By Lucy Conger
Faced with the likely fallout of a US recession, Mexico’s government is treading cautiously, with wide-ranging plans to stimulate the domestic economy. President Felipe Calderon is pinning his hopes on a massive surge in infrastructure spending. But as the credit crunch deepens, timing and luck will prove key
As the US economy sputters to a halt, south of the border questions about its likely knock-on effects are being asked, by the day, with a growing sense of urgency. And for good reason: during the last US downturn, Mexico’s economy too faltered into recession.
Since the signing of the North American Free Trade Agreement (Nafta) 15 years ago, more than 80% of the country’s exports now go to the US, and any drop in US industrial production sets off a quick and corresponding downturn in Mexican economic growth.
On current estimates, a US downturn is likely to lop 1.2% off the original growth estimate of 3.2% for 2008, according to GEA Structura, a Mexico City-based consultancy, while Mexico’s finance ministry has shaved nearly 1% off its estimate of 3.7%, to 2.8%. But as the picture goes from bad to worse in the US, the outlook for Mexico is likely to darken.
In an interview with Emerging Markets last October, finance minister Agustin Carstens characterized the prospect of a US downturn as a unique opportunity, rather than a threat. “This is an incentive for us to adopt policies that stimulate economic growth and make us less dependent on the growth of the US economy,” he said.
Moreover, Carstens pointed out, on the fiscal front things are more robust, and the government is now running a balanced budget. President Felipe Calderon’s administration, partly through Carstens’ tireless efforts, pushed a tax reform through Congress last September that was expected to increase government income by at least two percentage points of gross domestic product over the next six years.
Part of the plan is to spend much of that additional tax revenue on infrastructure projects – a fact that Carstens believes will help offset any negative effects from the north this year. But on March 3 – in the wake of pressures bearing down on Mexico’s flagging economy – the government released a 10-point, $5.6 billion fiscal stimulus package that will reduce taxes by $700 million, lower energy tariffs for industry and increase lending for small and medium business.
The tax cuts, which partly reverse the tax increase that took effect this year, signal growing concern among local officials that the US may fall into a recession, but the package has already drawn fire from some analysts. “It looks like they just gave back the fiscal reforms of last year,” says Walter Molano, director of emerging markets research with BCP Securities in Connecticut.
“It remains to be seen the impact on government finances of putting a discount on taxes that were supposed to finance the construction projects in the first place,” says Felix Boni, research director at Scotia Capital Research Mexico in Mexico City.
Predictably, the opposition was quick to denounce the measures: “These are very weak measures for the problem of lack of growth,” says Rogelio Ramirez de la O, president of Ecanal economic consultancy and former economic adviser to opposition leader Andres Manuel Lopez Obrador.
But others remain sanguine. Alejandro Hope, political analyst at GEA Structura, believes the measures will “not have much effect” but were nonetheless necessary “to give the impression they are doing something ... It’s a matter of image and message,” he says.
Calderon is using oil revenue to fund the stimulus measures, which come on top of 40 billion pesos of spending on infrastructure projects such as roads, ports and bridges this year. Mexico is the largest crude producer in Latin America.
Yet the stimulus package could have a positive effect for its timing, others argue. “The government could continue to spend on construction, even if there is a short-term shortfall, hoping the spending will generate more taxes later in the year,” says Scotia Capital’s Boni.
Time for an idea
Whatever the result, the fact is that Calderon is moving with resolve to brand his term in office with a national infrastructure programme that will spend $250 billion over the next five years to upgrade and expand the nation’s highways, trains, ports, airports and telecommunications, while revolutionizing the country’s ailing energy infrastructure. “We are determined to transform the country, and the strategy is very clear: to convert Mexico into a logistical platform, a multidirectional link in a global world,” Calderon said in March.
Fixing Mexico’s lagging infrastructure is an idea whose time has come. The country, which Calderon boasts will become the world’s fifth largest economy by around 2040, today ranks number 69 out of 131 countries in quality of infrastructure, according to the World Economic Forum’s Global competitiveness report, below Malaysia, at 18, Chile, at 30, and South Africa, at 43.
