The world economy was booming when Goldman Sachs first shone a spotlight on four fast-expanding economies with giant populations – Brazil, Russia, India and China. So how are the Brics faring after the global crisis? Stefanie Eschenbacher investigates.
In 2001, in a widely publicised research paper, Goldman Sachs called for the world to “Build better global economic Brics”. Back then, Jim O’Neill, the bank’s chief economist, prompted what has become a global debate about the opportunities presented by the rapid economic rise of Brazil, Russia, India and China.
But how have the Brics responded to the economic crisis of the past year? A concept that emerged in the midst of an economic boom is not necessarily well suited to a downturn.
Yet since the global crisis shook the world’s economic foundations last year, O’Neill’s call has proven to be correct in more ways than one. The crisis may hasten the rate at which the Brics will overtake some of the world’s largest developed economies and enable the emerging economies to rebuild the global order.
“I don’t think the Bric story was fully credible until it was tested by a crisis,” says O’Neill. In the past, the four countries have benefited from favourable economic and financial conditions. They had, in fact, grown more rapidly than Goldman Sachs predicted either in 2001 or in a later paper in 2003.
Now they are dominating the world growth picture even more than when the global economy was booming. While most of the developed world is in recession, this year the developing countries are generally still growing.
“The centre of gravity of the world economy is moving away from the older developed countries towards the growing economies, especially in Asia,” says Howard Davies, the director of the London School of Economics.
While all four of the Bric countries have been affected by the recession in different ways, in relative terms countries such as India and China have been less badly affected than America and western Europe. Both Asian giants have been, and are likely to remain, the star performers within the Bric universe. They are, on the whole, better placed than Brazil and Russia.
“Were economic growth to resume rapidly in western countries, which still seems unlikely at present, then Russia would benefit through an increase in the oil price,” Davies says.
Gerard Walsh, the regional director for Asia at the Economist Intelligence Unit (EIU), says GDP growth rates in China and India dropped from previous record highs of 13% and 9% respectively. However, both the Chinese and the Indian governments have managed to sustain a staggering level of growth by loosening fiscal and monetary policy.
Walsh says China’s economy was mainly affected by the falling demand for Chinese goods from America and Europe.
“The crisis has made it obvious that China needs to diversify its economy rather than rely on its exports,” he says. “The share of private consumption of GDP needs to increase significantly.” Chinese policymakers were forced to realise that the next step of economic development cannot be achieved by export-led growth.
The EIU predicts China’s economy will grow by 8.1% this year and by 8.5% in 2010. Davies, a former deputy governor of the Bank of England, says China is also in a strong fiscal position. Savings in the public and private sectors have enabled it to undertake a massive fiscal stimulus.
This has helped to offset the decline in export demand. “China’s growth will be sustained because it does have the capacity, if necessary, to adjust policy further,” Walsh says.
Whereas India, where government debt is already high, will have to tighten its policy soon. Walsh says India has to control its fiscal deficit, which is threatening to soar this year.
India’s economy, the EIU estimates, will grow by 5.5% this year and by 6.3% in 2010. India’s growth has been much more domestic in origin. So while the economy has slowed somewhat, says Davies, it is more insulated from international trends.
There have been severe concerns about India’s service sector. But Walsh says the sector did much better than most feared.
In contrast, Brazil was hit much harder than expected. Justine Thody, the regional director for Latin America at the EIU, says that having built strong economic fundamentals, the Brazilian government could address the crisis without putting pressure on its currency.
“Brazil will be one of the first countries to get out of recession,” Thody says. The EIU forecasts growth rates for Brazil’s GDP at 1% this year and 3.3% next year – not nearly as high as in India and China – but Brazil’s large economy is highly diversified: oil and mineral wealth, agricultural power, and a strong manufacturing sector. Its industrial production and manufacturing sectors were hit as global demand dropped. And its commodity sector suffered as prices for its main commodities, iron ore and agricultural products such as coffee and soya, collapsed. Meanwhile, commodity prices have recovered significantly from the record falls seen last year.
Fluctuations in commodity price movements have had a much greater effect on Russia though. Being highly dependent on the oil price, its economy was affected later than most others. Oil prices remained high until the second half of 2008 and then fell back sharply, putting great pressure on public finances and on the rouble.
Nicholas Redman, the economist for Eastern Europe at the EIU, says Russia’s economy is still in difficulty as the rouble and the stockmarket basically track the oil price.
Oil output has stayed more or less on an even keel but manufacturing is in retreat and so is gas production. With global demand for commodities now much lower than a year ago, Russian steel, copper, nickel and aluminium producers have been forced to cut back.
The Russian government acted swiftly and decisively at the start. “On some measures, in proportionate terms Russia was on a par or slightly ahead of even the US or UK in terms of the size of its stimulus plan,” says Redman. “But it didn’t yield any quick results and even now hasn’t had a greatly positive effect.”
