Ask the expert: BRICs and investor strategy

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Jim O’Neill is one of the more influential economists working in markets. As head of global economic research for Goldman Sachs, his views and insights are widely followed. He is most famous for creating the acronym BRICs to describe the collective grouping of the four emerging market powerhouse economies - Brazil, Russia, India and China.

Mr O’Neill answers questions below on issues ranging from the risks to the US economy, will China see a slowdown, how will emerging markets perform, what are the most favourable areas to invest in and the outlook for the US dollar. Read more background.


The housing market in the US is in a substantial correction. Do you think it is another bubble that if pricked will quickly collapse? Could you explain why the housing price was growing to today’s unsustainable level? China is facing a hot housing market now. It may be not easy to do international comparisons in housing, however, what China can learn from the US housing market correction?
Wu Peng, New York, US

Jim O’Neill: Wu Peng, I think the biggest reason for the rise in house prices , at least to the degree they rose, was the speed of the drop in both short and long term interest rates. I think the Fed has done a great job of helping to bring the housing market under control.

I think China is probably very different, although in some ways, quite similar. If China keeps interest rates too low for too long, there is a chance that, in some areas, housing prices may rise out of line with incomes, which would make them extremely vulnerable to declining severely as and when interest rates rise again (or broader liquidity is less available.)


China’s economy is still subjected to a lot of administrative fiats such as exchange manipulation, price control and interest rate control. It is likely to be a lot more volatile with sudden reverses, is there any simple way to mitigate that?
K Y So, China

Jim O’Neill: KY, I think that the Chinese authorities are very mindful of these dangers and are slowly trying to reduce the degree of administrative guidance, which you can best see through the evolving exchange rate system.

I am always encouraged when I talk to a Chinese policymaker about their openness about the need for changes in many of these areas.


I would like to know where do you see US inflation, US growth, Fed policy rates and 10 year UST rates in June of next year?
Adriana Isabel, Madrid, Spain

Jim O’Neill: Adriana, I think inflation will be closer to 2 per cent than 3 per cent, growth still below trend (of 3 per cent), short term interest rates around 50bp lower than today, 10 year bond yields a bit lower in yield.


As you know, countries such as India and Russia have their wealth concentrated in relatively very few hands, individuals or families (mostly with dubious ethics), while the vast majority of the population is impoverished. From an objective point of view, do you think this is the right way for a country to ‘emerge’?
Richard Feynman, London, UK

Jim O’Neill: Richard, I think it is both necessary and likely that the wealth will need to be distributed more evenly as the wealth grows in both India and Russia. More policy changes might be needed to accelerate this process, and I think in this regard, China is doing an exceptional job.


Be honest. Isn’t predicting the euro against the dollar these days closer to playing roulette than analytical?
Graham Cox, London

Jim O’Neill: Some might say it has always been closer to playing roulette! I don’t think it has really changed that much. The euro/dollar has huge liquidity and there is lots of information, but it was always the same with the dollar/deutsche mark. There are reasonably usable fundamental factors that broadly drive the rate, especially valuation, basic balance of payments and interest rates.


Hard or soft landing in the US during 2007? Or is it perhaps a mid-cycle slowdown we’re experiencing?
Peter Kimman

Jim O’Neill: Peter, no landing! I think the US is experiencing a “happy slowdown” which will continue through 2007, in which housing related areas weaken, but other parts of the economy stay strong, especially investment and exports. Growth will be below trend of around 3 per cent, but not by much.


I’m researching opportunities for small business investment in Saratov, a provincial city in Russia. Do you think that there is a risk of a large shock rise in the value of the Rouble as the market finally recognises oil, inward investment, business normalisation and organic growth? Much sentiment about Russia is still stuck in 1997. My ability to invest has already been eroded by large increases in asset prices.
Saratov, Russia

Jim O’Neill: It is good to get a question from a Russian bull, they are quite rare! Most people are usually bearish on Russia. I think it is likely that the real value of the rouble will continue to rise, but I also suspect that policymakers will endeavour to slow the pace of appreciation to help support the competitiveness of Russian industry. Russia has already got around $250bn worth of FX reserves and they may rise further.


What is the last lesson that you learned that you wished you would have known when you started your investment career
Jeff Meuler

Jim O’Neill: Hi Jeff, that’s a good question. Many things! I think the biggest thing I have probably learnt is that I am definitely going to get a good percentage of market calls wrong. I believe for example, in foreign exchange, it is probably the case that the very best forecasters and investors get it right no more than 60 per cent of the time, indeed to be this successful would be really good.

If I would have realised this at the start of my career, I think I may have been more balanced in some of my views.


