Country Report Mexico
When President Peña Nieto took office in December last year, he promised to deliver growth. The current figures are however disappointing, but, if his reform proposals will be proved in the coming months, Mexico’s outlook will definitely improve.
Strenghts (+) and weaknesses (-)
(+) Sound fiscal policy for more than a decade
For almost two decades, Mexico has been running a small budget deficit, accompanied by a low level of public debt and a fiscal rule targeting a balanced budget. This is a clear indication of Mexico’s prudent fiscal policy.
(+) Mexico competitive position
Mexico´s proximity to its main export destination in combination with relative low labor costs result in a good competitive position, augmented by rising labor costs in China and transportation costs.
(-) Narrow income base of the government
Mexico’s government income base is narrow, which is reflected by the fact that almost 60% of the workforce is not registered in the tax payment system. Furthermore, 30% of the government’s income is oil sector related, whereby we note that the oil production is decreasing gradually.
(-) Widespread corruption hinders the business environment
Widespread corruption in all layers of society has a negative impact on the business environment and makes the fight against drug cartels difficult.
1. Update structural reforms: energy sector
President Peña Nieto’s success as a president will mainly depend on whether he will be able to reform the country in multiple areas, whereby the reform of the energy is the most prominent reform. The constitution currently prohibits private participation in the exploration and extraction of hydrocarbons, as natural resources are fully owned by the state. Furthermore, private involvement in refining, petrochemical production, transportation and storage of crude oil is currently not allowed. The government intends to lift these restrictions, whereby the government will maintain full ownership of natural resources. In practice this will mean profit and risk-sharing contracts between PEMEX - the state-owned oil company – and private businesses will become allowed. This will be a substantial improvement, as Mexico needs both foreign capital and know-how to boost oil production. For a modification of the constitution, Peña Nieto needs a two third majority in both Congress and Senate, and the support of a majority of the states. In practice, this means that the PRI needs the support of the PAN, an opposition party, which is in favor of the reform. However, the PAN demands political reforms in exchange for its support first (see below). The constitutional modification regarding the energy sector is expected at the end of the year. Secondary legislation, which will be easier to adopt as its only needs a majority in both houses, is expected to pass during 2014. How these laws will be shaped is however unknown, and the devil will be in the details.
2. Political reform a precondition for energy reform
The reason behind the demands of the PAN for electoral reform are twofold; first, the political framework was designed under leadership of the PRI in the previous century, which still results in some favorable characteristics for the PRI. The PAN has not been able to modify the political framework under its own ruling, as the PRI blocked these reforms while it was in the opposition. Second, there has been a PRI corruption scandal during the local elections, making the reform more evident. The PRI is expected to partly grant the wishes of the PAN, which are also supported by the other main opposition party, the PRD, as this increases the chance of success regarding the energy reform. The political reform includes: a new national electoral institute and code, and a stricter oversight of political parties’ finances. This part of the reform has the aim to lower corruption. Both opposition parties have also opted for the possibility of the reelection of senators, local and federal legislators, and mayors, although both parties slightly deviate on the maximum number of consecutive terms. This proposal is likely to be adopted, and will result in less grip of the parties’ elite on legislators, and give legislators more control over their political career. As legislators cannot be reelected currently, they have an incentive to care more about their future job, than about good governance in their present term. The will of the PAN to introduce the possibility of secondary rounds in the presidential elections and a threshold for parties for national elections, are less likely to be adopted. Other reforms with are still part of debate are the fiscal reform, social security reform, competition and telecom reform, security initiatives and financial reform.
3. Economic performance weakens
Compared to the previous quarter, Mexico’s economy shrunk by 0.7% in Q2 2013 (qoq, seasonally adjusted, figure 1). The figure was disappointing as well as unexpected, and shows Mexico’s weak economic momentum. The economic contraction was the result of stagnating export growth and lower government spending. As a result of the contraction, the government lowered its growth forecast for 2013 from 3.1% to 1.8%. The IMF even expects growth to be 1.2% in 2013. The IMF projection is plausible since the recent floods and the temporary shutdown of the US government are not incorporated in the government’s projection. From 2014 and onwards growth is expected to pick up, as among others, Peña Nieto intends to introduce a USD 300bn worth infrastructure investment plan in 2013-2018, whereby the government will contribute one third and the private sector will add the remaining part. The money will be spent on the development of roads, ports, telecommunications, water and energy projects. If the money is spent wisely and efficiently these investments will improve the structure of the economy and may consequently support Mexico’s long term growth potential.
4. Limited effects of US tapering on Mexico
The announcement by the US fed that it may reduce its asset purchasing program, has led to depreciating currencies and rising yields on government bonds in emerging markets. Mexico seems to be one of the least affected countries, since compared to other countries, its current account deficit is relatively small and government finances are in a good shape. That the effects of US tapering are currently limited is shown in figure 2. While the peso has depreciated somewhat since May, it has remained constant in recent months. The same holds for the yield on government bonds.
Mexico has a long history of both debt and financial crises. The last crisis, which took place in 1994/95, triggered a political landslide. The Institutional Revolutionary Party (PRI), which had run Mexico for almost the entire 20th century, lost its absolute majority in the lower house in 1997. Since 2000, Mexico twice elected presidents from the National Action Party (PAN), a business-friendly and conservative party. The PAN did however not succeed in implementing the necessary (economic) reforms. The PRI through Peña Nieto regained the presidency, with the opportunity to reform the country, especially since PAN takes a pragmatic approach to being in the opposition. Another heritage of the crises is that Mexicans are cautious about entering into debt. Mexico’s political relation with the US is currently rather good, especially since both economies have become more and more integrated. Political themes are migration, security, energy, drugs and the environment, and do sometimes lead to small disputes. The strong economic ties are reflected by the trade agreement (NAFTA) and the fact that the US is Mexico’s main export partner. Mexico’s cheap labor is used to produce manufactured goods, which are then exported to the US. This type of business is typical for the northern part of the country, where the business climate is more developed than in other parts of the country, save the Yucatán peninsula. However, the north is also the battleground for the country’s war of drugs, which is hampering primarily socio-political, but also economic progress.