Mexico - Risk Assessment, February 2005
Roger Donnelly, Chief Economist rdonnelly@efic.gov.au
www.cia.gov
Risk profile
Trading with and investing in Mexico entails low-moderate risk of financial loss. Pluses are
reasonably strong policy and macroeconomic fundamentals, competent fiscal and monetary
policy, an independent central bank, a competitive and floating exchange rate, a generally sound
and well-regulated financial system, low single-digit inflation, a moderate external current
account deficit, and healthy FDI and remittance inflows. Handicaps are the economy's continued
susceptibility to an oil price downturn, large gross financing requirements in the public and
external sector, potentially problematic debt dynamics, a gridlocked political system and stalled
structural reform process.
Compared with its position at the time of the 1994-95 tequila crisis, Mexico is now a much
stronger and more resilient economy. It has investment-grade credit ratings, if low ones, and
pays correspondingly smaller spreads on its overseas borrowings, though these are likely to
increase when investor appetite for emerging market risk, currently at historic highs, inevitably
abates. The IMF believes that Mexico is generally well-placed to absorb adverse shocks' and is
well-protected against a sudden financial crisis'. It does, however, urge the government to
continue the process of crisis-proofing the economy to fully establish market confidence and
provide room for policy actions to buffer shocks.'
Political risk is rising in the lead-up to a presidential election scheduled for June 2006. No
one is seriously suggesting that the economy is likely to succumb to a crisis' in the currency
market as has happened so often in the past, in the last year of the government's six-year term of
office. But even the central bank governor has warned of increased financial volatility and
growth and inflation setbacks.
Moreover, just because Mexico now looks resilient to small and medium setbacks doesn't
mean it would withstand a large knock. The hallmark of a high investment-grade country is
its ability to withstand such a large knock. Mexico doesn't look to have attained such status yet.
According to IMF debt sustainability assessments, public sector debt sustainability remains
vulnerable to worsening of economic conditions and fiscal consolidation delays; under no
scenario does the current 50%-of-GDP public debt ratio fall rapidly. Similarly, Mexico's
external situation would worsen dramatically' upon a steep peso depreciation or a combined
GDP/interest rate/ exchange rate shock. If markets did begin to entertain doubts about Mexico's
solvency, their dumping of Mexican assets could quickly precipitate a liquidity crisis, given the
economy's large gross fiscal and external financing requirements. The fiscal need in 2005
is almost 7% of GDP (or US$52b), and the external one, 12% of GDP (or US$83b).
Some recent large corporate bond defaults and episodes of financial difficulty probably
reflect individual credit risk problems rather than systemic credit risk. That at any rate is
the view of the IMF, ratings agencies and other market participants.
Risk outlook
One development spelling increased risk would be a fraying of the political consensus in
favour of fiscal consolidation, especially if this coincided with a major oil price downturn.
Current fiscal performance is being boosted by windfall petrodollar revenues, but too much of
this revenue is being spent, not saved. In the event of an oil price downturn the authorities could
have difficulty winding back spending (see below). Their task would be made especially
difficult if opposition parties decided to thwart fiscal adjustment in Congress, as part of
electioneering for the 2006 presidential race. (There is already an element of this; see below.)
The risk profile would improve if the authorities stepped up their fiscal consolidation
efforts and restarted the structural reform process. Neither of these things looks in prospect,
however.
Economic performance and credit indicators
2003
2004
2005f
Real GDP growth, %
Real GDP per capita, %
CPI inflation, %
1.3
-0.2
4.0
4.4
3.0
4.3
3½ - 4½
2.1 - 2.8
3.8
Consolidated fiscal balance, % GDP
Gross public debt, % GDP
Public foreign debt service/exports, %
-3.1
51
17
-3.1
49
11
-2.6
49
13
External current account balance, % GDP
Foreign debt/exports, %
Gross official reserves/short-term foreign debt, %
-1.4
140
164
-1.1
118
157
-1.3
114
156
Source: IMF
Recent risk developments
The economy entered an upswing last year after three years of stagnancy. Real GDP grew
by around 4.4% in 2004 and is expected to grow between 3½% and 4½% in 2005.
Credit rating agencies have recently been upgrading Mexico in recognition of fiscal
consolidation, debt restructuring and improved external liquidity. Moody's raised the
country's foreign debt rating to Baa1 from Baa2 on 6 January, putting it on par with Chile.
Standard & Poor's followed suit on 31 January with an upgrade to BBB from BBB-. Moody's,
Standard & Poor's and Fitch all promoted Mexico to investment grade in early 2002.
Meanwhile, international capital markets have been supplying Mexico with credit at record
low cost. The government was able last month to sell US$1b of 10-year bonds at only 145 basis
points above the benchmark US 10-year note. The government will use this money to refinance
debt at low yields before US interest rates rise. It is also using proceeds from 2004 bond issues
to pre-fund 2005 financing requirements.
