Download Mexico 2016-04

SEB MERCHANT BANKING – COUNTRY RISK ANALYSIS
April 20, 2016
Analyst: Martin Carlens. Tel: +46-8-7638392. E-mail: [email protected]
The Mexican economy’s exposure to the US economy and to the poorly performing oil giant Pemex
have governed developments in the past year. Strong household spending helped to achieve a
moderate economic expansion. Despite a strong economic policy framework, the government faces
great challenges in getting the fiscal house in order.
Country Risk analysis
Summary
Economic growth surprised on the downside in 2015. While the GDP expansion of
2.5% is roughly in line with the average pace of the past 10 years it is significantly
slower than most countries in the region, and rating peers. Growth forecasts for
the near and medium term have been revised downwards recently.
Modest growth and low volumes of oil production due to under investment
contributed to a further widening of the general government budget deficit in
2015. Following cuts in the 2016 budget last year, the government announced
new, additional expenditure cuts in early 2016. Most of these savings are to come
from the state-owned oil company Pemex which reported a record loss in 2015.
On the external side, the country’s current account balance has been in deficit to
the order of 1.5% of GDP on average during the past 10 years. In 2015 it rose to
2.8% mainly due to the oil trade balance but is still broadly covered by foreign
direct investment and remittances. Foreign exchange reserves declined in 2015
following central bank interventions to limit a depreciation of the currency. By the
end of the year, they were equivalent to about 6 months’ imports. Financial
market sentiment which deteriorated in early 2016 has stabilized following the
coordinated tightening of monetary and fiscal policies announced in February.
Following local elections in 2015, the ruling Institutional Revolutionary Party has
an absolute majority in the lower house. However, approval ratings are low and
few observers expect any meaningful new structural reforms in the running up to
the elections in 2018.
Moody’s changed the outlook for their sovereign credit rating from stable to
negative in March 2016 citing risks to the government’s fiscal consolidation plans
and rising contingent liabilities from the state-owned oil producer Pemex.
Moody’s had earlier also been quick to raise their outlook.
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April 20, 2015
Recent economic developments
Modest economic growth: The economy has been expanding at an average pace
of 2.5% in the past ten years. This is a significantly slower than most countries in
the region, and rating peers. In this respect, 2015 was no exception as GDP hit the
average rate spot on. The growth engine switched from exports to mainly
household spending as consumers were supported by healthy real wage
increases. Meanwhile, government spending was held back by budget cuts due to
continued low oil production.
Inflation edging up. With plenty of spare capacity in the economy inflationary
pressures has remained muted. Low commodity prices together with falling
electricity and telecoms prices (following reforms in the sector) helped to contain
headline inflation at 2.4% last year, lower than in 2014. The pass-through from the
weakening exchange rate has been limited, far from the experiences of Chile and
Colombia for example. In the past months, however, inflation has edged up to just
below 3%.
External deficit slightly worse due to oil... Mexico’s economy is relatively open
with exports making up roughly 30% of GDP. Trade is dominated by exports to
the US which take 80% of the total. Almost a third of this is related to cars. With
non-oil products making up most of the trade, low oil prices have only had a
limited impact on the balance of payments. The country’s current account balance
has been in deficit to the order of 1.5% of GDP on average during the past 10
years. In 2015 it rose to 2.8% from 1.9% 2014 mainly due to the oil trade balance.
Normally, Mexico has a surplus in oil trade but this shifted to negative last year.
…but is easily financed. The deficits on the current account are easily financed as
they are normally covered by foreign direct investments of the same magnitude.
On top of that comes remittances which recently have become more important
than oil exports. By the end of 2015 gross external debt was estimated at 43% of
GDP (Oxford Economics), implying a continued small rise.
Weaker peso. The exchange rate
depreciated by more than 20% against
the USD in the year up to February
2016 broadly reflecting the decline in
global oil prices and concerns that it
would hurt public finances. The
tumble was less in real effective terms.
Following the central bank’s interest
rate hike in early 2016 (see below), the
currency has strengthened.
Reserves declined on interventions.
Foreign exchange reserves declined
during 2015 following central bank
interventions to limit the currency’s depreciation. By the end of the year, they
were equivalent to about 6 months’ imports, but have since edged up to USD 177
bn. Mexico’s two-year Flexible Credit Line (FCL) from the IMF approved in
November 2014 provides an additional buffer. The country has access to about
USD 65 bn.
Downgraded sovereign outlook. Moody’s changed the outlook for their
sovereign credit rating from stable to negative in March 2016 citing risks to the
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April 20, 2015
government’s fiscal consolidation plans and rising contingent liabilities from the
state-owned oil producer Pemex.
