Itaú BBA - Aftermath of the “gasolinazo”

Scenario Review - Mexico

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Aftermath of the “gasolinazo”

January 19, 2017

The liberalization of gasoline prices will be beneficial for the fiscal accounts.

Please see the attached file for all graphs.

 The hike and announced liberalization of gasoline prices will benefit fiscal accounts, but has worsened the near-term inflation outlook and triggered social unrest six months before a crucial regional election that might have a bearing on the result of the presidential and legislative elections (due in 2018).

 We have increased our inflation forecast for 2017 (to 4.6%, from 3.9%). Exchange-rate pass-through and the liberalization of gasoline prices will be the drivers of consumer prices in 2017.

 We have revised our exchange rate forecast for 2017 upward (to 20.5, from 19.5), as the risk of more protectionist policies in the U.S. has intensified.

 Inflation should eat through real wages and tighter macroeconomic policies will hurt consumers. This, added to growing uncertainty over protectionism, will weigh negatively on growth in 2017. We have revised our GDP growth forecast downward (to 1.6%, from 1.8%). 

 Given the deterioration of the inflation outlook, we believe that the Central Bank will tighten monetary policy more aggressively than we previously anticipated. We expect Banxico to hike 50 bps in February, and then follow the Fed (3x 25 bps), taking the reference rate up to 7% in 2017.

Liberalization of gasoline prices backfires

The liberalization of gasoline prices implies fiscal relief, at the expense of higher inflation and social and political backlash. In late December, the Ministry of Finance decided to frontload the adjustment of gasoline prices by announcing a 15% average increase that would take place on the first day of 2017. Different maximum prices were set in 83 regions, based on specific market conditions. Maximum prices will be eliminated according to a liberalization calendar, announced previously by the Energy Regulatory Commission (CRE), between March and December. Importantly, according to the government, maximum regional gasoline prices are already supposed to reflect market prices. By the end of this year gasoline prices will be fully market determined.

The main goal of liberalizing gasoline prices is to safeguard fiscal revenues. According to the government, keeping the gasoline subsidies would have cost MXN 200 billion (1% of GDP) per year. Coupled with another sizable dividend from Banxico (1.2% of GDP in 2016) from exchange gains on reserves, the liberalization of prices makes it easier for the government to achieve the 0.4% of GDP primary surplus target in 2017 and thus prevent a rating downgrade. Higher oil prices will help too.

Nevertheless, fiscal accounts deteriorated in the last months of 2016. We note that the 12-month fiscal deficit widened from MXN 369.5 billion (around 1.9% of GDP) in October to MXN 400.8 billion (2.1% of GDP) in November, while net public debt climbed from 46.8% of GDP to 48.5% of GDP during the same period (mainly as a result of sharp peso depreciation, which increased the local-currency value of foreign debt). We expect an annual fiscal deficit of 2.7% of GDP in 2016, as lower revenues from the oil hedge (USD 2.7 billion in 2016 vs. USD 6.3 billion in 2015, 0.3 pp of GDP difference in peso terms) and the back-loading of public-debt interest payments will widen the deficit in the last month of the year. Likewise, we believe that net public net debt ended 2016 at 49.2% of GDP, considering that the federal government purchased the pension liabilities of the National Electricity Company (CFE) for MXN 160 billion (0.8% of GDP) in December.

However, liberalizing gasoline prices worsened the inflation outlook further. Headline inflation ended 2016 at a moderate 3.4%, within the Central Bank’s target range, but the beginning of 2017 has featured multiple shocks on inflation. In addition to the “gasolinazo,” there has been a 15% rise in the liquefied petroleum gas price, a 10% hike in the minimum wage, a 15% increase in the tortilla price (an important staple), higher local taxes in 14 of Mexico’s 31 states, higher electricity prices and a further weakening of the exchange rate (over rising risk that President Trump will pursue protectionist policies). As a result, we have increased our inflation forecast for 2017 (to 4.6%, from 3.9%). Considering the temporary nature of the abovementioned shocks and assuming that Banxico manages to prevent significant second-round effects, we believe that inflation will moderate to 3.3% in 2018.

