We analyse the key policy choices of Peña Nieto’s Economic Policy Team since assuming office and focus on recent events. We included—despite its autonomy—the central bank. While external shocks complicate any sterilized judgment, we considered the performance of other Latin American countries as reference. Five categories were pondered. The overall result: so far, the administration has disappointed our expectations.
(1) GDP growth. Mexico’s 2.5% GDP expansion in 2015 came below market expectations but above the 1.4% and 2.1% expansion rates for 2013 and 2014, respectively. Is this 2.5% growth rate for 2015 mediocre for an emerging market like Mexico? Yes. Is it bad under current global economic conditions? Not much. Among its regional peers (Argentina, Brazil, Chile, Colombia, and Peru), only Peru (3.3%) was able to grow above 3% last year. Brazil’s 3.8% contraction was a terrible performance affecting all of South America via trade and contagion risk.
All of these economies, including Mexico, have being affected by massive FX depreciation, less demand for exports, and a plunge in commodity prices. Mexico is the least dependent on these goods, and the economy is more tied to the U.S. manufacturing cycle. However, the government has been unable to boost the economy above an annual 3% rate in any of the last three years, and this is worrisome. Budgetary cuts worth P$132.3 billion, low oil prices, and the government’s commitment to reduce the fiscal deficit by about 50 bps per year to 2.5% will keep pressuring public investment. These are positive actions for macroeconomic stability, but GDP growth will continue to underperform for one or two years, at least. That is plenty of time.
Our score: 6/10. Creativity has been absent throughout the administration. Reforms were bold, but have not delivered the expected (and much promised) results.
(2) Inflation and monetary policy. Despite the massive depreciation of the MXN against the USD (28.4% since 2013), annual inflation (2.9% through mid-February) and the key interest rate—recently lifted by 50bps to 3.75%—are slightly above all-time lows. Before the recent uptick, consumer prices had been declining in 2015 to a rate as low as 2.13% year-on-year. This was a major achievement for the central bank, which has a 3% ±1% target, which failed to meet in 2014. The consumer-price index (INPC) ended 2014 at 4.08%, compared with 3.97% in 2013. In 2015, the absence of demand-driven price pressures, lower telecom tariffs and persistently low crude oil prices contributed to inflation dynamics throughout 2015. Conversely, inflation spiked in all of Mexico’s regional peers.
However, harder comps and fiscal vulnerability make it unlikely that the official tariffs will keep declining. Consumption dynamics are picking up, but will hardly bring significant demand-side pressure. And while the peso’s depreciation has had limited pass-through, a prolonged weak currency will affect inflation at some point. With these forces in play and in coordination with fiscal authorities, the Bank of Mexico tightened the reference rate to 3.75% in February, a 50bps increase—a bold move that had a quick effect on the peso, which appreciated as much as 4.5% in that day’s trading session. Still, the move seemed long overdue. A hike before the Fed’s move would have been optimal and could have prevented unnecessary auctions of foreign reserves.
Our score: 8/10. Inflation was surprisingly low in 2015, but BANXICO followed the Fed for a long while.
(3) Debt, spending and revenue. The country renewed, for one more year, the Flexible Credit Line (FCL) from the IMF, worth $70 billion. Mexico, Colombia, and Poland are the only countries that enjoy this benefit. The current account deficit is financeable (2.9% of GDP). External debt accounts for only 25% of the public debt. Gross debt accounts for 46% of the GDP, while the 2016 debt maturities account for only 8.0% of the GDP. Non-resident investors in the local currency bond market remain resilient, at P$2.14 trillion up to February 3 (+0.5% YTD). Current account deficit widened in 2015 to $32.38 billion from $24.85 billion the previous year, the central bank said on Thursday. The accumulated current account deficit for 2015 was the equivalent of 2.8% of GDP.
Moody’s upgraded government bond ratings to A3 from Baa1 in February 2014. The rating agency said back then that “The decision to upgrade Mexico’s sovereign ratings was driven by the structural reforms approved last year (2013), which Moody’s expects will strengthen the country’s potential growth prospects and fiscal fundamentals.” Moody’s probably did not expect Mexico’s gross debt-to-GDP ratio to deteriorate to 52% from 46% in just two years (IMF). The MXN’s massive depreciation is partially responsible for this, as well as the Peña Nieto’s administration ambitions of expanding public spending after implementing fiscal reform.
