Last week, the alarm bells rang. Moody’s Ratings put Mexico’s rating on a negative outlook, meaning that if the course is not corrected severely, it will degrade the sovereign debt from the current Baa2, approaching the lower limit of the investment grade. What are their concerns? Some are still manageable, like the fiscal deficit, if the government is willing to adjust the size of its “social programs” and if it can increase tax collection significantly, both of which are not in sight.
Yet, the real serious concerns are related to the destruction of the country’s institutional framework and the rule of law through constitutional reforms that eliminate the independence of the judiciary and the autonomous regulatory institutions. This puts at risk the continuation of the trade agreement with its main partners, the United States and Canada, and with it, the main engine of the country’s economy.
Not to mention the widespread control of entire regions by organized crime, which not only generates unrestrained violence but illegally extracts dues from extortion, adding to the cost of doing business, and the level of incompetence in the management of the government-owned energy entities whose debts and short-term liabilities are of such dimension that all or part of them will have to be transferred to the Federal Government’s balance sheet.
Two days later, the government submitted its economic package for 2025 to Congress. In a nutshell, it estimates economic growth in the range of 2-3%, a reduction of the fiscal deficit from 6 to 3.9%, assuming a 2.4% increase in tax collection without increases or new taxes, a peso-dollar rate of exchange of 18.70 by the end of 2025, and oil output of 1.8 million barrels a day. The budget privileges the extension of “social programs”, which are the main foundation of the regime’s political support, and the pet infrastructure projects of the previous ruler, which respond more to his caprices than to economic common sense. However, this budget strategy has been criticized for lacking focus on economic growth and heavy reliance on social programs.
Also, an assumption of Pemex debt for USD 40 billion for debt maturities in the next few years, not including overdue debt to suppliers and contractors for more than 400 billion Pesos already invoiced and an additional 100 billion Pesos of jobs performed but not yet invoiced. However, the problem is more significant: the Social Security Institute, the Federal Electricity Commission, and Pemex have unfunded labor liabilities of more than 2 trillion pesos and overdue debt to suppliers and contractors for half a trillion pesos that must be addressed in the very short term.
But there is a problem. The economic package failed to mention the probability that remittances -one if not the primary source of foreign exchange which accounts for USD$65 billion- will collapse next year, given the threat of the upcoming Trump administration deporting millions of undocumented migrants. Also absent is the effect of potential tariffs on manufactured products containing components or materials of Chinese origin. Even worse, there is no mention of the possible impact of losing the Investment Grade for the Sovereign Debt motivated by the reforms at the end of the last administration and the beginning of the incumbent, which has already caused Canadian officials to call to end the trade agreement with Mexico.
Also, the 2025 economic package does not include any appropriations for emergency programs or subsidies to provide support to the hundreds of thousands of workers returning as a result of the inverted migration forced by the Trump Administration policy of persecution and deportation of undocumented migrants. Apparently, the Mexican authorities rely on the effectiveness of their allegedly humanitarian rhetoric and the economic common sense arguments to stop it and make the Trump government rethink its policy. Very unlikely.
If, as is logical, the US and Canada call for the early termination of the trade agreement, considering the recent reforms of Mexico’s institutional framework make it untenable, and as a result, the country loses its investment grade, institutional investors, pension funds, and foreign companies would no longer be able to invest in Mexico, as institutional investors require investment grade in at least two of the three rating agencies. This would also make financing the government, Pemex, CFE, and other agencies more difficult and expensive.
Today, Mexican debt trades at a surcharge of 190 bps, which can be interpreted as the market already discounting the loss of its Investment Grade, given the effects of the reforms violating the spirit of fairness of the agreement, along with low tax revenues for the size of the economy, the percentage of the budget committed to pay interests on the debt, the burden of the growing losses of the energy companies, the unlikely decrease of the public deficit, the monumental cost of the “social programs”, and the unreasonable target of 2-3 % GDP growth which experts estimate will be between -.05% (Bursamétrica), and +1.5% (World Bank).
Unlike the multiplying effect of public expenditure, the massive funds dispersed through the “social programs” stimulate consumption, but not necessarily domestic products, as many are imported, including the main components of Mexicans’ diets: corn and beans. They aim to produce a satisfaction and insurance effect on the lowest-income segment of the population, even if its effect is short-term and does not solve their poverty situation but is enough to ensure their allegiance to the regime, particularly during elections.
As for the rate of exchange, considering the psychological element in the equation to determine its value, anything is possible above the 18.70 pesos per dollar target of the 2025 budget. For starters, USD$86 billion of government securities in pesos held by residents abroad would immediately outflow when the investment grade is lost, making a dent in the central bank’s foreign exchange reserves, which amount to the equivalent of USD$216 billion. If the risk of losing the Investment Grade is perceived, the outflow of these resources could be precipitated together with a fire sale of stocks traded in the domestic exchanges and generate a violent depreciation in sovereign debt bond prices, increasing the cost of debt, triggering sky-high interest rates and the exchange rate, and evidently, causing a severe recession.
The problem with democratic systems is that they have brought to power experts in winning elections, most of whom only know how to do that. They lack a national project concept and have no idea how to govern or what to do with power except to keep winning elections and staying in control. A State without an Independent Judiciary is a Dictatorship. The 4T regime refuses to accept that what distinguishes a democracy from tyranny is a term called justice.
SEPGRA Economic Analysis Group
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