How much credence do you attach to the theory that the reason global equities markets are rallying despite rising interest rates and a worsening geopolitical backdrop is simply the diminishing amount of supply? It seems that between the private equity houses taking public companies private and the share buybacks of those public companies hoping to remain so amounts to roughly $600bn per year.
Stephan Bisse, Oxford, UK

Jim O’Neill: I think this is a very credible theory - it makes a lot of sense that these developments are additionally supportive to equity markets.


What scenario do you think is most likely for the revaluation of the Chinese renminbi: which timeframe, which level of revaluation, which political environment, and with which consequences for both Chinese businesses and MNCs?
Alexandre Arminjon, China

Jim O’Neill: I think the Chinese authorities have made it quite clear that they are not in favour of more one-off revaluations. More likely, and indeed, there is evidence of this happening now, is that the renminbi will be allowed to appreciate more quickly. I would expect more of this, and perhaps by the end of 2007, the renminbi would be somewhere between 5-10 per cent stronger than today.

If this is correct, especially in circumstances of the US slowing, then it is likely that Chinese exports will slow. This is something that should not be concerning, as china has huge potential to boost it’s rate of domestic consumption.


Looking at Russia, it is hard not to notice that the levels of its oil output have practically stopped growing - a situation which some analysts attribute to the role that the state plays in the energy industry. Recently, the state has been trying to get involved in other major Russian industries, with much success. How much of a threat do you think such behaviour could pose to Russia’s long-term economic prospects?
Levan Nadibaidze, New Haven, US

Jim O’Neill: I think it actually would be really good for other industries to grow more rapidly than energy, as to fulfill Russia’s BRICs potential, other industries will have to become more important. It is quite interesting in this regard, that a number of multinationals have announced plans to boost Russian-based auto production, and from what I here, they are doing rather well.


Do you think Hong Kong’s currency link to the dollar via its currency board is a stabilising influence given that it has created negative real interest rates in the boom up to 1997 and large positive real interest rates during the recession which followed. Wouldn’t it be better to let the Hong Kong dollar float?
Robert Kemp, Hong Kong

Jim O’Neill: I think the Hong Kong currency board arrangement will always have this dilemma, in that its real interest rates will be frequently driven by the US, by definition. In the long term, as China matures and develops more sophisticated markets, perhaps there will be a good case for a new currency arrangement for Hong Kong.


With the markets at all time highs despite the global geopolitical issues and talk of a slowdown in 2007, where is the ‘wise’ money being invested for next year and the next two to three years?
Trevor Webster, Tokyo

Jim O’Neill: Trevor, a tough question! I think we are seeing a “happy slowdown” in which a modest slowing of global growth is good for equities because it reduces the biggest threat, one of inflation. In our scenario of US slowing below trend, growth elsewhere remains strong, so earnings growth is decent and valuations remain modest.

All of this should give good returns. I continue to believe that opportunities from investing in either the BRIC economies or BRIC-like companies with exposure to the BRIC economies are the best strategic investment of our time by some distance.


Do you expect the US dollar to fall relative to the BRIC currencies in the coming 18 months?
Niall Duggan, Dublin, Ireland

Jim O’Neill: Yes I do expect the dollar to fall in the next 18 months against BRIC currencies, especially the renminbi and to a lesser extent the other ones also.


How do you view the future of Japan? When will the interest rates rise there and which of their sectors is worth investing in, real estate, technology or finance?
Rustum Boyce, Singapore

Jim O’Neill: I think the future of Japan looks “OK”. They have difficult demographic challenges which is a big limitation, but in recent years to partially mitigate this, productivity has improved notably. We would now estimate Japan’s growth trend to be around 2 per cent whereas for much of the past decade, we thought it was only around 1 per cent.

I am not an equity strategist but I would think there are many attractive areas to invest in Japan given the improved growth trend, not least because the BOJ will be very cautious about the speed by which they raise interest rates. The next one probably won’t occur until sometime in Q1, 2007.


Could you rank the vulnerability and impact of a US slowdown on each of the four BRIC countries? Would you agree that Russia would probably be the least affected by a US slowdown?
Hussain Premjee

Jim O’Neill: Hussain, I wouldn’t agree with your assertion. I think India is the least vulnerable to the US, as it currently has the most modest amount of its economy subject to trade, and domestic consumption is very strong. I think the most vulnerable in terms of simple calculations of exports to the US would be China, then with some considerable gap, Brazil , then Russia, then India.

