The State of Mexico

AFP via Getty Images

AFP via Getty Images

Uncertainty looms with regards to the state of Mexico and its economy. President Andrés Manuel López Obrador, or AMLO, as he is known, has made it his top priority to combat corruption and address the nation’s severe social inequality.

As noble as these initiatives may sound, they are worrisome to investors, especially in light of AMLO’s cancellation of a $13bn airport project in Mexico City and his promises to divert more government resources towards social programs aimed at alleviating poverty, including pension increases. The former erodes investor confidence as it demonstrates the government’s willingness to renege on existing contracts, and the latter makes investors wonder whether these diverted resources couldn’t be put to more productive uses. Ratings agencies share similar sentiments, having downgraded not only Mexico’s sovereign debt to negative from stable, but also that of Pemex, whose revenues fund a fifth of the national budget and whose $104b-worth of loans makes it the world’s most indebted oil company.

What the investment community is looking for is infrastructure spending, oil exploration joint ventures (to offset Pemex’s lack of expertise in deep water exploration and fracking) and tax reform to expand Mexico’s narrow revenue base. Investment in infrastructure stands at 20.5% of GDP, which is below its goal of 24%. The Peña-Nieto administration famously reversed Pemex’s course of 100% state-ownership by implementing energy reforms that opened up the country’s hydrocarbon resources to foreign investment. AMLO has put a hold on future joint venture and risk-sharing projects to wait and see whether existing ones will bear any fruit. After the recent announcement that Mexico has entered into a technical recession following economic contraction during in the first two quarters of 2019, Mexico should do whatever it can to spur economic growth, and this includes making amends with the investment community and collaborating with it to take on new infrastructure projects. Otherwise, the highly-optimistic 2% growth projection for 2020 will likely not materialize.

A recently unveiled plan to embark on 147 projects over the course of his remaining five years in office- including the construction of an $8bn oil refinery in AMLO’s home state of Tabasco, as well as new roads, railways, ports, airports, and water and tourism projects- is a good start. The first phase of the plan consists of private-sector commitments totaling 859b pesos ($44.3b US) and is a positive sign of collaboration between the private sector and the AMLO government.

Another obstacle to foreign investment is growing security concerns, almost entirely attributable to drug cartel violence that refuses to go away. So far AMLO’s plan of “love and hugs” has not worked, but neither has the policy of the “war on drugs” taken on in earnest by former president Felipe Calderón, and no viable solution seems to be in sight- another problem AMLO needs to address.

Mexico’s central bank recently lowered its benchmark rate by 25 basis points to 7.50 per cent, after making similar cuts in September and August, citing stagnant economic activity in the country, slowing global growth, and a relatively stable inflation rate of 3.02 per cent. In its statement it said Mexico needs to “improve the rule of law, abate corruption and combat insecurity.”

Despite the challenges and global economic headwinds that Mexico faces, some investors remain optimistic, citing Mexico’s current fiscal conservatism and ability to refinance its debt obligations in today’s favorable low-rate borrowing conditions. Another positive sign- the iShares MSCI Mexico ETF (EWW) is up 7% since AMLO took office in December 2018, an indicator of shareholder confidence overall in Mexican-domiciled enterprises. Additionally, the completion of the USMCA deal will prove to be a boon to all countries involved. The passing of the deal will unlock investment that has thus far been put on hold due to uncertainty surrounding the agreement.

Lastly, AMLO does have a strong track record on his side, having served mayor of Mexico City, where he helped reduce crime, worked with the private sector to construct new housing through the provision of tax breaks, and expanded social assistance programs to the city’s most vulnerable groups, including single mothers and the elderly. Results take time, and time will tell whether AMLO is able to implement the same kind of positive growth he accomplished in el D.F. on a national scale.

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