By Jonathan Lemco


In the past few months, the US press has devoted a great deal of attention to the challenges faced by Mexican workers. The media has stressed that China will compete ferociously for Mexico’s export markets, and that the Mexican labor force will be a big loser. Also, it is noted frequently that Mexican educational levels have not improved appreciably in recent years. Many critics stress that vital fiscal and other structural reforms will not pass the Mexican legislature, and this will severely crimp economic policy-making. Others note that the revenue base remains too small. There is truth to these allegations, but they do not tell the whole story.

According to the Mexican Finance Ministry, Mexico’s GDP growth rate is expected to be in the 4% range in 2004. Inflation is likely to remain a moderate 3.6%. The Mexican private sector is demonstrating higher levels of confidence in the economy going forward. Although China is a meaningful economic threat, it is also the case that China is buying Mexican commodities in substantial amounts. Trade is a two way street, despite all of the attention devoted to Mexico losing jobs and investment. It is also the case that the China threat has been less severe than some expected because of currency depreciation. Fewer businesses have left Mexico than one would anticipate, given the space devoted to this issue in the US media.

Further, and more important, Mexico’s economic future has far more to do with the fortunes of the United States than the fact that Mexico competes with China. The US is Mexico’s largest export market, and the two economies are substantially integrated. Over the past six months, the US manufacturing sector has expanded at an annualized rate of 7.1%. Mexico’s manufacturing sector seems to be keeping pace, and in fact has been growing faster than the US. The February trade report showed Mexican manufacturing exports up 10% on a yoy basis. It is important to note that this does not include the trade that will come from the 1% rise is US manufacturing in February. Investors should look for stronger output from Mexico in March/April as the effects from that strong US month are felt by its southern neighbor. In a very meaningful way, as the US economy goes, so goes Mexico’s.

In addition, in 2003, Mexico enjoyed the benefits of free trade agreements with the NAFTA nations, as well as Europe and Japan. Several multinational corporations are putting new money into Mexican industry. Volkswagen has recently announced a US $2.6 billion investment in new plants, with Mexican operations now acting as an export platform to Europe, taking advantage of the weak dollar. Japanese companies have made new investments, based on similar strategic thinking. Wal-Mart announced at the end of March that it would invest US $600 million in the next few months. BBVA’s decision to acquire Bancomer’s remaining shares should also deliver a substantial inflow. In short, Mexican entities are engaged in deepening financial, productive and trade links.

On the fiscal side, the Mexican Central Bank continues to guide the economy with strong budgetary discipline. The budget deficit is on target for the year at an acceptable 0.3%/GDP. The surplus in February was 8.1 billion pesos, with the year to date surplus of 35 billion pesos. That compares to a surplus of 18.4 billion pesos in the same period in 2003. Further, in February, recurring revenues expanded by 1.5% in real terms. That includes a 5.3% rise in tax revenues. The major reasons for this improvement were reduced spending, higher oil price revenues, and improved levels of VAT tax receipts. Overall, this improved fiscal performance also reflects the fact that Mexico should be better able to withstand external shocks or economic contagion.

We do not mean to dismiss Mexico’s problems however. There has been little progress on passing meaningful structural reform legislation in the Mexican Congress. Until that occurs, there will be limits on the economic progress that Mexicans can expect. Also, the Mexican political system now consists of three viable parties. That is good for democracy, but it makes policy-making that much more difficult. President Fox appears politically weak relative to the Congress. Furthermore, Mexico’s infrastructure needs are tremendous and its level of economic inequality substantial. But there appears little that the government can do to address these development issues in the short-term. None of this is new, of course. But what is different is that popular expectations for the success of the Fox government have been especially high, and many observers have been disappointed.

All this being said, Mexico continues to grow at a decent level. Its fiscal performance has been excellent such that the credit ratings agencies have steadily upgraded the credit in recent years to an investment grade level. Thus far in 2004, Mexican bonds have been among the best performers in the entire corporate bond universe. We conclude by noting that we expect that Mexico will remain an attractive investment opportunity for the foreseeable future.