ManattJones Global Strategies - September 2016

Manatt, Phelps & Phillips, LLP

Manatt, Phelps & Phillips, LLP

CEO’s Executive Summary: We have an unusually long update this month, given many developments in August and this morning’s cabinet reshuffle announced by the President.

On September 7 President Peña Nieto reshuffled the heart of his cabinet, accepting the resignation of Finance Minister Luis Videgaray and replacing him with Social Development Secretary (and former Foreign Minister) José Antonio Meade. This came in the wake of record-low presidential poll numbers, a new scandal affecting President Peña Nieto, and the problematic visit of Donald J. Trump to Mexico City last month. These developments overshadowed other noteworthy events in Mexico, including the PRI’s anti-corruption efforts and the President’s annual state of the union address. These events, the start of the fall legislative session, and the approach of key elections in 2017 and 2018 portend increasing political clashes. At the same time, there could be real progress in the current legislative session on the budget and the creation of semi-unified state police forces, as the PRI and PAN appear to be aligned on these issues. Meanwhile, renewed downward adjustments in growth estimates for the Mexican economy to just over 2% caused major credit ratings agencies to downgrade Mexico’s sovereign ratings outlook to negative. On the reform front, the energy reform program continues to progress, while unions opposed to education reform in four poor states greeted the new school year with a short-lived strike.

BREAKING NEWS: Major Cabinet Reshuffle

On September 7 President Peña Nieto announced changes to the core of his cabinet. Finance Minister Luis Videgaray, the President’s longtime right-hand man, resigned and was replaced by Social Development Secretary José Antonio Meade. An economist by training, Meade served as foreign minister during the first three years of Peña Nieto’s government, and previously served as finance minister and energy minister under President Felipe Calderon. His instructions from the President are to send Congress an austere budget with the first primary surplus in years. Meade was replaced at Sedesol by Interior Undersecretary Luis Enrique Miranda, who had been the ministry’s main interlocutor with dissident teachers who continue to protest the 2014 education reform. Stay tuned for further announcements and changes in the sub-cabinet in key ministries.

Mexican Politics

August was a difficult month for President Peña Nieto and his PRI party. The month got off to a decent start from the perspective of public perception, with PRI Party President Enrique Ochoa initiating the party’s first internal anti-corruption legal proceedings against three outgoing PRI governors and one ex-governor, which could lead to their expulsion from the party. The government also fired the federal police commissioner, holding him accountable for the May 2015 extrajudicial killing of 22 drug suspects. But three other developments overshadowed these actions. First, a Reforma poll showed President Peña Nieto’s support falling to a new low of 23% and that 76% of Mexicans think the country is on the wrong track. Second, the President’s popularity took a further hit with recent allegations that he plagiarized large segments of his undergraduate law school thesis (something he has denied).

Third, and most crucially, Peña Nieto invited Donald J. Trump—the U.S. Republican presidential nominee with a 2% approval rating among Mexicans—to visit Mexico, purportedly in order to calm financial markets by getting him to make reassuring remarks about NAFTA and trade. The visit backfired badly. The plan, which is reported to have been devised by Finance Minister Luis Videgaray, has sharply divided the President’s cabinet and drew strong objections from both Interior Minister Osorio Chong and Foreign Minister Ruiz Massieu (including reported offers to resign by both). Meanwhile, the public, 81% of whom disapproved of the meeting, saw Peña Nieto as a leader unwilling or unable to stand up to a man who has repeatedly insulted Mexico. This self-inflicted wound, which some analysts call the worst crisis of the Peña Nieto presidency, will likely undermine an already weakened government.

The fallout from the visit also overshadowed President Peña Nieto’s September 1 Informe (annual “State of the Union” message). The President’s remarks were given this year in a town hall format before a gathering of Mexican youth to make the event “friendlier” and “less rigid.” This format also avoided exposing an unpopular president to the potential embarrassment that a traditional speech before the country’s elite might have caused. Peña Nieto defined five priorities for the last two years of his presidency—education, poverty, security, corruption and improving the family budget—and decided not to send any bill to Congress this year as a “preferential initiative,” which would automatically have become law if Congress did not vote on it during the current term.

In preparation for the September 1-December 15 legislative session during which the income law and budget for 2017 must be approved, Mexico’s political parties held their annual conclaves to establish their own respective legislative agendas. There is precious little the parties all agree on other than the need to implement an anti-corruption system, and here they differ on the details. The PRI has called on all parties to work together to advance the goals they share, but the PAN and PRD will likely oppose the PRI with an eye to 2017 state elections in Nayarit, Coahuila, and a critical election in the state of Mexico, and the 2018 federal elections. This foundation for discord is apt to be reinforced by the PRI’s promise that the 2017 budget will be one of the most austere in years. The President also plans to present bills dealing with gay marriage, legalizing marijuana, and a labor reform measure to address pensions.

The good news is that the PAN shares two top priorities with the government: implementing education reform despite union opposition in the south and reducing the budget deficit through spending cuts rather than tax increases. The PAN also backs other government priorities, including full implementation of the new fiscal responsibility law that limits state budget deficits and borrowing, and the creation of semi-unified state police forces that will allow some large municipalities to retain an independent force rather than imposing a single unified force in every state. The PAN is at direct odds with the government, however, in insisting that significant portions of the 2013 tax increases be reversed and potentially calling for an electoral reform that introduces a second round of voting in presidential and gubernatorial elections.

