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BRICS: The End of Stability?

BRICSEver since the 2008 meltdown the financial markets of the Western industrialized states and democracies have remained fragile. Disappointed hopes that the BRICS states would help alleviate the situation in the global economic balance have, from early 2014 onward, done nothing to improve the situation. The conflict between Russia and Ukraine has only worsened global tensions. Is this the start of an extended phase of economic instability?

The Russian economy does not present a healthy picture. After the country’s slowdown last year to 1.3 percent expansion – too lean for an emerging market – the current year will be decisive for a return to stable growth. The times when high commodity revenues spurred the economy’s development are over.

From waste to investment

Yet the essential, longer-term structural reforms – demanded by market advocates and oligarchs alike – will need time. A massive reallocation of liquidity from unproductive, wasteful spending toward investment in infrastructure would be hard to push through. It would require massive cuts to the defense budget and, more or less, a freeze in public sector wages and salaries, which grew by a staggering 15 percent in real terms last year. Privatizations of state-owned industries have stalled. By 2016 the process was supposed to have injected a hundred billion dollars into the state treasury; to date the actual figure totals all of two billion. State-owned companies resist any reforms fiercely. The beneficiaries of the status quo have a strong lobby.

Russia’s population is shrinking, domestic consumption is flat, and the oil and gas boom of recent years is coming to an end. Despite a stable budget, in the coming years a gigantic deficit will open up in the country’s pension system. Red tape and old crony networks have already smothered many efforts to modernize the Russian economy. That’s why there’s good reason to fear that the government will remain largely idle economically and instead pursue an expansionist foreign policy, which will only further destabilize the economy.

Flagging export markets

Meanwhile, China and other emerging markets have been encountering a growing set of economic difficulties. For the time being these states will therefore not be functioning as vibrant export markets for the industrialized states. And, if the economic problems facing the “fragile five” – Russia, China, Brazil, India and South Africa – begin afflicting other emerging economies such as Turkey, the global economy could suffer as a result. In 1997 these states accounted for a fifth of global GDP; today their share is approaching 40 percent.

A hard landing for China would certainly have far-reaching consequences for economies around the globe. Warning signs are multiplying on Chinese financial markets. First and foremost is the aftermath of the torrent of credits that Beijing deployed to prevent the domestic economy from collapsing after the 2008 financial crisis. As a result, by the end of last year the Chinese economy’s aggregate debt had ballooned to twice the country’s GDP. In 2007 that figure was still 130 percent. The time is drawing near when the credit bubble will have to deflate. One beneficial element is that Chinese financial markets are still largely sealed off. Therefore, if a Chinese bank collapses, it will be no repeat of Lehmann Bros. Yet the real economic ripples would be felt, and very much so, from Asia to Europe. The first to suffer would be China’s biggest trading partners in Asia. Exports to China account for more than 20 percent of Taiwan’s GDP. For Malaysia and South Korea the figure is 12 percent. And although nearly half of all exports from the European Union to China originate from German companies, the importance of the Chinese export market for the German economy remains minor. On the positive side, it should be noted that China has pledged to begin liberalizing its financial markets.

The forgotten need for reforms

In Turkey the government’s autocratic policies are shaking the country’s political foundations. Turkey also has to grapple with a chronic foreign trade deficit. In South Africa the wave of strikes refuses to end, while in Brazil and India bureaucracy and ageing infrastructure are hollowing out economic potential. “Emerging markets were hurt by the easy money which flowed into their economies and made it easier to forget about the necessary reforms,” said Indian central banker Raghuram Rajan. The flood of liquidity with which the big central banks of industrialized nations tried to keep the global economy from unraveling unleashed a huge flow of capital toward the emerging markets. In 2013 the total was nearly 100 million dollars.

5527858164_a20e065cd1_o_flickr_cc_Dai LuoSpeculators took out loans at low interest rates in the US, Japan and Europe and investing the money at rock-bottom interest rates in the threshold economies. Depressed yields for sovereign debt in industrialized states sparked a hectic search among insurers for better-performing investments in threshold economies. Calculations by the International Monetary Fund estimate that since 2009, some four trillion dollars have flowed into emerging markets. Of that, the Federal Reserve’s expansive monetary policy alone accounted for 470 billion dollars.

The cheap money that flowed into the economies kick-started domestic demand and sent prices rising. Imports likewise rose, while deteriorating competitiveness put a damper on exports. Trade balances began to show deficits. And to finance their import surpluses, the emerging economies relied on foreign credit.

Now that the era of easy money is coming to a close, this chain of causes and effects is ushering in a period of instability. One can only hope that the West’s common tendency to wait out problems will not obstruct resolute action by the G7 and the ECB.

Photo Credit: João Felipe; Dai Luo

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