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November 7, 2008

BRIC economies withstand global financial crisis

Analyst Insight by Media Eghbal.

The global financial meltdown of 2008 has not left the economies of Brazil, Russia, India and China, known as the BRIC club, unscathed. As the developed world faces recession, BRIC growth is inevitably set to slow. Yet strong foreign exchange reserves and growing domestic demand will allow BRIC to withstand the crisis and continue growing, strengthening their position as a major consumer market.

Key points

  • The financial meltdown of October 2008 sent stock markets in BRIC economies tumbling as foreign investors fled. The notion that emerging economies were decoupled from the crisis in the developed world has proved wrong;
  • As the global economy is set to slow in 2009, BRIC economies will feel the consequences. China and Brazil will see weaker demand from the USA and Europe for their exports, while India's services sector, oriented towards developed economies, could suffer. Russia is the most vulnerable of the BRIC countries as it is heavily reliant on the hydrocarbon sector, which will be hit by falling energy prices;
  • However, unlike other emerging economies, BRIC have large trade surpluses and foreign exchange reserves that make them more resilient to the crisis. Governments are set to use the reserves to increase spending and boost consumer demand;
  • Growing consumer spending in BRIC countries will help them to withstand the crisis. While the pace of growth is excepted to slow, BRIC will remain a huge and growing consumer market;
  • The crisis is expected to remove the danger of inflation making life easier for BRIC consumers and allowing governments to ease interest rates, fuelling further growth.

Background

Up to September 2008, many believed that BRIC economies were isolated from the global financial turmoil:

  • Brazil, Russia, India and China are the world's largest emerging economies. Between 2002 and 2007, annual real GDP growth averaged 10.4% in China, 7.9% in India, 6.9% in Russia and 3.7% in Brazil. Fast growth, strong economic foundations and large populations have made BRIC into the world's most promising markets. By 2041, the combined BRIC economies are expected to outstrip the G6 (Germany, France, Italy, Japan, UK and USA);
  • In 2007-2008 the banking system of the developed world was rocked by the credit crunch, triggered by the collapse of sub-prime mortgages in the USA. Many believed the BRIC countries could emerge unaffected from the crisis;
  • In August-October 2008 the crisis escalated into a financial meltdown in the USA, the EU and other advanced economies. Governments took unprecedented steps to prevent the financial system from collapsing;
  • As the October 2008 financial crash is translated into large scale job losses, the USA and major eurozone economies are expected to enter recession in 2008-2009. Other advanced economies such as Japan and Canada are expected to grow at a much slower rate;
  • Contrary to previous predictions, BRIC economies were almost instantly hit by the events in the developed world. Foreign investors fled the BRIC stock exchanges in fear of a global recession. The MSCI BRIC index, representing overall equity performance of the four markets, fell by 50% between July 2008 and October 2008. The fall was especially sharp in Russia and Brazil, prompting authorities to shut markets temporarily to prevent further losses.

As economies in the West brace themselves for a painful recession in 2009, it is clear that this will have implications for BRIC economies. However, their strengths will help them to withstand the crisis better than other regions.

Global slowdown: threats for BRIC

The recession in the developed world bears bad news for BRIC:

  • Foreign investments from developed economies could slow. The exodus of foreign funds from BRIC stock markets in 2008 led to their sudden collapse. It is unclear how this will affect foreign direct investment (FDI) inflows, which have played an important role in fuelling BRIC growth. In Russia, for example, FDI inflows equalled 4.1% of GDP in 2007;
  • Consumer demand in the developed world will be hurt by the recession. This is especially worrying for China, whose exports accounted for 35.8% of GDP in 2007. Exports to the developed world made up two thirds of China's exports in the same year;
  • Brazil, whose main exports are iron ore and agricultural products such as coffee and soy, will suffer from the collapse of commodity prices due to the anticipated recession. Coffee prices fell by 36% between February and October 2008. Of Brazil's exports in 2007, 56.3% were destined to developed countries. The USA was Brazil's top export destination with 14.1% of exports;
Exports by destination in BRIC economies: 2007
US$ million
Source: Euromonitor International from national statistics/trade sources.
  • Russia is probably the most vulnerable of the BRIC countries, as its economy is the least diversified. Russia is heavily reliant on hydrocarbon exports, accounting for half of export revenues in 2007. Oil prices fell from US$147 per barrel in July 2008 to below US$70 in October 2008 amid the global economic slowdown. Additionally, Russia is considered more risky by foreign investors because of its summer 2008 war with Georgia and escalating tensions with the West;
  • India's economy depends on the services sector, accounting for more than half of GDP. The sector has thrived on outsourcing from the developed world. A recession in the developed world could hurt this sector if companies are forced to close or invest less;
  • The combined effects could lead to job losses and slower growth for BRIC. This will affect domestic consumer spending, which is supposed to fuel BRIC economies during the global slowdown.