The PRD will continue to play the role of a progressive opposition to the government, albeit one without the votes to pass initiatives on its own. Its legislative priorities include substantive modifications to the education reform, increased progressivity in the tax code, protecting human rights by limiting police use of force and promoting same-sex marriage. It will also oppose any cuts to education, health or rural programs in the 2017 budget and will insist on salary cuts for public officials.

Mexican Economy

The Mexican economy shrank for the first time in three years during the second quarter of 2016, driven by the steepest drop in industrial output since 2009. But the drop is likely to be temporary, since industrial production rose slightly in June, while construction and consumer spending remained buoyant—driven by rising credit, rising remittances and their increased purchasing power due to the peso depreciation, and a jobless rate that reached an 8-year low in July.

Even with the finance ministry’s downward adjustment of its growth estimate (to 2.0%-2.6%) for the year, BBVA estimates that this growth rate will be the highest in Latin America in 2016 and 2017. Nevertheless, expressing concern about slow growth and the rapid increase in government debt, which now totals nearly 50% of GDP, Standard and Poor’s reduced Mexico’s credit outlook from stable to negative. The same day Moody’s lowered its outlook for the banking system to negative for the first time in six years due to slow growth and exposure to Pemex. These moves echo Fitch’s decision last month to lower the ratings of Pemex and the CFE owing to increased country risk.

The minutes from the Bank of Mexico’s August meeting echoed S&P’s concern with Mexico’s fiscal deficit and growing debt, but concluded that 3% inflation is within reach. This reflects slowing growth and a 13% drop in telecom prices over the past year, and it incorporates the sharp increases in gasoline and electricity prices in July. Meanwhile, the Finance Ministry announced an additional gasoline price increase from September 1, but promised to propose moving up the date when the free market will set gasoline prices to 2017 from 2018. And it completed the purchase of oil hedges for 2017 at $38/barrel, which, in conjunction with funds from the oil stabilization fund, will support the $42 price estimate in the 2017 budget proposal.

Despite slower growth, foreign direct investment in Mexico totaled more than $14 billion in the first half of 2016, 4.6% higher than the same period last year and driven by record-high investments in the energy sector. And after strengthening to nearly 18 pesos to the U.S. dollar in mid-August, the peso closed out the month at 18.9, continuing its recent volatile trajectory. A final item of note economically is the release of the 2016 Global Innovation Index, which ranks Mexico as the third most innovative economy in Latin America (behind Chile and Costa Rica).

Recent Developments Affecting the Reform Agenda

Energy reform continued to advance in August. In the electricity sector, the President confirmed Jaime Hernández Martínez as the new director of the Federal Electricity Commission. A company insider, Hernandez is expected to continue restructuring the CFE as required in the 2013 energy reform, and takes over a firm that registered its first profitable semester in six years, due largely to reduced pension liabilities. Mexican officials also announced the November start of a yearlong pilot project to test Mexico’s cap-and-trade system in advance of the scheduled 2018 inauguration of a national carbon market.

In the oil sector, Exxon, Chevron and Hess announced that they will bid as a consortium for the right to drill in ten deepwater blocks up for auction on December 5, while regulators modified the terms of these auctions to reduce operational uncertainties for winning firms. Mexican oil regulators also approved the process for bidding next year on a set of mostly natural gas exploration blocks. And finally, the secretary of finance announced that the late-2015 negotiated changes in Pemex’s collective agreement with its union lowered its pension liability by $10.2 billion, but still totals 6.8% of GDP.

In education news, a teacher strike greeted the new academic year in four of Mexico’s poorest states. At issue is the mandatory testing of teacher competency and limits on the practice of purchasing or inheriting teaching positions introduced in the 2014 education reform. The dissident CNTE union has led a months-long protest to force the government to abandon the reform. The government is unwilling to give in to this demand, but has been unable to stop the marches and blockages. Out of frustration, Oaxaca businesses called a one-day general strike in early August to protest the economic costs—and resulting insurance claims—caused by the protests. Meanwhile, a growing number of parents have moved their children into private schools.

U.S.-Mexico Relations

At the August 4 U.S.-Mexico Summit in El Paso, Texas (sponsored by MJGS client the Borderplex Alliance), the U.S. and Mexican Ambassadors focused on the importance of U.S.-Mexico trade and the need to better explain this to the American public. The following week saw two additional binational announcements. The two governments announced the members of the new Mexico-U.S. Energy Council, which will begin operating this fall, and customs officials announced the success of a pilot program to speed up customs procedures at the border by instituting joint inspections of commercial vehicles. Wait times were cut from 3-4 hours to just 25 minutes. And after a 10-year absence, Royal Caribbean once again began making stops in Ensenada.

Publications, Press and Upcoming Events

The New York Times quoted ManattJones Chairman Jim Jones in an article about the Mexican government’s attempts to regulate the telecommunications monopoly held by Carlos Slim. Ambassador Jones also commented for Latinvex on the importance of NAFTA and likely negative repercussions should high tariffs be imposed on Mexican exports to the United States.

MJGS President & CEO Michael Camuñez commented on U.S.-Mexico relations and the fate of the TPP on National Public Radio and was further interviewed by fDI Intelligence Magazine on “Protectionism, Trump and the Future of FDI in the US.”

On September 13, 2016, Camuñez will discuss the U.S. election and U.S.-Mexico relations at the “Relación México-Estados Unidos 2016: Foro de Análysis” in Chihuahua, Mexico.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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