Saturday, May 24, 2008

The New Economic Order

Bubbles and bear markets are cyclical. But what's different this time around? This time, we have the BRIC newcomers to the party. BRIC is the new fangled acronym for Brazil, Russia, India and China.

BRIC has been playing a highly important role in global economy's growth over the last 7-8 years. This year, Chinese and Indian equities have fallen 30% and 21% in dollar terms respectively. Brazil has gained 7%, Russia matched MSCI world index, falling around 6%.

There is some homogeneity among the BRICs.

At heart, Russia and Brazil are plays on commodity prices, particularly energy while India and China are plays on the ability of countries with low labour costs to grow market share in services and manufacturing divisions. Still as a group, the BRIC plays a highly important role in reshaping the new global economic frontier. By the way, as it stands, BRIC collectively holds about 35% of total global reserves. No joke.

Let's consider a few things they have in common:

a) Huge population – largely owing to globalisation and opening up of economies, outsourcing has ignited the BRIC economies (except for Russia, but that's a whole different story). The lower labour cost saw companies investing in these countries aggressively to lower their production cost. This in turn created a huge new middle class population in BRIC, which in a major way, contributed to the present food crisis as more people could afford better stuff. A richer but substantial middle class has evolved in recent years. This is an important facet of how the economic paradigm is shifting.

b) Drivers and consumers – Again, due to the globalisation movement, these BRIC countries have gained a lot of traction in attracting FDI and reserves. This in turn, generated a lot of projects into real estate and infrastructure spending. They were once drivers of the global economy (by promoting cost savings and production efficiency through outsourcing).

Now that they are wealthier and the governments have better balance sheets, these countries have also become major consumers of goods and services. This another important factor in reshaping the new economic paradigm.

c) Current Account – Brazil, Russia and China are all piling up huge current account surpluses and foreign reserves and their balance sheet look very healthy. They have to contend with excessive growth issues and reducing the inflow of hot money into their currency system. However India sticks out like a sore thumb among the BRICs in that it has a substantial current account deficit. As oil and fertiliser costs go higher, these two items are exacerbating India's deficit problem. However, India still has a high FDI plus their foreign reserves remain high – once either of them gives way, India's currency will start to unravel quickly.

By having a current account surplus, the governments can use forex to contain domestic inflation i.e. by allowing the local currency to appreciate. This is something India does not have the luxury of doing. The looming food crisis will hit India very hard if we were to consider that factor. Hence there are strong reasons to believe that India will be hardest hit among the BRIC nations in facing up to a food crisis.

d) Commodity prices are basically positively correlated to the economic growth of BRIC. There is really no need to have a 100-page dissertation on why commodity prices are currently at stratospheric highs. Sure, there is an element of speculative activity and maybe even a hint of a bubble forming in commodity prices. If you have not heard yet, this year the collective oil demand of emerging markets will exceed that of the US for the first time. That shows the backbone of demand.

But what is also important to note is that many of these emerging market do not really pay for oil. Basically, if growth in BRIC stays from 7%-10% this year and next, commodity prices will continue to be firm – simplistic but probably true.

Between 2000 and 2005, Goldman Sachs estimated that BRICs had contributed some 28% of global growth in US dollar terms, and 55% in purchasing power parity terms. BRIC's share of global trade now stands at 19%, almost double the level back in 2001. What is even more important is that the BRICs trade among themselves a lot more, lending some weight to the decoupling theory.

Back in 2000 intra-BRIC trades made up only 5% of their total trade; the figure now hovers above 11%.The Chinese government shrewdly knows where the action is and a lot of work has been focussed on improving relations with Brazil. In fact, significant results are now flowing through. This will be a big asset when it comes to WTO and Doha negotiations.

Hence, while it is all good and noble to monitor the US housing starts or read Bernanke's mindset or look for leads in US banks recovery, it is probably more important to monitor BRIC's growth trends to get a better read of the macro picture for the rest of 2008 and 2009.

Looming Food Crisis

I have highlighted the looming food crisis as the new monster in the works for financial markets. How BRIC handles this crisis will count a lot towards resource allocation, appearance of market restrictive policies, currency outlook and inflationary outlook – all of which will play key roles in the rating of global equities globally and regionally.

History repeats itself, they will say. In the midst of any bull or bear markets, there will be shouts of “this time it's different”.

Only this time, it WILL really be different. It will be so because there has been a substantial shift in the economic paradigm as evidenced by: the prolonged demise of USD; the rise and rise of BRICs; the massive recycling of petrodollars; the emergence of a substantive new middle class in emerging markets; and the diminishing economic power of the US.

Here's to a new decade of possibilities!

p/s photo: Ella Koon


lsblmllms said...

I tend to concur that the economic powers are different today, where previously its purely advanced countries play. Moreover the coordinated injection of funds by all major powers to ease credit squeezed worries, including China, is a new phenomenon.
However, "The four most expensive words in the English language are, 'This time it's different.’’ -- Sir John Templeton

Salvatore_Dali said...


lol... good memory n a very important quote... thats why I brought up that "quote"... I would not use it without careful thought and I would say that 9 out of 10 times... the quote would apply... but this time I really feel that its diff...

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