Investment Adventures in Emerging Markets

Viva Reforma en México

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Elections come and go, but the real test of a candidate might be whether the promises made on the campaign trail are actually put into place. Enrique Peña Nieto and his Institutional Revolutionary Party (PRI) emerged victorious in Mexico’s July 1 presidential election on the promise of reform and the end to old, “undemocratic” ways. Mexico’s stock market reacted positively to the initial election results; Mexico’s IPC Index (Indice de Precios y Cotizaciones) rose to a new all-time high in June and extended those gains in July.1 While the final election results are still in dispute, I’m encouraged by the economic progress being made in Mexico, and optimistic about its potential—assuming Mexico doesn’t backslide into counterproductive politics and policies.

Time will tell whether the “new” PRI has truly changed its ways, but the election (and the fallout afterward) has proven that Mexico’s people seem hungry for change. Assuming Nieto’s win holds up amid post-election vote challenges, when he takes office in December he will need the support of allies in both houses of Mexico’s Congress to aid his ambitious agenda. Nieto pledged a number of structural labor, tax, business and social security reforms designed to fuel Mexico’s economy.

In my view, the key reforms Mexico needs to improve its global competitiveness and strengthen its economy are the proposed fiscal, labor and energy reforms. The fiscal reforms aim to increase government revenues to improve Mexico’s infrastructure, facilitate investment, provide quality services and foster economic growth. The plan to achieve this goal is to lower taxes and broaden the taxpayer base. Mexico has a large informal sector (a generally unmonitored or supported part of the economy), and it often does not pay taxes. The goals for labor reform include increasing productivity by improving workers’ conditions, promoting a meritocracy within corporations, promoting equality among employees and placing limitations on strikes.

Plentiful oil is one of Mexico’s strongest assets, but the industry could benefit from improved production efficiency and new exploration efforts to help stem a decline in output. Nieto’s “signature policy” goal is to open state-controlled oil and petrochemicals to private investment. I think a plan to allow private companies to own stakes in oilfields through joint ventures could emerge as a compromise to more ambitious privatization plans, and pave the way for Nieto to tackle monopolies and duopolies in other Mexican industries.

U.S. Ties a Double-Edged Sword

Mexico’s close ties to its neighbor to the north can be a double-edged sword. Mexico exports some 80% of all its products to the U.S. and is its largest oil supplier, so the Mexican economy benefits from increasing U.S. demand. On the flip side, however, when the U.S. suffers economic downturns, Mexico tends to suffer in tandem. The 2008 – 2009 U.S. financial market crisis had a ripple effect on Mexico’s economy, causing its GDP to sink more than 6% in 2009, the worst contraction there in decades.2

However, Mexico was able to quickly turn things around, taking fiscal medicine that included government spending cuts. According to the IMF, Mexico’s GDP growth was 5.6% in 2010, and 3.9% in 2011. This year many countries are struggling to maintain economic momentum, but in its mid-year report, the IMF lifted Mexico’s 2012 GDP growth forecast to 3.9%.3 Mexico’s growth rate looks to potentially outpace the U.S. this year, and it boasts a lower unemployment rate, too. Mexico’s foreign reserves rose to a record of more than US$150 billion this year,4 and its public debt-to-GDP ratio stood at 37.5% in 2011, lower than some of its Latin American counterparts (including Brazil).5 In my view, Mexico’s economy appears to be in pretty good shape to help weather current global challenges.

Risks and Potential

Mexico is seen by some as an underdog in Latin America. There are a lot of “ifs,” but I think it could be possible for Mexico to someday overtake Brazil as Latin America’s  largest economy. Improvement in security, successfully implementing the aforementioned reforms, and of course the U.S. economy’s performance all play important roles. Right now one could argue Mexico is in better shape than Brazil for a few reasons; Mexico is less indebted, the government plays a smaller role in the economy (based on percentage of GDP), and inflation seems to be more under control in Mexico, although always something that bears watch.

