BRIC Powerhouses Risk 'Middle-Income Growth Trap'

BRIC Powerhouses Risk 'Middle-Income Growth Trap': "Growth in the powerhouses of Brazil, Russia, India and China (BRIC) is slowing precipitously. Last week, India reported its slowest growth in a decade, while Brazil reported growth of just 1.9 percent for its first quarter, compared to a year-ago."

Now, several economists are warning that the BRIC economies which have driven much of the global growth over the past decade could be entering a middle-income trap, a shift which could have far reaching implications for the world.

"There is a growing risk that BRIC markets, along with other emerging economic, fall into the middle income trap. Cheap cash breeds complacency and record low interest rates and soaring capital inflows have pumped up growth in the emerging market world,while structural reforms have lagged behind," Frederic Neumann, co-head of Asian economic and global research at HSBC told CNBC.

The "middle-income trap" is commonly reached when developing economies grow quickly but struggle to maintain that growth because of a lack of structural reforms, labor market development and industrial growth.

The U.S. National Bureau of Economic Research (NBER) had suggested previously that the "middle-income trap" tends to appear when per-capita gross domestic product (GDP) levels reach around $16,000 in constant 2005 prices. But the latest report from the NBER warned in January 2013 that the income levels at which this slowdown occurs could be lower.

"Growth in middle-income countries may decelerate insteps rather than at a single point in time. This implies that a larger group of countries is at risk of a growth slowdown and that middle-income countries may find themselves slowing down at lower income levels than implied by our earlier estimates," NBER said.

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In Brazil, average per-capita GDP last year was $11,875, according to the International Monetary Fund. For China, the level was $9,162 and for Russia,$17,709.

'Cheap Cash Breeds Complacency'

The warning signs have been around for some time. Ruchir Sharma,head of emerging markets at Morgan Stanley Investment Management told CNBC last year in a prescient warning: "What these countries forgot is that the big boom over the past decade was very much because of a global tide lifting all boats;it was not about their own economic policies."

With global bond yields rising in recent weeks as investors price in an exit from the Fed's quantitative easing policy, things could come to ahead.

"When the global cost of capital begins to rise the structural flaws in many emerging markets will be exposed. As growth falters and debt loads rise, economies thus risk falling back into the middle income trap," HSBC's Neumann said.

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Neumann said that officials in emerging markets, including in China and India, will need to implement far reaching reforms, such as rationalizing the financial sector, encouraging more competition among local firms, and building fiscal reserves for a rainy day, to push into higher income brackets.

The worries about a middle-income trap extend beyond the BRICs. The International Monetary Fund (IMF) warned in April about such dangers for the entire Asian region Inits "Regional Economic Outlook", the IMF said the region must liberalize its labor markets and improve government institutions in order to achieve the economic level of developed nations.

Brazil No Middle Income Trap

Neil Shearing, an emerging markets economist at Capital Economics, denied that countries such as Brazil were bound to fall into the middle-income trap, saying the concept itself was an "artificial construct."

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"Rather than a middle income trap I would call ita Latin America trap. But then again there are a lot of countries that have gone from being very poor to very rich and I don't think there seems to be a specific level of per capita income at which economies get trapped."

Shearing cited Korea as an example of an economy that has "continued to grow despite having relatively high levels of per capita income."

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"But what does change the nature of the challenges facing policy makers is how they face them," Shearing added. "The key thing for policy makers is that, if you move workers from the farms to the factories you will get growth for awhile, but once you've used up that option, what is left to foster growth?"

"The key question is not whether you are going to be 'trapped' but whether policy makers are capable of doing things to keep growing and adapting to the economic challenges facing them by, for instance, fostering innovation and investing in research and development," he said.

Russia 'Like Greece'?

Last week, Ivan Tchakarov, chief economist at the Russian investment bank Renaissance Capital, said that Russia had already fallen"into the middle-income trap" as debt rose and growth declined.

The Russian finance ministry lowered its growth estimates for 2013 by a third in April, to 2.4 percent,which would be its worst annual growth since 2009 when GDP fell by 7.9 percent.

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"Fast-growing economies, including Russia, eventually slow down as the easy catch-up productivity gains relative to developed economies are gradually exhausted….However, they eventually come up against significant economic constraints, find themselves posting lower rates of economic expansion and become stuck in the so-called middle-income trap. We suggest that this is exactly what is going on in Russia right now," Tchakarov said.

What was worse was that Russia's leaders could be tempted to embark on a borrowing binge to stimulate growth in order to stay in power, he added, which could ultimately turn Russia into a debt-laden nation like Greece.

-By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt


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