SPEX Issue 4
SPEX Issue 4
SPEX Issue 4
- Understanding
the
BRICs
(Part
1
of
2)
- The
Price
of
the
Safe
Haven
(Part
1
of
2)
- The
Federal
Reserve
and
the
US
Economy
IN COLLABORATION WITH
PROUDLY SUPPORTED BY
BRIC, a term first coined back in 2001 by Goldman Sachs, refers to the countries of Brazil, Russia, India and China, poised to become major economic powers by 2050. These nations represent a shift in power away from G6 countries and played a crucial role in stabilizing and preventing the worlds output from plummeting during the recent financial crisis. With developed countries struggling to pick themselves up in the aftermath, these emerging markets are under unprecedented spotlight as investors look to them for new investment opportunities and diversification. According to reports from The Economist, they are now the four largest economies outside the Organisation for Economic Co-operation and Development (OECD), and are the only developing economies with annual GDPs of over US$1 trillion each. A sign of their rapid industrialisation is the fact that China has now become the largest CO2 emitter in the world, releasing 7.5 billion tonnes in 2009, accounting for 24 percent of the global total. Russia is close behind at third and India coming in fourth. But perhaps the most striking sign of their rising significance is their share of foreign exchange reserves. All four are among the ten largest accumulators of reserves, accounting for 40% of the worlds total. If the BRICs put aside one-sixth of their total reserves, they could create a fund the size of the IMF. So is now the time for investors to get involved? This article finds that, whilst it is useful to discuss BRICs as a bloc in some respects, the countries are now so divergent that investors need to look at each of them individually, and look at where they differ to find the ideal investment level. Fundamentally, they lack the coherence to change as a group. Two are authoritarian, two are democracies. Moreover, they differ economically and compete with each other as well as with developed countries. Their incomes range widely, from Russias US$15,000 per head per year to Indias US$3,000 (IMF figures using Purchasing Power Parities). China and Russia are huge exporters, whereas India and Brazils exports account for only a fifth of GDP. Their future seems to drift even further apart. Russia has a falling population and low fertility rate. The working-age populations of India, China and Brazil will all rise between now and 2030, particularly in India and Brazil. Despite these differences, they are working together intensively, to insulate themselves from the economic problems in US and Europe. Rising affluence is also further fuelling demand for goods and trade with one another. For example, China is now Brazil's top trading partner, surpassing the United States for the first time last year, consuming almost 14 percent of Brazils imports in 2009. Brazilian imports from China jumped 12-fold from 2000 to 2009, and exports went up a whopping 18 times. Furthermore, improvements in corporate governance and lower barriers of entry mean that emerging markets have now become more mainstream as investors embrace the potential for significant growth from these fledging markets. 2 Copyright 2011 SMU Economics Intelligence Club
This article will cover the first of the BRICs- Brazil. The second part will cover the remaining three BRICs and offer the authors outlook on the implications of their rise. Brazil Brazil did not avoid the downturn, but was amongst the last in and the first out. Its economy is growing again at an annualised rate of 5%. As shown in the figure below, the Brazilian GDP has been seeing significant growth for the past decade and its growth trajectory is expected to continue with current conditions. This speed should pick up even more in the coming years, as new oilfields come on stream, and exports are still sought after from its mineral rich land. Demand for Brazilian debt is also growing, with bond inflows up from US$1.8bn in 2009 to US$2.8bn in 2010.
Despite this, there are still weaknesses in the economy. Government spending is growing faster than the economy as a whole. The Brazilian currency, the real, has gained almost 50% since December 2009, making imports cheaper but exporting more difficult. Meanwhile, there are still a number of obstacles to doing business with difficult rules and cumbersome procedures imposed on tax payments and employment. A recent World Bank report on the ease of doing business in a country ranked Brazil at 126th out of 183, a drop from 120th from a year ago. Overall, the outlook for Brazil remains positive, with care taken over the downsides of currency strength and the volatility still inherent in emerging markets. Analysts believe that in the decade following 2014, Brazil is likely to become the worlds fifth largest economy, overtaking Britain and France. To be continued in Part 2 A multilateral economic organisation to stimulate economic progress and world. If defined strictly, refers to the foreign currency deposits and bonds held by central banks and related authorities. Expenditure by the government in the private sector in the form of building infrastructure and purchasing goods and services needed to operate the government. 3 Copyright 2011 SMU Economics Intelligence Club
USD/CHF tanking, i.e. appreciation of the Swiss Franc (CHF) against the US Dollars (USD) right after the first plane crash on 9/11
History Stability - one of the more common attributes associated with the term safe haven. As the worlds safe haven currency, one would usually presume a certain degree of prestige and even honour; and the idea that a country would actually dread possessing the honour seems rather irrational. For decades, the Swiss has been discouraging the use of its franc as a haven currency. Back in the seventies, negative interest rates were imposed on accounts held by foreigners and in more recent years, to deter excessive inflows, returns from a Swiss account have been taxed and marginalized. Interest rates have never risen above 3.5% for the past decade with current interest rate standing at 0% (see figure 1.2). The Burden As a haven currency, the franc strengthens at the slightest hint of crisis. The appreciation effectively translates to the tightening of Swisss monetary policy. The primary victims of the appreciation are the Swiss exporters. Being the 19th largest exporter in the world, principal Swiss exports include watches, machineries, chemicals, metals, and agricultural products. The appreciation of the Swiss franc poses a threat to the exporters as demand declines due to their 4 Copyright 2011 SMU Economics Intelligence Club
goods becoming more expensive to importing countries. Accounting for 72% of its 2010 Gross Domestic Product (GDP), it is evident that the appreciation is not only a threat to the exporters but potentially a threat to the entire Swiss economy. Also, if the decline in demand is to persist, prices have to follow suit, resulting to a deflation in the economy. While not always bad, a stubborn deflation could lead to an economists nightmare a deflationary spiral and liquidity trap.
