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The energy reform, the most anticipated of the announced reforms,  seeks to realize the vast and largely untapped potential of Mexico’s oil and gas reserves. Here the Pemex Burgos gas processing plant. (Photo: Pemex)
Wireless incumbent Telcel, a unit of Carlos Slim’s América Móvil, is set to face more competition. (Photo: Telcel)
Wednesday, July 17, 2013
Perspectives

Mexico Reforms Spur Investment


President Peña Nieto's energy, telecom, fiscal, labor and education reforms will spur more foreign investment.

BY GUILLAUME CORPART

The reforms Mexico’s new President, Enrique Peña Nieto, has introduced in the first months of his presidency have earned him praise from international media and political commentators. His bold reform proposals coupled with the political agreement his Institutional Revolutionary Party (PRI) signed with the two main opposition parties, his stance on security, and his general mastery of political deal making have reinforced international investors’ interest in Mexico. Indeed, against the backdrop of an economic upturn, the announced changes have very promising implications for business, with clear prospects for a reduction in monopolistic barriers, greater opportunities for more foreign investment, and a raft of measures aimed at boosting the economic growth rate to 5-6 percent a year.

REAL CHANGE IN THE OFFING?

When Mr. Peña Nieto won the Mexican presidential election in July 2012, his promises of change elicited controversy and skepticism. After all, the PRI had ruled Mexico autocratically for 71 years and gained a reputation for running the country with little regard for democracy, the spread of corruption, or the flourishing of monopolies. Despite spending 12 years in opposition, many people were not convinced that the party had renewed itself: indeed, there was concern that Peña Nieto’s victory heralded the return of political “dinosaurs” at the helm of the country and rule by presidential fiat.

To the surprise of many, Mr. Peña Nieto’s first five months in power have been marked by tangible progress and the push for much awaited change in critical and long-neglected areas of public policy.  The first step Mr. Peña Nieto took towards enabling substantive reforms was negotiating the “Pact for Mexico” with the two main opposition parties, the PAN and the PRD. The pact represents a significant political victory for President Peña Nieto: the agreement, signed as he came into office in December 2012, is designed to guarantee political support for a joint policy agenda in various areas of reform such as education reform, economic deregulation, and modernization of the energy sector. With the agreement in place, opposition parties are much less likely to block proposed reforms and interests groups will find it more challenging to lobby for changes or derail the reform agenda.

So far, Mr. Peña Nieto and his government are off to a promising start: after helping pass a labor reform in November 2012 and passing an education reform in February 2013, Mr. Peña Nieto is now pushing for a telecoms reform, which is expected to pass as soon as this spring. The real prize, however, and the big legislative battles everybody are bracing themselves for, are the energy and fiscal reforms, which many believe will make or break Mr. Peña Nieto’s presidency. Analysts and commentators expect him to introduce them only once he has accumulated enough political backing and as soon as his early—and broadly supported—reforms begin yielding dividends. The blueprint for the first wave of reforms is instructive both from a political and business perspective: understanding how the new administration designed and promoted these initial reforms offers clues about the potential scope of the more significant—and likely more controversial energy and fiscal reforms.

LABOR REFORM: INCREASING PRODUCTIVITY

The labor reform that Mr. Peña Nieto's senators and representatives helped pass in November 2012 was designed to make the formal economy more competitive and reduce the informal economy by raising the number of formal jobs, increasing the country’s tax take, and boosting labor productivity.

While wages in Mexico are low, labor productivity gains lag the OECD average. By making work contracts more flexible and specifying that productivity rather than seniority should be the main criterion for determining an employee’s suitability and eligibility for a position, the new legislation aims to make the workforce more competitive.

Tax evasion in the formal economy and tax avoidance in the informal sector are costing the government an estimated $50 billion in revenue a year and this means Mexico has one of the lowest tax intakes among OECD countries. By making it easier for companies to hire and fire workers, the new law encourages firms to create more jobs, which in turn would increase Mexico’s tax take.

REFORMING EDUCATION: BREAKING UNION’S HOLD

The education reform, passed by Congress in February 2013, has major implications for the future of Mexico’s economy. Mexico’s dismal education system has long acted as a brake on economic development. Mexican students’ test scores are amongst the lowest of the OECD’s Program for International Student Assessment (PISA).

