The crumbling BRICS
Brazil, Russia, India, China and South Africa were supposed to lead the world to new economic heights. But deepening woes in key emerging markets threaten to tip a teetering global economy into another recession.
When Wall Street powerhouse Goldman Sachs brought the BRIC concept to the investing world in 2001, it was more than a catchy acronym for the world's largest developing economies – Brazil, Russia, India and China.
Jim O'Neill, then Goldman's chief global economist and creator of the idea (and name), was attempting to highlight an important theme that many investors were missing: the rapid growth of major emerging economies with the potential to surpass the West and dominate the global economic tables by the middle of this century.
For the next decade, the diverse group exceeded even Mr. O'Neill's bullish expectations, mainly because of China's stunning expansion. South Africa's inclusion in 2010 turned BRIC into BRICS, adding African exposure and giving the club more political weight when speaking up for the emerging world at international trade and finance summits.
But the BRICS have been fading for several years as an investment story and united political voice on the world stage. Mr. O'Neill, now a British life peer and a minister in the Cameron government, suggested last year that recession-ravaged Brazil and Russia no longer belong in the club with India and China.
Since then, conditions across most emerging markets have gone from bad to worse in the wake of China's slowdown, the steep drop in commodity prices and weak demand in developed markets. Corruption scandals in Brazil and South Africa have distracted policy makers.
Forget about leading the world to new economic heights. Bearish analysts warn that the deepening woes of key emerging countries could tip a teetering global economy into another recession.
Investors reacted by siphoning billions of dollars out of emerging-market assets.
In January alone, foreign investors yanked more cash out of emerging securities than during the darkest days of the global financial crisis – $3.6-billion (U.S.) worth, according to an estimate by the Institute of International Finance. It was the seventh consecutive monthly pullback.
By February, though, inflows just about matched fleeing capital and now more money is pouring back into battered markets. That includes Brazil, where investors are betting beleaguered President Dilma Rousseff will soon be tossed out and her crumbling left-of-centre coalition will be replaced by a more market-friendly government.
The "excessive optimism" about emerging-market prospects in the years following the Great Recession – with China growing at or close to double-digit rates well into the future and Brazil morphing into the next Asian Tiger – "felt a bit overdone at the time … and was," says Neil Shearing, chief emerging-markets economist with Capital Economics. Today, "the pessimism about the imminent collapse of emerging markets is equally overdone."
This doesn't mean Brazil or the other troubled emerging heavyweights are climbing out of the deep holes they have dug for themselves. But it does signal they may have finally hit bottom – without taking the global economy down with them.
"The worst fears that people had coming into this year have not transpired," says Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley Investment Management in New York. "Things have stabilized. The problem is that if you look under the hood, it's still a bit of a precarious situation."
As with most emerging-market developments, good and bad, the source of the welcome stability is China, which resorted to an effective but temporary elixir for its faltering economy – a massive infusion of cash and credit.
"As we know, that really is not something which is sustainable," Mr. Sharma says. "They keep pumping in more and more credit to achieve less and less growth."
Here's a look at how each of the BRICS have been faring in these tumultuous times.
Evaristo Sa/AFP/Getty images
Evaristo Sa/AFP/Getty images
If there was an award for the most disappointing BRICS performance, Brazil would almost certainly win hands down.
Brazil is like a promising athlete, well-endowed with natural gifts and cheered on wildly by an adoring public. Yet, it seems unable to break away from the bad habits, poor lifestyle choices and dismal management decisions that keep it from achieving anything close to its vast potential.
Today, the country is mired in its deepest economic slump since the Great Depression. Gross domestic product shrank 3.8 per cent in 2015. And the outlook for this year is just as gloomy, amid weak export prices, high inflation, and falling business and consumer confidence. Then there is the dark shadow cast by the widespread corruption scandal that has ensnared senior political operatives, state-controlled oil giant Petrobras, and heavyweight construction and engineering companies.
President Dilma Rousseff could be impeached as early as Sunday over an alleged unrelated accounting fraud because she lacks the backing of the one-third of congressional deputies that are needed to fend off the charge. If she is driven from office, she would be replaced by Vice-President Michel Temer, her erstwhile coalition partner. But nearly 60 per cent of Brazilians want him impeached, too.
Optimistic analysts see all this as a healthy sign, particularly if a more pragmatic government emerges that can tackle the country's fiscal mess and get the economy back on a growth track.
But the bears don't see a quick recovery, regardless of whether Brazil can get its political house in order.
After sifting through a century's worth of data, Ruchir Sharma's research team at Morgan Stanley concluded that no key emerging economy is more closely tied to the ebb and flow of world commodity markets than Brazil. When prices are strong, the country's economy thrives; and when they're depressed, so is Brazil.
Everything else – from domestic consumption, manufacturing output and service sector expansion to the corruption headlines – is just noise, Mr. Sharma insists.
"What our work shows is that over the last 100 years, there's been only one driver of growth. And that's commodity prices. There's nothing else in Brazil that raises growth at the margin."
