15 February 2008
Karl Marx and Mao Tse-tung would be spinning in their graves with the news that two of the greatest Communist powers - Russia and China - are now beacons of global capitalism.
China and India were satellites of Stalinist Russia in the early fifties and economic basket cases.
Now Chinese and Russian political elites have embraced free markets, adding new life to world markets while the developed world is under pressure from the sub-prime credit fiasco.
But just a decade ago, US policy makers paralyzed by domestic issues, watched on as Asian economies edged towards collapse. Russia defaulted on loans sending shockwaves down Wall Street, and Brazil teetered close to the edge with massive debts.
Now, Russia, China, India and Brazil - known as BRIC - make up the group of leading emerging nations that have been powering along with robust growth, while the United States faces prospects of a recession.
The MSCI Emerging Markets Index galloped ahead last year with 33.4 per cent, with India, Brazil, Turkey and Indonesia up by 40 per cent and Chinese equities nearly doubling.
Analysts are now pondering on what the new world economic order could look like.
The Head of Emerging Markets at Schroders, Allan Conway, believes the BRIC economies will continue to grow at a significantly faster rate than most other economies for many years to come, and will transform the world economy over time.
In fact Goldman Sachs predict that by 2025 the BRIC economies could account for over half the size of the economies of the G6 nations - the USA, UK, Japan, Germany, Italy, and France. Currently they are worth less than 15 per cent.
And if things go right, Goldman Sachs also believe that in less than forty years the combined BRIC economies could be larger than the G6 in dollar terms.
But when it comes to emerging markets things can and often do change. So if you feel yourself being swept up in the hype of emerging markets, then it would be wise to keep one eye on history.
After all it was less than a decade ago that hedge fund Long Term Capital Management's imminent collapse reverberated throughout Wall Street.
Long-Term Capital Management plays Russian Roulette
Long-Term Capital Management (LTCM) was the brainchild of founder John Merriweather, a former Vice-Chairman at Salomon Brothers.
He collected together Nobel Prize winning economists, academics and traders, claiming they would profit from their collective skills of quantitative modeling and street-wise, trader judgements.
The fund raised $800 million from 80 founding investors, extracting exorbitant fees of two per cent a year plus 25 per cent of profits.
The portfolio under LTCM's control amounted to well over $100 billion at its peak and was also active in mortgage-backed securities, as well as dabbling in emerging markets such as Russia.
But on August 17, 1998, Russia devalued the rouble and declared a moratorium on 281 billion roubles ($13.5 billion) of its Treasury debt, which triggered a liquidity crisis of enormous proportions, dealing a near-death blow to LTCM.
LTCM had made huge bets on Russia and its quantitative model spectacularly failed.
The hedge fund was eventually bailed out by the New York Federal Reserve at a cost of US$3.5 billion.
In 1998, the current account deficit for the region was close to US $89 billion.
But in an incredible reverse of fortunes, eight years later the deficit had been transformed into a surplus of US $46 billion, thanks mainly to rising oil and gas prices, increased foreign investment, higher domestic consumption and greater political stability.
Brazil is another example of a country that was spurned by investors and institutions a few years ago and is now making a comeback. In its October 2007 World Outlook, the IMF expects Brazil to have over 4.3 per cent growth this year despite other Latin American countries stalling.
Emerging markets growth is good news for all
The double-digit production growth in India has flowed on to South-East Asia, with Malaysia, Indonesia and the Philippines all picking up.
Despite views to the contrary, China believes a major slow-down or recession in the United States will have negative effects on their economy.
According to the World Bank, China is still expected to grow by more than 10.8 per cent in 2008 and 10.5 per cent in 2009, while the Russian Federation will grow by 6.5 per cent this year and 6 per cent next year.
India is expected to grow by 8.4 per cent in 2008 and 8.5 per cent in 2009, down from 9.4 per cent in 2006. Brazil is also expected to grow by 4.5 per cent in 2008 and 2009.
The Bank recently stated that global economic prospects would slow to around 3.3 per cent in 2008, from 3.6 per cent in 2007 and 3.9 per cent in 2006.
A weaker US dollar, recession talk and more bad news on the sub-prime fiasco has US growth slowing to around 1.9 per cent in 2008, trailing Europe and just eclipsing Japan this year, which is forecasted to achieve 1.8 per cent.
To date, strong growth in developing markets has offset any effect of a US slowdown, but the World Bank believes "adverse effects in emerging markets are unlikely to be avoided."
However the January 29 release of revised growth figures by the International Monetary Fund (IMF) has world growth at 4.1 per cent this year, down 0.3 per cent from the last estimate.
The IMF has US growth at 1.5 per cent - 0.4 per cent lower and warns of more "downside risk" if turmoil in the financial markets continues.
But worse could be on the horizon if the US consumer decides not to spend. After all, around 70 per cent of US GDP is made up from domestic demand.
The World Bank also believes the integration of developing nations into the global economy has "helped dampen inflation globally through heightened international competition".
East Asia is expected to slow to 9.7 per cent in 2008 and 9.6 per cent in 2009.
With the tightening credit conditions in Europe, three exceptions stand out - Albania, Hungary and Turkey, all look to grow in 2008-9.
In Latin America, which has not been affected by the sub-prime fall-out so far, Argentina and Brazil leads with strong growth. But it may be early days.
New look world economic order
The further you look ahead, the less likely the view is clear.
To assume that the emerging BRIC countries will overtake many others assumes that these countries will continue with growth-supportive policies.
Goldman Sachs predicts that between 2010 and 2015, Brazil will grow on average by 4.2 per cent, China by 7.2 per cent, India by 5.9 per cent, and Russia by 3.8 per cent.
But despite this optimism, Goldman Sachs predicts that individuals in BRIC countries will be poorer on average than their developed nation counterparts - Russia being the exception.
And there are other emerging markets that will also contribute to world growth in Eastern Europe, Asia, Latin America and Africa.
Schroders' Allan Conway argues that, "the emerging markets are in the process of de-coupling from developed market growth."
"Although a US recession would not be good news for the world economy, emerging markets are in good shape to weather a downturn".
He argues that the drivers for growth in the developing world have changed over recent years, and they are now no longer as dependent on growth in the industrialized world.
"Emerging countries have seen a significant structural improvement in their economies, current accounts are generally in surplus, foreign reserves are rising and government debt to GDP is much lower than in the developing world", he said.
The IMF also believes that the emerging markets are in better shape to weather a US downturn, but face the challenge of higher inflation.
The adage that if the US sneezes the rest of the global economy will catch a nasty cold has a new twist to it.
As buoyant growth continues in emerging markets and falters in the West, higher commodity prices for food and oil will contribute to higher inflation and higher interest rates.
The tiger economies will still have a sting in their tail.
