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More Economic Trouble For The BRICS Ahead Part 1

7th_BRICS_summit_Logo.pngAs what often happens in the economic and political development of nations, actual events intrude upon the fiction of what many would like to believe is the future. Just a few years ago the rise of a number of nations known collectively as the BRICS, were supposed to massively change the international global dynamic. Labeled as such in 2001, the emergence of these nations was going to dramatically alter the balance of world power.

 Brazil, Russia, India, China and South Africa

Brazil, Russia, India, China and South Africa

The BRICS are compromised of the nations of Brazil, Russia, India, China and South Africa. At present if one was going to identify what the group holds in common, it would be growing economic trouble. Whereas their rise was seemingly inevitable and unstoppable, their economic rout seems likewise. Worse yet, foreign investors are withdrawing from these countries at an alarming rate.

Already in 2014, there were distinguishing characteristics that the BRICS were about to come upon some major challenges. The direct cause was a rapid decline in the price for commodities, especially those associated with energy. This would soon be accompanied by a general slow down in global economic growth, particularly in the emerging markets.

The BRICS leaders in 2014. Left to right: Putin, Modi, Rousseff, Xi and Zuma.

The BRICS leaders in 2014. Left to right: Putin, Modi, Rousseff, Xi and Zuma.

In retrospect, the signs for future trouble were all there, if one bothered to take notice. An over reliance on the sale of commodities, rapidly expanding government expenditures and the corresponding accumulation of debt.

One could go further and suggest another theme they all seem to have in common. That is corrupt and inefficient governments that are overly involved in the economic development of the nation. The centralized planning that seemed to make sense during the boom years, now clearly could be recognized for it shortcomings.

Dishonesty and greed among the political leadership, was tolerated by the public during years of rapid economic expansion. Now that these countries on the whole have fallen upon more difficult times, the electorate has become far more concerned on the accumulation and distribution of the wealth that has already been created.

Originally the grouping did not include South Africa, which was added in 2010. As the 21st century dawned the four original members together comprised 8% of world GDP (Gross Domestic Product). In 2014 right before the downward spiral in commodities commenced, the primary nations had grown this share to 21.3% of global GDP. China had become the dominant economy at 13.3% of the total. Brazil, India and Russia lagged far behind at 3%, 2.6% and 2.4% respectively.BRICS_summit_2015_18

For the last two years, the Chinese economy has been slowing rapidly. This has caused tremendous difficulties for two different groups of emerging nations. First, the east Asian countries that sold parts and finished goods to China has seen their exports plummet. These would include the nations of South Korea and Taiwan for example.

The second group which includes the other BRICS countries, are those that are effected by the plummeting demand for the fuel and raw materials, that a fast expanding China used to consume. This has resulted in a dramatic drop in commodity prices, which has in turn has devastated the economies of numerous emerging markets in Africa, Asia, and Latin America.

 Dilma Rousseff, President

Dilma Rousseff, President

Brazil has entered the worst recession since the 1930’s. In addition, the national political class has become discredited, as the progressive and once popular policies of the government has made the present economic downturn far worse.

Brazilian President Dilma Rousseff who barely won a second term in 2014, has become the most unpopular leader in more than two decades. Ms. Rousseff has been accused of hiding the true size of the budget deficit, before the presidential election. She now faces the prospect of impeachment by the legislative branch, but will probably survive. However, her political influence will be greatly diminished. This will only complicate the efforts at reform, which is desperately needed to reverse the economic decline.

The Congress has little enthusiasm for necessary spending cuts and tax increases, that will be needed to restore investor confidence both domestically and internationally. As unemployment and inflation both continue to rise, the effort to limit spending in social services would not be popular. Job losses are occurring at a rate of some 150,000 a month. Inflation for the first time since 2003, is above 10%. This impacts the working poor more than any other class, which is where the present government derives much of its popular support.250px-Brazil_(orthographic_projection).svg

Brazil as Latin America’s largest economy and seventh largest globally, is forecast to contract again in 2016 for a second year in a row. The GDP declined 3.7% in 2015 and is predicted to shrink an additional 2.8% this year. This is the explanation why the central bank did not raise interest rates even higher from 14.25%, in an attempt to squelch the rising consumer price index (CPI). This statistic spiked to 1.27% last month from 0.96% in December.

It had a direct effect on the value of the real which dropped an additional 0.2% against the United States Dollar (USD). The Brazilian currency has already lost 30% in valuation in the past year alone. If interest rates are not pushed higher, the currency will continue to slide in value.

However, the higher the rates of interest go, the more difficult it will become for Brazil to service both private and public debt. The last increase was in July of 2015. This state of affairs really puts the central bank in a no-win situation. Servicing government debt in Brazil is already consuming more than 20% of GDP. Total government debt is at 66% of GDP and rising. Before 2011, the total percentage had been dropping. Fortunately, central government foreign debt is just 2.45% of GDP.

Central business district of Rio de Janeiro.

Central business district of Rio de Janeiro.

