Mexico’s AMLO: A bumpier ride but not a train wreck

Mexico has maintained a semblance of stability, even as it endured the 2008-2009 global financial crisis, more than a decade on from the peso crisis and the fall of its one party regime.  Now, however, the election of President Andrés Manuel López Obrador (AMLO is the popularly used acronym) and his MORENA party have called that stability into question and left investors and creditors wondering what their claims of revolution or ‘change of regime’ mean.  To put it in Latin American terms, is he closer to (Venezuela’s) Hugo Chávez, or (Brazil’s) Lula da Silva?  Considering that Mexican trade volume is by far the highest in Latin America, $830 billion in 2017, the stakes are enormous.  Reading the signs to date, there could be some economic damage on individual projects, but by and large AMLO will represent a continuation of the status quo, much closer to Lula’s fiscal prudence than to Chávez’s chaos.     

AMLO in context

López Obrador had humble beginnings but rose through the political ranks by defending marginalised groups and staking out new political ground.  Born to a family of shopkeepers in Tabasco state in southern Mexico, AMLO studied political science and public administration at the National Autonomous University of Mexico in the 1970s, and he joined the ruling PRI (Institutional Revolutionary Party).  In 1986, he became disillusioned with the PRI and joined a leftist splinter party that became the PRD (Party of the Democratic Revolution).    

During the 1990s, he led grassroots protests in favour of indigenous communities and against environmental damage caused by Pemex, the Mexican state oil company.  His connection with indigenous communities is an important part of his political perspective and political movement, as evidenced by the prominence of indigenous people in traditional dress who stood with him during his inauguration and other events.  It is also an extremely sensitive theme in a country divided into an industrialised north and more indigenous and agrarian south.  These tensions exploded into a rebellion in Chiapas (southern Mexico) in 1994, when EZLN guerrillas fought against the government over the implementation of NAFTA.  

López Obrador has been much more than a leftist firebrand and has shown his ability to govern.  During 2000-2005, he was mayor of Mexico City with over 20 million constituents, he was well regarded and left office with an approval rating over 80%.  He launched a series of innovative social and cultural programs, and he cooperated with the richest man in Mexico, Carlos Slim, in restoring the downtown area.  He is generally credited with promoting business-friendly policies that promoted investment.  He had less success in controlling corruption and violence, however.   

Pragmatism in evidence

After two runs at the presidency with PRD, AMLO left the party in 2014 to found MORENA (National Regeneration Movement).  In four short years, MORENA has gone from a movement to a formal political party that controls congress and nearly two-thirds of state legislatures, putting it in a very strong position to change the Mexican constitution.  The key messages that it has built its political success on have been combatting corruption, reducing poverty, broadening political participation, and controlling Mexico’s chronic plague of largely drug-related violence.  MORENA claims that the ‘mafia of power’ that allegedly controls the country must be dismantled.  As always, symbolism is important: MORENA in Spanish means ‘dark-skinned’ and deliberately refers to Our Lady of Guadalupe, one of the foremost religious and national symbols of Mexico.  

López Obrador again showed his pragmatism as he has assembled his government and ruling coalition.  He created the ‘Together We Will Make History’ alliance, bringing in the religious conservative party (PES) and the Worker’s Party (PT).  His appointments so far have shown a tilt, but not a dive, to the left, with a fair number of US advanced degrees represented.  One of his central bank appointments, Jonathan Heath, is the former HSBC Mexico economist.  Alfonso Durazo, the new secretary of public security, served with PRI and PAN administrations since the 1970s, joining AMLO’s inner political circle in 2006.  

The government’s proposed budget, which was approved by the Congress on 24 December, includes money for AMLO’s promised social programmes but is fiscally responsible, projected to create a surplus of 1% before debt expense.  AMLO has said that he expects a considerable sum for his programs to come from eliminating corruption, but his budget does not assume that will happen, at least right away.  The budget also assumes 2019 GDP growth will be 2%, and that is conservative relative to the IMF’s forecast of 2.3%, although private economists are a little less optimistic.  

Overambitious forecasts?

However, according to Carlos Cardenas, head of Latin America Country Risk at IHS Markit, generating the funds for AMLO’s promised social programmes and infrastructure “don’t seem possible with just austerity and corruption control; there is a risk that tax enforcement becomes much more punitive for companies in Mexico.”

With Mexico being highly trade-dependent, and the US market representing 80% of exports, much depends on US economic performance and the smooth flow of trade between the two countries, and López Obrador seems highly conscious of that.  Despite the US administration’s often provocative comments on immigration, neither side has allowed that to contaminate trade talks, and on November 30, Mexico, Canada, and the US signed the adjusted NAFTA agreement now called the USMCA.  Although this deal was signed by AMLO’s predecessor, President Peña Nieto, AMLO has supported it, particularly because of the requirements of higher pay for auto workers and evidence that workers support collective bargaining agreements.   In public comments, both Trump and López Obrador have been cooperative, even agreeing to a Central American investment plan to help address Central American immigration.  

