A conversation with Ruchir Sharma, author of “Breakout Nations”
Jim O’Neill, from Goldman Sachs, coined in 2001 the famous “BRIC” acronym. In less than a decade, the four BRIC countries meet at Yekaterimburg in Russia in 2009 and established a “geopolitical club,” and China is number two in the global Economy since 2010, surpassing Japan. Last, but not the least, they added South Africa in 2011.
The big financial crisis gave them a geopolitical opportunity. A new bloc of great powers was born – G7 leadership became past. The world witnessed a once-in-a-lifetime shift in geopolitics, as at the end of the 19th century and the first decades of the 20th. Right? Not sure. “Customizing” Mark Twain famous quote: “the report of the death of the old order was an exaggeration”.
The long tail of this ongoing Global Recession brought a surprise – 2011 and 2012 will be the years when the BRIC altogether went down in growth. China slows from 9.2% in 2011 to 7.8% in 2012 (estimates). India from 6.8% to 4.9%. Russia from 4.3% to 3.7%. And, Brazil shows the worst performance of all: from 7.5% in 2010 to 2.7% in 2011 and 1.5% in 2012 (estimates) – despite all the hype around the pre-salt oil and the barrels royalties bonanza for coastal Brazilian states. In the peak of the Great Recession, in 2009, China growth was 9.2% and India 6.8%, higher than today. Brazil got a light recession of -0.6% but Russia had a brutal contraction of -7.8%. Those two are better today than in 2009, but showing a declining trajectory in the recovery from 2010.
Suddenly, a wave of unexpected downside risks arose. Uncertainty went up like a balloon. The BRIC group is tumbling? China, the second economic powerhouse, will follow Japan’s fate in the 1990s? Russia and Brazil are suffering from the Dutch disease? India may see the same fate as Brazil in the late 1970s? Who will be the breakout nations? From where will emerge the next wave of “economic miracles” and geopolitical surprises?
Ruchir Sharma is our guest. He is the Head of Emerging Markets and Global Macro at Morgan Stanley Investment Management (MSIM). He is based in New York. Born in Wellington, Tamil Nadu, India, he attended Shri Ram College of Commerce in Delhi.
INTERVIEW by Jorge Nascimento Rodrigues
Q: China and Brazil huge bubbles are about to burst in 2013? A new “phase” of the global crisis can emerge?
A: Not really. On the economy, we see China continuing to slow down, but gradually, not catastrophically, and Brazil has already slowed so sharply, to1 percent this year and probably to a long-term trend growth rate of between two and three percent, it’s hard to see it going much slower. If anything, some members of my team see reason to believe that Brazil is finally starting to push the right kinds of reforms, with its aggressive interest rate cuts and what may finally be a serious effort to start filling the crippling gaps in its networks of roads and other infrastructure. As for the stock markets, China has been performing poorly for a decade or more and Brazil for a year or more. They are not inflated to bubble levels right now.
Q: The BRICS are crumbling as an economic emergent bloc and also as a geopolitical entity?
A: My view is that the BRICs never were and never will be an economic or political bloc –in fact they never belonged together in the same acronym. These four countries represent commodity exporters (Brazil and Russia) and commodity importers (China and India); they represent democracies and authoritarian states; they represent low-inflation nations with strikingly high rates of investment (China) and sticky-inflation nations with strikingly weak rates of investment (Brazil). In short the only thing these nations really have in common is the fact that they are the largest economies in the region, but that is just a random link, it is not the basis of shared economic interests, or of a political bloc. Even as a trading bloc, the reality is that China’s trade with the other three is rising fast, but trade among Brazil, Russia and India is hardly rising at all. It is much more plausible to expect these countries to rise as regional leaders, based on real economic ties to their neighbors than to think that they will rise as a global bloc.
«Next miracles will inevitably rise in nations that have not been at the center of the radar»
Q: If the BRICS are not the future, who are the breakout nations, the next economic miracles?
A: Unexpected stars. It is also sheer coincidence, but each for their own reasons, the BRICS are slowing down. And, because they are the largest emerging markets, the next miracles will inevitably rise in nations that have not been at the center of the radar. In Europe, you have some standouts that have avoided the continent wide crisis of excess corporate and government debt, led by Poland. You have some nations that are now working themselves out of debt faster than the pack, led by Ireland. In Latin America, there is a new cluster of strong growth emerging on the Pacific coast, with Colombia and Peru following the reform example set by Chile. In Asia, the Philippines appears poised to shed its reputation as the regional laggard, and to finally tap the potential of its vast resource wealth. One of the more geopolitically intriguing developments is that the next two trillion dollar economies will emerge in large Muslim democracies: Indonesia and Turkey. So much for those who still believe Islam is an inherently backward culture that cannot produce economic success.
«China does share some important weaknesses with Japan, but it does not share the basic problem of Japan in 1990: a refusal to accept reality and painful reform.»
Q: China, the second economic powerhouse nowadays, will repeat the fiasco of Japan through the 1990s in the race for number one, or China is a great power with strengths that Japan hasn’t?
