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COVID-19 magnifies BRICS divergence as China solidifies lead


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COVID-19 magnifies BRICS divergence as China solidifies lead

Almost 20 years after the acronym BRICS was coined, the arrival of the coronavirus pandemic has been another opportunity for China to demonstrate why it is in a league of its own when compared with the group's other members, Brazil, Russia, India and South Africa.

China had been making a mockery of the grouping for many years, with sustained economic outperformance — real GDP has grown 979.9% since 2001, compared with 480.8% for second-placed India and 188.9% for the group laggard South Africa — but its superior economic management this year looks set to only widen the gap with its fellow BRICS.

China is the only BRICS economy predicted to expand this year, according to the International Monetary Fund. The world's second largest economy will end the year 1.9% bigger after recovering from a 6.8% contraction in the first quarter, IMF projections show. That compares with a 10.3% contraction for India, -5.8% for Brazil, -4.2% for Russia and -8% for South Africa.

"The pandemic will reinforce the trend," said Joydeep Mukherji, managing director and Americas specialist at S&P Global Ratings. "Those who were doing well immediately before the coronavirus will be doing well after it."

Globalization symbol

The original BRIC acronym was coined in a 2001 paper by Lord Jim O'Neill — then head of global economics research at Goldman Sachs, now a member of the U.K.'s House of Lords — and extended to include South Africa in 2010 despite O'Neill's own reservations. At the time the five countries represented a group of large, relatively underdeveloped land masses accounting for 45% of the world's total population, with the potential to achieve breakout economic growth.

The BRICS became a symbol of an increasingly globalized world with economic and political power shifting from the U.S./Europe axis to a wider array of countries, including some developing markets.

In some ways the prophesy came true. In the subsequent two decades the BRICS have seen their collective proportion of global GDP grow in terms or purchasing power parity from 18.8% in 2001 to 30.5% in 2019. A BRICS summit now takes place every year attended by the leaders of each country, with multilateral ties extending to a New Development Bank armed with $100 billion of capital.

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However, most of that growth has come from China, with a strong contribution from India. The others have struggled with various forms of economic disfunction over the past 20 years.

The Chinese century

China's share of global GDP has increased from 7.7% in 2001 to 17.4% in 2019, according to IMF data. China and India combined account for 24.5% of GDP, up from 11.9% in 2001.

China's rate of growth repeatedly exceeded Goldman Sachs' projections. Average annual GDP growth was expected to reach 8% between 2000-2005, 7.2% between 2005-2010, 5.9% between 2010-2015 and 5% in 2015-2020. In fact, GDP grew on average by 9.5%, 11.3%, 8.3% and 6.7%.

Even the arrival of a global pandemic has been a chance for China to outperform its fellow BRICS that have had much larger and more sustained epidemics.

Official figures suggest just 4,634 COVID-19 deaths in China, and while Europe is enduring a second spike and average new daily cases in the U.S. reach new heights of over 91,000, China's cases are measured in the 10s with zero deaths since April 17 when a glut of 1,290 were announced.

In suppressing the virus, China has been able to recover economically quicker than others. HSBC co-head of Asian economics research Frederic Neumann, said China is "holding up the world" in terms of GDP after the country achieved an expansion of 4.9% in the third quarter. According to the IMF, China is likely to be the only country to register positive growth in 2020 and is projected to deliver more than 8% growth in 2021.

The country is not without its challenges, though.

Alongside Russia, China's credit rating has improved the most among the BRICS in the last two decades, with its current rating of A+ four notches higher than the BBB rating it enjoyed in 2001. But S&P Global Ratings had increased the rating to AA- in 2010, and lowered it in 2017, noting, "the Chinese government's policy of monetary stimulus and other steps to encourage investment (especially at the local government level) began to create imbalances in the financial sector, raising the level of potential contingent liabilities for the sovereign."

While government debt appears manageable at 52.6% — expected to rise to 61.7% in light of the pandemic — the figure is up from 24.6% in 2001 and masks a broader debt concern in China.

Debt among nonfinancial corporations was 159.1% of GDP in the first quarter, having climbed dramatically since the financial crisis of 2008/09 when debt was 93.9%. By contrast, the figure among American companies equates to 78.3% of GDP. The total includes state owned enterprises, which are ultimately underwritten by local governments, the funnel through which China has stimulated investment in the past.

The concern about debt was reflected in the absence of a major fiscal stimulus this year in response to the pandemic. According to the IMF additional spending and foregone revenue totaled 4.6% of GDP, higher than India but lower than Brazil, South Africa and many developed countries.

