Last year, Mexico was the darling of the investor universe. In February, Moody’s upgraded Mexico’s sovereign rating one notch to A3 driven by approval of a comprehensive reform package that would lead to higher growth prospects. These reforms spanned across education, labor, politics, fiscal policies, telecommunications, and most importantly, energy. The country was ending a 75-year monopoly by Petróleos Mexicanos (PEMEX, the state-owned oil company) and opening up its energy sector to private participation, potentially leading to a flood of new investment that would revive the energy sector. On energy reform, the country was even able to deliver full approval of secondary legislation slightly earlier than markets expected in August, moving quickly into the implementation phase. Many analysts posited the reforms in total could boost Mexico’s potential growth from around 3% to 5% or more. On top of this, the US, Mexico’s largest trading partner by far, started showing stronger signs of economic recovery which would provide a boost to Mexico’s exports. Mexico’s leaders were praised for their ability to build consensus around key structural reforms, on top of an already solid credit profile with low levels of external debt and increasing reserves. It seemed the “Mexican Miracle” was solidly on track.
Fast forward to this year, and the Miracle has been already dubbed a “Morass” by the Economist1 among others. First, the precipitous decline in oil prices forced a re-evaluation of the scope and timeline of energy reform implementation. Despite not being a major exporter of oil – oil has been declining as a percent of total exports (only about 12% today) and the total oil-related trade balance is closer to zero once refined products like gasoline (which Mexico imports) are included – investors have clearly identified Mexico as an “oil story” anyway, evidenced by strong correlation recently between the currency (MXN) and oil prices. Secondly, growth disappointed throughout the year, coming in at only 2.1% for 2014. Potential GDP of 5%+ post-reforms started to look overly optimistic. Lastly, a slew of corruption scandals at the end of last year stoked social tensions and significantly tarnished the President and his administration’s image. Social pressures erupted when local government involvement was evidenced in the gang killing of 43 student protestors from Ayotzinapa. This was followed closely by the leak of what seemed to be below-market property purchases by the First Lady and the Minister of Finance from companies that had also won several government contracts. President Peña Nieto’s approval ratings tanked to historical lows for Mexican Presidents in their 3rd term (around 34%) and many called for serious anti-corruption and rule of law reforms.
In my recent trip to Mexico City, it was clear that these corruption scandals were top of mind for many individuals in the private sector. The government’s response has been viewed as insufficient and the absence of an opposing political party capitalizing on these scandals to build popularity has lead many to believe that corruption has become more widespread, what some referred to as the “democratization of corruption”. But despite the more negative mood on politics from private sector analysts, the government still pitched themselves as a paradigm of solid macroeconomic management. Unlike other emerging market countries dependant on oil revenues, the government has taken pro-active steps to protect the fiscal balance, including their successfully implemented oil hedge program last year and pre-emptive budget cuts announced this year. While these cuts will likely have some negative impact on growth, the government is choosing to differentiate itself from other emerging market countries by prioritizing fiscal discipline and macro-stability. On energy reform, while oil prices have not been a positive development for exploration and production projects, there are many other aspects of the reform touching midstream, downstream, electricity and gas sectors that will add meaningfully to economic prospects. But even these changes will take time to implement, as there are significant challenges in building out infrastructure and human capital, so it’s difficult to pencil in economic impacts from reforms in 2015 or even 2016. And while many Mexicans I met expressed some disappointment on progress in reforms so far, all were happy that there were at least reforms to be talking about in the first place. While the lights have gotten a bit dimmer, Mexico still looks like a solid credit among investment opportunities in emerging markets. Ultimately, maybe “miracles” are just a bit unrealistic and investors should be more than happy with just slow and steady progress.