By Ben Miller
Mexico is in for big change – or so say the optimists.
Enrqiue Peña Nieto’s July 1 victory in
the presidential polls will herald a new era, they say; his
government will not resemble the Institutional Revolutionary
Party (PRI) of old, but will instead consist of a competent
bunch of technocrats who will hasten the passage of critical
reforms to the judiciary, energy sector and fiscal system that
have long eluded bickering and divisive legislators.
US growth, say the hopers, will also rebound, pulling
Mexico’s economy with it. And an IPO of Pemex will
eventually follow, reversing the fortunes of the bloated state
producer, and spurring others to join it in deeper capital
So far things have not quite gone to plan: Peña Nieto
won with a 7 percentage point lead, a less resounding result
than many had expected; and his party fell short of an absolute
majority in Congress, complicating his ability to push through
reforms. The election result was also swiftly challenged by
runner-up Andrés Manuel López Obrador of the
leftist PRD, who, alleging fraud, demanded a recount. Although
the PRI candidate is still expected to emerge victorious, his
win is likely to have had some of the force knocked out of
Optimists will nevertheless take comfort in an economic
narrative that for the past 18 months has defied expectations,
lending some credence to their belief that Mexico has turned
Although this is hardly the first time followers of Latin
America’s markets have encountered such optimistic
predictions, over the past 10 years they have also witnessed a
handful of undeniable success stories. None has been as well
publicized as that of Brazil – the economy many are
now predicting that Mexico will replace as the favorite for
investors over the next decade.
Riding favorable commodity prices, extraordinary Chinese
growth and an expansion in consumer credit, Brazil had captured
many of the easiest gains over the past decade. But continuing
to do so, especially in the absence of tough economic reforms,
will prove much harder as demand from China – a
significant factor behind Brazil’s surge
– slows and consumer borrowing hits its limit,
dragging growth with it.
Mexico, by contrast, stands to gain from a Chinese slowdown
– a fact which could boost the country’s
competitiveness and, in particular, support the outlook for its
manufacturing sector. Its close economic links to the US
–an unwelcome weight during the crisis in which other
Latin American economies were relatively less affected
– could mean there is some upside in the event of a
sustained US recovery.
"Mexico is in a unique position, and as a result in the next
five years it will do better than Brazil," says Benito Berber,
an analyst at Nomura. "This has to do with first-unit labor
costs continuing to go down, which makes the manufacturing
sector very competitive. More reforms could push it even
further ahead." He expects Brazil’s GDP growth to
land at about 3.5%, Mexico’s could reach 4.5% from
3.5 % now.
Others analysts have similar expectations. HSBC sees growth
hitting 3-4% this year, after 3.9% last year. The bank says
without any reforms, the trend should be 3.5% to 4.0%. With
significant reforms, though that could be 4.5%.
Regardless of Peña Nieto’s victory or
whether or not he can deliver the promised change, several
trends point to an improving Mexican growth story. Last year,
the country’s economy grew faster than
Brazil’s, 3.9% versus 2.7%, and it looks set to
outpace its larger Latin rival again in 2012. Manufacturing
could grow by even more, as the US appears to be poised to be
the only G3 economy to grow, in contrast to the widening
slowdown across Europe. Mexico can also point to 17 years of
macroeconomic stability, low inflation, manageable debt,
sophisticated financial systems, an open economy and increasing
Brazil’s advantage in the last decade has in
effect been little more than a terms of trade shock, and it has
not taken advantage of a favorable backdrop to undertake tough
"Even with the overall lack of reforms, the government has
made some reforms that have made Mexico more competitive than
Brazil," Berber says. "In terms of no restrictions on lending
and open capital accounts, the model is Mexico, not
Berber says there are stronger fiscal rules, a lower fiscal
deficit, more flexible labor and capital markets. There are "no
surprises" in the fiscal accounts, and the government is not
intervening with the rates and foreign exchange markets to the
extent that Brazil’s government is.
