International | Sep 26 2006
By Chris Shaw
With good reason the so-called BRIC economies, Brazil, Russia, India and China, have been favourites among investors looking for exposure to emerging markets, as they have outperformed significantly in comparison to developed markets.
As Morgan Stanley global strategist Stephen Roach points out, in the 12 months until the end of last week and calculated in local currency terms, MSCI equity returns have been 12.8% in Brazil, 38.4% in Russia, 39.1% in China and 51.1% in India. As a group this performance represents returns more than twice those in more developed markets, a performance that to date has justified the additional risk involved in investing in such markets.
Fundamentals have also improved in recent years, as (Brazil excepted) the BRIC nations have enjoyed fast and accelerating growth. At the same time they have also improved their financial health in terms of turning current account deficits into surpluses, lower external debt levels, more flexible exchange rate regimes and higher reserves of foreign currency.
But as Roach cautions, investing in the BRIC economies in future years will require an approach that embraces some differentiation between the economies, as the blanket approach is unlikely to prove as successful as each economy appears set to enter a period where it faces unique stresses and strains.
China is the dominant force in the group, its growth accounting for 58% of BRIC GDP currently. Roach suggests it now faces twin pressures that are both internal and external in origin, the domestic issue being the economy is still facing an overheated investment sector, which has resulted in additional monetary and administrative controls designed to address this issue.
The measures appear to be working, Roach noting growth in fixed asset investment has slowed to 21% year-on-year in August from 31% in the first seven months of the year, with industrial output also slowing to 15.7% in August from 19.5% in June.
While this is a positive in terms of making growth more sustainable, growth itself is under pressure in Roach’s view from the slump in the US housing market, as he expects this will impact on the level of demand for Chinese exports, which have been driven by the US consumer. Roach expects coming months will see the current long-term hyper-growth story that is China for many in the market come under threat, meaning growth expectations will be revised down.
Such an outcome is also going to impact on Russia and Brazil, as Roach notes while China has dominated the demand side of global commodity markets the other two are among the dominant players on the supply side.
Russia is possibly the most direct commodity play currently available, the International Monetary Fund (IMF) estimating its non-agricultural commodities account for 34% of Russian GDP while energy related issues account for 70% of is equity market capitalisation. Roach suggests as China in recent years has accounted for around 50% of total growth in global demand for energy and industrial materials, a slowdown in China simply has to have an impact on the Russian economy.
For Brazil the problem is not just its close links with both China and the US in terms of its exports but the fact its domestic economy has the lowest growth dynamic of the BRIC group. The Brazilian economy has grown in large back due to higher exports, their contribution to GDP increasing from 6.2% in 1996 to 14.9% in 2005. In contrast, Roach notes in terms of internal demand its private consumption levels have fallen an average of 0.5% each year in the period 2001-2005.
As with Russia then, Roach suggests any slowdown globally and particularly in China and the US is likely to have some negative impact in terms of Brazil’s overall economic growth performance.
Factoring in these elements, Roach suggests there is now the potential for the BRIC economies to switch from outperforming the developed economies to underperforming. While India is likely to be the least affected given it is enjoying strong growth in its services sector and is not as reliant on exports, Roach sees Russia as potentially most at risk, with Brazil and China also likely to come under pressure.
Such a slowdown has implications for the global economy, as Roach notes the BRICs account for 27% of global GDP and more than 42% of the global population, meaning their significance for world growth cannot now be underestimated.
