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Latin American Economy & Business - October 2014 (ISSN 1741-7430)

Peña Nieto at the two-year mark

Mexico’s President Enrique Peña Nieto will mark two years in office this December – that’s one third of his six-year term. The president’s most significant economic achievement so far has been to secure congressional support for 11 major structural reforms. While it will take a few years for the results to feed through, international markets have been deeply impressed with the scale of the economic changes. Unlike other big Latin American economies, Mexico is now on its way to recovery. But these gains may be at risk because of the government’s poor record on security.

On taking office in December 2012 Peña Nieto had two big problems. One was an underperforming, oil-dependent economy with deep structural imbalances. The other was a savage war with the country’s drug gangs, escalated by his predecessor, which had cost around 70,000 deaths in the preceding six years. It is now evident that the new president decided to concentrate on the economic problem as priority one, envisaging that there could be slower, more gradual improvements in security – in effect relegating it to priority two. He may have also hoped that getting the economy right would help make the security problem more manageable.

In any case, Mexicans remain a little unclear as to how exactly government security policy has changed under the current administration. Officials say it is now more low-key and more intelligence-led; they also point to the creation of a small new police force, the National Gendarmerie. Critics counter that nothing has really changed; the latest massacres (including that of student teachers in the state of Guerrero), in their view, indicate an almost complete breakdown of law and order in certain parts of the country.

It is hard to underrate the significance of the structural reforms. President Peña Nieto tackled the fundamental problem of stagnating oil production and revenues by ending the seven-decade old oil, gas, and electricity generation monopoly. International oil companies will bid for exploration and production licences starting early next year, bringing in a flow of new inward investment. Petróleos Mexicanos (Pemex), the state oil company, will compete with them. As its obligation to fund the treasury with petro-dollars is eased back, it will be able to re-invest more. Meanwhile, to make up the shortfall, a fiscal reform has been approved to increase the contribution of non-oil taxes to the government budget. Reforms in the telecoms and broadcasting sectors are designed to reduce the power of oligopolies and promote competition (see inside for more details). Education reforms are designed to improve the skills of the work force. The overall aim is to achieve a more modern and competitive economy.

The optimists see signs that it is all beginning to work. At a time when Brazil, Argentina and Venezuela are all struggling with stagnation or recession, the Mexican economy is modestly gathering pace. After a slow start in 2013 the IMF predicts real annual GDP growth of 2.4% this year and 3.5% in 2015, due to “a stronger recovery in the US, an upturn in domestic construction activity, and the gradual dividends of the energy and telecoms reforms that are underway”. The IMF has also said that the reforms will help Mexico achieve an annual GDP growth of 4% within five years - well above the average of the last decade. Despite complaints from the business sector, there is evidence that the fiscal reform is beginning to pay dividends – tax collection rose by 6.3% in January-August this year. There are some question marks on the horizon. For example, lower-than expected international oil prices next year could widen the budget deficit (currently predicted at around 3.6% of GDP) and force the government to take on more debt; but at 48% of GDP Mexican debt is considered manageable and well below that of the UK, Germany, Brazil and Argentina.

However, it now appears that the big threat to the structural reforms is not posed by external factors such as oil prices. The threat is internal, and can be summarised in two examples: Iguala (Guerrero state) and Tlatlaya (Estado de México). In late September in Iguala, 43 students were kidnapped: it is feared they were massacred by municipal police acting in collusion with a criminal gang, on the orders of a local mayor, and with the complicity of other state officials. Amid the outrage, the governor of Guerrero was forced to take a leave of absence. In Tlatlaya in June, 22 people died in what was described as an armed clash between the army and another drug gang. Subsequent investigations revealed that the army’s account of events was untrue and that most were killed in extrajudicial executions. Both cases are considered emblematic of a breakdown in law and order, particularly at state level, for which President Peña Nieto is being held responsible. In late October, Mexico was shaken by a series of demonstrations around the country accusing the government of failing to protect its citizens.

Various analysts have highlighted how poor security threatens to undermine the economic reforms. “This is the most serious crisis Peña Nieto has faced”, said political consultant Alfonso Zarate, adding, “the President’s narrative in recent months has been all about the resources his structural reforms are going to bring the country. These tragic events are taking us back to the reality of widespread lawlessness”. The central bank (Banxico) governor, Augustín Carstens, acknowledged that “there is no doubt that violence has been a negative factor” in the management of the Mexican economy. While arguing that things would eventually improve, Carstens noted that in a Banxico survey of analysts taken in early October, most had identified security issues as the top obstacle to economic expansion; followed by fiscal policy, weak domestic demand and international financial instability. The international press – which has a big impact on investor sentiment – has also begun to turn. The Economist – which has expressed enthusiasm for the structural reform programme, commented at the end of October, “Mr Peña has prioritised economic reform, and played down law and order, as the way to modernise Mexico, without admitting that both are equally important”. While attempts have been made in the past to reduce corruption, improve the integrity of state institutions, professionalise the police, and reform the inefficient and slow-moving criminal justice system, the Peña Nieto administration may need to recognise that they have not succeeded. Initiating deep reforms in this area remains difficult and daunting, but the president will postpone them only at his own peril.

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