Recent growth and inflation figures spell bad news for the Brazilian economy. You would normally associate inflation as a consequence of higher growth rates but this looks like potential stagflation – stagnant growth and inflation. Although it is not as threatening as the stagflation era of the 1970’s, one wonders how the economy will get on hosting the World Cup and the Olympics games. You would have thought with these forthcoming events that economic growth would be generated with the huge infrastructure development required.
Here is a recent chart from The Economist. This is the first data on inequality to come out of China for 12 years – remember 0=perfect equality and 1=perfect inequality (all the income is earned by one person). It seems that poorer countries like South Africa, Nigeria and Brazil have benefitted from growth over the last few years but it hasn’t trickled down to lower income groups. As well as being better off Japan and Sweden seems to be more equal societies as opposed to India and China where most people are equally poor.
With the CIE A2 Paper 4 exam approaching I thought it would be useful to update what is happening in the BRIC countries – remember developing countries is a popular area that is examined. I was very fortunate to attend the Tutor2u 10th Anniversary Conference in June this year where one of the keynote speakers was Jim O’Neill of Goldman Sachs who coined the acronym in a 2001 paper entitled “Building Better Global Economic BRICs”.
The BRIC’s are struggling hard to ease policies and maintain economic growth in the face of a slowing global economy not of their own making. Although you might think that these rates are high in a developed nation for these 4 developing countries growth rates need to be maintained at much higher levels in order to keep apace with the factors of production that are coming on stream.
One of the reasons for the slowdown is the economic situation in Europe and the downturn on the USA followed by their own uncertainty associated with the coming fiscal cliff. There are also consequences of the BRIC slowdown are on the commodity market. BRIC countries were the reason behind the economic growth in the past decade, which meant they had a great affect on commodity prices. As economic growth decelerates rapidly in these countries, so does energy and commodity demand. Downward pressure on oil prices and other key commodities, such as copper, are likely to continue until one can be sure that the growth trend in the emerging market countries is moving higher again. We are not at that stage yet. BRIC nations, in their own
Other reasons for the growth slowdown is the ever worsening economic situation in Europe, followed closely by the general lack of economic leadership and market confidence coming from the aging industrial countries. One cannot, however, lay all of the economic challenges in the BRIC countries at the doorstep of Europe’s debt crisis and the massive policy uncertainty associated with the coming fiscal cliff in the US.
BRIC currencies represent high-risk, high- return carry trades, due to the near-zero level of interest rates in the U.S., Europe and Japan compared to the much high rates in the emerging market world. When BRIC currencies start to appreciate it will be a sign of confirmation of two important new trends.
1. A necessary, but not sufficient, condition for BRIC currency appreciation is that the global deleveraging process is abating.
2. To complete the scenario, economic growth and the ability to attract capital needs to return to the BRICs.
Source CME Group Market Insights – 25th July 2012
BRIC’s in 2011 – Source: The Economist – 29th Sept 2012
Just completing the Unit 6 of the A2 course and updating my notes on the current issue of debt hangover from the Global Financial Crisis. The FT recently reported that there are worrying signs of private sector credit in emerging economies.
Turkey Brazil Russia - private sector credit in year to April 2012 up 20%.
China – private sector credit in year to April 2012 up 15%.
Poland – private sector credit to GDP 49%
This is seen as inevitable if an economy is going to grow but there needs to be investment in capital which will ultimately increase a country’s productive capacity and long-term development. However a lot of this borrowing has gone into consumer goods rather than capital infrastructure projects. This is especially worrying in Brazil as the transport system needs a major overhaul if it is going to cope with the demands of the Olympic Games in 2016. According to the FT misdirected credit can produce two damaging consequences:
1. When too much money is directed into the housing market bubbles can occur – subprime for instance and more recently China.
