Can world economy count on developing countries for cure?

McClatchy NewspapersAugust 2, 2009 

WASHINGTON — As Wall Street rebounds and the U.S. economy shows other signs of life, stock prices in the world's four largest developing economies have climbed even faster.

In the so-called BRIC nations — Brazil, Russia, India and China — they've soared by an average of about 64 percent so far this year, according to the investment blog Seeking Alpha. That's led many observers to think the four are poised to power the global economy out of recession and into renewed growth.

Don't bet on it. The global economy this year will still suffer its steepest contraction in trade and industrial production since the Great Depression; despite their dramatic growth, the BRIC nations aren't powerful enough to power a global rebound; and all four of them face their own economic problems.

"Three of the four BRIC countries are leading the rest of the world out," said Jay Bryson, a global economist for Wells Fargo Securities in Charlotte, N.C. "But that doesn't mean they are pulling the world out. That's an important distinction. Combined, those countries account for only about 15 percent" of the world economy.

The United States and the European Union each account for 23 percent of global economic activity and, "There's no way that 15 percent is going to pull 46 percent," Bryson said.

This year's global outlook remains grim for rich and poor nations alike. The World Trade Organization in July revised downward its forecast for global trade, now projecting a year-over-year contraction of 10 percent for 2009.

The World Bank's latest projections have the global economy contracting 2.9 percent this year and the U.S. economy shrinking by 3 percent. Developing economies, it said, will collectively grow by 1.2 percent, but would contract 1.6 percent if not for growth in China and India.

Around the globe, industrial production fell 28 percent from January to March. U.S. manufacturing plants in June were operating at about 64 percent of their capacity, the lowest point since records have been kept. Excess capacity is reflected across the major industrialized economies.

"Once excess capacity appears, the economy gets trapped in a vicious cycle, because it becomes hard for firms to find viable investment opportunities," said Justin Yifu Liu, the chief economist of the World Bank, said in a July 15 speech.

As demand declines, layoffs and bankruptcies increase and consumption falls further. The global downturn feeds on itself, and "excess capacity becomes even larger, and the financial sector problems deepen as toxic assets and non-performing loans grow," Liu said, adding that, "Unless we deal with the excess capacity situation, we will have a protracted crisis that will continue to wreak havoc on all countries."

CHINA

China, which grew by 7.1 percent in the first half of this year, remains the lone bright spot of global significance. For China and its 1.3 billion people, however, that's subpar growth, and it's sparking fears that a rapid expansion in lending may bring the world's most populous country and the global economy new problems just over the horizon.

China's economy is getting a boost from a nearly $600 billion government stimulus package that's designed to offset lost earnings from foreign trade, as exports to many nations this year have fallen by 50 percent.

China seeks to boost domestic growth, partly by massively expanding bank lending. The nearly $1 trillion in loans granted by Chinese banks or guaranteed by the government in the first half of 2009 is more than 50 percent more than bank lending was for all of 2008.

"The fact that it took the government taking all the risk away from the banks means the quality of that lending is probably dubious. If those loans don't get repaid, someone has to pay the price of that," said Daniel Rosen, a partner in the Rhodium Group, a New York-based economic advisory group specializing in China.

However, while the lending boom may spark growth, it may not produce sustainable growth.

"Anybody could have high (economic growth) if they simply take the vault doors off the banks and let the money flow on out. It's what we called subprime lending in the United States," Rosen said. "That is an aspect of what is happening in China."

Since the mid-1990s, American consumers have driven global economic growth. As the U.S. economy boomed, U.S.-China merchandise trade soared sixfold, from $63.5 billion in 1996 to $407.5 billion in 2008. China's rising fortunes lifted the fortunes of others as it gobbled up Japanese electronic components, Mexican cement and Brazilian soybeans.

Today, however, that global growth model has unraveled. Japan saw industrial production fall 62 percent in the first three months of this year, and its economy could contract by almost 7 percent in 2009. Germany, another manufacturing and export power, saw industrial production plunge 42 percent from January through March.

Even with slower growth, however, China has overtaken Germany as the world's third largest economy and is projected to catch up with No. 2 Japan sometime next year.

BRAZIL

Putting the world's idled factories back to work is no easy task. Take aircraft manufacturer Embraer, one of Brazil's largest private-sector employers. Dependent on trade and exports, it shed 4,300 workers in February, a fifth of its labor force, posting a $23 million first-quarter loss.

Brazil, with a population of nearly 200 million, accounts for about 1.2 percent of global economic activity, and after a five-year boom, its job growth today is at a crawl. Tax collection fell 6.3 percent through June compared with the first six months of 2008.

