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Are BRICs Hitting a Growth Wall?

September 26, 2012

...we believe that the BRIC nations aren't hitting a growth brick wall, but if emerging markets in general continue to achieve strong economic growth in the coming years, the BRIC countries will have to scale a few obstacles.
-Mark Mobius, executive chairman, Templeton Emerging Markets Group

A global pattern of easing economic growth in the first half of 2012 has impacted the "BRIC" nations - Brazil, Russia, India and China. However, I don't think the BRIC economies have hit a brick wall. While some market participants have been waiting impatiently for governments to undertake further stimulus measures, others have wondered whether something more fundamental-and less within governmental control-might be at work. One theory in play is the concept of a "middle income trap." The premise is that emerging countries can find it hard to sustain high per-capita growth rates beyond a certain point since benefits from technology, low labor costs and easy productivity gains run out before the accumulation of technological capital permits a transition to a higher-wage, higher-productivity economic model. Our team is not convinced that this argument holds muster for the BRIC economies-or emerging markets as a whole.

China

We think some deceleration of China's growth rate was almost inevitable, given that the size of the country's workforce seems to be peaking and the transfer from agricultural to industrial labor has slowed. In this context, forecasts of around 7% annual growth this year (as opposed to the near-10% average annual gains seen in recent years) seem entirely rational to us. In his "Government Work Report" delivered to the National People's Congress in March, Chinese Premier Wen Jiabao projected a 7.5% growth rate for 2012, which we think could prove to be conservative.

Government policy has been shifting from state-directed, export-led and labor-intensive growth more toward an economic model emphasizing internal consumption, technological strength and entrepreneurial expertise. Both supply and demand might be driving this transition: A substantial investment in higher education has expanded the pool of educated labor, and demand is growing from the ongoing, rapid rise in the size and wealth of China's middle class. Consumer indebtedness, including mortgage debt, is low in China, and outside the high-end housing in major cities, we don't see a housing glut to pressure prices. Given these circumstances, we think China should be able to join South Korea, Taiwan, Hong Kong and Japan in escaping the "middle income trap."

China's leadership will be changing soon, and it will be interesting to see how its new leadership carries forward these structural changes and seeks to maintain China's status as a global growth leader.

India

In contrast to China, India's troubled government has been struggling to implement necessary investment and infrastructure projects, and a number of populist and anti-business initiatives eroded investor confidence in recent months. There was also concern that measures to support consumption were crowding out private sector investment and leading to balance-of-payments deficits. This summer, several international ratings agencies had threatened to downgrade Indian sovereign debt to near-junk status. But suddenly, Indian leaders delivered some welcomed good news.

In mid-September the government announced sweeping reforms, including plans to divest its stake in five companies, a shift away from subsidies, and the opening of foreign direct investment in power exchanges, the non-news broadcast media, retailing and aviation industries.

India's central bank followed up by cutting the cash reserve ratio to 4.5% from 4.75%, although it left its benchmark interest rate steady. While certainly more reforms could be made, I think the actions of the Indian government  and central bank represent positive steps toward restoring investor confidence, and could potentially set the stage for better growth going forward.

Despite its obstacles, India's economy has proved adept at generating growth in recent years without heavy investment and with a much better ratio of growth to capital spending than China. Unlike in China, India's working population is generally expected to experience strong growth over the next decade, and reserves of labor among the rural population are large. The impediments to continued growth should be surmountable, in our opinion, provided the political will is there-which leads us to believe in the economy's growth potential.

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