NO LONGER NEOLIBERAL

Mexico’s Populist Leader Drops Austerity to Investor Chagrin

AUSTERITY IS BAD FOR YOU AND ME

Maria Elena Vizcaino and Michael O'Boyle
Thu, September 14, 2023

(Bloomberg) -- Investors in Mexico’s $91 billion of foreign sovereign bonds are coming to an uneasy realization: Perhaps Andres Manuel Lopez Obrador is the populist they’d once feared him to be.

The 69-year-old president had, after all, campaigned in 2018 with vows to build out programs for youths and the elderly, create more jobs and revamp state-owned Petroleos Mexicanos. But in practice, he turned out to be so frugal as Covid ripped through Latin America that he was criticized for spending too little to help working-class Mexicans.

So when Lopez Obrador unveiled a budget plan last Friday that would result in the nation’s largest fiscal deficit since 1988, it caused some angst on Wall Street. Investors sent Mexico’s foreign bonds due in 2033 sliding to the lowest since January earlier this week.

Read More: Mexico Plans Biggest Budget Gap in 36 Years as AMLO Ends Term

This sudden pivot toward fiscal largesse couldn’t come at a worse moment. For the first time in two decades, interest rates are soaring in Group-of-Seven economies, handing investors such high returns on ultra-safe corporate and government bonds that they have little incentive to chase higher yields in riskier countries implementing policies that worry them.

The risk is that Lopez Obrador is creating a bigger deficit by committing to popular, hard-to-cancel social projects right before his term ends. It’ll be up to his successor — after next year’s election — to contend with any fiscal shortfalls that could, eventually, weigh on the nation’s credit score.

“It’s the end of austerity ahead of elections,” said Valerie Ho, a money manager at DoubleLine Group in Los Angeles. “The next administration will be more challenged, and the market may start thinking about the possibility of rating downgrades.”

The country’s debt is already rated BBB- at Fitch Ratings, the lowest investment-grade score. S&P Global Ratings and Moody’s Investors Service, meanwhile, both still score Mexico one level higher — largely due to Lopez Obrador’s penny-pinching ways.

Fitch’s projections still indicate only a gradual increase in the nation’s ratio of debt to gross domestic product over the medium term, according to Carlos Morales, director of sovereign ratings.

And of course, it would take rating downgrades into junk territory by at least two of the three major assessors to officially strip Mexico of its investment-grade title. But such a move would force investors in high-grade indexes to pull out of the nation’s debt and likely make the country’s borrowing costs higher.

The loss of an investment-grade rating would also threaten to interrupt decades of work by Mexico’s financial authorities after the market mayhem of the so-called Tequila Crisis in the mid-1990s. Officials have largely opted for conservative budgets to narrow the deficit and keep total government debt levels low.

Until recently, Lopez Obrador was a part of that effort. In the first part of his administration, he slashed salaries, sold the luxury presidential jet and refused to engage in the type of stimulus that helped other economies stay afloat during the worst of the coronavirus pandemic.

“We cannot put the country into debt,” he said during a Thursday press conference, explaining that the government wouldn’t spend more than what is authorized by Congress.

But with his latest budget plan, the country’s fiscal deficit is expected to balloon to 4.9% in 2024, compared to just 3.3% this year — a reflection of projects ranging from an ocean-connecting rail link to a new gasoline refinery and growing support for Pemex, the highly indebted state oil company.

On Wall Street, the question is whether a shift in Mexico’s spending habits is reason enough to take a more cautious approach. The nation’s government has about $91 billion of outstanding international bonds, according to data compiled by Bloomberg.

The bonds have outperformed for most of Lopez Obrador’s administration due to his frugality and boast some of the lowest risk-premiums in Latin America. The country has also lured the likes of Pacific Investment Management Co. to BlackRock Inc. as US companies shift their supply chains out of China and into Mexico.

But to Jaime Valdivia, the chief economist at Galapagos Capital, the market is too complacent. While investors have grown comfortable with the government’s financial strategies in recent years, he said, Lopez Obrador saved so that now he could spend.

The finance ministry’s own estimates show that the next government will need to bring the fiscal deficit down to around 2.1% to prevent further erosion of the country’s debt levels. With the economy estimated to grow just 1.5% next year, the risk is that elevated spending could eventually become unsustainable, said Carlos Serrano, chief economist at BBVA Mexico.

“I am concerned about this inertia,” he said. Especially when it comes to social programs, “once you have a program in place, removing it is very complicated.”

(Updates with Fitch projections in eighth paragraph and AMLO’s comments in 12th paragraph.)

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