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Testing Times A US Recession
and the BRIC Economies

By Deirdre Keown
July 29, 2008

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Grappling with Rising Inflation

Simultaneously, the BRIC nations are each struggling to control inflation. Russia recorded the highest inflation rate of the BRIC economies in 2007 at 11.9%, according to Rosstat, far higher than its previous estimate of 8%. Inflation in China reached an 11-year high of 7.1% in December 2007, according to its government, and India’s inflation soared to an eight-month high of 4.89% at the end of February 2008, according to its Ministry of Commerce. Brazil’s inflation is the lowest of the four, at 4.56% for the 12-months to January 2008.

According to a December 2007 report by China’s National Development and Reform Commission (NDRC), a macroeconomic management agency under China’s State Council which formulates policies for economic and social development and guides the restructuring of the overall economic system, inflation in the BRIC countries (and some other emerging economies) is attributable to both internal and external pressures including:

  • sustained growth of the world economy;
  • a global problem of excess liquidity;
  • the falling US Dollar;
  • a decrease in the production of farm products;
  • OPEC’s output restrictions;
  • excess speculative capital in the international markets; and,
  • an increase in the demand for grain used to produce bio-fuel.

In its report, the NDRC noted that to curb price rises and ease inflationary pressures, the BRICs were adopting similar measures, notably using financial tools, price regulation and market adjustment, food subsidies to low-income groups and the adjustment of import and exports to increase domestic market supply.

China’s central bank raised rates an unprecedented six times in 2007 to little effect – January’s CPI rose 7.1%, its highest one-month rise in over a decade. Earlier this year, China’s Premier Wen Jibao confirmed that China will tighten its monetary policy in 2008, to tackle inflation. “We must give priority to the quality rather than speed of development,” he said at the annual National People’s Congress. “The primary task for macroeconomic regulation this year is to prevent fast economic growth from becoming overheated growth and to keep structural price increases from turning into significant inflation.”

The aim in 2008 is to ensure inflation holds steady at around 4.8%, Wen said, stressing that efforts would be made to rebalance the country’s growth drivers. “We will continue to boost domestic demand, adjust the balance of investment and consumption, and promote the shift from the pattern of economic growth that relies mainly on investment and exports, to one that relies on a balanced combination of consumption, investment and exports.”

In January 2008, Brazil’s Finance Minister Guido Mantega announced that Brazil would not follow the US in cutting rates, despite widespread speculation it would, saying “Our monetary policy is aimed exclusively at controlling inflation [in Brazil].” Instead, Brazil’s central bank left the Selic rate (the overnight lending rate) unchanged at 11.25%. This paid off in February 2008 when inflation rate fell to a seven-month low.

To control inflation, the Central Bank of Russia raised its key interest rate from approximately 10% to 10.25% in the beginning of 2008. Like Brazil, the decision was not driven by issues in the US. Russian Finance Minister, Alexei Kudrin, said in February 2008, “Both Russia and Asia are outside these problems related to the rate cuts in the US. Our banks had almost no sub-prime loans.”

Instead, the decision to raise the official rate was aimed at “containing inflation and lowering the dynamic of the money supply,” the Central Bank’s statement said. Inflation has become a major political issue in Russia. Prices in Russia accelerated in January to a 30-month high as food costs increased and rising oil and gas revenue helped push up wages. And there’s no respite in sight in the short term. “The oil price we believe will stay at the same level and the food price will also be rather high,’’ Kudrin confirmed.

Unlike Russia, India does not consider itself to be immune to the US economy. The governor of the Reserve Bank of India, Y.V. Reddy, confirmed in September 2007 that US interest rate policy influences India’s policy. Nonetheless, India did not follow the US in cutting key rates in January, which clearly indicated its intention to contain inflation, even if it means compromising on growth. “We are happy that inflation expectations are quite benign now,” Reddy said in an interview at the time. “We are looking at a medium-term objective of 4% to 4.5%, and ideally a rate toward 3%.”



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