Country Report Mexico
Important sectors of the Mexican economy are characterized by a low level of competition, while the governments tax base is quite narrow. Furthermore, wide spread corruption remains a problem. In case the proposed reforms by new President Peña Nieto are implemented, Mexico’s growth potential will rise.
Strengths and weaknesses
Moderate external debt levels
Mexico’s external debt was equal to 23% of GDP and 65% of current account receipts in 2012.
Since labor costs in China have been rising in recent years, Mexico’s cheap labor force is attracting foreign direct investors. In recent months, multiple car makers have announced the opening of new factories in Mexico in the coming years.
Narrow tax base
Tax income is relatively low and around 30% of the government revenue is related to the oil sector. Without structural reforms, the oil producing capacity will continue to shrink, which may lead to a deterioration of public finances.
Wide spread corruption
Widespread corruption in all layers of society has a negative impact on the business environment and makes the fight against drug cartels difficult.
1. Government intends to implement structural reforms
Within his first week in office, President Peña Nieto closed a deal with Mexico’s two major opposition parties, the conservative National Action Party (PAN) and the left-wing Party of the Democratic Revolution (PRD). The deal is called “the Pact for Mexico” and focusses mainly on structural reforms. Since then, some major steps have been taken, although none of the major reforms has been turned into legislation yet. Three reforms are in their final stage of acceptance. First, the telecom sector will be reformed, with the aim of making the industry more open and competitive. The OECD has estimated that the current inefficiencies in the telecom sector lead to a welfare loss of USD 25 billion per year, equal to 1.8% of GDP, as consumers are overcharged by 52%. Higher prices have also led to a relatively low penetration rate. The new law includes the creation of a new regulator for the sector. This regulator may fine or even force companies to sell part of their assets, the latter in case they control more than 50% of the market. Second, the government aims to restrict the power of labor unions within the education sector. Currently, labor unions decide on the professional engagement and career development of teachers. The reforms target is to enhance the power of the state authorities and to boost educational quality. At the moment, Mexico’s schools are ranked as the worst performing ones of all OECD countries. Third, a financial reform has been announced to boost credit growth. Currently, the credit to GDP ratio stands at 26% in Mexico, compared to 61% in Brazil and 71% in Chili. Development banks will be given a new mandate to increase lending, especially to infrastructure projects and small and medium enterprises. The government hopes that this will induce commercial banks to lower their interest rate margin. Besides, Mexico wants to improve the regulatory framework, including bankruptcy laws. These laws will give borrowers less incentive to default and are therefore likely to boost financial intermediation. The reform is planned to be implemented in September this year.
In March, President Peña Nieto also announced a reform of the oil sector. According to Mexico’s constitution, Pemex, the state-owned oil company, is currently not allowed to form joint ventures with international oil companies. However, the company lacks the necessary knowhow and resources to extract deep-water oil on its own. According to Peña Nieto, Mexico will be running an energy deficit by 2020 in case it does not fundamentally reform the oil sector. Although the oil sector reform has been received with some skepticism, as many Mexicans are in favor of energy nationalism, the reform agenda clearly shows Peña Nieto’s intention. Implementation of this reform will not take place before the end of this year.
2. Central bank cuts policy rate
Mexico’s central bank cut its benchmark interest rate by 50 bps to 4.0% on 8 March, as it was worried about the slowdown of growth in the US and the euro zone, which will hamper Mexico’s exports. Although inflation is at the upper end of the target range now, it is expected to come down in the second half of 2013 amid weaker economic activity. This gave the Central Bank some room to maneuver. A positive side effect of the rate cut is that it may take away some upward pressure on the peso, which is good news for exporters. Thanks to the move the policy rate has reached a new record low.
3. Economic growth slows down
Recent data show that growth is leveling off. In the first quarter of 2013, growth amounted to 0.5% on a quarterly basis, and was thus similar to growth in the last two quarters of 2012 (figure 1). Growth in the first quarter was however lower than in the first half of 2012. However, part of the slowdown was caused by the lower number of working days in the first quarter of 2013, as Easter fell in March this year while last year it fell in April. Furthermore, industrial production – an important indicator for economic growth – grew by 0.3% on a quarterly basis, after a small decline of 0.1% in the last quarter of 2012. All in all, we expect the economy to grow by around 3% in 2013. The long term picture is mixed. First, structural reforms are likely to boost the long term growth rate. Furthermore, China’s labor costs have been rising rapidly compared with those of Mexico. In 1995, the average monthly wage of a Chinese worker was USD 55, compared to USD 229 for a Mexican worker. Since then wages have been converging. Although we have not corrected these figures for productivity gains and transportation costs of products, it is clear that Mexico attractiveness for new manufacturing plants has grown. However, drugs related crime may hamper investment in the tourist sector. Besides, Mexico already slipped out of the top ten of global tourist destinations in the past year, as the image of Mexico’s tourism industry in the US deteriorated.
The party of current President Peña Nieto, the Institutional Revolutionary Party (PRI), ran Mexico for almost the whole 20th century. However, since 2000, Mexico twice elected presidents from the National Action Party (PAN), a conservative party. Since the end of 2012, Mexico is again ruled by a president from the PRI party, Peña Nieto. He claims to be the opposite of the crooked party men who ran the country in in the previous century. A big problem for Mexico is that politicians cannot be reelected, which facilities corruption and nepotism, as politicians will not suffer the consequences of wrongdoing. Mexico’s macro-economic policies are rather sound. Mexico’s economy is relatively well diversified. The tourist, manufacturing, oil, agricultural and construction sectors are the main sector of the economy. The economy is strongly linked to the US. As a result, it tends to moves in tandem with the US business cycle. Drugs related violence remains a problem. It is estimated that it has reduced growth in recent years by 1% to 1.5% annually.