BUILDING BRIC BY BRIC

As the financial crisis grips global financial markets, investors have been keeping an eye on BRIC road ahead.

Historically, a sharp downturn in the U.S. market would lead to a crisis-level market plunge in emerging market countries. But in recent months, many emerging market economies, such as Brazil's, have shown a surprising resiliency despite the slumping U.S. economy. One of the main reasons is that many of the BRIC countries - Brazil, Russia, India and China - had solid balance sheets heading into the economic slump, along with vibrant domestic economies that continue to grow in the midst of economic contraction elsewhere, said a panel of experts at CME Group's Global Financial Leadership Conference in Naples, Fla. in September.

"It's one of the great upside stories," says Kevin Kajiwara, director, global markets of Eurasia Group, who moderated the panel. "You can actually add other emerging market countries - South Korea, Mexico, Turkey, South Africa - to this group. What is most striking ultimately is the differences between these BRIC countries, and not the similarities." Brazil, a country blessed with rich natural resources in forestry, oil, perhaps the world's most-developed biofuels industry, and strong grain production, is a country that has mixed sound government with controlled foreign and domestic investment.

"For Brazil, in this crisis which has lasted almost one year, the real has only gotten stronger except for the past 60 days,"says Gustavo Franco, former president of the Central Bank of Brazil. "Brazil, China and India are large economies. The only price that has been reacting to the crisis has been the stock exchange, and that's an impact from globalization."

Brazil's BOVESPA Stock Index plunged 38 percent from its May 2008 highs in the wake of the economic turmoil, before bouncing back almost 10 percent on September 19, when the U.S. government announced its dramatic bank bailout.

Franco says domestic growth is solid and inflation in Brazil is still under control, with a 4.5 percent rate expected in 2009. The situation in China also is compelling, explains James McGregor, chairman and chief executive officer of JL McGregor, an independent research firm based in Beijing. China's exports to the United States represent just 7 percent of its gross domestic product (GDP), moderating the downside risk of future export declines. The domestic economy continues to boom, McGregor said, while inflation remains under 5 percent. Real GDP growth is estimated at 9.8 percent in 2008, a drop-off from its double-digit growth of years past but strong nonetheless, according to fi gures from Economist Intelligence Unit (EIU). The Chinese government also has plenty of money to invest in massive infrastructure projects, which both moves the economy forward and gives China a competitive advantage in the coming months and years.

"China may be the most poised to handle this turmoil," McGregor says. "China is sitting pretty right now as the world kind of tumbles along." McGregor remains confident of China's prospects, despite its slumping stock market, which plummeted 60 percent over the first nine months of 2008. The China Securities Index jumped a record 9.3 percent on September 19.

"Let's not forget that the stock market went up 90 percent in the 12 to 18 months before that," McGregor says. "The Chinese market is actually coming down to some semi-rational levels. By and large, Chinese companies have pretty good earnings. We're going to see the market recover in the next few months."

Meanwhile, India's growth is forecast to slow to 7.6 percent in 2008, according to EIU figures, down from 9 percent growth over the past year. However, inflation is running at 5.8 percent, EIU reported. Russia's GDP was cruising along at an 8 percent rate, but has been affected by Russia's invasion of Georgia in September. Political troubles aside, in the Russian equity market, the Micex Index rose a record 28.6 percent on September 19 as Dmitry Medvedev, the Russian president, pledged $20 billion to end the nation's worst financial crisis since its 1998 default on public and private debt, which led to the devaluation of the ruble.

POLITICS ARE LOCAL

While BRIC countries have enjoyed the global investment spotlight, they also have unique political environments that require close scrutiny and understanding.

Raghuram Rajan, professor of finance at the University of Chicago Graduate School of Business, says the longer-term impact of the global financial crisis could affect the political arena in India as it considers moving more of its economy into a Western-style open financial market.

"The desire to go to free markets is tempered somewhat by the feeling that free markets can pose problems like we've seen in the United States,"Rajan observes. "The biggest concern we hear are comments like, 'You want us to move to that kind of financial system?'" Rajan says that economic policy also causes concern within India. Agricultural production has largely stagnated, he says, which has led politicians to embrace more populist policies, rather than free market programs.

From a different perspective, Franco said that Brazil has displayed political stability by seamlessly moving from one election to another. Worker's Party member Luiz Inacio Lula da Silva was elected president in October 2002. At the time, the election of a left-leaning candidate roiled markets and sent the Brazilian real downward. Since then, however, Brazil and its markets have been remarkably steady, allaying many of the early critics of Lula's election.

Franco said today's financial market crisis will be a test for Brazil's current government.

"We have not had stress since 2002 and that was caused by Lula's election itself," Franco says. "Since then, the economy has been friendly. We don't see the Lula government as a very active government in terms of reforms or doing anything novel in terms of building a market economy as the previous government was. The price for that is that if anything goes wrong, your response is going to be weak."

DECENTRALIZED THOUGHT

China's centralized government is in a difficult period as it tries to maintain centralized control over the world's largest domestic population of 1.3 billion people. McGregor's view on the government is that it will continue to allow more financial freedom in return for its continued centralized power. He added that the government has a number of domestic issues it needs to address, including ongoing corruption in local governments.

"You have a big problem with the 'haves' and 'have nots,' and unrest in the countryside with corruption, land seizures and pollution," McGregor notes. "So China's real challenge over a longer period of time - the next decade - is, how do they pluralize their politics somehow to let people have more of a say? You will not have a liberal democracy in China any time soon, if ever, but they do need to find a way to make government more responsive."

McGregor says that China's government has been evolving away from its highly centralized model for decades. He quotes a Chinese coal executive who said China's leader from 1978 to the early 1990s, Deng Xiaping, had about 80 percent of the government's decision-making power while today, China's president, Hu Jintao, has about 30 percent. "They now have to work a consensus at the top in order to move things ahead," McGregor explains. 'By moving the wealthy into the party six or seven years ago, the question is, how will they try to roll back reform and try to slow down foreign investment?"

LOOKING AHEAD

With relatively sound economic fundamentals and a push by investors to find growth outside Western markets, the panelists expect BRIC countries to continue creating value and attracting investors. The political terrain is always a key piece of the equation, but Brazil, India and China in particular appear to have their economies on solid footing with incredible potential moving forward.

Rajan says the future is bright indeed for countries such as India. "The ambition is there," Rajan notes. "India could be a big part of the next financial marketplace."

Back to Fall 2008 Issue Home