Country Analysis: Mexico On The Move
Posted 04 October 2012 - 10:00 AM
In this issue they examine the position of Mexico in the global market.
This is for information only purpose.
Source document: Euro Pacific Capital, Global Investor Newsletter, October 2012 edition.
Country Analysis: Mexico on the Move
By: Russell Hoss and Richard Hoss, Euro Pacific Funds
In recent years, news coverage of Mexico has tended to focus on the horrific violence of the drug trade. And while those graphic stories make for sensational news copy, they have unfortunately obscured some of the more positive economic news that has come from just south of the border.
Following the 2008-2009 global recession, Mexico rapidly recovered and has since exceeded pre-recession activity in most of its sectors. However, due to some weak results that have been recently reported in other parts of Latin America, including disappointing first half 2012 results from Brazil, many had expected that Mexico would be running out of steam. Instead, Mexican companies have reported earnings that surprised on the upside. Impressively, Mexico's economy continues to expand at approximately a 4% annual rate [Bloomberg, 2012] and appears to be largely undisturbed by the global financial turmoil. While the developed world remains awash in debt, Mexico's relatively balanced fiscal position is attractive from an investment standpoint. According to the IMF, its public debt is just 43% of its GDP (less than half the levels of the U.S.); its banks are some of the most well capitalized in all of Latin America; and Mexican consumers have very low levels of personal debt.
Mexico's economic strength rests firmly on its market-focused government and its robust industrial sector that specializes in high value added manufacturing of finished goods. Many Mexican firms rely on state of the art manufacturing techniques to skillfully turn basic materials into finished goods. This is in contrast to other Latin American and Asian peers whose economies are oriented towards low value added processes such as extracting commodities or basic component assembly. Importantly, recent Chinese wage inflation has helped Mexican manufacturers better compete in the global marketplace, especially in the U.S. market.
While we have significant long term doubts about the prospects of the U.S. economy, in the near to mid-term, Mexico should benefit from its close ties with its neighbor to the north. The recent deterioration of Europe, an anemic Japan, and a slowing China have created conditions that currently favor exporters with solid pathways into the United States. The North American Free Trade Agreement (NAFTA) ensures that Mexico will continue to enjoy these advantages. Not surprisingly, approximately 75%-80% of Mexican exports are sold in US markets. While we acknowledge that customer concentration increases risk, for now the arrangement is a big plus for Mexico. Investors should consider these advantages while keeping a close eye on economic developments.
In addition to slowly and strategically diversifying its customer base, Mexico must also look to privatize its mammoth state-controlled enterprises, such as oil giant Pemex. Amidst a period that has been generally favorable for petroleum producers, Pemex has had production declines for the last ten years. This has occurred despite access to attractive resources with low extraction risk (i.e. mostly onshore reservoirs). In addition, inexpensive and plentiful US shale gas (as well as Mexico's own shale resources) is a substantial global advantage to the Mexican petrochemical industry.
As Pemex is a significant portion of Mexico's GDP (we estimate 8%-10% in recent years based on government data), private investment in Pemex would be a major positive catalyst for the overall Mexican economy. Fortunately, Enrique Peņa Nieto, the newly elected president of Mexico, used increased privatization of state run enterprises as a cornerstone of his campaign.
Within the Latin American region, Colombia has set the best example for the positive influence and success that private investment can have in a state owned oil and gas enterprise. Privatization of Pemex is a significant undertaking that requires changing the constitution, and can only be done with cooperation amongst Mexico's political parties. However, Mexico will never reach its potential as long as Pemex remains a ward of the state.
Mexico also needs to make progress on labor reform. Highly bureaucratic unions and onerous labor policies make hiring and firing difficult and costly in Mexico. These conditions have led to a significant bifurcation between the official and underground economies. The laws have driven millions of workers underground into a permanent shadow economy, where their productivity is invisible to international statisticians and their wages untaxable by government revenue authorities. In fact, the high rates of under the table "informal" workers have placed the state in ever greater dependence upon state owned companies like Pemex to fund public sector expenditures (we estimate Pemex represents approximately 35% of government revenue based on government data). It is vital that Mexico take significant steps to modernize and liberalize its labor policies so that it can broaden its tax base and reintegrate its inefficient economy.
Today, Mexico has some of the healthiest fundamentals in the Latin American region. It is well positioned to outperform its peers, with the potential to reclaim its top economic position amongst the Latin American countries.
Russell Hoss and Richard Hoss, are co-portfolio managers of Euro Pacific Latin America Fund (EPLAX). Opinions expressed are those of the writers and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff. Russell Hoss and Richard Hoss are not affiliated with Euro Pacific Capital.
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Posted 04 October 2012 - 10:54 AM
"These conditions have led to a significant bifurcation between the official and underground economies. The laws have driven millions of workers underground into a permanent shadow economy, where their productivity is invisible to international statisticians and their wages untaxable by government revenue authorities."
When I hear about how low "official" wages are and I see all the new scooters (at $1500-2000 usd a pop) and all the new cars, one can see how the underground economy works in Coz. It's a mostly cash business on the island and it has made me wonder how much income there actually is.
I'm sure it can be easily tracked via retail sales and deposits at banks, but it certainly makes you think....were is all the money coming from.
Nah Ha 602
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