Remittances slip in 2013

Remittances totaled US$21.60 billion in 2013, 3.8% below their 2012 level and back to their 2009-2010 levels. The number of operations was up 3.3% last year but the average remittance fell 15.1%, to US$737. Remittances translated into pesos were down 6.7%.

Will the BRICS come tumbling down?

After the Fed invented QE (quantitative easing), concerns arose about unintended consequences. Inflation is one that hasn't proven a problem. Another concern is the possible formation of asset bubbles. The behavior of international financial markets in recent days suggests that the concern about bubbles is justified.

In today's global financial markets, US monetary policy has consequences for other countries, not just the US. The massive injections of liquidity that are the essence of QE seem to have done more to boost currency values in emerging markets than to boost lending in the US.

As the Fed has begun exiting from QE by slowly reducing its purchases of Treasury bills and asset backed securities in the US financial markets (the famous "tapering"), investors have reconsidered their love affair with financial investments in emerging markets. Judging by the abrupt devaluations suffered by the currencies of major emerging markets this month, investors have re-discovered risk aversion.

It's not just tapering that has investors nervous. The near default on US$500 billion in debt obligations in China spooked the markets. It's no secret that the Chinese banking system is far from sturdy. The rapid rise of a shadow banking system (estimated to be as much as 60% of GDP) brought the Chinese authorities their own "Lehman moment". They opted not to take the chance of seeing what the consequences of a default would be.

Corruption scandals in Turkey added fuel to the flames. When you start to look, there's plenty of reasons to wonder how solid economies with large government and current account deficits might be if portfolio investment isn't pouring in.

"A rising tide lifts all boats". So has a world awash in liquidity strengthened the currencies of emerging markets. Now that there's not quite so much liquidity, investors are beginning to differentiate amongst emerging markets. Turkey is not the same as Mexico. Neither is Argentina. Between January 2 and January 28, the Turkish Lira devalued 6.2%. The South African Rand devalued 6.1% and the Russian Ruble, 5.8%. The Argentine Peso plunged 22.8%. The Mexican peso hasn't escaped the backlash. It's devalued 2.5% in the same period.

That the differentiation process is beginning is not to say that it's well developed or particularly sophisticated: a former economist for the IMF turned hedge fund manager has considered turning the "Fragile Five" into the "Sorry Six" by adding Russia to Turkey, Brazil, India, South Africa and Indonesia. He's also quoted in the New York Times as suggesting avoiding currencies with four letters, like the Brazilian real, the Turkish lira, the South African rand, or the Mexican peso. If that was not a jest and it's indicative of fund managers' attitudes, it doesn't instill much confidence that investors have a deep understanding of the differences amongst emerging markets.

In addition, the peso is amongst the most liquid and deep markets for emerging market currencies. That means that when investors want cash, they sell Mexico, regardless of what's happening in Mexico. So, no matter how sound Mexico's policies, the peso can get battered, at least temporarily.

This afternoon, January 29, the FOMC announced that, as expected, it will continue to reduce its asset purchases by US$10 billion a month. Purchases under QE will have fallen from US$85 billion a month (September 2012 - December 2013) to US$75 billion in January 2014 to US$65 billion in February. The Fed's explanation of its decision and guidance on future policy talked only about US growth and inflation. There was NO reference made to the implications of Fed decisions for emerging markets. Buckle your seat belts; it's likely to be bumpy.

What's going on with the peso?

The cost of a dollar hit a new high for the year today, January 24th. At $13.49, the fix rate is at its weakest against the dollar in 18 months.

What's going on? After all, a pathbreaking energy reform changing the Constitution was approved in December and S&P upgraded Mexico's rating to BBB+. Shouldn't the peso be appreciating? It's obviously not a change in Mexico's economic fundamentals that caused the peso to depreciate.

The answer to the conundrum lies in portfolio investment, we believe. The Fed began "tapering" this month. One hopes that it's the $500 billion default on an investment product in China that has investors rethinking their appetite for risk. Is the Chinese Government facing its own "Lehman Brothers" moment? If the Fed's reducing its asset purchases from US$85 billion a month to US$75 billion has caused the peso to lose 3.0% in just 24 days, we're in trouble.

2014: a new political calculus

Last year was the year of sweeping reforms. This will be the year of fleshing out the details that will deliver – or fail to realize – the promise contained in the reforms. The process of writing the secondary legislation and implementing regulations for the host of potentially game-changing alterations that will open up previously closed sectors of the Mexican economy will be a time-consuming, constant battle. Meeting the deadlines will be challenging.

The companies and persons who benefit from the pre-reform status quo will naturally do all they can to leave as many of their existing advantages untouched as possible. The Administration will want to dismantle as much of the existing structure as possible without pushing those people into open opposition to the reforms or into support for opposition political parties. Then, there will also be the street protests promised by Andres Manuel Lopez Obrador (AMLO) to deal with.

There’s a new political reality this year: President Peña and the PRI don’t need PAN or PRD votes to move forward with their program. A simple majority will suffice to pass the laws needed this year. If the PRI leadership delivers its own party’s votes, the votes of its Green Party ally and the PANAL (controlled by the SNTE teachers’ union leader, Elba Esther Gordillo, before she was jailed), the PRI will have 50.2% of the votes in the Chamber of Deputies. No PAN or PRD votes required…

In the Senate, the PRI-Greens-PANAL vote count comes to 48.4%, just short of a simple majority. The PRI has two options. It can try to cherry pick the three votes it needs for a majority from the other four parties represented in the Senate (PAN, PRD, Movimiento Ciudadano, and Partido del Trabajo). Or, it can try for a reprise of last year’s strategy, allying with the PRD to pass some legislation and with the PAN to approve other laws.

