The unexpected departure of Mexican Finance Minister Carlos Urzua sparked concern and market pressure, particularly as it was punctuated with a powerful departure letter criticizing the lack of support for evidence based policy and many economic “discrepancies” in policymaking. The move, not entirely surprising, comes amid concerns about political pressure on economic policy not only in Mexico (where policies are still pretty orthodox), but in several emerging and developed economies including India and the U.S. and the most egregious case, Turkey. This note reviews the state of macro policy in Mexico in a global context. The events are likely to reinforce the chronic structural growth and credit challenges in Mexico while market pressure avoids too many policy changes.
Bottom line: The exit adds uncertainty to monetary and fiscal policy which have were already facing implementation challenges and contingent liabilities. Mexico’s balance sheet is resilient compared to some EM peers (Turkey, South Africa, Colombia), including decent external financing – low levels and relatively long duration corporate FX debt and a high real interest rate. Such risk premia are likely to remain, due to the mixed fiscal and energy policy messages from the AMLO government, constraining policy space further and keep a lid on economic growth rates, in turn will be credit negative. Still these issues look to be more chronic and manageable rather than acute financing issues. These trends will offset the generally improved financing condition for EM (easing from DM central banks, macro stabilization in China, and trade tail risk avoidance).
What to watch:Urzua has been replaced by his prior deputy, which suggests partial continuity but less autonomy. Markets will be watching for the overall budget target, funds for Pemex and much needed clarity on pipeline policies and gas imports. The budget debates in Mexico’s Congress including over social and energy spending will dominate the fall. USMCA, a possible positive catalyst, is unlikely to proceed in the current congress, especially given the sensitivities of the many Senatorial candidates running for president. The stabilization of US demand is likely to be positive for Mexican growth, especially as domestic demand will be subdued by financing costs.
Maintaining fiscal balance trajectory while shifting spending to the new priorities of the AMLO (mostly social spending) was always going to be difficult, and my baseline had assumed correspondingly some widening of the deficit in the upcoming fiscal year, the first year for new policies of the new administration. In the current year, underspending kept the fiscal outlook relatively tight, though capital injections to Pemex meant total liabilities went up. This upcoming budget was clearly more contentious, especially as funds need to be found for new security measures,
Government rhetoric will be critical and implementation likely to get weaker. Until now, Mexican authorities had sent mixed messages – arguing for reform and pulling back when markets sold off lest the costs of their priorities balloon along with financing costs. They may be less likely to walk the market talk at this point. The government, especially its market-friendly proxies/officials had long pledged that they would avoid widening the deficit and would achieve the goals by cutting other spending (expenditure-shifting) by clamping down on corruption, cutting the public sector payroll and changing some of the programs. These tend to be easier said than done, especially given the vested interests, the relatively sluggish growth and moderate tax take and the need to inject more funds into struggling state owned entities especially Pemex.
Mexico’s broader problems focus on its chronic growth challenges and not-so-slow Bleed from Pemex and its deteriorating energy balance. As I’ve written before, the decline in local energy production and rising demand for power and primary energy means that the energy trade is a drag on the overall external balance. The funds pumped in of late are only staunching the bleeding.
Mexico is not Turkey
The timing of Urzua’s exit, a few days after Turkish central bank governor was replaced has sparked many comparisons of the two. The broader political pressures on economic policymakers are not new – and indeed locals and foreigners in Mexico and Latin America tend to be especially vulnerable to any incursions. Compared to Turkey, Mexico has several advantages – low reliance on short-term foreign finance for banks, corporates or the sovereigns, relatively small current account deficit well financed by FDI, and still relatively orthodox policies including at the central bank.
That said, the chronic drag and contingent liabilities limit the scope for other government spending, discourage foreign and local private investment in related sectors, as the rules of the game are not yet set, and keep the sovereign on a slow grind downward. Clarity on the trajectory of policies both at home and in the U.S. will be critical. Failing to do so would keep financing costs climbing, weighing on growth.
Some of these pressure points and chronic issues are also visible in South Africa, which has even more problematic chronic growth and labor issues, and India, where the turnover at the central bank reflects in part unwillingness to address politically connected debtors. In both cases, it’s a good reminder that monetary policy can’t solve all problems, not least when central bankers face a challenge in gaining support from their political partners. When assessing EM assets, its always important to look at what’s priced in. After today, a lot of bad news is priced-in in Mexico, perhaps too much.
What does it mean for all EM: Across EM as a whole, financing conditions have been getting better due to repricing of the Fed trajectory and continued support from other central banks and some truces/time buying on the trade side. EM assets have generally done well, reflecting the fact global growth is ok. That said, current US rate pricing looks aggressive and suggests the balance of risks is tilted to less cuts than investors expect in the next few meetings. Not all EM are as well positioned as others – watching the external financing, and for countries with less reliance on restart of the credit cycle makes sense.
Ziemba Insights 