A Q&A with Finance Expert Gabriel España on Mexico’s Economic Recession and Recovery
Before the pandemic hit, Mexico was already facing its first contraction in GDP in a decade, and President Andres Manuel Lopez Obrador had instituted austerity measures while promising to spur employment through major infrastructure projects like the Tren Maya and an airport expansion in Mexico City. The first quarter of 2020 is a completely different world with various dire economic predictions that Mexico could experience a severe economic recession not seen since the Great Depression. Not only has tourism and the economy been hobbled by the pandemic but oil revenue has also plunged, as well as remittances from abroad, and lower demand for exports. Despite the grim outlook, President Lopez Obrador has not backed down from his austerity plan and is offering limited economic assistance to businesses, which could mean an even slower economic recovery. Gabriel España, a former investment officer with the International Finance Corporation, and managing director of Iskali Capital Group, LLC, an investment banking firm, says the next few weeks will be crucial in determining just how extensive Mexico’s economic recession and recovery will be.
Q: Mexico’s Central Bank held two extraordinary meetings in March and April reducing the interest rate to 6 percent and unveiling a $31 billion stimulus plan for medium and small-sized businesses. How much do you think this will help?
A: What the central bank is doing is promising. It’s huge in terms of amount—I mean historically but I’m not sure it’s going to be enough. It’s going to help increase liquidity which is very important. But the major question is will it be enough? The current situation is so different from other crises that we’ve had in the past, so the outcome is difficult to predict. If you compare it to the package that was put into place by the United States which is trillions of dollars, what Mexico has done could sound very minor but in the context of the Mexican economy it is a very important thing.
The level of bancarization in Mexico is very different from countries like the United Kingdom, the United States or any other developed economy. People in Mexico don’t have a lot of debt. So, it’s not that they are going to suffer because of a lack of financing. What is challenging is that a lot of small and mid-sized companies, which is basically the target of this program, are not well institutionalized to access financing from banks. At least 50 percent of the workforce is in the informal sector so there’s no way to track the money and whether it’s being used for the right purpose. There’s no database of all of these people to give them the economic support. So, it’s not going to be enough and the government program is very limited. The stimulus of $25,000 pesos per company is not going to help much either — that’s around $1,000 US dollars. It’s nothing. It might be useful to pay the salaries of a few lower-skilled people but that’s it.
Q: What impact will the huge decline in oil revenue have on Mexico’s economy?
A: This is another very critical issue. Roughly 60 percent of the revenues received by Pemex are paid as a royalty to the government. This connects to my previous comment about the huge informal sector in Mexico. Historically, there’s been a lack of interest in having these workers pay more taxes because oil revenue has been financing these informal sector groups for years and that has been a problem in Mexico for decades. We are going to end up facing a difficult situation in the near future in Mexico. The ratio of public debt to GDP is going to be affected and not necessarily because the government is going to take on more debt. They issued recently $6 billion to finance existing debt. The ratio that tracks total debt to GDP in Mexico is in the 50 percentile, and If the GDP falls further, banks have been forecasting anywhere between 6 and 11 percent for this year —and just with the reduction of the base— it’s counterintuitive at a moment like this, when the government can actually issue paper and get funding to address social programs and to boost the economy it’s doing the opposite. Instead, the government is repaying debt and not borrowing new money to help in the recovery.
Q: So, President Lopez Obrador is choosing to stick with his austerity program, no matter what?
A: Exactly. But in the end reality is going to hit us hard with the economy not growing and the country not collecting enough taxes, and the income from oil not coming in. You can imagine what is going to happen.
Q: Why is the president so intent on his austerity plan, despite the dire economic forecasts?
A: He won the election with a very strong base and a set of promises that he used during his campaign to attract voters. He wants to stay attached to those promises. The programs he’s presented for pandemic recovery basically cover the people who supported his campaign. The $25,000 pesos for instance, it’s nothing but for someone selling on the street it’s a lot of money. His insistence on austerity — it’s a political message that he’s doing his best. He’s covering his back. He reduced salaries. Recently, he announced that police officers are not going to get their annual bonuses and an additional salary reduction of 25 percent for high-level government workers. Again, it’s counterintuitive, because without money there’s going to be less consumption. And with less consumption there’s going to be a deeper recession. But politically speaking he’s playing his cards.
The money he’s saving from austerity is not even a lot of money. It’s not going to change the profile of the economy. What many are saying is that he should cancel the humongous projects he’s developing in his state, the Dos Bocas oil refinery, the Tren Maya rail system and all of the investments he’s putting into an airport expansion in Mexico City. The refinery alone is like $6 billion, that’s a lot of money. The Tren Maya is also a lot of money. Mexico is not in a position to develop those projects at this point. Maybe in the future, but not now, in the context of what is happening with the deep recession that’s coming.
Q: Where do you see Mexico’s economy a year from now?
A: That’s a tough question. I think the recession could be very deep. We haven’t had a GDP fall by 5 percent since the Great Depression. Even in 2008 it was not as bad as this one. But assuming that there is already a vaccine and the health system works and in the United States consumption starts to pick up, Mexico could have a better 2021 relative to 2020. What is clear is that small and midsize businesses are going to suffer the most. We’re going to see a lot of consolidation and businesses are going to change the way they’ve been operating and we’re going to see a new normal.
Q: What about the U.S.-Mexico border economy?
A: Right now, there’s a very interesting situation at the border. Mexico is one of the largest producers of medical devices in the world. Many of these factories do assembly work for companies in the United States that need these products right now to sell. But in Mexico, these factories are closed because they’re not considered an essential business during the pandemic. So, there’s been a lot of disruption with U.S. business and political leaders sending letters to Mexico’s president saying that part of the supply change cannot be closed in Mexico, because these products are needed in the United States.
Q: The U.S Department of Defense also sent a letter, saying that the shutdown was affecting aerospace and weapons manufacturing as well.
A: In the context of the border economy, this is a major thing. I’m pretty sure President Lopez Obrador is thinking of the sovereignty of his government and that another country is not going to impose its regulations on Mexico. I wouldn’t be surprised if in the coming months we see pressure to make changes to the new United States-Mexico-Canada agreement, USMCA, that will prohibit shutdowns, like the one that is occurring in Mexico right now, to protect these production chains that are interconnected.