The BRICS Turmoil: Reality or Overshooting?

Wednesday, September 4th, 2013

During summer, we have seen – and still see – quite some nervousness about the so-called BRIC countries in the emerging world – and some contagion to a couple of emerging market countries that also try to catch up, like Indonesia and Turkey. Three questions seem to be particularly interesting:

¤ Is the current nervousness about BRIC countries really motivated?

¤ Why do we have these contagion effects to several countries – to some extent similar to developments during the Asian crisis of 1997-98?

¤ Do we currently see the beginning of a real BRIC crisis which may turn much worse and which will also mean a notable downsizing of BRICS countries’ potential (trend) growth?


BRIC is a term that has been coined in the beginning of the past decade by an economist from Goldman Sachs, a major American investment bank. BRIC –nowadays BRICS since South Africa joined the “club” a few years ago – are the initial letters of Brazil, Russia, India and China. I always considered the BRIC(S) thing mainly as a marketing instrument for asset allocation. In reality, these countries did not have enough in common to put all four eggs in one basket. Relatively good economic growth during a couple of years and a large population were simply not enough to “harmonize” analysis and investment strategies for these countries.

By the way, similar simplifications could be recognized already in the latter part of the 1990s when Eastern Europe Equity Funds and Asia Equity Funds were launched as attractive alternatives for investors. At that time, countries with different structural and institutional conditions were put in the same investment baskets, too. This proved to be wrong after some time. BRIC supporters from all over the world could have learnt from these examples.

Many experts see the main reason for the current “BRICS problems” in the expectations of – right or wrong – forthcoming cautiously rising interest rates in the traditional industrial world, especially in the U.S. Such a development could (probably) lead to (further) substantial capital outflows from BRIC countries to North America (the U.S.) and (parts of) Europe, according to the BRICS pessimists.

This explanation, however, is too fluffy. A deeper analysis of the BRICS problems is urgently needed. Are there fundamental reasons for the contagion? Or have we got a new example of overreacting financial markets?    

Let’s first look at possible common characteristics of the four BRIC countries – South Africa is excluded in this context – that may have caused negative feelings about the BRICs as a group.

¤  Portfolio shifts?  More financial inflows to the traditional OECD countries – at the expense of portfolio investments in emerging markets because of expected gradual, cautious monetary tightening by mainly the Fed  (with the assumption that the four above-mentioned, leading emerging markets are running the highest outflow risks)
–> could partly serve as an explanation because the four above-mentioned BRIC countries represent the economically four most important emerging economies.

¤  Substantial slowdown in GDP growth?   A rapid weakening of GDP could actually been noted in only two BRIC countries during the past year – in Russia and in India. Brazil even stands for growth improvements four quarters in a row after a couple of growth stimuli.

The last GDP-growth numbers for the BRIC countries look as follows:

Brazil:    2013, q2: 3.3%;    2012, q2: 0.5%         –> coming down from around 9% in early 2010

Russia:  2013, q2: 1.2%;     2012, q2: 4.3%        –> coming down from roughly 5% in early 2010

India:    2013, q2:  4.4%;    2012, q2: 5.3%         –> compared with about
9% in early 2010

China:   2013, q2:  7.5%;    2012, q2: 7.6           –> compared with about 10% in early 2010

Obviously, GDP growth has not developed simultaneously in all BRIC countries in the past few quarters – but more visibly on trend during the past 3-4 years. This is indeed true for all BRIC countries.  This development strengthens the view that more positive growth signals that currently come from the U.S., Japan and some European countries to a high extent more strongly triggered the worsening cyclical view of financial investors on BRIC countries than any other single factor. But looking at GDP-growth developments since 2010 gives also certain reasons to find structural components in the now more dampened growth outlook for BRIC. Thus, we have
–>  an obvious  cyclical BRIC phenomenon combined with certain negative structural components (like, for example, demand from Southern Europe) – and not a pure structural problem.

¤  Current account problems?   Current account deficits are frequently used explanations for the problems of the BRICs – and the need for foreign capital inflows for financing these deficits. But only India has a (somewhat) too high deficit ratio in relation to GDP (around -4.5-5% in 2013).  Brazil’s predicted deficit in the range of 3 ¼ – 3 ¾ % for 2013 is a little bit high but should not be as scaring as markets consider the entire BRIC situation. China and – probably – Russia should even continuously manage current account surpluses which takes us to the conclusion
-> that current account problems should not really be considered as a major common problem for all the four major BRICS countries. From this point of view, the contagion effects that have been created by global financial markets, seem to be overdone. But they exist!

¤  Insufficient fiscal stability?  Public debt – annual and total – is, of course, an economic indicator that all country analysts watch very carefully. In this respect, Russia and – probably – Brazil seem to have their structural fiscal conditions roughly under control. China seems to be on the safe side for the time being – at least when official numbers are analyzed (about which, unfortunately, one may have serious doubts). India finally has been affected by negative fiscal developments since a long time ago. Thus, the question is
–> why well-known fiscal conditions – which are not really bad in all four BRIC countries – suddenly should lead to general worries on global financial markets. We probably can find psychological explanations in this respect. This urges for deeper analysis.

