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Country Report Mexico

Country Report

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Economic growth in 14Q1 was slightly disappointing, but Mexico’s economic outlook is improving considerably, as almost all intended structural reforms are approved. The most important one –energy- is likely to be approved soon.

Strengths (+) 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 relatively low labor costs results in a good competitive position, augmented by rising labor and transportation costs in China.

(-) 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 the oil production has been 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. 

Key developments

1. Almost all reforms approved, energy forthcoming

In the last six months, the government has taken multiple steps in approving and implementing much-needed structural reforms. The two reforms that are most important, in terms of boosting long term growth – energy and telecom –are expected to be approved in the upcoming weeks. The process of adopting and implementing the reforms has continued despite the fact the left-wing party (PRD) left the Pact for Mexico (an agreement on the reforms between Mexico’s three main political parties). On 15 May 2014, the Senate approved secondary legislation on political reform. The reforms include new and higher limits on private campaign contributions, conditions for independent candidacies, and the responsibilities/powers of the new National Electoral Institute. The approval is good news for the government, as it was one of the conditions of the government-supporting PAN, before it would approve secondary legislation on energy reforms. Another main hurdle was taken at the end of last year, as Congress, Senate and a majority of the states approved a change of the constitution. A modification of the constitution was needed, as since 1938, the constitution prohibited private participation in the exploration and extraction of hydrocarbons. In addition, natural resources were fully owned by the state, while private involvement in refining, petrochemical production, transportation and storage of crude oil was not allowed. The proposals for secondary legislation, which were presented on 30 April and are likely to be approved in the coming weeks, are mainly in line with the proposals as presented in the constitutional reform. This implies that private companies will be permitted to participate in the extraction and refinement of oil. Although the proposals are promising, it is still unclear how the new legislation will play out exactly, as the government will get a large say in the conditions of the contracts. Although the government has an interest to offer private businesses an attractive proposal to boost investment, if the conditions set by the government will be too rigid the sector may be less open then desirable. Potentially the energy reform could have the same importance as NAFTA in 1994, as it is expected to boost economic growth by 0.5 to 1.0%-points GDP per year. It will take 3 to 4 years before these gains will fully materialize. Next to the energy and telecom reform, the labor, fiscal and financial reform are also likely to have a positive impact on Mexico’s potential economic growth. All in all, the reforms are expected to shift potential growth from the 2-3% to the 3-4% range.  

2. Economic performance weakens

In the first quarter of 2014, Mexico’s economy grew by 1.8% compared to the same period a year ago. In seasonally adjusted terms, the economy expanded by 0.3% compared to the previous quarter. The 1.8% was slightly below the consensus forecast of 2.1%, but considerable better than 0.7% in the fourth quarter of 2013. A seasonally adjusted contribution per sector is not yet available, but yearly data shows that the construction sector still forms a drag on the economy (figure 1). This can be partly explained by the government’s decision last year to redirect its subsidized housing program from single-family homes in remote areas towards the construction of apartment buildings in city centers. Some main construction companies, who invested heavily in land positions and houses in these remote areas, were confronted by significant write-offs. Currently, the central bank of Mexico expects the economy to grow by 2.3% to 3.3% this year and by 3.2% to 4.2% next year. The projection that the economy will accelerate next years, and probably also in the years thereafter, relates to 1) the reforms the government is currently approving and implementing, 2) the government’s announcement of a private –public investment program worth USD 590bn for over the next five years, 3) an improved outlook for Mexican households, which may lead to higher private consumption, and 4) the Mexican economy benefitting from the improved outlook of the US economy, as the US is Mexico’s main trading partner.

Figure 1: Economic performance per sector
Figure 1: Economic performance per sectorSource: Inegi
Figure 2: Effects of US tapering
Figure 2: Effects of US taperingSource: Central Bank of Mexico

3. Upgrades from all three main rating agencies

In the last one and a half years, all three main rating agencies upgraded Mexico’s credit rating (Fitch BBB+ s, S&P BBB+ s, Moody’s A3 s). All three rating agencies argued that Mexico’s fundamentals had improved and that the reform momentum was larger than earlier anticipated. The upgrades endorse the positive momentum of the economy. This is also reflected by a stable peso and an inflow of both FDI and portfolio investment (figure 2).

Factsheet of Mexico
Factsheet of MexicoSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

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 however did not succeed in implementing the necessary (economic) reforms. The PRI through Peña Nieto regained the presidency in 2012, 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. 

Economic indicators of Mexico
Economic indicators of MexicoSource: EIU
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Author(s)
Maarten van der Molen
Rabobank KEO
+31 30 21 62666

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