| Vicente Fox | ||||||
Mexico ended 2000 on a high note. It was not only the fastest-growing economy in Latin America but posted its best economic performance in 20 years. Now, as it moves into 2001, analysts are divided on how it will fare. What is clear, however, is that regardless of the outcome, something must be done to improve the stock market’s lacklustre showing.
After growing an estimated 7% in 2000, Mexico’s economy is expected to register the sharpest slowdown in the region this year. Reined in by a downturn in the US economy and a drop in oil prices, growth targets have been lowered to 4.5% in 2001. Corporate profits and employment will be affected, say analysts, and the current account deficit is expected to widen from 3.3% to 3.8% of gross domestic product.
Mexico’s growth will still outpace that of its neighbours but the deceleration does not bode well for the stock market. Even during a banner year in 2000, the main IPC index continued to flounder below the psychological floor of 6,000 points. Strategists blame the drab performance on depressed markets worldwide and the uncertainty surrounding Mexico as it enters its first year under the leadership of its new president, Vicente Fox.
In addition to economic challenges, Fox is faced with passing a number of crucial but politically thorny reforms through an opposition-led congress. Investors will be keen to see whether Fox is able to fulfil his promises to improve Mexico’s abysmal tax collection and introduce private investment into the antiquated electricity sector.
“The next few months are going to be problematic for Mexico until the pace of US economic growth is established and the political questions are resolved,” says Jorge Mariscal, strategist for Goldman Sachs in New York.
But even if Mexico makes it through all the hoops, it may not be enough to jump-start the sluggish exchange. Since Mexico’s debilitating peso devaluation in 1994, both investors and companies have been reluctant to return to the market. Between recurring crises and the increasing draw of bigger, less volatile markets, Mexican companies prefer to list abroad while domestic investors number fewer than 120,000. As a result, stocks are worth one-third their 1994 values and the exchange’s market cap is equivalent to 24.4% of Mexico’s GDP, compared with 180% in the US.
The problems created by low liquidity and slim volumes are expected to be exacerbated in 2001 with the restructuring in December of the Morgan Stanley Corporate Index (MSCI). The index, which is used as an investment benchmark by foreign portfolio managers, has been reoriented to give more weight to companies with greater proportions of free float. The move will favour greater investment in Mexico’s regional rival – Brazil, which has an average free float of 60% compared with Mexico’s 45%.
“The Mexican market is faced with serious challenges that go far beyond bearish investors,” says Timothy Heyman, head of Heyman y Asociados, a local brokerage firm.
But although the odds seem to be against the market, it is not taking the challenge lying down. The Mexican exchange is pursuing an aggressive strategy to heighten its profile internationally while back home it is looking to wean itself off its dependence on trading and expand into related businesses.
In 2000, Mexico became one of 10 exchanges to join the Global Equity Market (GEM), the world’s first international market. GEM, whose members include the Paris, Tokyo, New York and São Paolo exchanges, will offer 24-hour trading and a combined stock listing worth an estimated $20 trillion.
Scheduled to begin operating on a pilot basis in the first quarter of 2001, the GEM will bring much-needed liquidity to the market, said Manuel Robleda, president of the Mexican exchange. Stocks will still be traded in their country of origin while American depositary receipts, a preferred vehicle for Mexican companies to list in New York, will disappear, he says.
Not everyone however is convinced of the benefits. Some local brokerages fear that Mexico, by joining the GEM, will eventually become superfluous as trading concentrates in larger centres while it will do little to increase the participation of domestic investors which, they say, is what is needed to boost slender volumes and reduce volatility.
Equity analysts also warn that Mexico will have to raise its standards if it wants to participate internationally. Regulators will be forced to harmonize accounting practices and improve transparency and Mexican companies, usually secretive and family-run, will need to improve corporate governance practices and treatment of minority shareholders.
Despite the potential difficulties however, Mexico is “better off participating than getting left behind,” says Robleda. “We don’t know where it is going to lead us but if we don’t integrate and unite forces with more developed markets, they will just take away our market anyway.”
In the same way, the Mexican exchange is looking to expand its horizons beyond sheer trading. Since 1998, the exchange has spun out six new business units which include a clearing house, risk management services, a technology service provider and a derivatives exchange.
In December, SIF, a unit of the exchange that operates as a debt broker, signed a joint venture with Garban-Intercapital, a UK derivatives, securities and currency operator. Together they are the largest broker in the Mexican money market, which represents 97% of all exchange trading.
“The big question is what is a stock exchange today,” says Robleda. “We see the exchange transforming into a series of business units that provide services instead of just trading.”
In the meantime, trading could receive an added boost from Standard&Poor’s, the US rating agency. If Mexico is able to weather upcoming economic challenges and implement needed reforms Standard&Poor’s is expected to follow in the footsteps of Moody’s Investors Service, another rating agency, and upgrade Mexico’s sovereign debt to investment grade by the first quarter of 2001.
The move would coincide with two expected cuts in interest rates by the US Federal Reserve. Together the two measures could significantly lower borrowing costs for Mexican corporates and as a result, take a lot of the edge off otherwise gloomy economic forecasts. In fact, not all analysts are predicting dour results.
“Mexico is facing a potentially sticky situation but we are pretty optimistic,” says Geoffrey Dennis, Latin American strategist for Salomon Smith Barney in New York. “This is a long term, fundamental growth story.”
