Once again on financial channels we see calls of India being the least preferred of the BRICs, at least economically (which leads inevitably to stock market calls) - it tends to happen every time the equity market fails to perform in tandem with the expectations of some expert or the other. This is despite the fact that the market had a good 2012 and despite a shaky start to the year, the Sensex is still outperforming China, Russia and Brazil in dollar terms at the time of this writing, though by a smaller margin. We are finding it hard to understand what's to dislike about an economy that is bottoming out and is heading into a cyclical upturn that can easily turn structural if the reform momentum continues relative to its peers (which the BRICs concept has bunched it in). All Emerging and growth countries have suffered cuts to their economic performance and growth outlooks. While India will recover from its self-inflicted wounds (and those that are collateral damage from slowing demand in the developed world), it helps to look whether the same can be said about the rest of the large EMs . Here is the big picture.
Brazil
For sometime, my thought was to define Brazil's current (and foreseeable) state of economy as 'being struck by the Indian malaise', however it is easy to overlook the fact that Brazil has been in a situation of no to low growth and very high inflation for most of its existence. In fact, it is India's current state that can more aptly be referred to as 'a touch of Brazil'. Brazil's latest annual GDP print was a meagre 0.87%.
A look at Brazil's net exports is telling. The country is known for - and to a significant extent, reliant on - its natural resource export prowess. However, the current account balance is widening and rapidly touching new lows. It is no surprise that it has toned down its rhetoric of 'currency manipulation' and is now wanting a stronger Real to counter its rising inflation. Something it is unlikely to get, despite the fact that 2012 was already a poor year for the BRL.
Brazil is in a bit of quandary trying to shore up its growth despite giving repeated stimulus which has led the fiscal balance turn to a deficit too (the budget still has a primary surplus). The link between the fiscal and current account deficits and inflation is well know. The problem is complicated by the low unemployment rate (despite its recent rise) which is one of the bright aspects of the economy. However, it is portending excessive demand leading to an even stronger inflation cycle. A further slowdown is imminent unless we see external support for the economy, especially from China for its exports. That may not be easy to expect, especially in the medium to longer term.
Brazil is an economy led by consumption. Household consumption accounts for over 60% of Brazil's GDP and government consumption adds in excess of 20%. With total consumption of over 81%, savings are minimal and capital formation stands at just over 19% (which is much better than the beginning of the century but nowhere close to the Asian savers). Just like we have seen in India, the rate of capital formation in now slowing down relative to consumption, which again is a negative for future growth.
Without the aid of demand from China, it is hard to see Brazil come out of its growth decline in any significant measure. There is possibility of continued stimulus, but it would need more focus from the government on creating infrastructure and work on moving Brazil away from its reliance on primary commodities (rather than just provide tax incentives to businesses) in order to create more sustainable growth and lower inflation environment.
Russia
Russia's political and economic environment stands in the way of many investors considering a longer term commitment to investing in the country. It's economy is even more one sided than Brazil, purely dependent on natural resource exports. Russia neither has the demographics nor the diversity of opportunity set that would attract continuing investor interest and thus becomes the most cyclical of economies and markets in this group. Such is Russia's vulnerability and GDP volatility, that for the quarter of June '09, the real GDP contracted a whopping 11.2% annualised (source: Bloomberg). Russia had the worst economic decline among BRICs during the recent crisis and it took far longer to recover. None of the other large EMs saw a contraction of this magnitude (Brazil suffered a 2.7% contraction in the March qtr of that year). With this context it is hard to see the overall economic structure of Russia as 'stable'.
Once again we see a similar trend of falling current account and worsening of the external balance. Russia's export composition of natural resources and defence equipment is not suited to a world lacking demand and lacking spending capacity on new arms. With net exports falling, household consumption has been the one taking up the slack. Stagnating exports are being met by a steep rise in imports of consumption goods even gross capital formation has been stagnant for many years. It is not surprising to see the comeback of inflation, which the latest figures suggest reached 7.3% for February. Russia is being hard pushed to find sustainable avenues for growth in a weak global economy. It lacks policy impetus, has lopsided distribution of wealth and ownership of businesses and constantly struggles with providing an environment for entrepreneurship to thrive (in fact entrepreneurship, despite the show of government efforts, appears to be consistently discouraged). With our expectations for commodity prices to weaken over the coming years and Russia's continued struggle with capital flight, it might soon find itself struggling for attention in global space.
