Mexico Country Risk Report & Analysis

Questionable policy choices and lack of confidence pave way for anemic growth

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MEDIUM RISK for enterprise

Economic risk
Business environment risk
Political risk
Commercial risk
Financing risk

Economic risk
Business environment risk
Political risk
Commercial risk
Financing risk

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GDP	USD1258.3bn (World ranking 15, World Bank 2019)
Population	127.6mn (World ranking 10, World Bank 2019)
Form of state	Federal Republic
Head of government	Andrés Manuel Lopez Obrador (President)
Next elections	July 2021

Sound macro-policy framework: fiscal spending is capped and pro-active inflation-targeting central bank
Moderate debt ratios and strong external position (manageable current account deficit, large FX reserves)
Strong legacy from pro-business reforms in the last decade
Structural business environment exceeds Latin American average
Durable political framework with stable handovers of power
Member of OECD
Easy access to capital markets
Support from IFIs likely if needed

Financial integration means market volatility is driven by both domestic (more or less pro-business stance) and external (US) policy risk. Trade uncertainty dissipated but doubts over the implementation of NAFTA remain
Fiscal position highly sensitive to oil price (oil = 30% of public revenues)
Sensitive to US business cycle (around 80% of exports)
Skewed income distribution (geographically as well as among socio-economic groups), still high poverty levels
Security issues related to drug-trafficking
Rule of Law and control of corruption below Latin America’s average

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From resilience to turbulence, then Covid-19 crisis mismanagement

Mexico’s economy showed resilience in 2016 (+2.9% GDP growth), 2017 (+2.1%) and 2018 (+2.0%). Indeed, the country managed to put up with uncertainty linked to President Trump’s foreign and trade policy, in addition to domestic uncertainty related to the 2018 election and the victory of a left-wing president. However, the election of Andrés Manuel Lopez Obrador inflated hopes (consumer confidence rose to the highest levels ever recorded) that failed to materialize, as it did not translate into increased private consumption and investment plummeted. Real GDP contracted -0.3% in 2019, mostly due to a severe hit to investment (-5%); this can be attributable to high domestic policy uncertainty and several policy decisions that overturned previous pro-business reforms, such as closing the energy sector to foreign players.

In 2020, we expect the Covid-19 shock to be devastating for the economy, as the country has the third-highest number of deaths (as of August 2020). GDP contracted -17.3% q/q in Q2, mostly due to a decline in the manufacturing sector (-23.6%) and the services sector (-14.5%). We expect a -9.5% contraction overall in 2020 for two main reasons: (i) external demand, in a country integrated in global manufacturing supply chains, took a huge hit; (ii) apathetic policymaking, i.e. the absence of a fiscal relief package – in a country where debt levels are under control and the government posts a primary surplus – means the state has failed to provide for the emergency liquidity needs of companies and households. The president has rejected tax breaks for businesses and refused to tap into the USD61bn IMF flexible credit line Mexico has access to while committing to fiscal austerity. While the short-term outlook is positive for the manufacturing sector (renewed stimulus in the US, and a vaccination campaign starting in 2021), the medium-term outlook remains challenging because of the absence of a stimulus, threatening household incomes and companies’ financials, and the latest policy moves of the administration that threaten the soundness of the business environment. Labor market indicators show that there is still a long way to a full recovery; in April, 12mn people left the labor force and though 8.4mn had returned in September, 6.2mn jobs are still missing. Mexico should be a major loser of the Covid-19 pandemic and will take three years to come back to its pre-crisis levels.

Still solid macroeconomic and fiscal fundamentals, competitive yet deteriorating business environment

Mexico’s current account deficit is entirely covered by FDI inflows and the country benefits from easy access to capital markets, besides enjoying a Flexible Credit Line from the IMF. FX reserves amounted to USD177bn at the end of 2019, after reaching a low of USD169bn in 2017, notably as the central bank has intervened in the FX markets to support the peso in a context of high US foreign-policy uncertainty. However, higher remittances in H1 2020, an unexpected reaction to the Covid-19 crisis, helped boost FX reserves to a five-year high of USD189bn. Import cover now stands at 4.4 months, a comfortable level.

