Mexico’s president-elect pledge to implement a potentially major institutional and judicial reform has increased investor nervousness and, if it is implemented along more radical lines, would diminish Mexico’s attractiveness as a destination for foreign investment at the every moment when the country was supposed to benefit from global supply chain restructuring. Similar to populist politician elsewhere, Mexico’s left-wing leaders see existing institutions as representing the deep state that prevent political change. But proposals to substantially reform or weaken existing institutions could heighten domestic and foreign investor concerns about Mexico’s institutional stability and predictability. Radical judicial reform would deter portfolio and especially foreign direct investors at a time when geopolitically driven economic fragmentation, de-risking and friend-shoring was making Mexico an increasingly attractive investment destination.
> On June 2, Claudia Sheinbaum of the left-wing Morena party was elected president and succeeded Andres Manuel Lopez Obrador or AMLO (2018-24). She will serve a single six-year term and will take office on October 1.
> The president-elect’s left-wing electoral alliance Sigamos Haciendo Historia controls 373 out of 500 seats in chamber of deputies and 83 out of 128 seats in the Senate. This gives the alliance a constitutional two-thirds majority in the House, while falling two seats short of one in the Senate.
> On February 5, President AMLO submitted a package of 18 constitutional amendments and two legal reform initiatives that would affect the executive and legislative branch, the electoral system and eliminate various regulatory agencies and autonomous constitutional bodies, among other things.
Mexico’s economy has underperformed in the past few decades, while it proved resilient to external shocks. In the 2000s, the IMF classified Mexico as a high-growth emerging economy. But Mexico never succeeded in growing more than 2.5% on a sustained basis. Explanations for Mexico’s relatively disappointing economic growth vary, including labor market informality, limited human capital and insufficient investment. Mexican economic growth is sensitive to the U.S. economic cycle and in particularly U.S. industrial production given Mexico’s extensive integration into U.S. manufacturing supply chains and the large share (85%) of Mexican exports to the U.S.. But economic shocks like the 2001 dotcom bubble, the U.S.-centered global financial crisis of 2008 or COVID-19 pandemic lead to sharp economic downturn, but they do not prove financially destabilizing due a robust macroeconomic framework, including sustainable debt levels, inflationary targeting by an independent central bank and floating exchange rate. The energy-focused reforms under President Enrique Pena Nieto (2012-18) were supposed to unleash Mexico’s growth potential by opening up and liberalizing the Mexican energy sector to foreign investors. But economic growth failed to accelerate. Under President AMLO, the government began again to play a more important role and liberalization and market competition were rolled back. While Mexico’s economic performance does not differ much compared to other large Latin American economies, such as Argentina and Brazil, the latter have experienced far greater economic and financial volatility and instability in the past three decades.
> Between 2000 and 2023, real GDP growth averaged a mere 1.7%. Under AMLO, real GDP growth expanded 1% a year, compared to 2% under Pena Nieto. This compares poorly to upper middle income economies in Eastern European and Asia. The IMF projects real GDP growth to average 2% in 200224-29. This is roughly in line with historical performance since the pay moratorium of 1982 and subsequent structural reform.
Mexico’s macroeconomic fundamentals are stable, but the government will need to rein the fiscal deficit. During the first few years of his mandate, AMLO stuck to a disciplined fiscal policy, leading to a broadly stable government debt-to-GDP ratio. The COVID-19 shock did lead to a sharp increase in the debt-to-GDP, like everywhere else. However, in the 2024 pre-election budget, the government increased social expenditure and investment, which led to a sharp increase in the deficit, which is expected to reach almost 6% of GDP. Meanwhile, state-owned of oil company Petroleos Mexicanos (PEMEX) required (and will require) government financial support in the context of a continued tangible reliance of the government on oil-related revenues.
> The IMF projects net public sector to stabilize at 50% of GDP, roughly the same level it was in 2020. But the IMF also forecasts Mexico’s fiscal deficit to reach almost 6% of GDP in 2024, a level that exceeds the deficit of 4.3% of GDP during COVID-19 when economic growth collapsed. The MF also predicts a change in the primary balance worth more than 2% of GDP, implying a substantial fiscal adjustment in 2025. If the Mexican government fails to lower the deficit next year, government will continue to increase, even if only gradually. But the risk of a credit downgrade, let alone broader financial instability would remain low as long as the new president remains credibly committed to adjust fiscal policy in 2026-27.