Mexico’s inflation rate hit an 18-month high of 4.3% in June (as measured by the consumer price index)6, which is a bit of concern, and I think in part why the Bank of Mexico  left its overnight lending rate unchanged at 4.5% in July. At the meeting, the central bank reported that while the short-term inflation risk had accelerated, annual core inflation remains stable in line with its expectations. Mexico imports about 20-30% of its corn consumption, so this year’s hot, dry U.S. summer withering the corn crop there creates a potential risk. Consumer sentiment is very sensitive to increases in the price of tortillas, which are a national staple. It wouldn’t surprise me if the government intervened, and I also think it’s possible we could see a slight upward revision in inflation estimates. Right now, corn is not the only factor increasing the risk. The prices of eggs and chicken have risen significantly because of a virus that has hit some farms in Mexico. This virus does not affect humans.

Manufacturing and Trade

Mexico is undergoing interesting changes. I have seen first-hand how Mexico is evolving from a “maquila” economy producing lower value-added products to a highly technological advanced manufacturer. Large manufacturers searching for low-cost, highly skilled labor are setting up operations in Mexico, including areas you might not expect, such as aviation and autos. I recently visited an industrial park in Queretaro which housed suppliers and R&D efforts, and there are other similar centers in the Northern part of Mexico.

Mexico’s geographical proximity to the U.S. allows many U.S. companies to manufacture goods more cheaply there than in China, benefiting from logistical efficiencies. While U.S. manufacturers have been outsourcing production to Mexico for some time, rising wages in China could lead even more to turn to Mexico as a low-cost labor alternative.

While the bulk of Mexico’s exports wind up in the U.S., more than 90% of Mexico’s trade is under free trade agreements encompassing more than 50 countries including Canada, Guatemala, Honduras, El Salvador, the Eurozone, and Japan.2 Mexico has also been asked to join the “TransPacific Trade Partnership,” an ambitious new Pacific Rim trade partnership that could help diversify its export base.

In the past few years, much-publicized violence took a toll on Mexico’s image, and its economic growth looked lackluster compared with some other Latin American countries. It remains to be seen just how Nieto and the PRI handle a legacy of corruption and crime, instill confidence in its people and turn around Mexico’s image in the eyes of the world. Nonetheless, aided by an aggressive public relations campaign7, tourism has been holding up well despite the bad press; Mexico’s Tourism Board estimates that this year, the number of international visitors looks on track to break last year’s record of 22.67 million. While most of Mexico’s visitors are from the U.S., increasing numbers of tourists from emerging markets are recognizing the beauty of Mexico’s beaches and its cultural riches.

Investing in Mexico

Investors are recognizing the attractiveness of Mexico as an investment destination now, too. From an investment standpoint, my team likes the energy sector, as it could potentially benefit from reform efforts. And, while oil is subject to short-term price fluctuations, global consumption is expected to grow in the long-term as vehicle sales in emerging nations such as India and China are expected to remain on an upward trajectory and of course, for its pervasive use in industry. We also like the consumer story. Consumer staples, banking and telecommunications are areas of interest, and we think increased privatization and foreign investment should increase their attractiveness. The Eurozone crisis has given many emerging market companies the opportunity to acquire European brands at attractive prices, and Mexican companies are among them.

Without a Congressional party majority, it may take some wrangling for Nieto to deliver on his campaign promises, but I’m optimistic that if even more limited progress can be made, the future holds potential for Mexico.


1. Past performance does not guarantee future results.  An index is unmanaged and one cannot invest directly in an index.

2. Source: CIA World Factbook, July 2012.

3. Source: IMF, “World Economic Outlook Update,” July 2012.

4. Source: Banco de México, June 2012.

5. Source: CIA World Factbook, July 2012.

6. Source: Banco de México, July 2012.

7. Source: Mexican Ministry of Tourism, PRNewswire, February 2012.

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