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Part 1: A Critical Confluence of Events
December 9, 2008 | 1213 GMT
Summary
Mexico is facing the perfect storm as the global financial crisis begins to impact the country’s economy and as the government’s campaign against the drug cartels seems to be making the country even less secure. Mexico also faces legislative elections in the coming year, which will involve much jockeying for the 2012 presidential race. The political implications of the financial crisis will be reflected in a decline in employment and overall standard of living. In a country where political expression takes the form of paralyzing protest, the economic downturn could spell near-disaster for the administration of Mexican President Felipe Calderon.
Analysis
Editor’s Note: This is the first part of a series on Mexico.
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Countries in Crisis: Mexico
Mexico appears to be a country coming undone. Powerful drug cartels use Mexico for the overland transshipment of illicit drugs — mainly cocaine, marijuana and methamphetamine — from producers in South America to consumers in the United States. Violence between competing cartels has grown over the past two years as they have fought over territory and as the Mexican army has tried to secure the embattled areas, mainly on the country’s periphery. It is a tough fight, made even tougher by endemic geographic, institutional and technical problems in Mexico that make a government victory hard to achieve. The military is stretched thin, the cartels are becoming even more aggressive and the people of Mexico are growing tired of the violence.
At the same time, the country is facing a global economic downturn that will slow Mexico’s growth and pose additional challenges to national stability. Although the country appears to be in a comfortable fiscal position for the short term, the outlook for the country’s energy industry is bleak, and a decline in employment could prompt social unrest. Complications also loom in the political sphere as Mexican parties campaign ahead of 2009 legislative elections and jockey for position in preparation for the 2012 presidential election.
Economic Turmoil
As the international financial crisis roils economies around the world, Mexico has been hit hard. Tightly bound to its northern neighbor, Mexico’s economy is set to shrink alongside that of the United States, and it will be an enormous challenge for the Mexican government to face in the midst of a devastating war with the drug cartels.
The key to understanding the Mexican economy is an appreciation of Mexico’s enormous integration with the United States. As a party to the North American Free Trade Agreement and one of the largest U.S. trading partners, Mexico is highly vulnerable to the vagaries of the U.S. economy. The United States is the largest single source of foreign direct investment in Mexico. Even more important, the United States is the destination of more than 80 percent of Mexico’s exports. A slowdown in economic activity and consumer demand in the United States thus translates directly into a slowdown in Mexico.
In addition to the sale of most Mexican goods in the U.S. markets, the United States is a major source of revenue for Mexico though remittances, and together these sources of income provide around a quarter of Mexico’s gross domestic product (GDP). When Mexican immigrants send money home from the United States, it makes up a substantial portion of Mexico’s external revenue streams. Remittances to Mexico totaled US$23.9 billion in 2007, according to the Mexican Central Bank. The slowdown in the U.S. housing sector has brought remittances down during the course of 2008 from highs in the middle of 2007. As of the end of September 2008, remittances for the year were down by US$672.6 million from the same period in 2007.
The decline in remittances is being matched by a slowdown in Mexico’s economy across the board. The Mexican government estimates that Mexico’s GDP will slow from 3.2 percent growth in 2007 to 1.8 percent in 2008. Given that the U.S. economy is sliding into recession at the same time, this is likely only the beginning of the Mexican slowdown, and growth is expected to bottom out at 0.9 percent in 2009.
With growing pressure on the rest of the economy, the prospect of rising unemployment is perhaps the most daunting challenge. So far, unemployment and underemployment in Mexico has risen from 9.77 percent in December 2007 to 10.82 percent in October 2008, (some 27 percent of the workforce is employed in the informal sector). But slowed growth and declining demand in the United States is sure to cause further declines in employment in Mexico. As happened in the wake of Mexico’s 1982 debt crisis, Mexicans may seek to return to a certain degree of subsistence farming in order to make it through the tough times, but that is nowhere near an ideal solution. The government has proposed a US$3.4 billion infrastructure buildup plan to be implemented in 2009 that will seek to boost jobs (and demand for industrial goods) throughout Mexico, although it is not clear how quickly this can take effect or how many jobs it might create.
