Lagging Russia Still Has Spot in BRIC

Trailing behind its emerging market peers in terms of capital inflows and facing a sharp economic contraction at a time when China and India are continuing to see growth, Russia is having a hard time making the case that fundamentals are driving its market rally and that it has the financial architecture to sustain these gains much longer.

Brazil, Russia, India and China -- collectively known as BRIC, an acronym coined by Goldman Sachs chief economist Jim O'Neill in 2001 -- will hold their first summit Tuesday in Yekaterinburg and are heralding their purchase of International Monetary Fund bonds as a signal that the countries are financial forces to be reckoned with.

But while China and India's economies both experienced growth of about 6 percent in the first quarter and Brazil saw its gross domestic product shrink 1.7 percent in the same period, Russia seems to be in a league of its own, with its economy shrinking 9.8 percent.

Similarly, Russia's equity markets are significantly lagging the rest of the group. The MICEX Index dropped more than 70 percent from its pre-crisis high in May 2008 to its low in October. Meanwhile, stock markets in Brazil, India and China experienced milder losses, giving up between 40 and 50 percent before starting on a slow but steady recovery.

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The disparity between Russia and Brazil has prompted some to question Russia's placement in the group and has led to speculation that BRIC may soon turn into BIC.

The underdevelopment of Russia's domestic financial system remains the country's Achilles heel, said Christopher Granville, manager director of Trusted Sources, an emerging markets resource service in London. "They really failed to develop the country's financial sector successfully, and they're paying for it," he added.

By contrast, Brazil, having largely shaken off its astronomical budget deficits and sky-high inflation rates, now has a properly developed financial sector and very grown-up monetary regime, Granville said.

Nevertheless, so long as China and India continue to be locomotives of growth, it may be too early to talk about Russia's exit.

"Both Brazil and Russia happen to be long of a lot of things China and India both need, so this is quite a natural grouping," O'Neil wrote in a recent note. "Linked to this, trade between the BRIC countries has grown even faster than the explosion of world trade this decade."

In addition, all four countries are in a position to use their giant forex reserves to gain clout in the international financial arena. Brazil's Finance Minister Guido Mantega said last week that Brazil and Russia would each lend the IMF $10 billion and that China would offer the fund $50 billion as part of a united effort to help fight the crisis globally.

The fact that these three countries are in the position to make such a generous offer shows just how far they have come in the past decade, said Nigel Rendell, an emerging markets strategist at RBC Capital in London. "Five or 10 years ago, the IMF was lending money to most of these countries. Now, it's the other way around," he said. "The BRICs are seen as trying to save the world from economic problems."

But money to lend does not make a high-performing economy, and what makes a BRIC, O'Neil said, is the potential for the country's economy to constitute 5 percent of global GDP.

But there is at least one good reason why that goal may still be within Russia's reach: "Russia follows oil, and it is going up," O'Neill said in the note.