Mexico prepares for a future that is unknown but will probably look quite similar
When Mexican president Andres Manuel Lopez Obrador swept to power in 2018 on a wave of anti-establishment sentiment, many international investors were concerned about the impact the left-wing populist would have on the country’s financial markets.
Now, as AMLO enters the final stretch of his six-year tenure, Mexican assets are in better shape than many investors had initially feared. The cost of insuring Mexico’s debt against default is back down to roughly where it was before he came to power. The currency has also been on a tear, hitting a high of 16.60 against the US dollar in July.
“From the point of view of a bondholder, it has been a success,” said Graham Stock, senior emerging market sovereign strategist at BlueBay Asset Management. “He didn’t blow out spending to address the Covid pandemic – rightly or wrongly, from a social perspective. But in terms of the fiscal impact, it meant that you didn’t have the kind of deficit we saw elsewhere in the region – he takes almost a household approach to budgeting, in that you can’t spend what you haven’t got.”
That, said Stock, is good news for Mexico’s credit metrics.
AMLO has also not been able to bend everything to his will. While he has exceeded expectations from an investor perspective, part of the reason asset prices have held up is that he has been constrained by the constitution, said Andrew Stanners, an investment director at abrdn.
"Can he take on the debt of Pemex? Not without constitutional change,” said Stanners. “Can he make expenditure payments from the central bank? No, it has to be on debt repayment. So these constitutional rules have restricted him perhaps him a little more than he wanted to be.”
While that has been positive for financial markets, cracks have emerged below the surface.
“Everybody looks at the macroeconomic policies, and he hasn’t rocked the ship too much, but the deterioration at the micro level is pretty significant,” said Aaron Gifford, an emerging markets sovereign analyst at T. Rowe Price.
That includes attempts to chip away at the country’s independent institutions, said Gifford, including seeking to weaken Mexico’s electoral authority and attacking the supreme court when legal rulings have not gone his way. He has also sought to rush through pet projects while shutting down existing investment programmes. Within weeks of coming to power, he cancelled Mexico City’s new US$13bn airport despite it already being partially built. By contrast, he has sought to invoke national security powers to complete his Maya Train project on the Yucatan Peninsula in a bid to avoid delays caused by environmental protests.
“He hasn’t over-stepped too much where he’s had some real liability on his hands, but a lot of that mentality has been anti-business and so that has hurt business sentiment,” Gifford said.
That is the backdrop whoever succeeds AMLO in next June’s election stands to inherit. At the moment, that is likely to be Morena’s Claudia Sheinbaum, former mayor of Mexico City, AMLO’s chosen successor and the frontrunner in the polls.
She will likely be up against Xochitl Galvez, a senator who rose to prominence in part because AMLO frequently criticised her during his morning press conferences.
Pemex problem
The winner will also have to deal with Mexico’s energy sector and state-owned oil company Pemex, which is buckling under more than US$100bn of debt. Under previous president, Enrique Pena Neto, Mexico had sought to reform its energy sector to ease the burden on Pemex by opening the market up to foreign oil companies, something AMLO quickly moved to snuff out.
“They need to do something about Pemex, otherwise it’s going to be a continual problem,” said Stanners. “From an ESG perspective, there’s fewer and fewer investors that can get involved with the name – it’s just a flat no for a lot of ESG funds. And these funds are becoming more and more prevalent, and so it’s more and more of an issue for investors.”
The ESG issue is something Sheinbaum might have some interest in solving – she is a physicist with a doctorate in environmental engineering.
Mexico’s broader financial outlook is also potentially less positive than at first glance.
“Objectively speaking, Mexico stacks up a lot better than its LatAm peers, but under the hood, there is a fiscal deterioration story happening,” said Nafez Zouk, emerging markets sovereign debt analyst at Aviva Investors. “They’ve eroded their fiscal buffers and they’re supporting Pemex at the cost of other means of support to the economy.”
When oil prices are trading at US$80 or US$90 a barrel, that is less of an issue, but if prices drop to US$60 or even US$70, that becomes a problem, said Zouk.
“We are entering a point where the fiscal is optically fine, but structurally vulnerable – the next administration needs to look at these things a little bit more carefully,” he said.
That means figuring out how to raise revenues, minimise the drag of Pemex and state-owned electricity company CFE on its budget, and expand the economy.
“A widely held view is that fiscal prudence is coming at the cost of weak growth,” said Zouk. “Mexico is a huge emerging market economy and it’s only growing at 2% – that’s just way too low. And part of where that problem is lying is in fiscal. Mexico has hid behind these good fiscal metrics, but it needs to convince that it is actually on a sustainable fiscal path that is conducive to better growth outcomes.”
Mexico, therefore, is at an inflection point, he said. The country is well placed to gain from favourable external factors such as the US seeking to reduce its dependence on Chinese manufacturing, but it is also suffering from underlying structural issues that could snatch the opportunity away.
“Mexico can benefit from things like near-shoring and the geopolitical tension between China and the US,” said Zouk. “But for those benefits to come through, Mexico needs to have more policy clarity and it needs to unwind some of the institutional erosions that have occurred under AMLO so that you can encourage more private investment.”
Even though the election is months away, most investors believe AMLO’s Morena party will hold on to the presidency, with Sheinbaum set to become the country’s first female president.
“We always get surprises at some point but the variability in scenarios in Mexico’s case doesn’t look very large,” said Gifford. “It feels like it’s Sheinbaum’s election to lose given AMLO’s backing even if Galvez does look competitive.”
Tame by comparison
Given the usual level of drama and uncertainty that accompanies Latin American elections, Mexico’s political backdrop looks relatively tame by comparison, said Stock.
“This is possibly going to be the dullest election in Latin America for the foreseeable future,” he said. “Sheinbaum owes a lot of her political position to AMLO and will respect his legacy. The key tenets will likely stay the same – fiscal conservatism and interventionist instinct, but tempered by the institutions. Probably the biggest change will be that the daily news cycle will no longer be set by AMLO’s two-hour press conference every day.”
To be sure, not all market-watchers believe the election outcome is a foregone conclusion.
“The fight for the executive might be more intense than previously expected,” said Bertrand Delgado, senior emerging market strategist at Societe Generale. “In that sense, whoever runs to the centre or is able to manage the voting from the centre will have a good chance. Claudia and Xochitl are very strong women, they have a lot to bring to the table, and that is a very good thing for Mexico going forward.”
But even if the presidential race is closer than people expect, what the post-election landscape looks like will hinge more on the distribution of seats in congress and the senate.
“If there’s a supermajority for Sheinbaum and they were able to move the needle on some of the more extreme policies that were kept in check during AMLO’s term, it could be pretty negative,” said Gifford. “Fortunately, this looks unlikely given recent polling.”
If Morena’s current majority diminishes, that would potentially be positive for Mexican asset prices because it further discounts the risk of more extreme ideas from gaining traction, said Zouk.
Another unknown is the extent to which AMLO will maintain influence in the post-election environment. While he has said he intends to retire, investors say Sheinbaum may need AMLO to hang around to maintain party unity.
“There is a long presidential transition in Mexico, but maybe it’ll be even longer this time,” said Stanners. “You probably want AMLO there at the beginning to ensure a smooth transition within the party.”
Regardless of the election outcome, for many Latin America-focused emerging market investors, Mexico remains an attractive proposition compared to other countries in the region, even if the long-term outlook is uncertain.
“If you ask me to buy a 10-year bond in Mexico or a 10-year bond in Colombia, it’s a no-brainer,” said Zouk. “Mexico has a lot they can capitalise on and really turn things to their advantage, but they can also squander it.”
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