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Mexico City: a boom town since entering Nafta after the peso crisis |
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Alberto Gomez gazes from his glass-walled office at the manicured lawns of Mexico City’s new financial district, Santa Fe. “It could be Houston, Texas, couldn’t it,” muses the chief economist at Banamex, Mexico’s second-largest bank.
Against the mountain backdrop, elegant new skyscrapers glint in the sun. Gomez is beaming. He has just helped clinch Citigroup’s $12.5 billion takeover of Banamex-Accival, or Banacci, as it’s known. Concluded in May, this was the biggest corporate deal in Mexican history and the largest financial services acquisition in an emerging market.
The Santa Fe district was once a sprawling waste tip picked over for anything saleable by the poor. It’s transformation is tangible evidence of the strides that the Mexican banking system and the economy as a whole have made after decades of financial crisis, including the catastrophic peso crisis in 1994.
Still, an array of glittering downtown architecture does not on its own spell continued stability and prosperity. Though Mexico has boomed since entering the North American Free Trade Area in the year following the currency crisis, some fear economic storm clouds are brewing.
President Vicente Fox, who ended 71 years of one-party rule on coming to power last December and does not have to follow the dictates of the IMF, was voted in on a platform of change. He has promised that his National Action Party (PAN) will deepen the country’s relationship with the US, overhaul one of the shakiest tax systems in Latin America, promote private investment in the state-run energy sector, pump investment into education and reduce the gulf between the rich and the poor.
The former Coca-Cola executive, who is out to promote a pro-business environment, has also pledged to reach an annual growth target of 7% halfway through his administration, generating 1.3 million new jobs a year.
Despite red-hot economic growth of 6.9% in 2000, Fox’s cherished relationship with the US has not been reaping bounteous rewards. Mexico, which sends almost 90% of its exports to its rich northern neighbour, has been hit hard by the downturn there as the dot coms fail and the long boom ends.
Growth starts to slow
With the US slowdown now biting and Argentina’s woes shaking emerging markets, Mexico’s official growth projections for the current year have been pared back to a mere 2%. Doomsayers who foresee a return to
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the savage boom and bust of the past two decades are in a minority. But the formula for prosperity has evaporated for the moment at least – second quarter GDP was flat this year, ending a 21-quarter run of growth and in June industrial activity declined by 3.9%. Significantly, after more than a decade of double-digit growth, the maquiladora industry, the assembly-for-export sector that is hugely dependent on the US, began to stutter.
Mexicans can take heart that this slowdown is not linked to a financial crisis at home or any grave mistakes on the part of their government. And it comes at a time of record-low inflation and a strong currency.
Mexico exported goods worth $160 billion in 2000, up from $52 billion in 1993. Back in 1984, 90% of export revenues came from oil. Today oil accounts for a mere 10% of export revenues. But this spells dependence on sales to the US – both a blessing and a curse.
“It is hard to resist the temptation of tying yourself to the US when you are living next door to the world’s largest economy,” says Manuel Sanchez, chief economist at BBVA-Bancomer, Mexico’s largest financial group. “The benefits are there but they won’t last
for ever. Mexico will have to look for other trading partners eventually,” Sanchez says.
His is pretty much a lone sceptical voice. The president’s cabinet is in no doubt about links with the US. Trade delegations from countries as diverse as South Africa to the UK have come and gone this year. The customary red carpet has been laid out, but few concrete deals have been made. Fox and his foreign minister, Jorge Castañeda, in particular, continue to press the US to play a bigger role in Mexico’s development.
They argue that Mexico’s decision to strengthen its ties with the US is protecting it from Argentina’s woes and the shake-up in emerging markets. They have a point. When fears of an Argentine debt default reached a peak in early July, Mexican market reaction was modest. Country risk, as measured in sovereign bond spreads, climbed only marginally from 346 points at the start of the month to 362 points above US treasury paper in mid-July. The impact on the real economy has been non-existent.
