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COLUMN-Mexico's reversal of fortune

Source: Reuters - Fri, 17 Jan 2014 16:58 GMT
Author: Reuters
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(The opinions expressed here are those of the author, a columnist for Reuters.)

By Gary Regenstreif

Jan 17 (Reuters) - In Latin America, this looks to be the year of Brazil - thanks to the impending World Cup and presidential elections. But with another lackluster year looming in emerging markets, fans of transformation, growth and investment potential should instead look to Mexico.

Brazil's president, Dilma Rousseff, is expected to win a second term this year, and its soccer team stands a good shot at victory. But growth has slowed considerably. In the world's seventh largest economy, reforms are stagnating and the country faces a possible ratings downgrade.

Mexico, by contrast, is in the throes of serious reforms. It will likely lead Latin America with at least 4 percent growth this year and an improving investment outlook. Standard & Poor's recently boosted Mexico's credit ratings because of energy reforms that the rating company trumpeted last month as a "watershed moment" for the country. It is becoming a story of inverted fortunes, as Michael Shifter and Cameron Combs of the Inter-American Dialogue recently wrote.

After years of stagnation and violence, a new reform government is positioning Mexico for significant growth. It should leave many emerging markets, including fellow Latin American economic power Brazil, in its wake. Jobs are increasing, inflation is lower, growth is higher and the returns on Mexican equities are multiples of what they have been in Brazil.

"Mexico may quickly swing from the region's worst to best performer," emerging markets economist David Rees from Capital Economics wrote in a research note to clients late last year.

Meanwhile Brazil, after soaring for a decade, has come back to earth. Its economy contracted in the third quarter and is expected to grow by little more than 2 percent for 2013. Brazil is struggling to stay competitive and contain inflation. Hundreds of thousands of demonstrators spilled into the streets in June to protest poor public service and the high cost of living. Growth is only expected to be 1.5-2.0 percent this year, while inflation could be up to 5.8 - 6.2 percent.

Brazil's finances, too, have worsened since the economy slowed sharply two years ago. Economists now say Brazil needs deep reforms to slash current expenditures and lower future pension payments. Standard & Poor's put Brazil's rating on negative outlook in June. Moody's is not far behind, lowering Brazil from positive to stable in October. We are now heading into an election year, when fiscal rigor is unlikely.

This needs some context. Most emerging economies suffered in the past two years, as growth slowed globally. The investment bank Nomura used a series of economic metrics to track Brazil's relative performance against a peer group of other emerging market economies: Mexico, Turkey, Indonesia, South Africa, Colombia and Chile. Brazil had a much-better-than-average recovery after the 2008 financial crisis, with both growth and investments coming in above average. Since 2011, however, it has been performing poorly compared to the others.

Enter Enrique Peña Nieto, a telegenic Mexican state governor who won the presidency in 2012, bringing the Institutional Revolutionary Party (PRI) back to power for the first time since its 70-year reign ended with the 2000 elections. His ambition was to transform the country.

A skilled negotiator and dealmaker, Pena Nieto, 47, crossed party lines and enlisted the opposition in a "Pact for Mexico," which puts Washington's sharply partisan politics to shame. He has driven changes many thought were not possible.

His most significant reform revised Mexico's constitution, opening the energy industry to private investment. Another key reform allows legislators and mayors to run for consecutive terms, which had been banned since the early 1920s. That will provide more accountability in a country with a history of authoritarian rule (by the PRI). The possibility of re-election should, in theory, be an incentive for better governance.

Peña Nieto also pushed through educational reform, making teaching more merit based, as well as introducing evaluations and performance tests. He is opening up the telecommunications industry to more competition, seeking to lower prices for consumers. His fiscal reform is designed to increase government revenue while redistributing the tax burden - raising rates on the wealthiest, taxing capital gains and dividends, homogenizing the value added tax rate and putting new levies on sugary beverages and junk food. He is also creating unemployment insurance and universal pension for people 65 years or older.

What is impressive is not just the sheer number of reforms but the skill he has demonstrated to get them through. The controversial energy and education reforms, for example, both needed a two-thirds super-majority in Congress to pass.

Meanwhile, the economic data is encouraging - if clearly not all the government's doing. Mexico's manufacturing sector is now competitive and its economy is not as reliant on commodities as other Latin American countries are. So the nation can weather the economic shocks of commodity price changes far easier. Its retail sales and manufacturing sectors are hitting highs not seen in almost a year. For almost 80 percent of Mexican exports, largely industrial, are directed to the U.S. market, which is recovering.

Standard & Poor's raised its main credit rating for Mexico on December 20 by one notch, in the latest sign of growing confidence. The credit rating company had lagged behind the other two main agencies, which have both placed Mexico just one notch shy of an "A" rating. Chile is the only Latin American nation that has an "A." Analysts and fund managers are saying Mexico could earn another upgrade by at least one of the agencies in the next few months.

Long term, Mexico has been positioning for stronger trade. Twenty years after the North American Free Trade Agreement (NAFTA) with the United States and Canada went into force, Mexico it is counting on at least two other major alliances to find new markets for its manufactured and other goods.

First, the ambitious Trans-Pacific Partnership would create a free-trade bloc of 12 countries, including NAFTA members, Chile, Japan and other Asian nations. This group makes up about 40 percent of the global economy.

Second, the Pacific Alliance, is a regional group that Mexico helped create in 2012 with Chile, Colombia and Peru. This aims to establish free trade and the free movement of people, as well as a common stock exchange.

In the short-term, however, domestic risks abound in how the government will implement these reforms. "Secondary" bills, for example, are needed to flesh out the details of the energy reform implementation. That will determine whether the investment conditions are attractive enough to lure foreign oil companies.

With one political party, the leftist PRD, now pulling out of the Pact for Mexico, Peña Nieto needs to keep the opposition on board to get this and other reforms through.

Passage of reform bills is not enough, however. The president will need to show the benefits to Mexicans. Those dividends haven't turned up yet. Indeed, some measures could cause problems. For example, roughly 45 percent of the population is poor, so new VATs and levies on junk food and soda would further erode their purchasing power.

Another remaining challenge is to reduce violence between drug gangs and other criminals. While murders fell slightly last year, kidnapping and extortion increased.

Jorge Castaneda, former Mexican foreign minister and foe of the PRI, touched on these improvements in his recent essay, "Mexico's Second Revolution."

"Mexico, a stagnant and violence-plagued country in recent years," Castaneda writes, " finally began to overcome its malaise in 2013, thanks to an activist president and a coalition of political parties determined to move the country forward. Thus, President Enrique Peña Nieto's task since taking office one year ago has been to ensure that the promise of major change in Mexico finally translates into sustained economic growth, improved living standards and faster convergence with the U.S. and Canada."

The president would do well to remember how Brazilians, following a decade of rosy economic indicators, took to the streets last year to complain they weren't seeing the benefits. As Pena Nieto told Foreign Affairs: "The government has come not to manage but to transform."

Yet careful management will be necessary, so that visible benefits can buy his government public patience for the continued transformation. (Gary Regenstreif; james.ledbetter@thomsonreuters.com)

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