Assessing Mexico's Economy at a Historical Milestone: Structural Reforms and Challenges
In 2013, Mexico’s government passed a constitutional reform, for which a slew of new legislation is expected to be implemented in the coming months. The effort to overhaul the country’s oil and gas sector is among the most anticipated liberalization efforts on the region.
Mexico is, without question, already an economically attractive country. With a population of 118 million and 2013 GDP of USD 1.26 trillion, it is the largest emerging economy after the BRIC countries. Mexico is Latin America’s most important player after Brazil, accounting for over a fifth of the region’s gross domestic product (GDP). In terms of economic policy, Mexico has reached an interesting point in history.
At the outset of President Enrique Peña Nieto’s term in 2012 he signed the Pact for Mexico, an agreement with the major political parties to jointly move forward with the most sweeping reform agenda in two decades. Throughout 2013, President Peña Nieto pushed through most of the agenda, and his administration is now focused on ensuring that the secondary legislation (containing all by-laws) is passed successfully in order to fully implement the reforms. The overhauls to communications, education, energy, finance, fiscal policy and even elections and politics are expected to lift potential economic growth in 2015 and beyond.
Consequently, most economic analysts surveyed by FocusEconomics are cautiously optimistic about Mexico’s economic outlook in the near term. Last year, the economy grew a disappointing 1.1%, which was the worst result since 2009. Yet this year, private sector analysts expect economic growth to rise to 2.7% and then to pick up to 3.9% in 2015*.
FocusEconomics participants also agree that, although the President’s initiatives are important, their impact should not be overestimated, particularly in the near term. The energy reform, which aims to open the energy sector and break up the monopoly that Mexico's state-owned Pemex has held for 76 years, is expected to reverse Mexico’s decline in oil and gas production, although this would not occur before the end of the decade. Education reform lays down the foundation for improved academic performance, but its impact on progress and, particularly, on the economy, will be gradual. Finally, the financial and fiscal reforms were disappointingly modest—market participants had expected more ambitious overhauls.
Overhauling the Energy Sector
The Mexican Congress approved the energy reform in December 2013. The ruling PRI party (Institutional Revolutionary Party) and the right-wing PAN party (National Action Party) voted for a bill that opens up the energy sector to private investment from domestic and foreign investors. The general consensus among analysts and investors is that the reform is transformational and that the principle of opening the oil, gas and electricity sectors remains in place, despite fierce opposition from the left-wing PRD party (Party of the Democratic Revolution).
In the oil sector, one key objective is to boost the production of crude oil. Pemex’s oil production reached a peak in 2004, totaling 3.4 million barrels per day (bbl/d) and output has been on a downward trend ever since. In 2013, oil production reached 2.5 million bbl/d and output could decline rapidly in the coming years with the depletion of fields that are now operated solely by Pemex. Oil production in Ku-Maloob-Zaap, currently the largest field, is expected to decline sometime around 2017. Experts have confirmed that Mexico has significant deep offshore resources in the Gulf of Mexico, in addition to shale gas potential in the northern region near the border with Texas.
However, Pemex has neither the resources nor the expertise required to harness that potential. The energy reform is designed to attract investment from both foreign and domestic firms and, to allow private sector involvement in attractive unconventional fields, to provide licenses, profit-sharing and production-sharing contracts as well as services contracts to be granted by the government, either directly or in association with Pemex. Pemex should continue to have priority for operating the fields, but could join private firms under profit sharing or production sharing agreements. Alternatively, Pemex could decide to operate the field, in which case a license could be awarded to a private investor. The arrangement would be close to a production agreement and the state would maintain ownership of petroleum resources. In economic terms, licenses are no different from concessions and firms would be able to report the expected benefits of a contract for accounting and financial purposes, even though they could not, in practice, book reserves.
The energy overhaul will provide foreign companies investment opportunities in exploration—particularly in the offshore deep-water fields and onshore shale resources—which are currently beyond the state-owned firm budget. In addition, the opening in the down-stream industry, specifically gasoline sales at retail level, will provide businesses the opportunity to enter a growing market of fuels, although competition in gas stations will be introduced gradually, so private businesses will not be able to compete with PEMEX in retail right away. Mexico will also need massive investments in infrastructure development of pipelines, roads and ports. Moreover, the proposed legislation confirms the government’s intention of transforming PEMEX into a “productive state enterprise” meaning that the government will gradually lower the tax burden on the company from 80% to around 65% a decade from now. In addition, PEMEX will have budgetary and management autonomy from the federal government and the new law also contemplates the creation of a sovereign wealth fund from excess oil revenue, which will be constructed step by step and which the government will not be able to tap until it reaches 3.0% of Mexico’s GDP.
