A global pattern of easing economic growth in the first half of 2012 has impacted the “BRIC” nations – Brazil, Russia, India and China. However, I don’t think the BRIC economies have hit a brick wall. While some market participants have been waiting impatiently for governments to undertake further stimulus measures, others have wondered whether something more fundamental—and less within governmental control—might be at work. One theory in play is the concept of a “middle income trap.” The premise is that emerging countries can find it hard to sustain high per-capita growth rates beyond a certain point since benefits from technology, low labor costs and easy productivity gains run out before the accumulation of technological capital permits a transition to a higher-wage, higher-productivity economic model. Our team is not convinced that this argument holds muster for the BRIC economies—or emerging markets as a whole.
We think some deceleration of China’s growth rate was almost inevitable, given that the size of the country’s workforce seems to be peaking and the transfer from agricultural to industrial labor has slowed. In this context, forecasts of around 7% annual growth this year (as opposed to the near-10% average annual gains seen in recent years) seem entirely rational to us. In his “Government Work Report” delivered to the National People’s Congress in March, Chinese Premier Wen Jiabao projected a 7.5% growth rate for 2012, which we think could prove to be conservative.
Government policy has been shifting from state-directed, export-led and labor-intensive growth more toward an economic model emphasizing internal consumption, technological strength and entrepreneurial expertise. Both supply and demand might be driving this transition: A substantial investment in higher education has expanded the pool of educated labor, and demand is growing from the ongoing, rapid rise in the size and wealth of China’s middle class. Consumer indebtedness, including mortgage debt, is low in China, and outside the high-end housing in major cities, we don’t see a housing glut to pressure prices. Given these circumstances, we think China should be able to join South Korea, Taiwan, Hong Kong and Japan in escaping the “middle income trap.”
China’s leadership will be changing soon, and it will be interesting to see how its new leadership carries forward these structural changes and seeks to maintain China’s status as a global growth leader.
In contrast to China, India’s troubled government has been struggling to implement necessary investment and infrastructure projects, and a number of populist and anti-business initiatives eroded investor confidence in recent months. There was also concern that measures to support consumption were crowding out private sector investment and leading to balance-of-payments deficits. This summer, several international ratings agencies had threatened to downgrade Indian sovereign debt to near-junk status. But suddenly, Indian leaders delivered some welcomed good news.
In mid-September the government announced sweeping reforms, including plans to divest its stake in five companies, a shift away from subsidies, and the opening of foreign direct investment in power exchanges, the non-news broadcast media, retailing and aviation industries.
India’s central bank followed up by cutting the cash reserve ratio to 4.5% from 4.75%, although it left its benchmark interest rate steady. While certainly more reforms could be made, I think the actions of the Indian government and central bank represent positive steps toward restoring investor confidence, and could potentially set the stage for better growth going forward.
Despite its obstacles, India’s economy has proved adept at generating growth in recent years without heavy investment and with a much better ratio of growth to capital spending than China. Unlike in China, India’s working population is generally expected to experience strong growth over the next decade, and reserves of labor among the rural population are large. The impediments to continued growth should be surmountable, in our opinion, provided the political will is there—which leads us to believe in the economy’s growth potential.
Russia, like China, may see its working-age population decline. However, we think Russia’s middle class also could swell as wealth from commodity exports could filter through the economy. Businesses supplying consumer goods and services to this burgeoning market appear to have potential to benefit. Russia’s financial structures are underdeveloped, consumer debt levels are generally low, and recent gross domestic product (GDP) growth has been strong.1 A heavy dependence on the oil and gas industry could represent a risk factor, as oil accounts for the bulk of Russia’s exports and a considerable portion of federal budget revenues. However, we feel that an oil price crash is unlikely, at least in the near or medium-term. In addition, the government recently announced ambitious economic reforms aimed at addressing the country’s dependence on commodity exports. Russia’s entry into the World Trade Organization could supply a similar growth catalyst as it did to China after 2001. (You can read more about my views on Russia in my recent blog: “The Russian Evolution.”)
Of the four BRIC economies, we believe Brazil perhaps gives investors most cause for concern. Its GDP growth in recent years has been below that of India and China,2 and a populist and interventionist tradition in government has left the country with unusually high taxes, a relatively high minimum wage compared to its peers, and potentially troublesome pension and benefit entitlements for public sector workers. Nationalist policies in some key industries, notably energy, have tended to slow and complicate investment programs. The country may also be more vulnerable than the other BRICs to fluctuations in the prices and demand for commodities, an area which financed its recent growth. However, in our opinion, we don’t see short-term commodity pullbacks leading to long-term weakness, as growth in several other emerging economies appears likely to continue to support demand. Moreover, the government has been moving to address some of its challenges, notably with measures to curb pension costs for state employees, and there are signs of a renewed appetite for privatization. Meanwhile, we believe domestic consumption could advance, supported by a young and dynamic working population, powering a gradual diversification of the economy.
Beyond BRICs—the CIVETS
The BRICs are by no means the totality of emerging markets. Behind them stand a cohort of new economies aiming to follow their example. “CIVETS” is a new acronym in emerging market circles, describing Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa, all of them pulling together various combinations of youthful, low-cost labor and abundant natural resources in an effort to propel rapid economic growth. We think many other nations in Africa, home to some of the world’s fastest-growing economies, hold potential.
I think these CIVETS economies could potentially help offset a growth shortfall that might emerge in emerging markets as a whole as the BRICs mature. And, by supplying resources and new markets, they could also help reduce the impact to the more established emerging economies from slowing growth and demand in developed countries.
For these reasons, we believe that the BRIC nations aren’t hitting a growth brick wall, but if emerging markets in general continue to achieve strong economic growth in the coming years, the BRIC countries will have to scale a few obstacles.
1. Bloomberg, August 2012. “Russia’s Economy Expanded 4% in Second Quarter, Slowest in Year.”
2. Source: World Bank. GDP growth (annual %) 2009-2011.