AMLO’s Choice – Investors or Voters

February 22, 2019

President Andrés Manuel López Obrador (AMLO) promised voters he would increase government spending on social programmes and infrastructure, without raising taxes. However, his administration will not be able to keep these promises without jeopardising Mexico’s financial stability. It is very likely that the new administration will favour macroeconomic stability over financial profligacy during his first year in office. Despite this, the economy will slow down during 2019 amid increasing uncertainty over AMLO.

Financial constraints notwithstanding, AMLO will increase social spending, particularly on his most popular campaign pledges, such as social aid for the elderly and for impoverished students. His administration will also have to devote increasing effort to restoring market confidence during his first year in office, which has fallen following an illegitimate popular vote on the future of the New Mexico City International Airport (NAICM by its Spanish acronym).

AMLO’s fantasy

During his inauguration speech, AMLO blamed neoliberal policies for Mexico’s economic shortcomings over the past two decades, alleging that these have led to greater economic inequality. AMLO affirmed that he will combat poverty and increase economic opportunities for the disenfranchised by increasing public spending on social programmes and infrastructure projects in marginalised regions. AMLO’s social programmes include raising pensions for the elderly, increasing funds for students in public schools and for citizens with disabilities. Additionally, AMLO pledged to open 100 public universities to ensure universal higher education. They are popular initiatives but they will amount to extra public spending of around 1.5% of GDP, according to the Mexican Executive Institute of Finances (IMEF).

These social programmes come on top of AMLO’s ambitious infrastructure projects, including a tourist train in the Yucatán peninsula (Yucatán, Campeche, Quintana Roo, Tabasco and Chiapas states), a freight train connecting the ports of Salina Cruz (Oaxaca state) in the Pacific Coast and Coatzacoalcos (Veracruz state) in the Gulf coast, and a refinery in the municipality of Dos Bocas (Tabasco state). It’s estimated these infrastructure projects will cost more than $17billion.

Following his landslide election victory on 1 July, AMLO enjoyed a brief honeymoon with the markets…

Funding these pledges would have a significant impact on Mexico’s federal budget forcing the government to increase taxes or run fiscal deficits. Both options are unappealing for AMLO – raising taxes would be unpopular with his support base while running fiscal deficits would have adverse financial repercussions that could unleash a crisis of confidence with the markets. Despite improvements during the administration of former president Enrique Peña Nieto (2012-18), Mexico remains an inefficient tax collector. The latest figures by the Organisation of Economic Co-operation and Development (OECD) show that the country’s tax revenues represent only 17.2% of GDP; compared to the average of 34.3% for industrialised countries. AMLO’s reluctance to promote meaningful fiscal reform over the next two years will prevent him from delivering the public spending increases to that he promised on the campaign trail.

Winning back investors

Following his landslide election victory on 1 July, AMLO enjoyed a brief honeymoon with the markets. He kept a moderate stance on his prospective policies upon taking office, focusing on maintaining sound macroeconomic indicators and a business-friendly environment. However, this changed dramatically following an illegitimate public consultation vote on 28 October, which resulted in the announcement of the cancellation of the NAICM project. Market reaction was overwhelmingly negative amid perceptions that given his strong mandate, AMLO would pursue a more populist political agenda and would overlook financial consequences. The Mexican peso devalued sharply following the vote and has struggled to recover since. Uncertainty over the future of the NAICM continues as bondholders of the project in early December opposed a government buy back offer to proceed with the project’s cancellation. Construction works remain underway and the government would face severe penalties if it unilaterally cancels contracts awarded to companies for the NAICM instead of reaching a deal with investors and bondholders. The International Monetary Fund (IMF) in early October lowered its growth prospects for Mexico for 2019, from 2.7% in July to 2.5%.

The Mexican peso devalued sharply following the vote and has struggled to recover since….

Following the negative reaction AMLO has taken a number of measures to try to restore market confidence. He made important changes and additions to his cabinet to allay fears among the financial community, such as appointing reputable economists Jonathan Heath and Gerardo Esquivel to the board of Mexico’s Central Bank (Banxico). These appointments, together with Finance Minister Carlos Urzúa’s commitment to fiscal prudence have helped assuage fears that AMLO could mishandle Mexico’s finances or undermine the autonomy of Banxico in order to fund his proposals. Nonetheless, AMLO’s administration will need to do more in order to restore confidence in his economic agenda, such as promoting more business-friendly measures for underdeveloped sectors such as infrastructure. Credit ratings agencies will remain wary of AMLO’s policies and will scrutinise the 2019 federal budget that was presented on 15 December. Ratings agencies will pay particular attention to the administration’s assumptions on several indicators that influenced the composition of the budget, such as inflation targets, oil prices and the exchange rate. In late October ratings agency Fitch downgraded Mexico’s sovereign outlook to negative from stable following the NAICM public consultation vote.

A competitive, challenging market

Investors shouldn’t worry too much. AMLO will not implement a radical reformist agenda that would greatly undermine Mexico’s dynamic business environment. Nonetheless, specific sectors will be adversely impacted by statist and populist measures, particularly the energy, mining and infrastructure industries. Mexico will remain an export-oriented economy, and growth will continue in the high-end manufacturing sector, particularly in the automotive and aerospace industries following the signing of the US-Canada-Mexico Agreement (USMCA) on 29 November. Certain proposals promoted by AMLO will have positive effects on the economy, such as the proposed increase in the minimum wage – currently the fourth lowest in Latin America, only above that of Cuba, Nicaragua and Venezuela – from MXN 88 per day ($4.3) to MXN 176 ($8.7) per day by 2024. Proposed wage increases in sectors such as mining and light manufacturing will also contribute to a rise in domestic consumption and the development of Mexico’s internal market. AMLO will continue to promote these types of policies as he believes that the country’s economy is too dependent on exports. Nonetheless, certain sectors will experience setbacks under AMLO, most importantly the energy sector, which was opened up to foreign investment in 2013 following a constitutional reform. Tenders and auctions for the oil and gas and electricity sectors have been cancelled or postponed. In early December, AMLO’s hawkish Energy Minister Rocío Nahle, declared that further auctions for oil and gas exploration blocks would be cancelled for at least three years. Meanwhile, the planned fourth electricity auction was indefinitely postponed in late November. These developments will reduce the foreign investment needed to overhaul Mexico’s energy sector. However, AMLO’s administration has taken steps to reassure investors already in the country, mainly by affirming that a wave of contract cancellations will not occur.

The mining industry will also experience setbacks under AMLO as he will promote stricter social impact studies for mining concessions – these could be politicised, as the Mexican Geological Service (SGM) will be the institution in charge of carrying out these studies. Security challenges will also remain for businesses operating or seeking to operate in Mexico. AMLO inherited an adverse public security environment, with the murder rate reaching a record high in 2018 – 24 murders per 100,000 inhabitants. The rise in other types of crimes such as fuel and cargo theft will also represent noteworthy concerns for businesses. Yet despite these challenges, security will not represent an insurmountable challenge for businesses in the country. The next few months should give us a telling indication of the direction Amlo will take over his six-year presidential term.