When Andrés Manuel López Obrador (popularly known as AMLO) won a landslide victory in Mexico’s elections in July 2018, his administration obtained a strong popular mandate and sufficient political capital to implement his sweeping legislative agenda. Through future defections and ad-hoc alliances, it could even affect changes to the constitution. Now that AMLO has been in office for his first 100 days, we can begin to examine what the outlook will be for Canadian companies already operating or thinking about investing in Mexico under the new regime.
Despite his massive popularity with Mexican voters, AMLO also has detractors who fear his policies are anti-business and anti-trade. Risks notwithstanding, widespread concerns of a radical regime shift appear to be overblown. For one thing, AMLO just doesn’t have the spare cash to finance a material change in the course of policy. The current fiscal reality in Mexico will constrain AMLO’s ability to make sweeping changes that are offside with the markets. And amid an increasingly challenging global financial backdrop facing emerging markets, relative financial market stability is key to sustaining a sound macroeconomic and fiscal framework and hence economic resilience.
AMLO’s challenges are further compounded by his administration’s bold attempts at tackling deeply ingrained corruption and security issues. Reducing corruption and spiralling criminal violence are highly popular goals among the electorate and badly needed to improve not only the commercial environment, but also institutional and governance quality and socioeconomic outcomes. AMLO’s biggest challenge will be to do so in a way that doesn’t foster an environment of protracted uncertainty, which would limit the large investments needed to meet López Obrador’s ambitious growth target of 4%.
A solid macroeconomic framework
When Canadian exporters and investors are assessing new markets in which to invest, there are three indicators of a healthy and stable economy they should look at:
- Economic growth. Is the economy expected to grow at a rate that will sustain high-demand growth potential?
- Policy predictability and continuity. Will a new government provide an environment where trading relationships can continue, the regulatory framework will remain stable, and supply chains won’t be disrupted?
- Financial market volatility. How stable is the currency? Will it depreciate and thus cause competitiveness issues for Canadian exporters or losses for investors?
To answer these questions, potential investors in Mexico are looking at some of the following issues related to the country’s overall macroeconomic framework.
Prudent fiscal stance
In recent years, Mexico has maintained prudent government finances, keeping a tight fiscal stance following the recent plunge in oil prices and amid the structural decline in domestic crude oil production that has reduced the government’s sources of fiscal revenues. Thus far, it appears that AMLO’s government intends to maintain a prudent fiscal policy and not ramp up spending or government debt in ways that could jeopardize financial market stability and even the sovereign’s credit rating. The budget his administration put forward for 2019 was in fact applauded as realistic and was well-received by the markets. Going forward, implementation will be key and closely watched.
What’s more, throughout his political career, López Obrador has built an image of himself as a frugal man of the people. He has carried this forward into the presidency, rejecting the trappings of luxury that come with the job, such as choosing not to live in the presidential palace, getting rid of his presidential security detail, and even using private commercial planes to travel. That said, there are lingering concerns that deep austerity in the public sector may lead to a brain drain and therefore, the erosion of institutional capacity to formulate and implement policy.
Central bank independence
Another indicator of a well-insulated emerging market is a central bank that takes action based on market fundamentals rather than at the whim of the government. Markets react favourably to a central bank that has a strong, reputable stance and can keep inflation stable and defend against marked currency depreciation by raising interest rates when needed.
Here again, the early signs from Mexico’s new government are positive. The country’s central bank already has a good reputation as a well-managed institution free from government interference. Last fall, some feared López Obrador would fill two vacant deputy governor positions at the central bank with people loyal to his agenda. But the two eventual nominees were both well-regarded and ivy-league trained economists. and one of them has even been critical of some of López Obrador’s policies. This is a testament of the institutional strength and degree of independence enjoyed by the central bank. These appointments should put to rest for now any concerns about the independence of Mexico’s central bank.
Openness to trade
The biggest issue here is obviously whether López Obrador will ratify the renegotiated North American Free Trade Agreement, the Canada-United States-Mexico Agreement (CUSMA). The president isn’t expected to challenge it and has indicated the government will ratify it once it passes in the United States’ congress. Therefore, trading relationships with Mexico are likely to remain as they were.