Furthermore, the francs recent appreciation due to the euro crisis suggests that if the rates are left untamed, the banking industry could potentially plunge into another round of defaults as 30% of bank loans and 60 % of mortgages in Hungary are denominated in francs. How the Swiss Franc became the Safe Haven First, prior to the recent UBS rogue trading incident, robustness has been the trademark of the Swiss banking system. Historically, its regulators have gone beyond the standards of international capital rules by requiring their banks to have higher safety margins. More recently in 2009, both UBS and Credit Suisse, their two biggest firms were required to carry core capital of 10% of risk-adjusted assets, 3% above the new Basel 3 capital rules. Second, despite protests from the American and German authorities, the nations controversial regulations on banking secrecy have attracted a significant share of international wealth, making the Swiss banks the largest private financial assets holders in the world. Third, the Swiss franc has been deemed as the proxy for the old German deutsche mark which further augments the investors confidence in the franc. Yra Harris (founder of Praxis Trading) has cleverly summed this up in his interview from Inside the House of Money, a book offering a glimpse into the world of hedge funds. He observed that in times of crisis money went to stability and that was Switzerland you know the Swiss wont come under attack because everybody dirty in the world has their money there. To be continued in Part 2
A vicious cycle where prices are falling, and as a result, providing consumers the incentive to delay consumption, which leads to decline in economic activity, and subsequently affects the level of investment, causing demand and prices to fall further. A situation where an increase in money supply fails to lower the strength of the currency and as a result, fails to stimulate exports and demand. A comprehensive set of reform measures designed to improve the regulation, supervision and risk management within the banking sector. The Basel Committee on Banking Supervision published the first version of Basel III in late 2009, giving banks approximately three years to satisfy all requirements. Largely in response to the credit crisis, banks are required to maintain proper leverage ratios and meet certain capital requirements.
bottom interest rates. Recently, we have seen the Fed beginning to explore more and more esoteric monetary policy. The Twist which the Fed recently enacted, involves playing games with its balance sheet to flatten the yield curve, essentially replacing short term bonds with long term bonds. (A higher demand for long term bonds will decrease the interest rate on the bonds, which will flatten the yield curve). This was done once before in the early 1900s, without much success.
The Bottom Line The Federal Reserve might reassure the public that is hasnt run out of bullets, but it is their duty to sound confident about the economy. The Federal Reserve has exhausted all conventional means of monetary policy, and looking forward, our eyes should be on Europe and the fate of Greece, because the global economy will not pick up until that problem is solved, and the Fed can only do so much to keep the economy propped up. In addition, on a broader perspective, to enable the Federal Reserves policies to be more effective, the US should look to more open dialogue and cooperative action with multilateral organisations such as the IMF, EU and even major trading partners such as China, South Korea and ASEAN. However, sometimes, the issue is sometimes more political than economical. With the bipartisan US Congress constantly divided and opposed between Republican and Democrat policies, the effectiveness of policies are always mitigated by unnecessary demands from the opposing party. However, such political intricacies of the US political system is not within the scope of this article. The policies set by the Fed have to work in concert and be in agreement with those of other major economies of the world. The buying and selling of government bonds in the open market. Doing so changes the amount of money supply in the economy. A graph that plots the interest rates of bonds against increasing maturity dates. Different shapes of the curve suggest different economic conditions. Requiring the involvement of two parties.
The
S&P
500
is
a
free-float
capitalization-weighted
index
published
since
1957
of
the
prices
of
500
large-
cap
common
stocks
actively
traded
in
the
United
States.
It
has
been
widely
regarded
as
a
gauge
for
the
large
cap
US
equities
market
The
MSCI
Asia
ex
Japan
Index
is
a
free
float-adjusted
market
capitalization
index
consisting
of
10
developed
and
emerging
market
country
indices:
China,
Hong
Kong,
India,
Indonesia,
Korea,
Malaysia,
Philippines,
Singapore,
Taiwan,
and
Thailand.
The
STOXX
Europe
600
Index
is
regarded
as
a
benchmark
for
European
equity
markets.
It
represents
large,
mid
and
small
capitalization
companies
across
18
countries
of
the
European
region:
Austria,
Belgium,
Denmark,
Finland,
France,
Germany,
Greece,
Iceland,
Ireland,
Italy,
Luxembourg,
the
Netherlands,
Norway,
Portugal,
Spain,
Sweden,
Switzerland
and
the
United
Kingdom.
Correspondents Shane Ai Changxun changxun.ai.2010@smu.edu.sg Singapore Management University Singapore John Ang John.ang@stern.nyu.edu New York University United States of America Tang Manhao m.tang4@lse.ac.uk
Ben Lim ben.lim.2010@smu.edu.sg Singapore Management University Singapore Tan Jia Ming jiaming.tan.2010@business.smu.edu.sg Singapore Management University Singapore Kwan Yu Wen (Designer) ywkwan.2010@economics.smu.edu.sg Singapore Management University
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