Income remittances to Mexico have been growing in leaps and bounds recently, providing
the country with a welcome cushion against oil price volatility. According to the central
bank, remittances, mainly from Mexicans working in America, totalled US$16.6b in 2004, which
represents a doubling since 2000 and a 24% jump from 2003. This money flow now constitutes
about 2% of GDP.
As a net oil exporter, Mexico has benefited from recent high oil prices, but has managed
the windfalls poorly. Best practice demands that governments save windfalls for the inevitable
rainy day when prices slump. In that way they damp rather than amplify the economy's business
cycle and minimise the risk of financial strains appearing when revenues decline. Yet the current
administration has been guilty of excessive petrodollar spending. Notice, for instance, how in
the table above there has been no improvement in the fiscal balance during the oil price rally.
This improvidence has made its fiscal position vulnerable to an oil price fall. Even if oil prices
do not decline sharply, significant spending compression or tax increases will be needed to meet
medium-term budget targets, according to the IMF.
Following an export pickup in 2004, concerns have eased about slow export growth and a
slide in Mexico's share of the US market. A rapidly growing Chinese share of the US market
in 2002-03 had led to fears that Mexico was being out-competed. But closer investigation
suggests different factors responsible for the growing Chinese share and dwindling Mexican
one. Much of China's gain seems to be the result of Japanese firms moving production to China
particularly after China's accession to the WTO. Whereas Mexico's losses have been in the small
and mid-sized car market, which was relatively weak during the US downturn, and in toys,
garments and electronic products, from which production has migrated to lower-wage countries,
often in Central America. Besides, in 2004 there was a strong revival, spearheaded by exporters
specialising in just-in-time delivery.
Because of a stalled reform process, the medium-term growth outlook is poor. The reason
for the standstill is a deadlock between the administration of President Vicente Fox and
Congress. Fox's party, the centre-right Partido Accion Nacional (PAN), lacks a majority, in
Congress, and this body is currently blocking passage of his 2005 budget. In addition, it is
holding up his structural reform agenda, including liberalisation of the energy and labour markets
and comprehensive tax reform. Since the tequila crisis the political system has become so
fragmented that no administration can look forward to support from Congress. The result has
been what the consulting firm Oxford Analytica calls permanent gridlock; a state that will only
be overcome by fundamental political reform. However, the consensus needed to effect such
change is currently lacking. Meanwhile, forecasters such as the IMF see at best only lacklustre
medium-term growth of around 3% pa. Worse, they worry that if a trend of deterioration in
productivity growth continues, GDP growth could turn out to be only around 2% pa, barely
above population growth of 1.4% pa.
Rating comparisons
Both the OECD and ratings agencies give Mexico low investment-grade credit ratings.
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The OECD rates Mexico 3 out of 7. This is one notch below Chile but on par with India,
Saudi Arabia and Tunisia.
Ratings agency Moody's gives Mexico a long-term foreign currency rating of Baa1, its
third- lowest investment grade. Corresponding ratings from Standard & Poor's are BBB
(second-lowest investment grade), and from Fitch, BBB- (lowest investment grade).
Moody's assigns an average financial strength rating of C- to the 10 Mexican banks it
rates, representing 85% of banking system assets, suggesting adequate intrinsic strength.
This rating puts Mexico just behind Bahrain and Chile, and just ahead of South Africa
and Thailand. The presence of major foreign banks with around 75% market share is a
key positive element, Moody says.
Other ratings portray a country with a high degree of political and economic freedom, but
with only a middling business and investment climate. Particular rating handicaps are
political instability, corruption and legal/regulatory uncertainty.
Organisation/indicator
Mexico's score/ranking
World Economic
Forum/Growth
Growth competitiveness ranking in 2004 of 48 out of 104
countries. Down from 47 in 2003
competitiveness
Institute for Management
Development/
Competitiveness
World competitiveness ranking in 2004 of 56 out of 60
countries/regions. Down from 53 in 2003
World Bank/ Governance Ranked in second top quartile of surveyed countries for democratic
accountability, government effectiveness, political stability, rule of
law and control of corruption. However, only just in the second
quartile (above the 50 percentile line) for political stability, rule of
law and control of corruption.
Heritage Foundation/
Economic freedom
Economic freedom rating in 2005 of 2.89 on 1-5 scale (5 worst),
meaning `Mostly Free'.
Freedom House/ Political Placed in the Free category 2 for both political rights and civil
freedom
liberties on a scale of 1 (Free) to 7 (Not Free).
Transparency
International/ Corruption
Corruption perceptions index in 2004 of 6.4 on a scale 10 ('highly
clean') to 0 ('highly corrupt'). Corruption ranking is 64 out of 145
countries.
Roger Donnelly
Chief Economist
rdonnelly@efic.gov.au
Disclaimer
This Country Risk Assessment is published for the general information of EFIC's clients and
associates. It is not intended as advice and readers should rely on their own inquiries in relation
to matters discussed. While EFIC endeavours to ensure it is accurate and current at the time of
publication EFIC accepts no legal liability for loss suffered by any person arising from any act or
failure to act on the basis of information and/or the opinions contained in it.
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