Don Quijones: Mexico on the Verge of a New Tequila Crisis?

By Don Quijones, a freelance writer and translator based in Barcelona, Spain, and editor at Wolf Street, where this article was originally published

As the old adage goes, things have an annoying habit of occurring in threes. It’s particularly true in the case of crises, which tend to fuel each other in a potentially lethal feedback loop. And Mexico is already experiencing blowback from two separate but strongly interlinked crises.

One is primarily social in nature, resulting from the rise of public rage and resistance following the disappearance of 43 students from the narco-controlled town of Iguala. The other is essentially political: support for the current government is in freefall after a string of funding scandals involving the country’s President, Enrique Peña Nieto.

Public anger is blossoming as the full scale of collusion between the local government and organised crime finally comes to light. As John Gibler, an author and independent journalist told Democracy Now, it’s no longer possible to talk about corruption in Mexico; what we essentially have are two sectors in an industry that have fully merged: the police and drug traffickers. Stuck in the middle are millions of law-abiding Mexicans who just want to go about their lives without the constant fear of disaster hanging over their heads.

But what if there were to emerge a third crisis – an economic one? On the surface Mexico’s economy is in a stable enough condition. Growth continues to splutter at around 2% this year (far less than the 3.5% originally forecast by the IMF). The country continues to serve as a vital global manufacturing hub, in particular for its largest trading partner, the U.S. And the historic bugbear of inflation seems to be under control, hovering around 3%.

However, there are worrying signs that Mexico’s travails could soon be made a whole lot worse by deteriorating economic conditions, both on the domestic and international front. The first reason has to do with oil.

1. Troubles at the Pump. Like many oil producing nations, Mexico is struggling to come to terms with the plunging oil prices. On Monday, the price of Mexico’s mix reached $63.72 per barrel on the Brent Index, its lowest point since July 2009. Mexico cannot survive for long on this price, especially considering that oil revenues account for roughly one-third of government finances.

The situation has put a hefty spanner in the government’s reforms to liberalize and privatize the state oil giant, Pemex. The idea might have seemed a smart one two years ago when the legislation process began and oil prices were sitting pretty at around $120 per barrel; now, with prices over 40% lower and threatening to drop further, the government’s timing could not have been worse.

The lower prices could well be here to stay. In such a scenario, Mexico could have serious difficulties selling off its oil assets, at least for a semi-reasonable price, piling further pressure on its already strained public finances. All the while…

2. The Debt Keeps Rising. External and internal public and private debts have more then doubled since 2000, from roughly $250 billion to $550 billion today. In the last two years alone, since Peña Nieto took over, Mexico’s public debt has increased by over 21%, to reach close to $400 billion dollars (38% of GDP). Granted, this pales in comparison with the staggering levels of debt registered by its Northern neighbor and most European countries.

However, as Raúl Zarate writes in El Sol de Puebla, this massive increase in debt has not generated respectable levels of growth at any stage during the last 14 years. After 32 years of PRI and PAN-sponsored neoliberal policies, the economy continues to labor like a “burrito” (little donkey), gingerly taking “four steps forward,” followed by “four steps backward.”

While 75% of this debt is internally financed, as the government is fond of repeating, the reality is somewhat more complex: The domestic banks that issue loans to the public authorities are in fact by and large subsidiaries of foreign banks, while the loans in local currency are pegged to a much stronger currency (the U.S. dollar). This means that if the peso is devalued or the value of the dollar increases – as is happening right now – the amount to be reimbursed increases considerably. It also means that the major foreign banks – primarily Santander, Citi, HSBC and BBVA – are making a tidy packet from the growth in internal public debt.

Then there’s Mexico’s biggest financial risk…

3) Hot Money and Cold Feet. Arguably the greatest threat to Mexico’s economy is a dramatic reversal in foreign investment flows. Since the U.S. Federal Reserve alighted on its madcap scheme to flood the global economy with cheap, easy-come-easy-go dollars, high-yield seeking “investments” have poured into emerging markets. Much of it ended up in Mexico, one of comparatively few Latin American economies to have completely liberalized its financial sector.

If the Fed were to begin raising interest rates, it would significantly tamper investor appetite for risky, high-yield emerging market assets. As the IMF warned in its so-called Article IV consultation with Mexican authorities, “A surge in financial market volatility, triggered for example by a disorderly normalization of U.S. monetary policy, could lead to a reversal of capital flows and an increase in risk premia.”

If that were to happen, the consequences could be dire, not only for Mexico but for the broader Latin American economy. The last time Mexico suffered a similar fate was during the 1994 Tequila Crisis when billions of fickle dollars fled the country to chase rising U.S. interest rates. The parallels with today are disconcerting. Then, as now, the Fed caught the world unawares with a sudden tightening of its monetary policy. Then, as now, Mexico was gripped by a sudden wave of political instability. A short-lived Zapatista insurrection flared in the Southern region of Chiapas. A few months later, two prominent political figures, including then-President Carlos Salinas’ anointed successor, Luis Donaldo Colosio, were assassinated.

4) The Vultures are Circling

Even more ominous is the enduring involvement of the IMF in Mexico’s economic affairs. In 1994-5 it played a frontline role in the bailout of Mexico’s financial sector. According to Larry Kudlow, the economics editor of the conservative National Review magazine, the beneficiaries were neither the Mexican peso nor the Mexican economy:

It is a bailout of U.S. banks, brokerage firms, pension funds and insurance companies who own short-term Mexican debt, including roughly $16 billion of dollar-denominated tesobonos and about $2.5 billion of peso-denominated Treasury bills (cetes).

As I wrote in “The Tequila Crisis: The Prelude to Europe’s Economic Storm,” the money lent by the IMF, US Treasury (without Congress’ approval), and the Bank of International Settlement was speedily channelled via Mexico’s treasury and struggling banks to the coffers of some of the world’s largest private financial institutions. The money barely touched Mexican soil, yet much of the debt remains to this day.

Now, 20 years on, the Fund of Funds is back in the driving seat. In June this year, it kindly renewed a $70 billion “flexible credit line” for the Mexican government. Merely meant as a “precautionary measure,” the FCL purportedly has no strings (i.e. no structural adjustment conditionalities) attached and is only reserved for countries that have shown themselves capable of consistently applying “solid economic policies” – in other words, following the IMF’s every order, something the Mexican government has done with aplomb.

The last thing Mexico needs is the attentions of the world’s biggest financial shakedown artist – an institution that, in the words of former IMF economist Davison L Budhoo, “make(s) or break(s) human life every day of every year as probably no other force on earth has ever done in the past or will ever do again.”

Mexico – or at least its middle class – is still paying off the debt from the first Tequila Crisis. The question is: could there now be a second one? Given the connections and affection I have for the country, I hope not. Things may turn around, public rage may die down, the narcos may lie low, and global macroeconomic economic conditions may pick up. But hope rarely is a good long-term strategy.

The Mexican government blames the nationwide protests on groups seeking to “destabilize the country” and undermine the “reform agenda.” But in this militarized and corrupt society, the risk of escalation of violence is immense. Read…  Mexico on the Brink – But of What?