2. Poor credit allocation can harm economic growth, both in the short and in the long term.
Although China and Brazil has loosened monetary policy this needs to be accompanied by a process that ensures it is directed to where it is most needed. Jeffrey Sachs in his book “End of Poverty” talked about how a country needs six major kinds of capital:
1. Human capital: health, nutrition, and skills needed for each person to be economically productive
2. Business capital: the machinery, facilities, motorized transport used in agriculture, industry, and services
3. Infrastructure: roads, power, water and sanitation, airports and seaports, and telecommunications systems, that are critical in-puts into business productivity
4. Natural capital: arable land, healthy soils, biodiversity, and well-functioning ecosystems that provide the environmental services needed by human society
5. Public institutional capital: the commercial law, judicial systems, government services and policing that underpin the peaceful and prosperous division of labor
6. Knowledge capital: the scientific and technological know-how that raises productivity in business output and the promotion of physical and natural capital
Figure 1 shows the basic mechanics of saving, capital accumulation, and growth. We start on the left-hand side with a typical household. The household divides its income into consumption, taxation, and household savings. The government, in turn, divides its tax revenues into current spending and government investment. The economy’s capital stock is raised by both household savings and by government investment. A higher capital stock leads to economic growth, which in turn raises household income through the feedback arrow from growth to income. We show in the figure that population growth and depreciation also negatively affect the accumulation of capital. In a “normal” economy, things proceed smoothly toward rising incomes, as household savings and government investments are able to keep ahead of depreciation and population growth.
Source: The End of Poverty: How we can make it happen in our lifetime by Jeffrey Sachs (2005).
With the stagnating growth levels in the developed world – USA, Europe, etc – the emerging economies are not immune from this environment. Lower export demand for goods and services impacts on average growth levels in those emerging countries. In order to get out this sluggish condition economies can employ both monetary and fiscal policy. However richer nations have tended to exhaust both these policy options by dropping interest rates to exteremely low levels (see interest rates below) and in their inability to exapand their borrowing because of the size of governmets deficits. Emerging economies average budget deficit 2% of GDP, against 8% in the G7 economies. And their general-government debt amounts on average to only 36% of GDP, compared with 119% of GDP in the rich world.
The Economist ranked 27 emerging economies according to their ability to utilise expansionary fiscal and monetary policy. They used 6 indicators to assess a country’s ability to use these policies. The first 1-5 focus on the ease of which countries can manipulate monetary policy interest rates. 6 concerns Fiscal Policy flexibility
1. Inflation – 2% in Taiwan to 20% or more in Argentina and Venezuela.
2. Excess Credit – measures the gap growth rate in bank credit and nominal GDP. Argentina, Brazil, Hong Kong and Turkey have seen credit grow vastly beyond GDP whilst Chinese bank lending is now rising mor slowly than GDP.
3. Real Interest Rates (interest rate – CPI) – tends to be negative in most economies. Over 2% in Brazil and China
4. Currency Movements (against US$ since mid-2011) – Nine countries, including Brazil, Hungary, India and Poland, have seen double-digit depreciations, with the risk that higher import prices could push up inflation.
5. Current-Account Balance – If global financial conditions tighten, it would be harder to finance a large current-account deficit, and so harder to cut interest rates.
6. Fiscal-Flexibility Index – combining government debt and the structural (ie, cyclically adjusted) budget deficit as a percentage of GDP.
From The Economist
The average of these monetary and fiscal measures produces our overall “wiggle-room index”. Countries are coloured in the chart according to our assessment of their ability to ease: “green” means it is safe to let out the throttle; “red” means the brakes need to stay on. The index offers a rough ranking of which economies are best placed to withstand another global downturn. It suggests that China, Indonesia and Saudi Arabia have the greatest capacity to use monetary and fiscal policies to support growth. Chile, Peru, Russia, Singapore and South Korea also get the green light.
At the other extreme, Egypt, India and Poland have the least room for a stimulus. Argentina, Brazil, Hungary, Turkey, Pakistan and Vietnam are also in the red zone. Unfortunately, this suggests a mismatch. Some of the really big economies where growth has slowed quite sharply, such as Brazil and India, have less monetary and fiscal firepower than China, say, which has less urgent need to bolster growth. India’s Achilles heel is an overly lax fiscal policy and an uncomfortably high rate of inflation. The Reserve Bank of India has sensibly not yet reduced interest rates despite a weakening economy. In contrast, Brazil’s central bank has ignored the red light and reduced interest rates four times since last August. In its latest move on January 18th, the bank signalled more cuts ahead. That will support growth this year but at the risk of reigniting inflation in 2013. Desirable as it is to keep moving, ignoring red lights is risky.
