Where the next BRIC economies will be

Brazil, Russia, India and China formed a block of countries that returned well to their investors over the past decade. Tom Stevenson tries to predict which countries could make up the next BRIC.

Ten years ago, Jim O’Neill of Goldman Sachs came up with the idea of throwing together the large and fast-growing economies of Brazil, Russia, India and China into one investable block called the BRICs.

In essence, the key common advantage among these countries was their size: very high populations (more than 40 per cent of the global total) and very big land masses (over 25 per cent of the global expanse), which in turn supported major economic growth prospects.

What are the emerging market opportunities a layer down from the BRICs that are not as well appreciated but have similar long-term investment potential?

Using the broad criteria of large and growing populations and strong long-term economic growth potential, we take a closer look at the following five countries: Turkey, Indonesia, Nigeria, Mexico and the Philippines.

Of all the contenders, Indonesia is perhaps the most similar to the BRICs, owing to its very high population (bigger than Brazil or Russia), comprised of a large and increasingly wealthy young working class producing strong average real gross domestic product (GDP) growth of 5.7 per cent in the last five years.

Even during the global financial crisis, the Indonesian economy proved impressively resilient, with few of the problems seen in developed markets.

The banking sector is well capitalised, with declining non-performing loan ratios and low and declining public and external debt levels.

Apart from its favourable demographics, Indonesia also benefits from a degree of economic diversification owing to significant commodity exports, including oil, gas and coal.

In December 2010, the government articulated an economic vision in which Indonesia grows to become one of the world’s 10 largest economies by 2025.

If it succeeds in this objective, investing in Indonesian assets early on could prove to be rewarding.

However, there are risks. Political risk is relatively high, with concerns about whether the government can stick to its reformist agenda owing to pressure from vested interest groups.

Corruption is also prevalent, adding to a high risk business environment that falls short of Western standards.

Although not as resilient to the global crisis as some of the other countries profiled here, the Turkish economy has nonetheless bounced back very strongly, growing around 8 per cent in 2010.

Turkey is now reaping the benefits of reforms and generally prudent policies it pursued after its own crisis of 2001.

The banking system survived the global crisis in relatively good condition, and the government’s budgetary and public debt position (around 40 per cent of GDP) is significantly better than many countries in the Eurozone. 

An important driver of political reforms has been the hope of the European Union accession.

Unfortunately, strong opposition from Germany and France makes this a difficult objective to achieve in the near term; however, it is more likely in the long run, and is a positive risk factor that deserves to be factored in by investors.

Over the last decade, the moderate Islamist Justice and Development Party (AKP) consolidated its political position.

Nevertheless, political risk remains high by European standards owing to long-standing tensions between the AKP and the secularist military.

Already the richest in per capita terms of the countries profiled here, Mexico’s growth prospects are not as strong as some of the others. Both a potential strength and weakness of the country is its very high economic exposure to the dominant US economy.

Around 80 per cent of Mexico’s exports go to the United States and, as well as receiving substantial amounts of US investment, Mexico also benefits from the remittances of a strong Mexican-American community that resides in the US.

Apart from benefiting directly from US demand, Mexico also has the potential to act as a relatively low-cost gateway to the US for third countries.

For example, there has been some evidence recently of Chinese firms setting up factories in Mexico for export to the US, as well as some companies choosing Mexico over China, owing to transport cost advantages.

On the negative side, Mexico’s notorious drug violence and associated security costs are becoming a growing concern for businesses, adding to other weaknesses in the commercial environment.

Following recession in 2008-09, the Philippines economy has rebounded impressively, growing by 7.3 per cent in 2010 – the fastest pace in over three decades.

The country benefits from a fairly large population, a growing middle class, and rising average incomes.

The economy has also seen some significant structural improvements in recent years.

Although a balanced budget remains an unlikely prospect in the near term, the government has made significant strides in its fiscal management, owing to reforms and reduced tax evasion.

Lower fiscal deficits (averaging less than 3 per cent of GDP in the last five years) have helped to push the debt-to-GDP ratio below 60 per cent in recent years. 

The economy also benefits greatly from a substantial number of overseas workers (around 20 per cent of the population), whose remittances help support domestic private consumption, as well as keep the overall current account consistently in surplus.

In terms of risks, the Philippines is susceptible to a high level of political unrest, with a history of military coups, political violence and civil unrest.

It also has significant weaknesses in its business environment owing to security risks, corruption and inadequate infrastructure.

Some other high-potential emerging markets

The countries profiled merely give a flavour of a range of high-growth emerging markets that could provide attractive long-term investment opportunities.

There are many others. For example, despite its Communist government, Vietnam (a country of more than 90 million people) has achieved impressive growth rates in recent years.

With wages beginning to rise steadily in China, Vietnam is increasingly seen as a low-cost alternative for global manufacturers.

South Africa (with 49 million people) is already the most developed country in Africa, and has significantly higher per capita GDP than its regional peers.

However, other African countries are keen to catch up, and with its more developed characteristics, South Africa is uniquely placed to both facilitate and take advantage of Africa’s growth potential and aspirations.

With a population of around 29 million, Malaysia is relatively small in comparison to some of the other countries mentioned, but its long-term record of development is impressive. Its economy is structurally quite diverse and benefits from a significant electronics exports industry, as well as commodity exports, a vibrant tourism industry and increasing domestic consumption.

Investors in the BRIC group of countries have enjoyed excellent returns over the past 10 years, and many will want to know who might repeat their success in the future.

While outright replacements for the BRICs are impossible to find, there are a number of less appreciated (but well-populated) emerging markets with attractive long-term economic fundamentals.

For all emerging markets, investors need to consider the associated risk factors. Recent instability in the Middle East and North Africa has highlighted a higher susceptibility to political risk, in particular.

Therefore, the task is to find assets within those countries that offer sufficiently high returns that adequately compensate for the level of risk being taken.

This can be a research intensive and time-consuming process that, in the case of many investors, is probably better left to specialist investment managers that have in-depth regional investment experience and successful track records.

Spreading investments across a range of countries or multi-country funds can also help to control risk.

Tom Stevenson is an investment director at Fidelity.