But for Mukherji, it is clear that China will remain the best performer of the BRICS. "China is clearly at one extreme and who is the worst, well you can argue, but clearly the rest have suffered more," he said.

India hamstrung by debt

India's response to COVID-19 has been among the most stringent as the country sought to quell an epidemic that has resulted in the second-highest number of COVID-19 cases — 8.3 million — and third-highest death toll — 123,000.

The economy had already slowed to growth of just 3.1% in the first three months of 2020, but the extensive lockdown meant output in the three months to June plunged 23.9%, the first quarterly contraction since 1997, with horrific declines in some sectors including a 50.3% contraction in construction.

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Yet India's government has restricted its fiscal response to COVID-19 to just 1.2% of GDP — as opposed to an average of 3% among emerging-market economieswith much of the response left to monetary policy, including liquidity provisions and reductions in cash reserve ratios.

Prime Minister Narendra Modi's purse strings have been tightened by relatively high debt levels for an emerging market country. A drop off in tax revenues and economic activity will see government debt-to-GDP surge to 89.3% this year from 72.3% in 2019, according to IMF forecasts. The debt burden is a particular concern for India, which is perched uncomfortably on the last credit rating rung above junk. Both ratings agencies Moody's and Fitch have put India on negative watch since the pandemic struck, though S&P has kept it stable.

"In India, the threat of a debt crisis is low, but the government is keen to return the debt ratio to a sustainable path and protect its investment-grade sovereign credit rating," Jennifer McKeown, head of the global economics service at Capital Economics wrote in a research note.

But while Capital Economics expects that an "inadequate" policy response will mean the country's growth outlook for the next two years "is bleak," Mukherji expects that long term, India will remain one of the best performing BRICS as the country continues to urbanize and the growing middle class creates ever more demand for goods and services.

Like China, India's GDP growth has consistently beaten Goldman Sachs' original forecast, reaching a peak rate of 10.3% in 2010. But annual GDP growth has been slowing each year since 2016, dropping from 8.3% down to just 4.2% in 2019.

India watchers have been disappointed by the slow pace of reform following Modi's pledge to loosen regulations in areas including labor and land, while a vulnerable banking sector is exposed to a glut of nonperforming loans.

But favorable demographics and years of growth have seen the middle class swell to 350 million, more than in the European Union, while competitive unit labor costs and a stable government are seen as longer-term reasons to back India.

The country also seems to be turning a corner in its fight with the virus. Cases are falling with the 7-day average down from a peak of over 93,000 to 45,000, while economic indicators show progress. India's combined PMI accelerated to 58.9 in October from 56.8 in September, as both production and new orders were boosted by the reopening of the economy.

"I prefer to look more long term to say OK, China's growth rate was the most impressive; after COVID that's still true. India was second and I think that's still true today," Mukherji said.

Brazil's 'horrible growth story'

Like India, Brazil has been hit hard by the pandemic. Brazil has had the third most cases and, at over 160,000, the second most fatalities. But unlike India, President Jair Bolsonaro's government decided against severe lockdowns and turned on fiscal taps, with stimulus totaling 8.3% of GDP.

In its October World Economic Outlook, the IMF significantly improved its outlook for the Brazilian economy in 2020, revising its forecast to -5.8% from -9.1% in June.

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"The combo of massive fiscal stimulus and a decentralized lockdown policy has propelled Brazil's economy to the pole position in Latin America's recovery race to pre-pandemic levels," Felipe Camargo, Latam economist at Oxford Economics, wrote in a research note. "Still, we are skeptical that the economy can hold the current momentum in the next year once fiscal consolidation measures kick in."

Average daily new cases have declined from a peak of 46,000 in late July to 22,000 as of Nov. 1. But like India, Brazil's longer-term problems are related to the need for major reforms.

Brazil's government debt-to-GDP is the highest of the BRICS. At 89.5% in 2019 it is now forecast to rise to 101.4% in 2020. Meanwhile economic performance has been poor for a number of years.

In the first decade as a BRICS country, Brazil's economy met expectations. Having been projected by Goldman Sachs to grow by 2.7% between 2000 and 2005 and then 4.2% between 2005 and 2010, the country beat expectations with five-year growth periods of 3.2% and 4.3%, respectively.

The past decade proved more difficult, with growth of 2.2% between 2010 and 2015 falling short of a 4.1% forecast. While a recession that saw GDP decline by 3.5% in 2015 and 3.3% in 2016 contributed to negative growth of 0.5% in the years from 2015 to 2020, as opposed to the expected 3.8% rate.