A: China’s main issue is simple: it is too wealthy to grow at the double digit pace of the last decade. Every miracle economy from South Korea to Taiwan and Japan, back in its day, started to slow down significantly when it got to the same level of development that China is at today, with an urbanization ratio of 50 percent. China just passed that point, and is slowing down as a result of the law of large numbers. It’s harder to grow from a high base. While China does share some important weaknesses with Japan, including a sharply aging population, it does not share the basic problem of Japan in 1990: a refusal to accept reality and painful reform. The leadership clearly understands that a deceleration is inevitable, and they are trying to manage the slowdown, not reverse it. That greatly reduces the likelihood of a collapse into long-term stagnation. I would note, too that some analysts are making an interesting case that Japan, after all these years, is finally, truly on the cusp of real change; the key is that over 20 years, the Japanese private sector has worked off nearly $6 trillion in debt, despite slow to no economic growth, and may now be ready to invest again. It’s hard to have real hope for Japan after so many false dawns, but maybe just maybe a turn for the better is coming.
«I am very alarmed when countries that are growing rapidly and get overconfident. They start to assume they are destined to be “the Next China,” and that virtually assures they won’t be.»
Q: Brazil is the eternal great-power-to-be?
A: No. Any nation can move quickly onto the breakout path, with the right leadership. It’s much easier for poorer countries than for Brazil, which with a per capita income over $12,000 is already too middle income a country to grow rapidly from a low base. Yet, Brazil does have some very obvious fundamental flaws, including a very low investment level, which has left its public infrastructure, from roads to phone systems, so weak that they can barely meet demand. That is why Brazil breaks out in inflation at a relatively low rate of economic growth, around four percent. Brazil, due in part to the trauma of its experience with hyperinflation has been building a welfare state it can’t really afford, rather than roads and schools. I don’t believe in destiny: I am very alarmed when countries that are growing rapidly and get overconfident. They start to assume they are destined to be “the Next China,”and that virtually assures they won’t be. Growth is hard work, but any nation is capable of it, including Brazil
Q: The present strategy of Brasilia, the pre-salt oil mania, risks a “Dutch disease” in a great dimension?
A: That affliction takes hold when commodity prices are soaring, driving up the value of the currency in commodity rich nations like Brazil. Then, the expensive currency starts to undermine the competitiveness of every non-commodity export, particularly manufactured goods. But Dutch Disease will evaporate when high commodity prices fall, as they are starting to do and the currency begins to weaken as a result. Going forward, Brazil needs to diversify to reduce its exposure to another bout of the disease.
«India has a decent track record on reform»
Q: And India is also a promise? Some analysts say the country may see the same fate as Brazil in the late 1970s?
A: In my book I gave India a 50-50 chance of becoming a Breakout Nation, defined as a nation capable of growing faster than rivals in its income class, and beating the expectations for that class. Right now, India is slowing sharply, from a recent growth rate around nine percent to more like six percent, but expectations have readjusted just as sharply. No one talks about being the next China anymore, which is a striking reversal in mood. So India actually has a somewhat increased chance of at least meeting or exceeding these lower expectations. India also has a decent track record on reform: the real stars reform steadily, even in good times, but India is at least in the second tier, of nations that push sensible reform when their backs are to the wall. Facing debt downgrades and other threats, India has begun to open its economy farther, most recently by opening retail to large foreign chains.
«Russian billionaires control fortunes equal to 20 percent of GDP, the highest share in the world.»
Q: In your book you are strongly critical about Russia. Why?
A: Russia remains one of the worst case examples of several of my rules of the road for spotting high growth countries. One thing to watch for is leaders who hang on to power too long because even the best ones seem to run out of economic momentum after about eight years. Russia’s leader is deep into his second decade with no end in sight. Another is to balance in the billionaire class: you want high turnover among billionaires, reflecting competition, and you don’t want to see billionaires controlling an excessive share of national wealth. Russian billionaires control fortunes equal to 20 percent of GDP, the highest share in the world. And, there’s little recent sign of change for the better.
«The failure of reform in South Africa»
Q: The BRIC founders added South Africa to the club. Even the “father” of the acronym, Jim O’Neill, had not understood why. What can we expect from South Africa?
A: South Africa according to a recent IMF working paper has one of the weakest long-term potential growth rates in the emerging world, just two percent. Much of this has to do with the failure of reform under the ANC government, now closing in on its third decade in power. So much depends on whether the current unrest in the mines evolves into a real challenge to what has become a one-party state. That would start to open the system, and the economy.
Ruchir Sharma published last April “Breakout Nations: In Pursuit of the Next Economic Miracles.”
Some lessons can be learned from the book:
# It is hard to sustain rapid growth for more than a decade
# The slowdown in the BRIC will look more worrisome than the sluggishness of the economic growth in the US, Eurozone or Japan
# Most CEOs of multinationals and major global investors still limit their strategic visions to three, five, or at most seven years, and they judge results on the same time frame; a longer view is needed
# The economic performance of the emerging-market countries will be highly differentiated
# Expect some surprising candidates for the next decade’s economic stars
# The next two trillion-dollar economies will emerge in big Muslim democracies
# Seven countries to watch: Philippines, Turkey, Indonesia, Thailand, Poland, Sri Lanka and Nigeria
# The current oil mania echoes the dot-com mania of 2000 and will end badly for oil states.
# The crisis of 2008 has undermined the credibility of past hyped role models like the Japanese way, the European Union “tigers”, the NICS miracles; breakout nations do not want to be “the next China”
# What matters, in the crisis environment we leave, is not the type of political system a country has, but rather the presence of political leaders who understand and can implement the reforms required for growth
© JNR, 2012