> Oil revenues amount to around 15% of budgetary revenue or a little more than 3% of GDP. This continues to make revenues sensitive to oil prices. But the government’s hedges it oil revenue, making situation manageable. Declining oil production does represent a challenge, but much more so over the medium term. Moreover, PEMEX has significant liabilities, which are contingent liabilities from the government’s point of view. Total liabilities of $106 billion as of 2023, almost half of which is set to mature in the next three years. The government has already allocated $ 10 billion to help PEMEX repay its maturities. With a GDP of around $ 2 trillion worth 5-6% of GDP. This represents a manageable risk in the short- to medium-term.
> Mexico’s net international investment position has been stable at – 30% of GDP. Its current account deficit is less than 2% of GDP and fully financed, generally over-financed by net foreign direct investment inflows in the form of reinvested earnings (rather than greenfield investment and intercompany loans. Mexico also has access to the IMF’s Flexible Credit Line worth $ 35 billion dollars, which more than financing provides Mexico with a seal of approval of its overall economic policies and financial position. The three major international rating agencies assign an investment grade rating of BBB or BBB- (or its equivalent) to Mexico.
Investors are concerned about the outlook for continued institutional stability. A stable, predictable and professional judicial system is important in terms of a country’s ability to attract long-term foreign (direct) investment. Financial markets reacted negatively to the electon outcome, less so because of Sheinbaum’s victory, which was expected, but because of unexpectedly strong performance of her electoral alliance in the congressional elections. With a two-third majority in the chamber and a near-two-thirds majority in the Senate, the likelihood of wide-ranging institutional reforms being approved has increased substantially. The president-elect has lent her support to the proposed reforms, which, among other things, could lead to an overhaul of the judiciary, including the firing of 1,600 judges and their replacement through popular elections. In principle, the reforms could be enacted as soon as September, but Sheinbaum has promised broad consultations, possibly as a way to give excuse to water down the reform. Her cabinet appointment point towards a more collegial, less top-down approach to policy-making. This may also suggest that she might be less keen to push through wide-ranging institutional reforms, particularly if they weigh on investment and economic confidence.
> The peso lost 10% of its value, and Mexican stock markets was down 6% the day after the elections, reflecting investor concerns about the risks associated with (uncertain) judicial reform.
> The nomination of Marcelo Ebrard, former foreign minister and PRD stalwart (and rival for nomination), as Economy Minister in charge of Industry, Trade and Investment and the decision to reappoint Rogelio Ramirez de la O as finance minister are important signals in terms of economic policy.
> Historically, ex-presidents have held little sway over Mexican politics, in part because they cannot run again for president, in part because consecutive re-election of members of the Chamber and the Senate is prohibited. Ousting a sitting president would require 2/3 majorities in both houses. This should limit AMLO’s ability to pressure Sheinbaum to do things she does not want to do.
In the context of reshoring and friend-shoring, Mexico is faced with a unique opportunity to attract foreign investment and integrate itself further into the North American economy. In the 1990s and 2000s, Mexico faced significant competition from low-cost China in terms of U.S. market share. But with international companies, including Chinese and American ones, seeking to diversify their supply chains, Mexico is again becoming a very attractive destination of foreign direct investment. With international companies pursuing supply chains diversification in the context of increasing geopolitical risks, Mexico’s membership in the United States-Mexico-Canada Agreement (USMCA, formerly NAFTA) provides companies with relatively easy access to the U.S. markets in terms of geography and tariffs.
> The IMF has shown that capital flows, and especially foreign direct, less so trade flows between geopolitical allies has increased, while it has decreased between geopolitical adversaries. To the extent that investment and trade flows are redirected, Mexico should be expected to benefit.
> In 2023, Mexico replaced China as the United States largest import partner for the first time 20 years. Annual FDI inflow data do not yet point to a significant increase in FDI. Inflows have been fluctuating between $25 billion and $35 billion a year. In the first quarter of 2024, the United States accounted for half of FDI inflows.