October 6, 2013

LATAM Report September 2013: Mxico

This report concisely summarizes the current macroeconomic environment as well as important macro events over the past month in Mxico. Latest News: Enrique Pea Nietos proposed energy reform, the most extensive since Lzaro Crdenas expropriated the oil industry in 1938, is meeting stiff opposition led by Andrs Manuel Lpez Obrador, leader of the new Movimiento Regeneracin Nacional (Morena)i. The double whammy of hurricanes Ingrid, which hit the countrys east coast, and Manuel, which hit its opposite side, has left at least 157 people dead. Both simultaneous hurricanes have established themselves as Mxicos costliest natural disaster. The economy was already debilitated, and it was hammered by this shock, said Alberto Ramos, chief Latin American economist at Goldman Sachs. Traders are increasing their wagers that Bnxico, the countrys central bank, will lower its benchmark interest rate by to 3.5% ii in response. The disaster also cut short President Pea Nietos international touriii However, financial ministry officials insist that damage from the storms will not affect the governments already established 2014 budget goalsiv. Mexican economic growth has slowed drastically in 2013. Q2 marked the countrys first economic contraction in 4 years. This development has prompted a greater than 50% slashing of rosy government forecasts of annual GDP growth from 3.5% at the beginning of the year to 1.7% today. Private economists think performance will be even worsev However central bank chief Agustn Carstens doesnt believe the slowdown will persist. He believes that economic growth is set to reaccelerate to roughly 3% in

| Rodrigo C. Serrano, CFA | SIPA | Columbia University Master of International Affairs 14 Candidate | New York City, NY | 01-305-510-0181 | rcs2164@columbia.edu

 2014vi. His prognosis will be aided by fast-tracked government spending announced by Pea Nietovii. With a dismal tax intake of roughly 10% of GDP, one of the lowest rates for a country of Mxicos size, Pea Nieto introduced in early September a broad tax reform package aimed at closing various loopholes and weaning the governments dependence off of Pemexs profits. With the increase in revenues, a universal social security system would be instituted as well as various anti-poverty programsviii. ----------------------------------

---------------------------------Current Situation:

After receiving substantial acclaim, consequence of stellar annual growth averaging 3.9% in 2011 and 2012, more than double Brazils meager 1.8% average annual growth over the same time period, Mxicos economy unexpectedly capitulated in 2013 to a fragile external environment and weakened domestic demand. In Q2 GDP growth fell out of bed, registering its first QoQ contraction in 4 years and bringing the YoY rate to 1.5%. Decreased economic growth has generated increased pessimism. Government estimates of annual economic growth for 2013 have been cut from 3.5% at the beginning of the year to 1.7% today. Furthermore, a recent Bnxico survey of economic pundits forecasts economic growth to average just 1.4% this year. There are plenty of reasons for the gloom. Growth in exports has steadily declined since peaking in early 2010, the result of a weak recovery in the U.S., which accounts for close to 80% of Mxicos exports. Industrial production has fallen into contraction territory on a YoY basis, in part due to a faltering construction sector as well as declining oil and gas extraction. Subdued economic growth has negatively affected consumer and producer confidence, the former translating to negative growth in retail sales. Despite these trends, central bank president Agustn Carstens expects growth to rebound in 2014. Indeed a number of factors support his forecast. Over the short-term, the rebuilding effort from the hurricanes should add to growth as well as fast-tracked fiscal stimulus announced early in September. Indeed the government will be running countercyclical policy over the

!50.00!! !40.00!! !30.00!! !20.00!! !10.00!! !*!!!! !(10.00)! !(20.00)! !(30.00)!

3/1/07! 7/1/07!

Mexican(Exports(

3/1/08!

7/1/08!

3/1/09!

7/1/09!

3/1/11!

11/1/06!

11/1/07!

11/1/08!

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Source: INEGI

Chart: RCS Investments

115# 110# 105# 100# 95# 90# 85# 80#

1/1/07# 5/1/07# 9/1/07# 1/1/08#

Mexican(Condence(

5/1/08#

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1/1/11#

5/1/11#

1/1/06#

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9/1/11#

1/1/12#

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5/1/13#

Source: INEGI

Consumer#

Producer#

Chart: RCS Investments

Disclaimer: Please first consult your financial advisor for all important investment related decisions

9/1/13#

75#

7/1/13!

