Mexico: The Road Ahead

BY WALTER T. MOLANO

Two months into the sexenio, the Calderon Administration is faced with a long list of pressing issues. However, in contrast to the previous administration, which was bogged down in a showdown with the congress (and its own political party), pursuing a set unachievable reforms and encumbered with a narcissistic cabinet; the new administration is embarking on a series of manageable tasks.

ENERGY REFORM

There are three major projects on the table. The first is energy reform, and the PRI is taking the lead. Pemex is in dire straits. Oil production is expected to decline 15 percent y/y in 2007. This follows a 12 percent y/y drop that was recorded in 2006. The Mexican government survived the last six years, without implementing any major structural reforms, by siphoning off all of Pemex’s revenues and investment capital, leaving it with dwindling oil reserves. Today, Mexico needs more than $15 billion in additional investment to stem the decline.

The best option is to privatize Pemex, but the government is taking a different tack. Under the command of Senator Francisco Labastida (PRI), the government is arguing, that instead of privatizing Pemex, private service providers should be invited to participate in the exploratory process. This should bring an injection of modern technology and private capital, without changing Pemex’s ownership structure. The new legislation and the change in regulatory framework will take some time, but the initiative should reverse the decay of the Mexican energy sector.

FISCAL REFORM

Fiscal reform is the second project on the table. Under the stewardship of Finance Minister Augustin Carstens, and assisted by Under Secretary of Finance Alejandro Werner, the government is preparing a new package of fiscal reforms to widen the tax base, eliminate loopholes and improve tax collection rates. The decline in oil output heightens the sense of urgency for the fiscal reforms, since oil royalties represents almost 40 percent of government revenues. Mexico’s fiscal performance in 2006 was good, due to high oil prices and a strong boost in economic activity during the fourth quarter, but it should erode significantly in 2007—as oil production falters and energy prices decline.

PENSION REFORM

The reform of the public-sector pension system is the third initiative. Under the leadership of Senator Santiago Creel (PAN), the Mexican government intends to create a new pension fund (AFORE) for public sector workers, slowly transforming the pay-as-you-go system to a fully funded scheme. Like some of the other Latin American countries, such as Colombia, the pension benefits for Mexican public sector employees are extremely generous and represent an ever-growing strain on the country’s finances. The decline in oil production and the need to increase investment in energy, electricity and infrastructure forces the Mexican government to take action.

Most of the problems facing the Mexican economy were well documented for more than a decade. However, the previous administration was unwilling (and often unable) to make progress, even though it campaigned on a reform platform. This means that the Calderon Administration will have to act fast.

TECHNOCRAT ASSISTANCE

Tapping into the deep bench of well-trained technocrats and administrators, President Calderon is increasing his chances of success. The Fox Administration may have marked an important turning point in Mexican history, by ending the iron grip of the PRI on the country’s political system, but he was unable to do much more. That is with one exception, his intervention during the final days of the 2006 presidential campaign tilted the electoral balance in favor of Felipe Calderon. That act, alone, allowed Mexico to avert total disaster.

Unfortunately, the new initiatives led by the Calderon Administration will need time to gestate. That means we could see an erosion of the country’s macroeconomic variables before they turn around. Nevertheless, these changes will put the Mexican economy on a more solid footing, thus allowing it to enter into a more sustainable path of development.

Walter Molano is head of research at BCP Securities.