Wed | Dec 7, 2016

Commentary: Mexico: Time for something new

Published:Friday | March 27, 2015 | 12:00 AM
File Mexico City's Zocalo square.

Mexico is the unsung hero of Latin America. It was not the beneficiary of any catchy acronyms or marketing campaigns.

Even though it is an important producer of raw materials, the commodity boom came and left without much of an effect on the economy.

Instead of hype, Mexico has been the victim of a bloody internecine campaign between drug cartels. The population has grown numb to the dull cadence of petty corruption. Local newspapers report that the tragic murder of the 43 students in Guerrero and the infamous 'White House' scandal involving President PeÒa Nieto and his wife marked the loss of the 'Mexican moment'.

However, nothing could be further from the truth. Mexico's success is the product of its own results, not the vacant promises of an over-hyped PowerPoint presentation. It is an example of a nation that is closing the gap with the developed world, not through the steroids of easy credit, but through the heavy perspiration of hard work.

A jaunt down the leafy lanes of Reforma reveals the nation that is rising out of the past. Towering skyscrapers, headquartering Mexico's top financial institutions, pierce the azure sky. Armies of young executives, darting to and fro, have brought new life to a formerly seedy neighbourhood.

Once known for its thick smog and debilitating pollution, the city replaced its ageing transportation system with new buses and trains. A modern highway system also alleviated much of its notorious congestion.

These measures have helped jump-start the economy. Last year, the pace of economic activity rose to 2.4 per cent y/y from 2.2 per cent y/y in 2013. Most analysts expect the level of output to rise above 3.1 per cent y/y.

Prudent planning on the behalf of the central bank allowed it to use derivatives to hedge part of its oil operations. Recently, United States regulators revealed a put option that Banco de Mexico (Banxico) bought last year to lock in the price for five million barrels of oil at US$80.

Although Mexico produces more than 2.5 million barrels per day, its net export balance is about a third of its total production. This is due to the fact that Mexico consumes much of the oil it produces, and it imports a great deal of distilled products. The derivative operations were a boom to the Mexican government, and they will avert a major fiscal adjustment in 2015.

Furthermore, the fiscal accounts are benefiting from the sharp increase in gasolene prices that were introduced last year. With pump prices almost twice as high as in the US, the government is escaping much of the pain that is being felt by the rest of the oil producing universe. The energy reforms will also attract a great deal of investment, despite the decline in energy prices.

The reforms were divided into two camps.

The first camp consisted of maritime exploration and production contracts. Fortunately, they remain firmly in the spotlight. More than 40 companies expressed interest in the first blocs that were offered by Pemex. These firms have a time horizon of 20+ years, and they are not deterred by the current slump in energy prices.

The second camp consists of land-based fields, with a large concentration in fracking activities. These projects were designed for smaller institutions. Unfortunately, many of the players were hurt by the decline in oil prices, and they will see less investment.

Overall, the Mexican government expects the oil sector to attract about US$12 billion in new investments this year, but the number could go higher.

Moreover, billions of dollars are flowing into electric sector, as CFE undergoes a major investment initiative in long-distance transmission lines, windmill generators, geothermal facilities and gas pipelines.

Hence, this will surely increase the US$22 billion in FDI that came in last year.

Strong capital inflows, the booming US economy and greater confidence in the Mexican economy will allow the MXN to appreciate.

Banxico is also showing a better disposition towards a stronger peso, as a way to keep the pass-through inflation in check. This makes MXN-denominated euro-clearable notes some of the most interesting selections in the emerging market spectrum.

Investors have always been at a loss as to how to play the Mexican market. Mexican high-grade bonds are too expensive, and the Mexican high-yield market is littered with the carcasses of deals that went wrong.

An interesting option is the universe of high-grade MXN-denominated corporates. These names provide strong credit stories, with a total return environment that is very attractive.

Mexico is one of the most interesting options on the table, and it is time to play it with something new.

• Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com