Viewpoint by Bill Dahl
The writer is a former Senior Vice President for Bank of America in Los Angeles, CA. He currently resides in Queretaro, MX. His insightful analysis of global economic affairs have been published widely. He is a contributing columnist for Mexico News Daily, IDN-InDepthNews and Wall Street International Magazine.
REDMOND, Oregon, USA (IDN) – The Coronavirus (COVID-19) global pandemic has revealed that there are certain human beings more susceptible to heightened risks of infection, serious illness and death.
You hear terms to describe this group of people like the elderly, those with compromised immune systems, impaired respiratory systems, pre-existing conditions, and those whose health is frail etc. We also know that certain countries, like individuals, possess characteristics that make them tangibly more vulnerable to the multi-dimensional deleterious effects of this pandemic. Mexico is one of those countries. Let me explain.
Researchers have found that human beings can suffocate in sand in just over one minute. Yes, human beings die with their head in the sand. Mexico’s President Andrés Manuel López Obrador (AMLO) has stated boldly “Pandemics … won’t do anything to us.” Thus far, he has refused to ban inbound travel from afflicted countries and has made bold public gestures rejecting offers of hand sanitizers to him in crowds. He has even publicly shared the good luck charms he carries with him, suggesting they are an adequate defense.
If this sounds like a rerun of the uninformed arrogant public utterances of U.S. President Donald Trump before the virus took hold in the U.S. – it is. When the reality of the oncoming tsunami of COVID-19 began to break upon the U.S. population, the devastation was sobering for Trump.
Yet, there’s a magnitude of difference between the resources available to Trump versus AMLO to respond to the destructive effects of this global contagion in their respective countries. AMLO and Mexico will require vastly more than a pocket full of lucky charms while bellowing boldly in the face of a virus that is notably immune to borders, ethnicity, religious beliefs and the like.
According to one source:
“Most experts agree the virus is already rapidly spreading within Mexico and that the government’s nonchalance about the situation could have disastrous results. A lot of people in Mexico would die unnecessarily unless the government gets very seriously prepared for this. Getting seriously prepared means taking drastic measures to curb the spread of the virus, bolstering the hospital system, and helping people cope when the economy grinds to a halt. Mexico all the conditions for this to turn into a tragedy, similar to Italy, if not worse. I think everybody senses Mexico is going to be overrun.”
Like the respiratory system, the cardiovascular system, our hormonal systems, and immune defenses in the human body, the strength of the economy of a nation is typically the focal point to determine the prospective health of a nation. Like other countries, Mexico’s economic health is subjected to routine and ongoing assessments of country risk, sovereign debt ratings, bond ratings for companies in major sectors of its economy, and currency valuation.
The Mexico/U.S. Economic Integration
Mexico’s economic performance over the past two years has been flat – basically no economic growth (realities AMLO aggressively rejects). Mexico is already experiencing a recession. Enter COVID-19.
80% of Mexico’s exports are sold to the U.S. market.
With the U.S. economy contracting at a rate never seen before in history, the economic downturn of the U.S. market will have a systemic, enduring negative impact on Mexico’s near term economic prospects. As an example, in 2009, Mexico’s economy plunged 5% due to the swine flu epidemic. Let’s examine the realities of the current U.S. economic downturn and its prospective impact on Mexico.
On March 20, the U.S. announced the temporary closure of the US/Mexico border to all non-essential travel. This follows a similar decision with the U.S. border with Canada. According to Goldman-Sachs, U.S. unemployment claims filed by American workers for the week ending March 27, 2020 were an all-time high estimated at over 3.25 million claims. (The previous record for U.S. unemployment claims was 695,000 during one week in 1982. Furthermore, it was in 1982 that Mexico formally defaulted on its debt obligations, bailed out by the IMF).
Today, there are 120 million Americans under state directives to stay home from work. That’s one in every 3 Americans. The U.S. Congress, U.S. Treasury, and Federal Reserve have all taken drastic steps to cushion the blow of this pandemic to the tune of a few trillion U.S. dollars. The expectation is that more will be required.
Translation: The U.S. economy is treading water. ..uncharted water. The magnitude and duration of the economic downturn in the U.S. is anybody’s guess at this time. What is certain is that Mexico will be infected and suffer from the woes of its neighbor to the north (to say nothing about the internal impacts the pandemic is likely to have on Mexico). Once again, the degree and duration of the economic downturn in Mexico is guesswork at this juncture.
Expectation: Mexico’s economy will experience a further plunge into deeper depths of recession. Expect negative economic growth and recession to endure through 2023.
However, there are obvious risks to specific sectors of Mexico’s economy that merit examination for probable deterioration. We now turn our attention to these sectors.