Economics Focus in “The Economist” magazine recently looked at developing countries and reasons why they may grow at a faster rate than their developed counterparts. Robert Barro at Harvard says that this will be the case if:
- the rule of law prevailed
- the terms of trade were favourable
- inflation and government wastefulness remained in check
- families are small in number
- population are health and educated
Goldman Sachs takes the BRICs’ income per person, relative to that of America, as a proxy for their economic backwardness. The bigger the gap, the greater the potential for catch-up growth. The bank also assumes that countries differ in how well they exploit this potential. Some absorb know-how from abroad quicker than others. Their “convergence speeds” would vary, even if the distance they had to cover were the same. The Economist December 10th 2011
The World Bank now rates and ranks emerging economies on such attributes as:
- openness to trade
- the diffusion of mobile phones
In 2003 it was estimated that Brazil’s GDP would overtake Italy by 2025 and China would overtake Japan by 2015. Both these countries overtook their above counterparts by 2010. Emerging economies will become the engines of growth in the world economy.
With the new English Premier League soccer season upon us next weekend it was interesting to read in The Economist and the Finacial Times in London that there seems to a reverse in the trend of Brazilian players taking up high paid contracts overseas. This is partly due to the continuing strength of the Brazilian economy:
- In 2010 the economy grew 7.5%
- Is the world’s 7th largest economy
- Grew fifth fastest of the G20 countries
- Since 2008 the Brazilian Real has appreciated 35% against the Euro and the British Pound. Also this year it hit a 12 year high against the US$. This has helped clubs to bid for players from Europe.
- The Brazilian Terms of Trade has improved by 27%
In 2010 spending on players in Brazil rose 63% compared with a drop of 29% in Europe. Total number exported from Brazil fell 14% in 2009. The stronger finances of Brazilian clubs are also helping them retain younger players.
Rivalling those in the Premiership, La Liga, and the Serie A Santos, the team of Brazilian great Pele, repelled a reported Chelsea bid for Brazilian teenage star Neymar by offering him a sophisticated compensation package that included revenue from image rights. FT London
The Economist last week introduced a new index for measuring emerging economies according to their risk of overheating. These economies make up more than 50% of the world’s GDP and over the last five years have produced more than 4/5ths of global real GDP growth.
The chart below tracks 27 countries according to their risk of overheating. The Economist take 6 different indicators and the scores for these are then added to form an index – 100 means that the economy is red-hot on all 6 measures.
The 6 indicators
1. Inflation - This has an average rate of 6.7% in the developed world. In the emerging markets inflation to vary – 1.7% Taiwan, 20% or more in Argentina, Vietnam and Venezuela. In China core inflatin is at 2.4% whilst Brazil has 5.5% and India is over 8%. When growth is bumping up against capacity constraints and labour markets are tight, food inflation may impact into wages and prices.
2. GDP – a country’s average GDP growth rate since 2007 compared with its growth rate between 1996 and 2006. Growth in Argentina, Brazil, India, and Indonesia has exceeded its long-term trend which assumes little spare capacity. However there appears to be plenty of spare capacity for other countrys – Hungary, Czech Republic and Russia.
3. Unemployment – a lot of emerging markets have been experiencing tight labour markets which are indicative of low unemployment levels – most have levels below their 10 year average. Brazil’s unemployment rate is at record low levels and this has led to wage pressure.
4. Credit Expansion – the best measure is to measure the different between the growth rate in bank credit and nominal GDP. In an emerging economy as the financial sector develops it is normal for the levels of GDP to be less than that of bank lending. However in countries like Argentina, Brazil and Turkey lending to the private sector has increased 20% more than nominal GDP. Though in China bank lending has halved over the past year and is in line with GDP growth.
5. Real Rate of Interest - (Interest rate – inflation rate) this is negative in over half the emerging economies. In rapidly growing economies, as many emerging are, negative real interest fuel faster credit growth and inflation. China’s rate is positive but this understates the level of its recent contractionary monetary policy.
6. Change in Current-Account Balance – economies that run increasing current-account deficits generally means that they are overheating as domestic demand outstrip domestic supply. Turkey, Brazil, and India seem to be experiencing huge demand relative to supply.
When the scores from the six variables we can see that there are 7 countries where the index is over 80. Argentina is the only country where all six are red and Brazil and China are close by.
I have blogged quite a lot on QE – Quantitative Easing – which has been extremely prevalent in the developed world. However, what about QT – Quantitative Tightening? Remember:
QE – putting more money in the circular flow to stimulate demand
QT – taking money out of the circular flow to slow down the economy
According to the Business Insider website the developing world are trying to slowdown their economies. Here are some approaches from central banks:
The Chinese strategy is the most well known, as the PBOC has been trying to slow down credit growth through a series of bank reserve requirement ratio (RRR) hikes. Therefore if the RRR rate goes up it means that the bank has to hold more cash in reserve and has less to lend out.
