By Chuck Butler
10/14/09 St. Louis, Missouri
A few years ago, someone coined the term: BRICs. This was an acronym for the countries of Brazil, Russia, India, and China. Before the huge deleveraging of risk assets leading up the collapse of Lehman Brothers in the fall of 2008, the currencies of these 4 countries were very strong versus the dollar, and growing in global prominence.
But then came the huge deleveraging of risk assets beginning in July of 2008. There’s an old saying that when established currencies that are widely traded and very liquid, get grounded, the emerging market currencies (like the BRICs) get sent to the woodshed. And so, we had the BRIC currencies lose major ground to the dollar during this period of time.
However, in March of this year, the non-dollar currencies began to rebound versus the dollar once more. This rebound in the established currencies like, euro, francs, yen, and Aussie dollars, has led to an even stronger rebound in the emerging market currencies, including the BRICs.
So… I thought it best to take a step back, and look at the fundamentals of each of the BRIC countries, and see if the stage if set for yet another strong run on the dollar.
Before we start though, I wanted to tell you the two reasons I originally put these countries together to form EverBank’s BRIC MarketSafe CD.
In the spring of 2009, China was making noise about the need for a new reserve currency to replace the dollar. The other BRIC nations joined in and at the next G-7 meeting, all four nations stood up and wanted to be counted as countries that want a new reserve currency, for they had see enough deficit spending in the US to convince them the dollar had no other avenue to follow but down.
The “markets” sort of shrugged off the BRIC nations call for a new reserve currency to replace the dollar. But I looked at it differently. I saw nations that had HUGE Treasure chests of dollar reserves, and nations that currently have a very large portion of the globe’s population. I believed then as I do now, that these countries would need to be reckoned with, and eventually their cries for a new reserve currency to replace the dollar would be heard, loud and clear.
Since we announced the creation of the BRIC MarketSafe CD, where an owner of the CD receives the positive gains in the currencies over 3 years, but does not experience any currency risk, as the CD has 100% principal protection, the BRIC nations are receiving more notice!
At the last G-20 meeting, of which the BRIC nations are a part of, it was announced that the watchdog duties for the global economies were being taken over by G-20 (from G-8). And a week later, the G-7 Finance Ministers suggested that G-20 take over the currency watchdog duties!
Now G-20 has both global economies and currencies under their watch and care, and the BRIC nations are right there to offer their suggestions…
So… Now that we’ve gone through the background, let’s take a look at the current fundamentals of these four nations, to see if the prospect of further potential currency appreciation is warranted.
First up… Brazil!
Brazil was the first Latin American country and first in the Americas to see its economy grind out of its recession. Brazilian GDP for 2009 overall will probably be just a nick over flat, while the forecasts for 2010 GDP show that economic growth will expand by 3.8%, as firmer domestic demand leads the economy.
For instance, Brazil’s recent Industrial Production output grew 1.2% in August, which was the eighth consecutive month of growth.
Brazil currently enjoys a Trade Surplus of 1.5% of GDP, with forecasts for the Surplus to also grow to 3.1% of GDP by 2011.
Overall, Brazil’s Current Account Balance is a narrowing 1.1% of GDP Deficit… as the economy gets back on track; the Current Account Deficit is expected to grow to 1.5% of GDP.
These are “manageable” deficit figures, and ones that would be welcomed in many countries of the world.
Inflation as always been a problem in Brazil, but assuming no economic shocks, and a strong currency (the real), it is expected that inflation could fall to 4.1% by year-end 2009, and remain stable throughout 2010-2011.
Brazil is one of the world’s largest democracies and emerging markets, which leads one to believe that their influence on the international stage will only continue to grow. Recently, China has moved past the US as Brazil’s top trading partner. It is believed that Brazil and China will sign a currency swap agreement that would remove the dollar in trade settlements. I’ll talk more about this in the “China segment”.
The prospects for the real are good. However, one must always remember, that even with strong economic fundamentals, any mass sell off of risk assets, would be magnified for an emerging currency like the real.
Next, we have Russia…
When we announced the BRIC MarketSafe CD, I received a lot of responses to the announcement with wishes that we had not included Russia in the CD. Well, it wouldn’t be a BRIC without Russia!
I told people that in essence, the only way I would buy Russian rubles is in a MarketSafe CD, and that the only way to look at Russia was as an “oil play”…
Who among us believes that oil prices will continue to remain in the $70 a barrel range?
OK… now that we’ve played that game… Let’s get to the data!
Russia went against the flow in September, by cutting their base interest rate, when it was believed that a good number of countries around the world were preparing to begin rate hike cycles.
