Seldon Matrix

Blog de opinión sobre política, religión, fútbol, y otras cosas

noviembre 16, 2011 economía, México

How safe is Mexico?

A recent news report by Mexico’s El Universal, a nationally circulated daily news outlet, recently stated that 2/3rds of the country are considered unsafe by foreign countries. However, data also suggests that Mexico’s National Security Crisis isn’t because of a disprortionate amount of criminality in the country, but because of the intensity of the violence. In fact, such data shows that Mexico is better than average in most metrics on crime.

So, how does this contradictory data translates to the National Business Climate in Mexico? Are investors calmed about Mexico’s criminal statistics, or worried about the disproportionate news coverage that the intense violence gets around the world? In fact, considering what’s going on around the world, how safe is Mexico perceived to be by Global investors?

A good measurement of long-term confidence is the willingness of investors to lend to a particular government. To find out this willingness, all we’d need to do is compare Mexico’s 10-yr bond yield to that of other countries. The lower the interest rates that investors demand from a particular government, the lower the risk they perceive that the particular country will have of defaulting. It is important to remember that, even though investors lend to a particular country, the interest rate is a reflection of investor confidence in the entire country’s economy, because investors know that the government will pay back their loans from future tax income, which can only be possible through national, and not government-specific, economic growth. In other words, the more trust and security an investor perceives from a particular country, the lower the interest rate that country’s government will have to pay.

To find out how “safe” is Mexico perceived to be by investors, I chose to compare it to 8 other nations: the 4 that make up the BRICs (Brazil, Russia, India and China), and 4 nations with higher GDPs than Mexico, but which have been in economic troubles as reported in global news outlets (the United States, France, Italy and Spain). The reason I chose the BRIC nations is because people in Mexico usually see these nations as their competitors. I also chose to compare Mexico to 4 nations with better GDP because it’s best to compare oneself with those that are better off (giving us something to aspire to), but I also chose nations with perceived economic trouble because I am trying to find out if Mexico’s troubles are bigger or lower than those in other countries. I am trying to find out if Mexico’s popular sentiment, that we are a sub-standard nation, is actually accurate.

Country 10-yr bond yield
United States 1.95%
France 3.19%
China 3.71%
Russia 4.73%
Spain 5.80%
Mexico 6.01%
Italy 7.51%
India 9.04%
Brazil 11.10%

The data was obtained from The Economist.

As you can see, Mexico is in 6th place out of the 9 that were measured. This is very near the average, but it is also in the bottom 4. What’s surprising is that Mexico is ranked better than Italy, India and Brazil, with the latter 2 being the most promising prospects for growth as considered by investors everywhere.

Of course, the above table doesn’t tell the whole story. The biggest problem this table has, is that it isn’t “inflation-adjusted”. What this means is that, since it’s comparing developed with developing economies, we don’t really know if this yield is high or low for that particular country. for example, 7.5% is excessively big for Italy, but, it would actually be normal for Mexico. In fact, not 10 years ago, 7.5% was considered “low” for Mexico!

The reason for this disparity has to do with the fact that investors want real-term gains. “Real-term” means that the returns they receive should compared to national inflation to find out how much more (or less) is the investor demanding from the government compared to the anticipated devaluation of the money they have lent. If the investor demands a lower yield than inflation, this is a sign that investors trust the government more than they trust other investments (such as stocks or business bonds). Negative real-term yields, though historically rare, have been common in the past few years.

The following table compares Mexico to the same 8 other countries, but this time, we compares real-term yields:

Country 10-yr bond yield Inflation Yield in real terms
Russia 4.73% 8.90% -4.17%
China 3.71% 5.40% -1.69%
United States 1.95% 3.10% -1.15%
France 3.19% 2.20% 0.99%
India 9.04% 6.80% 2.24%
Mexico 6.01% 3.50% 2.51%
Spain 5.80% 3% 2.80%
Brazil 11.10% 6.50% 4.60%
Italy 7.51% 2.70% 4.81%

Again, data on inflation was obtained from The Economist. The Yield in Real Terms is the 10-yr bond yield minus (-) the rate of increase in consumer prices (inflation).

Again, Mexico is 6th place out of the 9, also near the average, and also in the bottom 4. What’s surprising, however, is that virtually all other countries change their relative ranking when compared this way!

The United States goes from being the most trust-worthy economy to being the 3rd trust-worthy. Incredibly, Russia is the most trustworthy economy of them all, and by nearly a factor of 4! This isn’t small news, and it warrants attention. Either Russia is an economic powerhouse and investors know this while the rest of us don’t, or Russia is dramatically over-valued. The valuation of China seems to confirm what many in the US fear: that China is now a better economy than the United States. But leaving the political implications of the top 3, what is even more surprising is that investors are willing to lend below a 0% inflation-adjusted yield to 3 countries! They either believe these 3 countries are super-safe, or they believe the rest of the world is not worth an investment. By the way, France isn’t far off from this group of 3. Even though their real-term yield is positive, it still is less than 1%.

The next group, and this is what makes me confident about Mexico, is a group that pays what in normal times was considered a healthy yield: higher than 2% but lower than 3%. There are 3 countries in this group: India, Mexico and Spain. This explains why India is expected to be a source of global economic growth, and why Spain, though systemically fragile, hasn’t yet been through the tragic experiences of Ireland, Greece or Italy, and why some analysts are even predicting the collapse of France before predicting the collapse of Spain. The mere fact that Spain is in this group speaks volumes about the viability of the Euro. Yes, Europe is in crisis but, as Spain suggests, it isn’t dead yet. Not only that, but it’s more alive than many people consider.