They have increased their IOF tax – the IOF tax applies upon conversion of foreign currency into Brazilian reals related to equity or debt investments by foreign investors on the Brazilian stock exchange. This dampens the Carry Trade and means less speculative money is put into the Brazilian Real. They have also increased the reserve requirement in banks to reduce liquidity in money markets to slow economic activity in the market.
Carry Trade – a situation where an investor borrows money in one country that has very low interest rates and then invests it in another country with higher interest rates. This can be precariuous as exchange rates vary.
Here interest rates and reserve ratio requirements have actually gone in different directions.
Reserve requirements have climbed 8% for deposits maturing up to three months. These changes affect institutions with a local presence in Turkey. In order to sharply reduce the incentives for foreign players sending portfolio flows into Turkey, the policy rate was cut by 0.75% in conjunction with reserve requirement hikes in order to weaken the currency. The signaling aspect of such a cut has clearly played a strong role in driving market perception because investors tend to see Turkey’s monetary policy as expansionary. However, the net result of QT and policy rate cuts has likely been to make Turkish monetary policy tighter, not looser.
Still on the inequality theme – here is a very worthwhile chart that looks at World Income Inequality. It is from the publication entitled “The Haves and the Have-Nots,” a new book by the World Bank economist Branko Milanovic about inequality around the world which was recently reviewed by New York Times columnist Catherine Rampbell. The graph below shows how inequality in Brazil, USA, China, and India ranks on a global scale. On the x axis the population of each country is divided into 20 equally-sized income groups, which is ranked by each country’s household income per person. These are referred to as ventiles and 1 ventile = 5% of the population. So that we are looking at purchasing power parity (PPP) the data is adjusted for the variance in the cost of living in different countries.
Now on the vertical axis, you can see where any given ventile from any country falls when compared to the entire population of the world.
- poorest 5% are amongst the poorest in the world
- richest 5% are amongst the richest in the world
- the bottom 5% are richer than 68% of the world’s population
- the bottom 5% = 4th poorest percentile worlwide.
- the richest 5% = 68th percentile worldwide which means that USA’s poorest = India’s richest.
Now you might be wondering: How can there be so many people in the world who make less than America’s poorest, many of whom make nothing each year? Remember that were looking at the entire bottom chunk of Americans, some of whom make as much as $6,700; that may be extremely poor by American standards, but that amounts to a relatively good standard of living in India, where about a quarter of the population lives on $1 a day.
Here is another graphic from The Economist which shows the value of exports of individual economies to China.
% of exports to China – 2009
Australia – 21.8%
Japan – 18.9%
Brazil – 12.5%
South Africa – 10.3%
Thus exports to China are only 3.4% of GDP in Australia, 2.2% in Japan, 2% in South Africa and 1.2% in Brazil (see below). Export earnings can, of course, have a ripple effect throughout an economy but the multiplier effect is rarely higher than 1.5 or 2 – this means that they hardly ever double the contribution to GDP.
Recently, the Bank Credit Analyst, an independent research firm, asked what would happen if China suffered a “hard landing”. Its answer to this “apocalyptic” question was quite “benign”. As it pointed out, Japan at the start of the 1990s accounted for a bigger share of GDP than China does today. Its growth slowed from about 5% to 1% in the first half of the 1990s without any discernible effect on global trends.
Here is a great piece from the BBC and also on the Tutor2u blog. During the late 1980s and early 1990s, the price of everything in Brazil went up at least once a week and usually several times – in fact inflation was just under 3,000% in 1990. With this is mind shop owners colour-coded certain items that they felt wouldn’t sell straight away. With CD’s, for example, it was easier to update the colour-coded chart than to change price-tags on every item. Of course, all this changed abruptly in July 1994 with an inflation-busting economic plan that included the introduction of Brazil’s current currency, the real. Click here for the full article.
This grapic from The Economist shows how Brazil has transformed itself from an importer of food to one of the world’s biggest exporters. It is the largest exporter of five internationally traded crops, and number two in soybeans and maize. Furthermore, quite a diverse range of crops considering the climate.