4th September 2013
Brazil, India and Russia faces a dangerous stagflation risk of higher inflation and rising unemployment as they suffer knock-on affects from China’s slowdown says fund manager Schroders.
Schroders has downgraded its forecasts for Brazil, Russia, India and China which have been collectively dubbed the BRIC economies.
In a note this week, Schroders chief economist Keith Wade says: “Second quarter data for China pointed to a slowdown, while in the other BRICs a dangerous stagflationary environment is evident. India posted particularly weak activity data and is now focusing on currency stabilisation as the rupee plummets.
“Brazilian data has also been very weak on the back of softness in commodity prices, and monetary policy has become decidedly more hawkish and inflation and depreciation took centre stage as political concerns. A faltering China is also bad news for oil prices and hence Russia, where the central bank again faces the dilemma of below consensus growth and high inflation. Still, a glance across our forecasts shows an outlook of stability rather than massive deterioration, with a global recovery providing support even as domestic problems mount.”
Wade adds: “The BRICs are not alone amongst emerging markets. In general, countries that have seen their current account surpluses shrink since the financial crisis have also seen greater depreciation of their currencies. The correlation between the two variables turns out to be quite strong. A focus on the current account deficits is warranted because such a deficit leaves a country exposed to the risk of a ‘sudden stop’, which could be engendered by QE tapering. Under a ‘sudden stop’, capital flows to a country halt or even reverse following some trigger event, leading to difficulty in funding external liabilities. This in turn hurts domestic activity financed by those liabilities.
However he believes the initial general exit is changing into a more refined process where the most vulnerable emerging economies are being identified by the market.
“The relationship between macro variables and foreign exchange depreciation has strengthened, but we see little change in the relationship with equity markets. This might be expected as the relationship between macro variables and equity markets is typically more tenuous – valuations and other factors take precedence. Overall, we see these figures as providing evidence of increased differentiation within emerging markets. The initial general exit from EM appears to be evolving into a more refined process of identifying those most vulnerable in the event of QE tapering.”
The fund manager outlines its thinking on each of the BRIC economies below.
Our 2013 growth outlook for China has been downgraded to 7.4% from 7.8% as a result of weaker data and an uncertain outlook, with 2014 also down to 7.6% from 8.0%.
Second quarter GDP growth was 7.5% year-on-year, down from 7.7% in Q1. Though July’s data hints at improvement, with PMI, industrial production and exports all stronger than expected, taking a month by month approach to Chinese data will leave you disorientated.
The growth pick up that we are currently seeing is driven, in part, by domestic fiscal stimulus, though on a smaller scale than in the past. In particular, the government seems to be falling back on the property sector to drive growth.
This is reinforced by the credit tightening we have seen in China. Though the policy rate and reserve requirement ration are unchanged, the government has other ways to control the money supply.
One positive for growth is the outlook in developed markets, which should see sustained improvement in China’s exports next year.
We have downgraded our growth outlook for Brazil to 1.9% in 2013 and 2.1% in 2014 following a slew of weak data, headed by worse than expected GDP data for the first quarter of 1.9% year-on-year growth, against 2.3% expected.
Since this GDP release, other activity indicators have suggested a continued downward trend. Meanwhile, private consumption, the Brazilian mainstay, has been undermined by declining confidence, slowing credit and real wage growth, and high inflation.
On the policy front, there is little hope for an accommodative monetary stance. Inflation, though beginning to moderate, remains at the top of the target range and inflation expectations have become unanchored, while the real has depreciated almost 17% since Bernanke first mooted the possibility of QE tapering in May.
Though monetary tightening should ultimately feed through to contain inflation, fiscal stimulus measures from the government in a supply constrained economy and a weakening currency will impede the central bank’s efforts this year.
Our stance on India has become much more bearish in the wake of disappointing first quarter GDP, which came in at 4.8% year-on-year. Consequently, we are downgrading our 2013 growth forecast from 6.1% to 5.0%, and our 2014 forecast from 6.6% to 5.2%.
These are admittedly large adjustments, but justified on the basis of very poor macro fundamentals in India. We had previously thought that softer commodity prices would mean lower inflation and a smaller current account deficit, which would have provided space for monetary easing and given us optimism for short term growth prospects. However, the current account deficit has continued to grow and the rupee has depreciated over 19% since May 22nd.
Inflationary pressures are elevated, but look set to ease somewhat following a good harvest this year. Nonetheless, this does not provide much scope for monetary easing in light of the depreciation pressure on the rupee. Indeed, tackling the rupee depreciation will do more to ease inflation than a good harvest, given the behaviour of core inflation, which excludes food prices.
Second quarter GDP came in well below expectations at just 1.2% year-on-year, its weakest since 2009. The slowdown has been driven by weaker household consumption and investment, with some drag from net exports given commodity softness.
Our 2013 growth forecast has been downgraded from 2.7% to 1.9%, with the 2014 number revised down to 2.5% from 3.3%.
Domestic activity data has continued to be weak, with PMI prints dropping below 50, pointing towards contraction. We should see a modest pick-up in the second half on the back of a good harvest and a slowly improving external environment – but we emphasise, a modest pick up at best.
The harvest should help ease inflationary pressures too, given the contribution of food price inflation to the overall index.