Walter Molano | Mexico: Midterm blues

Mexico has been the top sovereign recommendation for the last few years.

The United States economic recovery, rising wages in China and the deep integration with its main trade partner were the reasons for the optimism.

Unfortunately, events in Mexico did not keep up with the general sense of enthusiasm. Gross domestic product (GDP) growth was usually half of what was expected and the MXN was the perennial dog of the currency markets.

Still, the country remained a top pick. However, patience is running thin and the economic/political environment appears to be getting worse. To begin with, the drop in oil prices is a serious problem for the government.

Oil royalties represent a third of government revenues. A prudent hedging programme softened this year's collapse in energy prices. However, the recovery that was registered during the second quarter was dashed when the wheels came off the Chinese bus.

Low oil prices no longer appeared to the object of Saudi manipulation, they were the victim of a collapse in Chinese demand. This means that the Mexican government needs to come up with additional funds to balance the books in 2016.

With Pemex handing over almost 70 per cent of its revenues to the government, there is very little room for it to pass on any more. Moreover, Pemex oil production continues to decline, and the debt stock continues to climb. These are the reasons it is about to be downgraded by the credit rating agencies.

That leaves the government no other choice but to cut spending and raise taxes. The tighter fiscal position will be a constraint on GDP growth in 2016, meaning another year of lacklustre performance.

The other major impediment is on the political front. While President Enrique PeÒa Nieto may have Hollywood looks, he could use a new agent. His endless gaffes and missteps indicate either extreme arrogance that borders on insolence or a complete disconnect with reality.

 

circling the wagons

His recent absolution by the special investigator, that he personally appointed to look into the so-called White House scandal, was the last straw. The incident helps explain why he has the lowest popularity rate of any Mexican president at the halfway point of his term.

However, instead of taking measures to rectify the situation, PeÒa Nieto is only circling the wagons. There are whispers that Central Bank Governor Agustin Carstens may be used as the scapegoat for the country's economic woes. Carsten's term ends at the end of this year, and the president said he would soon make a decision on his future.

It is said that Finance Minister Luis Videgaray chafes at Carsten's independence. He is not seen as a 'team player'.

Of course, this is what is expected of a central bank governor. A decision not to reappoint him to a second term would be a serious mistake. Not only is Carstens considered the architect of Mexico's brilliant recovery in the aftermath of the 1995 peso crisis, and one of the most audacious economic policymakers of the developing world, he is seen as the only bright light in the PeÒa Nieto admi-nistration. Getting rid of him would be a devastating blow to the country's image and reputation.

Yet, everything does not need to be so grim in Mexico. External and internal factors are working in its favour. The most obvious positive factor is the economic recovery in the US. Not only will it boost the demand for Mexican exports, a rebound in US economic activity will generate more remittances for families back home.

Next, the reforms are starting to kick in. Pemex is auctioning off production fields that will soon reverse the decline in total oil output. The deepwater concessions could be auctioned off next year, leading to a large influx of investment.

The problems in China can also be construed as a positive development. As Chinese wages increase and investment slows, Mexican firms will find themselves better positioned.

Last of all, the most important factor is the massive devaluation of the currency. The MXN has lost almost a third of its value, thus giving the country a huge competitive boost. This comes at a time when the demand for Mexican exports is rising.

The result should be more employment, higher investment and faster growth.

However, analysts are not focusing on the glass half-full aspects of the Mexican story. They are looking at the glass half-empty. Perhaps, this is symptomatic of the midterm blues associated with most terms in office.

 

Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com