Flash Report /

Mexico's Urzua: Dark clouds for the economy

    Rafael Elias
    Rafael Elias

    Director, Latin America Credit

    Tellimer Research
    18 September 2019
    Published byTellimer Research

    Earlier this week, Dr Carlos Urzua, Mexico's former Minister of Finance and the first to hold that post under the Lopez Obrador (AMLO) administration, published a note in a local newspaper with the title: "Dark Clouds for the Economy". (We provide a translation of the article below.)

    In the article, Urzua emphasises the low economic growth that was expected, and has now been confirmed by the budget assumptions sent to Congress.

    It is worth reminding investors that AMLO promised average growth of 4-6% (depending on his audience), something that clearly will not be achieved and that is most likely being closely monitored by the ratings agencies.

    It is also true, as Dr Urzua states, that state-owned enterprises (such as PEMEX and the Federal Electricity Commission or CFE) take in a big portion of the budget, highlighting their stand-alone deficiencies and inefficiencies. 

    At some point, the government will have to do what we have been saying all along. Either: 1) a cost-benefit analysis on whether it is worth jeopardising the health of the federal finances by continuing to support PEMEX and the CFE in order to avoid (or delay) negative ratings actions on these two entities at the expense of possible ratings downgrades on the sovereign, or 2) what we have been recommending, which is to return to the policies established in the Peña administration's Energy Reform and allow private investment (like the halted farm-outs at PEMEX) and maintain the sovereign rating intact.

    After all, a sovereign downgrade affects roughly half a trillion dollars, whereas PEMEX's debt is cUS$108bn.

    What will it be, Mr AMLO?

    Dark Clouds for the Economy

    "With the delivery of the 2020 Economic Package to the Chamber of Deputies this past 8 September, a waiting period was opened. Congress has until 31 October to draft the Revenues Law in its final form, while the Chamber of Deputies, and it alone, has until 15 November to draft the Expenses Budget. We hope that this waiting period leads to deep thought on the part of the legislators, since, as will be argued in this article, and two more to come, we can already see dark clouds hovering over the Mexican economy. The most troublesome are the following:

    1.- It is already expected that economic growth will be low during this administration, this said not only by some "neoliberals" but also by the government itself. In fact, the new General Economic Policy Criteria establishes the following estimates for the percentage of growth of GDP between the years 2019 to 2024: 0.9, 2.0, 2.3, 2.5, 2.6, and 2.7. Even accepting the optimistic figures for 2019 and 2020, the arithmetic average of these six rates is only 2.2%. This growth average is similar to that of the three previous administrations: 2.4% with Peña, 1.8% with Calderon, and 2% with Fox. Therefore, the economy, it seems, will continue with the meagre performance shown throughout the XXI century.

    2.- Although the public deficit will not be excessive, it will grow 5% in real terms in 2020. Here, it is worth clarifying the concept of economic balance that creates confusion among more than one. It is not true that there will be no public deficit this year; in fact, this will be more than 500 billion pesos. But that in and of itself is not worrisome, few governments achieve public surpluses in any given year. What is worrisome is that the economy does not grow in a corresponding manner. Putting it another way, deficits are cause for worry when the ratio of public debt to GDP increases significantly through time.

    One of the economic objectives stated by this administration in 2018 was precisely that such a ratio would be maintained throughout the six-year period of the administration. During the Peña administration that did not happen at all: the balance of public debt relative to GDP grew from 37% in 2013 to 49% in 2016; a disproportionate increase that the previous administration tried to correct. The current administration inherited a ratio in the order of 46% in 2018, similar to what it is estimated will be in 2019. However, in light of the Economic Package and the lack of growth, it could very well be argued that the ratio of debt to GDP will be growing throughout the term of this administration.

    3.- It also doesn't appear that another big objective will be met: that of increasing public investment in a significant manner, especially in the area of spending in public infrastructure (roads, ports, dams, etc.). The goal was to gradually increase this metric of 3.1% of GDP, achieved in 2018 for public investment, until reaching 5% of GDP by the end of this administration's term. But, in light of the new Economic Package, instead of increases, it seems that there will be decreases: for 2020, only 2.9% will be allocated to public investment.

    Further, such a reduction will essentially come at the expense of spending on infrastructure. This mistake, which has been taking place since 2015, partially explains the current lethargic economic growth. Private investment, if it cannot be increased, will not be able to take the place of public works. Both types of investment are complementary, not mutually exclusive. And then, maybe you will ask, why do these grave mistakes keep happening? The answer is that there is not enough money anymore. The pensions, the social programs, and the state-owned enterprises, take great slices of the limited budget."