Not an overly “majoritarian” issue this week.  But Martin Hutchinson’s mini-tour of the global investment hotspots makes a good read, even if you’re poor like me.

Breaking the BRICs

Over the last few years, emerging market investment has been overwhelmingly centered around the concept of the “BRIC” group of emerging economies – Brazil, Russia, India and China. These countries were supposed to be the giants of 2050 and the only emerging markets that a truly Important institutional investor should consider, because of their liquidity. Like most ideas spawned by investment banks (truly original minds are weeded out by the banks’ Darwinian appraisal systems pretty rapidly) this idea was vapid and silly at the time. More interestingly, it is now a recipe for gigantic investment losses. There are economies in the world with excellent medium term prospects, but none of the BRICs qualify.

Brazil, first, was always included in the BRIC group because it made the acronym euphonious and avoided a too obvious snubbing of the infinitesimal growth prospects of Latin America.  For a couple of years after the invention of the BRIC acronym, Brazil appeared to be justifying its inclusion, at least in relation to Latin America, though its long term productivity growth remained below 1% per annum, pathetic by any non-Latin American standards. However since the departure of the cautious Antonio Palocci as finance minister in March 2006 and the re-election of President Luis Inacio “Lula” da Silva in October, Brazil’s prospects have taken a significant turn for the worse.

Brazil’s growth rate was only 2.8% in 2006, or 1.7% net of its 1.1% population growth, in a period of unprecedented economic liquidity and synchronized world boom. That isn’t going to make the country an economic giant of 2050, or a political one. Moreover the relatively tight fiscal policy that had reduced Brazil’s debt was relaxed after the election and a public works program totaling over $100 billion was announced. At first sight, budgetary stringency appears to be being maintained, though the “primary budget surplus” target of 4.25% of Gross Domestic Product has been relaxed to 3.75%, but in reality public investment is not to be counted against the target but instead financed through long term low interest rate loans from BNDES, the development bank.

Brazil now has $83 billion of reserves – but it has more than $100 billion of foreign portfolio investment in the stock market, all of which can leave at a moment’s notice – or rather, wouldn’t be able to, since if any outflow became apparent, Brazil would instantly impose exchange controls. So even though Brazil indeed has a more intelligent ethanol program than the United States, it does not qualify as an exceptional market, either through rapid growth or enlightened government policy.

If you must invest in Latin America, try Colombia, which has never been securely on investors’ radar screens but where the economy grew 5.4% (4.0% net of population growth) in 2006 and where President Alvaro Uribe is genuinely committed to free trade, pro-U.S. foreign policy and free market economics. It’s less corrupt than Brazil, too – 59th as against 70th on Transparency International’s Corruption Perceptions Index.

Russia is an economic and political disaster waiting to happen. It is currently propped up by high oil prices, and has enjoyed half a decade of stellar economic and productivity growth. However, foreign investors have been ripped off over and over again, while domestic entrepreneurs are subject to being sent to Siberia or poisoned by little-known radioactive substances.  President Vladimir Putin in March 2008 has the choice of either violating what remains of Russia’s constitution by running for a third presidential term or handing the country over to one of his cronies,  none of whom he trusts (Putin being a pretty obvious clinical paranoid) and all of whom are at loggerheads with each other. Russia is No. 121 on Transparency International’s corruption list, level with Benin and Gambia; actually I would suggest that that ranking is rather too high.

For an alternative Slavic investment, why not try Bulgaria? It has lower wages than Russia, a equally good education system, a fully functioning democracy and it’s in NATO and the EU. What’s more, it’s a lot less corrupt – just above Colombia at #57 on Transparency International’s list. We’re used to thinking of Bulgaria as a corrupt, Mafia-ridden cesspit, but its corruption level is today closer to Scandinavia than to Russia, and it far more deserves the name of emerging market than the R of the ridiculous BRIC.

India does deserve the reputation of a growth market, but not with its current government. Prime Minister Manmohan Singh is perfectly adequately committed to economically sound policies, but he’s not in control. India’s new Five Year Plan works on the assumption that economic growth will magically average 9% per annum for the next 5 years, faster than it has ever grown before. The government as a whole is determined to spend more than its full share of that growth – and will do so whether or not the growth eventuates, state budgetary systems being what they are. Public spending in the 2007-08 budget announced on 28th February was up 18.3% over the previous year, in an economy whose official inflation rate is around 6%. That means public spending is substantially outrunning GDP, even in the middle of a roaring boom.