Further compounding the employment issue is the possibility of Mexican immigrants returning from the United States as jobs disappear to the north. Stratfor sources have already reported a slightly higher-than-normal level of immigrants returning to Mexico, and although it is too early to plot the trajectory of this trend, there is little doubt that job opportunities are evaporating in the United States. As migrants return to Mexico, however, there are very few jobs waiting for them there, either. This presents the very real possibility that the available jobs will be in the black markets, and specifically with the drug cartels. Demand for drugs persists despite economic downturns, and the business of the cartels continues unabated. Indeed, for the cartels, the economic downturn could be an excellent recruitment opportunity.
The turmoil in U.S. financial markets has directly damaged the value of the Mexican peso and has caused a loss of wealth among Mexican companies. Mexican businesses have lost billions of dollars (exact figures are not available at this time) to bad currency bets. Mexican companies in search of extra financing have had trouble floating corporate paper, which has forced the government to offer billions of dollars worth of guarantees. The upside to this is that a weaker currency will increase the attractiveness of Mexican exports to the United States vis-à-vis China (for a change), which will boost the export sector to a certain degree.
The fluctuating peso has also forced the Mexican central bank to inject about US$14.8 billion into currency markets to stabilize the peso. Nevertheless, the peso has devalued by approximately 22.6 percent since the beginning of 2008. Partially as a result of the currency devaluation, inflation appears to be rising slightly. The government has reported a 12-month inflation rate of 6.2 percent, through mid-November. This is actually fairly low for a developing nation, but it is the highest inflation has been in Mexico since 2001.
Mexico’s financial sector is highly exposed to the international credit market, with about 80 percent of Mexico’s banks owned by foreign companies, and the banking sector has been unstable in recent months. Foreign capital has, to a certain degree, fled Mexican investments and banks as capital worldwide veered away from developing to developed markets, in response to the global financial crisis. The result is a decline in investments across the board, and there was a sharp decline in the purchase of Mexican government bonds. After a four-week fall in bond purchases, the Mexican government announced a US$1.1 billion bond repurchase package Dec. 2 in an attempt to increase liquidity in the capital markets and lower interest rates. Although investors were not responsive, it is an indication that the government is taking its countercyclical duties seriously.
As the government seeks to counter falling employment and other economic challenges, it will need to lean heavily on its available resources. The central bank holds US$83.4 billion in foreign reserves, as of Nov. 28, and can continue to use the money to implement monetary stabilization. Mexico also maintains oil stabilization funds that total more than US$7.4 billion, which provides a small fiscal cushion. The 2009 Mexican federal budget calls for the first budget deficit in years — amounting to 1.8 percent of GDP — and has increased spending by 13 percent from the previous year’s budget, to US$231 billion.
Some 40 percent of this budget is reliant on oil revenues generated by Mexican state-owned oil company Petroleos Mexicanos (Pemex). Despite the fall in oil prices, Mexico has managed to secure its energy income through a series of hedged oil sales contracts. These contracts will sustain the budget through the duration of 2009 with prices set from US$70 to US$100 per barrel. Mexico is a major exporter of oil — ranked the sixth largest producer and the 10th largest exporter. The energy industry is critical for the economy, just as it is for the government.
In the long term, however, Mexico’s energy industry is crippled. Due to a history of restrictive energy regulations, oil production is falling precipitously (primarily at Mexico’s gigantic offshore Cantarell oil field), with government reports indicating that production averaged 2.8 million barrels per day (bpd) between January and September, which is far from Mexico’s target production of 3 million bpd. Thus, even if Mexico has secured the price of its oil through 2009, it cannot guarantee its production levels in the short term, and perhaps not in the long term.
To try to boost the industry’s prospects, the Mexican government has passed an energy reform plan that will allow Pemex to issue contract agreements to foreign companies for joint exploration and production projects. The government has also decided to assume some of Pemex’s debt in order to ease the company’s access to international credit in light of the tight international credit market.
