Fitch: Mexico election may signal fiscal, energy policy shifts

Press Release by

Fitch

Andres Manuel Lopez Obrador's victory in Mexico's presidential election could signal fiscal, economic and energy policy shifts, although the extent of change under the new government's policy and Congress remains uncertain, says Fitch Ratings.

This uncertainty could weigh on investment until greater clarity emerges on the administration's policy orientation. The new president will be inaugurated on December 1 and inherits a generally resilient but sluggish economy, a strong overall policy framework, and a stable to declining government debt burden.

Mexico's election, held yesterday, marks a significant political shift with Lopez Obrador from the left-wing MORENA party on track to win close to 54% of the vote, according to preliminary estimates. Estimates also suggest MORENA and its allies have made significant gains in Congressional elections and are likely to win over 50% of the seats in the lower house. Should this be confirmed, it would mean the Lopez Obrador administration will be in a strong position to control the legislative agenda.

Lopez Obrador has tapped into discontent with traditional political parties and campaigned on fighting corruption and income inequality. His economic program includes respecting central bank autonomy and the flexible exchange rate and inflation-targeting regimes. Stated fiscal policies include maintaining discipline but also potentially expanding and reprioritizing spending.

Lopez Obrador campaigned on raising spending in areas such as pensions, new subsidies for lowincome university students, and public investment, but this may be contradictory to maintaining budget discipline unless offset sufficiently with spending cuts or tax increases. He has proposed tackling corruption, addressing public sector inefficiencies and cutting certain federal transfers.

The prospects for savings from such initiatives remain unclear, however, and the sequencing of expanding social spending versus cost-saving measures will be important to ensure that public sector primary surpluses remain intact. Mexico's general government debt burden fell in 2017 after increasing for several years and we forecast a gradually declining trajectory provided that primary surpluses are maintained.

How Lopez Obrador will balance fiscal discipline with growing social spending, notably in the 2019 budget, could be an important early indicator of his administration's policy direction. His government will have to present the budget by mid-December and will likely coordinate with the current administration for its preparation. The makeup of the economic cabinet may be another early signal of how he will manage economic and fiscal policy-making priorities.

The energy sector platform envisions re-evaluating the energy sector reform undertaken by the current administration that has been important for attracting foreign investment in the hydrocarbon sector. Lopez Obrador has also called for modernizing and/or constructing new but potentially costly refineries. While a constitutional amendment to nullify the reform is unlikely, the new president could affect the structural reform agenda through top appointments at Pemex, reviewing assigned contracts to independent energy firms (although this will be legally challenging), and altering the pace of future bidding rounds for oil exploration and development. There are risks that the pace of opening the sector to foreign companies could be slowed. Protracted uncertainty over energy policy could affect FDI, economic growth, and oil production over time.

With NAFTA negotiations ongoing, the new president may inherit the process of renegotiation, which has proven challenging to conclude for the constituent countries. Fitch's base case continues to be a favorable conclusion to the NAFTA talks that does not materially disrupt Mexico's trade with the US. However, risks of an abrogation or substantial rewriting of the NAFTA agreement that would affect trade and investment remain.

Fitch affirmed Mexico's 'BBB+' sovereign ratings with a Stable Outlook in March 2018. We noted that Mexico's ratings could be negatively affected by the weakening in the consistency and credibility of the macroeconomic policy framework and/or undermining of structural reforms in the process of implementation, a trend increase in government debt burden, and deterioration in the country's economic, trade and financial links with the U.S. that dampen domestic investment and growth prospects.