Mexico’s underperforming economy has been covered here before. But those posts addressed long-term, structural impediments to Mexico’s ability to develop a modern economy with a higher growth rate. Notably, those posts did not address the most commonly cited ‘structural’ flaws in emerging market economies: fiscal irresponsibility, currency interventions, protectionist trade measures, etc. (think Argentina).
Indeed, as mentioned in the past post on FDI, by most measures Mexico has closely followed all of the standard macroeconomic recommendations issued by the World Bank, IMF, OECD, etc. The recent reforms were meant to address the major remaining areas where it supposedly fell short, even though the concrete benefits of following these policies have not always been apparent.
But now it seems Mexico is sailing into a storm – not entirely of its own making – that could severely damage the economy and influence political developments over the next several years. There are a number of causes:
- Shrinking oil production has driven a contraction in mining output, hitting GDP growth
- The dramatic fall in commodities prices has weakened the peso, but a slowdown in the US economy has precluded an increase in now-cheaper Mexican exports
- The commodities bust + an unrelated drop in investments in the oil industry means Mexico’s energy reform will do little to reverse declining oil production (even best-case scenarios inspire skepticism)
- Weak growth in fixed investments = no local stimulation of the economy
- A likely increase in the interest rate by the US Federal Reserve will further weaken the peso and funnel capital out of Mexico and into the US
- Mexican companies are sitting on a massive amount of foreign, USD-denominated debt, which becomes more expensive to service as the peso falls against the USD
Corporate Debt Bomb
It is difficult to overstate the importance of the last point: companies traded on the Mexican stock exchange have nearly doubled the volume of foreign-held debt in the last five years, and have rapidly increased borrowing over the past year. Moreover, as the graphs (source) below illustrate, the volume of this debt reaching maturity will spike over the next few years:
Of course, it will be more difficult to refinance these loans or seek new sources of cash in light of the conditions outlined above. Based on the graphs, about 26 percent of the Mexican private sector’s USD 105 billion in foreign debt will mature between now and 2018. Moreover, the instability that would prevent Mexican businesses from obtaining financial lifelines would likely also result in a general ‘fleeing’ of hot money from Mexico to the safe haven up north. It is also worth noting that 35 percent of Mexico’s public debt is held by foreign investors.
Corporate Bankruptcies = What Impact?
It is unclear how a wave of corporate bankruptcies would affect Mexico. The most indebted companies are on the stock market, which constitutes around 44 percent of Mexico’s economy. But the majority of Mexicans work in smaller, unlisted companies, or in the informal economy. In some ways, the large size of Mexico’s informal economy arguably benefits the country by acting as a buffer against financial ‘contagion’ from overleveraged enterprises. Still, a series of high-profile bankruptcies would have an extremely negative impact on Mexico’s perception as an investment destination, and could stimulate a vicious cycle leading to additional failures.
Political and Economic Implications
Perhaps the most substantial impact will be felt in the area of politics and governance. A weakening of the economy transitioning into a full-fledged crisis would likely influence the outcome of the 12 gubernatorial elections next June, as well as the presidential election in 2018. Specifically, there would be an increased chance of Andres Manuel Lopez-Obrador’s Morena party of establishing itself as a national political force in next year’s elections, and perhaps delivering the grand price to AMLO himself in 2018 (coincidentally, he is currently leading polls among other likely candidates).
At the same time, the gaps in employment and financing caused by a debt crisis would be filled by the informal sector, which roughly correlates with increased influence among organized criminal groups, such as narcotraffickers.
In terms of economic development, a crisis would not fundamentally alter Mexico’s role as one of the USA’s main source of manufactured goods. It could, however, potentially cause severe damage to Mexico’s role as a major energy-producing country, perhaps making the decline in oil production irreversible. It is debatable whether such a fate would consign Mexico to its middle class ‘stall’ or spur the country to modernize its economy without the luxury of petrodollars.
The Mexican government’s ability to intervene on behalf of private companies is limited, and it will probably have no choice but to play the part of observer when it comes to private entity failures. But, the government could undertake some measures to try and stimulate the economy and make up for the shortfall in increased exports and local investment.
For example, the government could increase spending on infrastructure. One selfish idea of mine is for the government to gift new, low-cost cars (e.g., Tata Nano) to all residents of the Mexico City area in exchange for older, higher-emissions vehicles (the ‘Oprah Solution’). Indeed, the federal government could buy a new car for all 350,000 residents affected by recent bans on Saturday-driving by older vehicles for USD 1.05 billion; compare to the USD 9 billion in budget cuts planned this year.
Nonetheless, the current administration has adopted a zero-based budgeting approach for 2016, which will complicate efforts to increase public expenditures, and likely result in greater cuts. It is unclear how the government expects to encourage economic growth with reduced public expenditures in an environment of depressed private investment, potential private sector failures, and low consumer confidence. Of course, if all else fails the Mexican government may be able to seek a bailout from the United States Government like it did during the ’94-95 Tequila Crisis, but they better hope that the US President’s name doesn’t rhyme with ‘pump’.