Russia is tricky due to the extreme importance of oil prices and oil exports, and if the US slowdown continues and oil prices drop more, Russia could suffer more than the others (India as a big importer, benefit). Overall, given that its growth rate in recent years has been the lowest, I would suggest Brazil is the most vulnerable, but even here, with a re-elected Lula committed to stronger growth, I think the vulnerability is significantly less than people assume.

Indeed, we are projecting that the combined BRICs influence on world growth will be stronger than that of the US from the middle of 2006 through all of 2007.


1. While the growth potential of BRICs economies continues to be strong, do you think that, given the huge gains in BRICs stocks this year, the growth potential already nearly fully priced in?

2. Do you think that the BRICs growth has the opportunity to spread to smaller emerging economies with some economic coupling to BRICs, for example Thailand, Indonesia, Malaysia, Taiwan, and others? How do you see that investment opportunity compared to BRICs, for those who can stand the volatility risk?

3. Given the changing political environment of Russia, do you still see Russia (for economic growth and investment opportunity) as good as your original BRICs view?
Nimish Shah

Jim O’Neill: 1. Linked to my previous question, I think two of the four BRIC equity markets seem actually cheap. India is the only one that might be regarded as generously valued but if Indian growth continues in the 8-10 per cent region, then it is also cheap. In our infamous 2050 BRICs projections, we assumed that India would grow around 5.8 per cent. I Just returned from a trip recently and some policymakers tried to persuade me that it might be closer to 8 per cent.

Russia and China have grown close to double the rates of growth we have assumed in our BRIC projections, and Brazil, the laggard, is likely to see new policies aimed at trying to significantly boost growth. Brazil could be especially interesting along with China between now and the year end.

2. I think China’s huge success in achieving so much growth and taking so many people out of poverty is setting a huge example to many other developing countries, ranging from Asia, Africa through Latin America. There are a number of large population developing countries that are suddenly trying to “engage” with the rest of the world in a way that they haven’t in the past. Vietnam and Nigeria would be two distinct examples, some of these seem like excellent, albeit, risky investments.

I think Africa is especially interesting and if any of these nations can use the positive terms of trade shock they are receiving to transform their economies, the returns from investing there could be enormous.

3. Russia is doing better than we originally assumed, despite many people’s caution. Indeed, russia seems to be closer to delivering stronger consumption growth for many of it’s citizens than some of the other BRICs. Obviously, Russia has a lot to do, but given how low most people’s expectations are, it is not difficult to provide positive surprises.


Jim are you still a US dollar bear over the next three to six months?
John Booke, Longmeadow, MA

Jim O’Neill: John, I do lean towards being bearish over the next three to six months. We believe that the US economy is slowing, and by the start of the second quarter, the Fed will begin to ease monetary policy. Given the role that short term US rates appear to have played in supporting the dollar in 2005-06, Fed easing is likely to be dollar negative. In addition, the Chinese appear to allowing faster appreciation of the renminbi which is likely to be dollar negative for Asian currencies.


What is your view on the dollar, euro and the rupee in the short, medium & long term? Also, do you feel that the current boom in emerging economies such as the BRIC nations is in anyway comparable to the bubble situation before the Asian economic crisis in the mid 1990s?
Prashant Parsana, India

Jim O’Neill: It is difficult to be particularly bullish on the dollar for the medium to long term given the situation involving US imbalances.

To reduce the persistent risk of a large dollar decline in the future requires the US to reduce its external deficits by at least half. Without a lower dollar, that can only be done if the US accepts much weaker demand and the rest of the world grows strongly. This may be starting to happen with the US slowdown, but it is highly unlikely that the US will accept it!

Against this argument, is that the dollar has already fallen a lot against many currencies since 2002, appears to be reasonably valued against many European currencies, and of course, it is pretty much the consensus view, especially from economists.

Often the consensus is wrong in forex so I am always looking for things that could really help the dollar - they are tough to find!

I suspect that in the next 12-18 months, we will have a look close to euro 1.40 and yen 100. I guess if the Fed were forced to raise interest rates a lot more, especially now it is not expected by markets, this could sustain the dollar for longer, but even then, given the external borrowing, there is a limit to how much support rising rates can give the dollar.

As for the rupee, if oil prices continue to decline, it may continue to strengthen, but I would prefer the other BRIC currencies.

I think that the boom in the BRIC economies has virtually no parallels with the situation pre asian crisis, not least because all the BRIC economies, except india, have got spectacular balance of payments. Collectively, on a broad basis-including FDI and portfolio flows, the 12 month average for the BRICs bop is a surplus in excess of 7 per cent. There are many many other differences also, not least that many of the equity valuations in the BRIC countries are quite modest, especially brail and India.


Next week (November 13) Michael Mauboussin of LeggMason on investment strategy

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