Threat of a downgrade hangs over Mexico

Subject Mexico credit outlook downgrades. Significance On August 23, ratings agency Standard & Poor's (S&P) lowered the sovereign credit outlook of the Mexican government to negative from stable. The same day, the credit outlooks of state-owned enterprises Pemex (oil) and CFE (electricity) were also moved to negative. Moody's modified its outlook on Mexico's debt to negative in March. Impacts A rating downgrade would represent both a financial and a political blow for the government. The 'normalisation' of US monetary policy should moderately increase borrowing costs for emerging sovereigns, including Mexico. In the unlikely case of a global liquidity crunch, Mexico may activate its IMF credit line, borrowing up to 88 billion dollars immediately.

Subject The outlook for public debt in Mexico. Significance Total public sector debt stood at 505.9 billion dollars in May, with external debt accounting for around one third of that amount, according to the most recent Finance Ministry figures. Fiscal deficits have pushed up indebtedness in recent years, but falling costs have provided a counterweight to the debt accumulation. Impacts Only an external shock will significantly diminish Mexico's creditworthiness. Public debt should reach 50-55% of GDP when the government absorbs Pemex's pension commitments. In the case of a global liquidity crunch, Mexico could activate its IMF credit line, allowing it to borrow up to 72 billion dollars.


Significance This volatility is driven by expectations of further monetary stimulus in response to a slowing economy. Despite persistent concerns about the fallout from the anticipated tightening in US monetary policy and many country-specific risks, such as the standoff between Greece and its creditors, equity market sentiment remains supported by accommodative monetary policies worldwide and expectations of the US monetary policy tightening being gradual. Impacts Market volatility could increase further, as better-than-expected economic data in the euro-area vies with weaker-than-anticipated US data. Decoupling of surging equity prices and weak economic fundamentals threatens the rally's sustainability, increasing scope for volatility. This decoupling is most pronounced in China, where weak economic data prompt buying of equities in anticipation of stimulus measures. The greatest risk in equity markets is uncertainty surrounding US interest rates and their impact on emerging markets.


Significance At its first meeting of 2017, on January 10-11, the COPOM reduced the benchmark Selic interest rate to 13%. The 75-basis-point (bp) rate cut decision, the largest in nearly five years, accelerated the monetary easing cycle that started in October 2016. Economic recession has been relieving inflationary pressures and opening room for more intense cuts in interest rates. Impacts Further reductions of interest rates may contribute to controlling government debt. Private debt renegotiations at lower interest rates may facilitate a recovery in domestic demand and output. Any positive effects of monetary policy on activity may help contain popular dissatisfaction with the government.


Subject Mexico's external accounts. Significance The plunge in global oil prices represents a significant blow to the Mexican economy, particularly in terms of fiscal revenue. However, a negative impact is also showing in Mexico's external accounts. Moreover, manufacturing exports are contracting, partly due to problems in the automotive sector. Mexico's floating exchange rate is acting as an effective cushion, and its level of international reserves remains comfortable. Nonetheless, the growing external deficits may spark greater uncertainty about the economy's prospects. Impacts If market confidence deteriorates further, the government may activate the 65-billion-dollar Flexible Credit Line that it has with the IMF. The peso should rebound from the all-time nominal lows it has reached, but only after US growth firms up and the oil price stabilises. Despite the increasing external deficits, the government will not introduce protectionist measures and the opposition will not demand them.


Subject Global liquidity trends. Significance Concerns over global liquidity have resurfaced since late 2014, both in advanced and emerging markets (EMs). Both central banks and the IMF note that market liquidity has declined, especially in bond markets, due to stricter regulations on derivatives trading in advanced economies, lower sovereign bonds demand in some countries and the end of the credit boom in some EMs. Global liquidity is a loosely defined concept that can be interpreted in different ways and covers a variety of countries and market realities. Impacts Liquidity is highly cyclical and follows a 'boom and bust' cycle. Accomodative monetary policy and financial regulation may partly offset the exposure to global liquidity volatility. US monetary policy tightening could exacerbate an EM crisis, where corporates have heavily issued dollar-denominated debt. The ECB monetary policy will remain accommodative until at least March 2017 partly offsetting risks of a global liquidity shortage.


Subject The outlook for fiscal consolidation. Significance The significant drop in oil prices should not derail the fiscal consolidation trajectory mapped by President Enrique Pena Nieto's administration, which envisages that the debt/GDP ratio should stabilise by 2017. The fiscal hole opened by reduced oil prices has been compensated with greater taxation income and one-off revenues. Impacts Defying expectations, the oil price plunge did not push the government into an overtly contractionary fiscal correction. An arguably much-needed simplification of the cumbersome taxation regime will not take place due to the government's pledge not to alter it. Loose monetary policy from the autonomous central bank has worked in tandem with the government's fiscal stance.


Significance That comes as the country’s own parliament prepares to vote on the 2020 fiscal bill before the end of the year. Amman is currently in the last year of a 723-million-dollar IMF credit line, which required it to cut debt levels. The budget is intended to stimulate growth and stave off further protests, while simultaneously persuading the IMF to extend its credit line for another three years during upcoming talks in January. Impacts There will be closer cooperation between the government and parliament over managing the economy. Signs of unrest and public discontent over economic reforms will ease, notably if a tax evasion crackdown features on social media. Razzaz will survive another year as prime minister, having already served 18 months, sending a positive signal to the IMF and investors. King Abdullah and Queen Rania will come under less public scrutiny and distance themselves further from day-to-day politics.


Significance The collapse of world oil prices has brought fiscal policy sharply into focus in Ecuador. At a time when the budget deficit is widening and the opposition is strengthening, the government faces the prospect of receiving significantly less income from the oil sector than anticipated. The fallout from the plunge of oil prices coincides with the beginning of the constitutional debate that could allow the re-election of President Rafael Correa in 2017. Impacts The government will intensify efforts to raise oil output in a bid to ease the impact of falling oil prices. Conflicts between central and local government will probably increase as public resources become scarcer. If oil prices remain low, the appeal of exiting dollarisation and establishing full control over monetary policy will rise.


Subject Renzi's bid for more growth-friendly policies. Significance In its paper, 'A shared European policy strategy for growth, jobs, and stability', the Ministry of the Economy and Finance (MEF) sketches a plan to create more flexibility in EU macroeconomic policy coordination. The immediate goal is to enable member-state governments to use more fiscal stimulus and public investment to boost growth. Impacts If Renzi's constitutional reforms do not go through in October, the government will be in disarray. The ECB is likely to ease policy further tomorrow, while reminding markets that monetary policy accommodation is insufficient on its own. The March 17 European Council summit will be Renzi's chance to reframe the macroeconomic conversation.


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