On the exposure of the BRIC countries

to global economic shocks

by Ansgar Belke, Christian Dreger & Irina Dubova*
2017 ASSA Annual Meeting
06-08 January 2017

*Ansgar Belke: University of Duisburg-Essen and Centre for European Policy Studies (CEPS Brussels)
Christian Dreger: German Institute for Economic Research (DIW Berlin) 1
Irina Dubova: University of Duisburg-Essen, RGS Econ
 Outline
1. Emerging Markets and BRICS:
– Before and just after GFC
– Slowdown
– Worldwide role of BRICS
2. Motivation & Research Questions
3. Literature Overview
4. Estimation:
– Variables
– Methodology
– Issues
5. Results
6. Conclusions

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 Paper in a nutshell
• This paper studies the divergence among emerging and industrial
countries business cycles after the Global Financial Crisis.
• The main finding is that this divergence is closely linked to Chinese
growth and policies.
• Using Bayesian VARs specified for the BRIC (Brazil, China, Russia,
India, and China), the paper finds that (i) China plays a crucial role
in determining global trade and oil prices; and (ii) there is a strong
impact of international variables on GDP growth in BRIC countries.
• Consequently, the shift in Chinese growth strategy to a
consumption-driven growth model puts additional pressure on
countries with abundant natural resources.
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 Emerging Markets and BRICS:
Before and just after GFC
• The catching-up of the BRIC countries (Brazil,
Russia, India, and China) has been a primary
source of global GDP growth in the period
before and the first years after the financial
crisis.
• EM economies surprised by weathering the
global financial crisis better than advanced
economies and bouncing back rapidly in 2010.
• EMs` successful performance during the crisis
combined with their newfound business cycle
independence led some even to argue that
emerging market economies had decoupled
Source: IMF *weighted by share of GDP at PPP
from AE.
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 Emerging Markets and BRICS:
Difference between weighted average EM growth and
Slowdown
weighted average AE growth
• Despite the gradual recovery in the industrial
countries in most recent years, the evolution started
to weaken in emerging markets (EMs).
• Growth in EMs has been slowing, from 7.6% in 2010,
to 3.7% in 2015 and is now below its long-run average.
• This slowdown has been highly synchronized across
EMs, with significant declines of growth in most EM
regions.
• In the largest EMs heterogeneous group of BRICS
growth has slowed from almost 9% in 2010 to about
4% in 2015, on average, with India being a notable
exception.
• This slowdown reflects both easing growth in China,
persistent weakness in South Africa, and steep
recessions in Russia since 2014 and in Brazil since
2015.
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 Emerging Markets and BRICS:
Worldwide role of BRICS
The BRICs
– are the largest and most regionally integrated heterogeneous emerging market group in their
respective regions
– have been the main source of EM growth and integration into the global economy
– during 2010-14, the BRICs contributed about 40% to global growth (all EMs – 60%), up from about
10% during the 1990s
– now account for two-thirds of EM activity and more than one-fifth of global activity—as much as the
US and more than the EA—compared with less than one-tenth in 2000
Share of the BRICs in the world economy Economic growth in the BRICs and China

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*The economic size of BRICS is much larger in terms of PPP adjusted GDP. BRICS constitute about 30% of global activity while the US constitutes only about 16%*
 Emerging Markets and BRICS:
Worldwide role of BRICS
• Given the size and integration with the global economy of the largest EMs - the BRICS - a
synchronous slowdown in these economies could have significant spillovers to the rest of the
world.
• Growth spillovers can operate via
– trade (reduced import demand from BRICs would weaken trading partner exports)
– financial linkages
– the confidence channel (consumer and business sentiment, e.g Levchenko and Pandalai-
Nayar (2015))
• The empirical literature finds sizeable spillovers from China to countries with close trade ties
(EAP region, Japan and Germany among the AE), and commodity exporters. Growth in Russia
and Brazil tends to affect growth of their neighbors and those with whom they have strong
trade and remittance linkages.

