Of BRICS and PIGS

Sep 21, 2011 Editorial

As we continue wallowing in the gossip and loose talk of the WikiLeaks cables, there is the danger of missing potentially seismic events in other parts of the world that could impact gravely on our efforts to climb out of poverty.
There is for one, the stagnant US economy and its rising poverty rates that will certainly cause remittances from that country to once again take a dip. Then there’s the slow-motion meltdown of the Eurozone, which locks together the world’s largest economy, and to which a substantial chunk of our exports are directed. In this editorial we focus on the latter.
The Eurozone has been brought low by the profligacy of the PIGS (Portugal, Italy, Greece and Spain) and their unwillingness to impose fiscal discipline early in the day that could have possibly saved them. As it is, it is now not just a question of Greece defaulting on the billions of Euro loans outstanding, exiting the Euro and devaluing its own currency (as Nourel Roubini of Goldman has recommended), but of the entire southern Europe rotten rope doing the same.
Earlier this week, the IMF sounded a warning bell in its ‘World Economic Outlook’: “Should the periphery’s debt crisis continue to propagate to core euro area economies, there could be significant disruption to global financial stability.”
European banks are ‘heavily exposed’ to countries facing rising borrowing costs and lenders should make efforts to increase their capital following holes revealed by recent ‘stress tests’ on the sector, the IMF said.
“A concern is that capitalisation of euro area banks is relatively low, and they rely heavily on wholesale funding, which is prone to freezing during financial turmoil,” it continued. “Trouble in a few sovereigns could thus quickly spread across Europe. From there it could move to the United States — by way of US institutional investors’ holdings of European assets — and to the rest of the world.”
Italy was the latest country hit by a credit downgrade by ratings agency Standard & Poor’s yesterday amid persistent fears of a devastating Greek debt default. This had followed last week’s forecast of growth by the European Commission, at only 1.6 percent in 2011, warning that the economy would grind to a ‘virtual standstill’ at the end of the year as a result of the debt crisis and turmoil on financial markets.
And so tomorrow, finance ministers and central bank governors of the BRICS group of emerging powers – Brazil, Russia, India, China and South Africa – will meet in Washington and, at the prompting of Brazil, in the words of its Finance Minister, “Talk about what to do to help the European Union get out of this situation.”
The table has now turned. Brazil’s premise is that BRICS should diversify its reserves – China at $3.2 trillion, Brazil at over $350 billion, India at over $320 billion – and make more money than investing in US Treasury bonds. Russia and India are not convinced, however, as the former has explicitly declared that the Europeans must come up with a clear strategy for rescuing the PIGS, before Moscow starts buying more Eurozone bonds.
China, now the largest and most important player in both the US and EU possible rescues, is playing it close, but its strategy can be gleaned from the words of a top advisor to China’s Central Bank: “The incremental parts of our foreign reserve holdings should be invested in physical assets.” And that only after “the US Treasury market stabilizes” would China be willing to “liquidate more of our holdings of Treasuries”. The key word is ‘liquidate’ and not diversify.
What this means is that most likely, the Germans, with their strong export-oriented economy will form the core of a rump Eurozone while the south – including France that cannot extricate itself because of the deep involvement of its banks – will have to exit and start printing their own currencies to stabilize – as is being suggested to Greece presently.
We can look to China and the other BRICS to continue investing in physical assets.

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