Country of the month: Mexico

Despite uncertainty around the North American Free Trade Agreement (NAFTA), and an election that could unseat the ruling Institutional Revolutionary Party (PRI), Mexico is likely to remain an attractive investment opportunity.

For one, strong growth areas such as tourism aren’t substantially affected by whether or not NAFTA is in force, says Brett House, vice-president and deputy chief economist at Scotiabank in Toronto.

Further, President Enrique Peña Nieto has instituted significant reforms in energy, education, telecommunications, banking and other sectors to boost economic activity, including through more foreign direct investment. In 2013, for example, the state-controlled energy company Pemex lost its monopoly on the exploration and development of oil fields.

Even if the U.S. withdraws from NAFTA, Canadian investments in Mexico would be protected under Chapter 11 of the agreement as long as the two countries maintain their sides of it, House notes. Canada and Mexico are also parties to the Comprehensive and Progressive Agreement for the Trans-Pacific Partnership, which would continue to build links between the two countries if the deal is signed.

Investors should also consider policy risks stemming from the July 2018 presidential elections, which will likely roil local markets, says Eduardo Suárez, vice-president of Latin American economics at Scotiabank in Mexico City. Investors may be avoiding Mexican stocks because of this volatility, Suárez adds, though real asset investors may see opportunity if they think their sector is protected by independent institutions.

Andrés Manuel López Obrador, leader of the left-leaning opposition party Morena and who is ahead in the polls, has pledged to hold a referendum on the 2013 opening of Mexico’s energy markets to foreign investors.

However, Suárez says investors can take comfort in Mexican laws for referendums. “You cannot subject things that affect public finances to a referendum,” he says, which would exclude most of the proposed reforms. “I think that has helped to reassure investors.”

López Obrador has also promised to cancel the new Mexico City international airport project if he is elected. Many international investors hold bonds issued to finance that project, but Suárez notes those bonds are collateralized by a trust funded by air travel taxes.

The sweeping U.S. tax changes passed late last year are another potential headwind for the Mexican economy. With the U.S. corporate tax rate reduced to 21% compared to Mexico’s 30%, some observers are worried about the impact on foreign—and even national—investment in the country.

The basics

Official name: United Mexican States

Capital: Mexico City

Government type: federal presidential republic

Population: 124,574,795 (July 2017, est.)

Head of state: President Enrique Peña Nieto (directly elected by a simple majority popular vote for a six-year term; the next election will be held July 2018)

Currency: Mexican peso

Citizenship: via birth and parentage; dual citizenship is recognized. Like many Latin American countries, Mexico differentiates between nationals and citizens. According to its constitution, citizens must be at least 18 years old and “have an honest way of life.”

Source: CIA World Factbook

Taxation

Corporate

Income tax rate: 30%

Branch tax rate: 30%

Capital gains tax rate: 30%

Real estate tax: determined at state or municipal level

Personal

Income tax rates: 11 progressive tax rates between 1.92% and 35% on wages

Basis: Mexican nationals are taxed on their worldwide income, while non-residents are only taxed on their income deriving from Mexico. Taxes are filed individually, regardless of marital status.

Capital gains: 10%

Inheritance or gift tax: None

Sources: Deloitte Taxation and Investment Mexico 2016; KPMG Mexico: Income Tax

Economy

GDP (purchasing power parity): US$2.315 trillion

GDP growth: 2.3%

Inflation rate: 2.8%

GDP per capita: US$18,900

Unemployment rate: 3.9% (underemployment may be as high as 25%)

Stock of direct foreign investment: US$473.5 billion (excludes investments through share purchases)

GDP per sector

Agriculture: 3.8%

Industry: 32.2%

Services: 63.4%

Source: CIA World Factbook

Stock exchanges

The Mexican Stock Exchange (BMV) is the second largest exchange in Latin America, with a total market capitalization of US$530 billion. The first foreign company was Citi-group, listed in 2001; the exchange made international shares available to investors in 2003 and demutualized in 2008. BMV’s parent company, CME Group, also operates the Mexican Derivatives Exchange, which lists futures and options contracts on interest rates, stock indexes, currencies and single stock futures.

In August 2017, the Mexican government approved the creation of a second bourse, the Institutional Stock Exchange (BIVA), set to open in March 2018. It aims to increase the number of public companies in Mexico (currently, around 150 are listed on the BMV). Santiago Urquiza, chairman of BIVA’s parent company Central de Corretajes (CENCOR), predicts the number of companies listed will grow by 30% in the next three years, and that the Mexican stock market’s average daily volume will grow by 50% over the same period.

Historically, few companies were publicly listed, Scotiabank’s Suárez says. “The utilities and energy sectors […] comprise a very large share of a typical stock exchange, and in Mexico, those sectors traditionally did not exist or were very limited. That’s changing now.” He anticipates a sure but gradual shift, with energy and financial services companies leading the charge.

Companies can trade on both exchanges and choose which bourse will have their primary listings. BIVA hopes to differentiate itself with technology: its infrastructure runs on Nasdaq’s X-Stream trading, while BMV’s technical problems caused trading to halt four times in 2016.

BIVA recently raised 450 million pesos from four pension funds, and argues this support demonstrates an appetite, from both local and foreign investors, for an additional stock exchange using the most reliable technology that appeals to investors accustomed to algorithmic trading.

Central bank

In December, the Banco de México increased its benchmark interest rate by 25 basis points to 7.25%. It noted the Mexican economy contracted during the third quarter of 2017, reflecting reduced oil production, the two significant earthquakes that hit southern and central Mexico in September, and a deceleration in manufacturing exports and private consumption. The decision was also tied to rapidly rising inflation, which hit 6.66% in August, dropped slightly through the fall, and then climbed back to 6.69% in the first half of December. In a statement accompanying its decision, the bank predicted inflation would approach the target 3% at the end of 2018, and fluctuate around that level through 2019.

However, some board members say the bank will have to take more drastic steps to beat back the high inflation: one member argued to increase the interest rate by 50 basis points.

Since there are signs that inflation will rise for a few months before rapidly falling, the central bank is in a difficult position, Suárez says. “Monetary policy usually acts with a lag, and the risk is if you cut too aggressively now, you may be backpedalling relatively soon, which central banks don’t usually like doing.”

In an October 2017 presentation in Washington, D.C., deputy governor Javier Guzmán Calafell noted the Mexican economy performed better than expected in 2017, and predicted 2% to 3% growth in real GDP for 2018.

Sara Tatelman is a Toronto-based financial writer.