Economic Analysis - Consolidation Efforts To Stall Growth In Debt Burden - SEPT 2017


BMI View : The Mexican government will continue its fiscal consolidation drive in 2017, stalling the spike in public sector debt seen in recent years. July 2018 ' s presidential election poses a risk to these efforts, as populist candidate Andres Manuel Lopez Obrador has proposed higher social spending.

In 2017, we see Mexico's budget deficit narrowing to 2.2% of GDP, from 2.6% in 2016, as the government will push forward with its fiscal consolidation drive in a bid to stymie its rising debt load ( see ' Commitment To Consolidation Will Narrow Budget Deficit ' , April 10). This is a modest upgrade from our previous forecast of 2.5%, as revenue growth has surprised to the upside thus far in 2017. In 2018, we see spending growth accelerating slightly ahead of July's presidential election, though this will be offset by higher intakes due to a rebound in economic activity. We forecast a 2.1% of GDP deficit in 2018.

Reversal Of Debt Growth On The Horizon
Mexico - Budget Balance & Debt Stock, % Of GDP
e/f = BMI estimate/forecast; Source: Banxico, BMI

Revenue Growth To De celerate

While we have become more positive on the Mexican economy following a strong performance in Q117, we maintain our view that real GDP growth will modestly decelerate in 2017, limiting the support revenue growth can provide to fiscal consolidation efforts. After 13.6% y-o-y revenue growth in 2016, we forecast growth of 8.2% in 2017 and 10.0% in 2018. Private consumption, which fuelled the economy in 2016, will be undercut in the year ahead due to energy sector liberalisation and higher interest rates ( see 'Uncertainty Tempering Growth Expectations', April 3), limiting intakes from income taxes and the national VAT. Tax receipts from the oil sector, particularly national oil company Petroleos Mexicanos (Pemex), will remain low, given that we see limited upside for oil prices in 2017 and 2018 and production will remain weak by historical standards.

Oil Revenues Providing Little Support
Mexico - Oil Revenue, MXNmn, 12mma
Source: Banxico, BMI

Moreover, uncertainty over US-Mexico trade relations, stemming from a likely re-negotiation of the North American Free Trade Agreement (NAFTA), poses a significant threat to the Mexican economy. While we expect that tight supply chain links between the two countries will ultimately keep any changes to NAFTA to a minimum ( see ' End Of NAFTA: Bilateral Brinksmanship Or Grand Bargain? ' , February 10), more substantial alterations than we expect would weigh heavily on the Mexican economy, which is reliant on the US market for both trade and foreign direct investment inflows. A restriction of trade flows in particular would severely crimp export-oriented firms' profits, significantly reducing government intakes and complicating the task of fiscal consolidation.

Government Spending To Be Contained

Given lower revenue growth, the bulk of fiscal consolidation efforts will hinge on cutting expenditures. In Q316, President Enrique Pena Nieto appointed Jose Antonio Meade as finance minister, suggesting a continuation of the country's conservative fiscal trajectory ( see 'New Finance Minister Will Push Austerity Agenda Forward ' , September 15 2016).The 2017 budget confirmed our view, and placed the bulk of spending cuts on Pemex ( see ' Pemex Will Pull Down Regional Capex In 2017 ' , September 21 2016), the transport sector and education, rather than deep cuts to social spending. Additionally, the liberalisation of petrol prices, which will be phased in throughout 2017, will remove effective subsidies, helping the government to reduce outlays. We forecast expenditure growth of 7.0% in 2017, down from 9.3% in 2016. Though we expect government spending will tick higher in 2018, to 9.0%, as the ruling Partido Revolucionario Institucional (PRI) attempts to shore up support ahead of the July 2018 general election, we expect this growth will fade thereafter.

Consolidation Efforts Having An Impact
Mexico - Budget Balance, MXNmn, 12-Month Rolling Sum
Source: Banxico, BMI

Consolidation Efforts Will Backstop Credentials

Despite a spike in government debt levels in recent years, we expect Mexico's consolidation push will keep its sovereign credentials solid. Total government debt rose from 34.3% of GDP in 2012 to 49.7% in 2016, spurring a deterioration in the outlooks of all three major credit ratings agencies on the sovereign. Moody ' s, Fitch, and S&P all currently have Mexico on negative watch. That said, we see the growth in Mexico's debt stock levelling off in 2017, before entering a gradual downtrend as economic growth accelerates and the country's fiscal responsibility law ensures that spending is constrained. Investors have welcomed Mexico's consolidation efforts, reflected in the compression of 5-year credit default swaps over recent months.

Spread Trending Downward
Mexico - 5-Year USD Credit Default Swap (Daily)
Source: Bloomberg, BMI

Presidential Election The Biggest Risk

The largest risk to our fiscal outlook stems from Mexico's July 2018 presidential elections. Leftist, populist candidate Andres Manuel Lopez Obrador (AMLO) has emerged as a legitimate challenger to the ruling PRI and the centre-right Partido Accion Nacional (PAN), neither of whom have nominated a candidate. While AMLO's Morena party suffered a setback in June's gubernatorial election in Estado de Mexico ( see 'June Elections: PRI Remains Political Force, But Significant Frustration With Politics As Usual', June 26), we believe that he will closely contest the presidential election. A victory for AMLO would mark a significant inflection point for Mexico's fiscal trajectory, as his advocacy for higher social spending would likely see the government reverse its policy of fiscal consolidation. However, with the election still a year away and the field of candidates not confirmed, this remains a risk we are monitoring.