"I really don't see any sector doing well other than autos," said Pedro Ferriera, an economist at the Getulio Vargas Foundation, a Rio de Janeiro-based economic research organization.

Brazil's auto sector saw record sales in June, thanks to a federal sales tax holiday, but exports of Brazilian-made cars declined 48 percent during the first half of 2009 from the year-earlier period, the National Association of Car Manufacturers in Sao Paulo reported.

The dock where cars are parked for loading onto ships in Rio de Janeiro is more than half empty, and in general there's less of everything moving.

"In November, we were unloading or loading 1,000 containers per vessel. Today's it's about 500," said Carlos Espirito Santo, a terminal planner at the Port of Rio de Janeiro, surveying a ship from Shanghai unloading machinery.

RUSSIA

If the "B" in BRIC is struggling, the "R" is in deep trouble. Russia's problems have economists suggesting that the bloc of large developing nations should be renamed BIC.

Most forecasters think the Russian economy will contract at least 7 percent this year. The International Monetary Fund recently projected that Russia's gross domestic product — the total annual value of all goods and services produced — will increase by 1.5 percent next year, below Brazil's projected 2.5 percent growth and well below China's 8.5 percent.

The Russian economy lives and dies by global energy prices.

Russia, the least populous of the BRIC countries at 140 million, is the world's second-largest oil exporter after Saudi Arabia, and its economy grew by 8.1 percent in 2007 before falling on hard times last year.

"Other BRIC economies have more diversified structures," said Elena Sharipova, a senior economist for Renaissance Capital, a leading Russian investment bank. "Russia is really subject to the Dutch disease."

That's a reference to how economies are often warped by the high amounts of money brought in by natural resources at the expense of other sectors, such as manufacturing.

When oil prices hit a record $147 a barrel in July 2008, Russian stocks streaked upward and one U.S. dollar was worth about 23.4 rubles. Months later, the ruble and the Russian economy tumbled along with oil prices. Russia's two main stock markets fell by more than 70 percent late last year, and by this February the ruble had lost about half its value against the dollar.

Oil prices and the Russian economy have since bounced back a bit, but attempts to diversify Russia's economy have been hampered by pervasive corruption and weak infrastructure.

"An underdeveloped judicial system, corruption, lack of proper guarantees for the rights of investors and the overall dependence of everything on oil and gas prices," are holding Russia back, said Vladimir Tikhomirov, chief economist at UralSib bank in Moscow.

A recent study by the World Economic Forum ranked several elements of Russia's business climate below basket cases Venezuela and Zimbabwe and poor nations such as Gambia and Mongolia.

"If Russia had a better investment climate, the decrease (in growth) this year would not be 8 percent, but 4 percent," Sharipova said.

Russia's banking system is also a chief concern. There's scant transparency about how much bad debt the country's banks have on their books, a concern that grows in tandem with the duration of the global slump.

"We think the banking system is very weak. If you think our system is living off of life support, go look at Russia," said Philip Suttle, chief economist for the Institute of International Finance, a trade group for global financial institutions. "Russia is clearly the weakest link in these four (BRIC) countries."

INDIA

The "I" in BRIC is also a question mark. India's economic growth, which averaged 9 percent annually from 2005 to 2008, has been less driven by global trade than Russia's, Brazil's and China's have. Domestic free-market reforms led to improvements in the standard of living in the nation of 1.1 billion, the world's second most populous after China, fueling the strong growth of recent years.

India's per capita income growth rate is thought to be 5.6 percent in the 2008-2009 fiscal year, which ended on March 31, according to India's Ministry of Statistics. That's atop 7.6 percent per person income growth in the 2007-2008 fiscal year.

When measured in current prices, the current year saw per-person income grow by 14.4 percent over the prior year. It all confirms the trend of higher standards of living that are leading factories and retailers to produce and sell more at home in a nation with more than 1.15 billion people.

India is expected to grow by at least 6 percent in calendar year 2009, but it has a new government and an old problem of too much government spending that clouds its economic future. Its 2008 government deficit was equal to 6.2 percent of its broad economy, a gap that'll surely widen this year because India, like many nations, is trying to stimulate its economy with public works spending.

"We know from the U.S. experience that high budget deficits can produce concerns about crowding out future growth," Suttle said. "My big concern is that the new government (in India) is supposed to be a strong government with . . . desire to fundamentally address the public sector debt . . . but politically, these things are always easier to talk about than do."

(Bridges reported from Rio de Janeiro, Hall from Washington and Lasseter from Moscow.)

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