I want to go back to Mexico’s 6th place. The fact that Mexico is equally ranked in both inflation-adjusted and non-inflation adjusted returns may suggest that Mexico is the most accurately-valued economy of them all. I think that the main driver of this, though, is that Mexico’s 10-yr bond isn’t valued in Mexican Pesos, but in UDIs. “UDI” is an acronym for “Unidad de Inversión” (Unit of Investment), and it is a virtual currency (meaning: it doesn’t actually exists, but is a legally valid pricing method) created by the Mexican government with the purpose of providing an inflation-adjusted reference for pricing. How it works is that financial institutions will give you a price in UDIs, and you’d have to find out what the Government values UDIs at in terms of pesos. The UDI is valued to an inflation-adjusted reference to pesos. Today, Mexico’s government states that 1 UDI was equivalent to 4.63 pesos, which means that the UDIBONO is paying a 1.9% interest on UDIs assuming that inflation is 4.63%. The existance of the UDIs make Mexico more financially stable, simply by removing investor’s anxiety about Mexican inflation, as the UDI is like an insurance policy on inflation.

I’ve heard a lot of Mexican businessmen talk about their country being “undervalued”, as they believe our country offers better economic opportunities than most BRICs, particularly Russia, India and Brazil (we’re all afraid of China). The inflation-adjusted 10-yr yield suggests that, no, Mexico isn’t undervalued. In fact, we may be the most accurately-valued economy in the bond market! However, the data also suggests that the sentiment of Mexican businesses is not far from the truth: we are at least as safe an investment as India, and we are a better investment than Brazil. In fact, Mexico is better valued than 2 big European economies: Spain and Italy! As for Russia, well, again, that’s still a mystery for me.

The last group is those countries that have to pay more than 4% for their inflation-adjusted yields. In this group, with similar valuations, are Brazil and Italy, with Italy being the worst ranked. It is clear, then, that all that fuss about Italy seems to be justified. There is actual fear that Italy could default, and thus, to make-up for that risk, investors ask a lot more from Italy than ever before. However, what’s interesting is that, for all of Brazil’s positive economic press, investors ask of Brazil almost the same that they ask from a country that, some investors fear, may collapse and default soon. Brazil seems to not be the hot bet that it’s made out to be…

Of course, the current blog post isn’t meant to be an analysis of the global economic outlook, or of the economies of all these countries. It simply is meant to be an answer to a question about my country: How safe is Mexico?

For all the bad press about Mexico’s violent war on drugs, and for all the positive data on crime rates, the economic impact of the security fears seems to be null on investors. Mexico is considered to be a safe investment. Perhaps not as safe as China or the US, or the World’s biggest economies (Germany, the UK, or Japan), but at least, good enough to be competitive.

And make no mistake, Mexico’s positive economic outlook is the direct result of current economic policy, which has been consistent for the past 18 years. Regardless of the volatility in exchange rates, unemployment and other economic indicators, investors visualize a positive prospect for Mexico for the long-term. With Presidential elections in Mexico less than a year away, voters would be wise to take this into account when choosing their candidate.

So, how safe is Mexico? It appears that it’s pretty safe as an investment, actually…

Additional Information,

By suggestion of a Reddit user called TheManInTheSuit I have compared Mexico to the new group of developing nations called MIST, which stands for Mexico, Indonesia, South Korea and Turkey. The following compares MIST economies, BRIC economies, and the 4 developed economies we have included previously:

Country 10-yr bond yield Inflation Yield in real terms
Russia 4.73% 8.90% -4.17%
China 3.71% 5.40% -1.69%
United States 1.95% 3.10% -1.15%
Turkey 9.60% 9.10% 0.50%
South Korea 3.75% 3.10% 0.65%
Indonesia 3.91% 3.10% 0.81%
France 3.19% 2.20% 0.99%
India 9.04% 6.80% 2.24%
Mexico 6.01% 3.50% 2.51%
Spain 5.80% 3.0% 2.80%
Brazil 11.10% 6.50% 4.60%
Italy 7.51% 2.70% 4.81%

Note, Indonesia’s 10-yr bond is valued in US dollars, and thus its yield has been compared to US inflation, not Indonesian inflation.

These, more complete numbers show us some very interesting suggestions:

  • Russia continues to be a mystery to me. Since I don’t have all the data, I’m going to suggest that it’s over-valued, but I won’t say for sure until I get myself some more data.
  • China and the US are apparently considered by investors relatively risk-free, so much so, they are willing to park their money there and pay these countries government’s a premium for the privilege of security.
  • China may be safer than the US.
  • All of the MIST countries, except Mexico, apparently are considered by investors to be at least as safe an investment as France. This is suggested by the fact that Turkey, South Korea, Indonesia and France all pay inflation-adjusted yields of less than 1%.
  • India, Mexico, and Spain could be considered “average-risk” countries.
  • Brazil and Italy are in trouble.
  • The term “BRIC” makes no sense anymore, as these countries are now so diverse they warrant different risk assessments.
  • Adding more countries pushes Mexico way below the rankings.
  • Either Mexico is undervalued, or the term “MIST” makes no sense, even though the whole purpose of the group as an analytical tools is to observer countries with similar political, geographical, and population-based conditions. If Mexico is undervalued, it may be because Mexico it is paying a premium due to the violence.
  • The security premium that Mexico seems to be paying due to bond investors due to the violence seems to be between 2.01% and 1.7% (these numbers are derived by subtracting the highest and lowest inflation-adjusted yields of MIST countries from the inflation-adjusted yield that Mexico pays).

Revisiting my question: How safe is Mexico? Well, apparently, about 2% less safe than countries that the bond market is comparing to France. In other words, bond holders may be confident enough that Mexico will be able to solve this problem in the long term, but just in case, they are demanding a small premium.

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