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2 The Future BRICS

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4 The Future BRICS A Synergistic Economic Alliance or Business as Usual? Rich Marino

5 Rich Marino 2014 Softcover reprint of the hardcover 1st edition All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6 10 Kirby Street, London EC1N 8TS. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act First published 2014 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number , of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan in the US is a division of St Martin s Press LLC, 175 Fifth Avenue, New York, NY Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave and Macmillan are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN ISBN (ebook) DOI / This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. A catalog record for this book is available from the Library of Congress. Typeset by MPS Limited, Chennai, India.

6 Contents List of Tables and Figures Acknowledgements vi ix Part I BRICS Forum: an Overview 1 Introduction 3 2 The BRICS Forum: an Overview 19 Part II Basel Accords 3 Basel III in Conjunction with Nation-Specific Regulatory Measures 37 Part III BRICS Macroeconomics 4 Macroeconomics of Brazil Macroeconomics of Russia Macroeconomics of India Macroeconomics of China Macroeconomics of South Africa BRICS Countries: Yesterday, Today and Tomorrow 131 Part IV Conclusions 10 Conclusions 151 Notes 196 Index 208 v

7 List of Tables and Figures Tables 1.1 Growth post-crisis has been much weaker than pre-crisis: BRICS without China Basel III minimum capital ratios and phase-in plans Pre-crisis and current levels of bank capital Remaining increases in bank capital ratios An increase in bank lending spreads relative to a one percentage point increase in bank capital Russia s percentage growth rates China: imports and exports of base metals in August Emerging and frontier markets China trade and A partial list of nations included in the World Bank s Doing Business reports Doing Business 2014: BRICS nations rankings for each measure Ownership of China s commercial banks Examples of the impact of Chinese trade on other nations India China bilateral trade South African trade with China by type of product Percentage of Chinese imports relative to total South African imports (WTO weights) Comparison of import unit values of key products imported from China in Chinese competition and producer price inflation in South Africa Industries in which loss to Chinese imports represented more than 10% of 2001 production 171 vi

8 List of Tables and Figures vii 10.8 China: changes in employment, and Estimated job losses in South Africa resulting from increased Chinese import penetration, Regression results for employment and wage models Simulated impact of Chinese competition on employment: selected industries BRICS trade profile (merchandise) BRICS trade profile (services) Sector analysis: agriculture Sector analysis: industry Sector analysis: services Tariff profiles Service sector commitments under GATS Economic indicators for the BRICS, Trade indicators for the BRICS BRICS share of world exports and imports of goods and services, selected years Share of BRICS economies in global FDI flows, selected years 191 Figures 4.1 Brazil: GDP growth Capital flows Value of Russia s infrastructure projects, planned and under construction Mumbai Sensex 30 days July August Emerging market private capital inflows, net China GDP g rowth China imports China exports South Africa: nonresidents purchases/sales of bonds $ billion, cumulative year to date South African inflation rate 123

9 viii List of Tables and Figures 8.3 Global GDP growth: emerging market economies and advanced economies (percent average annualized) South Africa: current account deficit South Africa: exports South Africa: imports Brazilian exports to China Brazilian imports from China Brazil China trade Russia: quarterly imports Russia: quarterly exports China South African bilateral trade balance by weighted WTO end-use classification Price per unit of Chinese imports relative to imports from other countries, BRICS nations GDP Trade between Brazil and the other BRICS nations Trade between Russia and the other BRICS nations Trade between India and the other BRICS nations Trade between China and the other BRICS nations Trade between South Africa and the other BRICS nations Exports of goods and services by the BRICS economies (US$ million) FDI inflows in the BRICS economies (US$ million) 192

10 Acknowledgements Without question, no manuscript can become a book without the support, encouragement and professional input of others. With that in mind, I would like to thank my editor Aimee Dibbens, my copyeditor Keith Povey, Gemma d Arcy Hughes and all of the Palgrave Macmillan production team. In support of my research findings, I would like to thank Maya Revzina of the World Bank, Enestor Da Rosa Dos Santos Junior of BBVA Research, Robin Koepke, Kristen Silverberg and Leah Davis of the Institute of International Finance a nd the Bank for International Settlements Basel Committee on Banking Supervision. June 2014 Rich Marino ix