US can’t be ignored
Many others support stronger US-Mexican integration. “Fox may not be an economist but he has a good economic team and he knows the US is a market that is too big and too dynamic not to tap into,” says Gomez of Banamex. “This slowdown is affecting Mexico, but it is affecting much of the world as well. It will pass and Mexico will reap the rewards in the upturn of the cycle.”
The warm relationship between president Fox and US president George W Bush has been cited as an integral part of the new US-Mexican relationship. Bush, who made his first presidential trip abroad to Mexico rather than Canada as is traditionally the case, is well known for his Texan background. A former governor of the state across the Rio Grande, Bush has turned his attention to the region in a way few previous occupants of the White House have.
Through his cordial dealings with Bush, Fox hopes to extend the scope of Nafta to include the free flow of labour. He is also pressing for an amnesty for some 3 million illegal Mexican migrants in the US as part of a wider immigration agreement that would include a guest-worker programme. Fox has told the US that it ought to treat Mexican immigrants not as a social problem but as an economic opportunity.
But throwing open the border into the affluent US for tens of millions of Mexicans would engender fierce resistance. Some 40 million of Mexico’s 100 million population live on less than $3 a day. And in early August the US senate voted overwhelmingly, after bitter debate, to slap tough safety inspection requirements on Mexican trucks wishing to use US highways. Bush may be forced to veto the measure which, his administration says, would violate US Nafta obligations.
Politically significant is the fact that Nafta is creating winners and losers in Mexico. Although it has transformed the US-Mexican border region – US-orientated maquiladoras today employ 1 million workers – Mexican farmers in particular complain that Nafta has not helped them to increase exports or market share in the US.
Grain, oilseed and livestock producers feel Nafta has done them great harm. From 1992 to 1999 grain production on average increased a mere 1.5%. Beef and pig production expanded by just 2.2% a year and oilseed declined by 4.8% a year. Since Nafta, grain imports have more than doubled, growing at an annual rate of 14%. In the same period, oilseed imports increased 10% per year and beef and port imports grew 15% per year.
On specifics there are intra-government tensions too. The World Trade Organization recently sided with the US on sugar, ruling that Mexican anti-dumping duties on US imports of high-fructose corn syrup – a cheap sugar substitute – violated international trade law. Mexico is to appeal. And the early success of Nafta has disguised structural flaws. “The image of success and recent Mexican economic growth covers a multitude of weaknesses in the economy’s structure,” says Raul Feliz, professor of economics at CIDE, the center for economic research in Mexico City. “Last year’s phenomenal growth was a one-off thanks to the astonishing growth of the US. That won’t be repeated so easily again.”
Oil dependency
Feliz predicts growth of 0.25% for the next three quarters and expansion of 4% when the US picks up, as expected, next year. “Productivity is around an average of 1% for all sectors, while agriculture and the informal sector are registering negative productivity,” Feliz explains. “Many things need to change if poverty is really to be alleviated.”
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One of the weaknesses is Mexico’s fiscal make-up. The government relies on Pemex, Mexico’s oil monopoly, for a third of revenues. Whereas federal tax revenues account for only 11.3% of GDP, compared with 20% in the US, public finances are alarmingly exposed to downturns in oil exports.
As a result, the finance ministry was forced to announce that it would trim spending by $740 million, the second consecutive budget cut this year. The ministry said budget revenues for the first half of the year came in at Ps10.2 billion ($1.1 billion) below target. In May the government announced $367 million in cuts in an effort to meet this year’s fiscal deficit target of 0.65% of GDP. In a bid to tackle the problem of collecting state revenues, reforms aim to bring up tax revenues by a quarter to between 14% and 15% of GDP.