Overall, oil and gas production could indeed be boosted by the energy reform, although analysts agree that there are some caveats. Investor confidence may remain stymied by concerns over the actual interpretation and application of the new reforms. Legal uncertainty could still be a potential hurdle, even though the by-laws provide a legal framework for investment. Opinion is mixed on how Mexico’s courts will interpret the laws when conflicts arise and ambiguity remains regarding the possibility of recourse to international arbitration. Physical security could also be an obstacle as many shale resources are situated in the violent northern and northeastern parts of the country.
Also, the upturn in production will be slow as the impact from new capacity—subject to the timing of contract negotiation, exploration, as well as construction of infrastructure—is expected to start no earlier than 2018. According to Pemex, the state-owned firm is likely to be able to return output to 3.0 million bbl/day in 2018 on improved operations in existing fields. However, uncertainty persists that Pemex is capable of doing so and that this objective would have a minor impact on the economy because, at the moment, the link between the oil sector and the rest of the economy basically runs through the government’s budget. In 2013, oil revenues amounted to just a third of total consolidated public sector revenues, or 7.8% of GDP. An increase in oil production by Pemex is, accordingly, expected to increase public sector revenues. However, keeping everything else constant, analysts estimate that for a 20% increase in oil production, revenues would rise by around 1.5% of GDP, not taking into account that the cost of producing an additional 20% would exceed the cost of current production. This could result in a bit more fiscal easing, but is not a structural change per se. It is likely that there are major unexploited oil and gas reserves in the northern part of the country and in the Gulf of Mexico. However, it will take time before these resources are online and thus they will have no significant macroeconomic impact before 2020.
Limited fiscal reforms
The fiscal reform, meanwhile, which was pushed through by the PRI party in conjunction with the left-wing PRD party, came as a disappointment when it was approved in October 2013. The market had expected a more ambitious tax reform and thus received the proposed overhaul with some dissatisfaction. The fiscal reform contains two main elements: First, a series of tax increases and new taxes in areas which were previously exempt from levies. The most notable increase is in the income tax rate (ISR) for high-income brackets, which will increase from 30% to 32%. New taxes include a 10% tax on capital gains from the stock market, a new levy on sugary soft drinks (to combat obesity) and a new carbon tax. Furthermore, exemptions on private education services and mortgage loans will be eliminated. Second, the tax structure for businesses was simplified by eliminating both the IETU, or corporate alternative minimum tax, and the IDE, a tax on cash deposits.
The fiscal reform is aimed at increasing the tax take by 1.4% of GDP in 2014. The hope is that it will increase revenues by nearly 3% of GDP by 2018. Investors’ disappointment with the reform was justified in some cases, but mistaken in others. First, the reform lacked the ambition to broaden the tax base. The burden is still imposed on those who cannot escape taxation, namely the economically active population in the formal sector. The government argued that broadening the tax base was not possible as it finds it difficult to tax the informal sector.
The counterargument came from economic analysts who studied government revenues as percentage of GDP for 2013. Of all countries whose long-term government bonds were rated Baa by the credit agency Moody’s, Mexico had one of the lowest ratios of government revenues to GDP, with 17.2% in 2013 compared to the median figure of 30.5%. Only the Bahamas, Colombia, Costa Rica, Indonesia and the Philippines had lower ratios. The conclusion was that the informal sector in Mexico could not be less accessible to taxation than that of Turkey (38%), Brazil (36%) or Romania (34%).
The second reason is that the Mexican government has failed to broaden the tax base because it sees no reason to do so. After the economic collapses of 1982 and 1994, Mexico had to follow fiscal orthodoxy, which became an anchor to economic policy after the country implemented the fiscal rules according to the principles laid out by the Washington Consensus, controlling mostly public expenditures.
Analysts and investors were mistaken, however, in their disagreement with the fact that basic foods and pharmaceuticals are still not subject to the value-added tax (VAT). Proposing a tax on these items would have been unrealistic, as the PRD would never have voted for the reform., A regressive tax on the consumption of basic necessities (for which the poor spend a much greater share of their income than the middle or upper classes) would have been a tough sell and difficult to justify.
Informal sector weight
While there is no doubt that Mexico is economically attractive, the impact of the structural reforms is not clear. The government, as well as some analysts and investors, agree that this comprehensive reform agenda should help address many of the country's economic weaknesses, including lack of competition, inefficiencies and poor performance in the sectors that the reforms target. In addition, the successful passage of the by-laws, combined with a gradual recovery in the U.S. economy, should support stronger economic growth in Mexico in 2015 and beyond. However, other experts and investors see that the impact of the reforms will only be felt in the long term, while they still believe that questions remain regarding the country’s overall development model.