Corporate debt, is another major problem for the Brazilian economy. Although it is not rising as fast recently, because of the reduced ability and the willingness of companies to take on even more debt. Still, it amounts to another 63% of total GDP.

Under these circumstances, it is little wonder that the major credit rating agencies of the world have downgraded the investment grade of the country to junk status.

To add to the country’s woes is the public lack of confidence in the business community. This is the result of the largest corruption scandal in Brazilian history. It involves the largest national oil company Petrobas, and numerous contracts involving public works. There is evidence of billions of dollars in kickbacks to industrial and political leaders. It is no coincidence that the head of Odebrecht, the largest construction firm in Brazil, is already in jail.220px-Petrobras_horizontal_logo_(international).svg

Brazil as a whole spent far too much money over the last few years. The government had increased social and infrastructure outlays considerably during Ms. Rousseff’s first term. The additional debt in nearly all levels of society was somewhat manageable, during the boom in commodities. Now that this cycle is in reverse, it is making this massive accumulation of debt unsustainable.

Russian_Federation_(orthographic_projection)_-_Crimea_disputed.svg (1)Russia has seen an economic contraction ever since the near collapse in oil prices, starting in August 2014 when crude was at $115 USD a barrel. The country needs crude to sell for at least $82 USD on international exchanges, in order to remain solvent in the long term. Now that the commodity is selling below $40.00 USD, for every $10 USD drop in crude prices, the Russian economy is expected to contract an additional 2%.

The Russian economy remains quite dependent on energy exports. In 2015 alone, 68% of all foreign exchange earnings were derived from this source. Oil and gas exports make up half of all government revenues. Output is now at levels not seen since the time of the Soviet Union. Therefore a ramp up in further production, is simply not possible. Prices for crude have plunged some 70% in 18 months.

The Russian government planned on oil to sell for at least $50.00 USD in 2016. At this price, the national budget would stay within a 3% deficit limit. As prices have remained far lower, authorities have recently called for an additional 10% cut in public outlays. This is on top of the 8% reduction that was already put in place at the end of 2015.

Moscow International Business Center

Moscow International Business Center

The year 2015 was the first time real wages in the Russian economy suffered a diminution. This did not happen even during the financial crisis of 2008 and 2009. As a result, domestic consumption has contracted a full 10% already. Worse yet, investment both domestically and internationally is abandoning the country at an dismaying rate. GDP is in full decline for a second year in a row, as the country enters a another year of recession.

Economic growth just 1.3% in 2013, dropped to 0.6% in 2014. It is estimated that growth for last year was a dismal -3.7% and forecasts for 2016, continue to revised downward. GDP is back at the level that existed at the beginning of 2008.

To make up for the shortfall, the government has been spending down foreign exchange reserves at an astounding rate. The equivalent of over $200 billion USD was used for various needs in 2015 alone. This reduced Russian reserves to $3.6471 trillion USD, from $3.8500 trillion USD from just a year ago. Inadequate funding this year, promises to dramatically increase the amount of reserves that will be needed to keep the state solvent.

On 21 May 2014, Russia and China signed a $400 billion gas deal. Starting 2019 Russia plans to provide natural gas to China for the next 30 years.

On 21 May 2014, Russia and China signed a $400 billion gas deal. Starting 2019 Russia plans to provide natural gas to China for the next 30 years.

The corporate sector in Russia is in trouble as well. Many parts of the economy are heavily indebted. An additional problem is the fact that 25% of company debt was created with the use of American dollars. Therefore, servicing these accounts cannot be done with inflated rubles. The Russian ruble reached its lowest level ever against USD last month.

The Russian ruble has lost more than 50% of its value against the American dollar, since the beginning of 2014. It has resulted in an inflation rate in Russia that exceeded 12% last year. It has since dropped to the rate of just 9.8% in January, but will be hard to control under the present situation. This also has created the unfortunate side effect of forcing financial authorities to keep interest rates at double digits, so hyper inflation does not get a hold of the economy. This in turn, slows down business activity even further.

In 2014, some 16 million Russians were estimated to be living in poverty. This has now increased to 20 million, which is near 14% of the population.

Vladimir Putin, President

Vladimir Putin, President

The more aggressive foreign policy enacted by Putin since his return to the presidency in 2012, has also come with a large price tag. The annexation of Crimea and invasion of eastern Ukraine have been a further drain on the Russian economy. It has resulted in the imposition of Western sanctions that are costing the domestic economy some $100 billion USD annually. It also complicates efforts to sell Russian bonds and securities overseas, at a time when the country could really use the extra financing.

The escalating involvement of Russia in the Middle East is creating a further drain on scarce resources. The growing tensions with Turkey a Western ally and a member of NATO (North Atlantic Treaty Organization), is putting even more stress on the Russian economy. Given the present needs of the domestic sector and the more hyperactive foreign policy being pursued by Putin, the current course is fiscally unsustainable. The country will simply run out of foreign exchange reserves.

Part II will discuss the nations of India, China and South Africa.

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