11 Part I BRICS Forum: an Overview

12 1 Introduction BRICS is more than an acronym. It s the official title of a structured economic association of five high-profile emerging market economies: Brazil, Russia, India, China and now South Africa. Each nation has its particular strengths along with its particular weaknesses, but in the case of the BRICS as one economic entity, the original purpose of the alliance is that each country s strengths will become stronger and their weaknesses will diminish. Beginning with the first formal BRIC summit in Yekaterinburg, Russia on 16 May 2008, an official summit is held each year and the summits are attended by each nation s head of state. In the first summit, discussions focused primarily on global economic conditions and opportunities for growth. Each country agreed that cooperation among the four was a distinct global economic advantage. At the end of 2010, South Africa became a full member of the BRIC extending the alliance and the acronym to the BRICS. The BRICS Forum was officially organized in The Forum is an independent organization of the BRICS countries which encourages economic, cultural and political cooperation among the BRICS nations. BRICS economic treaties on tariffs were established along with an international political alignment in terms of global affairs. Of particular importance is the macroeconomic reach of the BRICS. With a total estimated 2012 GDP of roughly $15 trillion, based on the official exchange rates, the BRICS nations are not far behind the United States, whose GDP is $15.6 trillion. Chapter 3 of this book looks at the upcoming regulatory changes, mainly Basel III, and is entitled Basel III in Conjunction with Nation- Specific Regulatory Measures. This is an important subject for the book s thesis. In order for us to determine if the future BRICS is a synergistic economic alliance or business as usual, we need to engage all 3

13 4 BRICS Forum: an Overview possibilities of future capital flows. This chapter in particular enunciates the reduction of capital available from the global banking system for capital flows, especially for the emerging market economies that are heavily dependent on foreign capital inflows to finance their aboveaverage GDP growth rates. From a technical perspective, to determine the exact reduction in capital unavailable from the global banking system is an extremely difficult if not impossible task due to the ever expanding money supply of the advanced economies, but nonetheless as students of the global economy it s imperative that we fully understand the negative future effects of increased regulation, most notably Basel III, relative to a reduction of future global capital flows throughout the phase-in Basel III period from 2013 to Ironically, the collapse of the Bretton Woods consensus in 1973 set the stage for a dramatic increase in contemporary financial globalization of the developed nations which ushered in the contagions and crises of the 1990s and laid the foundation for the subprime debacle and the Great Recession of With that said, the collapse of Bretton Woods undoubtedly produced a more elastic world economy which included the formidable growth of the emerging markets. The free flow of capital from the developed world into the emerging markets was relatively low in the mid- to late 1970s, but the global financial world witnessed a healthy increase of free-flowing capital to the emerging markets in the 1980s through to the mid-1990s. However in 1997, there was definitely a setback due to the Russian and Asian financial crises, but it should also be noted that, beginning in 1997, there was an inordinate increase of private capital flows to those countries: foreign direct investment (FDI). Beginning in the 1990s, the emerging markets in general became synonymous with staggering GDP growth rates which obviously spawned a greater need for capital funds. World financial intermediaries, such as mutual funds, pension funds and insurance company funds, worked their way into the emerging markets financial systems through international banks to capitalize on the exceptional growth rates. Moreover, the emerging markets were able to generate additional capital in the American markets with the creation of their own American Depository Receipts (ADRs) which trade on the American exchanges and also the Global Depository Receipts (GDRs) which trade on any number of world exchanges. China in 2007 received $190 billion in net private capital flows. The estimate for net private capital flows to China in 2012 is approximately $250 billion. In 2007, India received roughly $100 billion in net private capital flows. The 2011 estimate for 2012 is around $90 billion. Brazil

14 Introduction 5 in 2007 was the recipient of roughly $100 billion in net private capital flows and the 2012 estimate for net private capital flows to Brazil is between $135 and $140 billion. Now to a more checkered scenario: Russia in 2007 received roughly $200 billion in net private capital flows, only to see that number plummet to approximately $75 billion in 2008 followed by an even further decline in 2009 to almost flat. However, the estimate for Russia s net private capital flows for 2010 is almost $50 billion, but this amount is the precursor to the $100 billion per year estimate for years 2011 and The future success or failure of the BRICS as an economic alliance will depend on the answer to this question: why has the increase in upcoming global financial regulations underscored by sluggish GDP growth in the US, the Eurozone and Japan restricted capital flows to the emerging markets resulting in lower future growth rates for the BRICS? This is an important question because at this point in time we really don t know. For one thing, the lag time between the complete implementation of the new international financial reserve requirements (Basel III) and the actual culminating effects among the global BRICS is too great. As of this writing, a number of concerns are beginning to surface from the BRICS countries with regard to fundamental GDP growth, for example, huge capital outflows, civil discontent, inflation, deflation, unemployment, wealth distribution, and so on. These factors will obviously vary from country to country, but a so-called better-than-expected current GDP growth rate from an emerging market is not in and of itself a prediction of sustained future growth if the global financial markets are constrained. 2 This book will bridge the gap between the staggering growth rates of the BRICS over the past ten years and the BRICS forecasted growth rates for the next ten years. It will serve as a valuable resource for the world academic community in general and for anyone in particular who may have an interest in the long-term future growth prospects of the BRICS in conjunction with the success or failure of their economic alliance, the BRICS Forum. This book will also be an important resource for any government, legal or business organization that may have a vested or unvested interest in the success or failure of the future growth of the BRICS and the emerging markets in general relative to the past, present and future growth rates of the advanced economies. Chapter 2 will focus on the BRICS Forum as an economic and global political alliance. This chapter in particular sets the stage in analyzing the BRICS Forum as a synergistic economic alliance where all participants benefit equally or are there unequal factors among the five