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 Motivation & Research Questions
• The recent slowdown in EM has been a source of a lively debate:
– Some economists argue: impressive growth performance of EM prior to the crisis was driven by
temporary commodity booms and rapid debt accumulation, and will not be sustained.
– Others emphasize cyclical and structural factors as the slowdown drivers: weakening
macroeconomic fundamentals after the crisis; prospective tightening in financial conditions;
resurfacing of deep-rooted governance problems in EM; difficulty in adjusting to disruptive
technological changes.
– Still others highlight differences across EM - some of them are in a better position to weather the
slowdown and will likely register strong growth in the future.
• This paper analyzes the relative role of external factors in GDP growth for the
individual BRIC economies in the period before, during, and after GFC and more
recently
• The following questions are addressed:
– How have external conditions typically affected BRIC economies’ growth over the past decade and a
half?
– Are all BRIC countries equally exposed to external shocks, or are some economies more vulnerable?
– In contrast to other BRIC economies, how has China’s growth influenced global variables?
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 Literature overview
• Both external and domestic as well as cyclical and structural factors have contributed
to the slowdown in emerging markets (Didier et al. 2015)
• Before slowdown: large and sustained increase in commodity prices raised
investment and GDP in most commodity-exporting economies. The higher growth
reflected a combination of improved fundamentals and strong tailwinds that boosted
demand and raised productivity in most countries.
– Cubeddu et al. (2014): strong foreign demand, facilitated by advances in trade
liberalization, lower global interest rates, and the acceleration in commodity prices
accounted for one half of the acceleration in growth in the 2000s.
– Fayad and Perrelli (2014): lower demand from trading partners plays a key role in
explaining the current slowdown, besides an increase in risk aversion of
international investors.
– Anand et al. (2014): both China and India exhibited a slowdown in potential growth
related to a decline in TFP growth.

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 Estimation: Variables
• Foreign variables are captured by commodity prices (real oil price – OIL), World Trade Index
(source: CPB Netherlands Bureau for Economic Policy Analysis, WT) and international financial
conditions (US interest rate, VIX)
• Global shocks are disseminated through different channels, like
– the fiscal policy stance (e.g. lower prices of raw materials put increasing pressure on the public
budget)
– tighter monetary policy (e.g. to combat capital outflows due to a higher risk perception of
investors)
– and the real exchange rate, as the real depreciation of the BRIC currencies generates inflation
pressure through higher import prices
• Domestic variables:
– Real government expenditure(GSpend)
– Real GDP (GDP)
– Short-Term Interest Rate (in the following as difference with US interest rate - IR)
– Real Effective Exchange Rate (REER)

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Estimation: Variables

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 Estimation: Methodology

*Estimations are performed with RATS software; cointegration analysis with CATS software 12
 Estimation: Methodology
• Structural shocks are identified by imposing contemporaneous restrictions (apart from
exogeneity assumptions). There are no further restrictions on the lagged variables in order to
let the data reveal the patterns of the responses and the transmissions.
• Within “domestic” block (GSpend, GDP, REER, IR) we make the standard assumption of the
following ordering of the variables:
– GSpend is the most inertial variable, IR is the most fast-moving one
– MP transmission to the economy is lagged
• In terms of cross-linkages – the “global” block (OIL, WT, VIX) has a simultaneous impact on
domestic variables for each country.
• (GSpend, GDP, REER, IR, OIL, WT, VIX)
• Our robustness check to alternative
orderings was plausible.

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 Estimation: Methodology
• Bayesian methods provide an explicit, straightforward means of incorporating uncertainty
into modelling and forecasting.
• We perform MCMC (Markov Chain Monte Carlo) analysis of a combination of a near-VAR for
the lag coefficients and a structural VAR for the covariance matrix.
• The use of a near-VAR (rather than a flat prior full VAR) complicates the Monte Carlo
integration. For the full VAR, the structural coefficients can be drawn using only the covariance
matrix from the OLS estimates; here, we need to use the re-computed covariance matrix at
each Gibbs sweep.
• Technically, we use Metropolis-within-Gibbs. The structural (contemporaneous) model is
drawn using Random Walk Metropolis. Given the values of the structural parameters, the
variances of the shocks can be drawn directly, and given the covariance matrix, the coefficients
can be drawn using Gibbs Sampling methods for linear SUR systems of modest size.