Even under ideal circumstances, Brazilian GDP has rarely climbed beyond 4 per cent, apart from brief spurts. And the country's chronic structural problems, unaffordable social safety net and poor infrastructure could only be masked for so long by the years-long commodity bubble. Once it burst, not even the construction boom associated with this year's Olympic Games could keep the economy afloat.
The good news is that things couldn't possibly get any worse. Or could they?
"Of course, things could get worse," Capital Economics' Neil Shearing says, citing low business and consumer confidence and the strong possibility that the political crisis will drag on for months.
A more market-friendly government could emerge from the wreckage, but it's equally possible that a wave of populism could frighten off investment.
Walter Molano, chief economist with BCP Securities in Greenwich, Conn., argues that Brazil is in a far stronger position than the bears have concluded.
"While much of the emerging markets are withering under the collapse of commodity prices, Brazil is in the midst of an economic revival," Mr. Molano said in a recent commentary.
Citing the country's success in coping with economic adversity and tackling deep-seated corruption, he suggests that "we may no longer need to pine for a moment when Brazil will be one of the guiding lights of the planet, because the future has finally arrived."
But most analysts would still side with Charles de Gaulle, who reportedly once exclaimed: "Brazil is the country of the future … and always will be."
It's safe to say the sliding economy has not exactly been a top priority for Russian President Vladimir Putin, who has done little on the policy front as plunging oil and gas revenues and punishing sanctions have driven the country deeper into recession.
But the fact is the economy was sputtering well before oil prices nosedived and the West imposed trade and investment curbs in 2014 in retaliation for Russia's seizure of Crimea and its provocations in eastern Ukraine. And a sturdy recovery isn't in the cards even if the oil rebound gains traction and sanctions are lifted. Analysts predict both will occur next year.
The economy grew a mere 1.3 per cent in 2013, its fourth successive decline and the slowest pace since the 2009 recession, although crude remained well north of $100 (U.S.) a barrel for much of the year.
"That's when the hammer dropped that the easy ride based on oil had come to an end. And that's been the backdrop to this crisis," says Chris Weafer, a senior partner with Macro-Advisory Ltd. in Moscow.
The latest World Bank assessment calls for growth to resume next year at an annual clip of 1.7 per cent. Private sector estimates are lower, between 1 and 1.5 per cent.
"It doesn't really matter," says Mr. Weafer, who has spent the past 18 years studying the economies of Russia and its former satellites. "An economy like this needs to grow at 3.5 to 4.5 per cent, annualized, for the country to develop."
Without effective market and other reforms, as well as policies and safeguards designed to attract foreign investment and develop such largely neglected parts of the economy as services, manufacturing and agriculture, that kind of growth won't occur.
Still, for all his shortcomings, Mr. Putin has been smart enough to leave monetary policy in the hands of his capable central bank chief, Elvira Nabiullina, and her deputies.
"The Russian central bank has been the most efficient part of the government structure," Mr. Weafer says. "Its actions so far have been both credible and effective."
That includes the adoption in late 2014 of inflation-targeting and a floating ruble, which has kept Russian reserves stable and stands in stark contrast to the situation in Saudi Arabia and a handful of other petro-states.
Another positive outcome of the current fiasco? Plenty of Russians in policy circles now acknowledge that reforms are essential, says Mr. Weafer, who dusts off an old saying that governments do the right thing when they've exhausted all other measures.
Arun Sankar/AFP/Getty Images
Arun Sankar/AFP/Getty Images
The emerging countries whose fortunes depend on commodity exports or manufacturing trade with China have all taken a beating. But those that import much of their energy and other resources, and have limited exposure to the Chinese market and a reasonably vibrant domestic base, ought to be basking under sunnier economic skies.
That certainly seems to be the case for India, the only member of the BRICS club with that formula. While investors stampeded out of other emerging markets last year, they pumped billions into the Indian economy.
The International Monetary Fund forecasts that the country will lead the world with growth of 7.5 per cent this year, compared with China's 6.3 per cent and a 4.3-per-cent average for all emerging markets.
"The collapse in global oil prices is a large windfall gain for India," Paul Cashin, head of the IMF mission for India, said last month after the agency's latest survey. "The windfall has made room for more spending on goods and services, helped improve the external and fiscal positions, and allowed a sharp decline in inflation."
Ruchir Sharma of Morgan Stanley also remains upbeat about his native country's prospects, but warns that it typically suffers from a failure to meet rising expectations. No one has stoked those hopes as much as Prime Minister Narendra Modi, who swept to power two years ago on the promise of cleaner government and major market, land, labour, tax and other structural reforms.
His government launched a successful we're-open-for-business global sales pitch that has lured record foreign investment commitments. But it has largely settled for trimming some red tape and other small steps, rather than the wrenching changes essential to turn the economy into a major engine of global expansion.
In other words, India is not poised to become the next China – except perhaps in one respect. Both produce official data that analysts and investors regard with suspicion.
Nevsky Capital, a London-based hedge fund, cited untrustworthy numbers from China and India for its unexpected decision to shut its doors in January. "Unfortunately, their rise is increasing the global cost of capital because an ever-growing share of the most important data they produce is simply not credible," it said in explaining its move.
