Itaú BBA - AMLO leads, but the race is not yet over

Scenario Review - Mexico

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AMLO leads, but the race is not yet over

febrero 8, 2018

Risks related to Nafta and Elections persist.

Please see the attached file for all graphs.

In spite of anti-establishment candidate Andrés Manuel López Obrador’s dominant position in the polls, the outcome of Mexico’s presidential race is still quite uncertain.

Meanwhile, the recent 6th NAFTA renegotiation round confirmed a more positive tone regarding the future of the trade agreement. While negotiations will likely last longer, potentially overlapping with the election campaign season in Mexico, negotiators from the three countries seem more confident that a deal can be reached. 

The uncertainty associated with presidential elections and the NAFTA renegotiation are putting investment decisions on hold, but we expect the economy to grow at the same pace as in 2017 (2.1%), supported by the acceleration of the U.S. economy and falling inflation. 

Given the prevailing risks associated with NAFTA, presidential elections and monetary policy in the U.S., we expect the Central Bank of Mexico to hike the reference rate by 25 bps in the first meeting of the year (February 8).  

Finally, we note that the Mexican government achieved a primary fiscal surplus in 2017 and managed to lower the public debt as a proportion of GDP. The improved fiscal numbers add to a narrowing of the current account deficit, indicating that Mexico’s fundamentals are stronger.

Election outcome remains uncertain

The latest polls show that Ricardo Anaya – the candidate of the PAN/PRD alliance – is gaining ground on the long-standing leader of the pack, López Obrador (AMLO). Considering an average from four pollsters (Mitofsky, Buendía Laredo, Reforma, and El Financiero), the results from the beginning of this year (January and February), compared with the previous surveys (collected in November and December 2017), indicate AMLO consolidating at the top (28.2%, from 28.3%), Anaya gaining ground (22.3%, from 19.8%), Meade stagnated (17%, from 16.7%), and Zavala falling (4.7%, from 9.1%) significantly below her 10.6% average score in October 2017 (when she confirmed her decision to run as an independent). 

Recent simulation exercises cast doubt on the hypothesis that tactical voting would automatically catapult either Anaya or Meade into victory. In simulations of two-sided elections (that is, assuming there were only two candidates) – conducted by Buendía Laredo – AMLO would defeat Anaya by 8pp (46% and 38%) and win over Meade in a landslide (55% vs. 26%). In fact, the negative image of AMLO (at an average of 28% based on the most recent three polls publishing this statistic) is not significantly higher than that of Anaya (27%) or Meade (24.7%). However, we note that the PAN/PRD and PRI candidates are less well-known than AMLO, even though their name recognition is increasing. Taking the average of the three most recent polls, AMLO’s name is recognized by 95.7% of voters, while those of Anaya and Meade are recognized by 79% and 59.3%, respectively.

No doubt, anti-PRI sentiment (the party with the largest rejection rate) is the heaviest burden for Meade. However, given his untainted record and no previous formal political affiliation to the PRI party, Meade does not embody the traditional PRI leader and therefore has a chance of positioning himself as a quasi-independent technocrat running under the political platform of the ruling party. 

NAFTA, the other big source of uncertainty

The 6th NAFTA renegotiation round – held in Montreal on January 21-29 – ended on a positive note, as Mexico (and to lesser extent, Canada) showed more flexibility to give in to U.S. demands. In turn, there was a substantial change in rhetoric from U.S. negotiators. 

Our base-case continues to consider that NAFTA will be renegotiated “successfully,” but now there is a greater risk that talks become more protracted (and thus overlap with Mexico’s election dynamics).  By “successful,” we mean an agreement in which Mexico (and Canada) give concessions to the U.S., but without implying transformational changes for the Mexican economy. The next round, according to a press release published by Mexico’s Ministry of Industry and Trade, will be held in Mexico City between February 26 and March 6. Although the rhetoric of negotiators is certainly friendlier, we note that so far no agreement has been made on any of the thornier demands by the U.S.

GDP growth rebounded in 4Q17

In spite of the uncertainties associated with elections and NAFTA, which are likely already discouraging investment decisions, GDP growth weakened only moderately in 2017. The flash estimate of GDP growth for 4Q17 came in at 1.8% year-over-year, above median market expectations (1.6%, as per Bloomberg). According to calendar and seasonally-adjusted data reported by the statistics institute (INEGI), GDP growth was slightly lower (1.7% year-over-year in 4Q17), but still accelerated with respect to the previous quarter (1.5% in 3Q17), when the economy was hit by natural disasters. The flash numbers reported for 4Q17 imply that GDP expanded 2.1% in 2017 (from 2.9% in 2016), hampered by contracting industrial output (-0.6%, from 0.4%), and partly offset by robust service sector activity (3.1%, from 3.9%).  

