Investing is about information. Having more - and better - information allows an investor to paint a more complete picture about the financial health of a company, or even of an entire country's economy. This is especially important as companies grow their multinational presence, entering markets in areas that are rapidly developing and have an insatiable appetite for the world's goods and services. But venturing into these markets can mean entering a world in which the rule of law can be overlooked, and in which the principles that drive business in developed countries come face to face with a different reality. (For related reading, see 5 Government Statistics You Can't Trust.)
TUTORIAL: Economic Indicators
Economic Data Collection
Economists and investors alike look to certain statistics to judge the health of an economy, and thus get an idea of what threats and opportunities companies operating in those economies may face. Statistics such as unemployment, public debt, inflation, poverty rates and other macroeconomic and socioeconomic figures form the backbone of this type of analysis.
To compile these statistics governments create agencies to come up with the appropriate methodology and hire personnel to go through the cities and countryside to collect information. Examples of government agencies include the Bureau of Labor Statistics and Census Bureau (United States), Eurostat (European Union), Federal State Statistics Service (Russia) and National Bureau of Statistics (China). Personnel interview residents to find out how big their households are, check local prices for goods and services, visit schools to check attendance and gauge the general opinion of the population. This data is then brought back for analysis. (For related reading, see 4 Key Indicators That Move The Markets.)
There are several reasons why a country may manipulate the information coming in from the field.
International Investors Want Healthy Economies
Multinational corporations don't want to invest millions of dollars in new markets if they think that things will collapse. Growth in consumer demand, stable government policies and access to transport are important factors that contribute to a venture's success. For example, favorable education figures make the country look more attractive to companies who need an educated workforce to manufacture products.
Credit Markets Want Stability
Lower inflation rates give the country more flexibility in its monetary policy, as it may want to continue to print money to bolster its reserves or fend off accusations of scarcity. For countries obtaining credit through inflation-linked bonds, understating inflation can amount to significant savings for the home government and the equivalent amount of losses for investors. (Learn about the tools the Fed uses to influence interest rates and general economic conditions. For more, see How The U.S. Government Formulates Monetary Policy.)
Politicians Need a Rosy Picture In Order to Survive
The political aspirations of those in government are often the strongest incentive to manipulate economic data. Politicians are judged on the performance of the country while they are in office, and favorable official statistics make them look good.
A recent example of dodgy statistics comes from Argentina. The country had been losing international standing for several years leading up to 2011, both in the eyes of international institutions like the IMF and countries such as the United States. Argentina had defaulted on its sovereign debt in 2001 – then the largest default in history – and had dragged its feet in meeting the demands of many bondholders looking to recoup some of their losses. While the government slowly moved to repay some legacy bondholders, it had also entered into bond agreements with new creditors. Some of these bonds were indexed to Argentina's inflation, meaning that the country would have to pay bondholders substantially more if inflation increased. INDEC, the government statistics agency, reported inflation rates of 10%, but private economists calculated that the rate was closer to 25%. This discrepancy cost bondholders billions of dollars.
How can investors spot a country that may be up to no good? Depends on how much time and effort you put into fact checking. Here are a few places to start:
Check What International Agencies Are Saying
Several international agencies, such as the IMF and World Bank, aggregate official statistics for many different economies. If the country being examined is showing statistics that are significantly better than economies of similar sizes, something may be amiss. Look for rapid changes in statistical values, since some statistics, such as poverty levels, take time to change. Lastly, if trustworthy international agencies are skeptical, you should be too. (For more on the World Bank, see What Is The World Bank?)
Check the Papers
Arm yourself with information, but make sure to use different sources. Newspapers with reputable business, economic and political coverage may paint a less rosy picture than domestic media outlets, which may be tied to government leadership. If you read of bread lines, shortages and food riots, odds are any official statistics claiming no shortages are bunk.
Look at Unofficial Sources
Most countries have some level of unofficial statistics reported by private economists and organizations. These may be particularly useful sources of information if provided by reputable sources.
Beware of Shakeups and Changes in Methodology
If government employees and managers in charge of collecting and analyzing statistics are suddenly sacked and replaced, be wary. While they may have been let go for corruption, they may very well have been given the axe because they weren't reporting the positive results demanded by government bosses.
Determine Who Benefits from Positive Stats
If government officials are up for election in the near future, they have a real incentive to alter the statistics to bolster their chances of another term in office. Some officials also have cozy relationships with major industries and domestic companies.
The Bottom Line
What should an investor do? The first thing is to realize that official statistics in some countries need to be taken with a grain of salt. The second is to understand that every emerging and developing economy is not fudging the numbers, but that there is also a lot of room for corruption. After all, official statistics can be a politically-charged item. As the adage goes, if things seem too good to be true, they might just be. (For related reading, see What Is An Emerging Market Economy?)