Mexico experienced a long period of mediocre growth between 2001 and 2013, when the economy grew at an average rate of 2.1%. This contrasted the so-called post-NAFTA boom—the period between 1996 and 2000—when the economy grew 5.1% on average. Analysts argue that the mediocre growth rates registered in recent years mainly reflect the country’s informal sector that continues to occupy a large proportion of the labor force that weighs down on the formal sector characterized by modern and globally-competitive industries.
In order to catch up with other advanced economies, Mexico will need to foster its more productive formal sector. The structural reforms promise to do that and will therefore help transform the Mexican economy. However, their impact will be felt only in the long term rather than manifest as a short term panacea to improve growth.
*Note: In addition to macroeconomic analysis, FocusEconomics produces the LatinFocus Consensus Forecast, a monthly forecast based on 29 individual projections from investment banks, consultancies and think tanks. For more information, please contact us via www.focus-economics.com.
Date: September 18, 2014
TagsAfrica Japan Mexico China IMF Gold Investment Brexit Consensus Forecast United Kingdom United States Commodities Agricultural Commodities Inflation Healthcare Eastern Europe Asia Vietnam Base Metals Commodities Emerging Markets MENA Argentina Nordic Economies Australia precious metals Banking Sector Spain Turkey Germany Housing Market USA Canada Tunisia Oil G7 Major Economies Colombia Forex Brazil Energy Commodities Sub-Saharan Africa Venezuela Euro Area oil prices India Latin America Greece Portugal Unemployment rate Russia Cryptocurrency Exchange Rate South Africa Economic Growth (GDP) European Union Precious Metals Commodities UK Company News TPP OPEC France Infographic Ukraine Italy Iran Trade Bitcoin
The most recent estimates suggest that the Angolan economy is getting back on its feet. Read more: https://t.co/E1QrCcf8pe
10 hours ago
India is projected to grow 7.3% in FY 2018 and 7.4% in FY 2019. https://t.co/JNeqoY4fcN
11 hours ago
How will general elections in Malaysia affect the economy in 2018? Find out: https://t.co/wxJTHWfmrk
12 hours ago
Incoming economic data remains largely encouraging in India. Read our latest economic outlook for India here:… https://t.co/WRPhonAiNx
12 hours ago
Tighter monetary stance and ebbing Chinese demand to cause growth to moderate in Malaysia this year. Read more: https://t.co/wxJTHWfmrk
13 hours ago
- Latin America is the World Leader in eCommerce Growth Despite Serious Challenges
- What the TPP means for trade in Latin America
- How Student Loan Debt Affects the Economy
- Elections in Russia: Analysis and Implications
- 2018 & 2019 Economic Outlook for the Top Oil Producing Countries
- Nearly a Third of Latin Americans Have No Right to a Pension
- A Look at Healthcare Models Around the World
- The Poorest Countries in the World
- Newly-elected Chilean President Sebastian Piñera faces a myriad of challenges - economic and otherwise
- The Economic Effects of Trade Protectionism
- Regional Disparity: The Dark Side of Inequality in Latin America
- Coal: The story of the world's most abundant fossil fuel
- Venezuela's Electoral Conundrum
- Gold: The Most Precious of Metals (Part 3)
- Trump's 1st Year: 95 Analysts Surveyed on U.S. Economy
- The Latest on China and What's in Store for 2018
- An in-depth look at the Eurozone’s booming economy and the challenges that lurk in the shadows
- China’s growing influence on the Latin American economy
- Top Economics & Finance Blogs of 2018
- How Latin America emerged from recession in 2017
- Is this the beginning of the end for Bitcoin?
- Risks and Opportunities for 2018 - Daniel Lacalle
- Emerging Markets 2018 Economic Outlook
- The role of FDI in Vietnam’s socio-economic development
- Increasing poverty in Latin America takes a breather thanks to improving economic dynamics
- What will be the most miserable economies in 2018?
- The World's Top 10 Largest Economies
- Is Spain doing enough to address its high youth unemployment rate?
- Has Latin America gone far enough in reducing barriers to international trade?
- Commodities Outlook: Oil, Natural Gas, Coal, Lead & Tin
- 21 experts tell us what the future looks like for cryptocurrencies and blockchain
- Turkish lira plummets to all-time low on Erdogan’s monetary feud and tense U.S.-Turkey relations
- Copper: The first metal mastered by man
- The Mercosur-EU Free Trade Agreement: Obstacles & Opportunities
- Nigerian Economy Still Treading Water Thanks to Oil Sector
- Elections in Chile: What the results could mean for the economy
- QE’s Untold Story: A Chart That Fed Correspondents Need To Investigate
- Holland’s fragile one-seat majority government targets economic growth at the expense of fiscal sustainability
- South Africa: Economy at a tipping point?
- Latin American Commodities: What’s behind the increase in demand and prices?
- Is the UK really "shackled to a corpse"?
- Spain-Catalonia: 7 economic experts weigh in on how the situation will affect the outlook
- How well is Spain's labor market doing since the crisis?