¤  Lagging structural reforms?  Sure, all emerging countries have more or less burdening structural or fundamental shortcomings. What concerns Brazil, one may mention, for example, insufficient productivity gains and declining international competitiveness, lagging education and pension systems, etc. Furthermore, Brazil is nowadays increasingly competing with – currently – a more reform-minded and economically improving Mexico. Russia suffers from a significant number of institutional deficits – the financial system and support of entrepreneurship included – a too large role for the government/state in the economy and a too high dependence on the energy sector.

India, on the other hand, has more obvious fiscal problems than Brazil, Russia and China and more growth-impeding infrastructural shortcomings which are – also according to my own micro experience from these countries – much more serious than in the three other large emerging countries. The same conclusion can be made about the Indian current account deficit. Last but not least China. Nobody questions that China’s economy has proceeded substantially in the past two decades or so. But we know also that China despite all economic progress still suffers from lots of structural shortcomings particularly when it comes to microeconomic and institutional conditions – unfortunately combined with worrying transparency shortcomings.

Putting together the reflections of the above-mentioned structural thoughts means that structural shortcomings exist in all four  BRIC countries  
but without strong logical correlation for motivating sudden distortions and disappointment for the BRIC region as a whole as we have seen in the past months.    


In my opinion, the recent negative pressure from global financial markets on the artificial BRIC group – South Africa is excluded in this analysis – should not be considered as the result of a completely consistent and logical approach. Several factors point also at psychological overshooting. Common issues for all four BRIC countries are the insufficient demand for their exports, mainly caused by weak global demand – an issue that probably is characterized by both cyclical and structural dimensions – and the expected future monetary tightening in the U.S.

I have also found that several negative macroeconomic indicators do not point at the same degree of imbalance in all four BRIC countries (if at all).Consequently, it can be singled out that certain psychological overreactions are/were in place.

For this reason, I would argue that current developments have re-set the previously overdone BRIC enthusiasm – to some extent the result of artificial financial marketing – to a more justified stance of growth expectations (without considering the issue of the middle-income trap). This should induce some reduction of previously exaggerated expectations of BRIC countries’ potential GDP growth – but probably less dramatically than described in many recent analytical pieces. Again: Almost all countries have their own characteristics. This makes it most doubtful to put several “(emerging) country eggs” in one single analytical basket.

However, occasional negative contagion effects from one country to another will most probably be inevitable in the future as well. Here we have another example that clarifies the need for more research in behavioral finance.

Hubert Fromlet
Visiting Professor of International Economics, Linnaeus University
Editorial board


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Russia Enters Calmer Waters

Wednesday, February 6th, 2013

Last winter’s demonstrations in Moscow and elsewhere have more or less died out. This is an expected outcome as this non-movement always lacked of a leadership. Neither did it have any common program beyond the goal “Putin out!” But nature and society alike abhor a vacuum: there was no answer to that question. Polls claim that those participants that had any political identity divided quite evenly into nationalists, communist and new leftists and modernizers. The last ones are routinely called liberals in outside media. That is a problematic piece of terminology, because in Russia even self-nominated liberals are often supporters of a strong state.

This is not the end of opposition in Russia. There will be re-births and new declines. Part of the lesson should have been learned already of the Arab Springs. One can call together demonstrations through social media, but nothing compensates repeated face-to-face contact in building a genuine political movement. It has to be an organization. And Russia lacks the Muslim Brotherhoods and traditionally politically active armies in place to fill the organizational vacuum left by the street demonstrations.

The regime in power continues to put out potential bush fires. This and that visible oppositional is put in front of court and very probably condemned in due course. Foreign aid to NGOs is squeezed out and other barriers to cross-border contacts will be established. Some Russians vote with their feet and many more at least consider the possibility. But on the level of large-scale politics the regime sits tight – for the time being at least. At least three large dangers loom.

The first one is complacency. It has economic as well as political roots. The macroeconomic situation of the country is better than perhaps ever before. Economic growth is a multiple of most European levels, unemployment a fraction of some. Inflation is lower than ever in independent Russia, official reserves are as high as they have been. Both investment and consumption grow faster than aggregate production. Both the budget and current account have a surplus.

This is a dangerous situation, as the Russian policy advice consensus is right when it calls for profound but at the same time difficult decisions. The low hanging fruit of systemic change were picked years ago, though they continue to impact the society now and in the future. Neither can one count on continuous growth in export. On the other hand, a collapse of them – even of gas prices – is not in the cards.

Typically the decisions now ahead are difficult, socially divisive and without a ready-made recipe. Russia is not alone in this respect. Pension reforms are nowhere particularly easy. No political regime finds it easy to allocate scarce resources between social needs, much needed infrastructure investment and military outlays. Preparing for demographic change is a common European challenge.

