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Key Political Risks to Watch in Mexico
email this pageprint this pageemail usRobin Emmott & Jason Lange - Reuters
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January 03, 2011

Mexico City - Mexico is limping back from a punishing recession while drug war killings continue to climb four years into a government crackdown on traffickers, worrying investors in Latin America's No. 2 economy.


President Felipe Calderon's four-year-old war on drug cartels is failing to contain violence across Mexico.

Despite killing or capturing at least seven drug kingpins over the past 13 months, including La Familia (The Family) cartel leader Nazario Moreno on Dec. 10, the government faces many powerful gang leaders who are still at large.

Calderon is also struggling to deal with deep problems of corruption, money laundering, weak police and courts, and overcrowded prisons. Security experts say taking down capos is having little effect on the drug trade, instead risking more of the violence that is scaring off investors.

Government officials say Calderon's military-led campaign has led to a splintering of the cartels, reducing their ability to threaten the state.

Investors and Mexican businesses are concerned that attacks - beheaded corpses strung from bridges, women and children gunned down at parties and explosives in cars - are smearing Mexico's reputation as a top emerging market for foreign investment and a destination for U.S. and European tourists.

Violence has spread from notoriously violent cities along the U.S. border to Monterrey, Mexico's business capital city, and across Mexico. Hitmen have stepped up attacks on public officials. Armored car sales are soaring.

President Barack Obama reaffirmed U.S. support for Mexico's drug war in November but Secretary of State Hillary Clinton has compared Mexico to Colombia at the height of its fight against drug-smuggling guerrillas in the early 1990s.

Calderon's conservative National Action Party, or PAN, may pay a price for the violence at the next presidential election in 2012.

The violence has not yet become a major drag on Mexico's peso or bond yields, but some U.S. firms are rethinking investment plans in northern Mexico. Credit Suisse said in a September report that organized crime had become a threat to Mexico's economic recovery.

Finance Minister Ernesto Cordero has said drugs violence affects economic decisions in some areas. Generally, he says, countries with crime problems can see 1.2 percentage points sliced off their annual growth.

What to watch:

Political assassinations or more attacks on civilians.

Foreign or local companies freezing investment plans.

Signs that violence is seriously damaging Calderon.


Mexico is recovering from one of the worst economic contractions anywhere in the world in 2009. Economic output will likely return to pre-recession levels in 2011 after growth of around 5 percent in 2010 failed to make up for a 6.1 percent decline a year earlier.

U.S. growth rates are likely to remain sluggish, bad news for Mexico's economy as the United States buys about 80 percent of Mexican exports. Already, manufacturing is less of a driver in both countries' economic recoveries, and Mexico's consumer sector is chronically weak.

As central bankers in other Latin American countries raise interest rates to cool stronger recoveries, most analysts think Mexico's weak economy will keep the central bank from raising interest rates until early 2012.

A key economic risk for Mexico and other emerging markets this year will be the possibility of a sharp reversal in investment flows. Mexico opened a $73 billion credit facility with the International Monetary Fund in December that could be a backstop should investors sour on emerging markets or rush back into safe havens like U.S. Treasuries.

What to watch:

Reversal of capital flows.

Pace of recovery in Mexican exports or a contraction.

Any changes in weak consumer demand.


Calderon is unlikely to push through major reforms in his last two years in office. Investors had hoped for reforms to increase Mexico's paltry tax take, relax labor laws and increase private investment in energy, but he has failed to win the support of the opposition-dominated Congress. Even government efforts to gain approval for security reforms failed in December.

Calderon started his presidency looking nimble as he built support in Congress for a landmark pension overhaul and modest fiscal and energy reforms, but Congress has grown more hostile as parties eye the 2012 presidential election.

A lack of meaningful reform is seen hindering Mexico as other Latin American nations like Brazil, Chile and Peru take off. Political deadlock on reform led Wall Street rating agencies to downgrade Mexican debt in late 2009.

Calderon is fighting to make major reductions in the budget deficit by the end of his term. The Senate approved a plan in October to trim the deficit next year, but by less than the government had proposed.

What to watch:

Revisions to credit outlooks from rating agencies.

Signs Calderon drops plans for a balanced budget.


Mexican oil production, which funds about one-third of government spending, has stabilized after slumping by nearly a quarter between 2004 and 2009, but it is unlikely to quickly recover. The government says output will hold steady at around 2.6 million barrels per day through 2012.

Mexico is a major oil supplier to the United States. Its debt downgrade was partly due to the output decline and a lack of political will to cut its dependence on oil revenues.

Regulators have challenged state oil monopoly Pemex's estimates of recoverable oil reserves, calling into question the industry's long-term sustainability.

Pemex approved a new contracting model in November allowing it to hire foreign companies to operate oil fields on its behalf. Details of the first round of auctions of mature field operating licenses are expected to be released in February.

The contracts stand on more stable legal ground after the Supreme Court threw out a challenge to the underlying legislation.

Pemex is also studying imports of foreign crude oil for the first time in more than 30 years to improve the profitability of Mexican refineries.

But Pemex's dire finances, including debts that exceed assets and a mammoth pension liability, could hamstring the company.

Major spending on Pemex's giant Chicontepec project has drawn criticism, but the company has few alternatives for keeping output steady in the medium term.

What to watch:

The degree of interest of foreign oil companies in the operating contracts.

Any improvement in the performance of Chicontepec.

Any significant new oil finds by Pemex.

Further declines in monthly oil output figures.

(Additional reporting by Robert Campbell; Editing by Kieran Murray)

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