The underdog growls

Investors remain confident that despite the collapse in the price of oil, Mexico’s reforms will continue to push its economy ahead of those of its Latin American rivals.

The hero of 1940s’ Mexican cinema was Cantinflas – often referred to as the Mexican Charlie Chaplin. From the launch of his comedy Ahi esta el detalle, in English known as You’re Missing the Point, his character was taken to the heart of audiences and came to personify the spirit of Mexico itself, the underdog who triumphs.

In many ways, the spirit of Cantinflas is reflected in the way that Mexico has become one of the darlings of the emerging market sovereigns. Under the leadership of President Enrique Pena Nieto, elected in December 2012 on a promise that he would wake up the Mexican economy, the Latin American county has been winning cautious plaudits for his reforms.

Despite increasing personal criticism of the president and damaging allegations of crony capitalism, this has not spilled over into criticism of the economy.

A sign of how that is regarded is the success of the sovereign’s US$2bn dual-tranche bond sale at the start of the year. Indeed, what was the reopening of the Latin American primary market – a tap of its 3.6% 2025s as well as a new longer-tenor 2046 bond issue – was by any standards a success. A weighty US$8bn in total demand saw pricing on both tranches come in significantly before their being priced with only a 10bp–15bp premium.

The jewel in the crown of Mexican reforms has been its energy reforms. Chief among these is the liberalisation of the oil sector, which had been closed to private investment for nearly 80 years.

Given the collapse of the price of oil, it is not just sceptics who are wondering whether the low price could derail the government’s good intentions. But it does not seem to have hampered any interest in state-owned oil company Petroleos Mexicanos, better known as Pemex.

Towards the end of January, Pemex brought a US$6bn three-tranche bond offering to market. While premiums were generous, books were still a heavy US$16m and the company was able to print the July 2020s at 99.926 with a 3.5% coupon to yield 3.515%; the January 2026s at 99.82 with a 4.5% coupon to yield 4.521%; and the January 2046s at 99.274 with a 5.625% coupon to yield 5.675%. The 10-year portion, for example, was priced a comfortable 55bp inside the paper of Pemex’s nearest Latin American oil peer.

This was followed in early February with a successful, US$1.15bn-equivalent tap of its peso-denominated 7.47% 2026s. More than half came via a Euroclearable local instrument, called Euroclearable Cerbures. From a company point of view the deal made sense because it broadens the corporate peso market, but it is significant as it shows the depth of international demand for the name.

The interest in Latin American oil is not as counter-intuitive as it might at first appear.

“It is worth remembering that the cost of manufacturing oil in Mexico is low – about US$20–$23 per barrel. Even if you look at where the price of crude oil is at the moment, this makes Mexico profitable,” said Barclays’ Mexico economist Marco Oviedo.

Broader impact of oil

And while there might not have been a rush of oil companies to Mexico since the reforms were announced, that is for the quite simple reason that many of the big players are already there. Where it is possible to see the impact is in the offices along Mexico’s Gold Coast, which have seen an influx of smaller companies that service the oil industry.

But it is worth looking at the broader impact of the price of oil on the economy.

“The decline in oil prices from an external point of view is not an issue; however, about 30% of the government’s income does come from oil. The hedge should protect the federal income in 2015 – but if it continues into next year, Mexico will likely need to take additional fiscal measures to remain on track with its fiscal consolidation path,” said Shelly Shetty, head of Latin American sovereigns at Fitch.

Any oil threat to the economy has not been helped by the strength of the US dollar.

“The Mexican peso has suffered devaluation. It was around Ps13.5 to the US dollar; it is now around Ps15,” said Alfonso Elias Bornacini, managing partner for RSM Bogarin, one of the country’s leading accounting firms.

Bornacini points out that a weaker peso will be a driver for export-oriented business.

“Every time that there is a devaluation, this leads to traction for the rest of the economy and gives me a certain optimism for the second quarter,” he said.

But there is also a downside if the devaluation is too steep or goes on for too long.

“We will be importing inflation from consumer goods and if the peso slides to Ps18–19 to the dollar then the economy can go into panic mode,” Bornacini said.

Austerity measures

Aware of the dangers, the federal government has implemented austerity measures to reduce current spending. It expects to cut Ps34bn (US$2.3bn) this year, with the remainder to come from reductions in public investment. Some Ps18bn of special infrastructure projects have already been cancelled, notably the proposed US$3.75bn Mexico City to Queretaro high-speed rail link project.

It is safe to say that the austerity measures remain controversial.

“The government oversold the idea of a new Mexico,” was the downbeat conclusion of Alfredo Coutino, Latin America director at Moody’s. “Markets … forgot that the structural anaemia cannot be cured either by promises or in the short term,” he added.

“The austerity reforms in Mexico do not have an impact on economic activity in the same way that they do in Europe. In Mexico, they are contained because the public sector is small”

Others remain on the fence about the impact of the reforms. “The austerity measures will only become clear by the end of the year. How successful the Mexican government has been in implementing measures will only become clear in coming months,” said Fitch’s Shetty.

But not all are so critical. The austerity and the reforms are useful for what they say.

“It sends a positive message that the government is fiscally responsible,” said one banker, adding that Mexico is doing well, especially when its performance is compared with that of many of its peers. It might not be perfect, but “in the kingdom of the blind, the one-eyed man is king”, he added.

In one sense, while of course the austerity reforms are important, they do not carry the same weight as in some other countries.

“The austerity reforms in Mexico do not have an impact on economic activity in the same way that they do in Europe. In Mexico, they are contained because the public sector is small. It is worth noting that it represents 30% of GDP, which means that government spending is not an important factor as far as growth is concerned,” said Barclays’ Oviedo.

But it does look as though the message about stability and reform is getting out there. Certainly there is international demand for Mexican names. At the end of January real estate operator Corporacion Inmobiliaria Vesta was in the equity markets with a US$194.6m-equivalent all-primary equity raising, while in the debt markets Mexican bus transportation company Grupo Senda Autotransporte has finished roadshows and is looking for a possible US dollar 144A/Reg S bond offering.

So what is the outlook for growth? After GDP rose by 2.1% last year, the government had been touting growth figures of 3.7% for Mexico this year. Going on the doveish tone from the meeting of Banco de Mexico at the end of January, which kept the reference rate unchanged at 3%, it was clear even then that the central bank was not completely convinced by those figures.

“Due to a less favourable external environment, the downward trend in oil production and the prevailing weakness in some components of domestic demand, we are lowering our forecasts for Mexico’s GDP growth,” Banco de Mexico noted in its quarterly inflation report, published towards the end of February, as it revised its forecast downwards to between 2.5% and 3.5%.

Certainly these figures chime more with the view of the private sector. There is a broad consensus that growth will be less than 3% this year – Societe Generale, for example, expects 2.7% – and around, or slightly higher than 3.2% in 2016. These may not be headline-grabbing figures, but they do show how far the country has come in a short period. It looks as though the underdog might win.