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Are the BRICs being crushed?

June 09, 2008 – Comments (11) | RELATED TICKERS: CHN , CHP , ACH

The Chinese media is reporting that Beijing's financial authority, the China Securities Regulatory Commission, has instructed Chinese mutual funds, on pain of "administrative punishment," to shore up falling stock prices and prevent a deeper slump.

Three weeks ago the regulators appealed to the mutual funds to buy on patriotic grounds, to avoid a stock market plunge after the earthquake in Sichuan province. This time, among growing concern about inflation and economic slowdown, Beijing-based financial executives were called in by the commission Thursday and told to maintain "the principle of market stability."

This mixture of state authority and free markets is not unusual in China's hybrid system, with a communist state machine ruling over a rip-roaring capitalist economy. But manipulation of the stock market by state fiat is dangerous, particularly when the benchmark Shanghai Composite Index has fallen 34.75 percent this year after a gain of 97 percent last year.

Chinese and Western investors are nervous because China's economy is now globally important. As the economies of the United States and Europe slow in response to the financial and credit crises, there has been a broad and comforting assumption that the fast-growing emerging economies will take up the strain.

The BRIC countries of Brazil, Russia, India and China provided more than half of the world's GDP growth last year. China's 11 percent growth rate added another $275 billion to the global economy. Russia and India added another $80 billion each and Brazil added about $60 billion.

Altogether, they added another $500 billion to the world's total output, which is about what the United States adds when it is growing at its trend level of 3.5 percent.

In effect, the BRIC countries collectively took the place of the United States as the locomotive of the global economy, helping to haul the rest of the planet along.

But there is a problem. They may not be able to keep it up, because just as it looked like the world had found a new economic equilibrium, the double whammy of the fuel and food price shocks hit the emerging markets broadside.

Soaring demand from China, India and the Middle East accounted for more than 56 percent of the growth in world oil consumption between 2001 and 2007, and China is now the world's top oil importer after the United States. With the latest price rises, the oil import bill for China and India alone is now running at more than $250 billion a year. That takes care of half of the added growth they contributed last year.

Moreover, China's 1.3 billion people are not very big consumers. More than 40 percent of incomes go into savings, which is fine for future economic growth (or it would be, if local bank interest rates were not lower than the rising level of inflation). But this does not help make up for the faltering American consumer, who used to devote some 70 percent of national income to consumption.

The soaring cost of food is also eating further into the Chinese propensity to consume and is having sobering effects on the other emerging economies.

According to data for 2005 from the U.N. Food and Agricultural Organization in Rome, high-income countries like the United States and Germany spend about 10 percent to 15 percent of household incomes on food. Medium-income countries like Brazil and Russia spend from 25 percent to 35 percent of household income on food, and low-income countries spend far more. China spends almost 45 percent of household income on food and India almost 50 percent.

But food inflation is currently running high. Food prices rose by 8 percent in Russia between January and April, an annual rate of more than 20 percent. In China and India, food prices are rising by roughly similar amounts, eating ever more deeply into household income.

The oil price rise hits the overall economy of emerging markets and the food price rise hits the family budget. The combined effect is to erode by more than half the ability of the BRIC countries to make up for the slowdown in Europe and the United States.

More than that, since the prices for both food and fuel look likely to remain high for some time to come, and may well stay there, the BRIC economies and other emerging markets around the world could be in for a cruel disappointment. Just as they thought that they were on a smooth flight path to steady growth and prosperity, their economies start to stall.

It was always asking a great deal for them to compensate for the faltering of the rich Western economies. In dollar terms, the United States and the European Union together have a combined GDP of about $30 trillion a year, close to two-thirds of global output. The four BRIC countries muster little more than $5 trillion in GDP between them.

The BRIC countries also face another double blow. The decline in the value of the dollar against other currencies means their dollar-denominated foreign exchange reserves, which is to say their savings, are losing value. China's hoard of some $1.5 trillion, Russia's of $500 billion, India's of $300 billion and Brazil's of $200 billion are all worth a lot less in euros, in gold or in their own currencies than they used to be.

And the rich consumers of the West are no longer in a position to buy quite as many of their exports as they used to be. Last year's 14 percent growth to $232 billion in Chinese exports to the United States may not be repeated this year. So from the point of view of a BRIC citizen, they are paying more for their food and their oil, while their national savings erode, and the Western customers are less eager or able to buy their exports.

This hurts, which is why the Shanghai stock market has been falling so fast. That fashionable theory of "de-coupling," which suggested that the emerging markets were now strong enough to continue growing despite a slowdown or even a recession in the West, looks dubious today, whatever orders the bureaucrats of Beijing may give about "the principle of market stability."