Mexico: Changing of the guard

Published: Friday | November 30, 2012 Comments 0
Mexico City's Zocalo square, the heart of the ancient Aztec empire. FILE
Mexico City's Zocalo square, the heart of the ancient Aztec empire. FILE
Walter Molano, Guest Columnist
Walter Molano, Guest Columnist

By Walter Molano, Guest Columnist

There is a buzz of excitement in Mexico City, as the country prepares to inaugurate President-elect Enrique Pena Nieto.

After 12 years in the desert, the Institutional Revolutionary Party (PRI) is ready to return to the helm. Pena Nieto's inner circle is a mix of members or direct descendants of the Old Guard and aides from his days as the governor of the State of Mexico.

Leading the transition team is Luis Videgaray, an MIT-trained economist and former finance secretary for the State of Mexico. However, many people purport that former finance minister Pedro Aspe is the real force behind the curtains.

Although the PRI was traditionally a political machine that represented a wide spectrum of political ideologies and ruled with a populist bent, its latest incarnation reveals a shift to the right.

This is the reason why the transition team is working closely with President Felipe Calderon and the National Action Party (PAN) in order to advance on the legislative front before taking office.

The incoming president has three major economic initiatives, labour reform, the liberalisation of the energy sector and tax reform.

The first initiative was recently ratified by the senate, and it will go to President Calderon for signature. The legislative package overhauls the labour code by recognising outsourcing and part-time employment.

It also makes labour rules more flexible, thus providing employers with more discretion in making promotions and managing individuals.

Supporters of the bill argue that it will create hundreds of thousands of new jobs. However, many of these positions already existed, and it will only legalise them. In the process, it forces part-time workers to pay income tax.

It also makes it easier for companies to expand their labour force, without having to provide health and medical benefits.

In sum, it is a good deal for the government, because it will boost tax revenues. It is positive for firms because they will be able to reduce labour costs.

It is mixed for labour because it will raise taxes, but it will also raise the general level of employment. One element of the labour reform that was dropped was the enhanced transparency of the selection process for union leaders.

The decision to eliminate this part of the bill was a major concession to the unions that was probably made in order to get their support for the second initiative - the liberalisation of the energy sector.

PEMEX IN TROUBLE

Mexico is in urgent need of energy reform because Pemex is in deep trouble.

Mexican oil production peaked in 2003, with a daily production rate of 3.5 million barrels of oil. In 2011, daily production dropped to 2.6 million barrels of oil.

The main problem has been a lack of investment, due to the heavy tax burden the government places on the company.

Pemex generates more than a third of Mexico's total tax revenues. As a result, it gets taxed at a rate of 60 per cent, leaving very little for investment.

Most of the remaining funds are put into maintenance and operating costs. With investment low, it is little surprise that output has been declining.

The biggest problem is the huge offshore field of Cantarell. It is coming to the end of its life, and daily output is down 37 per cent since its peak in 2005.

Oil engineers are convinced that there are huge deposits in the deepest parts of the Gulf of Mexico, but the company does not have the resources or technology to extract it.

Foreign companies refuse to provide it with the capital needed to exploit the oil unless they can share in the upside.

Unfortunately, the constitution stipulates that all aspects of the oil sector are property of the state and can only be managed by Pemex. Hence, the government needs to change the constitution. The PAN tried valiantly to implement the changes, but to no avail.

However, with the PRI back in power, it is willing to make the changes—as long as it can control the process. The problem is that, even with the PAN on board, the PRI will not have the two-thirds majority needed to amend the constitution. This means that it will need to sign on one of the smaller parties, such as the Greens, in order to make the necessary changes.

The last part of the economic initiatives is the tax reform. It is evident that the Mexican government will need to diversify its source of revenues in order to allow Pemex to redirect more of its resources towards investment in capital equipment and technology. Hence, the government will generalise the VAT, leaving out a small basket of basic goods and medicines.

The new measures, particularly the energy reform, should add two percentage points to Mexico's growth rate, pushing it into the six per cent y/y range. This would put Mexico within the top league of emerging market economies, and leave it in a perfect position to take advantage of the energy-led US recovery.

Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC. wmolano@bcpsecurities.com

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