President Pena Nieto's Reforms - Crib Sheet

Since taking office in December 2012, Mexican President Enrique Peña Nieto has embarked in an ambitious reform drive, which has so far bolstered investor sentiment towards the country and has the potential of significantly improving the long-term trajectory of the economy. Key to Peña Nieto's ability to push through major structural reforms has been a tripartite coalition known as 'Pact For Mexico', which was formed by the country's three main political parties, the ruling Partido Revolucionario Institucional (PRI), the centre-right Partido Acción Nacional (PAN), and the left-leaning Partido Revolucionario Democrático (PRD). Peña Nieto requires two thirds of the votes in both the lower house and the senate in order to pass reforms that require amendments to the constitution. Under the current party composition of congress, this means that the PRI needs the full backing of either the PRD or the PAN to enact such reforms. Peña Nieto's flagship proposed energy sector reform, which seeks to open up the state-owned energy sector to foreign investment, has been subject to fierce opposition by the PRD and by a large segment of the population. However, we expect energy sector reform to be approved by end-2013, as we believe it has enough votes from the PRI and the PAN to move forward. While the impact of Peña Nieto's reforms will begin to feed through in 2014, when we forecast real GDP growth to accelerate to 3.3% from 1.6% in 2013, upcoming secondary legislation will be crucial in shaping the long-term success of reforms.

Latest Developments:

  • Polls reveal that Peña Nieto's approval rating fell to 44% in November from 52% in July, mainly due to popular opposition to the recently approved fiscal reform bill, which increases taxes on sugary drinks and junk food, and raises income taxes on the top bracket.

  • Proposed energy sector reform is expected to be sent to the senate floor for final debate, following the senate's approval of political-electoral reform on December 4.

  • The left-leaning PRD announced it will abandon the pro-reform 'Pact For Mexico' coalition at least on a temporary basis, in protest against plans by the PRI and PAN to liberalise the energy sector this year.

  • Large protests against Peña Nieto's proposed energy sector reform are taking place in Mexico City, lead by the PRD and former presidential candidate Andres Manuel López Obrador, who suffered a heart attack during the demonstrations, but is reported to be in stable condition.

  • Newly created telecoms regulator Ifetel will present a notice this month to the companies which it considers to be 'dominant' in the market, as it seeks to spur competition in the sector. The notifications will remain confident and will be followed by a defined period in which firms considered 'dominant' will be allowed to argue against Ifetel's ruling.

Energy Sector Reform

President Pena Nieto's Reforms - Crib Sheet

Since taking office in December 2012, Mexican President Enrique Peña Nieto has embarked in an ambitious reform drive, which has so far bolstered investor sentiment towards the country and has the potential of significantly improving the long-term trajectory of the economy. Key to Peña Nieto's ability to push through major structural reforms has been a tripartite coalition known as 'Pact For Mexico', which was formed by the country's three main political parties, the ruling Partido Revolucionario Institucional (PRI), the centre-right Partido Acción Nacional (PAN), and the left-leaning Partido Revolucionario Democrático (PRD). Peña Nieto requires two thirds of the votes in both the lower house and the senate in order to pass reforms that require amendments to the constitution. Under the current party composition of congress, this means that the PRI needs the full backing of either the PRD or the PAN to enact such reforms. Peña Nieto's flagship proposed energy sector reform, which seeks to open up the state-owned energy sector to foreign investment, has been subject to fierce opposition by the PRD and by a large segment of the population. However, we expect energy sector reform to be approved by end-2013, as we believe it has enough votes from the PRI and the PAN to move forward. While the impact of Peña Nieto's reforms will begin to feed through in 2014, when we forecast real GDP growth to accelerate to 3.3% from 1.6% in 2013, upcoming secondary legislation will be crucial in shaping the long-term success of reforms.

Latest Developments:

  • Polls reveal that Peña Nieto's approval rating fell to 44% in November from 52% in July, mainly due to popular opposition to the recently approved fiscal reform bill, which increases taxes on sugary drinks and junk food, and raises income taxes on the top bracket.

  • Proposed energy sector reform is expected to be sent to the senate floor for final debate, following the senate's approval of political-electoral reform on December 4.

  • The left-leaning PRD announced it will abandon the pro-reform 'Pact For Mexico' coalition at least on a temporary basis, in protest against plans by the PRI and PAN to liberalise the energy sector this year.

  • Large protests against Peña Nieto's proposed energy sector reform are taking place in Mexico City, lead by the PRD and former presidential candidate Andres Manuel López Obrador, who suffered a heart attack during the demonstrations, but is reported to be in stable condition.

  • Newly created telecoms regulator Ifetel will present a notice this month to the companies which it considers to be 'dominant' in the market, as it seeks to spur competition in the sector. The notifications will remain confident and will be followed by a defined period in which firms considered 'dominant' will be allowed to argue against Ifetel's ruling.

