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Yesterday we relayed Imara Asset Management CEO John Legat’s theory that a flat tax rate would be a boon for Zimbabwe and ultimately erode corruption while underpinning the country’s competitiveness (against the likes of South Africa, for instance) and moreover augment its moribund tax base. The Economist’s latest piece on business and bureacracy (“Snipping of the shackles”) touches upon some of these same themes, noting [in regards to the World Bank’s latest “(Ease of) Doing Business Survey 2011”] that “wherever the red tape is thickest, the result is widespread informality. Many small firms operate under the radar of officialdom, dodging taxes and ignoring rules [in order] to survive. But they have to stay small, and thus contribute much less than they might otherwise do to a country’s prosperity.” Cutting said tape, the theory goes, propels a positive feedback loop that–given how low a base some countries are coming from–can quickly translate into fairly remarkable results. The state of Lagos for example, home of Nigeria’s business capital by the same name, “has been improving its tax collection . . . encouraging formerly chaotic companies to keep proper accounts, which in turn makes it easier for them to do business with each other. The extra tax revenue is being used to improve services such as public transport, which among other benefits makes it a better place to do business.” Among other countries making recent gains in the rankings, Mexico (“the most straightforward country in Latin America”) and Kazakhstan (year’s most improved economy) were frontier stand outs.
Another, Saudi Arabia, is ranked higher than both Germany and Japan, which might cause some cynics to question the data’s veracity. On a similar note we switch gears to a project recently published by two MIT economists which used the internet to provide a daily gauge of consumer price inflation (see graph, inset) among various countries and which also calls into question the rosey conclusions offered up by some governments–namely Argentina’s:
“In countries where the apparatus for collecting prices is limited, or where officials have manipulated inflation data, the economists’ indexes might give a clearer view. In Argentina, for example, the government has been widely accused of massaging price figures to let it pay less interest to holders of inflation-indexed bonds. President Cristina Fernández has defended the government data. For September, the government’s measure of prices rose 11.1% from a year earlier. The economists’ measure in that period: up 19.7%.”
Patrick Fearon, a portfolio manager with Phoenix-based and Mexico-focused private equity firm TNV Mangement, hints at just how correlated Mexico’s export-led recovery is to U.S. inventories which, per the latest reading, may be due to begin a downtrend barring an unforeseen demand rash: the [business] inventory-to-sales-ratio, which measures how long it would take to clear shelves at the current sales pace, was 1.26 months in August, the highest since a matching ratio in February 2010.
“The third straight decline in the leading index is a negative sign for the Mexican economy, although more recent data suggest the index may be pointing more toward a slowdown in the economic recovery than an outright decline in activity. Not only did the country post an extraordinarily strong growth rate in second-quarter GDP (up 7.6% year-over-year), but figures for July showed a rebound in international trade and lower unemployment, while figures for August showed a rise in consumer confidence. Nevertheless, the Mexican economic recovery is fragile. To date, the recovery has stemmed primarily from increased exports, which have boosted industrial activity and spurred hiring. Even more disturbing, data suggest that almost 40% of the increase in Mexican exports in the first half of 2010 came solely from trucks, autos, and auto parts. This is not a very broad base on which to build a lasting economic recovery. To reiterate what has already been said frequently on this blog: If U.S. inventory rebuilding continues to slow and corporate and consumer demand north of the border do not soon accelerate, Mexico’s exports could peter out before other sectors of the economy are growing fast enough to take up the slack.”
From a relatively passive standpoint the iShares Mexico ETF (EWW) remains a prudent and cheap way to get exposure, though its chart pattern of higher lows since this spring does not necessarily inspire immediate confidence. That said, during that period it’s shown fairly strong resistance (high volume) on several occasions above the $45 level, and similar to Colombia’s ETF, its astonishing percentage run-up since early 2009 is almost unparelled.
How much was the global economic crisis made possible by a savings glut in emerging countries? While popular sentiment is to lambast securitization, bankers and even capitalism per se, a more nuanced view of the matter (and one widely embraced by economists of varying ideologies) embraces the appreciable role of emerging economies in inflating the world’s asset prices (though to be fair, said economies were awash in private capital flows from more developed nations). And while emerging countries were stung just as hard (if not harder, due to capital outflows) as developed ones from the crisis, their long-term fundamental health is not questioned. Among other changes which will be evident in international finance’s new paradigm, notes Mohamed El-Erian, chief executive and co-chief investment officer of Pimco, the bond investment manager, is that “multiple growth engines, largely from the developing world, will replace the single engine of growth of the US-centric twentieth century.”
One change G20 countries would like to see is a draw down on those very reserves that flowed so freely during the boom times, depressing yields even as interest rates continued to be slashed. The Economist writes this week, for instance, that the IMF’s resources will be increased by $500 billion to $750 billion, and that it will be allowed to issue $250 billion-worth of its own quasi-currency, the Special Drawing Right (SDR), to ease liquidity in emerging and developing economies. In essence, the “fund wants to provide crisis insurance to large emerging economies suffering a temporary loss of liquidity but with basically sound policies.”
The creation of a beefier but gentler IMF will give emerging economies a credible alternative to the practice of building up enormous foreign-exchange reserves. Many countries have done this in the past decade to protect themselves against fluctuations in capital flows or commodity prices. Given the opportunity to insure with the IMF, countries should have less need to insure themselves with vast reserves or to arrange large bilateral swap lines. When emerging economies have reserves worth several hundred billion dollars each, the IMF could not possibly have provided a credible alternative to self-insurance with a kitty of no more than $250 billion.
Yet skeptics worry that the social and political stigma that is (understandably) attached to the IMF may preclude leaders from knocking on its door, even when times are tough:
An almost visceral dread of having to approach the IMF, especially after the Asian crisis, was at least partly responsible for the enormous build-up of reserves to begin with.
Yet Mexico’s recent willingness to open a flexible credit line is perhaps a sign that said stigma has dampened. Gabriel Casillas, an economist for UBS Pactual in Mexico City, said the IMF loan “will in fact increase the central bank’s foreign reserves, giving…more firepower to the Mexican monetary authority to stabilize the currency. “In our view, this could make market participants concerns about Mexico’s foreign reserves level vanish completely,” Mr. Casillas said, adding that he expects the peso to surge against the dollar in the short term.
JGW
Frontier Markets 
