by Henry Teitelbaum, Editor, P3 Planet
It probably comes as no surprise to investors that great diversity exists among the countries that make up the world’s emerging markets. Yet, when a financial crisis strikes them, it’s often because the foreign portfolio managers that run giant global investment funds indiscriminately dump their holdings of emerging market debt and equity at more or less the same time.
This behavior has often been triggered by country-specific credit issues or by changes in interest rate expectations in the US or elsewhere. But the impact on many of these countries is both immediate and far-reaching, often dramatically raising the cost of financing for governments and businesses in those countries that rely on foreign borrowings to service their debt. Typically, this leads to liquidity shortages as buyers disappear, steep losses for investors, bank runs, government and private sector defaults, and catastrophic job losses.
It doesn’t end there either. The contagion that follows reaches across borders to engulf whole economic regions. Of course, this domino effect is rarely justified by the underlying economic reality, and many western institutional investors have become adept at exploiting such short-term selloffs to pick up stocks for their portfolios on the cheap or to lock-in high yields on bonds that have been beaten down by panic selling.
Correlations In Emerging Markets Declining
Lately, this pattern has started to break down. Individual country performances seem to be reflecting a more diverse range of economic and business conditions across emerging markets better than they have in the last 20 years, and investors appear to be standing by their convictions. This is a good thing, and the surest evidence yet that emerging markets have grown up in a very short period of time. Emerging markets have not only grown dramatically just in the past five years, they now offer more ways to diversify risk across credit and equity markets.
Naturally, investors will look at broader macro-economic factors affecting individual economies such as external debt, current account, domestic deposits and foreign currency reserves. But they are also looking more closely at the policy priorities within individual countries that affect long-term stability, including progress in political and economic reform, and at the choices governments make when investing for the long-term prosperity of their people.
The selloff in January 2014 was a case in point. Emerging market countries where reforms have been implemented, where governments have limited their borrowing and where domestic savings are growing, proved resilient to the selloff. Many of these mostly Asian and Southeast Asian markets have more than recovered the steep losses that followed the change in dollar interest rate expectations.
Investors are also drawing distinctions among emerging market countries based on major programs and policy initiatives. One good example of how this is playing out can be found in Mexico. The country, which has historically been a target for foreign investment due to its oil and gas resources and proximity to the US, has lately been garnering attention for its open, progressive and highly credible approach to developing public infrastructure.
Making Mexico Investment-Friendly
And it should be. Mexico’s 2014-2018 national infrastructure plan outlined earlier this year by President Enrique Peña Nieto is an excellent example of how to structure a large-scale investment program to make it attractive to private investors. Not only has the government incentivized domestic institutions such as pension funds to invest in early stage Public-Private Partnership projects, it has created the structures that will ensure that financing is available to get them off the ground.
The plan is nothing if not ambitious, envisioning some 7.75 trillion pesos ($590 billion) in public and private investment in infrastructure. There are 743 projects outlined for investment, and these focus heavily on energy, communications and transport. But the plan also includes new projects in housing and urban development, health and tourism.
To support investment, Mexico’s government-run infrastructure bank and fund trustee, Banobras (Banco Nacional de Obras y Servicios Publicos) has been given the capacity and the legal and structural mechanisms to make public private partnerships (PPP) “bankable” for a broad range of long-term investors, including foreign institutions.
What that means is that Banobras and Fonadin, the infrastructure trust fund that it runs, may help to catalyze private investment in infrastructure investment by taking the financial risks that private investors are unwilling to take. This is especially important in the early stages of construction, when risks are at their highest. They are also willing to provide long-term financing for projects, including PPPs that have low yields but high social impact.
Mexico, which has the world’s 14th largest economy, could really benefit from the investment, as its infrastructure places it only 64th of 148 countries in the World Economic Forum’s global competitiveness index. This was recognized as a key driver in the government’s decision to dramatically boost infrastructure investment. It also provides any and all potential investors with clarity on the value that the government places on the success of these projects.
A Helping Hand For The Poor
Mexico’s government has gone further than most in trying to ensure that the investment capital is channeled to infrastructure development in parts of the country where it can make a big difference. Finance Minister Luis Videgaray indicated early this year that the plan places special emphasis on Mexico’s poorest states in the south and southeastern regions of the country.
By targeting these regions for infrastructure investment, there’s a good chance the investment will do “double duty”, and have an outsized impact on the economy of these regions. That’s because in addition to creating public assets that boost local productivity and competitiveness over the long-term, the investment will bring a near-term boost to regional economies through the jobs it creates. Taken as a whole, the program amounts to a powerful instrument for addressing income inequality and increasing social stability throughout the country.
Foreign investors seem to have taken notice. The country’s equity market has been a strong performer in 2014, and currently stands out for both its emerging market-leading forward price/earnings ratio, and for its performance in relation to historical averages.
Could Mexico’s model for infrastructure development also be giving the country a leg up on the other emerging market countries with which it competes for stable, long-term foreign investment?
I wouldn’t want to generalize about individual investment decisions. But for any investor comparing long-term prospects in emerging markets around the world, Mexico’s PPP-driven infrastructure push sure seems to tick a lot of boxes.
full disclosure: the author holds listed shares in the iShares MSCI Mexico Capped ETF
This article has also been published in The Conde Report on U.S.-Mexico Relations