"The story may be still somewhat under-appreciated," says
Alonso Cervera, an economist at Credit Suisse. "There is a
focus on negative events, and many have heard talk of reforms
many times before, only to be disappointed by the result."
Investment is already returning to Mexico. Some $10 billion
has been ploughed into the auto sector over the last five
years. Nissan, Mazda and Honda have all announced plans to
build new plants in Mexico, and further new investment in
industries including aerospace and electronics are expected
The automotive sector represents 28% of total manufacturing
exports or 7% of GDP. Mexico’s exports have grown
more diverse, however, and it has attracted significant foreign
direct investment. It is the world’s first
exporter of refrigerators and the second largest supplier of
electronic products to the US market, computer equipment and
parts, and telecommunications.
Mexico had struggled as Chinese-made products replaced its
goods in the US, which buys about 80% of Mexico’s
exports. But a Chinese slowdown could mean less demand for
Brazilian commodities, and so less competition for Mexican
The faster rate of wage increases in China than in Mexico
suggests that the cost advantage China once enjoyed is fast
dissipating, according to Nomura. Chinese labor rates were 33%
of Mexico’s in 1996, yet now they are close to or
even higher than those in Mexico, the bank notes.
China-US transportation costs have also gone through the
roof, and Mexico could further extend the advantage if the
government is successful in lowering the costs of
Another point in Mexico’s favor is the shale
gas revolution in North America that has come on the back of
improvements in hydraulic fracturing, a process also known as
"fracking." Mexico and the US are sitting on one of the largest
shale reserves in the world. Mexico has a strong manufacturing
base which uses natural gas as a raw material for production,
adding another competitive advantage over China.
"This will drive the manufacturing in many industries, not
only commodities, but everything, the whole manufacturing base
will be more competitive just on the natural gas advantage,"
says Ramon Leal, chief financial officer of Alfa, whose Alpek
unit is among those companies standing to benefit.
The exchange rate also paints a favorable picture for
exporters. A weaker dollar relative to the world’s
major currencies, means more competitive exports in the US
which will help Mexican suppliers.
The global downturn could also boost Mexico’s
tourist sector, which stands to benefit from its proximity to
the US. Faced with tigher budgets American holidaymakers will
be reluctant to spend more on long-distance vacations and could
instead choose destinations, such as Mexico, closer to
Foreign direct investment (FDI) flowing into Mexico should
be $22 billion to $23 billion this year, according to HSBC, and
the country is able to make the most of its flows. Mexico gets
$14 of exports for every $1 of FDI, says Sergio Martin, an
economist at HSBC. This compares to $9 in China and $4 in
These advantages are striking when considering the lack of
obvious reforms in Mexico during the 12 years of National
Action Party (PAN) presidencies. To capitalize on these
fundamental shifts, experts say Mexico must make large
improvements in the energy, fiscal, labor and education
Much of the hype in the first half of 2012 over change was
down to the fact that Peña Nieto’s calls
for a new direction were the loudest of the three major
Followers of Mexican history may find it odd that the PRI
– which for seven decades restrained Mexico with its
tough grip on democracy, the economy and many facets of life
– is the party now poised to spearhead much-needed
changes. Supporters claim that Peña Nieto represents a
changed party, and point to a strong track record as governor
of the state of Mexico. Skeptics fear a return to the old
"There is a new wave of PRIstas, younger and more modern,
who are surrounding Peña Nieto," Cervera says. "The PRI
gets it and wants to stay in power for more than six years. The
only way to do this is to deliver. This is
Mexico’s golden opportunity."
The list of reforms is the same and almost all of the
politicians are agreed on them, Cervera says. He expects the
PRI to be more focused, and to avoid trying to control
everything, as it aimed to do before.
Peña Nieto strived to campaign for himself rather
than the PRI, presenting himself as a pro-market candidate that
would continue the process of liberalization. There are in fact
many strengths to point to during his governorship. His
government renegotiated debt efficiently and introduced
innovative means of funding, as well as oversaw several
infrastructure projects based on the public-private partnership
"We will not believe these reforms until they are passed,
but there is a clear need to pass, and this is the view among
all parties, even the PRD," Berber says. "Yes, there can be a
disappointment. But at the same time there seems to be much
more clarity about the need to pass reforms."
