Economic Analysis - Commitment To Consolidation Will Narrow Budget Deficit - JUNE 2017


BMI View: The Mexican government's commitment to fiscal consolidation will drive a slight narrowing of the fiscal deficit this year and help to arrest the rise in public sector debt. The latter will remain the administration ' s major focus, having driven a deterioration in Mexico ' s sovereign credit rating outlooks in 2016.

Mexico will continue its fiscal consolidation drive in 2017, with the aim of reducing the budget deficit and curtailing the substantial expansion of public debt seen in recent years. The major areas targeted for spending cuts in the 2017 budget passed in Q416 are state-owned oil company Pemex, the transport sector and education, reinforcing our long-held view that Latin American governments will look to cut capital spending over social spending ( see ' 2016 Retrospective: Key Latin America Themes ' , December 8).

Debt Will Level Off
Mexico - Debt Stock & Budget Balance, % of GDP
Source: National Sources/BMI

Moreover, we believe that additional budget reductions are likely this year, as was the case in 2016. President Enrique Pena Nieto's appointment of Jose Antonio Meade as finance minister in Q316 represents a continuation of the country's conservative fiscal policy trajectory ( see ' New Finance Minister Will Push Austerity Agenda Forward ' , September 15 2016). The government believes there has been a significant deterioration in the country's growth and exchange rate outlooks since the budget was passed. We have also tempered our expectations, as significant uncertainty over the future of US-Mexico trade relations will undermine fixed investment and cap appreciation in the peso, although our end-year forecast is more sanguine than Bloomberg consensus and the forward market ( see ' Uncertainty Tempering Growth Expectations ' , April 3 and ' MXN: Undervaluation And Improving Sentiment Underpin Constructive Stance ' , March 22).

The focus on reducing expenditures will ensure a further narrowing of the budget deficit this year, falling to 2.5% of GDP, from 2.6% in 2016 and 3.5% in 2015. We are slightly less optimistic than initial government estimates, which put the budgetary shortfall at 2.4% of GDP. In addition, we see the debt stock leveling off, coming in at 49.0% of GDP, after rising from 44.7% of GDP in 2015 to 49.7% in 2016. Debt will remain the main area of focus for the government in 2017, as all three major credit ratings agencies have cited rising debt levels as a catalyst for a deterioration of their outlooks on the sovereign over the last couple of years. Moody's, Fitch and S&P rate Mexico A3, BBB+ and BBB+, respectively, all with negative outlooks.

We anticipate a slight loosening of the purse strings in 2018, in advance of the July general election, but stronger spending will be offset by a pick-up in revenue growth as economic activity regains some momentum. We see real GDP growth accelerating to 2.0% in 2018 from 1.6% in 2017, as private consumption ticks up and the major headwinds to investment begin to fade. Pre-election spending will boost total expenditure growth to 9.0% next year, up from a projected 7.0% in 2017, as Pena Nieto and his PRI are facing an uphill climb next year. The president is highly unpopular, as high inflation, rising violence and a relatively conciliatory stance toward US President Donald Trump has eroded voter perceptions ( see ' 2018 Election: A Big Opportunity For Populist Candidates', February 17).

Populist Victory Could Reverse Downtrend In Yields
Mexico - USD2019 Sovereign Bond Yield, %
Source: Bloomberg, BMI

While the PRI has yet to announce its candidate (Pena Nieto is constitutionally barred from running again), leftist, populist candidate Andres Manuel Lopez Obrador is proving to be an early challenger to the establishment PRI and centre-right Partido Accion Nacional ( see ' Lopez Obrador Consolidating Position On Security And Trump ' , March 29). A Lopez Obrador victory would likely mark a significant shift in Mexico's policy trajectory, especially on the fiscal front. He has advocated for higher social spending, including an initiative to combat rising violence through job training for youths. Nevertheless, Lopez Obrador has played down the potential market impacts of looser fiscal policy, noting that he maintained a solid fiscal track record during his tenure as Head of Government of Mexico City, akin to mayor, from 2000-2005. We will be watching for additional policy statements that suggest a more concrete trajectory for fiscal policy under a Lopez Obrador presidency.