Summary: Seismic changes lie ahead for Mexico with the election of Andrés Manuel López Obrador as the country’s next president. Whether the Mexican economy under AMLO goes the way of Venezuela under Hugo Chavez or Brazil in the initial years of Lula’s presidency remains to be seen. Two areas that will surely be disrupted are energy and trade.
Yesterday, Mexicans voted resoundingly against the establishment by electing left-wing populist Andrés Manuel López Obrador (“AMLO”) as their next president. He will be sworn into office on December 1, 2018. This was the largest election in Mexico’s history, with some 3,400 federal, state and local races contested in all, so there will be changes at the federal, regional and local level.
ALMO’s victory is a political earthquake in a country where almost all voters alive today have never been governed by a president who was not either from the PRI or PAN, the two parties that have dominated Mexican politics for the past 89 years. Moreover, he could become Mexico’s strongest president in more than 30 years if it turns out that his MORENA party has captured a majority in both houses. Just like with the Macron election in France last year, the majority would give AMLO enough power to push through his plans with little interference.
Until the 1980s, Mexico was an inward-looking state ruled by a single party. Then, subsequent presidents undertook some transformative initiatives such as joining the global trade regime, privatizing state enterprises, creating the framework for transparent competitive elections, and other market-friendly measures that opened up Mexico’s economy and markets to the world. Those changes lifted Mexico from an economy dependent on oil exports to a manufacturing powerhouse with a rising middle class.
But the country’s improved prosperity has not benefited everyone equally, and economic growth has been modest. GDP has expanded at a tepid annualized rate of 2.5% over the past six years, inflation-adjusted wages have been stagnant, and the poverty rate has risen from 32% in 2006 to 39% last year. Foreign direct investment dropped from $3.9 billion in 2012 to about 500 million in 2017. And, because of rampant corruption, Mexico is now ranked 135th out of 180 countries in the corruption perception index of Transparency International, worse than Sierra Leone and alongside Russia and Paraguay.
At the same time, Mexico’s crime rate has spiraled out of control, leading some firms to pull out of the most affected areas. In May alone, nearly 2,900 people were murdered — roughly 4 victims per hour. There have been 13,298 registered homicides YTD, a 21% spike on the same period last year, and over 200,000 lives have been claimed by violence since 2007. The mere act of running for local office has been a death sentence for many. Since campaigning began in September 2017, over 130 political candidates have been killed, most commonly due to their unwillingness to comply with Mexico’s powerful drug cartels.
AMLO has vowed to tackle the poverty, violence, and corruption and to give more attention to the domestic economy. Some of his stated plans, such as building oil refineries and trying to achieve food self-sufficiency, signal a bigger economic role for the state going forward.
AMLO avers that he would lead a market-friendly government — without tax increases, new taxes or an increase in public debt — respect the independence of the central bank, and maintain the free-floating peso. During his tenure as Mayor of Mexico City from 2000 to 2005, he acquired a reputation as an economic pragmatist and fiscal hawk.
His proposals to fight poverty center on increased social spending and public investment, including a public-works program to employ 2.3 million young people, a plan to double the retirement pensions of the elderly, guaranteed food prices for small farmers, and subsidized gasoline prices.
AMLO intends to pay for all this, not by raising taxes, but with the $25 billion a year he will purportedly get by ending corruption, and $20 billion more a year he will save through an austerity plan. He aims to balance the budget in three years by scrapping government employee perks, ending inefficient social programs, and halving civil servants’ pay.
The estimated cost of these projects is about 2.5% of GDP. Expectations of success are mixed, but most economists are skeptical the sums add up, given that Mexico already runs a budget deficit that’s about 2.5% of GDP. Rafael Elias, an analyst at emerging markets investment bank Exotix, suspects “finances would be much less orthodox, public spending would balloon, current account would deteriorate, and perhaps we could even see a ratings downgrade as public finances worsen.” This scenario would lead to a weaker currency, falling FDI, capital flight and perhaps a recession. In other words, AMLO will likely face a choice between scaling back his promises or taking on debt, possibly damaging Mexico’s hard-won financial stability.
