with uncertainty.
Barring a full-blown double-dip in the United States and Europe, Asia will still suffer significant bruising from deepened dashed expectations, with most of the pain centred on highly exposed nations Taiwan and South Korea. No doubt, the BRICS economies are bound to face clear challenges in responding to the angst over weakened global conditions.
O’Neill has since suggested his original four BRICs be expanded to include Turkey, Indonesia, Mexico and South Korea, to form the new “growth markets”. A fresh look is taken to measure exposure to equity markets beyond market capitalisation (GDP, corporate revenue growth and volatility of asset returns); any emerging market accounting for 1% or more of world GDP should be taken seriously. Mexico and South Korea each represented 1.6% of world GDP, Turkey, 1.2% and Indonesia, 1.1%.
Among them, I particularly favour Indonesia. Like Brazil, Indonesia’s success is based on the commodities boom: gas and coal to China and India, and palm oil to the world. Investments are flowing in. With a population of 237 million (the world’s largest Muslim nation), the country is in the midst of a consumer boom.
Indeed, it has the potential to become one of the world’s biggest economies. But it has to get its act together. It will grow 6.2% this year (6.1% 2010) and hopefully 6.5% in 2012. South-East Asia’s largest and fastest growing economy is firing on all cylinders. It is today rated a notch below investment grade and should be upgraded soon. It will become a credible 6th member of the BRICS.
What impresses is its growing middle class. World Bank puts private consumer spending at close to one-half of GDP. The middle class (disposable household income exceeding US$3,000 a year) numbered 1.6 million in 2004. Today, Japanese investment bank Nomura estimates it to be about 50 million, more than in India and larger than in any of its nine other Asean neighbours. By 2014-2015, Nomura thinks it could reach 150 million.
The country is growing so fast, especially in the urban areas, that inflation is a major political issue at 7.2% for 2011. But it’s stable, bearing in mind the rupiah appreciated 5% this year. Affluent middle-class Indonesians are spending, mainly on motor cycles (eight million sold in 2010, dwarfing sales in the rest of South-East Asia), cars (750,000 in 2010) and smart phones.
Indonesia is reputed to be the world’s No. 2 in Facebook members and world’s No. 3 in Twitter users. But, Indonesia, to be frank, remains a difficult place to do business because of poor infrastructure (adding to production and distribution costs), and corruption (“non-transparent random regulations”). But there are signs things are changing for the better. It is still attractive to foreign investors: nowadays “if you are not here, you have to have a good reason.” Most new consumer desirables are still imported.
Wall of BRICS
As a group, the BRICS are growing fast. China has surpassed Japan as the world’s No. 2. India and Brazil are following fast behind. Catching-up is always much easier because the leader has already set the path and the pace. At some point, reliance on emerging nations as engines of growth begins to disappoint, as it becomes harder to sustain the pace. Growth will slow down (as did Europe, and Asian Tigers and Japan before them) or may even falter (as did Latin America in the 1990s).
There is a lesson from history. A recent study by three scholars Barry Eichengreen (University of California, Berkeley), Doughyun Park (ADB) and Kwanho Shin (Korea University) called the EPS study* attempted to draw potential warning signs by examining economies since 1957 whose GDP per capita (on a purchasing power parity or PPP basis) rose more than 3.5% a year for seven years, and then suffered a sharp slowdown when growth dipped precentage points or more.
The focus was on economies enjoying sustained catch-up growth. The common sense behind PPP is the same amount of money should purchase the same product in any two countries (hence, the term purchasing power parity). That is, the purchasing power of money, expressed in one currency, should change pari passu in different countries. If US$5 buys a cup of Starbucks coffee in New York and the actual cost of the same Starbucks coffee in KL is RM12, then the exchange rate should be US$1=RM2.40 according to PPP. But the actual exchange rate is close to RM3, or 20% cheaper. So, the use of PPP serves to neutralise any currency distortions.
What emerged was as follows: (i) growth slowdowns occurred when GDP per capita reached about US$16,740 per capita; and (ii) the average growth rate then falls from 5.6% per year to 2.3%. In the 1970s, growth rates in Western Europe and Japan cooled off at about the US$16,740 threshold, as did Singapore in early 1980s and South Korea and Taiwan in the late 1990s.
Thereafter, growth often continues and may even accelerate. Japan’s boom lost momentum in early 1970s, then accelerated until it blew up in the 1990s. But, no one-size-fits-all depends on circumstances. When the United States passed its threshold, it kept on growing rapidly, consistent with its innovative prowess. Other risk factors matter, including openness to trade; lifting of consumption to beyond 60% of GDP; low and stable inflation; high ratio of workers to dependents. On the other hand, an under-valued exchange rate raises the risks of a slowdown.
* “When Fast Growing Economies Slow Down: International Evidence and Implications for China.” NBER, March 2011.
The EPS study does draw interesting parallels. China is destined to reach the US$16,740 GDP per capita threshold by 2015, well ahead of India and Brazil. Will it then slacken? The risk factors for China include: an ageing population, low consumption and an under-valued currency. On these alone, the study suggests high odds (over 70%) of a definite slowdown by then! But China is unique. These risks can be managed by shifting development inland, leaving the maturing urban centres room to innovate.
China is already reforming to become a more consumption-based economy, while its currency is being managed to reflect market considerations. Prompt structural reforms help cushion the effects of any slowdown. Even so, a percentage point drop in growth to 6%-7% does not sound so scary. For China, it should not really be such a big deal.
● Former banker, Dr Lin is a Harvard educated economist and a British Chartered Scientist who now spends time writing, teaching & promoting the public interest. Feedback is most welcome; email: email@example.com