!(40.00)!

60# 55# 50# 45# 40# 35#

 coming quarters, expanding spending but offsetting some of this expenditure by way of a tax reform aimed at expanding the tax baseix. Over the medium to long-term, the benefits of increased competition in the telecoms sector and the possibility of partial liberalization of the countrys oil sector would induce increased foreign direct investment. Furthermore, the countrys dynamic export sector will continue to enjoy the tailwinds of rising costs in China, which in turn will drive U.S. companies to invest in its southern neighbor; this would be in addition to an improving U.S. outlook. Education reforms, while slow to enact, would provide a long-term tailwind via increased factor productivity. Additionally, macroeconomic conditions are currently conducive to additional support from monetary authorities should growth falter. In fact, there is increasing expectation for Bnxico to cut its benchmark rate from an already record low 3.75%. To be sure, there are plenty of downside risks to this benign view. Continued deadlock in Washington over the twin issues of the debt ceiling and the budget deficit risks tipping an already fragile U.S. economy into a negative feedback loop, which would significantly reverberate throughout the Mexican economy. Furthermore, deadlock in the Mexican Congress would deny the passage of important legislation widely expected to act as the impetus for sanguine long-term economic growth forecasts. The Pacto por Mxico has already seen a couple of close calls in its breakup, such as increased political tension between the major parties on reports that officials in the state of Veracruz were using social programs to benefit their political aspirationsx. Finally there is the risk that key legislation designed to increase long-term economic growth is watered-down, losing its effectiveness. In point of fact, the recently presented energy reform fell short of market expectations due to preference towards profit-sharing versus more inclusive production-sharing agreementsxi. This may limit the amount foreign firms are willing to invest in Mxico. A preliminary vote to amend the constitution (articles 27 and 28) is slated for this month. Meanwhile, the energy reform Pea Nieto covets is increasingly being tied to electoral reform demanded by the PANxii.

3/1/07"

7/1/07"

3/1/08"

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3/1/11"

11/1/06"

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3/1/06"

7/1/06"

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7/1/12"

3/1/13"

Source: INEGI

Headline"CPI"

Core"CPI"

Chart: RCS Investments

Disclaimer: Please first consult your financial advisor for all important investment related decisions

7/1/13"

7" 6.5" 6" 5.5" 5" 4.5" 4" 3.5" 3" 2.5" 2"

Ina%on'YoY'

 i http://www.france24.com/en/20131007-thousands-mexico-protest-energy-reform-plans ii http://www.bloomberg.com/news/2013-10-03/goldman-sees-acapulco-vacancies-spurringrate-cut-mexico-credit.html iii http://www.hispanicallyspeakingnews.com/latino-daily-news/details/mexican-presidentpena-nieto-cancels-international-tour-to-tend-to-natural-/27334/ iv http://www.reuters.com/article/2013/09/28/us-mexico-floods-idUSBRE98R0DP20130928 v http://www.latimes.com/world/worldnow/la-fg-wn-mexico-economy-pena-nieto20131001,0,711698.story vi http://www.reuters.com/article/2013/09/25/mexico-economy-growthidUSL2N0HL00Z20130925 vii http://www.ft.com/intl/cms/s/0/b7fd4510-1cdf-11e3-889400144feab7de.html#axzz2gyW4OGEA viii http://www.nytimes.com/2013/09/09/world/americas/president-of-mexico-proposes-taxoverhaul.html ix http://online.wsj.com/article/SB10001424127887323595004579067172257381140.html x http://www.ft.com/intl/cms/s/0/b0f0801a-ac42-11e2-a06300144feabdc0.html#axzz2gyW4OGEA xi http://rationalcapitalistspeculator.tumblr.com/post/63354567456/mexican-conservativesthreaten-to-block-oil-reform xii http://www.reuters.com/article/2013/09/24/us-mexico-reforms-idUSBRE98N01Q20130924

Disclaimer: Please first consult your financial advisor for all important investment related decisions