On the face of it, things don’t look good for Mexico – and that’s reflected in asset prices. Its largest trading partner has threatened to scrap a free trade agreement that has been in place for almost a quarter of a century. In addition, a populist is leading in the polls to replace President Enrique Peña Nieto in the July elections. But look again and you might see a country potentially on the cusp of a spectacular comeback.
Mexico is a manufacturing powerhouse. Only a handful of emerging markets have managed to increase their global manufacturing share against a rising China. Mexico, after suffering in the wake of China’s inclusion in the World Trade Organisation in 2001, is again leading the pack. Anyone specialising in development economics is likely to tell you that few indicators predict a country’s long-term prospects as well as manufacturing prowess.
Second, the ambitious energy reform of 2014 has started bearing fruit. Auctions of oil fields are progressing well, foreign direct investment remains high at around 3% of GDP, and oil output could soon rise again after falling since 2005. Pemex, the state-owned oil giant, was a drag on public coffers until recently, but is now profitable once more.
Third, public finances look good, broadly speaking. The budget deficit fell from 4.6% of GDP in 2014 to 1.1% of GDP last year, beating the target by a wide margin.
Fourth, uncertainty is weighing on consumption and investment, but when the fog clears, Mexico will be in a strong cyclical position. As a manufacturing hub it is geared to the global recovery, inflation is falling rapidly and the current account deficit is shrinking and sustainable.
Fifth, the mood music around a potential US withdrawal from the North American Free Trade Agreement is improving. President Donald Trump exempted Mexico and Canada from steel and aluminium tariffs for 30 days, with the prospect of an extension. While Trump is hard to predict, it is likely that Congress will prevent such an obvious act of self-harm.
Finally, with respect to the elections, the current three-way race for the presidency should turn into a two-way race. Voters from the Institutional Revolutionary Party, the ruling party, and the National Action Party could unite to back the leading mainstream candidate. Even if populist leader Andrés Manuel López Obrador were to win, he would lack a majority in parliament, let alone a super-majority to reverse the energy reform. Also, on many issues, including energy reform, his positions are turning firmly mainstream.
Erik Lueth is Global Emerging Market Economist at Legal & General Investment Management. This article first appeared on the LGIM Macromatters blog.