The War in Ukraine, AMLO and Mexico’s Potential

The global economic outlook, which overall looked promising post-pandemic, was dramatically shaken by Russia’s invasion of Ukraine. For Mexico, which is still recovering from its worst economic downfall since 1932, it means lower growth for 2022, extra pressure on the business environment coupled with domestic headwinds stemming from the President Andrés Manuel López Obrador (AMLO) administration policies.

Indeed, Mexico’s GDP will grow by 1.5 percent in 2022, driven by exports (3.5 percent), government spending (2.9 percent), and consumption (2.7 percent). Before the invasion, I was expecting Mexico to grow around 2.4 percent in 2022, but with the Russia-Ukraine conflict severely impacting global growth, supply chains, and inflation across markets, the numbers for Mexico to grow more than 2 percent in 2022 are simply not there.

The war in Ukraine will have a mixed impact on Mexico’s outlook in 2022, both positive and negative. Mexico’s government will receive more revenues stemming from higher Mezcla prices (Mexico’s oil). This is relatively positive because AMLO announced (and perhaps he does not have another card to play) that oil windfall will be destined to subsidize gas prices aiming to avoid another “gasolinazo” and higher inflation. Many governments in Latin America do not have that fiscal leeway to subsidize gas prices amid the current juncture but Mexico does, thanks to the conflict savaging Ukraine.

With the global supply in jeopardy due to Russia’s oil disruptions, Brent is likely to average US$111 per barrel in 2022, helping to sustain Mexico’s oil despite PEMEX’s operational and managerial problems. Indeed, Mezcla has increased by 44 percent since January, from US$70 on Jan. 3 to US$100.9 on April 20. In fact, Mezcla averaged around US$104 throughout March. Although PEMEX is unlikely to increase output in 2022, keeping it around 1.6-1.7 thousand oil bpd, Mexico will substantially increase its international oil sales, which last year amounted to US$28 billion. In January-February, PEMEX’s international sales increased by 31 percent YOY (worth US$4.2 billion) as oil prices continued to increase, stemming from the war in Ukraine. Amid an electoral year, AMLO and MORENA, Mexico’s ruling party, want to increase their political clout by winning most of the governorships at stake on June 5 following the lackluster recall referendum victory. Against this backdrop, the oil windfall is a tool to cushion the inflation blow that Mexicans, as the rest of the planet, are suffering. Thus, AMLO will continue using the oil windfall to patch the public finances of the 100 percent subsidy to gas prices his government has put in place by not collecting the impuesto especial sobre producción y servicios (IEPS) on gasoline. Without this subsidy, the already high gas prices would have been even higher, ranging between MX$26-33 (US$1.28-$1.63), which would have unleashed social unrest.

The negative impact of the Russian-Ukrainian conflict on Mexico’s 2022 outlook will be felt on supply chains and inflation, where it has tilted toward a significantly more pessimistic scenario. Inflation rose to 7.45 percent YOY in March, the highest in 20 years, mainly driven by increasing gas, food, merchandise, and service prices. The war in Ukraine has generated a bull market for commodities, in no lesser degree food, as Ukraine, Russia, and Belarus are key suppliers of fertilizers, corn and wheat, among other items essential for global supply chains and food security. Inflation in Mexico was already on the rise, accelerating after 2Q21, and firms should expect that it will be above Banxico’s targeted range (3 percent+/-1) in 2022 and 2023. The drivers do not lie. Just in March, food prices increased by 16.12 percent YOY, as the market continues to cope with the impact of “La Niña” on crops, faster-than-expected demand recovery, and supply disruptions stemming from the war in Ukraine.

Regarding Mexico’s supply chains, firms should factor in protracted disruptions, particularly in the auto sector. As Ukraine, Russia, and Belarus produce a large percentage of key components needed for microchips and semiconductors, such as neon, palladium, platinum, and aluminum, the key auto exports will feel the pinch, as well as Mexico’s external sector and overall economic growth. To put it in perspective, auto exports represent, on average, 30 percent of the value of Mexico’s total exports, and the fact that they might even experience negative growth in 2022 due to supply chain disruptions, should be a key factor in firms’ assessment of Mexico’s economic outlook this year. Even though auto exports grew by 6 percent YOY (worth US$22.5 billion) in January-February, I would advise caution as they are growing below potential. Just in 2021, they managed to grow by a meager 2 percent YOY, after their contraction by 21 percent YOY and 18 percent YOY, in Q3 and Q4 respectively. This trend indicates that supply chain disruptions are stickier than it was originally forecasted and are likely to continue as the conflict in Ukraine remains with no end in sight.

This takes me to the third point: the potential of Mexico vis-à-vis emerging markets, not least among Latin American markets. All the economies in Latin America are exposed to more headwinds than tailwinds stemming from Russia’s invasion of Ukraine, such as supply chain disruptions, higher inflation, and social instability driven by higher food prices and further economic deterioration. Even though Mexico is not immune to these headwinds, it is better positioned in Latin America to attract more FDI into the region, building upon its better public finance stability and privileged access to the US economy thanks to the USMCA agreement. Furthermore, Mexico is more likely to beat Brazil in terms of FDI attractiveness in the short to medium term given its still large market size, but relatively lower risk, higher growth, and lower cost of doing business. However, for the country to capitalize on these factors the main stumbling block needs to be lifted: AMLO’s government policies against private investment are counterintuitive to Mexico’s diversified economy.   

The latest policy initiatives showcase this fact: the controversial electricity reform that was soundly defeated in Mexico’s lower house, which was aiming to shore up the state-owned electricity company (CFE) at the expense of private investors, and the reform of the mining legislation, effectively nationalizing lithium. Mexico is an open economy, with a lot of potential to be tapped, that requires policies that improve state-owned companies but without curtailing investment toward strategic sectors that could spur higher economic growth. Finally, as the US-China decoupling continues and the vulnerability of supply chains is greatly exposed, Mexico is poised to gain from nearshoring production from Asia and Russia, but only if the country remains open to business and private investment is not portrayed as an enemy. Hopefully, the government can see what everyone else is seeing, but until one witnesses a course correction from the López Obrador administration, it is better to temper the growth expectations for 2022, and perhaps until the rest of the sexenio.