CEO’s Executive Summary: The economy dominated the news in September. The President presented an austere 2017 federal budget that concentrates 42% of its cuts on Pemex, forcing the firm to further deepen spending cuts. The Congress has until October 31 to approve the tax bill and until November 15 to approve the spending bill. September also reaffirmed the peso’s new role as a proxy for the U.S. presidential election causing currency volatility and pushing the peso to new lows. In the energy sector, Pemex discovered six new light and super light oil fields while two of its 27 private sector competitors received permission to drill Mexico’s first privately owned exploratory well. The country’s second electricity auction included 36 renewable plants which should attract US$4 billion in investment and yielded an average price 30% below the first auction. And U.S. firms announced over US$6 billion in new investment in Mexico. In politics, the attorney general issued an arrest warrant for one allegedly corrupt former governor and took over the investigation of another, raising hopes of precedent-setting prosecution and punishment. Finally, with all eyes on the U.S. election, Mexican Central Bank President Agustín Carstens openly stated what many privately fear – that election of Donald Trump would have an impact on Mexico “stronger than a hurricane.”
On September 8, President Enrique Peña Nieto presented an austere 2017 budget package to Congress that reduces spending by Mex$239.7 billion when compared with the 2016 budget, and includes no tax increases. This is Mex$77 billion on top of the Mex$162 billion already cut during the year from the 2016 budget, totaling 1.7% lower spending in 2017 than in 2016. This should create an estimated 0.4% primary surplus, the first such surplus since 2008, an overall 0.6% reduction in the deficit to 2.9%, and a minor drop in government debt to 50.2% of GDP.
This budget proposal is based on estimated economic growth of 2%-3%, which assumes a renewed expansion in the U.S. industrial sector – a core driver of Mexican economic growth. Oil revenues are based on a price estimate of US$42/barrel, backed by oil hedges at US$38/barrel and the oil stabilization fund, and assume the lowest level of oil production since 1980 – just 1.9 million barrels/day. The budget forecasts an average peso price of 18.2 per dollar, a figure well below its current price of 19.4. Although the government considers the peso to be substantially undervalued at its current rate, its estimate may be revised when the legislature reviews the bill.
This budget lowers Mexico’s fiscal reliance on Pemex to just 18% of total revenues. In conjunction with tax revenue increases in previous budgets, this is evidence of the fiscal silver lining that low oil prices created for Mexico that MJGS has noted previously. Equally important, broad cuts to investment spending should open new opportunities for a wide range of public-private partnerships.
Pemex is the single largest target of these spending reductions, slated for Mex$100 billion in cuts equaling 42% of the total spending cuts. The executive branch of the federal government saw its revenues cut 16.9%, while sharp cuts to federal transfers to state governments produced a 3.1% drop in total state revenue. By contrast, the historically underfunded judiciary is slated for a 14.8% increase to help it implement criminal justice reforms and deal with a recent rise in violent crime. Nondiscretionary spending also increased due to higher debt financing costs and the peso’s slide.
The budget is now being discussed in Congress with an October 31 deadline for both houses to clear the tax bill and a November 15 deadline for the chamber of deputies to approve the spending bill.
The peso went on another wild ride in September, losing 3.25% of its value after fluctuating wildly throughout the month, helping to drive consumer confidence to a two-and-a-half-year low. After strengthening during the first seven days of trading, the peso plummeted to record lows before closing the month at 19.4 per dollar. This despite a recovery in oil prices late in the month and the Bank of Mexico’s third 0.5% interest rate increase this year. Several factors contributed to the slide – a broad market pullback from emerging markets on news of lower commodity prices and concerns about recent increases in Mexican government debt and the possibility of higher U.S. interest rates. Adding to these pressures is the peso’s new role as a proxy for the U.S. election. It fell as Donald Trump’s prospects improved and strengthened with Hillary Clinton’s success, jumping 1% in the wake of the October 26 presidential debate. According to Bank of Mexico President Agustin Carstens, this “exceptional circumstance” has caused an undervaluation of the peso that could correct itself later this year.