15 6 BRICS Forum: an Overview nations which tilt the alliance in favour of one country or another at the expense of the rest, making the economic alliance business as usual? Chapter 3 extensively addresses the Basel Accords in general and most specifically Basel III, but it s important to note that due to the role of regulation within the global economic spectrum, Basel III will be analyzed in conjunction with nation-specific regulatory measures most notably the US, the EU, the UK and Switzerland. For our purposes, we will discuss the Basel Accords and Basel III both in conjunction with nation-specific measures and in terms of its ramifications on the world banking system. The Basel Accords and Basel III establish the world s uniform bank reserve requirements. It s important that the reader grasp the regulatory reserve requirements of Basel III in conjunction with its phased-in implementation timetable ( ). Chapters 4 to 8 will analyze the overall macroeconomics of each BRICS nation in relation to its position as a high-profile emerging market economy past and present, but more importantly the analysis will highlight the macroeconomy of each BRICS nation relative to its peers within the BRICS Forum. Chapter 9 will analyze and forecast the BRICS GDP projection for In Chapter 10, we arrive at a conclusion. In this effort, we will answer two pivotal questions with regard to the success or failure of the BRICS Forum: (i) why has the increase in upcoming global financial regulations underscored by sluggish GDP growth in the US, the Eurozone and Japan restricted capital flows to the emerging markets resulting in lower future growth rates for the BRICS; and (ii) the BRICS future a synergistic economic alliance or business as usual? In 2013, the BRICS GDP forecasts underwent a significant reversal accompanied by a substantial rotation of capital outflows especially in Brazil, India and South Africa. In an interview on 7 July 2013 IMF Managing Director Christine Lagarde said that the IMF s global growth forecast for this year would be scaled back this week and emerging market economies were to blame. We had a growth forecast of about 3.3%, Ms Lagarde said, referring to the fund s forecast for this year. But I fear that considering what we are seeing now in emerging countries in particular not developing countries and low-income countries but emerging countries I fear that we might be slightly below that, she told an economists conference in the southern French city of Aix-en-Provence. 3 In April 2013, the IMF had cut its 2013 global growth forecast to 3.3 per cent, down from its January estimate of 3.5 per cent. For South Africa in particular, the revision in growth estimates is extremely disappointing. South Africa s entrée into the BRICS economic alliance was underscored by hopes that the economic alliance would help bridge the gap in South

16 Introduction 7 African exports due to a prolonged slowdown in European economic activity. Moreover, the recent IMF growth revisions work in tandem with the World Bank Global Economic Prospects report which claims that the growth rates of BRICS member have long been overstated. 4 The report argues that inflation problems continue to worsen in conjunction with deteriorating current account balances which are a clear indication that the BRICS countries are unable to maintain rapid growth momentum without increases in prices. The report blames domestic supply bottlenecks arising from weak or poorly enforced regulations, corruption, inadequate or irregular provision of electricity, or inadequate educational and health investment for the price pressures. 5 In light of its latest BRICS revisions, the IMF will probably upgrade other forecasts, particularly in the United Kingdom where the IMF and the UK Treasury have publicly disagreed with each other over monetary and fiscal policies. In all likelihood in the case of the UK, the IMF will probably increase its growth forecast from 0.7 per cent to 1 per cent. In April 2013, IMF chief economist Olivier Blanchard warned Chancellor of the Exchequer George Osborne he was playing with fire and should consider adjustment to the original fiscal plans. The IMF had expected the world economy to grow 3.3 per cent in 2013 and 4 per cent in 2014, with corresponding growth of 1.2 per cent and 2.2 per cent in the advanced economies, and 5.3 per cent and 5.7 per cent in emerging economies. The IMF s latest World Economic Outlook report, from April, forecasts a growth rate of 2.8 per cent for South Africa this year, rising slightly to only 3.3 per cent next year, owing to sluggish mining production and weakened demand from the Eurozone, which remains a key export market for the country (see Table 1.1). 6 Table 1.1 Growth post-crisis has been much weaker than pre-crisis: BRICS without China Percentage Brazil Russia India S. Africa Source: Based on data collected from International Monetary Fund, World Economic Outlook, April, 2013.

