Just a few months ago, Felipe Calderón, Mexicos
president, was staring into a fiscal abyss. His country was
nursing the deepest recession in Latin America, its economy
ravaged by the US downturn. And with oil revenues sharply down,
a diluted tax reform did not go far enough to stave off
downgrades by two ratings agencies.
Calderón can breathe again, however, now that
resurgent US automakers have thrown a tentative lifeline to the
countrys exporters. Yet until Mexico revamps its creaking
economy, it can only hope for mediocre growth rates chained to
the economic mood swings of its northern neighbour.
As Mexicos bloody drug war consumes
Calderóns attention, economic woes erode his
popularity, and a formidable opposition positions itself to
take over in 2012, the type of far-reaching structural reforms
Mexico needs to compete with its emerging market peers look
further out of reach than ever.
The window of opportunity to pursue any reforms is
going to dwindle after 2010, says Shelly Shetty,
Fitchs main Mexico analyst. The political landscape
at the moment does not allow for reaching consensus.
Last year was dire for Mexicos economy. Around 80% of
Mexicos exports go to the US. As the worlds largest
economy reeled from the worst recession since the Great
Depression, it passed the pain south, and Mexican gross
domestic product fell an estimated 6.5%.
Faced with a Ps480 billion ($37 billion) revenue gap,
Calderóns conservative government tried to redress
the main structural problem dogging Mexicos economy
its abysmally low fiscal revenue brokering a deal
with the powerful opposition Institutional Revolutionary Party
(PRI) that raised the countrys VAT rate from 15% to
The tax push, even in the watered down form in which the
PRI, eager to avoid alienating its mass voter base, backed it,
was a bold move the government was essentially
tightening fiscal policy during a recession.
But it didnt go far enough. Both Fitch and Standard
& Poors lowered Mexicos debt rating from two
notches inside investment grade, down to one.
Now, true to a pattern that has long tethered Mexicos
economic fortunes to those of its northern neighbour, for
better or for worse, the US economy is again coming to the
rescue. US auto sales are improving; automakers are ramping up
orders from Mexico again and even setting up new production
Mexican industrial output began rising at the end of last
year for the first time since 2008, and auto exports more than
doubled year-on-year in January. While 2009 fourth quarter GDP
was still down 2.3% from a year earlier, it rose 2.03% from the
third quarter. The government lifted its 2010 growth estimate
from 3% to 3.9%. We have gone from a situation three to
four months ago when market participants were talking about
sustainability of debt to GDP levels in Mexico, to a situation
now where those views have almost completely disappeared,
says Guillermo Osses, who manages tens of billions of dollars
in Mexican assets for Pimco, the worlds largest bond
Economists, however, are less optimistic. The US stimulus
package to the automobile industry may have breathed some life
into Mexican manufacturing, but with US consumers still timid
and out of work in stubbornly high numbers, they cannot yet be
relied upon to buoy Mexicos economy.
Moreover, exports count for only part of Mexicos GDP.
While Mexican retail sales and consumer confidence are
beginning to pick up, unemployment is still high, and internal
demand remains sluggish, stifled in part by the recent tax
Its a story thats perhaps overly dependent
on the US, says Enrique Alvarez, head of Latin American
research for IDEAglobal in New York. The US shows some
signs of bouncing back, and thats positive for Mexico.
However, as far as the domestic dynamic goes, youre still
lacking in various aspects, and that may come back and haunt
the economy overall in 2010.
The only way to fire up Mexicos internal growth
engine, most economists agree, is through radical reform. About
40% of government revenues come from state oil company Pemex,
where production has steadily declined in recent years. While
vast new reserves are known to lie deep in national waters in
the Gulf of Mexico, Pemex lacks the technology to access them,
and a constitutional ban dating back to 1938 limits help from
At the same time, the country suffers from one of the lowest
tax takes as a percentage of GDP in Latin America. Combined tax
and energy reforms would boost oil revenue while making Mexico
less dependent on the volatile commodity, reform supporters
Calderón has made the pursuit of those reforms
central to his presidency, and has vowed to continue pushing
them, but his attention is diverted by a bloody fight against
warring drug cartels. As his term nears its end, any political
capital he had is quickly slipping away.
CHASING THE DRAGON
Claiming an estimated 18,000 lives since Calderón
took office in late 2006, the drug war, with its gangland
massacres and beheadings, continuously reaches grisly new
heights. In the border city of Ciudad Juárez , a dozen
killings a day are common, and government successes are soon
eclipsed by more gore.
One major victory in December, a deadly hit on drug boss
Arturo Beltrán Leyva, quickly turned pyrrhic when gunmen
on a revenge mission shot dead the grieving family of a marine
hero killed in the operation. In January, the cartels raised
the bar again, gunning down 15 people, most of them teenagers,
at a Ciudad Juárez high school party. [For an in-depth
look at the effects of Mexicos drug war, see
While many Mexicans object to Calderóns use of the
army to fight the drug war and see no impact on levels of
violence, they largely support him for taking on the cartels.
Despite the media frenzy surrounding drug violence at home and
abroad, however, two out of three major pollsters show Mexicans
to be more concerned about the economy.
In this area, their patience with the government is wearing
thin more quickly, and getting a tax hike instead of any major
fiscal stimulus programme has not helped. Local pollster
Mitofsky recently put Calderóns approval rating at
52%, his lowest ever.
