By Mary-Therese Barton
Social unrest has caused headaches for President Enrique Peña Nieto, who has pledged to end drug-related violence that is estimated to have cost the economy more than 17% of GDP and killed around 100,000 people since 2007.
Now, both he and emerging market fixed income investors may be just as preoccupied with the impact of falling oil prices on the economy.
However, having met a number of corporate executives, central bank and finance officials as well as local investors during my recent trip there, I do not believe Mexico deserves to be penalised by the markets. If anything, my trip has left me more convinced that the government’s determination in implementing an array of structural reforms and maintaining economic stability will help Mexico’s local currency bonds weather short-term volatility and outperform other markets in the long run.
Fruits of reform
Mexico’s industrial overhaul is picking up pace. The country’s reform responsiveness rate, or the extent to which it acts on reforms recommended by the OECD, reached 58% in 2013-2014, above the EM average.
And I found plenty of evidence that reforms are beginning to bear fruit in a number of areas.
Take telecoms reform. Locals I met during my trip said they can now shop around for the best deals on wi-fi networks and enjoy lower connection costs and better services from phone providers, just eight months after Peña Nieto signed into law new rules for telecom and broadcasting industries.
Fiscal credentials
Mexico’s budget deficit has substantially worsened over the past three years to 3.3 per cent of GDP. However, this needs to be put into perspective. The government is overhauling the country’s tax law to broaden the range of taxes people must pay as part of fiscal reforms.
The sin tax – a 5% tax on packaged foods that contain 275 calories or more per 100 grams to dissuade Mexicans from eating sugary and salty foods – may be the most infamous one, but the government has also introduced a 10% capital gains tax on individuals and ended special treatment for certain industries which have avoided tax. For 2015, the government is also cutting spending by 0.7%of GDP. I do not believe the government would loosen its fiscal belt and threaten macroeconomic stability ahead of the mid-term elections due in summer 2015.
During my meetings with monetary policymakers, meanwhile, I got the sense that the central bank’s top priority remains macroeconomic stability – and this explains why it is stemming volatility by conducting daily FX auctions and interventions. I think it could even be that the Bank of Mexico may tighten before the Fed to tell the world that Mexico is prepared to deal with the challenges of a new phase in the economic cycle. Our economists expect Mexico’s GDP growth to recover to 2.5% this year before accelerating further to 3.5% in 2016.
Investment implications
It is too early to give a Mexico a clean bill of health in the short term. Over the next few months, the front-end of the bond market is likely to remain volatile given its sensitivity to changes in US interest rate expectations.
However, this trip made me more comfortable with holding the long-end of the yield curve given that the long-term economic outlook for Mexico is likely to improve thanks to structural reforms.
We expect the yield differential between the short end and long end of the bond market to narrow.
The MXN is likely to remain under pressure in the face of broad USD strength, at least over the near term. However, it is a currency we find attractive and we will be looking to increase our exposure as soon as we see signs of a stabilisation in emerging economies. Moreover, Mexico’s inflation-linked bonds, also known as UDIs, look appealing given that inflation is likely to rise towards the central bank’s target in the medium term.
Mary-Therese Barton is senior investment manager, Emerging Market Debt at Pictet Asset Management
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