Mexico's AMLO (left) and Brazil's Bolsonaro

Brazil to the far-right, Mexico to the left. At first glance, this is the most evident political shift Latin America’s largest economies opted for in 2018 when they elected, respectively, Jair Bolsonaro and Andrés Manuel López Obrador. The political rupture also brings a new economic dawn for both countries and naturally, financial markets have reacted to it. While the new administrations in each country have only just begun, moves in asset pricing suggest a shift in how investors perceive each country — with gleaming perspectives for Brazil and gloomy ones for Mexico.

“Regarding Brazil, there is hope about what needs to be done, while in Mexico there is fear about what can be done,” says Luciano Sobral, an economist at Santander Brasil. His assessment is backed by a survey carried out by the bank during a conference with senior management of 129 companies and more than 300 institutional investors earlier this month.

When asked which market they expected to be the best-performing in the region this year, 68 percent of respondents picked Brazil, up from 22 percent in 2018. Meanwhile, only 5 percent chose Mexico. According to Mr. Sobral, this shows the high expectations regarding Brazil’s business-friendly reform agenda — and the concerns about the contentious approach the Mexican president has shown towards financial markets so far.

</span></p> <p><span style="font-weight: 400;">Mr. Bolsonaro was sworn in Brasília in January 2019 to serve a four-year term and Mr. López Obrador, also known as AMLO, took office in Mexico City just a month prior and is set to stay in power until 2024. Since June, when politics became an increasingly important driver for the markets in both countries, Brazil’s benchmark stock exchange index has gained 23.7 percent. Meanwhile, Mexico&#8217;s S&amp;P BMV/IPC index lost 3.2 percent</span><span style="font-weight: 400;"> as of January 28. </span></p> <p><span style="font-weight: 400;">The turning point in both cases is directly related to the new heads of state. </span></p> <hr /> <p><img class="alignnone size-large wp-image-13677" src="https://brazilian.report/wp-content/uploads/2019/01/export-kWcMw-1024x708.png" alt="ratings brazil mexico amlo stock market" width="1024" height="708" srcset="https://brazilian.report/wp-content/uploads/2019/01/export-kWcMw-1024x708.png 1024w, https://brazilian.report/wp-content/uploads/2019/01/export-kWcMw-300x208.png 300w, https://brazilian.report/wp-content/uploads/2019/01/export-kWcMw-768x531.png 768w, https://brazilian.report/wp-content/uploads/2019/01/export-kWcMw-610x422.png 610w, https://brazilian.report/wp-content/uploads/2019/01/export-kWcMw.png 1200w" sizes="(max-width: 1024px) 100vw, 1024px" /></p> <hr /> <h2>How markets reacted to Bolsonaro and AMLO</h2> <p><span style="font-weight: 400;">In Brazil, markets soared in the first week of October, when polls gave Mr. Bolsonaro a clear lead in the electoral race. Later that month, the stock exchange in Mexico plunged after AMLO announced he would suspend the construction of an airport near Mexico City. </span></p> <p><span style="font-weight: 400;">The USD 13 billion project had already been partially built and the president’s decision—after a referendum in which only 1 percent of the electorate turned out—sent shockwaves through the political and financial worlds. The concerns are that the new president may be willing to scrap contracts and take a populist stance, backed by questionable referendums, to rule as he wishes.</span></p> <p><span style="font-weight: 400;">AMLO has been </span><a href="https://www.economist.com/the-americas/2018/12/01/amlo-will-be-the-most-powerful-mexican-president-in-decades"><span style="font-weight: 400;">labeled</span></a><span style="font-weight: 400;"> “the most powerful Mexican president in decades” by </span><i><span style="font-weight: 400;">The Economist</span></i><span style="font-weight: 400;">. The broad majority his party coalition has in Congress boosts the chances of implementing policies and market fears alike. </span></p> <p><span style="font-weight: 400;">His political strength is among the main risks listed by Nomura Securities when assessing the economic outlook for Mexico in 2019. “Risks associated with market and business-unfriendly proposals by AMLO ’s Morena party in Congress are likely to cause much policy and political uncertainty and represent another source of volatility,” reads the report by João Pedro Ribeiro, the institution’s Latin American strategist.  </span></p> <p><span style="font-weight: 400;">With a similar view, the credit agency Fitch revised its outlook for Mexico&#8217;s sovereign rating from stable to negative, right after the construction of the airport was halted. </span></p> <h2>Contrasting starting points</h2> <p><span style="font-weight: 400;">Despite the market&#8217;s suspicions, AMLO is in a much more comfortable situation than Mr. Bolsonaro. That is because the Mexican economy is in better shape than Brazil&#8217;s, reflected in both countries&#8217; </span><a href="https://tradingeconomics.com/country-list/rating"><span style="font-weight: 400;">sovereign ratings</span></a><span style="font-weight: 400;">. Two out of the three largest credit rating agencies place Brazil three steps below the investment grade benchmark. For S&amp;P and Fitch, Mexico is three notches above that same threshold. </span></p> <p><img class="size-full wp-image-13676 aligncenter" src="https://brazilian.report/wp-content/uploads/2019/01/ratings-brazil-mexico.png" alt="ratings brazil mexico" width="750" height="112" srcset="https://brazilian.report/wp-content/uploads/2019/01/ratings-brazil-mexico.png 750w, https://brazilian.report/wp-content/uploads/2019/01/ratings-brazil-mexico-300x45.png 300w, https://brazilian.report/wp-content/uploads/2019/01/ratings-brazil-mexico-610x91.png 610w" sizes="(max-width: 750px) 100vw, 750px" /></p> <p><span style="font-weight: 400;">In comparison, Brazil has the same rating as Bolivia, Bangladesh, the Dominican Republic, and Uzbekistan. Mexico is in the same group as Peru and Thailand, leaving behind countries such as Colombia, Uruguay, India, and Italy. For Moody’s, both countries are one step up in the credit rating ladder.</span></p> <p><span style="font-weight: 400;">Credit Default Swaps (CDS) are another way of assessing a country’s reputation within the financial markets. These are a sort of insurance against the risk of default. That is, the more the markets fear a country’s fiscal situation, the higher its Credit Default Swap is. </span></p> <p><span style="font-weight: 400;">Government debt in Brazil represented 84 percent of its Gross Domestic Product (GDP) by the end of 2017 and is expected to increase even further if no fiscal reform is implemented. In Mexico, the ratio was at 54 percent, according to the latest data compiled by Bloomberg. Therefore, it is no surprise that Brazil’s five-year CDS remains higher than Mexico’s. But we must observe, however, how that gap is narrowing. </span></p> <p><span style="font-weight: 400;">After it reached 185.3 points on September 3, the difference between both countries fell to the current 40.5 points. This is the smallest difference since March 2018. The movement coincides with Mr. Bolsonaro’s increasing favoritism in election polls and AMLO’s controversial decision in the airport episode.</span></p> <hr /> <p><img class="alignnone size-large wp-image-13675" src="https://brazilian.report/wp-content/uploads/2019/01/export-9OACl-1024x683.png" alt="amlo bolsonaro mexico brazil" width="1024" height="683" srcset="https://brazilian.report/wp-content/uploads/2019/01/export-9OACl-1024x683.png 1024w, https://brazilian.report/wp-content/uploads/2019/01/export-9OACl-300x200.png 300w, https://brazilian.report/wp-content/uploads/2019/01/export-9OACl-768x512.png 768w, https://brazilian.report/wp-content/uploads/2019/01/export-9OACl-610x407.png 610w, https://brazilian.report/wp-content/uploads/2019/01/export-9OACl.png 1200w" sizes="(max-width: 1024px) 100vw, 1024px" /></p> <hr /> <p><span style="font-weight: 400;">“I have no doubt that Mexico’s fiscal situation is much better than Brazil’s. Their debt cost is much lower. AMLO has a lot of room for mistakes and the markets still will assess a lower country risk,” Mr. Sobral says.</span></p> <p><span style="font-weight: 400;">On the other hand, Mr. Ribeiro notes that Mr. Bolsonaro faces a far more urgent need for fiscal reform. “In very simple terms, we would argue that Mexico’s economy could perform fairly well in the next few years if AMLO’s government is cautious on the policy front, without making very big changes,” he wrote for Nomura’s Global Annual Economic Outlook report. “Alternatively, because of the urgent need for fiscal reform in Brazil, Bolsonaro needs to hit the ground running to keep growth conditions favorable in the medium term.”</span></p> <h2>The global effect</h2> <p><span style="font-weight: 400;">It is impossible to analyze the outlook for Brazil and Mexico and ignore the international scenario in which they are situated. Otavio Costa, a global macro analyst at Crescat Capital, warns that a “much bigger force” approaches Latin America&#8217;s biggest economies. “There will be a global recession and it will be caused mainly by China,” he says. </span></p> <p><span style="font-weight: 400;">In such a scenario, Brazil has a lot to lose as it is extremely exposed to what happens in the Asian giant — much more than Mexico, as Mr. Costa explains. “Brazil is still very dependent on the commodities market. Nearly 5 percent of its GDP is made of net exports to China.” He continues: “Meanwhile, Mexico imports less than it exports to China”, the Denver-based analyst says.</span></p> <p><span style="font-weight: 400;">However, perspectives of a global slowdown — or even the consequences of the trade war between Beijing and Washington — will likely impair the Mexican economy. Although not dependent on China, the country relies heavily on the U.S. That is why most economists have said the approval of the USMCA trade deal to replace NAFTA is good for the Mexican economy. It prevents a rupture in trade with its main commercial partner and puts an end to uncertainty surrounding the negotiations.