The regime should also be able to control itself. Though statistics are inevitably murky, corruption is widely seen as the big problem faced. There is a fair possibility that Vladimir Putin is finally serious about fighting corruption. He is also ready to call it a systemic feature of his country, and thus also of his own regime. If the former Defense Minister Serdyukov actually goes to court, a leaf in Russia’s history has turned. There was no necessity for doing that: a dismissal with lukewarm thanks would have sufficed.

But if that is the case, the Putin regime has to be able to control the Pandora’s box. In a society where so many people reportedly have files of negative material on so many others, a war of everybody against all would be easy to ignite. And when there is no political opposition or alternative society ready to take and use power that would be a recipe for catastrophe.

Finally, though new goods and services have flooded Russian markets, export-wise Russia remains as dependent on energy and other commodities as before. Being rich in resources is glorious, but they cannot continue maintaining an economy which is growing. Measured – as it should – in constant prices the share of the wide energy sector in Russia’s GDP peaked at about thirty per cent. It has already declined, and may well reach ten per cent in a couple of decades. This at least is what the Russian experts say, and the policy makers seem to concur.

This is a tall order and must imply a new kind of integration in the world economy. The first months of Russia’s membership have shown that Russia tends to be more apt in defensive than offensive measures. The country is testing the limits of what WTO membership allows in terms of protectionism and such. Established members are testing the limits of Russia’s resolve.

But that, naturally, was fully to be expected.





Pekka Sutela
Nonresident Senior Associate Carnegie Endowment, Washington D.C. & Visiting Professor at the School of International Affairs, Paris


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How the Euro Connection could Boost Russian Asset Prices

Wednesday, October 3rd, 2012

One of today’s puzzles is the low valuation of Russian equities. On average, these cost just 6 times the expected profits of 2012, while Canadian stocks trade at 15 times earnings and Norwegian stocks at 12 times, to mention just the two commodity producing countries which lie in the same climate zone. The message from the price-to-book ratios is similar: if a company is attractive for investors, the ratio should be well above 1. But Russian stocks average only 0.85 whereas Canadian and Norwegian stocks trade at 1.85 and 1.58.

Creating conditions that bring valuations on par with those of other stock markets would do wonders for the country’s spending on capital goods, including foreign direct investment, the growth rate of real GDP and thus for the standard of living.

One way to achieve this is to create an institutional framework similar to that of the democracies of Western Europe. This is just as important as broadening Russia’s production base and reducing its dependency on raw materials. Indeed, a comprehensive and state-of-the-art institutional framework is probably the precondition for that sort of structural change. Economists emphasize more and more the role of institutions in development, such as independent courts, media, regulators and central banks, a fair and efficient tax system, genuine opposition parties which have a reasonable chance to oust the existing government in secret ballots, an incorruptible bureaucracy, good and affordable kindergartens, schools and universities, a well-maintained infrastructure, and so on.

Russia has serious deficiencies in all these areas and pays the price in the form of undervalued equities and real estate. In spite of its enviable endowment with natural resources it is an unnecessarily poor country.

One approach to improve things is to use the European Union’s “Acquis communautaire” as a guide for institutional reform. Norway and Turkey, very successful economies for some years now, have done this – without being members of the EU. The Acquis covers the EU Treaty, the whole body of laws, decrees and guidelines passed by EU institutions as well as the judgments of the European courts. These are binding for all 27 countries, and new members have to fully adopt them. Dauntingly, the complete edition of the text comprises 31 volumes and more than 85,000 pages. Cyprus and Malta have been able to do it, so Russia’s civil service could certainly do it as well.

For years, Russians did not care much about institutional reform. They were able to increase their spending at a higher rate than production, as export prices have outpaced import prices. The general feeling is that the standard of life continues to improve. Since this is not accompanied by political and institutional progress, the rising middle classes are getting restive, demanding a bigger say in the country’s decision making process.

To rely on ever higher commodity prices is not a sustainable growth model in any case – prices will certainly not go up all the time. Every so often they crash and cause havoc in the rest of the economy. The 8 per cent decline of Russian GDP in 2009, the 80 per cent fall of stock prices between mid and end-2008, the 36 per cent depreciation of the rouble against the dollar during that time, and the collapse of the real estate market were direct consequences of the crash of raw material prices, in particular the oil price which imploded from $146 to $35 in just half a year. To this day, markets are not yet back to pre-crisis levels.

If Russia had more robust institutions and took the rule of law seriously, investors would demand lower risk premiums for holding shares of companies and government and corporate bonds – which is another way of saying that asset prices could be much higher, and the cost of capital correspondingly lower. A big increase in capital spending is needed to wean the country from its reliance on commodities. China’s impressive growth model has at its core very high saving and investment ratios. Anything that helps to boost these must have top priority for policy makers. Right now, the value of Russia’s firms that are traded at the stock exchange is about 19 trillion roubles (€465bn).

If the government could credibly show that it will launch an institutional reform process on the basis of EU standards, this number could easily double, cutting the cost of capital expenditures by one half. Perhaps more importantly, Russia would become a more normal country where people like to live, rather than trying to emigrate.






Dieter Wermuth
Chief Economist & Partner, Wermuth Asset Management


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