The indications were that Peña Nieto supports key
reforms, such as the privatization of Pemex, and might even
push for political reforms including the reduction of the
number of senators and federal deputies. However, the election
results seemed to suggest that the PRI would not get the
legislative majority that many had expected, complicating its
ability to pass multiple reforms.
"This lowers the optimism about the passage of reforms,"
says Berber. "They are going to need alienaces with the other
parties. That is going to reqire some manouvring."
The PAN opposition creates an interesting dynamic copmpared
to what was seen in the current administration, with the PAN in
the presidency and the PRI in opposition, Berber says. In the
current setup the PAN has proposed pro-market reforms that, if
passed, could still be watered down before passage. With
Peña Nieto in Los Pinos, Mexico’s
presidential residence, proposing the pro-market reforms he
promised in the campaign, the opposition PAN would be likely,
if anything, to push to make them even more pro-market. All
this suggests to Berber that, if Peña Nieto puts forward
the reforms he promised, their passage would be a binary
question – a strong reform or nothing –
rather than the potential for watering-down seen during
"Peña Nieto has the economic team, the political
team, and the right connections," says HSBC’s
Peña Nieto is on good terms with the unions
– often a source of pushback in previous attempts to
reform areas including energy and education – and may
be in the best position to deal with them, Martin adds.
"Even without a majority in congress, you can push ideas if
you negotiate," he says. "[Former presidents] Zedillo, Fox, and
Calderón all had the right ideas, and knew what needed
to be done, but they didn’t have the political
teams to push through the ideas."
Mexico’s need for a more flexible labor market
is most evident at a company like Pemex, but needs less union
invention and more freedom to hire and fire workers across the
board. Competition is also an important issue in many
industries. This has notably played out in telecommunications,
where some feel domination by Carlos Slim companies has led to
"We haven’t heard, at least in public speeches
from the two most important candidates that they are likely to
address that issue, says Alfa’s Leal. "Everybody
knows that Telmex is a monopoly and there is a lot of room for
improvement in the telecommunications sector. We’d
like to see the sector being more competitive and open for FDI.
Any improvement would be beneficial for us, and for the
But where to invest?
Alfa’s Alpek unit raised 10.44 billion pesos
($794 million) in a April IPO, the country’s first
since the previous July. For years Mexicans have been hoping
for more activity in the public equity markets, but the
consensus is that the public companies are concentrated and not
fully representative of the wider array of quality businesses
in Mexico. Even if investors have a positive view on the county
and want to express it, they can’t make plans
"Most stocks in Mexico remain quite expensive," says Matt
Hochstetler, portfolio manager at Janus. "In general,
it’s harder to find world-class companies at the
same valuation that we’re seeing in Brazil. The
ability to find ways to express a positive view is more limited
than in deeper, more liquid markets such as Brazil."
Hochstetler sees the reforms discussed by the candidates as
positive if completed, but says that undertaking them presents
a formidable challenge.
"We think Mexico is the place to be," says Christian Egan,
global head of equities at Itau. It offers more liquidity than
Colombia, Peru or Chile, he says, though the lack of investable
names is a problem.
In many ways there is easier access to the capital markets
versus other markets in the region. Bonds are Euroclearable,
and there no IOF-type controls that are vexing investors in
Brazil. The local bond market could be deeper – as
could all domestic markets in LatAm – but has kept up
steady issuance in the first half of the year while corporate
issuers in places like Chile and Colombia have stalled. Private
equity also has room to maneuver.
"Headlines in Mexico are a cause of concern over security.
Structurally, the country is here to stay," says Martin
Díaz Plata, head of LatAm at private equity firm Capital
International. "Structurally, it is going in the right
direction. Mexico is one of the top in terms of rule of law,
and that is what is key for us."
Díaz Plata’s fund looks at other
emerging markets as well, and doesn’t have a
specific allocation for Mexico.
