Confidence Boosting Mexico’s Economy

Rising confidence in the Mexican economy and in President Vicente Fox’s fiscal reform proposals is sparking a dramatic upturn in flows of foreign capital into the nation and a surprising spike in the value of the peso, analysts said.

The optimism comes despite dire warnings that Mexico’s economy would inevitably slow this year along with the United States’. Indeed, the effects of the U.S. economic slump are visible in cutbacks or closings in Mexican factories owned by Goodyear Tire & Rubber Co., Volkswagen and dozens more that feed the U.S. marketplace. February industrial output fell 3.7% over last year, the government said Wednesday.

But the Mexican economy is by no means following in lock step and may be displaying less dependence on the U.S. economy. Although growth will slow from last year’s torrid 6.9% pace, it will still expand three times faster than the U.S. economy and attract as much, if not more, foreign investment as it lured last year, a World Bank study predicted this week.

“Various economists expected that the U.S. slowdown would have affected Mexico more,” said John Boord, a Salomon Smith Barney investment banker based in Mexico. “But people are very bullish on the new government and are beginning to see Mexico on the same radar screen as highly industrialized nations.”

The peso closed at 9.29 to the dollar in currency trading Wednesday, the highest level since September.

Mexico is still vulnerable to external events, and analysts warn that a protracted U.S. slowdown or a collapse in the Argentine economy could derail its progress. Most economists expect the U.S. economy to bounce back later this year.

But investors are looking past the risks and at the rewards to come, especially those to accrue from passage of Fox’s sweeping tax reforms. His package would increase non-oil tax revenue by as much as 30%, putting the nation on a much sounder economic footing and setting the stage for a debt upgrade by Standard & Poor’s later this year.

“The financial markets have internalized the probability that the fiscal reforms will be approved by Mexico’s Congress. You see it in the strength of the Mexican currency,” said the World Bank’s Olivier LaFourcade, loan manager for Mexico, Colombia and Venezuela.

Confidence in Mexico is running high enough that the country will probably smash last year’s record level of foreign investments. Over the first three months of this year, $10 billion in foreign investment landed in Mexico’s factories, offices, stocks and bonds, Mexican Central Bank chief Guillermo Ortiz said recently. That’s a 54% rise from $6.5 billion over the same period last year.

An S&P; upgrade of Mexican bonds to investment grade would put the country in a league apart from its Latin American neighbors, attracting new funds from large U.S. institutional investors that can put money only in investment-grade bonds. Moody’s Investors Service last year granted investment-grade status to Mexican government bonds, but the lack of a similar rating from S&P; still keeps Mexican bonds off limits to some U.S. institutional investors.

Among Latin American nations, only Chile has received such an S&P; rating, but Mexico would occupy a special status by virtue of its size, being roughly eight times larger than the Chilean economy.

Though U.S. investment in Mexican factories could decline this year because of the slowdown, the shortfall is apparently being compensated by investments from Europe, whose free-trade agreement with Mexico took effect in mid-2000, said Jonathan Heath, an economist with LatinSource in Mexico City.

That diversification of investment sources augurs well for Mexico’s development and offers some insulation from the effects of the U.S. economy, analysts said.

Confidence in Mexico’s long-term prospects is being demonstrated by investors’ preference for stocks in Mexican infrastructure companies, including ones that own and operate airports, shipping interests and ports, Salomon’s Boord said.

The public stock offering later this year of the government-owned company Grupo Cintra, which controls Mexico’s two largest airlines, AeroMexico and Mexicana, is highly anticipated, Boord said. Last week, Delta Air Lines Inc. said it plans to buy as much as 25% of Aeromexico when shares become available.

Investor confidence also is apparent in the fact that the difference in interest paid on top Mexican corporate bonds and U.S. corporate bonds has narrowed to 1.3 percentage points from nearly 5 percentage points in 1998--showing that investors will accept a much lower “risk premium” to buy Mexican bonds.

Some skeptics, including Citibank emerging-markets strategist Stephen Leach, maintain that the peso’s strength and the influx of foreign capital could be due more to the tight monetary policy of Ortiz’s Central Bank that has kept short-term interest rates at 15.48%, an attractive return for investors looking at the 4% yields available on comparable U.S. Treasury notes.

If the Central Bank eases rates to put them more in line with Mexico’s targeted inflation rate for 2001 of 6.5%, the peso would inevitably weaken, Leach said.

But Heath said skeptics used the same restrictive monetary policy to explain Mexico’s high level of foreign investment last year, only to find out that 99% of foreign capital that entered Mexico in 2000 was directed toward long-term investments not directly tied to short-term interest rates.

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Peso Power

Mexican President Vicente Fox’s fiscal reforms have boosted investor confidence, attracting foreign investment and strengthening the peso.

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Source: Bloomberg News