Overcoming the wall of uncertainty

A year ago, many economic commentators in Mexico were predicting the economy would fall into a recession as Donald Trump soared in opinion polls in the US. In fact, GDP is expanding at 2.3% a year and the Mexican business community has become more relaxed about now-president Trump’s threats to build a wall between the two countries and his insistence that the Mexicans pay for it.

Investors are now focusing on the renegotiation of the North American Free Trade Agreement, which came into force on January 1 1994. Some even believe a revised treaty could create opportunities for Mexico if it includes new provisions for energy, financial services and telecommunications that were not present before.

New standards for cross-border investment and protection of intellectual-property rights in these sectors make sense for all three of the treaty’s member states – Mexico, the USA and Canada.

However, Mexican businesspeople are concerned about general elections on July 1 next year. Voters will elect a new president to serve a six-year term, all 500 members of the Chamber of Deputies and all 128 members of the Senate.

Incumbent president Enrique Pena Nieto – who represents the centrist Institutional Revolutionary Party (PRI) – is not allowed to stand for a second term under the Mexican Constitution. The new president will take office on December 1 2018.

Andres Manuel Lopez Obrador ­– the veteran left-wing candidate who now represents the National Regeneration Movement, known as Morena – is an early favourite to win the presidential election. He was the candidate for the centre-left Party of the Democratic Revolution (PRD) on two previous occasions in 2006 and 2012, and almost won against Felipe Calderon in 2006 (Morena broke away from PRD in 2014).

“Mexico has been the story of two elections,” said Christopher Gilfond, head of debt and equity capital markets origination for Latin America and the Caribbean at Citigroup.

“Trump’s election created a lot of trepidation about what his presidency could entail for emerging markets especially. But as his rhetoric about ‘the wall’ died down – until recently – investors’ fears started to recede. They are now thinking a lot more about Mexico’s own presidential elections next year.

“We are seeing quite a bit of de-risking through capital-raising in the equity and debt markets. Business people want to get their transactions out of the way and their balance sheet in order before the elections create any disruption.”

For the year to August 23, US$2.3bn was raised in Mexico’s equity capital markets, compared with US$711m for the same period in 2016, according to Thomson Reuters data. So far this year, 94 mergers and acquisitions have taken place for a total value of US$3.17bn. Around US$19.6bn has been raised through international bond issuance, in 15 separate transactions.

The past 12 months have seen some important IPOs, including listings by Becle SAB, the beverages producer, in February (US$910m was raised); Vista Oil & Gas, the oil producer, in August (US$650m); Banco del Bajio, the banking group that operates in northern, western and central Mexico, in June (US$482m); and Infraestructura Viable, an industrial real estate developer, in October (US$625m). In October, Infraestructura Energetica, an energy infrastructure developer, also carried out an important follow-on that raised US$1.45bn.

Most of Mexico’s economic fundamentals are pretty strong. Unemployment stands at only 3.5%; annualised inflation at 6.4%; and the benchmark interest rate at 7%. The fiscal deficit is around 3.3%, much better than in other Latin American countries (8.5% in Brazil and 7% in Argentina).

“Mexico does not have a crisis on the fiscal side but there have been consistent deficits,” said Cesar Barceinas, a director at Standard & Poor’s, which rates the sovereign BBB+ with a stable outlook. “We expect the deficit to drop during the next few years and for debt levels to stabilise.”

He said the country’s debt-to-GDP level is hovering around 45% and it has managed to avoid the 50% level that many commentators expected. During the past decade, the country has been mostly spared the boom-and-bust cycle witnessed in Brazil and Argentina by pursuing more prudent fiscal and monetary policies.

Violence and corruption

Mexico’s two biggest problems are continuing drugs-related violence and corruption. At least 80,000 people were killed in the country due to organised crime-related incidents between 2006 and 2015. Prosecutors opened 2,234 homicide investigations in June alone, up 40% on last year.