Economic policies
Strong fiscal policy framework but high reliance on oil. Mexico’s strong fiscal
policy framework is often highlighted as a key factor that contributes to strength
and credibility of the sovereign. The framework was recently revised with a new
law requiring that 70% of the annual profits delivered to the government from the
central bank should be used to repay debt. The main challenge that repeatedly
puts the framework to the test is the state-owned oil giant Pemex. About 20% of
all government revenues come from the oil sector. Although declining, this may
seem high compared to the fact that the sector represents less than 6% of GDP.
This reflects the relatively low tax take from other parts of the economy, partly
due to the large informal sector.
Small deterioration in budget balance. Modest economic growth and fiscal
stimulus contributed to a further widening of the general government budget
deficit (defined as non-financial public sector) to 3.5% of GDP last year. Budget
revenues have been lower, and the deficit higher than expected, mainly due to
lower oil production volumes on the back of chronic underinvestment. We believe
it may be difficult to reduce the deficit in the near-term as planned by the
government. The government targets the public sector borrowing requirement
(PSBR) which actually fell from -4.6% of GDP to -4.1% in 2015.
Policies are adapting to lower oil production and prices. Following cuts in the
2016 budget last year, the government announced new expenditure cuts worth
0.7% of GDP in early 2016. Most of these savings are to come from Pemex which
reported a record loss in 2015. A new round of public capitalisation has also been
announced to ease the company’s liquidity pressures. These measures are positive
and since the funds stem from profits recently delivered from the central bank
they will not impact the government’s balance sheet. However, they will do little
to improve the poor fundamentals of the indebted company and the strong
political interests that surround it.
More adjustments are likely. Pemex pension liabilities of more than USD 80 bn
and its financial debt of over USD 90 bn reflect that the latest cash injection of
about USD 4 bn is a drop in the ocean. The company’s dire situation is likely to
remain among the government’s main fiscal and economic challenges in the short
and medium term. On balance, we expect that the government will have the
flexibility to handle Pemex difficulties while broadly getting its fiscal house in
order by 2018 as planned, but it will be a challenge.
Government debt edging up.
Moderate growth and a continued
primary deficit in 2015 caused the
government debt as a share of GDP to
rise to about 48%. We expect it to
continue up in 2016 and risks are
rising that the debt will not stabilize
as early as expected.
Monetary policies reacting to weak
exchange rate. After largely focusing
on achieving an orderly peso
depreciation through foreign
exchange interventions, the central
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April 20, 2015
bank started raising interest rates in late 2015 and continued to bring rates further
up to 3.75% in early 2016. It also switched from a rule-based scheme for FX
interventions to a discretionary one. Fears that the depreciated currency would
feed through to higher inflation was the chief argument. Inflation has been rising
recently and at 2.9% it is close to the midpoint of the bank’s inflation target range
of 3+-1%.
Banking system is relatively small and sound. The IMF recently judged the
commercial banking system sound, profitable and well capitalized with the
average capital adequacy ratio standing at about 15% by end-2015. Nonperforming loans declined in 2015 from already low levels. The small overall size
of the Mexican banking sector, with total assets equivalent to less than half of
GDP, means that the government could provide support for banks without risking
putting finances in an unsustainable position.
Political situation
Following local elections in 2015, the ruling Institutional Revolutionary Party won
an absolute majority in the lower house. However, corruption related issues and
the subdued economic growth have led to low approval ratings for President
Pena Nieto who is now in his second term. Few observers expect any meaningful
new reforms in the running up to the elections in 2018.
Outlook
The near-term forecasts for the
Mexican economy hinge crucially
on what you envisage for the US, in
particular its manufacturing
industry. We see activity humming
along at slightly above the average
pace in 2016 and 2017. Consensus
expectations for near-term growth
have been revised downwards
slightly recently, partly as a
consequence of the outlook in the
US but mainly due to increased
fiscal tightening.
Longer-term growth expectations
slightly lower. Mexico’s structural reform agenda is expected to raise trend
economic growth. Reforms to the labour, energy and education sectors should
increase competition and boost productivity, factors that have been putting a limit
on growth. However, at this time most observers have also cut their forecasts for
longer-term GDP growth, mainly as a consequence of increased fiscal tightening.
Downside risks to our medium term scenario include a worse than expected
performance of the US economy and a steeper slowdown in China. That would
put a break to Mexican growth by hitting exports. We also see a risk coming from
the fiscal consolidation measures announced recently. They may well have a
larger adverse impact on domestic demand than we assume. A final risk would be
a sudden shift in global financial market sentiment towards higher risk aversion.
The Mexican peso is among the most traded currencies in the emerging market
sphere, and reacts quickly to changes in global risk sentiment.
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How to read the chart?
Moving out from the center
reduces risk.
Resilience
Macro
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Absence of
Event Risk
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Disclaimer
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The information in this document has been compiled by SEB Merchant Banking, a division
within Skandinaviska Enskilda Banken AB (publ) (“SEB”).
Opinions contained in this report represent the bank’s present opinion only and are subject
to change without notice. All information contained in this report has been compiled in
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