Country Report Mexico
Mexico’s economic growth starts to pick up and its economic outlook is also improving, as all intended structural reforms are approved. The most important one –energy- is likely to contribute the most.
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.
1. Economic growth starts to pick up
Mexico’s economy seems to gain momentum, as the Q2 economic growth figure showed an increase (1.0%, qoq), after quarters of low growth. Even more encouraging was that almost all sectors contributed positively, except for mining. Most eye catching was the 1.7% qoq expansion of the construction sector, after six quarters of negative growth. Mexico’s economic outlook is also quite positive, as monthly data points to a further acceleration for the rest of this year. Among others, the Mexican economy is expected to benefit from a rise in external demand from the US. Mexican manufacturing exports have shown solid growth rates and Mexican car industry figures are also strong. In the years thereafter Mexico is expected to bear fruit from the reforms it has been implementing in the last two years.
The energy reform is expected to contribute the most, as it will boost economic growth by an estimated 1%-point per year in the medium term. On 11 August, President Peña Nieto signed into law secondary legislation, which will open the energy sector up to foreign investment. This has made the reform almost final. Left-wing parties are still trying to stop the reform and have collected the signatures of 2% of the voters, which is the required threshold to request a national referendum on the matter. However, the chance that this will indeed lead to a cancellation of the energy reform is small. First, the Supreme Court is likely to qualify a referendum as unconstitutional, as according to the constitution no referendum can be held on matters than relate to government revenue. This while energy accounts for around one third of the federal budget income. Second, current polls indicate that ‘only’ 40% of the people does not support the energy reform.
That said, the government still continues with the preparations for the first bid round, which is likely to take place in the first quarter of 2015. On 13 August, government officials announced which areas will be offered in a first bid round. Mexico’s state-owned energy company, Pemex, will maintain 83% of the country’s proven and probably oil reserves and 21% of the prospective reserves. But, Pemex will look for private partnerships in 10 projects, as it lacks the technical and financial resources to further explore these fields. In addition, 109 blocks for exploration and 60 for extraction will be offered to local and foreign companies in the first bid round. The terms for these blocks will be released between November 2014 and January next year. Since these projects and blocks show a great variety in terms of complexity and maturity it seems likely that there will be enough appetite by foreign investors. Energy Minister Pedro Joaquin Coldwell expects that USD 50 billion will be invested Mexico’s oil fields between 2015 and 2018.
2. Budget for 2015
On 16 October, the Revenue Law for next year was approved by the Lower House. The underlying assumptions of the proposal seemed quite realistic at the time the Revenue Law was approved by the Lower House; an average price for crude oil of USD 81 per barrel, while Brent oil was traded at USD 85 per barrel. In addition, the Ministry of Finance always hedges the oil price, although the details of these hedge are not made public. Moreover, the assumption for economic growth (3.7%) was in line with market consensus of 3.8%. However, on 28 October the Ministry lowered the projected oil price from USD 81 to USD 79 and therefore the Revenue Law has to be reassessed. All in all the government is expected to run a deficit next year of 1.0%, excluding investments in Pemex. Finally, the Lower House also approved an amendment to the definition of the budget balance, namely that next to investments in Pemex investments in large infrastructural projects will be excluded. These investments represent 2.5% of GDP, which brings the overall deficit to 3.5% of GDP.
3. Regional violence remains are problem
Recently, considerable demonstrations broke out in Guerrero, as 6 students were found dead and 42 disappeared. Protestors are especially angry as they believe that the government is not doing enough to find the missing students. In addition, there are indications that the local mayor and police forces cooperated with a drug-cartel. Although figures indicate that on a national level homicides, extortions and kidnapping decreased in the first half of 2014, there are large regional differences. One of Mexico’s problems is the declining quality of the institutions, as they become more local. To solve the problems in Guerrero and to find the missing people President Pena Nieto has send federal police forces to the region. Regional violence may also become an item mid-term elections next year. Pena Nieto is already keen in blaming local opposition mayors and governors for increasing violence in some regions. That said, the PRI is likely to remain the strongest party after the 2015 mid-term elections.
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.