Now, more than at any time during Calderóns
presidency, the key to any reforms lies in the hands of the
people Calderóns National Action Party (PAN) spent
years trying to drive from power.
Born from the ashes of Mexicos 1910 revolution, the
PRI ruled Mexico for 70 years until it was ousted from power in
2000 by Calderóns PAN predecessor Vicente Fox.
But while it lost the presidency, it has never left
government. As a mass-based conglomeration of interests deeply
rooted in Mexican society, it has continued to dominate
politics through its weight in both houses of Congress and its
powerful network of state governors.
Thriving on disenchantment with Calderóns
handling of the economy, it gathered nearly half the seats in
the lower house of Congress last year in a sweeping mid-term
electoral victory. It is ahead in the polls for the 2012
presidential elections, and one of its top cadres, the dashing
young governor of populous Mexico State, Enrique Peña
Nieto, is an early favourite to succeed Calderón.
Hoping to prevent a similar PRI landslide in state and
municipal elections this July, the ruling party is forming
electoral alliances in at least two gubernatorial campaigns
with its diametrically opposed rival on the left, the Party of
the Democratic Revolution (PRD). While such an ungainly
alliance is probably not viable for the presidential race
itself, it hints at how threatened the PAN feels.
Its the same PRI as 30, 40 years ago, says
Roberto Gil, the PANs second-in-command in the lower
house, warning that the PRIs real power brokers were not
new talents like Peña Nieto, but a clique of
unreconstructed state interventionists and cronies who would
think nothing of slapping on price controls and having
the government selling bicycles.
The candidates have young faces, but its the
same old men making the political decisions, says
Were at a crossroads. We could go pretty far
backwards and de-democratize, or we could continue the
course, says Jeffrey Weldon, a political scientist at
Mexico Citys private ITAM university, echoing Gils
The PRI leadership is aware that some still see their party
as the bogeyman of Mexican politics. The problem is that
the PRI was at one time the bogeyman, says Gils
opposite number in the PRI, Jorge Carlos Ramírez.
It was the great transformer, the great party that pushed
Mexicos economy forward. But it was also the party that
tolerated corruption, and didnt do enough to push
We have to return to power so we can win back the
voters confidence and show them that weve learned
from our mistakes.
Wall Street was overjoyed when Calderón won the
presidency in 2006, beating out charismatic leftist
Andrés Manuel López Obrador by a hair. Months of
paralyzing street protests by López Obrador as he
contested the result soured voters against him, and he has
drifted out of the political limelight, although pundits warn
against writing the former Mexico City mayor off in 2012,
especially if the economy double dips.
It is not clear what economic policy would look like under a
PRI government, as its pragmatist militants straddle the
political spectrum, and even individual cadres are hard to
pigeonhole. Ramírez, for example, sounds protectionist
when he talks about revising dropped import tariffs, but his
belief that Mexico could risk a higher fiscal deficit for the
sake of job creation is hardly radical, being shared by some on
A lot could depend on which of the partys myriad
factions rise to the top, but investors are generally unfazed
by the prospect of a PRI presidency, believing its inherent
diversity would keep more extremist views in check.
Calderón has said he still wants to push energy
reform, but in the heated electoral climate, any proposal
breaching the taboo of increased foreign investment in the
sector is probably dead on arrival.
Whether fiscal reform still stands a chance is not as simple
to predict. Both the PRI and the PAN say they support an
overhaul that lowers taxes but widens the tax base. Indeed,
there is also a strong argument that the PRI should approve tax
reform now, letting the PAN pay the political cost and reaping
the benefits itself once in power.
But the devil is in the detail, and most analysts are deeply
sceptical that, with the electoral race gaining momentum,
Mexicos two main parties will have the political will to
Were more resilient than before, but politicians
and policy-makers seem to be happy driving at 40 miles an hour
on a highway with an 80 mph speed limit, says Alonso
Cervera, Credit Suisse chief economist for Mexico.
Others are more optimistic, saying the PRIs agreement
last year to raise VAT, albeit by a meagre percentage point,
was a rare breakthrough that could hint at further
The goalposts are shifting, says Joydeep
Mukherjee, team leader for the Latin American sovereign ratings
department at Standard & Poors. That
doesnt mean its a huge change, but what was off the
table before, is not only on the table, but discussed. Next
time you go back to debate it, you will have moved it
The incumbent PAN could well remain in the driving seat to
steer that debate into 2012, particularly if the economy vastly
improves. No strong PAN candidates have emerged, but, as
Mukherjee points out, two years before the 2006 election,
López Obrador was way ahead in the polls, and few people
had heard of Felipe Calderón.
López Obradors electoral defeat splintered
Mexicos left, but Mexico Citys popular leftist
mayor Marcelo Ebrard, the cycling enthusiast who is
Mexicos closest thing to a third-way politician, could
even sweep up votes if he runs from a social liberal platform,
in defence of the capitals controversial legalization
over abortion and gay marriage.
Im very confident that two years from today,
whatever discussion we have today will sound absurd,
Mukherjee says of premature speculation over candidates.
So much can happen in a very short time, says
Allyson Benton, an analyst for political risk consultancy
Eurasia Group, based at Mexico Citys CIDE university.
A revelation of corruption or anything like that can
completely derail a candidate or a partys chances.
A lot of people say Peña Nieto will be the
candidate for the PRI and the PRI is going to win, but these
are people who dont know Mexican politics.