End of the line for the BRICs ?

Il se confirme que la croissance des BRICs (Brésil, Russie, Inde, Chine) s’essouffle, avec des conséquences négatives sur toutes les économies du monde, écrit Andrea Goldstein, dans un article pour Aspenia, le site de l’Institut Aspen Italie.

What initially appeared as an annoying possibility is now being confirmed by solid figures : the BRICs – Brazil, Russia, India and China – are slowing down. According to Goldman Sachs, they contributed over 50% to global growth over the past three years, compared with an average of 27% over 2000-07. This time around, their weaker domestic demand and slower growth are contributing to the degradation of the world economy.

Why is the outlook worsening ? Much attention is focused on China – and it could not be otherwise since it accounts for well over half of the BRIC combined GDP. Earlier this month, the country’s National Bureau of Statistics reported that it had grown just 7.5% in the second quarter of 2013, the slowest pace in more than three years. Released only a few days after the end of the period, never subject to any revision, and approved by the Politburo and the State Council – it is easy to show skepticism regarding the official NBS number. There was a famous WikiLeaks cable in which now-Premier Li Keqiang told US diplomats that he doesn’t even look at official GDP numbers. Instead he looks at more concrete numbers, like rail cargo shipments, energy consumption, and credit expansion. And this “Li Keqiang index” suggests that the Chinese economy is now below the low point it hit in 2009, when the official GDP was reported as 6.5% and some people even felt the economy was in recession.

Only first quarter data are available for the other countries, but they are more reliable – although they hardly paint a rosier situation. India has recorded its worst GDP growth in a decade : in January-March it hit 4.7% and overall growth for the fiscal year ending in March dropped from 6.2% last year to 5% in 2012-13. Growth rates were nudging towards 10% between 2005 and 2009 and optimism was widespread. Brazilian GDP growth, for its part, disappointed once more at just 0.5% compared to the previous three months, and is likely to continue to do so. Figures from the central bank showed a 1.4% month-on-month contraction in May. Russia’s economy expanded by 1.6% in the first quarter, the slowest since 2009, and represented a decline in year-on-year growth from 3.4% in 2012 as a whole. The Federal Statistics Office’s breakdown of production showed a sharp decline in output of mineral resources, confirming anecdotal evidence that Russia’s metallurgical sector is having a rough time as demand and prices slide.

Underlying these dynamics are both global and domestic factors. Slower economic growth in China and falling commodities prices have worsened the outlook for Brazil and Russia, while India has been more affected by the EU recession. Stubbornly high inflation at above 8% and 6.5%, respectively, add to India’s and Brazil’s problems and depress consumer spending. Failure to invest in infrastructure, especially in the power sector, can be also blamed for the current decline in Brazil and India, while in Russia, investors are increasingly concerned with the quality of the judiciary and the defense of property rights.

China, on the contrary, has hit the limit of ramping up industrial investment to sustain its export-led growth model of the last 30 years. The unbalanced model that turned China into the second-largest economy in the world – use cheap labor to export, suppress domestic consumption and channel as many resources as possible into investment – is not working anymore. Nowadays, it is very difficult for the rest of the world to absorb those imbalances. And Chinese society, after many years of trading off the lack of civil rights for fast economic growth, aspires to a new development based on higher salaries, better quality of life and freedom of expression.

This is not so dispute that the high-end muddling through of the past few years seemed to work. China responded to the post-2008 falloff in exports by engineering a monetary stimulus which in turn saw the investment share of GDP rise from 43% to almost 50%. But building infrastructure, houses and factories without a demand from within China only aggravated the imbalances, adding an internal one to the external one. Overcapacity is massive in certain industries, such as ship-building and the solar sector, with similar pressures mounting in steel and aluminum. Underused high-speed rail lines and airports are numerous, to say nothing of Olympic-sized stadiums without a home team. Returns are diminishing fast and the financial system is weakened as a result. And yet, between October 2012 and March 2013 credit expanded by around $1.6 trillion, with about half of that lending coming through “shadow” investment vehicles, which promise high returns and where it is not clear who bears the risk. They are now paying out from money coming in, rather than from the return on their assets, and likening these vehicles to Ponzi schemes is not far-fetched.

The soft patch in the BRIC’s economies is forcing authorities to do something to stimulate growth, but the pace at which policy makers take any meaningful steps is uneven. Brazil cut overnight interest rates for the seventh time, India is slowly removing restrictions on foreign direct investments, and calls have also mounted in Russia for lower interest rates to give the economy a lift. More could be done to focus on top-priority development projects, but no BRIC can keep raising public spending for ever.

Trying to adjust toward more balanced growth is now the top priority for the Chinese leadership. This means first and foremost introducing more market discipline, rewarding banks and companies if they generate a return and not only when their investment adds to GDP growth. Directing more resources to services and the competitive segments of the economy would sustain wage and consumption. Obviously such a correction – no more bailouts and endless credit to paper over bad loans, a process of creative destruction instead – would generate winners (many, but unable to make their voices heard) and losers (fewer, but very powerful and capable of lobbying with the authorities). But the longer such reform is put off, the harsher it will be for China – and henceforth for the rest of the world.

Taking a more granular view of emerging markets makes it possible to identify significant opportunities within them. In the future, as BRIC countries downshift to lower growth levels, they may lose their shine to smaller emerging economies. Bright spots can be found in Southeast Asia (the Philippines, Indonesia and Thailand) or Latin America (the Pacific Ocean markets such as Mexico, Chile and Colombia). There will still be emerging markets and significant opportunities within them. Yet, while they seem to offer an attractive alternative to their massive-sized predecessors, these economies remain much smaller than the BRICs and are also vulnerable to a China “hard landing” scenario. The BRICs are here to stay.