The Daily Update - Mexico and Gasolinazo

Mexico has been hitting the headlines this month on the back of riots and demonstrations relating to a steep 14% average hike in gasoline costs as of 1 January.  Under the new system the price reflects the price of an international reference plus a fixed tax thereby transferring the volatility of prices to consumer and smoothing out government revenues.  Plus, maximum prices will be set for 90 regions rather than a single national price reflecting logistical differences. Unsurprisingly, consumers have been up in arms that the price has jumped by so much overnight. But gasoline prices at $0.82 per litre, although higher than the US at $0.69, do not look unreasonable against the likes of Chile, Brazil and China at $1.15, $1.18 and $1 respectively; the reality is between 2006 and 2013 the administered price was never adjusted enough to adjust for market moves and the government ended up subsidising gasoline consumption.  Estimates suggest that the subsidies reached as much as 1.8% of GDP in 2008 (Citi).  In 2013 the government began a policy to liberalise prices and the reforms and any fiscal consolidation was viewed positively.

Mexico is an interesting case as despite its vast oil reserves it is a net importer of gasoline from the US.  Estimates suggest limited refining capacity means that as much as 60 percent of gasoline needs tends to be imported from the US. This is one area that the government’s energy reform program established in 2013 attempted to address by removing subsidies and liberalising the sector and ending Pemex’s monopoly on the sector, allowing private companies to import fuel.  However, it has yet to result in lower prices which the President Peña Nieto suggested would be the outcome of the reforms.

It is unhelpful that this adjustment is coming at a time when prices in the inflation basket generally are showing upward pressure and the December CPI figure was 3.36% yoy even before the gasoline price increase (gasolinazo) was enacted.  Compounding this, the minimum wage is set to increase by 9.6% yoy although this will only affect ~15% of the workforce. With inflation above the Central Bank’s 3% target and the peso languishing yet further against the US dollar, Banxico will be under pressure to raise rates again.  But Governor Carstens (speaking yesterday) sees the impact from fuel price and minimum wage hikes as being temporary, stating also that he sees the FX pass-through to inflation as having fallen significantly.  He described the current peso volatility as an ‘overreaction’ not helped by portfolio flows.

Economic growth is slowing which could be made worse if a negative trade scenario materialises under a Trump presidency. Clearly, the cancellation of a USD1.6bn major expansion project by Ford in favour of locating in the US bodes poorly for a prosperous trading relationship with the US; the auto industry is a key target for Trump as it accounts for a substantial part of the US trade deficit with Mexico. In 2015 the US imports of cars and auto-parts from Mexico exceeded the overall goods trade deficit of USD58.4bn. Governor Carstens also noted the increased uncertainty on Mexican growth under Trump and the need to look to other markets to diversify.

Following the election of Trump as US President, Moody’s has downgraded its Mexican growth forecast for 2017 to 1.9% from 2.5% and the 2018 estimate to 2.3% from 2.7%. Changes to the NAFTA trading relationship could have further negative repercussions. Mexico is a large exporter to the US with exports to the US accounting for over 20% of its GDP.  Mexican car exports to the US equalled 6% of Mexican GDP in 2015.  Mexico has appointed Luis Videgaray, the ex-Finance Minister, to the position of Foreign Minister which will be tasked the issue of tackling trade relations under a Trump administration.

It is still too early to determine how much of Trump’s rhetoric will actually be enacted into policy but if the Mexican peso is any guide a pretty pessimistic scenario has already been factored in along with the negative of higher inflation and rates.  The positive is that Mexico is facing this storm from a position of fiscal strength.  Moody’s latest estimates for 2016 put general government debt to GDP at 35.8% and a fiscal deficit of 2.3%.  For us, the US dollar issue of United Mexican States 4.6% 2046 is trading ~2.7 notches cheap on a best rating (A3) basis.  Although, the quasi-sovereign issue of Pemex 6.625% 2035 screens even more attractively on our models trading ~5.7 credit notches cheap; it is 100% owned by the government and rated Baa1 equivalent (best rating S and P/Fitch).