Neither the PAN nor the PRD have the bargaining power they did last year. Complicating their positions, both parties, riven by internal strife, will elect new leaders this year. The PRD’s “tribes” continue their ongoing dispute for control of the party. Soundly rejected at the polls in 2012, the PAN has fallen victim to the recriminations and infighting that often accompanies such a massive electoral defeat. 

It will be an interesting year.

Reflections on 2013...

1) Congressional gridlock is not inevitable.

We've seen that congressional gridlock is not endemic to Mexican democracy: game-changing legislation can be passed even though the president’s party does not control Congress. Whatever your opinion of President Peña, it is undeniable that he is a skilled politician.

2) Reforms don’t work their magic overnight.

This year has taught us that reforms don’t boost the growth rate immediately. The time that elapses between passage of a law and its impact on growth depends on the type of reform and its scope. The energy reform is a case in point: it could be a decade before the expected new investments in oil production bear fruit.

3) Tweaking the economic model.

The Peña Administration has enlarged on prior governments’ commitment to sound macroeconomic policies. This Administration’s economic policy overlays the classical PRI strategy of government-provided social programs financed by deficit spending on a commitment to maintaining macro-economic stability. It can be a difficult balancing act, especially over the medium and long-term. Structural reform is the second piece of the policy puzzle. The Administration is betting on reform to boost the economy’s sustainable long-term growth rate.      

4) A changing external environment.

A consequence of the Fed's quantitative easing (QE) policy was that liquidity flooded world financial markets. Some of that liquidity found its way into emerging markets, strengthening their currencies. The Fed will, at some point, decrease and then eliminate its liquidity injections. When that happens, the countries that have received large inflows of portfolio investment should not be surprised if foreign investment in their fixed income and equity markets drops off.

The number and breadth of the economic reforms passed by Congress in the first year of the Peña sexenio is nothing less than breathtaking. The next five years will tell if the reforms live up to their billing.

The many ways one purchase affected direct foreign investment numbers...

Foreign direct investment (FDI) totaled US$28.2 billion in the first nine months of 2013, nearly doubling that of the first nine months of 2012. FDI should exceed US$30 billion this year and is likely to exceed annual portfolio investment for the first time since 2009.

Judging by the third quarter FDI figures, AB InBev’s purchase of the 50% of Grupo Modelo shares it didn’t yet own finally went through in the first half of the year. FDI in the third quarter of 2013 was just US$3.4 billion, just 12.0% of total FDI in the first nine months of 2013. Without the Modelo purchase, FDI this year won't be much more than last year's.

New investments were a minimal 2.3% of FDI in the third quarter. Increases in subsidiaries’ debt with their parent companies accounted for virtually half (49.7%) of FDI in the third quarter while reinvested profits, which appear as an outflow in the current account, accounted for 48.0%.

Reflecting the sale of Grupo Modelo, nearly half (47.0%) of FDI in the first nine months of this year came from Belgium. The US, traditionally Mexico’s principal source of FDI, was the second largest source, with a quarter (25.3%) of the total. The Netherlands contributed 6.6% of the total, followed by the U.K. and Japan, with, respectively, 4.4% and 4.2% of the total, and Germany, with 3.3%. The remaining 9.2% came from all other countries combined. 

Four-fifths (79.9%) of FDI in the first nine months of 2013 went into manufacturing, the sector in which the Modelo purchase falls. Typically, about half of FDI goes into manufacturing. Mining received 4.6% and commerce, 3.9% of the total. Information in mass media attracted 3.0% of the total and temporary lodging, 3.0%. The remaining 5.5% went into all other sectors.  

Assets held abroad rose US$28.0 billion through September, roughly in line with their US$29.3 billion increase in the same period of 2012. However, there were significant changes in their composition: Mexican FDI plunged while Mexican deposits in foreign bank accounts climbed.

Mexican deposits in foreign bank accounts soared US$26.1 billion in the first nine months of 2013.  In the same period of 2012, they rose US$4.2 billion. The tremendous jump in deposits in foreign bank account may well be explained, in part, by the sale of Grupo Modelo: Mexican shareholders may have chosen to place the proceeds of the sale in foreign bank accounts.

In the first nine months of 2013, Mexican FDI totaled US$6.5 billion, a third of its level in the first nine months of last year. Mexican FDI this year should be above its 2005-2009 annual average (US$6.3 billion) but far below its 2010-2012 annual average (US$17.0 billion).

If you see an FDI figure of US$1.2 billion reported for the third quarter, that's FDI using the new reporting methodology, which nets FDI in Mexico and FDI by Mexican companies. In the third quarter of 2012, that number was US$0.3 billion. For the first nine months of this year, thanks to the Modelo purchase and the drop off in Mexican FDI abroad,  FDI with the new reporting methodology was US$21.8 billion. Mexican FDI exceeded incoming FDI in the first nine months of 2012 to the tune of US$4.4 billion.

Portfolio investment is back but not like before...

Portfolio investment returned to Mexico in the third quarter: US$6.70 billion (net) came into the country in the form of investments in equities or fixed income instruments. This year's US$12.87 billion of portfolio investment through September is on a par with portfolio investment in the same period three years ago. But, it it is about half its level in the first nine months of 2011 and a third of its level in the first nine months of 2012. No wonder Mexico's central bankers are spreading the message that the monetary policy decisions by central banks in developed countries have consequences for emerging markets.