Caution on policy predictability and contract certainty
Despite the strong macroeconomic framework, investors in Mexico still face risks and the perception that the AMLO government may not have a good grasp of the challenges in front of it. The quality of the new government’s policy implementation has been criticized as discretionary and at times, even chaotic, rather than as affirming a stable commercial environment.
Threats to energy reform, corruption and security
AMLO has long been critical of the recent energy reform, which is enshrined in the Constitution. It opened the sector to foreign participation in a bid to attract the capital investment needed to finance higher exploration and production activity, favouring instead a more state-interventionist policy stance. In fact, one of the biggest challenges facing the AMLO administration is to reverse the structural decline in crude oil production volumes, where the fragile finances of state-owned oil company, Petroleos Mexicanos (Pemex), are a constraint on—and increasingly a contingent liability risk to—government finances.
After assuming power, AMLO suspended auctions for international energy companies bidding on developing Mexico’s oil and gas resources, initiated a review of the more than 100 contracts already awarded, and conducted a popular consultation on the construction of a new refinery in his home-state of Tabasco. Businesses are concerned that some of those contract awards may be revised or reversed. This is obviously making potential global investors in Mexico ill at ease with respect to the state of the rule of law: they can’t rely on the certainty of a contract that has already been awarded. Given the government’s limited fiscal resources, foreign direct investment inflows into the sector are badly needed to support a recovery in crude oil production volumes. However, such inflows are now likely to be lower than previously expected as foreign capital is sidelined.
The energy sector is also a focal point of Mexico’s corruption and security challenges and another area where policy solutions may create additional problems. To combat fuel theft, López Obrador shut down the pipelines and fuel is now transported around the country in tanker trucks. This is a much more expensive distribution method and therefore deemed unsustainable. The battle against fuel theft ultimately resulted in severe fuel shortages that were reported over large swaths of the country and lasted for weeks in January and February. The fuel shortage crisis may have negative implications for economic growth in the first quarter of this year. The supply shock crisis was further exacerbated by a massive pipeline explosion that killed more than 100 people, and by indications that criminal organizations may have begun operating in the lucrative fuel theft business, which highlight the challenging nature of the security of fuel supply.
Cancellation of Mexico city airport expansion
Another of López Obrador’s first acts was the cancellation of the new $13 billion US Mexico City airport, which effectively ended his honeymoon with markets. The cancellation was shocking, given the critical need to increase airport capacity, and the fact that construction funds had already been raised and the project was already one-third completed. What’s more, the cancellation went ahead after a controversial referendum in which only about 1% of the Mexican electorate voted. The stated reason for the cancellation was to root out corruption, in addition to the project’s price tag. But the rushed decision left many scratching their heads, and the alternative development plan the government put forward has been criticized by sector specialists as unfeasible.
Ending incentives for foreign investment
Despite the new government’s pledge to remain open to foreign investment, AMLO’s government has closed an international trade and investment promotion agency called ProMexico, a promise he campaigned on. It also ended financial incentives for auto sector investments in the country. López Obrador even decided to end the approximately $20-million government subsidy for the Formula 1 race in Mexico City, diverting the funds to a railway project instead.
López Obrador’s thinking seems to be that there are budgetary savings to be had by eliminating incentives and that Mexico remains competitive enough on costs that many of these investments would have happened anyway, regardless of whether or not they were incented.
Forecasts for Mexico’s economic growth for this year and next have recently been revised downward, predominately on account of lower expectations for business investment. Notwithstanding the risks, Mexico’s macroeconomic framework is expected to remain broadly in place, supporting economic resilience amid policy uncertainty. Strong U.S. economic growth and the expected CUSMA ratification are tailwinds to exports, and consumers will benefit from surging confidence, decelerating inflation and high remittances.
Limited fiscal resources, the challenging global financial market backdrop facing emerging markets, and the political imperative of improving socioeconomic outcomes are expected to limit the extent of policy disruptions. We therefore expect that despite the increased uncertainty and volatility, policy-making in Mexico is likely to remain fundamentally pragmatic, warranting our cautious optimism about a recovery in the medium-term outlook horizon.