For all the talk about the power, influence, and positive trends in the nations comprising BRIC (Brazil, Russia, India, and China), it’s always important to examine how they are funding growth. For example, Ireland and Eastern Europe appeared to be among the fast growing economies over the last decade until investors soon discovered it was all a facade of easy money backed by little productivity. The population, land, and resources of these nations are undeniable, providing justice to their exclusion as a separate entity of emerging markets. However, these are not the only factors to consider in evaluating popular investment areas. Poverty, corruption, infrastructure, government influence, and free markets are all important factors to consider. However, in a debt driven world bordering on crisis levels, this will be the attribute to consider most. Let’s take a look…
Moodys:Brazil’s Baa3 Rating Captures Improved Conditions
In its annual sovereign report on Brazil, Moody’s Investors Service indicates that the Baa3 government bond ratings with a positive outlook capture both the material improvement that has been observed in the sovereign credit profile and the presence of favorable medium-term prospects as the country is well-positioned to resume growth at a fast pace.
“Brazil’s performance during the recent global turmoil confirmed its economic and financial resilience,” said Moody’s Vice President Mauro Leos, regional credit officer for Latin America and author of the report. “A short-lived GDP contraction, minimal weakening of the country’s international reserve position and lack of financial stress in the banking system reflect increased shock absorption capacity which is consistent with the government’s investment-grade ratings.”
Moody’s upgraded Brazil’s ratings from Ba1 to Baa3 and assigned the positive outlook in September 2009, incorporating a favorable assessment of policy continuity on the fiscal and monetary fronts.
According to Moody’s, Brazil’s fiscal challenges include a persistent upward trend in primary spending, government debt ratios that are above peer group benchmarks –gross debt amounts to 60% of GDP — and gross financing needs that exceed 10% of GDP.
“The government’s balance sheet has strengthened steadily as an improved debt structure has significantly reduced credit exposure to exchange rate and interest rate risks,” said Leos. “Foreign currency-denominated debt now accounts for less than 10% of government debt, while floating rate debt has steadily declined during the last six years to 33% at year-end 2009.”
Despite a solid economy with excellent performance of late, Brazil still has significant challenges. I think Moody’s assessment is right on, which is interesting considering there are many other sovereign debt situations with better ratings and much more substantial risks. Nonetheless, I remain cautiously bullish on Brazil due to a government seeming to understand fiscal restraint and pro business policy, combined with a fundamentally sound outlook for commodities going forward.
On to Russia…
Yet it has been long road since 1998 for Western investors to gain confidence in the Russian economy. Today Russian credit default swaps, which measure the cost of insuring against default, are at 193 basis points over those for Germany, but they soared to a screaming 772 basis points exactly a year ago in the midst of the global credit crisis.
The market was pricing Russian bonds as if the country was about to default, even though it had little or nothing to default against. “The sentiment was negative on Russia, so no one bothered to look at those fundamentals,” says Svedberg.
Such is the nature of the market that Russia’s new bond issue this year could be as much a statement about itself, as it is an attempt to raise money. “It’s a chance to say that we’re stable, and for Russia to show a certain level of confidence in its future,” says Marshall Spectrum’s Kart.
There are other practical reasons why Russia is going to the debt markets, and not just tapping into its $450 billion of foreign currency reserves or borrowing from local banks, to pay down its new budget deficit.
Among other terms, Russia’s so-called Stabilization Fund is only meant to be used to balance the budget when oil prices fall below $27 a barrel. And issuing new treasury bills to domestic banks would risk pushing up local borrowing rates and crimping economic growth. “They want to get foreigners to fund some of their spending,” said T. Rowe Price’s Conelius.
I really like the Russian economy. With the rest of the world at excessive debt levels, it makes news that Russia is even tapping the debt market. This is a telling sign and a major opportunity for Russia. Energy prices are probably not coming down any time soon and investors are enthusiastic about Russian prospects again. Nonetheless, the Russian economy still relies far too heavily on energy prices. We saw what impact that had during its 1998 default and scary 2008 situation. Still, Russia is growing heavily and not from the debt driven reasons seen elsewhere. This is a positive sign for investment going forward.
Next is India…
Indian Bonds Fall as Investors Wary of First-Half Debt Sales
India’s 10-year bonds fell, pushing yields to their highest level since October 2008, on concern the government will increase borrowing in the first half of the year beginning April, when the bulk of debt will mature.
The government will raise a record 4.57 trillion rupees ($99.3 billion) in the next fiscal year, Finance Minister Pranab Mukherjee said on Feb. 26. Debt payments will more than double to 1.14 trillion rupees, of which almost three quarters are scheduled to be repaid in the four months through July, according to the government’s budget.
“Since you have heavy redemptions you have to be prepared for big bond sales in the first half,” said Rajeev Radhakrishnan, who manages the equivalent of $4 billion of debt at SBI Funds Management Pvt. Ltd., a unit of the nation’s biggest bank, in Mumbai. “Yields will be under pressure until the auction calendar is announced.”
Of the economies in the BRIC group, I’m not particularly crazy about India. They have a well educated population and competitive labor force but poverty, poor infrastructure, government corruption, and questionable business public policy. Add these debt problems and I think investors need to choose their Indian plays wisely.
Finally China…
China’s Hidden Debt Risks 2012 Crisis, Northwestern’s Shih Says
China’s hidden borrowing may push government debt to 96 percent of gross domestic product next year, increasing the risk of a financial crisis in the world’s third-biggest economy, Professor Victor Shih said.
“The worst case is a pretty large-scale financial crisis around 2012,” said Shih, a political economist at Northwestern University in Evanston, Illinois, who spent months researching borrowing transactions by about 8,000 local-government entities. “The slowdown would last at least two years and maybe longer,” the author of the book “Factions and Finance in China” said in a phone interview March 1.
Surging borrowing by local-government entities, uncounted in official estimates of China’s debt-to-GDP ratio, is the key reason for Shih’s concern. Harvard University Professor Kenneth Rogoff said Feb. 23 that a debt-fueled bubble in China may trigger a regional recession within a decade, while hedge-fund manager James Chanos has predicted a Chinese slump after excessive property investment.
By Shih’s count, China’s debt may reach 39.838 trillion yuan ($5.8 trillion) next year. His forecast for debt-to-GDP compares with an International Monetary Fund estimate for China of 22 percent this year, which excludes local-government liabilities. The IMF sees Spain at 69.6 percent, the U.S. at 94 percent, Greece at 115 percent and Japan at 227 percent.
Chinese officials allowed lending to explode from late 2008 to fight off the effects of the global financial crisis. In 2009, new loans rose to a record 9.59 trillion yuan ($1.4 trillion).
Because China has such substantial foreign reserves, their debt problems tend to go ignored. Shih’s analysis is intriguing, as Chinese official statistics are generally unreliable. Since China grew at such a tremendous pace, we now see public debt problems, a guaranteed credit default problem in their consumer space coming soon, a property bubble, and an economy dependent on their export sector. Add substantial poverty and the potential for public unrest and China is not the miracle story it is commonly portrayed as. This is why I’m so confused why everyone is so certain their currency will appreciate if left to float. Personally, I want no part of the renminbi in light of the uncertainty of how the currency would respond. Because of their substantial trade surpluses, the currency would probably appreciate in the short term, but I think this trend could reverse very quickly. Without such export dominance and these vast reserves, China’s various holes are ripe for exposure. Long-term, China will grow and eventually become the world’s largest economy. Access to their market will drive asset prices around the globe for a long time to come. I simply prefer Taiwan, Singapore, or the most fundamentally sound Chinese companies because of the substantial risks in China’s macroeconomic situation.