March 27th, 2008

Mar. 27, 2008 - In November 2008, Goldman Sachs’ Chief Global Strategist, Jim O’Neill, and associates, who coined the “BRICs” term, have followed up with a complete updated report on the fundamentals for each of Brazil, Russia, India and China. The report goes on to cover the markets of the Next 11 frontier markets. Click the following link to download the complete report, BRICs and Beyond (Goldman Sachs).

Here are some excerpts:

India’s rising growth potential
…We argue that there has been a structural increase in India’s potential growth rate since 2003 on the back of high productivity growth. In this paper, we explain why productivity (by which we mean total factor productivity, or the manner in which all inputs are combined to achieve more output) has surged, and why we think this is likely to continue over the next decade.
… Industry is increasingly becoming an important growth driver, contrary to conventional wisdom that growth in India is only services-led. A quarter of services are directly linked to industry, in sectors such as trade, transport, electricity and construction.
…In India, labour is nearly four times more productive in industry and six times more productive in services than in agriculture, where there is a surplus of labour. Economic theory tells us that as labour moves from low-productivity sectors (such as agriculture) to high-productivity sectors (such as industry or services), overall output must improve.
…In absolute terms India will remain a low-income country for several decades, with per capita incomes well below its BRIC peers. But if it can fulfil its growth potential, it can become a motor for the world economy and a key contributor to generating spending growth.
 

…India’s imminent urbanisation process has implications for demand for housing, urban infrastructure, location of retail and demand for consumer durables. We expect the coming onstream of major highways (especially the Golden Quadrilateral) to drive growth in the transportation sector, spur demand for vehicles, increase real estate values along the corridor and potentially boost construction of suburban homes as people escape congested cities. The SEZs hold out substantial investment opportunities in all spheres of activity.
 

Russia: A smooth political transition
 

…There are signs that investment has begun to accelerate over the last 12 months, with capital expenditures up over 21%yoy in 2007H1. Private investment growth may suffer a brief interruption due to the recent troubles in the local credit markets. But public investment may make up some of the shortfall: after repairing its balance sheet and accumulating a substantial ‘rainy-day’ fund, the government has announced ambitious plans to invest over $1-trillion over the next ten years in roads, rail, ports, pipelines and other infrastructure projects.
 

…The BRICs dream is not even a best case scenario in fact, Russia’s recent performance has been considerably better than projected in the original BRICs papers. But it does assume that the necessary conditions for long-run growth are in place, conditions that we have tried to capture in our Growth Environment Scores (GES). Russia scores well above the emerging market mean on education, government deficit and external debt; marginally above average on openness and life expectancy; lower but still above average on technology (phones, PCs and internet access per capita); and somewhat below average on inflation, which is now in the high single digits.
 

…Our equity strategists’ favourite themes are the consumer, telecoms and retail sectors, as well as steel and pipe companies, and other names poised to benefit from the state’s infrastructure spending. They also see opportunities in domestic restructuring stories, such as power generation and gas. With significant segments of the economy still private, we see considerable opportunities in direct investment.
 

China: Will China grow old before getting rich?
 

…China’s unrivalled economic growth over the past quarter-century has surpassed all records and created a new standard in the history of economic development. With an average annual real GDP growth rate of 9.6% from 1978 to 2004, China’s pace of growth is faster than that achieved by any East Asian economy during their fastest-growing periods.
 

China’s investment strength is sustainable
 

…One of the most widely-held misconceptions about China is that the economy contains an over-investment time-bomb, which will soon result in a sharp correction in both investment and GDP growth, resulting in rising non-performing loans (NPLs) and in deflation. The reasoning behind this theory is that fixed asset investment (FAI) is growing at above 20% year on year, while the investment-to-GDP ratio is already above 45% (higher than the levels reached by Asian economies before the 1997 crisis). Furthermore, this investment boom is financed by misallocated bank credits and generates few returns.
 

Although this is a popular view, we believe it is wrong for two reasons. First, the conclusion is based on macro data that is deeply flawed, leading to a substantial overstatement of the investment-to-GDP ratio. Second, a high investment-to-GDP ratio is consistent with China’s rapid growth. The fact that the return on capital is high and generally has been climbing over the past decade supports our thesis that Chinas investment strength is sustainable.
 

The “B” in BRICs: Unlocking Brazil’s growth potential
 

We remain confident about Brazil’s growth potential, at least in terms of what we have envisaged in our BRICs studies. The main reason for Brazil’s underperformance is that, until now, the government had been in the process of implementing a stabilisation programme, with a view to achieving macroeconomic stability. This is a key precondition for growth. Thanks to these adjustment efforts, macroeconomic conditions are more favourable now than they have been for decades. The large balance of payments surpluses have been used to prepay external debt and accumulate reserves, while a credible central bank (BACEN) has reduced inflation to 3.0% in 2006.
 

We believe that the Lula II administration will sustain sound macroeconomic policies and make some progress on structural reforms. Stability should allow real GDP growth rates to move gradually towards Brazil’s potential rate of about 3.5%, which is near our BRICs potential growth rate of 3.7%.
 

We also believe that Brazil could grow much faster, perhaps at a secular growth rate of about 5.0%. For this to happen, the government will have to tackle four difficult structural problems:
 

·         Brazil saves and invests too little. To address this issue, the government will have to deepen and improve the quality of the fiscal adjustment.
·         The economy should be opened to trade.
·         The government must improve the overall quality of education.
·         The government should implement structural reforms to improve institutions, with a view to increasing total factor productivity.
 

We do not believe that the Lula II administration and Congress will be ambitious enough to implement this politically difficult agenda. Therefore, while Brazil has the potential to grow at or above 5.0%, this is unlikely to happen during the next four years.
 

People who read this post also read these:

• Why the selloff in commodities and emerging markets?
• The World in 2050
• BRICs Lay Foundation Stability: Merrill Lynch
• Morgan Stanley’s Global Outlook for 2008
• How Solid are the BRICs? (Part 2)

Tags: BRICs, China, Emerging Markets, India, Markets, Russia
Posted in Markets |

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