China
China always poses a conundrum. It is an economy that in investors' mindset occupies a large space in between two extremities - one that says it is a massive investment bubble about to collapse (see this viral 60 Minutes clip on China's ghost cities and many other that have been done before) and the other that relies on an enlightened government guiding the economy to the path of continuing high growth. That high growth has come in doubt and is no longer sustainable is true. Even the outgoing Premier of China issued a warning with the declared 7.5% growth target that this number will be difficult to achieve. Add to that the desire of the government to rebalance the economy and help growth through spending leading to a rising fiscal deficit (targeted at 2% for this year). Inflation is rising (but fed by food costs than manufacturing), but remains below the target that the government has set for the year.
The reality is always somewhere in between these extremities The past 3 years have seen China grow robustly, but growth dropping from the 11% to 12% range it was averaging before the crisis to 7.9% as of 4Q 2012. The drop is definitely less worse than India but not by much for a country that is consistently being considered as one to emulate. China significantly increased its investment rate post crisis to aid this growth even as contribution from the external sector declined (India's capital formation rate actually fell post the financial crisis).
China remains the most robust as to its external situation but the worsening of this balance is not insignificant. It is largely because it was one of the biggest beneficiaries of the pre-crisis consumption booms and the CA/GDP ratio seems to show a return to a more 'sustainable' pace. The word sustainable here is used with caution; China continues to follow largely mercantilist policies, but it is no longer guaranteed that it will stay this way - the need to rebalance the economy, the rising cost of production and currency appreciation pressures (though lessened) will continue to put pressure on the current account. It will also continue to face demand pressures from Europe, which is a very significant export market. The wildcard is imports - if the rebalancing towards consumption is pursued, imports will rise significantly. This, though desirable, will also require a rethink from investors on how to invest in China. In the near term, a stabilising globe is good for exports.
Most announcements by the Chinese government and their analysis leads me to conclude that economic growth may trend higher, but not on the basis of rising consumption but an even further rise in investment, which can still be funded easily because the savings rate is higher than the investment rate. The expectation is that the stimulus will be more targeted to avoid the excesses of the previous stimulus raises doubts as to how much lift can come from here. Undoubtedly this spend will come from the SoEs, which have shown rising savings so questions as to the efficiency of this spend and the benefits to the wider economy will remain. Ultimately, how sustainable can a continuous rise in investment spend and its contribution to GDP be? An investment spend to increase capacity, overcome supply constraints and increase efficiency should lead to higher consumption, but such a change has not taken place in the last decade and a half. China represses household savings and now with a clamp down on Real Estate speculation, it is possible to see some of those savings go to a depressed equity market. The longer term reorganisation of the economy may take more than a generation - an ageing China risks turning into a nation of perpetual savers and exporters of capital, like Japan.That, as mentioned, is for the longer term.
In conclusion, in the shorter term the economic outlook looks much clearer for China than Russia or Brazil.
How is this relevant to investing? The above is not an exercise to point to out attractive or unattractive growth opportunities for equity investors, rather at understanding the economic risk premium - something that will factor into the discount rate projections of global investors in Emerging (or Growth) markets. In the near term, China appears to offer the lowest forecast economic risk premium. Growth in China is unlikely to pull growth substantially in Brazil or Russia and the quantum of investment spend is unlikely to have a substantial pull on commodities. However, the risks in Russia and Brazil are relatively high. India offers the largest reduction in economic risk premium as the CAD and fiscal deficit come down, growth rebounds and rates fall further. This should provide stronger support to valuations than in B, R & C.
Brazil
For sometime, my thought was to define Brazil's current (and foreseeable) state of economy as 'being struck by the Indian malaise', however it is easy to overlook the fact that Brazil has been in a situation of no to low growth and very high inflation for most of its existence. In fact, it is India's current state that can more aptly be referred to as 'a touch of Brazil'. Brazil's latest annual GDP print was a meagre 0.87%.
