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Mexico Politics January 2019

Mexico: Budget calms markets, promises primary surplus

Mexico’s new government earned plaudits on the announcement of its 2019 budget on 15 December, its first since Andrés Manuel López Obrador (AMLO) took power on the heels on last July’s landslide election victory. Devoid of any major surprises, the proposal drew widespread praise from analysts given its restrained spending plans—which many had previously written off given the new president’s numerous promises to expand the social safety net. Of particular note, the government set out to achieve a primary fiscal surplus of 1.0% of GDP, making good on an earlier campaign pledge and, if realized, a modest improvement on last year’s outturn. Importantly, the plan is also expected to keep the debt-to-GDP ratio stable this year, although any improvement appears unlikely over the medium-term. The announcement was a much-needed first win for AMLO, having sent financial markets into a tailspin only weeks earlier after cancelling Mexico City’s partially-built airport (NAIM).

This year’s budget earned the new left-wing majority some credibility after a rocky couple of months at the helm. Expenditures are expected to comply with fiscal-responsibility laws (LFPRH), rising no more than 2.4% from a year earlier. This is roughly unchanged from previous years but commendable nonetheless given the shifting political winds. A breakdown showed that, although public spending on social programs is seen rising in line with campaign promises, there will be little room for any payout to bondholders of the canceled NAIM—which could exacerbate market worries down the road. As for revenue, analysts are skeptical of the government’s ability to follow through on a pledge to close loopholes in the tax code. According to the plan, however, this should increase tax revenue by about 0.5% of GDP and would offset slashed income and value-added taxes within the border zones (equal to about 0.2% of GDP). Again not rocking the boat, the government’s financing strategy remained broadly unchanged from previous years and focused largely on local debt instruments.

In the weeks following the announcement, the peso strengthened considerably as investors shook earlier concerns about fiscal mismanagement. By 11 January, the Mexican peso had almost recovered from the NAIM-driven freefall in late October and traded at MXN 19.14 per USD, which was up 5.3% from the same day a month earlier.

As analysts from Goldman Sachs noted:

“After a dramatic selloff in the MXN in late October, we argued that the takeoff of the incoming administration was likely to be bumpy, but that the attractive carry and value combination of the MXN was an important macro anchor. Since then, market perceptions have indeed fluctuated: MXN has retraced the bulk of that October selloff. While recent moves have been substantial, the valuation signal is still strong on our metrics (fair value for the USD/MXN cross is near 17.50, compared to current spot near 19), and carry remains among the highest in EM.”

Although significant risks are inherent in the budget—foremost, how the state-owned oil company will fare in light of lower oil prices and the continued volatility of financial markets—analysts largely took the budget’s announcement as good news. That said, there were some reservations.

As noted by analysts at Profuturo:

“Sovereign-credit risks, the cancellation of the NAIM, heavier spending on state-owned enterprises, as well as possible changes to economic policy, are risk factors for the public finances. […] In this context, we see limited room for the government to maneuver in terms of expenditures. […] We consider the [government’s spending plans] highly biased toward consumption over investment. Likewise, incentives near the border, a minimum-wage hike and lower taxes could all boost consumption levels going forward. Given this, we estimate that consumption will continue to sustain economic activity in 2019, which would partially offset lower levels of investment.”

Although the government anticipates a fiscal deficit of 2.0% of GDP this year, our FocusEconomics panel sees instead a larger 2.5%-of-GDP shortfall—having now widened considerably since last year’s election.

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