Public revenues will remain covered this year through: the oil hedging (at US$49 per barrel), extraordinary resources from Banco de Mexico (P$34.45 billion), and the resources of the Stabilization Funds (P$112 billion). Taxes have indeed increased, but oil revenue—despite hedge production being partially hedged—has been declining. GDP growth at 2.5% in 2015 brought insufficient fiscal revenue improvement to cover increasing debt. It is unlikely that Moody’s will downgrade Mexico’s sovereign credit rating soon, but the increase in public debt and slow economic growth will surely slow down S&P’s or Fitch’s plans of an upgrade, which impedes the country from clinching a full A-status like Chile’s.
Our score: 6/10. The oil hedge worked, but did not start in this administration. Non-oil revenue increased. However, debt-to-GDP ratio deteriorated to 52% from 46% in just two years. The recent spending cut is just a first step; PEMEX is in deep financial trouble; and the primary deficit persists.
(4) International trade. Currently, 67% (US$574 bn) of Mexico’s commerce and 53% (US$228 bn) of Mexico’s FDI is within NAFTA. Commerce with countries included in the TPP other than those in NAFTA (USA and Canada) add an additional 5% (US$40 bn) in commerce and 2% (US$14 bn) in FDI for Mexico. The TPP boosts NAFTA as exporting platform to Pacific Asia. This allows the integration of North America’s supply chain. Mexico could boost exports driven by higher exports USA-Asia made up of Mexican inputs that comply with “origin rule”, which could not be achieved through a bilateral agreement. Mexico gains access to a market of goods of which 90% will have immediate liberalization; 9% with 5- to 10-year period liberalization; and 1% with partial concessions. The TPP will allegedly boost strategical sector’s exports in vehicles & auto-parts, aerospace, medical devices, electric equipment, cosmetics, tequila, mescal, beer, avocado, beef, pork and orange juice.
Mexico basically had no choice but to join the TPP and smile like it meant to from the beginning. This does not mean that the country’s strategic sectors could not benefit in the long term, offsetting negative expected effects on traditional economic activities. But the bottom line here was that if Mexico didn’t sign the agreement, the benefits granted in NAFTA could be at risk; it could also have placed the country in a disadvantageous position to later negotiate trade agreements in the Pacific Rim, which is expected to counterweight China’s expected trade domination.
Our score: 7/10. The TPP and FTA talks with Brazil were the correct moves. However, we subtracted three points on (1) weak response to Trump’s negative campaign against NAFTA; (2) slow progress in lifting trade barriers with new Argentine government; (3) inaction to balance massive deficit with China—via exports promotion, not imports inhibition.
(5) Rule of law and corruption. Violence and corruption scandals affect the economy predominantly via uncertainty: if the rules of the game are not clear and the same for all, investment—in physical and human capital—decreases. The Peña Nieto administration has failed to reduce violence levels. Official data is unreliable, but public perception matters and a lot, and there is no sign of improvement. Moreover, Casa Blanca and OHLMEX cases prove that the federal government has been incapable of transmitting certainty that the correct steps are being taken to improve transparency and the efficient use of public revenues. If the Peña Nieto administration wants to improve in this field, it needs bold actions. Otherwise, most of the bold yet unproven reform agenda is in risk of losing credibility.
Our score: 4/10. Violence remains high. Brazil, Chile and Guatemala have acted following corruption scandals; Mexico lags.
LATAM PM’s Overall Grade: 62/100 (31 x2), or “C-”. The Peña Nieto administration has talked a lot, but done little. The economic team refuses to acknowledge mistakes, and lack of self-awareness makes correcting flaws impossible. Self-criticism is key for the government to deliver the long-promised and long-awaited economic and welfare benefits of structural reforms. Luck may not be on their side, but that is not the only recipe for economic improvement. We expect much more. Mexico needs much more.
Analyst: MPA Mario Campa