WHERE IS THE ECONOMY? (19 November 2019)

After its first year in office, the government of President Andres Manuel Lopez Obrador has undertaken two sets of priorities. One is the launching of major constitutional reforms aimed at changing radically the conduct of elected governments, their relationship with the people at large, and institutions. The other is the start of some projects that fit within a regional development approach, though these projects only apply today to the southeast and the northern border.

By far, the greatest priority has been the establishment of a new legal framework and extensive social programs. The latter, with a new approach to grant supports straight to the individual beneficiary, rather than through the network of the government social development administration, in an effort to prevent misuse of resources and corruption.

These projects have been welcome by the people, which explains very high approval rating, at 59% on November 12th, according to El Economista newspaper. In fact, changes make the elected government and officials responsible to the people and subject to trial, changing the long-standing presidential immunity. Elected officials will also be subject to a mid-term vote to confirm them in their posts or remove them, which ends a long period of disregard of voters by officials once they take office. Corruption, electoral fraud, gasoline theft are now 'major' crimes allowing no bail to the accused party. And top level salaries of officials, which were higher, compared to those in the US, Brazil or other countries, have been reduced, discouraging from government those individuals whose priority is to make money.

The impact of these changes should be positive, but will materialize over the long term. The changes address one of the two major drivers of the 2018 election, i.e., government corruption. One of the practical implications of these changes is that at present the government is focused on reducing high costs of contracts and purchases of goods and services from its suppliers, which in the past most often involved high corruption and bribes to officials.

Yet, apart from these changes relating more to the legal framework of the government, progress on security (another salient demand and driver of the 2018 election) still shows no material progress, at least in the level and in the geographical extension of violence. As this is a a long standing problem and despite the organizational changes intriduced by the new government, we expect the situation to worsen before it improves, as it follows an inertia from the past few administrations, when drugs, extorsion and kidnapping strengthened, at least in one third of the territory.

And, as we commented in our previous forecast, the new government de facto underwrote the previous government's tight fiscal targets and main objective of reducing gradually the debt-to-GDP ratio. This was after the previous administration had reduced such debt, by sharply cutting public investment, to 44.8% of GDP. Maintaining this priority has meant very poor levels of public investment, which does not allow much room for needed capital expenditure in the energy sector or in infrastructure. As this policy has been combined with very tight monetary policy by the Bank of Mexico, the outcome, not surprisingly, is very low economic growth. The slowdown, from 2% growth in 2018 to our projected -0.2% in 2019 has resulted from this tight policy and, to a lesser degree, from the US slowdown. The increase in economic growth that would be expected from a government that has a good project to change Mexico by fighting corruption and improving the fundamentals of long-term growth, must wait for now.

All the same, this policy has won the approval of foreign markets and rating agencies. Having the confidence of fixed rent foreign investors is key to understand that markets like Mexico are few for foreign investors, considering the extremely low yields in advanced economies and the wild policy swings in Turkey, Argentina, Chile or South Africa. From this perspective, the policy of AMLO has been the right one in avoiding any market turmoil.