Terence James ‘Jim’ O’Neill, retiring chairman of Goldman Sachs Asset Management and a British economist, was responsible for the acronym BRIC for emerging markets (Brazil, Russia, India, China) which over time was extended to BRICS to incorporate South Africa.
So, now that investors have apparently cooled their love affair with emerging economies, we can thank him or blame him for whatever has befallen us during those years of perceived opportunity versus reality.
But you can never keep an optimist down, and now Jim has come up with another acronym to tempt our attention: ‘SMIT’ countries are the new growth markets of South Korea, Mexico, Indonesia and Turkey.
In Jim’s defence, in 2013 Brazil, China, India and Russia accounted for a quarter of global output, a figure that is forecast to rise to about one-third by the end of the decade. So what are the prospects for the SMITs and will investors warm to them so readily as the BRICS, now that the International Monetary Fund (IMF) has cut its growth forecasts?
After years of talking up the BRICS, the IMF now admits that these countries have either exhausted their catch-up growth models or run into the time-honoured problems of supply bottlenecks and bad governance.
With one swipe, IMF has slashed its forecast for developing economies by 0.5% to 4.5% in 2013, and by 0.4%
to 5.1% in 2014.
India: down 1.8%. Russia: down 1%. Mexico, one of the new SMITs, is forecast to be down by 1.7% – all compared with IMF forecasts just six months previously. Similar damage is expected for SMIT starlets Turkey and Indonesia (not to mention the likes of Ukraine and others with big trade deficits).
In what commentators say amounts to a mea culpa, the IMF has hinted that it has long been blind to festering problems in the BRICs and smaller emerging economies – resulting in its downward revisions: IMF forecasts for Brazil, China and India are now 8% to 14% lower for 2016 than it had forecast two years ago.
The BRICs’ malaise, their poorer pace of economic growth, implies “serious structural impediments”, says the IMF. Time is running out, it says, even for kingpin China’s growth model (driven by a world-record investment rate of 50% of GDP), which is afflicted by excess capacity and diminishing returns. China has picked “the low-hanging fruit” of catch-up growth, relying on mass migration of cheap labour from the countryside, yet the “reserve army” of peasants in the interior will have disappeared by 2020 and wages will be forced skywards.
The IMF now predicts “disappointment everywhere” for investors in emerging markets and that, as a result, global growth will remain in low gear for the foreseeable future.
As a result, net capital flows to emerging markets have inevitably taken a tumble. But, for the less faint-hearted, the IMF digs deep to predict that emerging markets will muddle through. And growth among emerging markets will still settle near 5.5%, far higher than in the 1980s and early 1990s.
So, what do the SMITs have to offer?
Mexico has a free market economy in the trillion dollar class. It contains a mixture of modern and outmoded industry and agriculture, increasingly dominated by the private sector. Recent administrations have expanded competition in seaports, railroads, telecommunications, electricity generation, natural gas distribution and airports. Per capita income is roughly one-third that of the US.
Since the implementation of the North American Free Trade Agreement in 1994, Mexico’s share of US imports has increased from 7% to 12%, and its share of Canadian imports has doubled to 5.5%. Mexico has free trade agreements with more than 50 countries including Guatemala, Honduras, El Salvador, the European Free Trade Area, and Japan – putting more than 90% of trade under free trade agreements.
In 2012, Mexico formally joined the Trans-Pacific Partnership negotiations and formed the Pacific Alliance with Peru, Colombia and Chile.
Following 3.9% growth in both 2011 and 2012, in 2013 the economy will only grow slightly above 1%. However, a return to 4% economic growth is expected in 2014.
Since November 2012, Mexico’s legislature has passed several structural reforms which include a comprehensive labour reform, telecoms reform, competition reform and an energy reform, all of which prioritise structural economic reforms and competitiveness.
Indonesia still struggles with poverty and unemployment, inadequate infrastructure, corruption, a complex regulatory environment, and unequal resource distribution among regions. The government faces the ongoing challenge of improving Indonesia’s insufficient infrastructure to remove impediments to economic growth, labour unrest over wages, and reducing its fuel subsidy programme in the face of high oil prices.
Yet, Fitch and Moody’s upgraded Indonesia’s credit rating to investment grade in December 2011.
Indonesia has an increasingly industrial and services economy (47% and 39% respectively of GDP). Industrial production grew by 5.2% in 2012.
As a result, the country has a healthy export trade with Japan (15.9%), China (11.4%), Singapore (9%), Republic of Korea (7.9%), US (7.8%), India (6.6%) and Malaysia (5.9%) (2012 figures) in products and services including petroleum and natural gas, textiles, automotive, electrical appliances, apparel, footwear, mining, cement, medical instruments and appliances, handicrafts, chemical fertilisers, plywood, rubber, processed food, jewellery, and tourism.