Some trade financiers are optimistic.   Volker Helms, managing director at LBBW in Mexico City, says that his Mexican business (as distinct from his regional ECA business), will continue to be absolutely fine, as German, Austrian, and Swiss manufacturers are continuing to use Mexico as their export platform to the US and the rest of the world.  “Mexico continues to be a strategic export platform for our customers, especially compared to the opportunities they have in Europe,” says Helms.  He adds, “The Mexican economy will be OK as long as the US stays out of recession.” 

In terms of economic growth, López Obrador could create a mixed picture.  On the one hand, if he continues his rapport with Trump, the USMCA gets ratified by both congresses, and the US somehow stays out of a recession, the key automotive and electronics sectors will continue to thrive.  The government has even proposed to set up a low tax zone in northern Mexico.  

Unclear prospects for oil, gas, power and planes

The fate of the oil and gas sector is less clear, as AMLO has promised to review for corruption the foreign contracts that were initiated under his predecessor, while putting much more emphasis on strengthening Pemex and building a refining capability (in AMLO’s home state of Tabasco).  With Mexico’s oil production in chronic decline, the opening of the sector to private and foreign investment under Peña Nieto was intended to reverse that decline and make state-owned Pemex more internationally competitive.  Now, oil investors may be hesitant to put new money into Mexico, and Pemex, with reportedly a $100 billion debt load, is in no position to make the needed investments.  Another area that investors and lenders had been excited about, the power sector, now carries its own risks with the key personnel – including the CEO of state utility CFE, Manuel Bartlett – being lukewarm (at best) on private and foreign investment.  In December, the new government suspended auctions worth billions in the power sector, citing the need to review the scope and aim of the energy reforms.   

According to Cardenas at IHS Markit, one important risk is what happens after the three-year point of this administration, when it promises to hold a referendum on its rule. After that, certain industries, including banking  and oil and gas could be targeted for any number of regulatory changes. Other sectors such as mining and hydropower will face contract cancellation risks when facing opposition from local communities and NGOs, Cardenas says.  

Prior to his election, AMLO called a ‘public consultation’ to determine the fate of the $13.3 billion international airport currently under construction.  AMLO has said the project wastes money and is tainted by corruption.   The result of the less-than-transparent ‘consultation’ was that 70% of voters were against the airport, and so AMLO announced his intention to cancel the contract.  It is not clear what will happen to the $6.5 billion in outstanding bonds.  

The wider questions are the following: How many other projects will suffer this fate, and if AMLO can arbitrarily call into question the legal basis of an investment, what will prevent his successor from doing the same? “The uncertainty is the most difficult part of the current environment, making planning for ourselves and our customers very challenging,” says Helms at LBBW.

Violence is a threat       

The risk of violence to property and personnel is another key and evolving risk, although it also has to be put in perspective.  According to the UN Office on Drugs and Crime, Mexico had 19.3 intentional homicides per 100,000 people in 2016, but that compares to 29.5 in Brazil and 82.8 in El Salvador.  AMLO has promised to try a new approach and not fight violence with more violence through military deployment, dealing with the socioeconomic underpinnings of the problem.   However, for the first three years at least, he will depend on the military while he trains a new civilian-friendly National Guard.  

According to Gavin Strong, director for Mexico, Central America and the Caribbean at Control Risks, “it used to be that insecurity was confined to certain areas of the country, but over the past 18 months or so insecurity has become a significant challenge nationwide. It’s anachronistic to just speak of drug cartels. Now most criminal organisations engage in a diverse array of illicit activities.” On the bright side, Gavin adds, “you can do business here if you take the right precautions, and it is positive that the president is taking ownership of tackling insecurity in the country.” In addition to targeted criminal violence, spontaneous riots have also occurred. In January 2017, 250 stores (including Wal-Mart, Grupo Comercial Graui SAB, Grupo Elektra, and Organización Soriana SAB) across seven states were looted in response to a gasoline price increase.  

Having created his own political party that controls Congress and almost two-thirds of state legislatures, President Andrés Manuel López Obrador holds more power in Mexico in this moment than any individual in modern memory.  His promises to attack poverty, corruption, and violence have created tremendous expectations that will be difficult to fulfil.  It will be tempting for him to use a heavy hand to get things done, but his long history of civilian politics, administration, and coalition-building indicate that he will not be authoritarian in the Hugo Chávez mould.  However, as he manages the various factions within and outside MORENA, some adverse decisions may be made on particular projects, raising the risks for lenders and investors compared to what they saw under the PRI and PAN.