Solid Fundamentals Key to Mexico’s Long-Term Economic Potential
Art by Alex Eben Meyer
So how is Mexico, long-time whipping boy of a US president and home to vicious drug gangs, doing on the economics front? Surprisingly, better than you’d expect.
Yes, no one seems to think that the recently concluded agreement to replace the NAFTA trade pact is a boon to Mexico. Apart from a perceived tilt of the US-Mexico-Canada Agreement toward the United States, America’s neighbor to the south has plenty of other problems, ranging from crime to poverty. And President Donald Trump remains adamant on building a border wall to keep out Mexican immigrants, who he deems undesirable, an affront to Mexico’s pride.
Plus, in spite of the new trade deal, Trump has not yet lifted the duties on steel and aluminum that he imposed on Mexico (and Canada). What’s more, the new pact mandates that 45% of new autos made in the three nations must be where workers earn at least $16 an hour, far above the going Mexican rate. That could crimp manufacturing employment south of the border.
Given all that, why should investors be upbeat about Mexico and its economy? “It’s a really well-run country, with a moderate pace of expansion,” said Phil Torres, global co-head of emerging markets at Aegon Asset Management. “Mexico will be able to produce more middle-class jobs with higher wages and employment.”
Today, Mexico benefits from a strong central bank, lower dependence on oil exports, and a more diverse economy—virtues that should aid its growth over time.
Indeed, its stock market has held up fairly well as other emerging market equities have been flagging, and that’s even before last week’s global rout, led by plunging US shares. The MSCI Mexico index is down just 0.66% this year, versus much worse for most other EMs; the MSCI index for the whole emerging category is off 16% in 2018. Alone among major EMs this year, Mexico can boast that its currency has grown in value in relation to the US dollar.
Mexico, the world’s 15th-largest economy at $1.2 trillion, has successfully dragged itself out of two slumps over the past 10 years: the 2008-09 worldwide Great Recession and a 2015-16 dip attributed to the collapse of oil prices and other commodities. Economic growth of around 2% hasn’t been spectacular, but at least gross domestic product has remained positive, unlike Latin America’s No. 1 economy, Brazil, which suffered two years of shrinkage.
Certainly, accelerated economic progress could help Mexico meet its many remaining challenges. It remains a very poor country, with a 46% poverty rate. Moreover, income inequality is stark: The wealthiest 10% of Mexico’s population earns 20 times more than the poorest 10%, while the average figure for peer OECD nations (which includes Chile, Greece, Hungary, and Turkey) is eight times. In the US, it’s around 10 times. NAFTA did little to move that needle, although the North American Free Trade Agreement did create numerous relatively well-paying manufacturing jobs in Mexico’s north.
Meanwhile, crime is a major concern. Overall, the crime rate is only slightly worse than in the US, but Mexico’s violent crime is five times as bad, with a murder rate of 218 per million people. The drug cartels are a significant force, and the government has been fighting them for more than a decade, with only small results. This past year, the drug lords killed dozens of officials and politicians in an evident bid to gain a better foothold in government with their own candidates.
Politics and economics intersect in Mexico, which can be good or bad. The election of Andrés Manuel López Obrador, due to take office Dec. 1 as the new president, was owing to popular discontent over tepid economic growth and widespread government corruption. Foreign investment has been robust, although it flagged a bit over the last couple of years likely because of fear that the Trump administration would harm Mexico by canceling trade preferences. That threat, thanks to the survival of the trade entente, has apparently passed.
AMLO, as the incoming president is known, is an avowed leftist, yet he has said he wouldn’t monkey with the country’s capitalist underpinnings—such as, in recent years, lightening regulation of the telecom and energy sectors, and permitting foreign investments there. He has pledged to boost investment in the state energy companies and infrastructure, and hike social spending without pumping up budget deficits or expanding public debt.
The central bank is now solid. López Obrador also has promised not to interfere with the operations of the Bank of Mexico. The low point for the institution came in 1994, during the so-called Tequila Crisis, when its actions helped sink the peso and touch off hyper-inflation. That same year, it won independence from the executive branch.
These days, the central bank is widely regarded as a paragon of monetary prowess. “They do a very good job,” Aegon’s Torres said, noting the extensive renown of its former chief, economist Agustín Carstens, who served as head of the Bank of Mexico from 2010 to 2017, and now leads the Bank for International Settlements.
Starting under Carstens, the central bank has been jacking up interest rates to keep inflation at bay and shore up the peso. Inflation, reaching a 17-year high of 6.8% in 2017, now stands at 4.9%. The bank is considering further monetary tightening.
The economy is less dependent on the volatile oil sector. Time was, Mexico depended on oil exports, courtesy of its state-owned oil company, Pemex. Naturally, whenever volatile oil prices crashed, the entire economy took a body blow. Those days are gone, although oil remains a major factor in the economy.
The Brookings Institution found in a report at the end of 2016 that the oil bust had hindered Mexican economic growth, but hardly devastated it. While Mexico at the time was “significantly affected by low oil prices,” Brookings said in the report, the impact on GDP growth was “limited because oil production is only one component of a more diversified economy.”
Oil now makes up about 6% of GDP, down from 13% in the mid-2000s, an OECD study noted. In addition, Mexico has embarked on a sophisticated hedging strategy to mitigate the effect of petroleum price gyrations.
The economy is more diverse and manufacturing export-driven. NAFTA has been a primary driver for that. The lure of cheaper Mexican labor has enticed many US companies to open plants south of the Rio Grande, and transfer American jobs there. Outrage over that helped elect Trump, who has badgered US companies like air conditioner maker Carrier to trim plans to decamp to Mexico.
The proximity of the US market led to the creation of a manufacturing belt along the American border. In 1990, the US accounted for 69% of all Mexican trade. And by 2000, that had risen to 80%, where it remains roughly today. Mexicans now labor in factories dedicated to autos, aerospace, machinery, and electronics.
“Mexico is a good place for investors,” said Sylvia Jablonski, managing director of capital markets at Direxion. If that continues to be true, then maybe some of Mexico’s downsides will diminish.