The primary obstacle to improvements in education has been the tight control wielded by the National Union of Education Workers (SNTE) over education policy, staffing, and funding. Indeed, the SNTE was in control of all teachers’ hiring and firing; the union repeatedly blocked any attempts to administer any evaluations of teachers’ performance; and all too often teaching posts became hereditary or could be bought from union power brokers. The might of the SNTE was such that the government had no official records of the number of teachers in Mexico.

To the surprise of many, Mexican prosecutors arrested the longstanding leader of the SNTE, Elba Esther Gordillo, in February on charges of embezzling $150 million of union funds. Gordillo has traditionally been the main obstacle to any educational reforms and her arrest dealt a political blow to the union just as the government introduced its education reform in Congress. The ambitious education reform purports to upend the entire education system by setting out clear merit-based guidelines, implementing mechanisms for evaluating and improving teacher performance, and improving school quality and the student environment.

LIBERALIZING TELECOM: BREAKING UP MONOPOLIES

Perhaps one of the most exciting of Peña Nieto’s reforms is the telecommunications reform, which the lower house passed in March 2013 and the Senate is expected to approve by mid-2013.

Mexico’s telecom market has long been dominated by two main players: Carlos Slim’s América Móvil, with 80 percent of landlines and 70 percent of mobile phone and broadband connections; and Emilio Azcárraga’s Televisa, which has 70 percent of the national free-to-air market and half of pay-TV subscribers. In 2012 the OECD estimated that the lack of competition in telecoms cost Mexico’s economy $25 billion a year, due to high prices for broadband and calls from fixed lines to mobile phones. The reform, which Mexico’s finance minister says would increase the economy’s annual growth rate by 1 percent, intends to increase competitiveness in the sector by allowing greater foreign ownership and introducing new competitors into the market.

Mr. Peña Nieto’s government intends to set up an independent regulator with the authority to assign licenses and charge stiff penalties to firms that control over 50 percent of their markets. This could force Televisa and América Móvil to divest, creating more opportunities for both domestic and foreign investors. The reform would allow 100 percent foreign ownership of telecom companies (it is currently limited to 49 percent), and up to 49 percent foreign ownership of broadcast media networks. The new regulator could also implement asymmetric connection fees (charging market leaders higher interconnection rates than their small rivals). The reform would also create two new national television networks by holding an auction from which Televisa and its smaller competitor, TV Azteca, would be barred. Finally, the new legislation would force content providers to offer their programs to all cable-TV firms, and cable-TV firms would have to carry the shows of all content providers.

The telecoms reform creates opportunities even for the current dominant players, as both América Móvil and Televisa have been aiming for a slice of the other’s market. While facing potential losses from increased competition and price cuts, they both stand to profit from increasing their shares in markets now closed to them.

ENERGY AND FISCAL REFORM

The most highly anticipated of Peña Nieto’s announced reforms are the energy and fiscal reforms, which he is likely to try to push through before the 2015 mid-term elections. The energy reform seeks to realize the vast and largely untapped potential of Mexico’s oil and gas reserves. Pemex, the state-owned oil and gas monopoly, hands over most of its profits in taxes to the state. This prevents the company from investing in new technology or optimizing production, which has led to a gradual decline in oil production since 2004 and forced Mexico to begin importing petrol and natural gas from the United States.

While Mr. Peña Nieto has ruled out privatizing Pemex, many hope that the energy and fiscal reforms will, on the one hand, allow private investors to enter into risk-sharing contracts with Pemex for deep water exploration (half of Mexico’s oil is in unexplored deep waters), shale gas, and refining; and, on the other hand, allow Pemex to reinvest more of its profits as the government weans itself off oil revenue and relies on a greater tax intake.  This is why the administration argues that any changes in the energy sector must go hand in hand with fiscal changes. The most likely approach would be to introduce a value-added tax on food and medicine (which are now exempt) and undertake a new social-security reform to ensure more Mexicans emerge from the informal economy and contribute to the public safety net through social security taxes.

Mr. Peña Nieto’s reforms have the potential to open up attractive new business opportunities and spur greater foreign investment in Mexico. If the new administration can build on its early reforms and open up the energy sector to private investment while restructuring its public finances, Mexico is sure to attract more attention from international investors and become a top investment destination.

Guillaume Corpart is the Managing Director of Americas Market Intelligence and a veteran of Latin American competitive intelligence and strategy consulting.


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