BRIC's strengths

However, BRIC countries have considerable strengths, which should allow them to withstand the crisis:

  • After a decade of growth, BRIC economies have built up strong consumer demand, which could take the lead as the prime engine for growth. In 2007, consumer expenditure as a share of GDP amounted to 35.0% in China, 48.0% in Russia, 54.1% in India and 61.0% in Brazil;
  • All BRIC countries have accumulated high levels of foreign exchange reserves, measuring in 2007 US$1,528 billion in China, US$464 billion in Russia, US$266 billion in India and US$179 billion in Brazil. These foreign exchange reserves will allow governments to boost public spending in order to support the economy. This could take the form of social benefits to encourage consumers to spend more;
  • The surplus could also be used for public investments in transport infrastructure upgrades, which are planned in all BRIC countries. These upgrades would improve the business environment and create jobs that could offset job losses from weaker exports.

BRIC consumers

As consumers in developed countries are curbing their spending, BRIC represent a huge growing market with 2.8 billion consumers or 41.8% of the world's population in 2008:

  • In 2007 consumer expenditure for the BRIC countries amounted to US$3.2 trillion. China accounted for slightly more than a third of this figure;
  • Strong economic growth since 2001 has increased disposable incomes, creating a large stratum of middle class consumers. In 2002 BRIC countries had 20.6 million households with an annual disposable income over US$10,000. By 2007 their number catapulted to 90.1 million households;
  • BRIC consumers are hit less by the credit crunch as they are less dependent on mortgages and debt. Many consumers, especially in India and China, do not have a bank account. The limited level of debt has helped to minimise banks' vulnerability to the credit crunch.

 

Households according to disposable income bracket in BRIC countries: 2002/2007
'000 households
Source: Euromonitor International from national statistics.

Inflation

The expected decline in inflation as economic growth slows will help boost consumption and economic growth:

  • Rising commodity and food prices, as well as the overheating of BRIC economies, have pushed consumer prices high in 2008. Annual Inflation for 2008 is expected to measure 6.4% in China, 5.7% in Brazil and 7.9% in India. In Russia annual inflation is forecast even higher at 14.0% in 2008 due to the overheating of construction and domestic consumption sectors;
  • In the third quarter of 2008 commodity prices fell sharply, expressing the slowdown in the global economy. Prices of energy, raw materials and agricultural products declined. As a global economic slowdown looms, it is expected that commodity prices will remain low and the pressure on consumer prices will ease;
  • Falling inflation will benefit consumers in BRIC countries, especially among lower and middle income households, who spend a greater share of their income on fuel and food than consumers in the developed world;
  • As the threat of inflation recedes, central banks are able to cut interest rates, which will encourage growth and stimulate consumer spending. China reduced its basic rate by 0.27 percentage points in October 2008. Brazil, Russia and India are expected to follow.

Future Scenarios

BRIC economies will suffer from the 2007-2008 financial crisis, yet they will be less affected than other countries:

  • Domestic consumption and investment are expected to sustain BRIC growth, albeit at a lower level than previously anticipated. The IMF revised its projections for BRIC economies downwards in October 2008. In China, real GDP growth is expected at 9.7% in 2008 and 9.3% in 2009; in India, 7.9% in 2008 and 6.9% in 2009; in Russia, 7.0% in 2008 and 5.5% in 2009; and in Brazil 5.2% in 2008 and 3.5% in 2009. Developed economies, in contrast, are expected to approach or enter a recession over 2008-2009;
  • As consumer demand in the developed world is expected to slow, BRIC will provide marketers of consumer products and services with a growing market. This will enhance the BRIC's importance for the global economy, which is expected to return to average annual growth of 4.2% in 2010, from 3.9% in 2008 and 3.0% in 2009;
  • The global slowdown is expected to keep commodity prices below record levels seen in 2008. This would slow growth in commodity exporters Brazil and Russia, but will benefit all BRIC consumers, who will be spared the burden of rising consumer prices.

« The Global Financial Crisis – The Impact on Emerging Economies and Consumers | Main | Global youth populations »

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