At a time when money is flowing out of emerging markets, particularly those in Latin America, Mexico stands as a bastion for investment, pulling in record flows as its growth continues to excel. Key reforms and trade agreements have helped make it the 11th-largest economy in the world, with $1.845trn in purchasing power, according to the World Bank. Its exports and manufacturing far exceed that of its Latin American neighbours, and despite erratic growth in recent years, Mexico is currently attracting unprecedented investor attention. With the Mexican Stock Exchange growing (see Fig. 1) and currently valued at some $451bn – second to only Brazil in Latin America and fifth in all of the Americas – banks and investment firms are heralding this as an economy to watch.
Now, a deregulation of major sectors such as energy and telecoms could finally boost the economy once and for all, making Mexico one of the brightest growth stories out there. Financial firms are currently seeing a second wind as key reforms are ensuring more open and regulated markets. With Mexico already racking up a track record for incredible manufacturing booms, as witnessed by its auto industry following the implementation of NAFTA in the 1990s, the economy is quickly becoming a favourite recommendation of major firms like HSBC and Scotiabank. With emerging economies in the region experiencing poor growth following the global deceleration in commodities, as well as a slowdown in manufacturing, Mexico is currently the only LATAM economy which investors can assuredly invest their money in. Mexico’s economy is the happy product of trade deals, as well as broad and effective deregulation, which has transformed the economy.
International trade
The main driver for Mexico’s growth was its adoption of NAFTA in 1994, which nearly tripled its trade with the US and Canada and made it the largest trading nation in Latin America. At the time, Mexico, similar to many current Latin American economies, was developing and had a somewhat protectionist economic stance. NAFTA helped create a more open, value-added and focused Mexican economy, led by an outward-focused manufacturing sector rather than by commodities, or in some cases inward-looking manufacturing, which dominates the rest of the region. This is highlighted by the fact that Mexico exports 1.8 times more manufactured products than the rest of Latin America combined, despite its economy being only 32 percent of the size of the rest of the region. What’s more, data proves that this divergence coincides with Mexico’s entry into GATT and NAFTA, as manufacturing exports grew from eight percent of GDP in 1980 to 18 percent in 1995, and 23 percent by the end of 2012. By way of comparison, South American manufacturing exports as a share of GDP have mostly hovered in a three-to-six percent range.
[T]he economy is considered a strong bet for growth from 2015 onwards as the effects of fiscal and industry reforms start to take effect
In addition to this, Mexico is also party to a number of free trade agreements including deals with the EU, the new Latin American trade bloc, Pacific Alliance, and the proposed Trans-Pacific Partnership, which would include the US, Singapore and Australia in addition to various other Pacific nations.
“International and bilateral trade deals have made Mexico more competitive by changing production costs, rolling back protectionist trade stances and making the economy more open. Because Mexico keeps pursuing competitiveness, we look at the economy favourably and believe we will see a trend of growing GDP bringing growth over 3.5 percent from 2015 and onwards,” explained Andre Loes, HSBC’s Chief Economist for Latin America.
Opening up energy
International trade deals aside, the Mexican government has also worked hard to reform its economy by opening up key sectors such as automobile production, energy and telecoms. This has helped bolster Mexico’s economy, the GDP of which plunged 6.5 percent in 2009 as exports dropped during the financial crisis.
The most important recent reforms have opened up Mexico’s energy sector. So far, one player has dominated the energy market for the last 75 years: government-run Petróleos Mexicanos, otherwise known as Pemex. However, this will soon be in the past, as President Nieto surprised global investors last year by gaining support for a constitutional change to open up one of the most closed energy sectors in the world to foreign investment and refashion Pemex into a for-profit company within two years. Analysts from consulting firm McKinsey expect the move to attract $20bn of investment by 2016 alone.
“The energy reform will allow for private company intervention in a notoriously closed market,” said Loes. “Given the size and perspectives of Mexico’s oil fields and shale oil and gas, energy will be a very important sector to invest in”.
There are big opportunities for the domestic economy and foreign oil companies as Mexico is estimated to have 54.6 billion barrels of oil in conventional resources, and 60.2 billion in unconventional, according to Pemex figures. Lower energy costs would help Mexican consumers and boost domestic demand. With electricity and gas prices higher than any other North American country, Mexico is keen to invest in its energy sector and bring down grid prices. This is also why the government is pushing for private companies to produce shale gas in northern regions, in addition to promoting partnerships on deep-water drilling projects in the Gulf of Mexico.
Financial sector stability
In addition to the convergence in manufacturing and energy development, Mexico’s financial system has also become more integrated with the rest of the world, making its financial services some of the most stable and regulated institutions in the region. Reforms opened the country’s financial system to foreign players in the late 1990s and recent changes have contributed to the country ranking 30th globally for its ‘soundness’ according to the World Economic Forum.
Analysts suggest that engagement with foreign institutions through NAFTA led to strong financial standards being set up by local regulators, plus the supervision of parent companies from various countries. In addition, the presence of major banks also helped Mexico import institutions from mature financial markets, and has contributed to a banking system with an average tier-1 capital ratio of 15.7 percent. “As part of the efforts to make the economy more competitive, there has been a continued push to reform institutions (with different levels of success over time), but which has over the past 20 years resulted in an independent and credible central bank, relatively liquid financial markets (one of the most liquid forex and fixed income markets in all emerging markets, and in some metrics, even a rival to lower tier developed markets), as well as a stronger balance sheet and solid institutions,” explained Eduardo Suárez, an analyst at Scotiabank, in a recent report on the Mexican economy and the impact of NAFTA.
By allowing for capital market integration, the domination of foreign banks and eliminating restrictions on trading, Mexico has managed to successfully link domestic incentives with those of foreign players, and this again is opening the economy to much needed foreign investment.
Balancing China and the US
That said, the Mexican administration continues to face many economic challenges, including improving the public education system, upgrading infrastructure, modernising labour laws, and fostering more private investment in the energy sector. To this end, the president has stated that his top economic priorities remain reducing poverty and creating jobs.
Dealing with labour issues is especially important as Mexico continues to compete with China when it comes to low-cost manufacturing. Although its auto-industry reigns supreme as the top North American producer, China has already caused several shocks to the Mexican economy since its entrance into the WTO in 2001, which led the Latin American economy to adjust its wages and increase trade through more reforms in order to remain competitive. Despite Mexican exports taking a slight dive in the early 2000s, there seems to be a clear lesson that developing economies can compete with the Chinese if non-protectionist policies are encouraged.
Mexico has made itself extremely dependent on trade, and as with any open economy, this makes the country especially subject to structural changes in the global economy and particularly the US, which currently absorbs about 80 percent of Mexico’s exports. Consequently, analysts at Scotiabank suggest that education reform will be crucial for the country to step up productivity and become less reliant on the US.
Finally, what’s really key for Mexico is to boost its levels of foreign direct investment (FDI). As of now, the economy is considered a strong bet for growth from 2015 onwards as the effects of fiscal and industry reforms start to take effect. According to HSBC, this will boost investment flows into the Mexican auto, energy and electronics industries, and FDI is sure to pick up as the energy market continues to develop in line with ongoing global demand. As a result, Mexico is poised to become the fifth-largest economy in the world by 2050, making it one to watch among emerging markets.
