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 Business News | September 2007 
Fiscal Reform Seen Positive for Mexican Markets
 Polya Lesova - MarketWatch
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 |  | This reform is a significant but limited step toward strengthening the government's fiscal position by reducing its high reliance on oil revenues.
- Enrique Bravo, Eurasia Group |  | |
A fiscal reform package approved by Mexico's lower house late this week should help fill the government's coffers and reduce the country's dependence on oil revenues, a long-term positive for Mexican markets, analysts said.
"From a sovereign credit worthiness perspective, it's a positive thing," said Paul Biszko, senior emerging markets analyst at RBC Capital Markets. "Longer term, an improved fiscal position will increase the odds of rating upgrades and that should underpin Mexican assets."
The reforms also aim to improve the finances of state-run oil company Pemex.
Analysts cautioned, however, that external market developments, particularly those in the United States, are the main factor that investors in Mexico are watching in the near term.
"In the long term, they [fiscal reform implications for the Mexican markets] are good and had it happened at a slightly less turbulent time, you'd probably see a strong reaction early," said Cameron Brandt, global markets analyst at EPFR Global.
In recent weeks, Mexico, like many other emerging markets, has been hit by subprime and credit woes that have caused turmoil in world financial markets and prompted investors to avoid risky investments.
"Given the fact that Mexico is still sending at least 80% of its exports to the U.S., what happens with the US economy in general and what happens at the Fed meeting next Tuesday in specific are the things that are really going to move the market and frame investor sentiment toward Mexico [in the short term]," Brandt said.
Mexico City's IPC benchmark stock index has gained 14% year to date. But its gains have been limited by this summer's credit crisis, which rocked markets globally.
On Friday, the IPC fell 0.5% in intraday trading. The Mexican peso edged down 0.1% against the dollar.
Lower house approves fiscal reform
Late Thursday, the Mexican lower house of parliament approved both the fiscal reform package as well as an electoral reform. Mexico's Senate was expected to vote Friday on the fiscal reform package, which should increase government revenue by approximately 2.5% of GDP by 2012, according to reports.
While the fiscal reform package is supportive for the peso, "we need to see further reforms in labor and energy for the market to have any bigger positive reaction to what's already happened," said RBC's Biszko. "If you look at the Mexican peso, there's basically an 85% to 90% correlation with US equities year-to-date. Everyone's concerned about external markets."
Among the fiscal reform measures approved by the lower house is a gradual increase of the corporate single rate tax to 17.5% from 16.5% over three years as well as a 5.5% increase of the gasoline tax.
In addition, state-run oil company Pemex will get a tax cut, which will provide the company with about $2.8 billion of additional resources for investment in 2008.
"This reform is a significant but limited step toward strengthening the government's fiscal position by reducing its high reliance on oil revenues," said Enrique Bravo, analyst at the Eurasia Group, in a research note. "The successful approval of the fiscal and electoral reforms demonstrates [President Felipe] Calderon's effective compromise driven strategy."
Brandt of EPFR Global said that if the reform "plays out as written, it gives the government a bit more to spend on some of the country's huge infrastructure needs."
"Given that Mexico's now has its advantage at the lower end of the production scale rapidly eroded by China, the need to help itself by more educated citizenry and better roads is that much more important," Brandt said. "It takes a little bit of the pressure off Pemex and will hopefully free up more money for exploration."
Outlook for Mexican equities
Deutsche Bank said Friday that Brazil and Mexico are its overweight recommendations from the Latin American equity markets.
"Brazil is our top pick in the region based on our soft landing scenario for the U.S. economy and constructive view on commodity prices," said Deutsche Bank strategist Guilherme Paiva in a research note.
"We also recommend an overweight position in Mexico, as its local equity market should benefit from the imminent approval of fiscal reform."
Brandt of EPFR Global was also optimistic about the outlook for Mexican equities, saying that the market has seen big gains since 2005.
"Yes, it's been bumpy recently and some of those profits have been booked," Brandt said. "[But on] any slightly longer time frame, it's still pretty remarkable."
Polya Lesova is a MarketWatch reporter based in New York. |
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