Russia’s economy is still mired in a deep recession, as witnessed by the 10.5% fall in GDP from a year earlier, and industrial activity contracted by 12.6% in August!
Russia’s economy had seen two consecutive months of growth before this step backwards in August, and thus the rate cut in September. There are only mixed signs that the recession in Russia has bottomed out. But that means the Russian ruble is much cheaper than a year ago, and will probably remain weak as long as 1. The price of oil remains in the $70 range, and 2. The Russian economy remains mired in a deep recession.
Growth for 2010 is forecast to be 3.5%, which would mean that Russia’s recession will have ended late in 2009. An end of the recession and economic growth are very dependent on the persisting problems of the bad assets on the books of Russian Banks.
So… the rebound in the ruble may take some time to come to fruition. The good thing about that is that the ruble will remain cheap for new buyers.
India has maintained strong economic growth through the global financial meltdown, and will post a very impressive growth of 5.5% this year. This does represent a sharp deceleration from the 10% growth rates during the go-go years before the global financial meltdown. So, while 5.5% growth is lower than previous growth rates, it remains one of the best rates of economic growth in Asia!
Economic growth in India is forecast to grow 6.3% in 2010 as private consumption, investment and trade growth all show renewed strength.
Inflation in India, at present is not a problem coming in at 1.3% in 2009. However, as domestic growth takes hold, inflation is expected to rise to 5.1% in 2010.
The Indian Central Bank will continue to fight inflation, probably raising rates as we go along in 2010. The higher interest rates will go a long way toward additional currency strength.
India does not have a problematic current account deficit, like many emerging market countries. With rising exports at a 9.6% rate, the current account deficit will be the equivalent of 0.5% of GDP… Future growth in India will present itself as a problem as far as the Current Account Deficit is concerned. But it will remain manageable, and again, not the stuff that some countries experience.
The prospects for the rupee remain strong going forward.
And, last on the roster, but number one in the hearts of the fans….
This is the proverbial 200 lb gorilla in the room! China has long been on my mind as the most undervalued currency on the planet, and as long as the Chinese government has their hands on the purse strings of the renminbi, it will remain that way.
However, there are signs that the Chinese government is looking to widen the use of the renminbi, which would eventually lead to more of a free float or at least a wider band of currency movement allowed.
The IMF recently wrote that the renminbi remains the most undervalued currency at probably a level of 40% undervalued versus the dollar. As long as the renminbi’s daily movement is controlled so strictly by the Chinese government the renminbi will not be allowed to cut into that 40% figure by very much. However, with the signs of a wider use of the currency, it is thought that the renminbi could be allowed to float more in the future.
What is this “wider use” I’m talking about? Well… you see, the renminbi is not a transactional currency, it is not liquid, and is traded on what’s called a “non-deliverable forward”. Which simply means it cannot be converted to physical form, or deliverable form.
It is my belief that China is taking baby steps to one day, have their currency take over the title of reserve currency of the world replacing the dollar. And to do this, the Chinese must begin to obtain a wider use of their currency.
They began this process by signing currency swap agreements with most of the Asian countries, and then moved on to Argentina. As I said earlier, it is believed that China will soon sign another of these currency swap agreements with Brazil.
The currency swap agreement between two countries eliminates the dollar from any transaction between the two countries, and only uses the currencies of the two respective countries. This is the “first step” toward gaining a wider use.
The “second step” came in September when China issued renminbi denominated bonds in Hong Kong. These were the first renminbi denominated bonds issued by China.
A wider use, in my mind, is equal to a stronger renminbi versus the dollar going forward.
Now for some data!
China’s GDP is expected to grow 8% in 2009, and 8.6% in 2010. China’s economic recovery this year has been fueled by government stimulus. But Hey! China has a treasure chest of reserves and surpluses… So, if any country was going to spend some money to boost their economy, China would be the one, for they have the money to do so!
And… with China being a Communist country, they were able to dictate where and to whom the money was being directed to, and how it was to be spent. This has gone a long way toward seeing the results of China’s stimulus.
Inflation remains a problem in China, and the sooner the Chinese realize that a strong currency can go a long way toward fighting inflation, the better!
So… For now, the renminbi remains pegged to a basket of currencies, and controlled by the Chinese Government, through the Chinese central bank. However, there are signs that this arrangement for the currency is changing, and a wider use of the renminbi is the objective… If that’s the case, then the prospects for a potentially stronger renminbi versus the dollar are very good.
And that’s how I see the BRIC currencies/ countries…
for The Daily Reckoning
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