We maintain our GDP growth forecasts of 2.1% for both 2017 and 2018, and a moderate acceleration to 2.4% in 2019. Factors playing against economic growth in the short-term are tight macro policies (fiscal and monetary) and the uncertainties associated with the NAFTA renegotiation and the presidential election (affecting private investment). In fact, gross fixed investment fell by 4.5% year-over-year in November. On the positive side, we note that the fiscal drag will be smaller in 2018, relative to 2017. More importantly, a dynamic U.S. industry, coupled with a competitive real exchange rate, will likely continue to sustain Mexico’s manufacturing exports (which expanded by 11.2% QoQ/SAAR in 4Q17, measured in USD). Finally, lower inflation and a continuingly robust labor market will support consumption.

Another rate hike coming

Annual inflation started on a downward trend. Headline inflation decreased to 5.5% year-over-year in the first half of January (from 6.9% in the second half of December) – mostly thanks to a favorable base effect associated with energy prices – while core inflation decreased to 4.6% (from 4.8%) during the same period. Moreover, the diffusion index, which tracks the percentage of items in the CPI basket with inflation greater than or equal to four, went down to 69.4% (from 71.7% in the second half of December), well below the peak observed in the first half of August (79.8%). 

The Central Bank of Mexico (Banxico) resumed the tightening cycle in December (hiking 25-bps, to 7.25%), after staying on hold for the past three meetings. The latest comments from board members to the press are consistent with the guidance in the policy documents (statement and minutes), hinting that the tightening cycle will continue. On January 29, in an interview to the Financial Times, Governor Díaz de León stated that even though headline inflation decreased in January, the board is “very vigilant that this trend be maintained […] and very conscious of the uncertainties ahead”. 

We expect the board to hike the reference rate by 25-bps in the first meeting of the year (February 8), in spite of more positive news on inflation and NAFTA. While we see the policy rate peaking at 7.5% in 2018, the risks are still tilted towards more rate hikes. Assuming risks related to NAFTA and the domestic political scenario dissipate, we expect the board to deliver two 25-bp rate cuts in the second half the year, and 100 bps in 2019 (taking the reference rate down to more neutral levels). 

Fiscal consolidation continues

Finally, we highlight some positive news from the fiscal front as December’s numbers confirmed that the Mexican government achieved a primary surplus. The bulk of the improvement observed in the fiscal accounts throughout 2017 is attributable to the massive MXN 322 billion (1.5% of GDP) dividend received from the Central Bank in March (the outcome of exchange rate gains on international reserves during the previous year). However, even excluding 70% of the dividends received (as the remaining 30% is directed to stabilization/sovereign funds, and therefore recorded as both revenues and expenditures), the 12-month rolling primary balance reached a surplus of MXN 85 billion (0.4% of GDP) in 2017, from a deficit of MXN 192 billion in 2016, meeting the target for 2017 set by the fiscal consolidation plan (before the dividend announcement). Likewise, using the same metric (ex-dividend), the 12-month nominal fiscal deficit narrowed to MXN 464 billion (2.1% of GDP), from MXN 671 billion in 2016, smaller than the assumption (2.4% of GDP) in the 2017 budget. Finally, public sector borrowing requirements (ex-dividend) – the broadest deficit indicator – narrowed to MXN 555 billion (2.6% of GDP), from MXN 798 billion in 2016, beating the 2017 target (2.9% of GDP, also set before the dividend was announced) by a significant margin. 

As a result, the government has managed to reverse a concerning upward trend of public debt to GDP ratios (net debt had increased by 30 percentage points between 2007 and 2016). Currency appreciation also helped, by reducing the value in MXN of foreign currency debt. Net public sector debt came to MXN 10,089 billion in year-end 2017 (46.5% of GDP), from MXN 9,693 billion (48.2% of GDP) in 2016. Similarly, gross debt came in at MXN 10,287 billion (47.4% of GDP), up from MXN 9,934 billion (49.4% of GDP) last year.

The ambitious fiscal deficit targets for 2018, which will mark the last year of the fiscal consolidation plan, imply further adjustment, although they will represent less of a drag on the economy than in 2017. While the ex-dividend primary balance improved by 1.3% of GDP between 2016 and 2017, the target for this year is to lift the surplus by 0.5% of GDP (to 0.9%). 

João Pedro Bumachar
Alexander Muller

Please see the attached file for all graphs. 

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