Overall, a weaker peso relative to the dollar may be helpful
to attracting FDI and repatriating investment. Local rates are
also low, Cervera says – a possible boon for the long
end of the yield curve.
"International banks’ lending capabilities will
be diminished, and the capital markets will be an additional
source of funding," Leal says. "Now that the Afores [pension
funds] have more exposure to capital markets and specifically
to stocks, you are more likely to see more [equity] issues in
the near future."
Domestic investors represented 50% of Alpek’s
sale, and Leal says it could have been 100%.
"Despite international investors reacting to volatility,
there will be windows in which Mexican companies will have a
good shot at leveraging the ample Mexican base of investors and
getting IPOs done," Leal says.
A $700 million-equivalent follow-on from the Fibra Uno real
estate trust in March was the year’s other notable
deal. Investors have high hopes for the new Fibra asset class,
of which Fibra Uno was the first. However, plans for a second
fund have yet to materialize. In June the equity market awaited
a follow-on from infrastructure firm Pinfra and an IPO from
industrial property developer Vesta, though these have been put
off until after the elections.
The big jewel would be the long-awaited IPO from Santander
Mexico, which could raise more than $2 billion as the
bank’s Spanish parent looks to continue plugging
holes in its balance sheets. Deutsche Bank and UBS have been
hired to manage the offering, along with Santander.
The sale is expected by the end of the year, and would give
a boost to the IPO market in Mexico. However, with financial
exposure already available in the public equity market, the
deal would not necessarily herald the diversification of the
equity market that investors are seeking. The real stuff of
bankers and investors dreams is the floating of state-owned
energy giant Pemex.
The Pemex Question
Faced with declining reserves, more Mexicans than ever seem
to think that Pemex, the once-sacred property of the state,
could do with some outside help. Models in the region such as
Petrobras and Ecopetrol suggest that floating part of the
company would raise funds, improve practices and make the
company more transparent and efficient. Those content with a
few baby steps at first see at a minimum more opportunity for
foreign partnerships and outside know-how.
"[Partial privatization] would bring foreign direct
investment into the country, and bring foreign technology into
Pemex," says Alfa’s Leal. "It will professionalize
Pemex in certain areas, and that is going to make Pemex
competitive in certain products. There are also large reserves
of shale gas that have not been exploited because Pemex does
not have the resources to do so." Leal expects Pemex to open up
in some form during the next six-year term.
There remain a number of problems that could keep Mexico
from realizing the potential of the positive trends and derail
reform plans. The biggest is perhaps the security situation. It
remains to be seen what a PRI administration might do
differently than the PAN.
That said, in 2009 and 2010, the most violent years in the
drugs war, foreign portfolio investment averaged $22.4 billion,
HSBC says, compared to a $3.4 billion average for the previous
10 years. Though the increase was mostly due to liquidity, the
bank says the investment shows confidence in
Mexico’s sound macro framework.
The external backdrop will also remain challenging. Mexico
can’t count on a strong US recovery materializing.
Despite economic indicators inspiring confidence earlier in the
year, the US has posted weaker numbers in recent months.
Trouble could also come from other regions.
Moody’s expects Mexican corporate credit to remain
stable. However, the sovereign debt crisis in Europe combined
with the slowdown in China could ultimately add pressure to
Mexico’s economic performance, which could in turn
result in corporate credit quality deterioration, the ratings
Social unrest is always on the back burner if parts of
society feel they are being excluded from gains elsewhere.
Mexico needs to ensure there are mechanisms to lift people up
from the bottom. Real wages haven’t increased,
says HSBC’s Martin, and Mexico has more people
Martin, however, considers as low the odds of discontent
that could shift the government – historically, change
has been muted even in the midst of far more severe social
pressure. "Social conditions are not such that we will see a
revolution," Martin says.
A more likely result is simply that politicians will fail to
seize their moment, and the country’s growth
languishes at 3% or less. Here, too, they have only to look to
Brazil to see what happens when tough decisions are put off
when the going looks good. LF