Mexican Economy Shows Signs of Slowing

Mexico’s economy experienced its first quarterly decline in three years, posting a modest contraction of 0.2% in the second quarter of 2016. Economic performance was impacted by falling oil prices, government budget cuts, and a decline in output at state oil company Petróleos Mexicanos (Pemex). For full year 2016, Mexico’s economy is expected to grow between 1.7% – 2.5% and between 2.0% – 3.0% in 2017.

Following continued low oil revenue, President Enrique Peña Nieto’s administration announced it would reduce spending by US $1.7 billion to achieve its deficit reduction target. Over US $115 million of the budget cuts correspond to Mexico’s transport and communications ministry (SCT), which will affect roughly 1,600 infrastructure projects, many of them road works. A budget cut of approximately US $90 million for the environment ministry (SEMARNAT) will affect 41 projects related to water treatment and agriculture. Mexico previously announced spending cuts of over US $7.0 billion earlier this year and estimates cuts of nearly US $13 billion for 2017, with Pemex earmarked for a US $4.6 billion reduction in funding. The government’s 2017 budget plan, announced by new Finance Minister José Antonio Meade, foresees an overall deficit of 2.9% of GDP. The government’s commitment to fiscal tightening comes after Moody’s and S&P each lowered Mexico’s sovereign rating outlook to negative from stable in recent months. S&P rates Mexico BBB+, three steps above junk, and one level lower than Moody’s. Fitch Ratings gives Mexico the same grade as S&P with a stable outlook. Meanwhile, Pemex’s rating was cut to Baa3 from Baa1, leaving the company at minimum investment grade.

Strained by the continued slump in oil prices, Pemex posted a US $4.4 billion loss in Q2 2016. It is the 15th consecutive quarterly net loss for the company. Pemex’s revenues fell 17% from the second quarter of 2015, while crude output declined 2.2% on the year to 2.18 million barrels per day (bpd). However, thanks to cost reduction and efficiency strategies, Pemex’s operational expenditures decreased 54% year-on-year, and its tax burden also fell by nearly 38% year-over-year. Despite the challenges it faces, the company is actively exploring new opportunities provided by the nation’s 2014 energy reform. Pemex and Mexico’s oil regulator will license out the Trion light oil field in the Gulf of Mexico, an area with probable reserves of approximately 485 million barrels of oil. It will require upwards of US $11 billion to develop. In late July, Pemex and the Mexican National Hydrocarbons Commission (CNH) published the terms of a bid process to award to one or more private investors the right to partner with Pemex to develop the Trion block. Under the terms, Pemex is required to retain at least a 45% stake in the new joint venture. Many of the world’s top international oil companies are expected to participate in the auction, which will take place on December 5th. Mexico will also auction 10 separate deepwater fields, including four surrounding Trion, by year-end.

Overall, Mexican economic growth faces headwinds from continued low oil prices, government spending cuts and Pemex’s strained finances. These challenges have seen Peña Nieto’s approval ratings fall to an all-time low of 23%. If conditions continue, they could drag on growth into the third and fourth quarters of 2016. Fortunately, a competitive exchange rate, foreign reserves of around US $177 billion and a recently renewed flexible credit line with the IMF leave Mexico relatively well positioned to manage any shocks.

Authored by: Lorena Reategui