By Jim O’Neill, Goldman Sachs Asset Management (weekly “Vewpoints”)
Most stock markets enjoyed a further rally last week with a lot of subsequent media attention especially surrounding the succession of record highs in the Dow Jones index in the US, although the S&P is still yet to vault its pre-crisis highs. It wasn’t such a big week for important data, although as always, many interesting things are going on all over the place. {{{*}}} I went on a very short trip to Singapore later in the week to participate in the annual ACI FX conference (Financial Markets Association), as well as to meet important GSAM clients as I move towards my GS afterlife. This week I want to highlight and focus on the forthcoming meeting of the BRICS political leaders and the interesting topic, as is being discussed by some media, of the creation of a BRICS Development Bank. If they do, it could have important implications and certainly powerful symbolism about how the world of economics and finance is changing. The meeting will be in Durban on March 26-27th.
The Importance of the BRICS.
The BRICS leaders’ meeting will be taking place against the background of a somewhat improving mood about the world economy. This is primarily because of the US, and despite the fact that the BRICS economies are individually facing more challenges than they have done for some time. In fact, while there are major differences, each of them face important challenges about their future economic growth. As I touched on last week, some people now believe that the evidence is such that the whole BRIC concept was overhyped. For a longer piece I am in the process of writing, I have looked more closely on my trip to Singapore and back about how the BRIC countries have fared recently compared to the past as well as reasonable expectations about this decade. I have attached a table about their growth, growth in other key regions and the world as a whole over the last 3 decades, this last decade and the decade to date.
The BRIC economies have clearly slowed down from their remarkable pace of the 2001-2010 era of 8.1%, but as can be seen, collectively for the first 2 years of this decade, they have grown in line with our expectations. In this context, it is far too early and not particularly accurate to say that the BRICS have disappointed, unless one believed that the 8.1% collective growth rate was sustainable. As I have discussed on numerous occasions and in “The Growth Map, Economic Opportunities for the BRICs and Beyond”, their growth in 2001-2010 was considerably stronger than we expected, so it would not be surprising if their growth rates slowed during this decade. We have been assuming an approximate 6.6% growth rate for this decade because it was quite clear that China in particular would slow, not least because we expected that the Chinese authorities would want a somewhat slower and more balanced growth rate.
It is impossible to exaggerate the importance of China in all aspects, including within a BRICs context. Its current size of $8.2 trillion at the end of 2012 is actually the same as the other BRICS (including the small sized South Africa around $400 billion), and since 2010, its $2.3 trillion increase is bigger than the actual size of India. Not only have they been creating another Greece every 13 weeks in 2011, but they were creating another South Africa every 4 months. Relative to our assumed growth rate of 7.5% for the decade for China, they are still actually positively surprising, as over the first two years, they have grown by around 8.5% on average.
Amongst other things this means that the influence of China within the BRICS group is key. This is probably true as well when discussing the creation of a BRICS Bank, and what form and substance it takes, although it is clear from my conversations that each of South Africa, India and Brazil have considerable views on these matters. Russia seems less interested and indeed seems to question its need, which is quite interesting given that according to my best knowledge the original BRIC political forum was their initiative.
While China is economically dominant, the scale of the others should not be dismissed. Brazil, India and Russia are all included in the world’s top 10 economies, and their combined $2.3 trillion increase in 2011 was equivalent to creating another Italy that year. While China contributed more than half of this, the others added an additional $1 trillion between them.
Looking at the table, it is fair to argue that both Brazil and India are having relatively disappointing decades so far, 2012 being particularly weak, and in Brazil’s case, our assumption is their growth rate will accelerate this decade. So while it is not appropriate to assume the aggregate BRIC growth performance this decade is disappointing, it is certainly true so far for these two, and Brazil in particular. One would think that this might mean they will be looking for continued initiatives to boost their growth, including joining forces with the other BRICS leaders. On one level, I wonder whether this might explain the relative degree of eagerness about the formation of a BRICS Development Bank.
What Might a BRICS Development Bank Do?