The EIU expects Russia’s GDP to fall by 7% this year. Provided that the oil price does not collapse, it may return to a growth rate of 2.5% in 2010.
Two years after Goldman Sachs first wrote about Brics, it predicted that over the next decade the Brics as a whole would be bigger, in dollar terms, than America, Japan, Germany, Britain, France and Italy combined.
Ever since Goldman Sachs introduced this Brics 2050 scenario, two themes have come up repeatedly. Will the Brics make it? And who else might join them?
In “The World and the Brics Dream”, published in 2006, O’Neill wrote that Brazil, Russia, India and China represent the group of countries that have the potential to become central players in the world economy and global policy making.
The case for China and India seemed straightforward, simply because of the basis of their massive populations.
Goldman Sachs did not include Brazil and Russia just because the acronym would fail to be made if they were left out, as has been repeatedly and jokingly suggested, O’Neill writes. These two economies have the potential to be among the most interesting global economic stories and investment themes, he says.
In its initial, 2001, report Goldman Sachs excluded several other large developing countries, such as South Africa, that had the potential to be much bigger economies in coming decades. Other candidates were already excluded in earlier studies because they lacked the potential to become large and important players. For others, fulfilling the conditions was simply an unrealistic assumption.
Even with the collapse of its GDP in 2009 and its rather gloomy outlook, Russia should not be dropped, O’Neill insists. But he adds: “If they don’t recover notably in 2010, then this issue needs to be re-examined.”
The other three Bric countries seem to be already well positioned to overcome the crisis. China keeps getting all the big policy issues right, India has excellent demographics and Brazil’s macroeconomic framework is good.
“Indeed, I think Lula [Luiz Inácio Lula da Silva, Brazil’s president] should probably be regarded as the top policymaker in the world this decade,” O’Neill says.
Even with the economic crisis, Goldman Sachs’ take on the Bric concept has not changed. That of others has.
Redman, for example, long argued that there were two classes of Bric: China and India, then Brazil and Russia.
The first two have more than a billion people each and in recent years have consistently posted dizzying growth rates; performance from Brazil and Russia has been less spectacular and their populations are smaller.
Even though within the past year there was a major multi-year revision of Brazilian GDP data, which revealed that the economy was more dynamic than previously assumed, Redman says his point still holds.
Russia does not have the attributes to be a low-cost manufacturing powerhouse like China, nor a manufacturing and service centre like India. And, Redman adds, it does not, like those countries, have a huge internal market. Property rights are “a mess” and the demographic outlook is “fairly catastrophic”.
Simon Freemantle, a senior economist at the pan-African banking group Standard Bank, says Russia is turning its attention to abundant energy reserves in Africa to ensure medium-term stability.
Some African countries are becoming increasingly important as a support base for the Bric economies’ attempts at engineering a shift towards the emerging south in global economic and political affairs.
Freemantle says renewed diplomatic ties with Africa will allow Russia greater geopolitical clout in its bid to engineer a shift towards what it terms a multi-polar world.
Davies says a combination of South Korea, Thailand, Vietnam and Malaysia is almost as significant in global economic terms as Brazil. “We should not forget that until a decade or so ago we used to talk about the Tiger economies of East Asia. They are still there, and some of them are very competitive indeed, with exciting growth prospects,” Davies says.
The Bric countries are in rather different positions. Yet O’Neill says their relationship has not been changed much by this crisis. If anything it has perhaps been strengthened, as evidenced by them meeting as a separate group. The emergence of the G20 as the core economic grouping that includes Brazil, Russia, India and China has emphasised that change.
The four countries are also trying to translate their growing economic power into a greater geopolitical clout. O’Neill says: “I don’t think it makes sense permanently. When I created the term [Brics], it was deliberately to say they were key bricks missing from the world governance structure.”
With the G20 established, O’Neill says that maybe there is less need for the Bric countries to meet separately. However, until the G7 and G8 cease to exist, he supports the idea of their group meetings.
“All four Bric countries are well placed to play an important role in the G20 in the future, but I think it is unlikely that they will act as an effective bloc,” Davies says.
After all, their political relationships with America and Europe are very different, which is perhaps as important as the differences in the structure of their economics.
While the Brics have attempted to produce a coherent position on some issues, Davies remains sceptical whether the underlying community of interest that would allow them to act as a bloc in future is really present.
However, there has certainly been a long-term shift of economic power to-wards developing countries. The recession has only accelerated this shift.
Stefanie Eschenbacher welcomes your comments at:email@example.com
Bric consumers ‘are the big game’
The collapse of Lehman Brothers one year ago last week plunged markets into turmoil. Investors sold off equities indiscriminately across global markets, including Bric countries.
Michael Konstantinov, the manager of the Allianz RCM Bric Stars fund, used the sell-off as an opportunity to add to high conviction holdings. At the time, he predicted that companies with solid balance sheets and strong cash flows would come out of the crisis in a stronger position than before.