17 8 BRICS Forum: an Overview The year 2013 seems to have been something of a turning point for the BRICS nations in terms of its illustrious economic history. Numerous financial news headlines and lengthy articles inside the BRICS countries have begun to surface, for example: BRICS a force but cannot challenge US due to disputes Though BRICS has emerged as a dynamic emerging economic market group with its plan to set up a development bank, it would be unrealistic to expect the grouping to challenge US hegemony as the member nations face many hurdles, including territorial disputes, preventing them from deeper cooperation. 7 The above headline is part of an article which was originally published in Beijing and written by Chu Zhaogen, a Chinese scholar. On 2 April 2013 it was picked up and published by the Economic Times of India. 8 Moreover, the article was originally titled: BRICS a force despite ifs and buts. According to Zhaogen, It is unrealistic to expect Brazil, Russia, India, China and South Africa (BRICS) to become a center of power that can break the existing world order, which is marked by Western dominance and US hegemony. 9 In order for the reader to fully appreciate the BRICS as an economic alliance, we need to take a step back and try to understand its geographical disparities. Each BRICS nation is a regional power, but history has put each of them in precarious situations in terms of territorial or political disputes. For example, as of this writing Russia is in an ongoing disagreement with Chechnya while simultaneously trying to come to terms with its pro-us neighbours. On the other hand for years, China has had territorial disputes with India, Japan and a number of Southeast Asian countries. Moreover, India has historically had ongoing territorial disputes with Pakistan and China, and in the same vein, Brazil is very wary of Argentina. Plus it is important to remember that China shares its borders with Russia and India. From a political perspective that can be somewhat problematic for the Chinese and the Indian authorities as well. Here recently, tensions have increased in the China India relationship over China s objections to India s enhanced nuclear programme. An interesting side-note took place in March 2013 at the annual BRICS Forum meeting which was held in Durban, South Africa. The BRICS Forum officially announced the formation of its own development bank which in essence would rival the World Bank. Needless to

18 Introduction 9 say, this came as a complete surprise to the world economic community and from the outset was widely regarded with enormous scepticism. The BRICS Development Bank is still at least four to five years from inception and there are a number of inter-brics issues that have to be resolved. Seed money for the bank is set somewhere around $50 billion, but there are concerns in some quarters that South Africa would have trouble with that amount. The idea behind the development bank is to eventually create development funds for infrastructure projects worth $4.5 trillion mainly on the African continent. Notwithstanding the fact that the whole notion of a new development bank is in and of itself a very lofty goal, one with an eventual lending infrastructure capability of around $4.5 trillion is even more mind-boggling. However, the reader should keep in mind that the five BRICS countries represent 43 per cent of the world s population and roughly 17 per cent of its trade. The physical location of the bank is yet to be determined, but with an economy 20 times larger than South Africa and four times as big as Russia or India, most analysts agree that China will be the dominant player. However, South Africa is lobbying very hard for the bank s headquarters for that very reason, notwithstanding the proposed infrastructure development in Africa. Moreover, Caroline Bracht of the University of Toronto and a member of the BRICS research group claims, My opinion goes with the mainstream opinion, which is South Africa. It has financial stability and is the smallest but one of the most eager members of the BRICS. Geographically it s central. But the location is not as significant as who the CEO will be. 10 And along the same lines, South Africa s Finance Minister, Pravin Gordhan, said: The roots of the World Bank and IMF still lie in the post-world War Two environment. The reforms that have taken place are still inadequate in terms of addressing the current environment. We still have a situation where certain parts of the world are over-represented. We should see the BRICS bank as part of a new paradigm to share resources and, as the Chinese minister said, achieve a win-win outcome. 11 Moreover, according to Patrice Motsepe, the South African mining magnate and one of South Africa s richest men, who is also the newly appointed chairman of the BRICS Business Council, We have a particular preference, but it s for the BRICS members to decide. If you look at the strength of the South African financial institutions, our corporate governance and auditing and accounting have been recognized as world