</span></p> <div id="attachment_13679" style="width: 1034px" class="wp-caption alignnone"><img aria-describedby="caption-attachment-13679" class="size-large wp-image-13679" src="https://brazilian.report/wp-content/uploads/2019/01/amlo-mexico-president-1024x576.jpg" alt="amlo mexico president" width="1024" height="576" srcset="https://brazilian.report/wp-content/uploads/2019/01/amlo-mexico-president-1024x576.jpg 1024w, https://brazilian.report/wp-content/uploads/2019/01/amlo-mexico-president-300x169.jpg 300w, https://brazilian.report/wp-content/uploads/2019/01/amlo-mexico-president-768x432.jpg 768w, https://brazilian.report/wp-content/uploads/2019/01/amlo-mexico-president-610x343.jpg 610w, https://brazilian.report/wp-content/uploads/2019/01/amlo-mexico-president.jpg 1280w" sizes="(max-width: 1024px) 100vw, 1024px" /><p id="caption-attachment-13679" class="wp-caption-text">AMLO promises &#8220;peaceful but radical transformation.&#8221;</p></div> <p><span style="font-weight: 400;">Following that logic, and taking into account a weaker American economy, the Nomura group forecasts that Mexico will grow 1.9 percent in 2019, from 2.2 percent in 2018. In Brazil, the trend is the opposite. GDP is poised to rise by 2.8 percent this year, after an expected increase of 1.2 percent last year.</span></p> <p><span style="font-weight: 400;">As Mr. Costa puts it, Brazil is in a difficult economic situation, but under good political leadership. Mexico, in a better economic situation, but doing poorly in the political aspect. That is why, in relative terms, Brazil’s economy may not drop as strongly as other markets in the case of a recession, the analyst at Crescat Capital says.</span></p> <h2>The Brazilian debut</h2> <p><span style="font-weight: 400;">At Santander’s 23rd Annual Latin American Conference, when asked about the main risks for the region in 2019, most managers and investors mentioned “political intervention and regulatory risk.” Therefore, despite the global negative outlook, the political scenario in Brazil and Mexico can act either as a buffer or a catalyst.</span></p> <p><span style="font-weight: 400;">In Brazil, Mr. Bolsonaro’s main task will be to have a pension reform passed before the end of the year. According to a survey carried out by Santander, 48 percent of respondents believed the reform will be approved in the second half of 2019, while 18 percent expect it to pass by June. Only 11 percent are considering a significant delay — with the reform being voted on during the second half of 2020 or not voted on at all.</span></p> <p><span style="font-weight: 400;">One month into his presidency, Brazilians are yet to know what Mr. Bolsonaro and his economic team&#8217;s plans for the pension reform are. In January, the Brazilian president was in the spotlight during the World Economic Forum in Davos. But instead of the scheduled 45-minute speech, he spoke for a mere six minutes. The president failed to give any details on how he plans to boost the economy, fight corruption and place Brazil in the international scenario. In short, Mr. Bolsonaro </span><a href="https://brazilian.report/power/2019/01/22/takes-bolsonaro-davos-debut/"><span style="font-weight: 400;">flopped</span></a><span style="font-weight: 400;">.</span></p> <p><span style="font-weight: 400;">Moreover, the pension reform did not even make to the list of the top 35 priorities of the administration for its </span><a href="https://brazilian.report/power/2019/01/24/brazil-bolsonaro-100-days-goals/"><span style="font-weight: 400;">first 100 days</span></a><span style="font-weight: 400;">. The lack of concrete indications on the economic plans and the concerns about how Mr. Bolsonaro’s administration will deal with Congress after it reopens in February have kept skepticism high, especially among international investors.</span></p> <p><span style="font-weight: 400;">The Brazilian Report has shown how the </span><a href="https://brazilian.report/money/2019/01/01/bolsonaro-stock-market/"><span style="font-weight: 400;">2018 electoral rally</span></a><span style="font-weight: 400;"> in the local stock market was driven by local investors, while foreigners pulled nearly BRL 11 billion (USD 2.8 billion) out of Brazilian stocks last year.</span></p> <h2>First steps in Mexico under AMLO</h2> <p><span style="font-weight: 400;">For AMLO, reality seems to be more complex. As a left-wing leader with outspoken criticism towards the markets, he will have to gain the trust of economic agents. “Will AMLO be a version of 2003 Lula (who had a past of radical stances but toned them down upon taking office) or will he be more like Dilma Rousseff, who ran a willful administration?” ponders Mr. Sobral.