“A fiscal reform is crucially important because Mexico’s public accounts are far more unbalanced than they appear,” says Manuel Suarez Mier, an economist formerly with the Mexican central bank and now with CIDAC, a Mexico City think-tank. “The outgoing government was proud of its fiscal situation. Official figures showed a total debt ratio to GDP of 30%, which is excellent – half of that of the US. But the true figure, the unofficially-recognized debt, is 130%, four times higher than the official figure,” Suarez Mier insists.
He explains that the debt is inflated from the $80 billion bail-out of the country’s bankrupt banks in 1994 following the peso devaluation. That’s no less than 20% of GDP. Furthermore government liabilities from state-funded pensions stand at 70% of GDP. The rest is made up of liabilities of government-owned development banks and the like.
Francisco Gil Diaz, Mexico’s finance minister, has unveiled a blueprint of his tax reform proposals, which are aimed at boosting the paltry fiscal revenues by four percentage points of GDP, or about $25 billion. Diaz insists that he would also use a large part of the revenues gained from reform to bring down debt and to eliminate the deficit.
The reform package is threefold. Its most controversial aspect is to unify value-added tax at 15%, sweeping away exemptions on most food and medicines. In an attempt to reduce tax evasion, the reforms also aspire to cut income tax for companies and individuals to a top rate of 32%, eradicating exemptions for special interest groups such as transport companies, and to simplify the tax structure.
“It is very simple for people with enough resources to siphon off the high rates of personal income tax into a corporate income tax, which is lower,” Suarez Mier comments. Another 40% of revenues could be collected with a clampdown on tax evasion, according to government projections.
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The fiscal package aims to reduce the amount spent in bureaucracy and to allow the government to go on functioning in the case of non-approval of the budget by Congress.
Lastly, the reforms plan to simplify and improve the supervision of the financial system. These reforms include reducing the excessive protection provided to companies by bankruptcy laws. At the moment, once a corporation declares bankruptcy and the liquidation of assets there are legal tricks and loop-holes that allow companies to go on doing business for up five years in some cases, with creditors frequently denied their money.
But the government is facing an uphill struggle. Despite the best efforts of his economic team, the president appears to be losing the political battle on VAT. The reform process has already dragged on since March and there is less and less prospect that a bill will be passed in the next period of Congress. Further delays could compromise the approval of the 2002 budget.
Power problems
Inevitably, for a president who admits to a need for popular support, his plans to levy tax on food and medicines have met with a hostile reaction. Protests at VAT rises have raged throughout the country, prompting Mexico’s former ruling party, the Institutional Revolutionary Party (PRI) to side with the poor and use its majority in Congress to make things difficult for Fox.
“There is a great danger that the reforms will be diluted to get them past Congress, thereby losing their meaning,” says Sanchez of BBVA-Bancomer. Others warn that Fox must negotiate more deftly behind the scenes with the PRI to get his reforms through Congress.
Fox’s other big challenges include reforming the state-owned energy sector and the labour laws. Power cuts are common in Mexico City. Energy analysts estimate that there will not be enough electricity to sustain economic growth of 5% a year. The principally gas-fuelled electricity sector needs to double its capacity by 2008.
The state has a near-monopoly on generating and distributing power. Pemex, the world’s fifth-largest petroleum company, controls some of the world’s richest hydrocarbon deposits. But natural gas is often flared off because Mexico lacks the infrastructure and expertise to process it. Estimates say the sector needs $4 billion to $5 billion a year over the next decade to meet growing energy demands.
Raul Muñoz Leos, head of Pemex, puts the figure at $9 billion a year because of government neglect in the past 20 years. At 2001 prices, investment for exploration and production of hydrocarbons fell from $13 billion in 1981 to $5 billion in 2000, provoking a crisis in oil and gas reserves.
Under current laws, Pemex owns all underground hydrocarbons, making exploitation of natural gas by foreign companies problematic. The reform would loosen up the rules so that domestic and foreign companies are encouraged to generate and sell electricity. Negotiations are expected to begin in March. But there are stumbling blocks.
