Beware of Crumbling BRICs

By Mike Burnick

Don't look now, but two of the most popular emerging markets in recent years are in trouble. It seems the BRICs are crumbling under the weight of soaring inflation!

These fast-growing emerging market countries include Brazil, Russia, India, and China. This year, they are facing their biggest economic challenge so far this decade: Runaway Inflation.

Inflation is accelerating in the BRIC economies and central bankers are responding with tighter monetary policy. While higher interest rates may be the standard remedy to combat inflation, tight money policies usually wind up dealing a death-blow to stock market investors.

The China Syndrome

The biggest runaway success story in recent years has, of course, been China. "The next century belongs to China," say the bulls. And while there's a lot of truth to that, the fact is sky-rocketing inflation is cutting into the Chinese miracle.

Consumer price inflation in China (which is almost certainly understated) is running at an "official" rate of nearly 8%. That's the highest in nearly 12-years!

As a result, the People's Bank of China raised benchmark lending rates six times last year. The Bank has also ordered banks to set aside more reserves than ever before. Both of these monetary tightening moves are definitely NOT friendly to stocks. So it's no surprise that the Shanghai market index is down 48% year-to-date.

Still, China's got a lot going for it. This impressive economy has massive foreign currency reserves - that swelled by US$40 billion last month alone - to an estimated US$1.8 trillion!

China also has an undervalued currency. If policymakers allowed the currency to float more freely, it would almost certainly erase a large chunk of that country's imported commodity price inflation.

Unfortunately, other BRICs in the region don't have it so easy... 

The "I" Is Being Incinerated

The "I" in BRIC, India has been one of the emerging world's most popular markets in the last few years. But now the country faces a big reversal of its recent fortune.

For starters, the Indian stock market, bond market, and currency are all getting incinerated as inflation soars, and investors lose confidence in the economy.

Wholesale price inflation is running at 11% in India - the highest level in 13 years and climbing. The Reserve Bank of India responded by raising interest rates, but it may be too little too late.

Investors are scared that a combination of accelerating inflation and more rate hikes could derail India's record 8.8% annual growth.

Overseas investors are pulling money out of India at a record pace now. Investors sold a net US$6.2 billion worth of Indian shares so far this year, sending its benchmark stock index plunging 30% in value.

Bond prices and India's currency, the rupee, have also come under intense selling pressure. The rupee, which had been one of the world's strongest currencies, retreated 8% in value this year. That's its worst performance since 1993.

What's Happening in Brazil and Russia

The other BRICs, Brazil and Russia, have so far held up relatively well.

This is mainly due to their resource-rich economies. Brazil is a big net exporter of agricultural products and metals. And thanks to a growing energy industry and new offshore oil fields, Brazil should become energy self-sufficient this year.

Russia, of course, is one of the world's largest oil producers, so it too enjoys a favorable trade balance amid booming exports, and growing foreign exchange reserves.

Is India an Early-Warning Sign for the BRICs?

Still, the BRIC economies are under stress of seeing their economies crumble under the threat of runaway inflation. India's troubles are perhaps just an early-warning sign. Inflation in China is running close to 8% in spite of higher interest rate.

Inflation in Russia just topped 15%. Brazil, which suffered a painful hyper-inflationary past, recently raised interest rates after inflation crept up to 5.4%.

Stock investors, seeing this threat on the horizon, are now pulling money out of the BRIC markets. As an Indian government official said recently, "Until inflation slows, this crisis is only going to widen."

Inflation is the biggest threat to emerging markets this decade, and threatens to derail the BRIC success story. How aggressively these nations deal with the problem, will be the key to how quickly they can get back on track again. But for now, it's safer to watch from the sidelines.

Disclosure: none

Comments

[RichardSchweitzer]

If this concerns U S investors with BRIC-related holdings, shouldn't some of the commentary reflect "relative" rates of inflation; using, for example, the true rate of U.S. inflation? (see, Bill Gross and others)

If the true U.S rate is about 5.3% (being adjusted closer to the "world average" of about 7%) the competitive edge for the PGJ index should increase.

It is interesting to note that the increase in supply of U.S. Dollars in an open economy, produces lower inflation rates than occur in "command" sytems such as China and Russia. Brazil has become more open and normal. India is a political mess with subsidies distorting the pricing mechanisms.

[LoveShorting]

Thanks to both authors. I had a feeling India was in trouble and was glad to have my suspicion confirmed. I know China is dicey these days so I am only 10% long there. I am turning towards Brazil and appreciate the positive sentiment (relative to RIC). Thanks again.

[Jgib]

I was very big on Brazil until I read that Lula believes Obama's trade policies are very positive for Brazil. 54% tarrifs on Brazilian ethanol from the country which subsidizes sugar beet production. I don't think so.

[anvor]

Just read, belatedly, that Buffett recently said that the US is in "stagflation"... in which "stag-" will deepen, while "-flation" will continue to soar. Betting against Buffett is not my cup of milk, so let me think aloud: With some BRICs "damaged", we still have the other two. So, long Russia and Brazil? (and "so long" CHina and India?:)

With Russia in particular: since russian ruble will continue to appreciate against the dollar, it makes sense converting dollar-denominated instruments into ruble-denominated ones and sleep quite happily on the Russian index (even their largest, fully state-insured bank offers 9% on ruble 3-month deposit.) Inflation or not, I'll be up in the end, for higher ruble securities eventually converting into diminishing dollar should make additional sense. With both Putin and his puppet gearing to combat inflation, russian growth may not be above 10% as it should be with this price of oil (which ain't coming down, folks), but even 8% GDP will do wonders for my Russian index.

Tell me if I am wrong. Ple-ease:)

[vitaminc]

"China also has an undervalued currency. If policymakers allowed the currency to float more freely, it would almost certainly erase a large chunk of that country's imported commodity price inflation."

Higher RMB => more expensive goods made in China => higher inflation in US

Blue collar jobs complained most about China's RMB but now they are getting burned because of a richer RMB.

[phinsuntanning]

EGY for Russia with some drops of UK and Nrth Africa

[Corson]

Brazilian inflation has been mostly due to international pressure of comodities. however it's central bank has been responsible enough, differently from the FED, to start working on the inflacionary pressures early. The main world economy central banks should act in syncrony to combat inflation...Europe seems to be posed to do its share in cutting inflation, Brazil has already been doing that since long what about the (irresponsible )FED? I guess there is another countries at even greater risks, considering its "down-the-bottom&... weak currency.