National development banks are usually important in helping to provide finance for long-term economic projects deemed in the country’s national interests and ones that may be difficult for the private sector to initiate. Given the post-2008 ongoing traumas, there are some discussions about similar sorts of institutions within the so-called developed world. I have suggested on a number of occasions that due to the predictable squabbles about where a BRICS Bank might be head-quartered, perhaps London might be a good choice. Given the amount of newspaper print about a national bank in the UK, perhaps some of our policymakers could persuade them to concentrate on our infrastructure instead of theirs. However, I suspect BRICS leaders might not take overly kindly to this notion…
The main obvious purpose of a BRICS Bank would presumably be to help provide the capital for long-term infrastructure projects, especially between the countries, and perhaps also to support further efforts at deepening trade and financial links. Of course given the disparate geographies between some of them, it isn’t so easy to think of specific shared physical infrastructure projects, for example between Brazil and Russia. With that said, between China and India, and between China and Russia, the case is more than clear. And beyond that, given the huge resource constraints facing China and India, and the huge constraints around technology and infrastructure in Brazil, Russia and South Africa, there is quite a case to be made, especially if their advisors feel that neither the World Bank nor their own national development banks are sufficient. For South Africa, this issue is perhaps especially important within the BRICS context because it would justify its presence within the grouping, if it plays a role in helping the African continent to improve infrastructure and trade between countries. South Africa is somewhat obligated in this regard, since without that, it is not clear why they warrant a BRICS inclusion. If they deliver, then the case has been made in my view despite narrow economic rationale of being too small an economy, as previously mentioned.
Singapore.
Although I was only in town for 24 hours, you can certainly feel the pulse of some of the great Growth Market story in Singapore these days. The impact of China is evident in all ways, including in the somewhat cavernous and frankly, somewhat soulless Marina Bay Sands complex where the ACI event was held. As I joked with some of the attendees, walking through the various malls, at times I thought I was in Shanghai. These days, Singapore is clearly receiving some impulse from India too and perhaps increasingly from the broad ASEAN story that is becoming so exciting to some. I was told about the plans to build a Eurostar-like high-speed train between Singapore and Kuala Lumpur which is due to open before 2020, and will clearly add to this excitement.
There are some signs that it is difficult to manage this remarkable growth, for example with the immigration queue at the airport which is nothing compared with the irritating standards of many so-called developed countries, and one of two other little hints of efficiency not quite being up to their usually impeccable standards. It is the case that inflation is at somewhat uncomfortable levels, and as a couple of experienced property players told me, the best parts of the Roppongi area of Tokyo compare favourably with Singapore these days.
I also heard one other anecdote which is particularly interesting for the UK. Partly due to the low Pound, many Singaporeans regard the cost of a British education as being relatively cheap these days, compared to other attractive destinations, with Australia specifically cited. I can imagine many wealth owners from other countries with aspirations for their children think similarly.
Forex Trends as seen from Singapore.
A logical conclusion from the previous anecdote might be to short the A$ against the Pound. However, in the panel discussion I was part of, with some respected panellists including the retiring Government of Singapore Investment Corp. CIO Ng Kok Song (our host), ex- Swiss National Bank President Philipp Hildebrand, and “Mr. Yen” himself, Mr Eisuke Sakakibara, this currency pair didn’t come up.
There seemed to be some consensus that out of the “majors”, the US$ was the best of a bad bunch although all agreed it was and might still be held down by the Fed’s Quantitative Easing. While I shared this view, I seemed to be the least convinced about the long-term scale of US$ upside.
We were all asked to rank our favourites over the next 2-5 years of the Dollar, Pound, Yen, Euro and Swiss Franc, and somehow I was the only one that actually gave a specific answer. I suggested this order of preference: Dollar, Pound (although I added I thought the Pound might positively surprise), Euro, Yen and Swiss Franc.
In other discussions, Mr Sakakibara said he did not see the Yen weakening through Y100, he thought it would settle in a Y92-98 range, and believed that achieving 2% inflation would be much harder than people realise, which is a general view I hear from Japan. I was a bit surprised that the others seemed to agree with this view, which left me more uncertain about the Yen’s next move, on top of my own current lack of conviction. I think the shift of Bank of Japan (BoJ) policies is bigger than perceived by the other panellists but against this, I can see all the sensitivities of ongoing further straight line weakness of the Yen through and beyond the Y100 level. So for me, for Yen weakness to now continue, we will need to see continued evidence of an improving US economy.
We also discussed the emerging world and “exit” policies. Philipp Hildebrand tried to reassure the audience that the major central banks were full of such talented and committed people that the exits would not be disruptive. This was reassuring if not completely persuasive, and I cited the 1994 experience as a real reality check on how things can pan out, at least for a time.
On China and the Renminbi, it was especially interesting to hear local thoughts, and there is a view that more opening and usage will continue but full-blown free-floating of the RMB will not necessarily happen for some time, if ever. There seemed to be a general view that there should be much stronger use of the RMB for trade purposes, but for global investment purposes, this should be done only if tightly regulated. Some shared my view that they will do enough opening to be sufficient for SDR basket inclusion (Special Drawing Rights foreign exchange reserve assets), possibly as soon as 2015.
