Emerging Markets Weekly

Central banks in BRIC economies pursued mercantilist policies in recent years aimed at export promotion through currency manipulation. Large trade balances were achieved through foreign exchange accumulation specifically US dollar accumulation. China is the most extreme example where rapid foreign exchange accumulation resulted in nearly US$2-trillion forex reserves. These reserves were an inefficient use of domestic savings given the cost of accumulating these reserves equals the difference between domestic interest rates and the yield on US Treasury bonds.

Nevertheless, these reserves have proved an important source of stability for BRIC countries in the current economic downturn in contrast to previous episodes of currency weakness. The reason is simple, dollar reserves are hugely important to protect both private sector borrowers with dollar denominated debt. Russia used roughly one-third of its forex reserves to provide dollar funding to the domestic economy over the past six months. This process allowed for a more steady unwinding of dollar loans during capital flight in recent months.

In contrast, the Asian currency crisis and Russia's debt default in 1997-98 were all about US dollar loans that could not be financed. As currencies fell abruptly, the domestic cost of funding these dollar loans went through the roof and caused widespread insolvency. It is also noteworthy that despite better polices in the BRIC countries, not all emerging nations have managed foreign exchange risk properly. Hungary is drowning in a sea of foreign currency debt where roughly 80% of new home loans and 50% of business credit and personal loans between 2006 and 2008 were denominated in Swiss francs. As the forint has fallen, the cost of servicing debt has ballooned.

Russia, India and Brazil experienced currency depreciation in recent months due to capital flight. As a result, export competitiveness has risen substantially because inflation has also fallen. There are still ample reserves to maintain currency stability and there are strong signs that currencies have stabilized since the start of this year. The widespread economic slowdown in these countries have not resulted in a fundamental deterioration in the growth outlook over the medium term in contrast to the currency crisis last decade. In other words, government policy has resulted in a much better growth picture for BRIC nations this time around.

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Emerging Markets Weekly

Data released this week confirms a near-term bottoming phase in China's economy. The GDP data marks the point that US$586-billion stimulus package and aggressive lending policies are achieving their desired results.



Fixed asset investment growth increased at a 28.6% pace in the latest quarter representing a substantial pickup in activity from last year. The bulk of this activity is direct consequence of official policy that is geared toward infrastructure investments.



Lending activity has increased at a torrential pace in the first quarter of 2009 a clear sign that the change in policy direction is being felt in the real economy unlike in the developed world where flooding of bank reserves by central banks is not leading to increased lending. More than 90% of intended lending for 2009 was reached in the first quarter alone suggesting that things are progressing in the loan department too quickly and may have to be reigned in later this year.



The data confirm that China's economy has clearly bottomed and is the first to emerge from the global economic recession. The government will continue to pump life into the domestic economy until a broad based global economic recovery takes hold. There is no telling when this might happen, and it is quite possible that more stimulus measures could be announced late in 2009 or early 2010.

We have been highlighting China's better prospects for growth over any other country in the developing world for several months now and continue to believe that the authorities have the wherewithal to maintain economic growth despite severe headwinds in the global economy.

Emerging Markets Weekly

As central banks in developed nations around the world are running out of means to stimulate their economies, emerging markets still have plenty lot of room to ease monetary policy further to stimulate their countries' economies in 2009.

Around the globe, developed nations, with the exception of continental Europe, have cut key lending rates to close to nothing to ease lending rates in the midst of a severe credit crunch that has unfolded since the fourth quarter of 2008. Central bankers in the advanced world have now moved toward quantitative easing - a form of money printing in simplest terms.

In contrast, emerging markets have been slower to ease monetary policy for several reasons. For one thing, inflation fell more slowly in emerging markets and given that the economic slowdown hit the developed world with a lag. For another thing, some countries, most notably Russia, were forced to raise rates to shore up their currencies due to capital flight and inflation pressures.

Now that the global economic recession has firmly taken hold and inflation concerns have receded, there appears to be ample room for BRIC countries to ease monetary policy over the balance of the year and in 2010. These countries continue to grow on average in 2009 whereas the advanced economies are contracting deeply. Room for policy easing in the emerging markets will support stock market recoveries that have taken hold in earnest.