Where to Invest Around the World, 2014 Edition
Welcome to this year’s Baseline Profitability Index.
Do you work at a company that does business overseas? Or maybe you’re an investor hoping to buy a chunk of the growth in emerging markets? Either way, you’re probably wondering where the right places are to invest for the next five years. It’s an especially tough question today, given the geopolitical and financial risks plaguing the global economy. But a detailed consideration of all the things that can happen between earning a return abroad and bringing it home can offer a useful place to start.
Last May, I presented the first edition of the Baseline Profitability Index (BPI), which brought together eight factors to predict the total pretax return investors might expect in countries around the world: economic growth, financial stability, physical security, corruption, expropriation by government, exploitation by local partners, capital controls, and exchange rates. (In the original article linked above, I list my data sources.) In each case, I estimated how likely a given factor was to affect an investment, and then how costly the effect might be.
The idea of the BPI is to see how all of these factors might affect a foreign direct investment — the kind a private equity firm might make — over five years.
To my knowledge, it’s the first publicly available tool that explicitly takes a holistic approach to forecasting investment returns. It’s not perfect, because it doesn’t account for the interactions between all of these factors; just looking at them individually already involves many layers of complexity. But it’s a start.
See a larger version of the interactive map here.
In just the past 12 months, quite a lot has changed in the global investing environment. Some struggling economies have found their feet, notably in Europe, while others around the world have fallen victim to conflict. A few have improved their economic institutions, too; neighbors Greece, Macedonia, and Turkey all bolstered legal protections for investors, and nearby Azerbaijan strengthened its property rights.
Thanks to the availability of new data, four countries joined the BPI this year: Cyprus, Ethiopia, the Democratic Republic of Congo, and the Republic of Congo. It also lost a few: Benin and Tunisia (whose sovereign debts are no longer rated by Standard and Poor’s); and Ukraine (whose economic forecast from the International Monetary Fund is currently in flux).
Before I get to the results, I have three notes: In the 2013 edition, I used the International Property Rights Index as a gauge of the likelihood of government expropriation. The index is valuable, but covers fewer countries and does so more idiosyncratically than other sources. This year, I decided to use the property rights component of the Heritage Foundation’s Index of Economic Freedom. In the rankings below, I have recalculated the 2013 numbers using last year’s edition of the Heritage index. Also, the World Bank changed its methodology slightly for measuring protection of investors and then revised all previous years of data; these changes are reflected in the 2013 rankings as well.
Finally, the Chinn-Ito index I used to evaluate capital controls has not been updated, so I’m using the same values as last year. Some countries did indeed change the ease with which money could be moved across their borders; Cyprus, Ghana, and notably Ukraine made it more difficult, while Argentina and Venezuela made it easier. Hopefully a future update will include the effects of these new policies.
With all of these considerations in mind, here are the rankings:
See a larger version of the sortable, searchable table here.
Comparisons across the first two years of the BPI tell plenty of interesting stories. Botswana originally ranked second last year, but using the Index of Economic Freedom puts it in first place for two years in a row. Four other countries in sub-Saharan Africa join it in the top 20, with strong prospects for growth and, in Ghana and Rwanda at least, friendly business climates. East Asia performs even better, locking down seven of the top 20 places. India maintains its sixth position in large part because of the potential for real appreciation in the rupee; this may now be more likely than ever, thanks to Narendra Modi’s supposedly reform-minded government and the strong hand of Raghuram Rajan at the central bank.
China’s case is one where the switch to the Index of Economic Freedom is noticeable. It ranked 21 in the original 2013 BPI and slipped to 43 after the change. The index takes a dim view of Chinese property rights, perhaps because of the country’s nominally communist system. China’s expectations for growth dimmed significantly as well, pushing it still further down the rankings to 60th place in 2014.
Several countries made even wider jumps between the two years of uniform data. The biggest movers in the right direction were Jamaica, Japan, and the Philippines. Forecasts for faster growth, a better credit rating, and an increase in political stability helped the Philippines. In Japan, the 2013 BPI foresaw a real depreciation in the exchange rate, which indeed came to pass thanks to the huge expansion of the money supply encouraged by Shinzo Abe’s government; with this risk somewhat lessened going forward, Japan became more attractive for investment. Jamaica had a bit of both: a slight increase in its growth forecast and a suggestion that its currency was ripe for appreciation.
The deepest drops in the BPI were by Cape Verde, Egypt, Turkey, and Uruguay. Cape Verde suffered downgrades in both its economic forecast and its credit rating; Standard and Poor’s cited the country’s rising budget deficit — in part a consequence of lower growth and tax revenues — in cutting the rating. In Egypt, expectations for the economy worsened markedly as the army’s coup heightened the general level of uncertainty, while the likelihood of being shortchanged by a local partner rose. Turkey actually improved some protections for investors, but its security situation and its growth forecast both became gloomier. The political tribulations these economies have suffered in the past year did them no favors in terms of attracting investment. Meanwhile, peaceful, pot-smoking Uruguay also saw some erosion in the rule of law and a decrease in expected growth. I’ll let you draw your own conclusions.
Once again, the BPI suggests that not every fast-growing country is a perfect target for foreign investment. Many other factors determine just how much of that growth will be transformed into a cash return back home. Plenty of them are not included in the BPI, but it still contains much more information than a simple economic growth forecast.
We won’t know how predictive the BPI has been of investment returns until a few more years have passed. Even then, it might be tough to compare its forecasts to the profits earned by multinational corporations and private equity funds. But at the very least, the BPI synthesizes the many
factors that can affect an investment; as a first approximation, it should at least help investors to ask the right questions.
For questions about the BPI itself, please feel free to contact me here.