Capital Economics pegs India's real growth rate at 6 per cent this year and 6.5 per cent in 2017. Other economy watchers have come up with slightly lower forecasts. Even more than China, India's outlook "is the one that really polarizes people," Neil Shearing of Capital Economics says. "I don't think it is quite as bright as some analysts have suggested."
Nicolas Asfourini/AFP/Getty Images
Nicolas Asfourini/AFP/Getty Images
Most of the world's economy-minders fervently hope Beijing can engineer a soft landing in the midst of a crucial transition to an economy largely driven by domestic consumption and services from one focused on investment and export manufacturing.
China bulls are convinced that if anyone can shift gears so dramatically without stalling the economic engine, it's the current crop of technocrats running the show. But a chorus of pessimists, including prominent hedge fund managers with aggressive short bets, are equally certain that, despite Beijing's increasing reliance on huge stimulus injections, the economy is already heading off a cliff.
Ruchir Sharma of Morgan Stanley, who is firmly in the hard-landing camp, likens China's economy to a Ping-Pong ball bouncing down a flight of stairs. Every time policy makers ease credit conditions or open the public spending taps, the ball bounces up. But the rebounds get smaller with each infusion and the overall direction remains the same.
Backing a big bet against the yuan, financier George Soros declared in January that a hard landing "is practically unavoidable." And famed short seller Jim Chanos has been pouring cold water on the China growth story as far back as 2010, when he declared that the country was on "a treadmill to hell."
The official numbers don't indicate that the economy is in some sort of death spiral. The latest gross domestic product reading released Friday pegged first-quarter growth at 6.7 per cent on an annual basis. That's the weakest quarter since the darkest days of the global recession in early 2009. But it's only slightly below the 6.9-per-cent pace for 2015 and in line with Beijing's target of 6.5 to 7 per cent this year.
The problem is that the figures may not bear much resemblance to reality. Analysts using a variety of other data, including freight shipments, electricity production, steel and cement output and even movie ticket sales, have concluded that the economy likely has been growing at no more than 4 to 4.5 per cent. By China's standards, that is indeed a hard landing.
"Growth has certainly slowed … for structural reasons," says Neil Shearing of Capital Economics. "I think it's going to be permanent. But it's not collapsing."
For China's leaders, though, "the real issue is not the fundamentals, but rather one of credibility," says Benjamin Tal, CIBC World Markets' deputy chief economist. "People woke up to the realization that maybe they're not as powerful as we believed in the past. They will have to labour very hard to regain this credibility."
Mujahid Safodien/AFP/Getty Images
Mujahid Safodien/AFP/Getty Images
As the most industrialized country in a continent that has enjoyed an economic boom for most of the past decade, South Africa should have been perfectly positioned to capitalize on the growth around it.
Instead, the post-apartheid nation has fallen into its worst slump since the global recession of 2008-09. And much of the damage has been self-inflicted – mostly by political leaders who have feuded for power while the economy has sunk into stagnation.
Despite its vast mineral resources, South Africa failed to take advantage of the commodity boom at its peak. With the cycle now stuck in a trough, its loss-riddled mining sector cannot be the engine of growth any more.
South Africa could be manufacturing goods for the rest of the continent, where a new middle class of consumers has emerged. But foreign investors and even domestic entrepreneurs have often chosen to put their money elsewhere, wary of the ruling African National Congress and its toxic combination of heavy-handed labour laws, a soaring government payroll, policy contradictions, internal battles and powerful union allies.
The country does benefit from lower prices for oil, its biggest import item. But that's one of the few bright spots in a stagnant economy plagued by infrastructure woes, low investment rates, weak productivity and high structural unemployment marked by mismatches of skills and jobs.
"Put that all together, and it's pretty grim," says Capital Economics' Neil Shearing.
The economy grew just 1.3 per cent last year – less than the rate of population growth – and is forecast to expand by only 0.8 per cent this year (although some economists believe it has already sunk into recession). This means the unemployment rate, which has been stuck at 25 per cent for years, will remain high. Unofficially, the jobless level is 36 per cent, when discouraged workers are included.
Consumed by politics, the ANC government has failed to undertake the long-term investments in electricity and other infrastructure that industry badly needs. Instead, it bet on resource demand from China, leaving the economy vulnerable to the Chinese slowdown.
The problems have been compounded by the erratic behaviour of President Jacob Zuma, who fired two finance ministers in the space of four days in December. Already dogged by corruption allegations, Mr. Zuma had to endure an impeachment motion in Parliament after a court ruling that he violated the Constitution by refusing to pay back the state funds spent on his private home.
Even the normally cautious analysts of the World Bank took a jab at South Africa's political leaders, assigning them much of the blame for the country's slow growth last year. "A political crisis kept business confidence low and put pressures on the currency," the bank said in a report this month. It noted that South Africa's per capita gross domestic product had actually declined in 2015 for the second consecutive year.
Many analysts predict the major rating agencies will downgrade South Africa's credit rating to junk status this year. Standard & Poor's warned this month that political controversies were "diverting" the government's attention from policy issues.
-Geoffrey York in Johannesburg