With a semester under his belt, President Felipe Calderon is showing his mettle. The Mexican president faces a daunting task. Six years of status quo under former-President Fox, the partial displacement of the drug trade from Colombia and the deceleration of the U.S. economy made for a rough honeymoon. However, President Calderon came through with flying colors. He implemented difficult reforms in spite of a fragmented congress. He assembled a team of some of the best administrators, delegated responsibilities and engaged the opposition in dialogue. President Calderon is perhaps Mexico’s last hope to avoid a return to the boom-bust experiences that marked the latter half of the 20th century.
Mexico is in a delicate situation. It is dependent on the U.S. for trade flows and remittances. More than 90% of Mexican trade is with the U.S. Oil revenues are declining, due to a lack of investment over the past six years. Remittances comprise an ever-important part of Mexico’s current account balance. Over the past six years remittances surged four fold—reaching $23 billion in 2006. Much of the increase in remittances was associated with the U.S. construction boom and the slowdown in housing starts is depressing flows. The Mexican Statistics Agency (INEGI) reported a 26% decline in remittances since May 2006—the peak of the U.S. construction boom. At the same time, a credit-fueled consumption boom is increasing the import bill. Mexican banks and financial institutions doubled credit as a percentage of GDP since the start of the decade—allowing Mexican households to buy more homes, cars and durable goods. This is leaving the Mexican economy extremely vulnerable to a U.S. slowdown.
Fortunately, Mexico is making up for the current account shortfall with capital account inflows. Foreign direct investment (FDI) is strong, as Asian companies take advantage of the Maquila manufacturing base to penetrate the U.S. market. Some Asian firms are capitalizing on the low shipping costs into the U.S., particularly for bulky products. U.S. auto producers are also moving more of their production into Mexico in order to skirt high medical and retirement benefits. However, the inflows are not relegated to FDI. The emerging market boom is pushing capital into Mexico’s equity and debt markets. The capitalization of the Mexican bolsa is now 44% of GDP, and hedge funds are active players in the local currency market. Last of all, narco-related revenues are boosting the nation’s errors and omissions. The narco industry moved aggressively into Mexico during the Fox regime, and the new Administration is fighting back. President Calderon deployed thousands of troops to problematic areas, deported cartels leaders to the U.S. and confiscated assets. Nevertheless, the cartels are not standing still. They are gruesomely decapitating the heads of local leaders and members of the press, in a macabre show of force. Unfortunately, Mexico is not only suffering from the problems with U.S. economy. It is the new front line in the war against drugs.
President Calderon and his economic team are well aware of the threats facing Mexico, and they are trying to address the problems. The government is spearheading a set of fiscal reforms to reduce its dependency on oil revenues. It is taking measures to subcontract exploration services to foreign firms, particularly Petrobras. The government is trying to promote greater competition, attacking some of the large monopolies in telecommunications and the media. This was a taboo topic in a country that is known for having some of the richest men on the planet thanks to their ability to collect monopoly rents. Finally, the Mexican government is boosting investment in public works, such as roads and ports. Mexico is clearly running against the clock. The high level of international liquidity is providing an opportunity for the Calderon Administration to work double-time and make up for the lack of progress during the last six years.