Mexico’s Economic Vulnerability
Experienced Economic Leadership
Mexico’s population is estimated at 130 million. It is the second largest economy in Latin America. According to the World Bank, in 2018, the percentage of the Mexico’s population living below the monetary poverty line was 48.8 percent…comparable to the figure from 2008. Mexico’s GDP is around US $1.2 trillion. It ranks 12th in the world as an exporter. GDP growth in 2019 was -0.1% annualized. On March 17, 2020 Credit Suisse forecast a 4.0% contraction for Mexico’s economic performance in 2020.
Credit Suisse was joined by Barclay’s, Moody Analytics and Goldman-Sachs in adjusting their forecasts to negative for Mexico in 2020. The downturn was the first in ten years attributed primarily to lack of confidence expressed in the economic strategies expressed by AMLO during his first year as a President.
AMLO’s economic leadership has been controversial since he became Mexico’s President. He killed the new $13 billion Mexico City Airport project and threw bondholders into a tizzy. The project was one-third completed and Mexico had issued $6 billion in bonds. The repayment of these bonds was renegotiated at a significant cost to Mexico.
AMLO shakes international investor confidence in Mexico – institutional investors that matter for the future of his country. When rating agencies downgraded Mexican companies and the sovereign debt rating of Mexico in March 2019, AMLO railed against their actions. Economists George Akerlof and Robert Shiller write in their book Animal Spirits: “Confidence is not just the emotional state of an individual. It is a view of other people’s confidence, and of other people’s perceptions of other people’s confidence.” AMLO has not garnered the essential confidence of the world’s economic institutions that matter most for Mexico.
In ordinary times, experienced economic leadership that inspires confidence and trust in world economic institutions is essential. In times of economic crisis, new, more advanced skill sets are required.
Crisis management requires crisis managers who have tangible experience anticipating, confronting and overcoming new forms of economic challenges that emerge. At present, Mexico has not shown it possesses this capacity for addressing the myriad of economic challenges the COVID-19 pandemic is about to thrust upon it.
One observer characterizes the challenge national leaders face as follows:
“For policymakers, the decisions may be difficult, but “ultimately, it’s an easy choice,” said Jason Furman, who headed the Council of Economic Advisers in the Obama administration and currently teaches at Harvard’s Kennedy School of Government. “There’s no time to do careful cost-benefit analysis” of whether a particular restriction might cause more damage than it prevents.
Instead, government officials have to “follow a simple rule,” Furman said: “Anything the health people want to do to save lives they should do,” then “the economic people can do what they can to mitigate the damage.”
Expectation: Confidence by world economic institutions in AMLO’s leadership capabilities will continue to erode.
Remittances from Mexicans Working Abroad
In 2019, $36 billion was received in Mexico by Mexican migrants working abroad. To give you a sense of this contribution to Mexico’s economy during the same timeframe, Mexico’s petroleum exports and foreign tourism contribute $22 and $25 billion respectively. California, Illinois and New York are the top three states in the U.S. where remittances to Mexico account for approximately $15 billion annually. 94% of these remittances come from the U.S. Over 100 million remittances are received by Mexicans each year.
According to Mexico’s BBVA Research: “The most important factor is the economic one: what could have important impacts on future remittance flows to Mexico would be a decrease in economic activity in the United States.” With New York, California and Illinois currently under “stay at home and shelter-in-place” directives, and unemployment skyrocketing, expect 2020 remittances from Mexican migrants working in the U.S. to plummet substantially.
These remittances sent from Mexican workers in the U.S. to family members (and extended family) in Mexico serve fundamentally vital purposes. They pay for housing, healthcare, education, food, utilities and clothing. They are an integral part of the established fabric to maintain social welfare and stability in Mexico, particularly for the impoverished and most vulnerable.
According to a study by PEW Hispanic Research and the Inter-American Development Bank, millions of Mexican residents receive regular remittances from Mexican workers in the U.S. 63% of remittance recipients are women. Remittance recipient households in Mexico range from 3-6 people. The average remittance is approximately US $32o per month.
Expectation: It should be anticipated therefore, that the downturn in U.S. economic performance will negatively impact the value of remittances received by Mexicans for the duration of 2020. Furthermore, with the US/Mexico border now restricted to solely essential crossings, the seasonal migration of laborers to the U.S. will likely be impaired. Unfortunately, a decrease in remittances to Mexican residents from the U.S. will impair the already most vulnerable in Mexico. This reality will create social stability and welfare challenges for those affected at a time when they require these remittances the most.
Currency Valuation – The Mexican Peso
On March 16, 2020, the Mexican peso fell 3.6% to 22.7354 to the U.S. dollar. On March 21, it is 24.42. Since the first of March it has declined over 18% in March 2020 alone, This recent devaluation of the peso is the worst performance among 24 peers characterized as emerging market countries. The peso to the US Dollar devaluation is the most rapid since October 2008. Why?