A broad consensus about the need for upgrading the full range of transportation arteries coalesced in recent years. Opposition leader Lopez Obrador, who lost the presidency to Calderon by a whisker, campaigned on the promise of an ambitious infrastructure programme, which included a bold and emblematic project of a fast train to the US border.
The resources are within reach. “For the first time in two decades, a Mexican government has room for a counter-cyclical policy,” says Hope at GEA Structura.
An oil revenue windfall of $15 billion above the original official estimate for the year has created the fiscal space for public investment. What’s more, Mexico could also increase borrowing since its foreign debt will come in below 20% of GDP this year.
Public investment will be expected to rise to 4% of GDP from the previous level of 3.2% under former president Vicente Fox. That figure would jump to 5% of GDP – in an ideal scenario – if Congress approves an energy reform that would open national oil monopoly, Pemex, to some private participation, and a labour reform is passed.
What’s to come
The programme aims to modernize transport infrastructure and take advantage of Mexico’s location bordering the United States and facing Asia and Europe from the country’s two long coastlines.
If all goes to plan, by the end of the Calderon term in December 2012, Mexico’s 120 largest cities will be knitted together with smooth-running highways, telecoms and air service networks. Out-of-the-way tourist attractions will be made accessible; the prospect of reliable, modern port and railway facilities – many of which will then hook up with transportation corridors to the US heartland and beyond – could provide a boost to foreign trade.
The programme also foresees massive investment in the energy sector, with hydrocarbons absorbing 47% of all infrastructure spending and electricity accounting for another 25%. The petroleum and gas industry is slated for $111 billion in investment. That includes $76 billion for exploration and production of oil plus almost $35 billion for downstream segments, including expansion of refining capacity to add another 100,000 barrels per day for a total of 1.4 million barrels.
Electricity would receive a $35 billion injection to expand generation capacity and distribution and transmission networks to be able to meet growing demand.
The infrastructure programme will gain a head of steam this year, with highway projects slated to come first. The president gave his biggest push yet to this vision in March by setting up the National Infrastructure Fund and endowing it with $25 billion in government properties like highways that will be sold off as concessions to finance infrastructure projects. Public spending on transport infrastructure in the first 15 months of his term has already increased by 45%.
The infrastructure grid will put in place east-west linkages so far lacking in Mexico, where north-south routes have dominated the landscape. A new highway would connect Acapulco with Veracruz; Pacific and Gulf coast ports would be united with multi-modal transport routes linking Lazaro Cardenas and Veracruz and the Salina Cruz-Coatzacoalcos terminuses of the Isthmus of Tehuantepec, the narrowest Atlantic-to-Pacific land passage.
Funding the vision
Spending on roads will top $6.7 billion in 2008, communications and transportation secretary Luis Tellez said in March.
The funding will be split evenly between brownfield highway projects – existing roads concessioned out to private operators for upgrading and maintenance – and subsidized roads that connect isolated beach towns, with the aim of promoting regional development and tourism.
The next roll-outs during the year will be bids on suburban trains for metropolitan Mexico City and, likely, concessions for a new airport in the Riviera Maya, near the pre-Columbian site of Tulum, railway switching yards in the northern cities of San Luis Potosi, Monterrey and Matamoros and expansion of the Pacific ports of Mazatlan and Manzanillo and the Gulf coast port of Veracruz.
Reality bites
Yet like so many ambitious plans, while it all sounds good on paper, getting the bureaucracy to make it happen is no small challenge. “For many years, Mexico has not built infrastructure; the machinery is out of use and lacks agility for facilitating actions,” says Ramirez de la O. Mexico’s engineering talents might be stretched beyond capacity.
Timing and luck will play a role as always, and with the global liquidity crunch deepening, could be more important than usual. “We can tell that equity and global dedicated infrastructure investors are willing to participate in these types of transactions,” Gerardo Rodriguez, under-secretary for public debt at the finance ministry, tells Emerging Markets. “Whether financial institutions are as willing and able to invest in these projects as they were before, that remains to be seen.”