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Estimation: Methodology

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 Estimation: Issues
• Stationarity issues – VAR in levels or differences? VECM?
– Most of the empirical studies that identify the impact of MP did not test the stationary condition of their variables (Cushman &
Zha (1997); Brischetto & Voss (1999); Kim & Roubini(2000))
– Sims et al. (1990) reported that the VAR model with these non-stationary variables although might incur some loss in the
estimator’s efficiency but not its consistency
– According to Brooks (2002), differencing the variables might lead to losing a lot of information – such as long-run relationships
between variables
– Sims (1980) recommended against differencing the variables since the main objective of the VAR approach is to analyze the
inter-relationships not the coefficients
– An alternative would be to estimate a VECM. However, since it is hard to identify with any degree of accuracy the underlying
structural parameters of a VECM which includes a large number of variables, for practical reasons we derive impulse responses
from the model in levels
• Lag length selection
– Due to the shortness of the data set, we set the lag length of the SVARX to 2 –also in accordance with Schwartz and Hannan-
Quinn’s information criteria and our tests of autocorrelation of residuals
• Stability
– According to Luetkepohl (2005) and Hamilton (1994), the estimated SVAR model is stable if the absolute value of all eigenvalues
or the largest value is less than one
• Residual tests
– Serial correlation test (LM tests)
– Normality tests
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 Results: Impulse responses for model with global variables
and China’s GDP
• Impulse Responses • Variance Decomposition
Response to Cholesky One S.D. Innov ations ± 2 S.E.
Response of WT to WT Response of WT to OIL Response of WT to VIX Response of WT to GDP
.03 .03 .03 .03

.02 .02 .02 .02

.01 .01 .01 .01

.00 .00 .00 .00

-.01 -.01 -.01 -.01

-.02 -.02 -.02 -.02

-.03 -.03 -.03 -.03

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of OIL to WT Response of OIL to OIL Response of OIL to VIX Response of OIL to GDP

.1 .1 .1 .1

.0 .0 .0 .0

-.1 -.1 -.1 -.1

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of VIX to WT Response of VIX to OIL Response of VIX to VIX Response of VIX to GDP
.3 .3 .3 .3

.2 .2 .2 .2

.1 .1 .1 .1

.0 .0 .0 .0

-.1 -.1 -.1 -.1

-.2 -.2 -.2 -.2

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of GDP to WT Response of GDP to OIL Response of GDP to VIX Response of GDP to GDP
.04 .04 .04 .04

.02 .02 .02 .02

.00 .00 .00 .00

-.02 -.02 -.02 -.02

-.04 -.04 -.04 -.04

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

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 Results: GDP impulse responses
• Brazil

• Russia

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 Results: GDP impulse responses
• India

• China

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 Results: GDP variance decompositions
Brazil Russia

India China

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 Conclusions
• The Bayesian VAR analysis suggests that the BRICs are heavily affected by the global economy*,
albeit to a different degree:
– Commodity prices can explain the downturn in Brazil and Russia to a large extent.
– India is less affected by the price evolution, but the slower expansion of world trade reduced GDP growth.
– Prices for raw materials and the expansion of world trade are both relevant to explain output growth in
China.

• However, in contrast to other countries, the relationship for China is bidirectional.

– China plays a crucial role in determining oil prices and global trade.
– Hence, the change in the Chinese growth strategy puts reform pressure on countries with abundant natural
resources.

• Topics of further research

– Considering other potential determinants – e.g. policy uncertainty (Anand and Tulin, 2014,
DoF problem  FAVAR?)
– Explicit analysis of spillovers (from China to BRI; within BRIC; BRIC and other EMs; BRIC and AEs  GVAR?)

*In line with Almansour et al. (2014) who concluded that the global development accounted for one half of the variance of
emerging markets growth.

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 Conclusions II
• Choice of oil prices to summarize commodity prices might be
troublesome. Particularly, Brazil is not even a net-exporter of oil and its
main export products are agricultural and mineral.
• It may make more sense to use a general commodity price index such as
the IMF commodity price or country-specific commodity export price
indices to capture the effects of commodity prices on these economies:
– But oil and non-oil commodity prices tend to be highly correlated.

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 Conclusions III
• Differences in financial shocks could also be important to account for the
divergence among industrial and emerging countries.
Although we include the VIX to account for this channel, cross border
bank claims could also be useful to evaluate their importance.
• The WTI index obtained from the CPB World Trade Monitor includes only
trade in goods (also referred to as 'merchandise trade') while especially for
India trade in services is an important source of growth.

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 Conclusions IV
• Our analysis that concludes that China plays a significant role in
determining oil prices and global trade may control for other potential
determinants.
• Particularly, recently there has been a lot of attention to the
financialization of commodity markets and the inclusion of US interest
rates would be crucial to evaluate the importance of this channel.
• Moreover, there was a huge increase in oil production in the US due to the
shale industry.
• May check whether inclusion of these factors (and others like US GDP for
example) could reduce the role of China in determining oil prices dynamics
since the Global Financial Crisis.

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Thank you!

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Annex 1.0 Weak exogeneity tests

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Annex 2.0
24 countries

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