Brazil, India, China – why the brickbats?

For years we have had a two-speed global economy composed of constrained advanced countries offset by strong growth in the emerging world. The emerging world now accounts for more than 50 per cent of global gross domestic product and it was hoped it would keep the world growing at a reasonable rate.

Over the past year, though, it has become apparent that even emerging countries, led by Brazil, India and China (the BICs) are struggling, with all experiencing a sharp slowing in growth.

A big part of the reason for this is the growth slowdown in advanced countries driven by recession in Europe and slowing growth in the United States. Apart from dampening business confidence, this has affected exports, particularly in China and Brazil, where 20 per cent or more of exports go to the European Union.

A slow response to post-GFC policy tightening has also contributed. The BICs and most emerging countries experienced a strong rebound in growth after the GFC. The post-GFC rebound in commodity prices led to rising inflation, which in turn led to policy tightening to bring economic growth back to a more manageable level. Interest rates rose in all three countries and fiscal policy was tightened.

Currency appreciation also added to the tightening in China and particularly in Brazil as its currency surged in value.

Structural change has also played a role, as a combination of the need to aim for more balanced growth (China) and a lack of further economic reforms and imbalances has highlighted that potential growth in these countries is somewhat below what had been achieved in the years before 2008.

India is the most problematic of the BICs. While there was talk a few years ago that it was becoming the next China and that its potential growth rate may be about 8 per cent, it is clear that this is not the case.

To maintain decent economic growth, India needs radical economic reforms to cut subsidies, reduce red tape, reform its tax system and boost infrastructure spending. But in recent years reform has ground to a halt, erratic government policy has scared foreign investors and the government sector is running a 9 per cent of GDP budget deficit, such that ratings agencies are threatening to remove India’s investment credit rating.

The combination of these factors has meant a worsening current account deficit and hence reliance on foreign capital at the same time that a lack of competition and investment has led to a chronic inflation problem.

These factors suggest that India’s sustainable medium-term growth rate is closer to 6 per cent.

Brazil has also slackened off on the economic reform front and underinvested in infrastructure in recent years, although a just-announced stimulus program focused on infrastructure will also help.

Although growth in Brazil, India and China and more broadly the emerging world has disappointed and longer-term sustainable growth rates have dropped, the underlying fundamental picture is far stronger than in the US, Europe and Japan.

First, public finances are far stronger so the need for fiscal austerity is not a constraint on growth and there remains room for more fiscal stimulus if need be.

India is an exception on this front given its budget deficit problems, although it should be noted that when economic and population growth are strong, it is much easier to sustain public debt at about 68 per cent of GDP as is the case in India.

Second, official interest rates remain relatively high (at 6.5 per cent in China and 8 per cent in Brazil and India) so there is plenty of scope for further monetary easing if need be.

Finally, the emerging world still has plenty of catch-up potential.

India’s per capita GDP at about $3700 on a purchasing power parity basis is still below the $5000 level at which the mass purchase of TVs, washing machines and cookers occurs.

China at $8400 is still below the level where mobile phones, cameras and cable TV become common.

And Brazil at $11,800 is well below the $22,000 level at which the mass ownership of cars occurs.

They are all a long way from the $40,000 per capita GDP experienced in Australia. This means that while they may not be growing as strongly as thought a few years ago, the growth potential in the BICs and the emerging world is generally still high.

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