November 2007 - Article for Business Brief
Many readers will be familiar with the acronym
BRIC, which was introduced to the world by economic researchers at
Goldman Sachs in 2003. They argued Brazil, Russia, India and China
would become global economic powerhouses within a generation and be
symbols of the migration of wealth and prosperity from the west to
the east. In this article I would like to review the factors
leading to these forecasts as well as introduce some of the risks
and problems faced by these economies. How investors can think
about accessing this growth story is also reviewed.
Why should the BRIC economies appeal
to investors?
At the very basic level a country’s
economic growth is directly linked to the capital in the economy
and the size of its population. The common denominators across the
BRIC countries are the influx of foreign direct investment
(capital) and the sheer size of their populations. However, these
two factors in isolation do not automatically signal economic
prosperity. A third item needs to be added to the equation –
economists call this TPF or Total Productivity Factor and this
measures the ‘sophistication’ of the economy. For example, an
economy relying on the growing and exporting of fruit will be far
less prosperous over the longer term than an economy able to design
and build electronic microchips and semi conductors for domestic
use and export. The BRIC countries are benefiting from a
significant increase in their TPF and each has the scope for
further increases in the years
ahead.
Economic growth is expressed as a change in
the Gross Domestic Product measure – GDP. Table 1 compares the
average growth in GDP, per annum, achieved by the ‘mature’ OECD
(Organisation for Economic Co-operation and Development) nations
compared to the ‘emerging’ nations of China, India and Russia over
a 10 year period from 1995 to 2004 inclusive.
Table 1 GDP growth, 1995 -
2004
(% per year annual average)
OECD
Emerging
Old EU:
2.2 China:
8.7
New EU:
3.7
India: 6.1
USA:
3.4 Russia:
6.0*
(*1998-2004)
Source- OUBEP 2006
There is clearly a stark contrast between the
emerging and mature economies’ average growth rates and these have
continued to diverge in recent years. Both China and India are
expected to deliver growth rates of 10.5% and 9.0%** respectively
in 2007. By comparison, OECD growth is estimated to be 2.4%**.
These rates of growth present tremendous opportunities for the
corporate sector and investors alike.
Table 2 details the levels of GDP per capita
achieved by the major economic regions of the world periodically
from 1870 to 2003. These numbers reflect the ‘economic
wealth’ generated by each member of the population and remove the
distortions created by market exchange rates. The striking economic
‘catch up’ with the USA and Western Europe delivered by the Asian
Tigers (Japan, Singapore, Malaysia, South Korea etc.) from 1973 to
2003 is very clear. From the available data, it is also clear China
and India lagged significantly behind the Asian Tigers in 2003 but,
assuming the growth rates currently being delivered can be
sustained, the economic prosperity these two countries are set to
enjoy in the future is demonstrable.
Table 2 Levels of GDP/Capita
($1990,ppp)
1870
1950
1973 2003
Africa
500
894
1410 1549
Asian
Tigers
595 955 3631 17162
China
530
439 839 4392
India 533
619 583 2160
Latin
America 681 2506
4504 5786
Western
Europe 1960
4579 11416
19912
USA 2445
9561 16689
29037
Source: Middleton (2006)
Table 2 is also useful in illustrating how important it is not
to get too carried away with the investment opportunities presented
by the BRIC countries. The GDP/Capita number in 1973 for Latin
America ($4,504) is ahead of the Asian Tigers ($3,631) and yet by
2003 Latin America has only increased to $5,786 compared to the
marked increase to $17,162 for the Asian Tigers. Latin America
(Brazil) failed, for a variety of reasons, to catch up with the
mature economies of the world and who is to say we are not
witnessing another ‘false dawn’.
What are the risks faced by the BRIC
economies?
Each of Brazil, Russia, India and China face
their own unique problems as they strive to improve economic
performance, however, common problems across them all include:
The need to improve formal and informal
institutions
A sophisticated economy, for example, requires
a robust and regulated capital markets infrastructure to assist the
domestic corporate sector in raising finance as well as instill
investor confidence and attract money from overseas. An effective
central bank and markets regulatory authority free from political
influence and corruption are seen as essential components to this
process. The BRIC countries do not yet meet international standards
in these areas and this has limited the capital flows into the
countries.
A reliable due process of
law
Contract enforcement and property rights are
essential to attract direct investment from overseas to the BRIC
countries. The law in China is dictated by the Communist Government
and this gives them the power to ultimately sequester privately
owned assets for the state. The legal infrastructures in China and
the other BRIC nations have undergone reform, however, investors
are alive to these risks and this is another limiting factor to
economic growth.
A backlash to
globalisation
The mature economies of the OECD are facing
increased competition from the BRIC nations and in many areas they
see this competition as unfair. The slow progress made at recent
GATT (General Agreement on Tariffs and Trade) meetings illustrates
this point. Exporters to the BRIC countries often face penal
tariffs which are not reciprocated on imports to the OECD from the
BRICs. The EU has entered into the ‘bra wars’ with China as a first
shot across her bows. Further ‘protectionist’ policies may result
and this will damage global trade and growth, and hurt economic
progress in the BRIC nations.
How to invest in the BRIC
story
Investors have been able to gain access to
this growth story by buying branded BRIC funds over the last few
years. Managed funds investing into each country are also available
and the continued growth in the Exchange Traded Funds arena now
allows investors the opportunity to track the equity markets of
each of the countries individually or collectively via highly cost
effective vehicles. At Fairbairn Private Bank, we have used each
type of these funds to gain exposure to the BRIC economies with the
choice dictated by the objectives and risk profile of the investor.
We also seek to achieve investment return for our clients by
investing in the BRIC story in slightly different ways. For
example, each of the four countries is committing significant
resources to building new roads, ports, airports, schools and water
treatment and sanitation works to assist economic growth. The
benefactors of this enormous infrastructure spend are power
generators, utility companies, cement producers and construction
companies. Investing in infrastructure funds with exposure to these
areas is likely to reward investors over the medium to long
term.
ENDS
**Source: Invesco. Data to and estimates as
at 30 June 2007.