Searching for “breakout nations” in the emerging markets

Book Review: Breakout Nations, by Ruchir Sharma (2012).

During the 2000s, almost all emerging markets experienced strong economic growth. However, the global forces that enabled such broad growth are running out of steam, and only some developing countries will continue to grow so consistently. They will be the “breakout nations” of the future. This the message of a recently published book by Ruchir Sharma, the head of emerging markets at investment bank Morgan Stanley.

Sharma describes two broad forces as having supported emerging markets’ growth during the last decade. The first was high commodity prices. The second was a flood of “easy money” in the form of very low interest rates in the US and the Eurozone. Low interest rates in the West stimulated domestic consumption, which fueled demand for exports from emerging markets, which in turn demanded more commodities.

Now, these forces appear to be on the wane. The Great Recession curtailed Western demand for exports. It is true that, to combat the recession, the US Federal Reserve Bank  deployed two rounds of “quantitative easing” of the money supply. However, the Fed has indicated it will be much more cautious with further quantitative easing.

Having set the global context, Sharma takes us on a tour of the emerging world. For many countries, Sharma advances arguments that are largely sobering, if not outright pessimistic. Sharma’s overarching point is that emerging markets can no longer be viewed as a single class, but vary significantly and will have different growth trajectories. If the universal allure of emerging markets was the story of the last 10 years, the divergence between “breakout nations” and also-rans may describe the current decade.

Breakout Nations devotes individual chapters to China, India, Brazil, Russia, Mexico, Turkey, and South Africa. There are also chapters on Central Europe, Southeast Asia, and the “fourth world.” Below, I summarize Sharma’s key takeaways for the BRICs:

China: China has been growing at 10% annually for 30 years, but this cannot continue much longer because the country is becoming richer and workers are demanding higher salaries. China is entering the “middle income trap” where production costs are higher and reforms are more challenging. Expect growth to slow to a new 7% range.

India: After just one decade of high growth, India is experiencing overconfidence and complacency. The government has dropped the ball on economic reforms and is more focused on social programs. Corruption is a major problem and may be worsening. Politics are becoming more decentralized, as national parties give way to state-level ones, and state governments increase their authority over economic policies.

Russia: Since 2008, the Putin-led government has been shedding popularity and, as a result, is reallocating Russia’s oil and gas wealth “to purchase the good graces of the people.” The Kremlin’s deepening involvement in the economy will lead to closer relations with the oligarchs, which will fuel an intensifying “criminalization of politics.”

Brazil: Brazil is blessed with natural resources, but cursed with poor governance. The high cost and complexity of doing business in Brazil means its top rate of growth is about 4%. Growth has exceeded this rate in the last few years, and the economy is overheating. Normally, a central bank would calm an overheating economy by raising interest rates. However, Brazil’s rates are already among the highest in the world; increasing rates would serve to further appreciate a very strong local currency while making economic life much more difficult for Brazilian consumers, many of which are overloaded in debt.

If China, India, Russia, and Brazil have such mixed outlooks, then where are the “breakout nations” of the 2010s? For Sharma, the answer is: South Korea, Poland, Czech Republic, Indonesia, Turkey, and (maybe) Thailand. For different reasons, he sees each of these countries as well-positioned to experience strong growth through 2020.

Elsewhere, he makes convincing arguments for why Vietnam is not the next China, and why Sri Lanka may surprise as a high-growth nation in the coming years.

Sharma’s book is not perfect. The author has a tendency to take a position on a country and back it up with numerous facts, without sharing – and defeating – key counterarguments. For example, his favorable outlook on Turkey excludes inconvenient truths, such as its high rate of consumer indebtedness. Meanwhile, optimistic sections on Thailand and the Philippines seem to glance over those countries’ problems.

Also, Sharma’s coverage of emerging markets was not comprehensive. In Latin America, he did not look beyond Brazil and Mexico. I would have been interested to learn his thoughts on the growth prospects of Chile, Colombia, and Peru.

These are not critical flaws. Breakout Nations is best understood as a summary of a highly informed person’s opinions of the emerging markets. Sharma’s role at Morgan Stanley provides him with access to a variety of data and analysis, travel opportunities, and access to political and business leaders around the world. Presumably, this enables him to cultivate some very well-informed opinions, many of which may have a good chance of being proven in the coming years. But they are not necessarily the final word – as Sharma acknowledges, there is no blueprint for identifying “breakout nations.”

Written by David Gates for Emerging Markets Blog

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