Mexico: beware of the political wild card
With the pre-payment of $3.5bn to the US Treasury on January I5 this year, Mexico finally closed the chapter on the "Tequila Crisis" Although the Mexican economy had been showing signs of recovery for over a year, the payment marked the formal end of the need for external support and, hopefully the beginning of a period of sustained growth. The equity market celebrated the pre-payment with a 2.7% jump and to date, the Mexican stock exchange has risen 15% in peso terms.
Economic improvements have been pivotal to the recovery of the market. In 1996, GDP growth was 5.1% reversing the 6.2% drop in 1995 and inflation declined to 27.7% from 52% and remains on a firm downward trend. The exchange rate was stable during most of the year, closing at P$7.87, just 2% below its end-l995 level, and despite the real appreciation of the peso, the export sector continued to show strong growth. Exports reached $96bn on the back of higher manufactured exports and a high oil price, imports turned around sharply, but Mexico still managed to generate a $6.5bn surplus, just marginally below the $7.6bn registered in 1995. The current account deficit (Mexico's Achilles heel in 1994) was just $1.8bn, easily financed by inflows of $7.5bn in foreign direct investment. As confidence recovered, the government and private companies were able to return to the markets, thus allowing international reserves to be replenished. The government maintained fiscal balance despite stagnant tax revenues and the need to finance the bail-out of the banking system. All of the above contributed to a sharp drop in interest rates and a 21% rise in the stock market in 1996.
Progress continues to be made in 1997. With funds conserved from 1996 and with the proceeds of fresh issues, the Mexican government was able to make the final payment to the US treasury as well as pre-payments to the IMF. At the same time, portfolio flows to equities and domestic money market instruments have increased, resulting in a further improvement of Mexico's debt profile and an increase in reserves to $10.7bn. Combined with the persistent decline of inflation, this has allowed a sharp drop in interest rates. The 28-day Cetes rate declined from just under 30% in December 1996 to 18. 6% in February. With the exchange rate stable around the P$8.OO level, this has encouraged fresh interest in the eq-uity market.
Given the economic turnaround, there are three key issues facing in-vestors in 1997; the impact of US markets, the strength of the domestic recovery and politics. The Mexican market remains closely tied to the US market. An increase in short-term rates above the 25bp expected in either March or May has the potential to weaken the peso and send local rates sharply higher. On the economy, the one doubt about the recovery is whether private consumption spending will grow strongly enough for companies to benefit. This is crucial for the Bolsa since most companies are oriented toward the domestic economy rather than ex-ports, but it is the latter which have led the recovery since 1996. We expect to see a modest recovery of private consumption in 1997 based on higher employment and lower real interest rates but no consumption boom.
Politics is the one wild card in 1997. For the first time ever, residents of Mexico City will elect their mayor. At the same time, mid-term congressional elections will be held and there is a real possibility that the ruling PRI will lose control, thus exposing Mexico to the joys of cohabitation. In addition, governors will be elected in a number of key states, notably Nuevo León. Although politics will no doubt be a source of volatility, Mexico appears to be moving towards a genuine multi-party system with greater composure than many might have suspected. Overall, we expect 1997 to be a strong year for the stock exchange and look for a US dollar return of around 25% for the full year and for the IPC index to reach 4,600.
Lars Schonander is director of research at Santander Investment, Mexico City