Other Things of Interest. China
Last week was another not so great week for Chinese stocks with the local A-share market now having given up all its year-to-date gains. This topic came up in many conversations last week, and it is indeed quite worrying even if one can find specific temporary reasons for the sell-off. One of these days, for the “new” and “more quality” China story to be confirmed, the stock market will need to rally and hold gains. Some people cite more anecdotes about the clamping down on luxury and lavish gifting as well as curbs on property speculation as important recent reasons. It will be most interesting to see how the locals respond to the details of the new leadership as last week we got to hear about all the major roles going forward. In general, they don’t mean much to me, not least as I don’t personally know many of the people announced. Also, as I have said before, it seems to me that you have to buy into the central planned direction to be part of the team. I guess in marginal terms some characters might be more important than others.
A number of commentators alerted me to the news that a UK-based (Leeds) food producer announced it was going to produce pot noodles as it was now more cost-competitive than China. I read that story on the cover of the FT on Wednesday and I highlighted it to a group of Conservative China Party watchers who I was coincidentally speaking to that morning. One day in the future, perhaps the UK may export pot noodles to China?
Japan, More Substance than Just the Yen?
In the background, a couple of additional developments caught my eye. There is rising talk of a concerted effort to boost wage growth, which is indeed probably required to sustain an end to deflation, even if the BoJ is being more aggressive. Some people I spoke with doubt it is something that can be just agreed, but in a Japan context, I suspect it could.
Concerning ongoing dramatic developments in the energy revolution, a number of newspapers reported that Japan has announced some positive signs of commercial application of “sea ice” for gas usage, through a type of methane hydrate. One even suggested the source could replace up to 11 years of gas imports. This would be fantastic for Japan and, amongst other things, change my view about the inevitability of a sustained current account deficit in the future.
Russia.
Has a new central bank governor, Elvira Nabiullina, who I have the pleasure of knowing. Many think she was given the role as she will serve political masters, but while this is obvious, I think there is a bit more to her than I hear people suggest.
UK. A New Mood?
Mervyn King made some eye-catching comments this week which certainly surprised all those who were short Pounds, telling the media that he thought the Pound was appropriately valued and was not talking it down. He even added for good measure that if you remove the weakness from construction and oil, then the 2012 real GDP would have been +1.5% and the economy would be on the way back. I continue to have very mixed feelings about the UK economy, but I do find it difficult to understand why it is so supposedly weak compared to others (although fiscal tightening and enforced bank capital-raising are perfectly plausible as I have discussed before). A suspicion lingers for me in addition to those interesting comments from King, that data revisions will reveal the economy to have not been quite so weak. I do have a suspicion that the short Pound trade is not such a great idea.
Emerging Markets Versus Major Equity Markets.
Finally a number of people continue to opine that the US and other Developed Market equities are outperforming Emerging Markets. This is true of course due to the weight of the BRIC markets and China and Brazil in particular, but it is not a widespread phenomena and really reflects the weakness of these two markets. Many others, including a notable number of the N-11 country markets, continue to actually outperform the US year-to-date, including for example and in some case significantly, Indonesia, Philippines and Nigeria. As I have said for years, it is increasingly illogical to bracket all Emerging Markets as one, either economically or otherwise.
Cyprus Scary Move.
One fresh development that I read when I got off the plane on Saturday morning, has of course dominated all news since it emerged late Friday. As part of the agreed banking bailout, depositors in Cypriot banks are going to face a significant haircut, split between close to 10% for those above 100,000 euros and around 6.5% for those with less. This is a somewhat astonishing move, seemingly motivated yet again by what can be “done” through the German parliament, with little thought of contagion to the rest of the Euro-zone, and indeed perhaps the world. There are so many issues that arise from this, ranging from the fairness of penalising small savers, to whether this means investors can trust European politicians at all. I know some people in genuine business in Europe and Cyprus which have some of their cash deposits with Cypriot banks, and they are going to be indiscriminately hurt along with the foreign investors whom they want to penalize. While I am sure it will not set a precedent, I wouldn’t be surprised if markets gave a risk-premia to other global banking centres which are perceived as not being quite so stringent in attracting less desirable investments. Additionally, this would be similar for peripheral euro-area banks and markets, and it will require considerably more thought from Euro policymakers to ensure this doesn’t get out of control. I can’t help thinking that as much as they try to generally do things to preserve the Euro at all cost, ongoing policy decisions appear to be dismantling the underlying free market for cross-border goods and services within the euro-area.
As I go to print, I now read that there is talk of extending the proposed law on bank bonus limits to include hedge-funds and other investment managers too.
Anyhow good luck out there as we move towards the Easter holidays.
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