- Which countries will have the highest and lowest inflation in 2017?
- How vulnerable is Latin America to economic crises today?
- Iron ore facts and common questions answered
- The bulging economic costs of obesity
- How much investment is needed to salvage Latin America’s crumbling infrastructure?
- A Look at the Potential Impact of Brexit on the Dutch Economy
- Emerging Markets Are Kicking Into Higher Gear In 2017
- Why is foreign direct investment in Latin America falling again?
- Are Central Banks Nationalising the Economy?
- Bounty or burden? The impact of refugees on European economies is far from clear
- What’s the future of U.S.-Latin America trade relations?
- Taxes or cutbacks? Latin America's challenge of sustaining spending without causing debt to skyrocket
- Are uranium prices making a comeback?
- Taxing the Economy: Achieving a Delicate Balance
- How will Latin America’s upcoming lengthy election cycle affect the reform agenda and credit ratings?
- How will emerging market economies perform in 2017?
- Chilean Economy in Focus: Interview with Senior Economist of the Chamber of Commerce of Santiago
- CEOs Rank Top Economies for Growth Opportunities
- The Mobile Ecosystem & Latin America's Economy
- Prospects and Challenges for the Global Economy: Interview with Tim Cooper from BMI Research
- How will the Fed reduce its balance sheet & and how will the ECB end QE? - 19 economic experts weigh in
- Thoughts on "unwinding" QE from Frances Coppola
- The Fed and ECB at a crossroads: Unwinding QE
- Spain: The economy that continues to silence the critics
- Latin America: The Most Unequal Region in the World
- The History of OPEC: Has it been a Success?
- FocusEconomics Announces 2017 Analyst Forecast Awards Winners
- Latin America’s rising unemployment bucks nearly decade long trend
- Escape from the Central Bank Trap by Daniel Lacalle
- China's economic rebalancing act: What to look out for in 2017
- Driving Growth in Latin America: Challenges & Priorities
- Is the Global Economy Rebalancing?
- Commodity exporters face challenging times
- Recent Global Events Facilitate Mercosur-Pacific Alliance
- 23 economic experts weigh in: Why is productivity growth so low?
- Mexico's outlook as Trump nears 100-day mark
- Interview with Oxford Economics Senior Economist on implications of the possible outcomes of the French Presidential Election
- The anxiety of the small saver in a world of negative interest rates
- Brexit negotiations. Between Uncertainty and Urgency
- An Economic History of the EU from El Blog Salmón
- Baby Boomin': Implications of high population growth in Latin America
- Survey of International Economists Predicts a Le Pen Defeat in French Elections, Says Macron has Best Economic Plan
- Spain in a global context: developed economy with some challenges
- How much is crime costing Latin America?
- Predictions & Estimates from Economist Daniel Lacalle
- What economy will the new Dutch government inherit?
- “The data is not a true reflection of reality in India” Interview with Société Générale India Economist
- What are the prospects for Emerging Economies in 2017?
- What to expect in Asia for 2017
- Top Economics & Finance Blogs of 2017
- Latam to Resume Moderate Growth in 2017 but Important Risks Plague Outlook
- 4 Key European Elections That Will Impact the Economy in 2017
- How are security concerns and political chaos affecting Turkey’s economy?
- Global growth to edge up in 2017
- Set to breach targets again? Debt and deficit outlooks for Southern European Eurozone countries in 2016 & 2017
- What does Donald Trump mean for the U.S. economy?
- How will emerging markets perform in 2017?
- The economic impact of a break in U.S.-Philippines ties
- Trump election: Base metals surge due to infrastructure plan
- 5 updates on the Venezuelan economic crisis
- Canada: When your neighbor’s house is on fire…
- Short-term pain before long-term gain? A look at French labor reform and economic growth
- Asia: Unremarkable growth & unfulfilled promises?
- How India's latest monsoon is affecting the economy
- Russian economy update in wake of OPEC deal announcement
- Innovation in Latin America: Potential Goes Untapped Due to Weak Economic Conditions
- The Wisdom of the Crowds and the Consensus Forecast
- Can the peso predict the U.S. election results?
- There's no end in sight to the Venezuela crisis
- A Look at the European Union Political Calendar
- Survey of international economists shows uncertainty surrounding elections damaging U.S. growth prospects
- FocusEconomics partners with leading online statistics provider Statista
- China: Recent postive economic data may be papering over the cracks
- Sub-Saharan Africa's 2016 & 2017 growth rates
- The Italian Dilemma: Weak banks pose risk to already faltering domestic demand
- How much money do migrants from Latin America send home?
- The U.S.' (Not So) Mysterious Case of the Missing Men
- What to expect from the G20 economies by 2020
- The Pain in Spain: Robust GDP growth cannot mask the persistent structural deficit