Cracks in the BRICs?

By LIAM DENNING

As all else has crumbled, the BRICs have come through the crisis looking relatively solid. Yet clear differences have opened up among the fast-growing emerging-market quartet consisting of Brazil, Russia, India and China.



Two members under the spotlight are Brazil and China. Emerging markets fund manager Mark Mobius was quoted recently as saying the Latin American giant's economy was "more sustainable" than that of the Asian powerhouse, mainly due to Brazil's self-sufficiency in major commodities.



Resource riches help, but hardly guarantee prosperity: Just ask that other BRIC, Russia. Indeed, Brazil's commodity exports represent a potential source of weakness near term. Beijing's efforts to tighten monetary policy likely will reduce Chinese demand for raw materials. Brazilian industries like energy and iron-ore production, which make up a disproportionate share of the stock market, would bear the brunt.



Exports, however, account for a relatively small proportion of Brazil's economy. Consumer spending is more important, accounting for about 60%, according to Credit Suisse.



In China, where per-capita gross domestic product is about two-thirds that of Brazil, consumption is just 35% of the economy. Exports, backed by heavy investment in industrial capacity, rule.



Lombard Street Research notes industrial production in China surged to 16% above its pre-crisis peak in the fourth quarter of 2009, supercharged by rampant bank lending. Core inflation remains suppressed by the imbalance of supply compared with consumption and a system of subsidies. But rampant lending has fueled real-estate bubbles, and socially sensitive items like food and energy remain subject to inflationary spikes.



Brazil faces higher inflation, with consumer prices up 4.6% year to year in January. Monetary tightening looks likely. However, industrial utilization rates still are low, according to Lombard Street. Meanwhile, Brazil's memory of hyperinflation in the early 1990s means real interest rates even now are high, at over 4%.



Such conservatism risks strangling recovery. But a silver lining is well-capitalized banks and structural restraints on credit. Loosening these would provide fuel to stoke the engine of consumer demand should it falter.



In order to do this safely, Brazil still needs to address the rigidities that stoke inflation, not least restrictive labor markets and inadequate infrastructure investment. If Brazil can address these capital allocation and regulatory issues, it can capitalize on its head start in developing a sustainable consumer economy, the critical challenge for all the BRICs.



In addition, Brazil enjoys more favorable demographics than China. If the latter hopes to transition to a broad consumer economy, it had better get a move on: China's fertility rate already is below the replacement rate for the population, and the prime 15-to-64-year-old age group will peak in 2015, according to World Bank projections. Brazil's is set to keep rising until 2045. Such resources trump anything lying beneath Brazilian soil.