Business leaders want change and applauded Fox’s decision in June to woo heads of Canada’s leading energy firms. The guest list included Westcoast Energy, TransAlta, Petro-Canada and Canadian Hunter Exploration. And the Canadians are not the only suitors. The French and British are enthusiastic and have sent missions to the energy ministry. Energy minister Ernesto Martens has also visited Finland and Spain.
Yet, as with fiscal reform, Fox appears to be stumbling in Congress on energy deregulation. “The PRI and even members of Fox’s National Action Party (PAN) think in a very nationalistic way. They think the government should be in charge of energy generation and Fox is finding it very hard to change that mentality,” says Raymundo Winkler, director general of Mexico’s federation for the private sector, the business council CCE.
Fox is not making life easy for himself either. “The president has pledged energy reform but has promised to see to it personally that not a single member of the national electricity trade union loses their job. That sort of promise goes against the grain of reform. You cannot keep everyone happy,” says one Mexico City political analyst.
Labour inflexibility
So far, the Fox team has appeared reluctant to tackle another vexed issue: the country’s inflexible labour laws. Consultation is underway, but an initiative will only be ready to go to Congress in March next year. Critics of the current legal regime, passed in 1930 and last modified in 1970, say it is a huge obstacle to creating a more dynamic economy. The laws were designed for a closed economy and shedding labour is prohibitively expensive. In some cases, companies go bankrupt because they cannot fire people – and it is almost impossible to sack public servants.
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President Vicente Fox |
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Probably the most intractable issue is agriculture. Fox’s pro-business cabinet has shown its scant experience of the nitty-gritty of politics through a failure to reach out to farmers since coming to power. Pledges to transform the backward sector into a businesslike enterprise have clashed sharply with the interests of subsistence farmers, in particular.
A quarter of the population is active in farming, but the sector produces a mere 5.3% of GDP. And destitute farmers are facing one of the country’s worst agricultural crises in decades. With low international commodity prices, rudimentary infrastructure, no credit and shrinking government subsidies, farmers have seen incomes slashed by as much as half in a decade. Any steps that worsen their position further will spark a fierce storm of protest.
The future of the Mexican economy must lie in an educated workforce. Chinese entry into the World Trade Organization will put pressure on Mexico’s low-skills industries as the two countries both rely on cheap labour and compete head-on in many export sectors. A better-educated workforce would allow the country to move away from light manufacturing and agricultural commodities – textile production, autoparts, sugar and coffee – to electronics and higher value-added services, such as aerospace and hi-tech industries.
Such a leap should be feasible. “What you see now is a contradiction in the Mexican economy,” says Gomez of Banamex. “On the one side you see a very strong deceleration of economic activity, even higher than that of the US. But on the other side you see the financial variables telling you that the economic outlook for Mexico is very, very positive. There are good macroeconomic fundamentals and good opportunities.”
That confidence is apparently shared. In July the government decided to issue 10-year fixed-rate bonds for the first time. And in August, Mexico defied adverse emerging market conditions and worries about Argentina by issuing a $1 billion 30-year bond. In many people’s eyes the issue, Mexico’s first 30-year bond since 1996, confirmed investors’ readiness to discriminate between the prospects of individual Latin American countries.
Issuing a fixed-rate bond would have been unthinkable just a few years ago, of course, when the government could only go for a maturity of three to five months. And more recently, the government has been issuing three- and five-year fixed-rate bonds. The finance ministry said Ps500 million ($55 million) of the new bonds would be issued every eight weeks from July 24. The aim is to extend the average maturity of Mexico’s domestic public debt, thereby lowering the government’s refinancing risk.
Furthermore, taking advantage of declining inflation expectations and investors’ upbeat views of Mexico’s prospects, the government has been buying back Brady bonds, and is in a position to issue longer-term, less expensive bonds. Brady bonds make up about 50% of Mexico’s debt, compared with 100% in 1995.