Not everyone is pessimistic. These optimists believe AMLO will transition from a redistributive candidate to a staunchly middle-class president who will soften his leftist stance. They draw parallels between him and Luiz Inácio Lula da Silva (“Lula”), Brazil’s former president. Lula too had radical leftist views prior to election, but reversed policies once in office, and ended up presiding over a business-friendly economic boom, albeit a short-lived one. But, skeptics point to differences between AMLO’s and Lula’s business experiences and philosophies that would suggest otherwise.
Whether Mexico ends up going the way of Venezuela under Hugo Chavez or Brazil in the initial years of Lula’s presidency remains to be seen. Two areas that will surely be disrupted under AMLO are energy and trade.
For decades AMLO has described Mexican oil reserves as the property of “the people,” meaning the government. He has also said that Mexico will have an “open door” for private investment in everything except energy. It is therefore highly likely that he will roll back energy reform. The oil tenders that began under Peña Nieto will be paused while more than 100 contracts are examined. Oil companies have so far put $4bn on the table, with as much as $200bn of investment to follow. But, this will probably be put on hold as well. The net effect will be less Mexican oil flowing into global markets. AMLO has also suggested that Mexico should re-build its oil refining capacity, a proposition unlikely to find private sector support.
AMLO maintains that he will continue negotiations to revamp NAFTA. He is expected to take a hardline position in areas like agriculture and manufacturing to gain credibility with his base, and has expressed a willingness to walk away from the talks if he feels Trump has gone too far. If that happens, he would have to quickly secure new partners, as trade agreements are a big reason for Mexico’s success. Notably, 81% of Mexico’s exports went to the United States last year. If NAFTA was torn up, Oxford Economics estimates that Mexico’s GDP would lose 4 percentage points by 2022 and fall into a technical recession by mid-2019. The Mexican peso would fall further to around 23 to 25 per dollar from its current value of 19.72 pesos per USD.
Mexico, with a GDP of $1.1 trillion, is Latin America’s second largest economy and the 15th largest in the world in nominal terms. The country has enjoyed an unprecedented period of macroeconomic stability, which has reduced inflation and interest rates to record lows and has increased per capita income. With this disruptive election result, the BIG question is whether the nation’s transformation into a modern, advanced democracy can withstand a six-year term under a leftwing government. Investors can take a bit of comfort in the fact that major economic reforms would have to be preceded by congressional votes or referendums. That would give market participants some time to evaluate their options before the grounds shifts further underneath them.
Investors can gain exposure to Mexico’s equity markets via the iShares MSCI Mexico Capped ETF (EWW). The ETF has underperformed the S&P 500 (SPY) by 12 percentage points since MRP’s April 2 DIBs report titled Mexico’s Economic Model Could Shift After July 1.
We’ve also summarized the following articles related to this topic…
Mexico: Leftist Wins Mexico Presidency in Landslide With Mandate to Reshape Nation
Andrés Manuel López Obrador was elected president of Mexico on Sunday, in a landslide victory that upended the nation’s political establishment and handed him a sweeping mandate to reshape the country. In building his third candidacy for the presidency, he cobbled together an odd group of allies, some with contradictory visions. There are leftists, unions, far-right conservatives and support from religious groups. How he will manage these competing interests remains to be seen.
Mexico’s president-elect has vowed not to raise the national debt and to maintain close relations with the United States. AMLO, has a history of working with the private sector, and has appointed a respected representative to handle NAFTA negotiations.