Over the last three months, three former state governors representing the PRI party have been arrested for illicit acts: Roberto Borge of Quintana Roo state; Javier Duarte of Veracruz state; and Tomas Yarrington of Tamaulipas state.

These high-profile corruption scandals and a failure to tame gang-related violence has cost the governing PRI party dearly in political terms. It is one of the factors behind Lopez Obrador’s rise in the polls.

“It is possible that Lopez Obrador will win the election,” said Peter Hakim, president emeritus at the Inter-American Dialogue, a Washington DC-based think tank. “He came very close in the past.”

Right-wing commentators have compared him with Venezuela’s Hugo Chavez, but in reality he appears to be a lot more moderate. He campaigned against opening Mexico’s energy sector to private capital, a key reform under Pena Nieto, but no longer vows to reverse it.

However, Edward Glossop, Latin American economist at Capital Economics, a London-based economics consultancy, said: “If Lopez Obrador retains his lead and the Nafta renegotiations run into next year, I think many business people will be put off investment decision-making.”

The country’s three main political parties ­ – PRI, PRD and the centre-right National Action Party (PAN) – have not yet chosen their presidential candidates.

Pena Nieto’s right-hand man and Foreign Affairs Secretary, Luis Videgaray, is a definite contender as the PRI candidate, given that he was one of the masterminds behind the many structural reforms approved under the current administration (he was Finance Secretary between 2012 and 2016).

However, it is not yet clear whether those reforms will bear enough fruit by the time of the next elections, and the budget cuts under his watch were highly unpopular with many Mexicans. Videgaray could also suffer because of his perceived closeness to Pena Nieto.

Mexico’s economy has been benefiting from the liberalisation of the energy sector. The country changed its constitution and de-regulated the industry in 2013. Strict state controls over the oil and gas and electricity sectors were lifted. Since then, more than 70 contracts have been signed with the private sector and it has committed to invest more than US$50bn in the industry.

Many Mexican analysts believe that if an energy provision is included in any revised Nafta agreement, it could benefit Mexico by making it easier for US and Canadian firms to invest in the country’s energy sector (the same applies to telecommunications and financial services).

Energy was scarcely mentioned in the original treaty because it was too politically sensitive at the time of ratification in 1993.

“A new Nafta agreement need not be all bad for Mexico,” said Roberto Langenauer, managing director at Nexxus Capital, the country’s largest independent private equity firm. “Energy is now open to the private sector and I think we could see a lot of foreign investment in the industry.”

Opening up the oil sector to more foreign investment and expertise (in shale and deep-water oil in particular) could allow Mexico to regain its position as one of the top crude producers in the world (currently, it produces around 2m barrels per day, down from 2.6m in 2013).

Hakim said: “Mexicans are a bit more confident now, as they have realised that what Trump can do is limited. A big proportion of the American business community wants to maintain Nafta the way it is. It is very unlikely that the US will place tariffs on Mexican imports.

“Trump is looking for ways to gain public approval, and if he can get publicity around a few American companies desisting from Mexico, he would have achieved his goal.”

The US president continues to raise the issue of the ‘new wall’ regularly (he last did so at a major political rally in Arizona in August) but most Mexicans are now more sanguine about the subject and their government has sworn that it will never pay for it.

After all, Mexico has political muscle in its talks with Trump. It imported US$240bn in US goods in 2015 and many American states rely on Mexico as their largest export market. If Nafta were to disappear, the hardest hit US states would see their economies shrink between 5% and 15%, according to recent studies.

After Chile, Mexico is probably the most sophisticated economy in Latin America. It has the most free-trade agreements in the world, partnered with 45 other nations. It also has 32 reciprocal investment promotion and protection agreements (RIPPAs) with 33 countries.

It is a founding member of forward-looking trading bloc, the Pacific Alliance. Its supply chains are highly entwined with those of the United States and Canada. Despite its problems with the drugs trade and corruption, the country has one of the best placed Latin American economies.