According to one analyst: “The coronavirus outbreak and violent drop in crude oil has intensified recession risk, which could lead to credit downgrades that exacerbates recent Mexican Peso weakness and USD/MXN upside.”
Nations heavily reliant on oil exports like Mexico have seen their currencies deteriorate as the flight to safe-haven currencies like the US Dollar occur. Without Mexican Federal Bank intervention (using foreign currency reserves to retard the inertia toward further peso devaluation) the peso can be expected to continue to be unstable against the US dollar.
This is a double edged sword: depleting foreign currency reserves in an attempt to retard the decline of a country’s currency both depletes these important reserves and triggers the attention of those who oversee the sovereign debt rating of a country, and the bond-ratings of the companies within the country that are central to its economic performance.
Expectation: Expect the value of the peso to continue decline against the U.S. dollar throughout the remainder of 2020. Further deterioration in the peso may be expected beyond 2020 – should recessionary impacts deepen and anticipated downgrades of PEMEX bonds and Mexico’s sovereign debt rating occur – as discussed below.
The Oil Price Crash – PEMEX & MEXICO
I have written extensively elsewhere on the precarious financial condition of Mexico’s national petroleum company Petróleos Mexicanos or PEMEX. It is the world’s most indebted oil company. For 2019, PEMEX posted a net loss of US $17.7 billion (346.1 billion pesos). Currently, Pemex’s US $100 billion in bonds are rated as Baa3; one notch above junk. Rating agencies also have a negative watch on Mexico’s A3 sovereign debt.
Junk bonds are costly bonds with a lower credit rating than other types of investment grade bonds. Moody’s rates junk bonds as ‘Ba’ or lower while Standard & Poor’s ratings of this class of bonds as ‘BB’ or lower. If corporate bonds or the sovereign debt rating of a nation are downgraded to junk status, several things occur; the cost of these bonds and/or cost of borrowing to a country increase.
Furthermore, institutional investors are typically prohibited from holding bonds and sovereign debt that fall into the junk category. Thus, a sell-off by current bondholders would ensue. Lenders like the IMF and World Bank may also impose rigid conditions on requests for financial assistance.
In June 2019, Fitch downgraded Mexico’s rating to BBB, close to junk status. Fitch stated, “The financial woes of state oil company Pemex were taking a toll on the nation’s prospects.” Both PEMEX and Mexico are under a “negative outlook” from the rating agencies.
Although Moody’s has stated publicly that they would not review the Pemex bond ratings until mid-year, recent events are likely to accelerate their examination – and that of Mexico’s sovereign debt rating. Although Mexico hedged oil sales (against oil price devaluations) in 2020 at a reported US$ 49 per barrel in January 2020, how many barrels, and at what cost (approximately US $1 billion) were not disclosed. The hedge typically covers the period from December 1, 2019 to November 30, 2020 of up to US$ 20 billion. Mexico can make money on this hedge if oil prices plummet. Well, they did.
PEMEX requires US $50 per barrel to break even. On March 11, 2020 Saudi Aramco ramped up oil production to 13MM barrels per day in an attempt to garner more global market share. Petroleum prices plummeted across the globe. Mexico, depends on Pemex to supply 18 per cent of the capital resources for the national budget. As of March 22, 2020 Mexican crude was priced at US $17.70 per barrel. Thus, instead of increasing production as AMLO has told the world, PEMEX is facing the necessity to drastically reduce production.
Expectation: Expect the bond rating of Pemex to be downgraded to junk status by July 1, 2020. Although the impact of COVID-19 on the nation of Mexico has yet to materialize (at the time of this writing), it is clear that Mexico’s sovereign debt rating will become susceptible to a downgrade by the end of 2020.
This article did not address other significant components of the Mexican economy that are being devastated by the current Coronavirus pandemic. The obvious ones are tourism, consolidation in Mexico’s airline industry, and the impact on small businesses and sole proprietors in the services sector.
Although Mexico has a reported US $184 billion in international reserves and a 60 billion dollar credit line with the IMF, capital capacity for Mexico to effectively deal with the strategically imperative economic dimensions of the pandemic remain concerns.
In summary, the global COVID-19 pandemic afflicts the most vulnerable across the globe. This includes nations, as well as individuals, communities, regions and cities. Unfortunately, there is no current immunity against the devastating effects of this virus. It creates conditions and complexities that require experienced leadership, extensive capital reserves, and a collaborative approach to mitigate its multi-dimensional destructive forces. Mexico is going to need external assistance from a myriad of world institutions to cope successfully with the obvious, forthcoming effects of this contagion.
A pocket full of lucky charms just won’t cut it. [IDN-InDepthNews – 29 March 2020]
Image credit: Bill Dahl.
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