19 10 BRICS Forum: an Overview class. Additionally, Motsepe dismissed the notion that the BRICS bank would compete against American and British interests: There s a huge need for partnerships and a role for all financial institutions and I ve no doubt they ll continue to play that role. I m on the board of JP Morgan which is chaired by Tony Blair and they are very excited by the opportunities in Africa. 12 On a different note, President Zuma of South Africa later commented on the BRICS bank proposal, The bank will establish a BRICS contingent reserve arrangement, a pool of $100 billion to cushion member states against any future economic shocks and further lessen dependence on Western institutions. 13 In the same vein, Zuma invited fifteen other African leaders to the BRICS Forum in Durban in order for them to meet South Africa s BRICS counterparts, but unfortunately not all African leadership is convinced that China s economic role in Africa is beneficial to and for the economic development of Africa. In a later article, Lamido Sansui, the governor of Nigeria s central bank, accused China of being a significant contributor to Africa s de-industrialization and underemployment with its cheap manufactured goods flooding the continent and its consumption of raw materials preventing Africans from adding value to their natural resources. There is a whiff of colonialism about China s approach to Africa. 14 While I certainly don t want to rain on their parade, there are many in the world economic community who are less than enthusiastic about the notion of a BRICS development bank. It s interesting, but most of this uncertainty arises from the fact that while the acronym BRICS suggests a combined GDP of around $15 trillion, the reality is that most BRICS countries have very little in common with one another. The [BRICS] countries economic management policies run the gamut from strong state control to free market. 15 In terms of currency reserves, the BRICS countries overall have impressive financial firepower, especially China which accounts for $3.3 trillion of the BRICS total of $4.4 trillion, but according to Charles Robertson, emerging markets economist at Renaissance Capital in London, in reality, does China or Russia want to see their currency reserves bailing out unsustainable macroeconomic policies as the IMF is regularly asked to do? It would take years for a BRICS version of the IMF to create a staff of economists and experienced professionals who could manage such bailouts. 16 From my perspective at this point, it s unclear what role a BRICS development bank would play in terms of integration with existing institutions such as the World Bank, the African Development Bank, the Asian Development Bank and the Inter-American Development Bank.

20 Introduction 11 On the other hand, a BRICS development bank could foster and fund projects that are mutually beneficial, for example, it could fund pipelines to transport Russian gas to China or finance Brazilian infrastructure projects which would be built by Chinese construction companies. Let s face it, to create a development bank like the World Bank is a very tall order! And the idea that the BRICS can quickly build a counterweight to the World Bank and the IMF is naïve, claims Martyn Davies, chief executive of Frontier Advisory, an emerging market research group in Johannesburg. Unlike the Western nations that agreed to set up the World Bank and the IMF after World War II, the BRICS have no common ideology and the glue that s required is not there, said Davies. 17 Before we can put the entire notion of the proposed BRICS development bank to rest at least for this book, we need to draw some pre-emptive conclusions by discussing the answers to a few viable questions. First off, is a BRICS development bank a foregone conclusion? From everything that I ve read, I would have to say that it s definitely a BRICS joint decision: have agreed to establish the New Development Bank, but almost immediately following the press release, there were additional comments that were more or less unsettling. For example, President Jacob Zuma of South Africa said almost immediately afterwards that we have decided to enter formal negotiations on the BRICS bank. Moreover, while newspaper headlines in the Financial Times read: BRICS agree to create development bank, 18 at the same time Voice of America headlines read BRICS Summit Ends Without Development Bank Deal. 19 Obviously, all these comments are a bit disconcerting which leads us to the next question: is there enough common ground among the BRICS countries to even sustain a shared institution? That s a very important question! There is no question that these five countries are politically different: from a thriving Brazilian democracy to an oligarchy in Russia to a state authoritarian government in China combined with massive internal struggles in India in conjunction with an underdeveloped South Africa compared with its counterparts, but with that said, there was no lack of disagreement among the European and American powers at Bretton Woods and for whatever reason the decisions of Bretton Woods still stand today almost 70 years later. Another interesting question that comes to mind is: if a development bank is indeed in the pipeline, what exactly is its funding mission? On the surface, and from everything that I ve read thus far, I would have to say infrastructure. According to Isobel Coleman of Foreign Policy: The BRICS themselves have an estimated $4.5 trillion in infrastructure needs over the next five years, and coincidentally, have about