S&P had put Brazil, rated BB-, on a negative rating in light of its problems, but the election of Bolsonaro brought the prospect of wide sweeping reforms of taxes, civil service structure, central bank administration and privatization, and S&P switched the outlook to positive.

"They had a horrible growth story. We thought things had hit bottom and at the beginning of the year we thought OK, they have huge fiscal challenges, a huge debt burden, but they also had a pretty ambitious reform agenda," Mukherji said. "When COVID-19 hit they were obviously set back not just health-wise and economic-wise, but their agenda was put back. So, we put the outlook back to stable."

Russia's energy problem

Russia and South Africa veered off of Goldman Sachs' projected course earlier than anyone else. Having beaten the average growth estimate of 5.9% in the years 2000-2005 by achieving 6.8%, Russia then fell short by 0.7 percentage point and 1.6 points in the following five-year periods, with growth shrinking to 4.2% then 2.2%. Between 2015 and 2020 growth averaged just 0.7% of GDP, as opposed to the expected 3.4%.

Russia has struggled to broaden the structure of its economic growth away from the volatile energy sector, while sanctions were put in place by the U.S. and European Union in 2014 following Russia's occupation of Crimea, with further measures imposed in 2017 in response to Russia's alleged interference in the 2016 U.S. election.

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The initial hit of sanctions resulted in GDP contracting by 2% in 2015 and, while growth had recovered, it stood at just 1.3% in 2019.

COVID-19 hit Russia hard with the country ranking fourth in the world for total cases at 1.7 million. Lockdowns slowed the average daily new cases from 11,000 in early May to 5,000 in August, but cases have spiked again in line with Europe's second wave and are approaching 20,000.

The Russian government responded on May 31 with fiscal stimulus totaling 2.5% of GDP, of which 64% was directed to healthcare and social spending, and what ING Chief Economist Dmitry Dolgin termed "modest" support for industry.

With demand for energy hit by the slowdown in global growth, lower oil and gas prices have forced production cuts agreed with the members of OPEC, reducing a crucial source of revenue for Russia. The IMF forecasts GDP will shrink by 4.1% in 2020.

Like India, Russia's credit rating is BBB-, teetering just above junk status. That is despite government debt-to-GDP of just 13.9% in 2019, expected to rise to just 18.9% this year as a result of the pandemic.

In its July rating update, S&P wrote, "the ratings are constrained by the structural weaknesses of the Russian economy, which remains dependent on revenue from oil and gas exports, as well as by wider institutional and governance bottlenecks."

Demographics are not in Russia's favor either. It is the only BRICS country to have seen its population decline since 2001, having fallen from 146 million to 145.9 million in 2020.

South Africa's ballooning debt burden

Having been downgraded to BB- on April 29, South Africa is the only BRICS country to be rated lower by S&P than it was in 2001 when it was three rungs higher at BBB-.

South Africa's problems were growing before the arrival of COVID-19. Economic growth is structurally weak despite a decade of government spending, which has seen public debt-to-GDP rise from 30.1% in 2010 to 62.2% in 2019, while unemployment is around 30%.

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Between 2000 and 2005 average growth exceeded Goldman Sachs' projection of 3.4% at 3.9%, but the country has fallen short ever since, with growth in the subsequent five-year periods of 3.5%, 2.3% and 1% below the expected 4.4%, 3.6% and 3.3%.

Stabilizing the trajectory of public debt is a primary concern, with the effects of COVID-19 expected to more than double the fiscal deficit from an already high 6.8% of GDP to 15.7% in 2020. President Ramaphosa announced a ZAR500 billion ($31.21 billion) social-relief and economic support package — equivalent to 10% of GDP — on April 21, including a fiscal boost of ZAR170 billion of new expenditure and ZAR200 billion was allocated to a loan guarantee scheme.

South Africa's treasury has calculated that a continuation of low growth, higher debt service and public expenditure could see debt-to-GDP reach 141% of GDP by the end of the decade. Economists have prescribed spending reductions and tax rises, but confidence in the government's ability to deliver tough measures is low.

"Our comparatively weaker rating assessment partly reflects the inability of the countries' political leadership to take timely and adequate measures to restore economic growth and stabilize public finances," S&P Global Ratings said.

The IMF has already stepped in, approving a $4.3 billion emergency support loan on July 27.

To Mukherji, the divergence in outlooks for the BRICS is part of a longer trend that has seen the countries go down different paths.

"The original hook to the Goldman Sachs story was "look, here are a bunch of countries that are big or at least are prominent, we think they have really good growth prospects and we think they will grow faster than average and over time they will become growing players." For a while it made sense, the numbers were there. The growth rates where at first consistent with the call. In the last 10 years, they were not."