Indonesia grew more than 6% annually in 2010-12. During the global financial crisis, Indonesia outperformed its regional neighbours and joined China and India as the only G20 members posting growth in 2009.
The government made economic advances under the first administration of President Yudhoyono (2004-09), introducing significant reforms in the financial sector, including tax and customs reforms, the use of Treasury bills, and capital market development and supervision. The government has promoted fiscally conservative policies, resulting in a debt-to-GDP ratio of less than 25%, a fiscal deficit below 3%, and historically low rates of inflation.
THE REPUBLIC OF KOREA
In 2004, The Republic of Korea joined the trillion dollar club of world economies, and is currently the world’s 12th largest economy.
Throughout 2012 the economy experienced sluggish growth because of market slowdowns in the US, China and the Eurozone.
The incoming administration of 2013 faces the challenges of balancing heavy reliance on exports with developing domestic-oriented sectors, such as services. Long-term challenges include a rapidly ageing population, inflexible labour market, and heavy reliance on exports, which comprise half of GDP.
The Republic’s export-focused economy was hit hard by the 2008 global economic downturn, but quickly rebounded in subsequent years, reaching 6.3% growth in 2010. The US-South Korea Free Trade Agreement was ratified by both governments in 2011 and came into effect in 2012.
Over the past four decades the Republic has demonstrated significant growth and global integration to become a high-tech industrialised economy. Back in the 1960s, GDP per capita was comparable with levels in the poorer countries of Africa and Asia.
The Asian financial crisis of 1997-98 exposed longstanding weaknesses in the Republic’s development model including high debt/equity ratios and massive short-term foreign borrowing. GDP plunged by 6.9% in 1998, and then recovered by 9% in 1999-2000. The Republic adopted numerous economic reforms following the crisis, including greater openness to foreign investment and imports.
“The IMF now predicts “disappointment everywhere” for investors in emerging markets and that, as a result, global growth will remain in low gear for the foreseeable future.”
Turkey’s largely free-market economy is increasingly driven by its industry and service sectors, although its traditional agriculture sector still accounts for about 25% of employment. An aggressive privatisation programme has reduced state involvement in basic industry, banking, transport and communication, and an emerging cadre of middle-class entrepreneurs is adding dynamism to the economy and expanding production beyond the traditional textiles and clothing sectors.
The automotive, construction and electronics industries are rising in importance and have surpassed textiles within Turkey’s export mix. Oil began to flow through the Baku-Tbilisi-Ceyhan pipeline in May 2006, marking a major milestone that will bring up to 1 million barrels per day from the Caspian to market. Several gas pipelines projects also are moving forward to help transport Central Asian gas to Europe through Turkey, which over the long term will help address Turkey’s dependence on imported oil and gas to meet 97% of its energy needs.
Growth dropped to approximately 3% in 2012. Turkey’s public sector debt to GDP ratio has fallen to about 40%, and at least one rating agency upgraded Turkey’s debt to investment grade in 2012. Turkey remains dependent on often volatile, short-term investment to finance its large trade deficit. The stock value of foreign direct investment (FDI) stood at USD 117 billion at year-end 2012. Inflows have slowed because of continuing economic turmoil in Europe, the source of much of Turkey’s FDI. Turkey’s relatively high current account deficit, uncertainty related to monetary policy-making, and political turmoil within Turkey’s neighbourhood leave the economy vulnerable to destabilising shifts in investor confidence.
After Turkey experienced a severe financial crisis in 2001, Ankara adopted financial and fiscal reforms as part of an IMF programme. The reforms strengthened the country’s economic fundamentals and ushered in an era of strong growth – averaging more than 6% annually until 2008. Global economic conditions and tighter fiscal policy caused GDP to contract in 2009, but Turkey’s well-regulated financial markets and banking system helped the country weather the global financial crisis and GDP rebounded strongly to 9.2% in 2010 (levelling out to 8.5% in 2011), as exports returned to normal levels following the recession.
UHY has member firms operating business centres in the SMIT countries:
UHY Glassman Esquivel y Cía S.C.
Contact: Oscar Gutiérrez Esquivel
KAP Hananta Budianto & Rekan
Contact: Hananta Budianto
Republic of Korea
UHY Seil Accounting Corp
Contact: Sam-Won Hyun
UHY Uzman YMM ve Denetim AS
Contact: Senol Çudin
Detailed information about investing in countries abroad is given in the UHY Doing Business Guides on the UHY website at: www.uhy.com/publications/