Energy Sector Reform

President Peña Nieto's proposal to liberalise the energy sector is the flagship reform of his policy agenda to date, with potentiallly the most far-reaching implications for the economy. We expect the proposed energy liberalisation bill to be approved by December 15, which marks the end of the final congressional session of 2013. The original bill proposed by the PRI, which is currently being debated by congress, seeks to allow private sector investment through a profit-sharing scheme. The proposed reform is a big step in reversing the declining trend in oil production Mexico has sustained since 2004, however, it falls short of allowing foreign players to acquire much-coveted ownership of Mexico's hydrocarbon reserves. Conversely, the PAN proposed a more wide reaching reform that includes the possibility of granting concessions, which would allow foreign companies to book oil discoveries as proven reserves in their asset portfolio, and would therefore attract greater investment interest. Lastly, the PRD proposal is based on internal reforms of state-oil company Pemex and rejects the opening of the sector to private investment. While the PRD is widely expected to vote against PRI's energy reform, we believe the PRI and PAN are undergoing an intense negotiation process behind closed doors, which increases the likelihood that the final energy bill will surprise to the upside. Indeed, after fiscal reform was watered down to appease the PRD ( see relevant section below), the PAN gained political leverage and now has the upper-hand on energy sector reform. A potential scenario for the final bill is one in which contract terms will be based on the risks involved in the production of resources, with profit-sharing offered for low-risk operations and production-sharing offered to more complex geological plays.

Political-Electoral Reform

Political-Electoral reform was set by the PRD and PAN as a pre-requisite to debating energy sector reform with the ruling PRI. The bill, which was approved by the senate on December 4 has been sent to the lower house, and seeks to allow the re-election of legislators and local officials and increase oversight over elections. Indeed, through the creation of a new national electoral institute, the new bill will impose more stringent campaign spending rules and sanctions, allowing the nullification of any electoral process in which any party exceeds the pre-agreed spending limit by 5%. Campaign spending limits would hurt the PRI the most, as its extensive country-wide networks with labour unions and industry have historically given the party an edge over the opposition in terms of spending power, which means that the bill will likely be subject to significant resistance by many PRI legislators. We expect electoral reform to pass the lower house in the coming days, which further reinforces our expectations for energy liberalisation to move forward by end-year.

Financial Sector Reform

Financial sector reform, which seeks to bolster loan growth, was approved on November 26. The bill targets small and medium-sized enterprises and individuals, in a bid to increase their access to finance, through incentive-based regulations. Indeed, the new legislation facilitates the recovery of collateral on non-performing loans and streamlines the bankruptcy process, incentivising banks to lend more. While the success of financial sector reform will depend heavily on the effectiveness of the sector's regulatory body, Comisión Nacional Para La Protección Y La Defensa de los Usuarios de Servicios (Condusef), we believe it has the potential of bolstering loan growth significantly over the coming years. Indeed, banking penetration in Mexico remains very low even by Latin American standards, with assets as a percentage of GDP at 38.8%, significantly below peers such as Chile (109.2%) and Brazil (106.2%), illustrating the sector's large growth potential.

Fiscal Reform

Mexican legislators approved President Peña Nieto's fiscal reform on October 31, which we believe will contribute modestly to the government's long-term fiscal consolidation drive. However, political resistance from the PRD resulted in a watering down of the bill. The main components of the fiscal bill include an increase in the value-added-tax (VAT) in border states from 11% to 16%, a change in the income tax rate structure, which will increase the tax burden progressively for higher earners from 30% to 35%, a new 7.5% tax on mining firms' royalties, a 10% capital gains tax, and increased taxation of sugary drinks and junk food. However, the bill left medicine and other food items untaxed, and scrapped initially proposed taxes on education and housing. While the new tax structure will contribute to a stronger fiscal position over the coming years, it will have a mixed impact across sectors, with particularly negative effects on the food and drink and mining sectors. In addition, we note the negotiation of fiscal reform, which mainly appeased the leftist PRD, rebalanced political leverage to the benefit of the PAN, posing upside potential for proposed energy sector reform.

Education Reform

Peña Nieto's education reform was approved by congress on September 4, following weeks of violent protests by teachers in Mexico City. The highly contentious bill imposes evaluation-based firing, hiring and promotion standards. It also creates a national agency that supervises education, effectively reducing the role of unions in processes such as hiring and allocation of funds. It is worth noting that education reform followed the arrest of Alba Esther Gordillo on February 26, the leader of the largest and most influential teachers' union in the country, and who is now imprisoned on charges of embezzlement and organized crime. We expect education reform to remain a source of social tension over the coming months, particularly among the 1.4mn teachers who were part of Gordillo's labour union. However, there is growing popular and political dissatisfaction towards teachers' protests, which reduces their ability to have an impact on future policy-making in the education sector.

Telecommunications Reform

Long-awaited telecommunications reform was signed into law on June 3, which looks to spur competition in Mexico's highly monopolised telecommunications sector. The bill will target fixed-line phone, internet, mobile and TV providers with over 50% market share, including firms like América Móvil, Televisa and TV Azteca, by introducing further competition and forcing operators with significant market share to sell off assets. The success of recently created regulator Ifetel in implementing new laws will be the key factor in determining the telecoms reform's effectiveness in stimulating competition in the sector. The financial resources and influence of the three industry tycoons targeted by this legislation, Carlos Slim (América Móvil), Emilio Azcárraga (Televisa) and Ricardo Salinas Pliego (Televisa) is such that a new regulator may still struggle to implement significant change.

Key Research:

Wide Reaching Energy Reform Could Be Within Reach , November 8

Fiscal Reform: Mixed Impact On Sectors But Upside For Energy , November 6

Reforms To Move Forward Despite Rising Political Challenges , October 7

Fiscal Reform Proposal Improves Outlook For Energy Reform , September 10

Reform Drive Reinforced But Not Without Risks , September 4

PRD Has Little To Say But Potential For Sway , August 22

A Step Forward, But Investment Still Uncertain , August 14

Banking On Reforms And Improved Macroeconomic Conditions , July 19

Proposed Banking Reforms To Bolster Loan Growth , April 24

Reforms Hinge On New Regulator's Power , June 12

Bold Reforms Could Improve Outlook , March 12

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