If the Indian electorate comes to its senses in 2009, is offered a reasonable free-market alternative similar to Atal Bihari Vajpayee’s 1998-2004 government and takes it, India may once again be worth ranking as a growth economy. Meanwhile, it is a liquidity crisis waiting to happen and at over 20 times earnings, its stock market is thoroughly overpriced.

As an alternative to India, try Indonesia. With 245 million people, it’s a decent size even by BRIC standards. Its growth rate was only 5.4% in 2006 – 4% after deducting population growth, but on the other hand it had a budget deficit of only 1.5% of GDP compared to India’s 8%. Its corruption is appalling – 130th on Transparency International’s list, below even Russia, but is improving fairly rapidly under the current government of Susilo Bambang Yudhoyono. The stock market is on about 17 times 2006 earnings, so significantly cheaper than India.

China has grown so rapidly for so long that it has become the icon of emerging markets, untouchable because un-understood. In 2006 it again posted a growth rate of more than 10% (on dodgy official figures), at least some of its people appear to be sharing in the new found prosperity, and its problems of bad debts and inefficient state industries have been decried so often that nobody believes the nay-sayers any more.

So central is Chinese growth to emerging market investors’ optimism that a 9% drop in the Chinese stock market the other week caused a chill to reverberate around the investment world, even though foreigners could not have been significantly affected by the drop as the market is closed to them. China has benefited enormously from the last few years of globalization and high world liquidity, particularly as it has allowed the country to build a $1 trillion hoard of foreign exchange reserves and tempt greedy and careless foreigners to prop up its tottering banking system.

In the very long run, China bulls may be right. The decision by the National People’s Congress Friday to adopt a property law that gives private property the same protections as state property is immensely important. It offers the possibility that rural China will join the much smaller urban China in increasing prosperity. It will not be clear whether the change is genuine however until implementation has occurred; in particular until a substantial portion of the 30 year usage licenses from the state under which Chinese peasants currently farm land have been replaced with proper titles. The stated intention of the Congress to prevent land seizure for development by corrupt rural bureaucrats needs to be proved on the ground. However if that happens, then for the first time since the late Song Dynasty Chinese property rights will have become secure. That will bring its worryingly growing inequality, approaching Latin American levels, once again within bounds consistent with rapid and stable growth.

Meanwhile tighter world liquidity, combined with a slowdown in the U.S. market, will cause more trouble in China than in anywhere else in the world. Foreign speculators have been propping up Chinese banks; they will cease doing so. Domestic liquidity will tighten, causing a slowdown in the Chinese economy and producing negative cash flow in all the office buildings and speculative apartment developments that have sprung up. Foreign demand for Chinese manufactured goods will drop, and a protectionist backlash in the West will squeeze Chinese profitability still further as its major export markets are blocked. Probably the Chinese banks will run out of money; that will liquidate the $1.8 trillion of Chinese domestic savings and cause a massive run on confidence, depressing economic activity for a decade to follow.

Imagine the decline in Japan after 1990, only without the cushion of Japan’s overall wealth and sound economic structure. Japan’s downturn lasted a decade; however improved China’s property rights a Chinese recession could last at least as long. The only saving grace is that there’s effectively no political downside risk, because the country is already a Communist dictatorship!

For this we pay 35 times earnings?

As an alternative to the last BRIC, consider Taiwan, at about 16 times earnings. Taiwan has the world’s leading contract semiconductor manufacturer, Taiwan Semiconductor, and the company Hon Hai Precision Industries, that manufactures all three of the new video game consoles and the Apple iPhone (since Taiwanese wage rates are rather high, it manufactures them in China.) Taiwan has a 5% economic growth rate, which with 0.6% population growth that figure works through to 4.4% per capita (its national statistics are much more reliable than China’s). Taiwan had land reform in 1949-53; since then private property has been sacrosanct.  Taiwan is as rich as Europe, but works a hell of a lot harder. All this is available from a freely functioning international market for less than half the price of Chinese investments.

Thus each of the four BRIC economies is economically and/or politically in severe danger, and is distinctly less attractive than a neighboring economy whose asset prices have been far less run up by international speculators. The BRIC concept, dubious when it was introduced, has become thoroughly counterproductive to those international investors who want to make a profit, as distinct from merely charging clients a fat fee plus performance bonuses for losing their money.

Face it: the BRICs are broken!

Martin Hutchinson is the author of Great Conservatives.