Meanwhile, the Schroder International Selection Fund-Bric, managed by Allan Conway, was already defensively positioned.
Robert Kalin, the manager of the DWS Invest Bric Plus fund, also moved into defensives and held a high level of cash. “This crisis was a lot more nerve-racking and more difficult to deal with than previous ones,” he says. A decent exposure to consumer staples and a slight underweight in financials helped the fund through the worst. Its exposure to energy, however, hurt overall performance. Domestic consumption and infrastructure are the dominating themes in Kalin’s fund.
“The big game going forward is the Bric consumer,” agrees Jim O’Neill, the chief economist at Goldman Sachs. “This is the beginning of the next phase, and it is very exciting.”
Consumer-orientated companies and commodities have also taken the largest part of the Templeton Bric fund. Mark Mobius, the manager, expects commodities to do well as demand rises and the dollar weakens. Rising income levels within emerging market populations hold opportunities for consumer-orientated companies and banks.
Konstantinov favours Chinese financials and real estate. He expects these sectors to be the main beneficiaries of the Chinese government’s efforts to push domestic consumption.
“There have been no changes in our portfolio strategy,” Mobius says. “We continue to seek investment bargains wherever they may appear. Crisis presents opportunities, so at such times there are good opportunities.”
When the Russian market appeared heavily oversold at the beginning of the year, Konstantinov started allocating to Russia, buying stocks in the energy and materials sector. “We are believers of the long-term commodity story,” he says.
Conway recently took on more risk and reduced his fund’s cash level. He used the proceeds to further reduce the underweight in Brazil, where the macroeconomic picture is improving and valuations are reasonable.
Although Kalin agrees that Brazil has great potential, the country is his biggest underweight. “The markets have had a hell of a run,” he says. “It needs a pause. Earnings need to catch up with valuations.”
Some managers say valuations in Russia look attractive. The stockmarket had discounted many problems but the oil price has recently been more supportive. India’s stockmarket looks fully valued and earnings outlook is relatively strong.
Opinions on its neighbouring giant China, however, are divided. Some managers fear that China, in particular its real estate and construction sectors, are over-invested. But the manager of the HSBC GIF Bric Freestyle Equity fund, for example, is still hoping to increase exposure to China.
Alex Tarver, an emerging markets specialist at HSBC Global Asset Management, says the most apparent changes of the portfolio were that China’s weighting was increased. Then, when it performed well, it was reduced to invest in India.
One argument, mainly put forward by global emerging markets managers, is that they find more compelling investment opportunities in other countries. Axa Framlington, for example, launched an Axa World** Fund Talents Brick with a wider mandate to invest in South Korea. Having continuously expanded regionally, the group recently rebranded it into Axa World** Fund Framlington Talents Emerging Markets fund.
“There are far more companies and ideas out there,” says Guillaume De Corbiac, the co-fund manager. “There is no reason why we want to limit our investment opportunities to four countries.”
**Note: Correction made to name of fund, Sep 21.
Fund managers foresee a change in the Bric countries’ role
After having been the darling of the market for years, the Bric concept is starting to show signs of falling out of favour.
While fund managers do expect these four countries to be the main engines of global economic growth, according to Roberto Demartini, an associate director at Standard & Poor’s fund services, Bric funds are increasingly regarded as marketing-led vehicles with high fees and fairly constrained mandates.
Standard & Poor’s latest review of the global emerging markets sector shows that until the first part of 2008 Bric funds continued to attract considerable inflows of investors’ assets. Even the number of these funds in the sector grew.
“However, one view that seems to be gaining momentum among managers is that the role of Bric countries is likely to change in the future,” Demartini says.
In many ways, the concept behind Bric funds was correlated to infrastructure-building. Brazil and Russia were meant to provide resources for India and, in particular, China.
Yet the recent severe correction in commodity prices, coupled with the increase in spare capacity in several of these countries, is likely to lead to a change of focus from infrastructure to consumer-related plays.
Demartini says this might represent more of a problem for countries such as Russia that depend largely on exporting commodities. More recently, as investors have moved back towards risky assets, Bric funds have also had their fair share of inflows.
“The jury is still out on Bric funds,” Demartini says. “They have definitely been a success story in asset gathering and fees.”
Recent returns have been less compelling than global emerging markets funds and, unsurprisingly, volatility levels have been higher.
On average, the number of holdings within emerging markets and Bric funds alike has gone down.
S&P’s sector review also notes that it has become more difficult for fund managers to outperform their benchmark as the four Bric markets becoming more efficient. Fund managers in search of higher returns are therefore increasingly seeking access to frontier markets – first into bigger markets in Asia and eastern Europe, and then into ever more exotic locations such as central Africa, central Asia and central America.
This trend is underscored by the number of fund launches. According to Demartini, among recently launched funds there were more funds investing in the Middle East and Africa.