UBS’s Javier Kulesz analyzed in a recent report why Mexico “has stolen” Brazil’s darling status. Here’s an excerpt:
“… Relative competitiveness
Brazil’s hot labor markets and Mexico’s cooler ones have created a large disparity in unit labor costs. In Brazil, these have grown quite fast, at rates that are difficult to justify by productivity gains. That has not been the case in Mexico, where labor supply has been more plentiful and both employment and wage growth more tamed. Relative FX performance has also exacerbated labor cost differentials in dollar terms. Despite recent weakness, the BRL is still considered among the most expensive currencies within EM and despite its recent strength, MXN remains among the cheapest. A dollar would get you a lot more goods and services in Mexico than in Brazil, including an hour of labor. In 2006, the average Brazilian worker earned roughly the same as his/her Mexican counterpart. Today, he/she is 80% more expensive (Chart 3).
This relative competitiveness may be influencing performance in the tradable sectors. Take industrial production (IP) as a proxy. While Brazil’s IP has been contracting, Mexico’s has been expanding steadily and taking market share from key competitors in the US market. Today, Brazil’s IP is below pre-Lehman crisis highs. Mexico’s is above. The exact same conclusion applies when we compare export volumes in each country (dollar exports have been rising but due to a price effect).
… Inflation and monetary policy
Mexico offers investors a less uncertain inflationary outlook and a more predictable monetary policy stance. Core inflation is likely to remain well contained, thanks to an output gap that, in our estimate, has not yet closed and no significant wage pressures to speak of. In Brazil, rapidly rising wages, tariff increases, and more recently, relaxation of policy and some BRL weakness, raise doubts about inflation’s future trajectory (our inflation year-end forecasts for Mexico and Brazil are 3.7% and 3.8% in 2012 and 5.2% and 6.5% in 2013).
On paper, these two countries have very similar monetary policy regimes of targeting inflation explicitly using a reference interest rate as a policy anchor. Mexico’s economy appears to be flying at cruising altitude without developing visible inflationary pressures. The Central Bank is likely to keep its rate at the current 4.5%, as it has over the past three years. The Brazilian Central Bank has adjusted policy rates up and down rather widely (Chart 7), signs of an economy that has been too hot or too cold but not lukewarm enough. Moreover, recent aggressive rate cuts have planted doubts in investors’ minds about commitment to inflation targeting (we expect the Central Bank to hike rates next year as inflation regains momentum).
… Financial system
It is no secret that when EM investors think about Brazilian banks, they think about potential risks, and when it comes to Mexico’s, they think about potential upside. In Brazil, there has been no shortage of reports and comments referring to ‘Brazil’s credit bubble.’ The increase in past due loans, delinquency rates in the context of a slowing economy have raised fears about the system’s strength. Mexican banks have been less aggressive in extending themselves. Its system remains unlevered and with no significant deterioration in key credit metrics. Conventional wisdom is that Mexican banks stand on stronger footing, present better conditions to boost credit and absorb negative shocks that may come from abroad.
… Saving and investment
Brazil has demonstrated more limited capacity to both save and invest, even after the phenomenal windfall in commodity prices and despite the credit boom over the past few years. Savings and investment ratios are stuck at or below 20% of GDP, comparing unfavorably even against business-unfriendly Argentina and Venezuela. On the other hand, Mexico consistently invested more than Brazil, but this has not really translated into higher growth rates, and there lies Mexico’s problem. The presence of uncompetitive markets in a number of sectors, relatively low labor productivity, a sharp rise in organized crime, and declining oil output might have weighed on performance. This raises a host of more micro-related issues.
… Trade policy
Mexico has kept a very open policy, signing free trade agreements with all countries and trading blocs that matter in the world. On the other hand, Brazil has been stubbornly married to Argentina,1 a US$400 billion economy (about a sixth of Brazil’s), notwithstanding its periods of large macro instability and/or aggressive protectionist practices. Currently, Mexico is advancing another agreement with Colombia, Peru, and Chile, LatAm’s fastest growing economies. Meanwhile, Mercosur has finally accepted Venezuela as a new member, another highly unstable country quite unlikely to become the engine of regional growth. As a result, Mexican businesses not only face a lower wage (and tax) bill, but also more favorable access to key markets than their Brazilian counterpart.”