He has promised to review the contracts for oil exploration awarded to international firms, and to respect those that are clean — and take legal measures against those that are not. It is possible that the awarding of new contracts will cease, potentially placing Mexico’s future oil exploration and production back into state hands. From there, it is unclear whether Mr. López Obrador would hand the rights back to the nation’s state-run oil company, Pemex. For many, the future of the nation’s oil industry exemplifies the central concern of a López Obrador presidency: uncertainty. NYT
Mexico: Mexico’s Presidential Watershed
The leftwing Andrés Manuel López Obrador claims to have moderated his views but retains his zeal for the corporatist Mexico of the 1970s. With a six-year term he could reverse the progress this nation of 130 million has made to becoming a modern, advanced democracy.
AMLO has moderated his views in his third try for president. He has dropped his opposition to Nafta and talks about the need to continue Mexico’s economic progress. Yet AMLO remains a man of the left whose instincts are for state economic control. For decades he described Mexican oil reserves as the property of “the people,” meaning the government. He now says he’ll respect private contracts as long as he deems them fair, which implies political leverage over investment. And he says Mexico should aspire to be self-sufficient in agriculture and gasoline.
Optimists say he is following the playbook of Brazil’s Lula da Silva who was able to calm markets with the right talk and presided over a short-lived, commodity-led boom. But Lula gradually undermined central bank independence, openness to foreign investors and fiscal discipline. By the time his Workers’ Party left after 13 years, corruption was rife and Brazil endured a near three-year recession.
Even if his Morena party didn’t win a majority in Congress, AMLO would command significant power. He’d be able to name at least three members to the 11-member Supreme Court, four vice governors of the central bank and a new central bank governor in 2021. That would leave financial markets and trade agreements as the main checks on his power. WSJ
Mexico: Mexico’s presidential front-runner could shake up Trump and NAFTA
Mexico’s presidential election results bring a paradigm political shift to the country. AMLO is expected to shake up markets with a far less business-friendly approach than his competitors, and a much more aggressive response to Trump than his predecessor Enrique Pena Nieto.
For market watchers at emerging markets investment bank Exotix Capital, the left-winger spells trouble. “I am of the view that finances would be much less orthodox, public spending would balloon, current account would deteriorate, and perhaps we could even see a ratings downgrade as public finances worsen,” says Rafael Elias, an analyst at Exotix.
For NAFTA, Elias expects “a belligerent AMLO that would not hesitate to take a hard stance and could possibly derail the advances” of the current administration’s delegation. We could potentially see the negotiation process starting from scratch, as AMLO’s natural tendency “will be to try to use NAFTA as a way to gain credibility with his base by ‘not letting the gringos get the best of us,’” and by taking a hard position on areas like agriculture and manufacturing. He has also shown willingness to walk away from the talks if he feels Trump goes too far.
AMLO has previously been critical of NAFTA, and his popularity among farmers and the working class was further boosted thanks to his confrontational attitude toward President Trump. CNBC
Mexico: Amlo as Lula?
The parallel that many are reaching for, when thinking about Andrés Manuel López Obrador’s victory at Mexico’s presidential election, is Luiz Inácio Lula da Silva of Brazil. Like Amlo, as Mr López Obrador is widely known, Lula, as Mr Lula da Silva is known, came from humble beginnings. They had failed attempts to win the presidency before finally winning. Both also scared markets with their earlier radicalism There are perhaps three main differences, in so far as financial markets are concerned.
First, Lula’s economic boom, fed by the commodity price boom, eventually dissolved into a near-orgy of corruption. Amlo, by contrast, has made fighting corruption the signature theme of his campaign: any sign he is deviating from that would rob his administration of legitimacy.
Second, Lula sought to project his policies globally — indeed the corruption this spawned via the Odebrecht scandal has since proved one of his undoings. Amlo, by contrast, has stressed his primary focus will lie at home.
But perhaps the most important difference lies in their backgrounds. Lula was a trade union leader who often worked with business and knew what it means to have to deal with a payroll every month. That helps explain his willingness to work closely (arguably, too closely) with business. Amlo, by contrast, is a social activist, with little experience of business or how it works. FT