US debt ceiling: the wary view from Mexico

If the US government defaults on its debt it could hurt Mexico, which has an increasingly intertwined economy with its northern neighbor.

For an institution often associated with scandal and shenanigans, Mexico's Congress always approves its annual budget – and on time.

Mexico's lower house of Congress has been debating part of its 2014 budget, which the conservative opposition alleges will kill the middle class with proposed tax increases on everything from their incomes to pet food to private school tuition.

But this year, the tax increases are only part of the uncertainty in the budgetary process for Mexican lawmakers. The task is made more difficult by the looming threat of the US government defaulting on its debt and triggering chaos in emerging markets like Mexico, which has an increasingly intertwined economy with its northern neighbor. Mexico sends 78 percent of its exports to the United States, totaling more than $500 billion. Uncertainty in the US economy can negatively impact the peso.

“By looking at this as some sort of isolated activity that’s only impacting the Treasury Department of the United States, I think the leadership in [Washington] DC is missing the wider North American economic impact that this could really cause,” says Kenn Morris, president of the Crossborder Group consultancy in San Diego.

Economists say a US default would do damage in Mexico at a time when the country is dealing with an economic downturn and rebuilding after hurricanes simultaneously struck both coasts in mid-September.

The uncertainty – the US must raise the debt ceiling by Oct. 17 or the Treasury might not be able to pay its obligations – has already taken its toll on the peso, while economists and observers say a default-driven US recession would result in an even worse scenario for Mexico.

“Slow growth in the US means slow growth … if not recession in Mexico,” says Deborah Riner, chief economist for the American Chamber of Commerce Mexico. A US default would increase borrowing costs for both the Mexican government and the state-backed oil company, Pemex.

Setting an example?

The timing of the debt ceiling debate is inopportune for Mexico. The Finance Ministry recently readjusted its 2013 economic forecast from 3.5 percent growth to just 1.8 percent for the entire year, while some private sector economists project even lower figures. Economists blame the subpar performance, in part, on sluggish manufacturing exports so far this year.

Consumer confidence also dropped in September, according to the country’s statistics service, INEGI. Last month’s storms and the introduction of tax increases – part of a fiscal reform meant to raise more government revenue and decrease its dependence on oil income – prompted the pessimism, according to an investors’ note from Mexican bank Banorte-Ixe.

Speaking at the APEC summit in Indonesia on Monday, President Enrique Peña Nieto expressed expectations that the debt ceiling would be raised, but also cautioned, “It’s going to impact the entire world, not just countries having significant geographic or economic interaction with the United States.”

Few in Mexico see a silver lining in the debt ceiling debate, although some spot irony.

“The Mexican Congress is acting more mature than the US Congress,” says Jeffrey Weldon, political science professor at the Autonomous Technological Institute of Mexico, and an American expert on Mexican legislatures.

Mexico’s lower house of Congress – notorious for its big Christmas bonuses, short sessions, and lawmakers’ blind loyalty to party bosses – must approve the revenue portions of the 2014 budget by a constitutionally imposed deadline of Oct. 20.

But Mr. Weldon doesn’t expect them to miss the deadline, despite the difficulties of the proposed fiscal reform being debated. Such an eventuality, Weldon says, might result in the government being unable to collect taxes the following year.

Losing its luster?

Optimism was infectious among analysts and investors last year as President Peña Nieto took office, promising to promote long-stalled structural reforms and triple economic growth during his six-year administration. But Mexico may be losing its luster – and possibly in part for reasons beyond its control.

Investors poured billions into Mexican stocks and bonds, but many have started moving money out of the country, according to Ms. Riner. Now, they are likely searching for safe havens in a time of economic uncertainty and are unlikely to look at Mexico, even though it boasts some sound macroeconomic fundamentals such as low government debt and high foreign reserves.

“If investors are concerned about risk, they’re going to put their money in the safest thing they can get,” Riner says.

Safety used to mean Treasury Bills for many, “But if you’re not even sure that you’re going to get paid on your Treasuries, then where do you put your money?”  Riner asks. “I don’t think it’s going to be emerging markets.”  

Uncertainty

The US government shutdown, which today entered its second week, is expected to cost the US economy 0.10 percent to 0.15 percent of its GDP growth weekly. The shutdown will have little if any impact on Mexico – the debt cieling is the real risk – says Gabriel Casillas, chief economist and head of research at Banorte-Ixe. The possibility of a default and the associated uncertainty is more concerning, Mr. Casillas says.

“The first thing that reacts is the exchange rate,” he says.

The peso has already lost 5 percent of its value since Sept. 19.

The uncertainty extends to the border region, where exporters are concerned that the debt ceiling debate could derail US investments and slow down border crossings.

“The debt ceiling, if that hits, the disruption that might cause is both for short-term inspections and then funding of some of the border infrastructure that’s long past due,” says Mr. Morris, from the Crossborder Group.