</span></p> <p><span style="font-weight: 400;">So far, he has given mixed signals. One positive note had to do with his budget proposal for 2019. Analysts feared he would take a populist approach and increase spending. However, his bill was deemed &#8220;</span><a href="https://www.economist.com/the-americas/2018/12/18/mexicos-new-president-presents-a-sober-budget"><span style="font-weight: 400;">sober</span></a><span style="font-weight: 400;">,&#8221; suggesting he would take a fiscally responsible path instead. </span></p> <p><span style="font-weight: 400;">According to Bloomberg, his budget plan did </span><a href="https://www.bloomberg.com/news/articles/2018-12-16/mexican-president-promises-surplus-in-2019-budget-proposal"><span style="font-weight: 400;">include</span></a><span style="font-weight: 400;"> more spending on infrastructure and social programs but still preserved the fiscal framework adopted by former administrations. In reaction to that, </span><a href="https://www.bloomberg.com/news/articles/2018-12-17/mexican-peso-bonds-jump-on-lopez-obrador-s-solid-budget-release"><span style="font-weight: 400;">the Mexican Peso and bonds rallied</span></a><span style="font-weight: 400;"> as investors perceived a more market-friendly decision.</span></p> <p><span style="font-weight: 400;">On the other hand, his decision to implement a crackdown on fuel theft has led to unanticipated problems. The measure, announced on December 27, led to the closure of six major pipelines, the allocation of troops at nearly 60 refineries and the delivery of fuel by road and rail, which cost more and are less efficient. </span></p> <p><span style="font-weight: 400;">The changes led to fuel shortages across western and central Mexico. Not only have people been waiting in long lines to pump gasoline into their cars, but an explosion at a pipeline in Hidalgo killed 107 people, as local villagers attempted to collect gas. The move was a “rookie mistake,” according to GZero Media, a media company owned by political risk consultancy Eurasia. </span></p> <p><span style="font-weight: 400;">Elected under the platform of bringing &#8220;peaceful but radical transformation&#8221;, the Mexican leader is “struggling with the transition from the poetry of campaigning to the prose of governing,” as it often happens to &#8220;change agents,&#8221; they write.</span></p> <p><span style="font-weight: 400;">Another item on AMLO&#8217;s list of &#8220;rookie mistakes&#8221; concerns a self-inflicted brain drain. When his Morena party decided to limit government spending by capping public employees’ wages to USD 5,000 per month — the same amount earned by the president — it pushed public servants to the private sector or into retirement. “Effective reform requires talented people who understand the systems that need to be changed. Hollowing out bureaucracy might save money, but it directly undermines the president&#8217;s government-centered approach to problem-solving”, GZero reports.</span></p> <p><span style="font-weight: 400;">Despite the negative repercussion and severe social consequences, markets still do not see these to be major problems for AMLO’s administration. In mid-January, rating agency Moody’s stated it expected the fuel shortages to have limited impact on the country’s economy and fiscal situation and would not impair Mexico’s credit rating any time soon.</span></p> <p><span style="font-weight: 400;">In fact, AMLO’s take has been rather </span><a href="https://www.ft.com/content/56199f86-182b-11e9-9e64-d150b3105d21"><span style="font-weight: 400;">welcomed</span></a><span style="font-weight: 400;"> by the markets since Mexican state-run Pemex was reportedly losing about USD 3 billion per year to fuel theft. Earlier this month, Mexico’s federal administration successfully raised USD 2 billion from bond investors, with demand exceeding supply by a ratio of four to one. </span></p> <p><span style="font-weight: 400;">Ever since the new president took office, Mexico’s benchmark index is up by 5.8 percent. Although it still does not make up for the losses during the electoral period, these financial reactions show that market agents still have not turned their back on the Mexican president. </span></p> <p><span style="font-weight: 400;">If they do, Brazil will be around the corner looking for opportunities to overtake Mexico as the best regarded Latin American economy. Since Mr. Bolsonaro took office, the Ibovespa is up 8.7 percent, showing investors are still optimistic about his administration.</span></p> <p><span style="font-weight: 400;">Depending on the lane AMLO chooses — and where he might take the country’s economy with him — an inversion on how economic agents assess Latin America’s two largest economies may take place. “If the primary expectations come true, the prices of Brazil and Mexico might converge at some point in the future,” Mr. Sobral estimates.

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BY Mario Braga

Braga is a journalist from São Paulo. He is an Erasmus Mundus Journalism scholar pursuing his Master’s degree at Aarhus University (Denmark) and at the London’s City University.