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Spring 2006 Newsletter

FEATURED PAST EVENT

Mexico Election: Implications for the Markets (By: Emily Unverzagt, College of William and Mary, edunve@wm.edu)

On Wednesday, February 15th, 2006, the U.S. Mexico Chamber of Commerce hosted a panel on the upcoming Mexican Presidential Elections and Implications for the Markets.

Alfredo Thorne, Managing Director of Latin America Research for JP Morgan, began the discussion by offering comments on Mexico’s economic growth normalization. Following a boom in the third quarter, Thorne charted the cooling of economic growth to 3.6%. He issued positive predictions for 2006, predicting that the economy will keep its momentum and grow at 3.9% with strong inputs from manufacturing and services.
Thorne then discussed the three most probable outcomes of the upcoming election. The first, garnering a 50% chance, is an AMLO Presidential victory with a split of Congress control between PRI and PAN. Thorne considers that this would be the least exciting scenario, as reforms would lag, and growth might slow to as much as 2% below capacity. The second possible outcome is an AMLO Presidency and a PRD-controlled Congress. This scenario carries the greatest risk of investor concern as lagging reforms accompanied by the erosion of fiscal and monetary discipline. As a result, economic growth would fall, the peso would weaken, and interest rates would rise.

The final third outcome—a Calderón win with a PRI or PAN dominated Congress—has the greatest potential upside for the markets. Assuming Calderón can push through reforms, this scenario would be good for growth and a strong peso. Here Thorne commented that, while election risks have been priced in, this potential positive outcome has not been.
Alonso Cervera, Director of Emerging Markets Economic Research for Credit Suisse Securities, followed Thorne. Examining the polls from early 2006, Cervera presented an AMLO victory as the base case scenario. He underscored the importance of independent voters in the election’s final outcome.

Elaborating on the base case of an undisputed AMLO victory, Cervera predicts that this will eliminate any strong reason for López Obrador to move further left. The performance of Mexican assets would be sensitive during the transition period, and would then depend on elements of AMLO’s leadership—his respect for the central bank and his fiscal and monetary policies.

Cervera presents a “too close to call” scenario in favor of Calderón as the alternative to a strong AMLO victory. Were AMLO to contest the results, near term assets might be vulnerable to market uncertainty. However, Cervera pointed out that 55% of Mexicans would trust a mandate by the Federal Electoral Instution (IFE) over their own candidate—demonstrating the relative stability of the Mexican political process.
Dario Lizzano, Managing Director and Head of Latin American Equities for Banco Santander Centra Hispano, continued the discussion with a look at Mexico’s corporate sector. Lizzano cited massive free cash flows and a growing ‘capex’ as support for strong balance sheets and increasing profitability.

However, while balance sheets are strong, they are less impressive relative to the rest of Latin America. Lizzano noted that Mexican equities are cheap relative to Mexican bonds.

Mauro Leos, Vice President and Senior Analyst for Moody’s Sovereign Ratings, concluded the panel by examining Mexico’s investment ratings. Leo presented a historical look at Mexico’s road to investment grade ratings—highlighting its January 2005 upgrade to Baa1. Analyzing the impact that the July elections might have on ratings, Leos emphasized the need for a long-term perspective.

In examining avenues for politics to impact the ratings, Leos highlighted economic policy and the role of institutions. For Mexico, this means that continuity is the key word regarding economic policy. Leos pointed out that Mexico has received a good rating because its institutions are considered strong.

Leos presents a stable rating for Mexico that is not expected to change. He notes that a negative electoral outcome might prevent an upgrade, but is not likely to lead to a downgrade.