The socalled "BRIC"

Some of the smaller economies in the world have emerged as the “Next generation developing economies” over the years and have seen a consistent growth in the recent past. But the real question to answer is “Are the fundamentals of these economies are as strong as they seem?” A lot of parameters can be used to judge the real worthiness of these countries to be termed as the future global powers. The emerging economies now account for around 30% of global GDP, some of them have current account surpluses and have become net exporters to the emerged economies, some have seen spectacular growth in the respective stock markets and have attracted huge amount of foreign capital in the form of FDI and FIIs. The corporations in these economies have been showing a profitable trend over the years. They have become the major consumers of global energy and have increased their output levels significantly over the years.
This is just an overall picture. If we try to analyze individual emerging economies then the scenario looks quiet gleam. Some countries are having current account surpluses and have become net foreign creditors but there are some countries like India, South Africa, Czech Republic, Turkey, and Hungary who have huge current account deficit. Similarly there are countries like Hungary, India, Brazil, and Czech Republic who have good amount of budget deficit. Major emerging economies like Russia, Brazil, and Argentina have seen greater increase in net bank lending.
One of the major concerns for these economies has been inflation. Almost all the major emerging economies (Including so called BRIC nations) have seen tremendous rise in inflation figures in the recent fiscal year. Although in some of the countries like India, where wholesale price index is used, still the inflation has reached double digit figures. It is estimated that if the real CPI were to be used the actual inflation figures might have been 20-30% higher than the reported levels. So this shows a grave concern of the central banks of the countries to control the ever rising inflation rate and bring it back to normal levels.
The question here is what is actually causing this higher inflation rates. There are various factors governing this but the most logical factor being the “flow of speculative capital” into the economy. In the recent past due to subprime crisis and other negative factors many people predicted the fall of US economy. But being the power house of global economy and being the major developed country there are a lot of supporting factors that came into the rescue. The huge budget deficit of US has been supported by its domestic consumption. But due to slowdown of the economy it is feared that the consumption might come to lower levels. So the Fed has been continuously decreasing the interest rates in the country. This is one of the reasons that cause a higher degree of interest rate differential among the US and the emerging economies.
The emerging economies are also in a vicious cycle. Countries like India, which already has current account deficit, cannot allow its currency to appreciate as it will lead to lower export levels and more trade deficit. So it has been trying to keep the currency at a stable level which is a difficult task for central bank looking at the amount of capital inflows. So in order to prevent the appreciation of currency, the bank has been absorbing foreign currency and printing domestic currency. This is leading to higher amount of foreign currency reserves in the county. But along with it is causing more infusion of domestic currency into the market which is causing higher inflation. In order to absorb this excess liquidity the central banks have been increasing the reserve requirements and interest rates. This is leading to higher interest rate differentials and causing more amount of foreign capital inflow. Same argument holds good for other emerging economies also.
Another reason of rise in inflation is the support levels. Major portion of inflation is due to rise in food prices and surging oil prices. Non-food items have not seen much of a price increase. Though in these countries the food prices have risen because of supply constraint, it should have been temporal. But due to speculative capital which is creating bubbles in most of the investments and has lead to strengthening income and money growth have been able to support these high prices. So the prices are not coming down even if the demand in met by increasing supply.
It shows how vulnerable the emerging economies are. Due to inflow of capital, the stock indices have seen huge increase in the recent years. For instance in Indian stock market more than 40% investments is by foreign institutional investors (FIIs). They have the volume to create a bubble and even burst a bubble. Once the investors hold a negative view of the economy and once the credit ratings of an economy goes down the capital outflow can lead to major corrections in all the emerging markets. As the current scenario prevails, due to dubious economic conditions of US and due to fear in global slowdown, the stock market in India has seen a major correction. It again puts the question as how strong are the fundamentals?
Because of such speculative capital, stock market bubble and over borrowing many emerging economies have crashed over the years. Mexico, East-Asia, Russia, Brazil, Turkey, Argentina and Venezuela have experienced such bubbles disappearing and leaving behind their currency and economy vulnerable. As currently the emerging economies don’t have a strong fundamental to back the growth rate in stock market, similar future cannot be ignored.
A recent threat is the concern about US slowdown and its decrease in consumption expenditure. Some economists argue that if US consumption slows down, then other emerging economies will increase their consumption expenditure and will support the production levels of China and similar countries. But the US slowdown can also be seen as a part of resilient constraint which will help US to comeback as a stronger consumption economy. The fed has been consistently reducing the interest levels to ensure higher investments and domestic consumptions.
Although China can be assured of its export volumes and trade surplus in the future, the major concern is the inflow of speculative capital. This has been a challenge for other emerging economies also that how to stem the inflow of speculative capital. As these countries are still coupled to US monetary system, any changes in the monetary policy of US affect these countries also. According to some economists the revaluation of currency to much higher levels might solve the problem. This solution might work for net exporting countries like China, but countries like India having a current account deficit cannot revalue the currency to much higher levels as it will curb exports. Another solution might be to tighten fiscal policy which can lead to reduction in demand. But again countries like china having current account surplus won’t be benefited.
So this kind of inflation in emerging economies, which seems to be uncontrollable, has lead to a fear of rise in global prices. Emerging economies have enjoyed lower factor costs, leading to production of goods and services at a much cheaper rate as compared to developed countries. But once the factor costs rise, this advantage of emerging countries will be wiped out and the demand in developed countries will be catered by the domestic production itself. Though it will lead to higher prices of the products and services, the developing countries will be affected as their domestic demand is not sufficient enough to support the production.