Notwithstanding these headwinds, Mexico jumped six positions to rank 51st globally in the World Economic Forum’s Global Competitiveness Index, its highest rank in 10 years. The WEF attributed this improvement to greater market efficiency due to the country’s economic reforms and trade policy, greater labor market flexibility and financial market development. The latest edition of the World Bank’s Doing Business in Mexico report identified seven states where the ease of doing business in four categories is above the OECD average. Aguascalientes came out on top and Mexico State advanced the most.
Oil and Gas
Pemex losses, caused by a 43% cut in its budget and low oil prices, have delivered a “huge blow” to the firm, in the words of Energy Minister Pedro Joaquín Coldwell. Next year’s spending cuts include a proposal to eliminate 8,997 jobs, including a 35% reduction in top management posts and increased reliance on farmouts and joint ventures. The latter includes the Trion light oil field located in deep water just south of the U.S.-Mexico maritime border. This past month the National Hydrocarbons Commission approved Pemex’s request to reduce its stake in this field from 45% to 40%. At least eight large oil firms are vying to partner with Pemex to develop this field.
On September 13, Pemex announced the discovery of six new light and super light oil fields which will require an investment of over US$6 billion to develop, according to the director of Pemex exploration and production. Besides Pemex, there are now 27 companies undertaking oil exploration in Mexico, two of which just received approval from the National Hydrocarbons Commission to drill an exploratory well, the first by private actors. Twenty-six firms have paid to participate in the December 5 deep-water tender, including BP, Chevron, CNOOC, ExxonMobil, Pemex, Shell, Statoil and Total.
On September 28, the energy ministry announced the results of Mexico’s second auction to produce electric energy to meet CFE’s estimated future demand. The auction featured 36 renewable plants that should attract investments of US$4 billion over three years and yield an average energy price that is 30% below the previous auction. Also in renewables, the Sempra Energy subsidiary IEnova announced the purchase of Mexico’s largest wind farm.
Mexican Politics and U.S.-Mexico Relations
The Attorney General took over the corruption investigation of Veracruz governor Javier Duarte and issued an arrest warrant for former Sinaloa governor Guillermo Padres on charges of fiscal fraud and money laundering. The PRI took advantage of this sequence of events to play up its September 25 decision to suspend its governor’s party membership, the first time the party has acted against a sitting governor, while criticizing the PAN for not acting against Padres.
Meanwhile, the dissident CNTE teachers union continued its protests against education reform. This month it blocked highways in the state of Chiapas which forced Central American banana producers to shift shipments to the United States from land to ocean routes. The CNTE’s penchant for hijacking and occasionally burning buses in the state of Michoacán led bus companies to temporarily cease operations to pressure the state government to act.
Although Mexican firms continue to limit their investment in Mexico, foreign and especially U.S. companies continue to expand their presence. In September, Cisco Systems announced a US$4 billion investment in its Mexican plants over two years, and Walmart announced a US$1 billion investment to strengthen its distribution system. The Mexican competition commission approved IEnova’s purchase of a 50% stake in Gasoductos de Chihuahua. And in the first days of October, Citibank announced a US$1.5 billion investment over four years in its Banamex subsidiary and rebranded it CitiBanamex.
A September statement by Ford that it will take advantage of a previously announced US$1.6 billion investment to move all of its small car production to Mexico provoked a sharp rebuke from U.S. presidential candidate Donald J. Trump. Trump based his opposition on the mistaken belief that the move would cost U.S. jobs despite Ford and its union’s insistence that no jobs will be lost in the United States and that the new operations in Mexico should help maintain Ford’s competitiveness in the global small car market. Meanwhile, Central Bank President Agustín Carstens said the election of Donald Trump would have an impact on Mexico “stronger than a hurricane.”
Finally, a new report from the Pew Hispanic Center shows a continued decline in undocumented migrants coming to the United States from Mexico. But a parallel rapid increase in migrants from Central America, India, and China has kept the U.S. undocumented population unchanged. The Center’s findings are supported by a U.S. border patrol report that the number of apprehensions of Mexican migrants is at its lowest level since 1969.