According to Benito Berber, analyst for consultancy IDEAglobal, the financial stability and the latest bond issues are evidence of trust in the Fox administration. “The way president Fox and his team are managing fiscal policy is giving Mexico credibility. They are not falling into the Mexican trap of the past of spending money they don’t have,” Berber says.
Clearly, the central bank’s tight monetary policy is crucial. Interest rates are at 10%, down from 17% at the start of the year and well below the high of 47% in September 1998. This sharp decrease in real interest rates is expected to revive bank lending after six years of negative growth. Inflation is at a 30-year low of 5.8%, which contrasts with 51% at the end of the peso crisis in 1995. Thus Latin America’s largest economy looks ready to surpass the inflation target of 6.5% set by the central bank for this year. Indeed some economists predict inflation could meet government goals by converging with US levels in 2003.
Banking on foreigners
Banking, which was reprivatized in 1991-92, is unrecognizable from how it was. Citigroup’s expansion in Mexico is the first time a US bank has snapped up one of Mexico’s premier institutions. But other foreigners have been busy. There has been a five-year buying spree by BBVA and BSCH and by Scotiabank.
If, as expected, Scotiabank launches a takeover of Banorte, another leading Mexican bank, there will be only five major players – four of them foreign-owned. Only a year ago foreign banks held less than 20% of the Mexican banking system. Now they account for 80% of assets.
Foreign banks bring with them innovation. Banco Santander Mexicano, a unit of BSCH, recently launched a short-term mutual fund open to all. Until now, mutual funds have been open only to institutional investors and wealthy Mexicans with Ps1 million ($109,000) or more to invest. Mexico’s two other leading financial groups, BBVA-Bancomer, a unit of BBVA, and Banacci, may follow Santander’s lead, signalling a desire to tap further into the growing savings market.
An indicator of Mexico’s new-found macroeconomic resilience is the investment rate, which is up more than three percentage points on the 1994 figure. Domestic savings finance 88% of that investment, a sharp increase. And foreign direct investment is also pouring in. The figure is expected to reach $20 billion this year, up from $13 billion in 2000. Mexico is seen as a safe haven in a region preoccupied by Brazil and Argentina.
The peso is the most visible indication of Mexico’s new macroeconomic robustness. It has strengthened 5.9% against the US dollar so far this year, making it the world’s strongest appreciating currency. It was the world’s third-strongest currency last year.
According to Hector Chavez, economist at Banco Santander in Mexico City, the realization that the economy is less vulnerable to external shocks and better supported by domestic policy than in 1994 has done wonders for Mexico’s currency. The smooth transition to the Fox government has helped too.
“Both the 1982 and the 1994 crisis followed a change of administration. But when US investors and Mexicans abroad did not see a repeat of a catastrophe when Fox took office, given that interest rates were low in the US and high in Mexico, the dollars started flooding in,” Chavez says.
The success of the handover was largely thanks to the previous administration’s decision to reschedule external debt maturities from 1996 onwards and to increase international reserves, strengthening the balance of payments. International reserves stood at $6.1 billion in 1994. Today they are more than six times that figure.
The peso’s strength has been helped by stability in the trade deficit. Despite a fall in exports, the contraction of consumer demand has meant that the trade deficit has not widened. The trade deficit for the first five months of this year was $4.5 billion, pretty much unchanged from a year earlier. The current account deficit has also been smaller than expected, giving the pesos an added lift.
All this good news has been reflected in the Mexican stock market. It was the world’s best-performing in the first half of this year and many expect the success to hold up. The main IPC index was up 25.5% at the end of June at 6666 points. Deutsche Bank strategists in New York say the Mexican stock market is their favourite in the region.
Mexico’s popular president is said to want to change everything. The economic fundamentals for such a transformation look sound, even if the focus on ties with the US is looking more of a gamble in the short term. The uncertainties will, however, test to the full the ability of the salesman-turned-politician to drive through overdue reforms.
