Mexico has made a bid to become part of the emerging market (EM) elite by stating that it too may decide to lend to the IMF, either through a direct loan or the purchase of IMF debt. The announcement on June 12 by central bank governor Guillermo Ortiz came shortly after EM heavyweights Russia and Brazil declared plans to purchase US$20bn in IMF bonds, and China and India also look set to follow suit. Yet while there is some basis to Mexico’s pretentions to be considered a key EM player, I think there are still major structural weaknesses to overcome if it is to outperform over the long term.

A Contender For BRIC Status

On a superficial level, Mexico has an argument to be included in the same league as the BRICs. For one, its economy is only slightly smaller in nominal GDP terms than India’s, and dwarves all other LatAm economies with the exception of Brazil. It was also the first to receive IMF backing in the current downturn, in the form of an unconditional US$47bn flexible credit line, suggesting that not only is Mexico’s economic health of systemic importance to the region, but that the IMF is confident in President Felipe Calderón’s sound macroeconomic management.

Current Account Balances of Selected Countries, % of GDP

Other metrics also point to the relative health of Mexico’s economy. As a percentage of GDP, its current account deficit remains above that of Brazil and on a par with India’s (see chart), although I don’t anticipate it to widen significantly from 1.4% in 2008 to 2.1% this year. Its external debt stock is also within manageable limits, at only 16.6% in 2008, and even if this increases in line with our end-2009 forecast of 24.0% it will still be lower than most other major EM economies.

Total External Debt Stock of Selected Countries, % of GDP

But Falling Short Of Top EM League

Yet despite these arguments, I believe the structural failings of Mexico’s economy are too deep to take lightly. The clearest signal of this weakness is the extent to which real GDP growth plummeted in Q109, contracting 8.2% year-on-year (y-o-y) on an annualised basis, and with the swine flu outbreak putting downside pressures on economic activity in Q209 (I actually expect a steeper fall between April and June than in the first three months of the year), I believe Mexico’s economy will be one of the major EM sufferers in 2009.

Mexico – Total Private Sector Credit By Type, MXNbn & Growth

More concerning, though, is the country’s growth potential beyond this year. The days of easy credit appear to be over for now, with total private sector credit growth slipping to 9.2% y-o-y in March, after 57 consecutive months of double-digit expansion. With April experiencing another fall, down to 7.1% y-o-y, private sector lending appears to have peaked (see chart), which is bad news for household spending and fixed capital formation, the twin engines of the plus 3% real GDP growth levels averaged over the last five years.

Less Room For Political Manoeuvering

Another worry from my perspective is the sustainability of the fiscal accounts over the medium term. Risk Watchdog believes President Felipe Calderón’s governing Partido Acción Nacional will lose major ground to the opposition Partido Revolucionario Institucional (PRI) in July’s mid-term elections, making it both harder to push much-needed reforms through congress as well as creating more tension between the federal and state governments, which are dependent on the Hacienda – Mexico’s finance ministry – for fiscal revenue. With the weak performance of key revenue generators, specifically income tax and VAT, likely to continue over the coming months as unemployment levels rise, the nominal fiscal deficit could widen to 3.0% of GDP this year. Add to this the chronic decline in the productivity of Mexico’s oil sector, and the deficit is likely to remain in negative territory over the next 10 years at least.

Mexico – Net Public Sector Debt, MXNbn

This in turn is likely to keep upward pressure on net public debt levels, which rocketed from MXN1.6trn to MXN3.2trn between November 2008 and March 2009 (see chart). While I think that a credit event is certainly not on the radar, thanks to ample reserve levels and support from both the IMF and US Federal Reserve, I wouldn’t rule out a credit downgrade by one of the major ratings agencies in the near future.

Goods Export Concentration of Selected Countries, Top 3 Trade Partners, %

My main concern, however, is Mexico’s external picture. Despite attempts to diversify the country’s export base in recent years, Mexico’s goods export concentration (as measured by the percentage of goods exports to the top three trade partners) was more than double that of China in 2008 (at 86% compared to 43%), the second most concentrated out of all major EM economies. Its dependence on the US (which alone received over 80% of all Mexico’s exports last year), where real GDP growth will not exceed 4% over the next 10 years according to forecasts by my colleagues at Business Monitor International (BMI), suggests to me that the Mexican economy will underperform its EM peers going forward. As such, it cannot be considered in the top league of EM sovereigns.

Financial Market Implications

This view of underperformance has some key financial market implications over the medium term. For one, I would concur with BMI’s end-2009 peso target of MXN14.70/US$, adopted back in January, as ongoing economic weakness keeps downward pressure on the currency. This in turn is bad news for peso-denominated debt, particularly at the longer end, as the long-term inflationary outlook becomes increasingly clouded. I could also imagine a continued widening of the spread on Mexico’s benchmark five-year CDS contract, particularly against Brazil, which has continued to move in Brazil’s favour since mid-May.