RUCHIR SHARMA, head of emerging markets at Morgan Stanley, deals a blow to many oft-hyped emerging markets in his new book, Breakout Nations: In Pursuit of the Next Economics Miracles, published this year. Sharma says the BRIC countries are not where investors should be looking for opportunity. Only a few select countries meet his criteria as having the potential to be the next rising stars—Indonesia among them.

You described the past decade as “freaky,” as all countries grew. Can you place the progress of the BRIC countries into global perspective?

In the last decade, what we saw was that virtually every single emerging market did well. It was captured in the peak year, 2007, when only three countries recorded a negative GDP growth rate: Fiji, Zimbabwe, and Congo. That was really the peak of the emerging market boom of the past decade.

What caused this exceptional decade was a combination of many factors. The 1990s was a very poor period for emerging markets so there was scope for catch-up. Many emerging markets experienced crises during the 1990s—East Asia, Russia, Mexico—which is why the growth rates of emerging markets in the 1990s were rather low, at only 3 percent or so.

The other reason was that from 2003 onward a liquidity rush started from the United States. We’ve spoken about how the liquidity led to a housing bubble in the United States and in Europe, but not enough analysis has been given to how the very low cost of capital and high liquidity also led to these exceptionally strong growth rates in emerging markets. The average growth rate of emerging markets from 2003 onwards jumped to more than 7 percent.

These were the exceptional circumstances, but what we are seeing now especially in the last couple of years is that the growth rates of many of these emerging markets are falling back. Brazil has not been able to grow faster than 3 percent. Russia is back to growing at 3 percent. India’s growth rate has slipped back to about 6 percent from being at 8 percent. As liquidity becomes tighter in the global market place and people become more risk averse, we are seeing that growth rates of many emerging markets are falling back. And we’re going back to the old pattern, which is that there is much greater distinction [between countries]. Just because you’re an emerging market doesn’t mean that you’re destined to grow much faster than the developed world. My entire theme of the book is about differentiation; that you’ve got to treat emerging markets individually. This term is still too loosely applied.

You have argued that Indonesia approaches economic policy differently—that there is a rare caution in Indonesia, which distinguishes it from other emerging markets.

Based on my travels to Indonesia and elsewhere, Indonesia seems to have used the commodity windfall better compared to the likes of Brazil and Russia. And one big factor is that the investment of the share of GDP in Indonesia has been steadily rising over the last 10 to 15 years—standing now at about 32 percent of the economy. That to me is a fairly positive factor compared to Russia and Brazil, who have not utilized the commodity boom well, and the investment of the share of GDP remains very low at barely 20 percent or so.

Also, some of the banks in Indonesia still remember the ’97-’98 crises, which keeps them from doing something that is too out of control. If you look at the credit growth in Brazil, over the last five years it has been rapid; this is causing problems in the banking sector with some of the auto loans going sour and some of the credit quality metrics deteriorating quite significantly. But in the case of Indonesia we’ve seen that banks have been a bit more cautious.

So do you think Indonesia should not be focusing on increasing commodity exports? Is it really domestic investment that is putting it at an advantage?

Yes that is my view. Indonesia should be looking to increase its exports because exports as a share of GDP is relatively low. Indonesia has to assume that the benefits over the past decade from high commodity prices are over. That’s what Indonesia needs to be careful about.

The other breakout nations that you mentioned are South Korea, Poland, and the Philippines. What similarities do you see between these countries and Indonesia?

My whole point about breakout nations is not looking for similarities but looking for differences. My definition of a breakout nation is a country that will be able to exceed expectations. Expectations are very important. Looking at, let’s say, India, the growth rate is about 6 percent. That’s a pretty decent growth rate in absolute terms, but in India it’s feeling like a mini-recession for a couple of reasons. Expectations of growth rates came to be 8 to 9 percent. So at 4 to 6 percent it really feels hard. Also India’s per capita income is still very low at only US$1500 and at that per capita income level to grow at 6 percent doesn’t feel as great. Whereas in a country like Korea with a per capita income of more than US$20,000, at that level if it’s able to grow at above even 3 percent, that still feels pretty good.

So the similarities are countries that are able to exceed expectations in terms of what the consensus is for their economic performance. And also countries where they are able to grow at a fast pace adjusted for their per capita income level.

You said that if India’s growth rate were to lower by 1-2 percent, it would face a mini-recession. Indonesia is approaching 250 million people. You don’t see a correlation between India and Indonesia?

No, Indonesia’s per capita income is much higher than India’s, and expectation got high, unlike the Indonesian level. No one expected Indonesia to grow at 8 to 9 percent, whereas in India those expectations came to be, so they are adjusting for that shock now. Plus Indonesia’s per capita income is double that of India’s. So India needs to grow more quickly to get more people out of poverty as a share of its total population compared to Indonesia.

You mentioned that very few emerging markets have reached two decades of growth. Do you think Indonesia might be a country that has the potential to do that?

As I mentioned in the book, if you have grown rapidly for one decade the probability is lower that you’ll be able to do it for a second decade. The probability of doing it for three decades gets even lower. But I still feel good about Indonesia’s prospects that they’ll be able to sustain a relatively good growth rate in the coming decade.

You are a proponent of looking at individual governments rather than political systems when assessing the prospects of emerging markets. What’s your take on Indonesia’s government?

I think that the fact that they have had a reasonably popular leader elected democratically over the past decade who has had some focus on economic reform has been positive. The point I make in the book is that leadership is what matters, not the political system; that whether it’s democratic or authoritarian has no correlation with the growth rates you achieve. Vietnam can have a command and control system and try and go China’s way, but the quality of leadership is just not as effective so its performance has been much more disappointing compared to China’s. In Indonesia’s case the fact that they’ve got a strong leader who’s been able to keep political stability and some focus on economics is a positive.

You are an avid traveler. Which country do you think is where the world should be looking for investment opportunities?

I think that all countries have some prospects but the question is which will do better than others and which will exceed expectations. I do feel optimistic about Southeast Asia’s prospects in general. Indonesia, Thailand, and the Philippines all are in pretty good shape just now. Today is a reverse of the 1990s when China devalued its currency, which was a problem for the region’s competitiveness. Now China’s currency, which has been appreciating over the past few years, is turning the advantage back in the favor of Southeast Asia. The cost of hiring a factory worker in China has risen significantly over the past five years and the labor costs in China now are twice as high as those in Thailand, and roughly three times higher than those in the Philippines, and four times higher than in Indonesia. So this is something that makes the region quite competitive and makes it interesting from an investment perspective.

Is there a particular message that you would want to leave with us?

I would say that the message is more for the governments: focus on the economics and make sure to keep reducing the level of cronyism. The throwback I always get [about Indonesia] is that cronyism and corruption are high. I keep saying yes, true, but the rate of change is what we are focused on and the rate of change so far has been positive in Indonesia.