Mexico at risk from populism

Populism is on the rise, but it could make Mexico too hot to handle

Lying 38th out of 186 countries in Euromoney’s country risk survey global risk rankings, Mexico remains the second-safest option in Latin America, trailing Chile in 16th place.

Mexico, a stable top tier-three borrower consistent with its investment grades, also has the full support of the IMF via a precautionary credit line should it become necessary.

The economy weakened for much of last year, but with GDP growth accelerating in the fourth quarter – underpinned by construction activity after the devastating earthquakes to hit the capital – forecasts for this year are improving.

The IMF has upgraded its 2018 growth prediction from 1.9% to 2.3%, matching last year’s estimated pace. This is within the central bank’s 2% to 3% forecast range and is broadly consistent with private-sector opinions.

The country was one of six in the region to see its total risk score fall slightly in 2017 in Euromoney’s survey, with experts downgrading their scores for a range of indicators, including institutional risk, policymaking and government stability, signalling political risk is the dominant theme.

Investors are watching on nervously as the electoral race enters its final stages.

In July, voters will have an opportunity to elect a new parliament and president to replace Enrique Peña Nieto, who is constitutionally barred from standing again.

The leftist candidate and former Mexico City mayor Andrés Manuel López Obrador (known as Amlo), representing the National Regeneration Movement in an alliance with two other parties, is leading a pack of three frontrunners.

Another is the ruling Institutional Revolutionary Party candidate and former finance minister José Antonio Meade, also standing in coalition with two other parties.

The last is Ricardo Anaya, the former leader of the centre-right National Action Party (PAN), who resigned to form a left-right alliance with PAN, the Party of the Democratic Revolution and Citizen Movement.

Amlo’s campaign pledges to investigate oil contracts, eradicate corruption and address inequality must be weighed against speculation he might reverse parts of the government’s energy reforms ending the state monopolies and spurring private competition in the electricity and petroleum industries.

Although he is also promising to maintain macro-fiscal stability, Amlo’s plans are populist – and risky – with his rise reflecting public dissatisfaction with the established parties.

“If he gets elected, it will be less likely that the planned structural reforms in the energy, financial and telecommunications sectors will go ahead,” says ECR contributor Jacob Jordaan, specializing in international economics at the Utrecht University School of Economics.

“This will have negative effects on the Mexican economy.”

Negative impact

Even if Amlo does not win, Jordaan speculates the new government might decide to weaken or postpone the planned structural reforms, and together with the ongoing problems associated with crime and drug trafficking, this will also have a negative impact on the Mexican economy.

Another of Euromoney’s survey contributors stated privately that Amlo will be hard to beat in July.

“The financial markets are somewhat complacent about him this time around [he has stood twice before], based on the narrative of the new, moderate Amlo,” says the individual.

“However, as we approach the election and he shows his more radical side, there will be some nervousness and volatility.”

Whoever wins power has a tough job steering the country to prosperity, not least because of the risk of currency depreciation accompanying the elections and the renegotiation of the North American Free Trade Agreement (Nafta) with Canada and the US, which is threatening to overrun and conflict with the elections.

With annual inflation climbing to 6.8% in December, its highest level in more than 16 years, the central bank is under pressure to respond to meet its 3% target rate – with a tolerance band of +/- 1% – by raising interest rates again after a move in December sent the benchmark rate up to 7.25%.

Higher borrowing costs will stifle economic recovery, while more generally any populist strategy might undermine other indicators – Amlo remains a key risk to achieving a favourable Nafta deal, with his promise to scrap energy reforms and his anti-trade slant.

However, if economic growth is undermined, and public spending raised, the deficit that is already heading higher this year to 2.4% of GDP, according to the IMF, could be worse, breaching the present government’s 2.5% target which aims to stabilize the debt.

Mexico’s external debt position, at around 40% of GDP, is not onerous by the standards of emerging markets, but if it drew on the flexible credit line available from the IMF the fiscal metrics become more complicated.

The IMF is talking down the possibilities, couching its analysis in comforting words of debt sustainability, but confidence is fickle, and it would not take too much to rattle the markets.

Mexico is not a very risky bet – but it is not a riskless one, with the elections potentially the game-changer.