A look at Brazil's net exports is telling. The country is known for - and to a significant extent, reliant on - its natural resource export prowess. However, the current account balance is widening and rapidly touching new lows. It is no surprise that it has toned down its rhetoric of 'currency manipulation' and is now wanting a stronger Real to counter its rising inflation. Something it is unlikely to get, despite the fact that 2012 was already a poor year for the BRL.Brazil is in a bit of quandary trying to shore up its growth despite giving repeated stimulus which has led the fiscal balance turn to a deficit too (the budget still has a primary surplus). The link between the fiscal and current account deficits and inflation is well know. The problem is complicated by the low unemployment rate (despite its recent rise) which is one of the bright aspects of the economy. However, it is portending excessive demand leading to an even stronger inflation cycle. A further slowdown is imminent unless we see external support for the economy, especially from China for its exports. That may not be easy to expect, especially in the medium to longer term.
Without the aid of demand from China, it is hard to see Brazil come out of its growth decline in any significant measure. There is possibility of continued stimulus, but it would need more focus from the government on creating infrastructure and work on moving Brazil away from its reliance on primary commodities (rather than just provide tax incentives to businesses) in order to create more sustainable growth and lower inflation environment.
Russia
Russia's political and economic environment stands in the way of many investors considering a longer term commitment to investing in the country. It's economy is even more one sided than Brazil, purely dependent on natural resource exports. Russia neither has the demographics nor the diversity of opportunity set that would attract continuing investor interest and thus becomes the most cyclical of economies and markets in this group. Such is Russia's vulnerability and GDP volatility, that for the quarter of June '09, the real GDP contracted a whopping 11.2% annualised (source: Bloomberg). Russia had the worst economic decline among BRICs during the recent crisis and it took far longer to recover. None of the other large EMs saw a contraction of this magnitude (Brazil suffered a 2.7% contraction in the March qtr of that year). With this context it is hard to see the overall economic structure of Russia as 'stable'.
China
China always poses a conundrum. It is an economy that in investors' mindset occupies a large space in between two extremities - one that says it is a massive investment bubble about to collapse (see this viral 60 Minutes clip on China's ghost cities and many other that have been done before) and the other that relies on an enlightened government guiding the economy to the path of continuing high growth. That high growth has come in doubt and is no longer sustainable is true. Even the outgoing Premier of China issued a warning with the declared 7.5% growth target that this number will be difficult to achieve. Add to that the desire of the government to rebalance the economy and help growth through spending leading to a rising fiscal deficit (targeted at 2% for this year). Inflation is rising (but fed by food costs than manufacturing), but remains below the target that the government has set for the year.
The reality is always somewhere in between these extremities The past 3 years have seen China grow robustly, but growth dropping from the 11% to 12% range it was averaging before the crisis to 7.9% as of 4Q 2012. The drop is definitely less worse than India but not by much for a country that is consistently being considered as one to emulate. China significantly increased its investment rate post crisis to aid this growth even as contribution from the external sector declined (India's capital formation rate actually fell post the financial crisis).
China remains the most robust as to its external situation but the worsening of this balance is not insignificant. It is largely because it was one of the biggest beneficiaries of the pre-crisis consumption booms and the CA/GDP ratio seems to show a return to a more 'sustainable' pace. The word sustainable here is used with caution; China continues to follow largely mercantilist policies, but it is no longer guaranteed that it will stay this way - the need to rebalance the economy, the rising cost of production and currency appreciation pressures (though lessened) will continue to put pressure on the current account. It will also continue to face demand pressures from Europe, which is a very significant export market. The wildcard is imports - if the rebalancing towards consumption is pursued, imports will rise significantly. This, though desirable, will also require a rethink from investors on how to invest in China. In the near term, a stabilising globe is good for exports.
In conclusion, in the shorter term the economic outlook looks much clearer for China than Russia or Brazil.
How is this relevant to investing? The above is not an exercise to point to out attractive or unattractive growth opportunities for equity investors, rather at understanding the economic risk premium - something that will factor into the discount rate projections of global investors in Emerging (or Growth) markets. In the near term, China appears to offer the lowest forecast economic risk premium. Growth in China is unlikely to pull growth substantially in Brazil or Russia and the quantum of investment spend is unlikely to have a substantial pull on commodities. However, the risks in Russia and Brazil are relatively high. India offers the largest reduction in economic risk premium as the CAD and fiscal deficit come down, growth rebounds and rates fall further. This should provide stronger support to valuations than in B, R & C.
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