Another negative spillover of the “gasolinazo” is the social and political backlash. Social unrest began as street protests and degenerated into the looting of 370 retail stores across 9 of Mexico’s 31 states (according The National Association of Supermarkets and Department Stores, ANTAD); something that will likely affect activity in January. Moreover, the radical-left political leader, Andrés Manuel López Obrador ((AMLO), capitalized on the unrest by blaming the government’s energy reform for the increase in gasoline prices. Importantly, after the tax reform – which came into force in 2014 – President Peña Nieto made a public promise not increase taxes further. The point is that gasoline prices have increased because the government is no longer subsidizing them. And semantics aside, most citizens probably do not care about the difference between the elimination of a subsidy and a tax increase.   

The regional elections, due in June 2017, could show which party has the better chance of winning the presidential election in 2018. According to Reforma’s poll, President Peña Nieto’s popularity stood at a low 24% in December 2016, and is expected to fall more in January as a result of the “gasolinazo.” Crucially, the regional elections will include the most populous state in the country, the State of Mexico (PRI’s historical stronghold, where President Peña Nieto was the Governor between 2005 and 20011). We believe that an alliance between the PAN (right) and PRD (left), as they successfully implemented in the 2016 regional elections (with a net gain of five states over the ruling party PRI), would have a high chance of winning the State of Mexico and thus gain traction for 2018. However, If the PRD allies with the anti-establishment Morena (AMLO’s party) at some point in the presidential race, the perception of political risk in Mexico is set to increase.   

Peso weakness keeps pressuring the central bank

Peso depreciation and the possibility of second-round effects are keeping Banxico under pressure. After depreciating 19% in 2016, the Mexican peso depreciated further in the first days of January, over concerns that the next U.S. administration might disrupt FDI inflows into Mexico and adopt more-protectionist trade policies. Against this backdrop, the Foreign Exchange Commission (formed by the Central Bank and the Ministry of Finance) sold USD 2 billion in the spot market without meaningful impact on the currency. In its statement about the decision, the FX Commission mentioned that it acted to mitigate volatility, rather than to defend a specific exchange-rate level. Nevertheless, the statement stressed that the government’s main approach to anchoring the value of the currency will be the “preservation of solid economic fundamentals.” This, in our view, means that macroeconomic policies (monetary and fiscal) will likely be tightened further, and that the government will remain committed to implementing structural reforms.

We have revised our exchange rate forecast for 2017 upward (to 20.5, from 19.5), as the risk of more protectionist policies in the U.S. has intensified. With uncertainty over protectionism gradually dissipating, we expect a moderate appreciation (to 19.5) in 2018.

Our take is that Banxico is more worried about the occurrence of simultaneous shocks, which could derail inflation expectations (and thus produce second-round effects on inflation). Therefore, we believe that the Central Bank will tighten monetary policy more aggressively than we were previously expecting. We expect Banxico to hike 50 bps in the next meeting, and then follow the Fed (3 hikes of 25 bps before the end of this year), taking the reference rate up to 7% in 2017. With lower inflation and a better-behaved currency next year, there would be some room for easing (we expect two 25-bp rate cuts).

Activity is slowing down

Mexico’s economic activity slowed down in the beginning of 4Q16. The monthly GDP proxy (IGAE) expanded by 1.2% year over year in October, leaving the 3-month moving-average growth rate at 1.9% year over year (the same as in 3Q16). At the margin, GDP gained a weak 0.2% from the previous month, with the quarter-over-quarter annualized growth rate (qoq/saar) decreasing from 4.2% in 3Q16 to 2.8% in October. 

Manufacturing exports are firming up, while consumption seems to be weakening. Manufacturing output advanced 0.7% month over month (the highest print in fifteen months), which is consistent with the pick-up of manufacturing exports (11.4% qoq/saar) reported in November’s trade balance. On the consumption side, the monthly private consumption indicator expanded at a modest 1.8% year over year in October, pulling the three-month moving-average growth rate down to 3.3% year over year (from 3.5% in September). At the margin, private consumption stood flat from September. Also, fiscal consolidation (mostly through Pemex) continues to weigh negatively on mining production and non-residential construction.

We still expect GDP growth of 2.1% in 2016, but have revised our forecast for 2017 downward (to 1.6%, from 1.8%). Tighter fiscal and monetary policies, as well as lower real wages (mainly because of higher inflation) and uncertainty over protectionism, will weigh negatively on economic growth. A buffer, however, is that if protectionism doesn’t materialize, manufacturing exports will likely benefit from stronger growth in the U.S. For 2018, we expect a moderate pick-up to 2.1%, assuming that bilateral relations with the U.S. are not disrupted significantly, in spite of some protectionism.


João Pedro Bumachar
Alexander Andre Muller

Please see the attached file for all graphs. 


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