Mexico's Goldilocks Moment

With all the hype Mexico's "booming" economy has been garnering over the past, it may have come like a dousing of iced water to see GDP growth screech to a halt during the first quarter of the year, the first full quarter under the administration of Enrique Peña Nieto. At first glance, the figures looked grim: year on year growth was a meagre 0.8%, the weakest since the 2009 recession, and far below the 3-5% rates Mexico watchers had been accustomed to over the past three years. Fortunately, behind this number was a statistical anomaly in that the Easter break fell in March rather than April, thereby knocking off a few days of activity when making the year on year comparison. However, a calendar adjustment showed that growth was still sluggish at 2.2%, a number which looked more fitting for the gloomy past decade than in the roaring era of the "Aztec tiger."

Since then, there's been a slight reversal in the tone about Mexico. After a smooth ride since 2010, it has now dawned on many of the formerly excited observers that there are some bumps on the road to prosperity. For all these recent jitters, it certainly doesn't appear like the fiesta is over. There are still questions, however, over just how bombastic it will turn out.

A great start for the PRI, but with caveats

Like many of the best things in Mexico, hype is best taken with a pinch of salt. At the Economist Intelligence Unit, we have taken a cautious stance regarding the somewhat hyperbolic media attention the country's economy has been receiving over the past year. To be fair, there is little doubt that the new government has made a very positive start, silencing the pessimists who were braced for yet another sexenio of legislative gridlock and a return of old-style PRI authoritarianism. Neither has happened. That the government has succeeded instead in bringing the opposition together -- through the Pacto por México -- in order to set a cross-party structural reform agenda is unquestionably one of the greatest political achievements in recent Mexican history even if it doesn't last beyond 2013. This is, of course, a shared victory not only for the PRI but also for the opposition PAN and PRD who have placed obstructionism and ideology aside to work together for a common goal (or more specifically, 95 goals).

It is also true that some of the reforms such as education and telecoms are ground-breaking in the sense that they open the possibilities of significant improvements in the sectors they address. But this is where the first caveat arises: implementation. Sure, the education reform may strip the teachers union of much of its power in influencing education policy, but that is still no guarantee in itself that educational outcomes will improve to the point of noticeably narrowing the (huge) gap with Asia or the West (many other Latin American countries have similar outcomes without an all-powerful union). Likewise, the telecoms reform makes some strides in denting certain companies' monopoly powers but already these same companies may be pulling their weight to have "friendly" bureaucrats manning the newly created regulator, IFETEL. Given how easy Mexico's institutions tend to bend to the whims of the powerful, it will be a truly colossal undertaking to keep the IFETEL truly independent considering the multi-billion dollar stakes involved.

It's all about the tax reform

The second caveat is that the success of upcoming reforms is far from a given. First and foremost, without a well-designed fiscal reform, it's difficult to see Mexico truly living up to its enormous potential. Unfortunately, this is one area where consensus among the big three parties is not fully guaranteed and where the risk of passing a water-downed bill would kill the chances of truly breaking the country's bottlenecks to long-term growth. For starters, a fiscal reform is needed to boost revenue and reduce dependency on Pemex's budgetary contributions which amount to 4.6% of GDP (this merely the bit from oil taxes and royalties). For a country that collected just 8.5% of GDP in non-oil taxes, that is not an insignificant sum that needs to be partly compensated. Furthermore, a planned universal welfare reform could cost anywhere around 3-5% of GDP plus any additional funding for anti-poverty programs, public infrastructure, security, etc. It's also hard to imagine that evasion and informality will be reduced either without a major streamlining of the tax code.

The magnitude of the effort needed is therefore obvious and will truly require a reform which doesn't cut around the corners to please special interests or the whims of any of the three main parties (all of which will need to make some sacrifices regarding their traditional ideological positions on fiscal matters). Yet one gets a sense from the global media that success is practically a given, and that as well as all other upcoming reforms will fall naturally together in the next few months. Many foreigners will be surprised that most Mexicans do not share this optimism, given a history of chronic disappointments -- in local parlance, this syndrome is known as the "ya merito" ("almost but not quite"). For many, prosperity still appears as a distant hope and far from a foregone conclusion. This is, after all, a country where 52 million people remain mired in some form of poverty, 60% work informally and who see their increasing "labour cost competitiveness" as what it truly is: stagnant wages compared to Asia.

A Goldilocks moment

With this in mind, it is clear that Mexico's momentum is still fraught with many risks. But just as one should take the media hype with a pinch of salt, so too should the first quarter GDP results be viewed for what they are: a bump on the road, not a derailment. Sure, it may bring fears of a repeat of Brazil's recent fall from grace but if anything, the slowdown may even have the positive effect of bringing a dose of reality back to both the political class and investors. Mexico is undoubtedly a country of tremendous potential and a once-in-a-generation chance of getting it right for good. Let's hope it doesn't get squandered.

Rodrigo Aguilera is Editor/Economist (Latin America) for the Economist Intelligence Unit.