These changes could help Mexico pull its oil production rate out of the doldrums. However, most of Mexico’s untapped reserves are located either in deep complex formations or offshore — environments in which Pemex is at best a technical laggard — making extraction projects expensive and technically difficult. With the international investment climate constrained by capital shortages, foreigners barred from sharing ownership of the oil they produce and the price of oil falling, it is not yet clear how interested foreign oil companies will be in such partnerships.
The decline in the energy sector has the potential to produce a sustained fiscal crisis in the two- to three-year timeframe, even assuming that other aspects of the economic environment (nearly all of which are beyond Mexico’s control) rectify themselves. The slack in government revenue will have to be taken up through increased taxes on other industries or on individuals, but it is not yet clear how such a replacement source of revenue might be created.
The overall political implications of the financial crisis will be reflected in a decline in employment and the standard of living of average Mexicans. In a country where political expression takes the form of paralyzing protest, the economic downturn could spell near-disaster for the administration of Mexican President Felipe Calderon.
The Shifting Political Landscape
In power since 2000, the ruling National Action Party (PAN) has enjoyed a fairly significant level of support for Calderon both within the legislature — where it lacks a ruling majority — and in the population at large, particularly given the razor-thin margin with which Calderon won his office in 2006. The Calderon administration has launched a number of reform efforts targeting labor, energy and, of course, security.
Although the PAN has maintained an alliance with the Institutional Revolutionary Party (PRI) for much of Calderon’s administration, this is a unity that that is unlikely to persist, given that both parties have begun to lay out their campaigns for the 2012 presidential election.
For the ruling party, there are a number of looming challenges on the political scene. Mexico has seen a massive spike in crime and drug-related violence coincide with the first eight years of rule by Calderon’s PAN after 71 straight years of rule by the PRI. To make things worse, the global financial crisis has begun to impact Mexico — through no fault of its own — and the impact on employment could be devastating. Given the confluence of events, it is almost guaranteed that Calderon and the PAN will suffer political losses going forward, weakening the party’s ability to move forward with decisive action.
So far, Calderon has been receiving credit for his all-out attack on the drug cartels, and his approval ratings are near 60 percent. As the economy weakens and the death toll mounts, however, this positive outlook could easily falter.
The challenge will not likely come from the PAN’s 2006 rival, the Revolutionary Democratic Party (PRD). The PRD gained tremendous media attention when party leader Andres Manuel Lopez Obrador lost the presidential election to Calderon and proceeded to stage massive demonstrations protesting his loss. Since then, the PRD has adopted a less-radical stance, and the far-left elements of the party have begun to part ways with the less radical elements. This split within the PRD could weaken the party as it moves forward.
The weakening of the PRD is auspicious for Mexico’s third party, the PRI, which has been playing a very careful game. The PRI has engaged in partnerships with the PAN in opposition (for the most part) to the leftist PRD. In doing so, the PRI has taken a strong role in the formation of legislation. However, the PRI’s prospects for the 2012 presidential election have begun to improve, with the party’s popularity on the rise. As of late October, the PRI was polling extremely well — at the expense of both the PAN and the PRD — with a 32.4 percent approval rating, compared to the PAN’s 24.5 percent and the PRD’s 10.8 percent.
In the short term, the June 2009 legislative elections will be a litmus test for the political gyrations of Mexico, a warm-up for the 2012 elections and the next stage of political challenges for Calderon. As the PRI positions itself in opposition to the PAN — and particularly if the party gains more seats in the Mexican legislature — it will become increasingly difficult for the government to reach compromise solutions to looming challenges. Calderon is somewhat protected by his high approval ratings, which will make overt moves against him politically questionable for the PRI or the PRD.
Although a great deal could change (and quickly), these dynamics highlight the potential changes in political orientation for Mexico over the next three years. In the short term, the political situation remains relatively secure for Calderon, which is critical for a president who is balancing the need for substantial economic resuscitation with an ongoing war on domestic organized crime.
Mexico’s most critical challenge is the convergence of events it now faces. The downturn in the economy, the political dynamics or the deteriorating security situation, each on its own, might not pose an insurmountable problem for Mexico. What could prove insurmountable is the confluence of all three, which appears to be in the making.