Mexico’s monetary policy has been extremely cautious and restrictive, pursuing three goals: (i) anchoring inflation expectations so they converge towards the 3% target, (ii) aligning with the Fed’s tightening momentum and (iii) smoothing effects on the currency due to uncertainties related to Trump’s economic policy. Yet this monetary policy appears to have hindered growth. During the Covid-19 crisis, Banxico eased rates from 7.25% to 5% but its stance remains less accommodative than peers as the interest rate is still higher than four years ago. The central bank has room to cut rates again and we expect the interest rate to be even lower by the end of 2020.

Mexico enjoys relatively sound public finances. The public debt-to-GDP ratio has increased from 42% in 2010 to close to 53.8%, which led the administration to commit to public primary surpluses, even during the Covid-19 crisis. Due to the strong recession, we forecast that the debt-to-GDP ratio could exceed 60% in 2020. Household debt stands at a reasonable level. Credit to the non-financial sector is lower than in other emerging economies.

Mexico’s structural business environment is the second best in the Latin American region, losing its first place to Chile last year according to the 2020 World Bank Doing Business Survey. It ranks 60th worldwide out of 190 countries (down from 54th in 2018). However, key shortcomings remain in its World Governance Indicators, specifically the areas of rule of law (152nd) and control of corruption (170th). Future challenges include improvements to the tax system and raising the female labor participation rate, which is lower than the Latin American and OECD averages. Mexico’s tax collection rate stands at 13% of GDP vs. at least 16% of GDP in its regional peers and 25% of GDP in high-income countries. Successive administrations have also failed to curb escalating corruption and crime that stifle economic and social outcomes. Since the election of AMLO, the business environment hasn’t stopped deteriorating. Recent policy moves include: (i) changes to the rules in the electricity sector, penalizing renewables projects to favor the national power company CFE, which has triggered complaints and threats of arbitration and (ii) obliging the central bank of Mexico to purchase from banks US dollars whose origins have not been verified. While the proposed legislation aims to help lower income groups who receive remittances, this obligation for Banxico to accept and convert such funds would reduce its independence and would represent a significant weakening in Mexico’s anti-money laundering/combating the financing of terrorism (AML/CFT) controls. - December 2020

Trade structure by destination/origin

(% of total)

Exports	Rank	Imports
United States 74%	1	50% United States
Canada 6%	2	18% China
China 3%	3	4% Germany
Germany 1%	4	3% Japan
Japan 1%	5	3% Korea, Republic of

Trade structure by product

(% of total)

Exports	Rank	Imports
Road vehicles 23%	1	14% Electrical machinery, apparatus and appliances, n.e.s.
Electrical machinery, apparatus and appliances, n.e.s. 11%	2	10% Road vehicles
Telecommunication and sound recording apparatus 9%	3	7% Telecommunication and sound recording apparatus
Office machines and automatic data processing machines 6%	4	6% Other industrial machinery and parts
Other industrial machinery and parts 5%	5	5% Petroleum, petroleum products and related materials

The law provides no framework on standard payment terms, but it is common to rely on 30 days credit starting from the date of the invoice. In practice, payments take place wihtin 40 to 50 days on average, whilst delays of 15 to 30 days may be expected.

Low
Medium
Sensitive
High

Payments
Court proceedings
Insolvency proceedings

Payments
Court proceedings
Insolvency proceedings

The court system is complicated by its federal structure and it is known for a lack of transparency and independence. Business disputes are not dealt with by specialized judges and in practice the fast track mechanisms which could facilitate proceedings when the claim is straightforward cannot be relied upon. Overall, procedural delays and costs are significant and pre-legal action remains the most efficient means of collecting debt.

The debt restructuration process is not efficient at all, and proceedings may last for years (ex. Mexicana). As a result, liquidation is in practice the default procedure when the debtor becomes insolvent and the chances of collect debt through this channel are very low.