Mexico’s next leader faces gaping budget hole

Soon after Mexico’s new leader puts on the presidential sash in October, she — for it will probably be a woman — will have to contend with one all-encompassing issue: how to pay for her plans.

The two leading candidates, former climate scientist Claudia Sheinbaum and self-made businesswoman Xóchitl Gálvez, have said they don’t think tax hikes are needed.

Yet the winner — and polls show the ruling party’s Sheinbaum holds a comfortable lead — will have to face slashing the largest budget deficit since the 1980s, after current President Andrés Manuel López Obrador abandoned austerity and went on a spending spree.

The economic in-tray will also include turning around the world’s most indebted oil company and converting investor interest into concrete projects. All that while dealing with a sensitive revision of Mexico’s trade agreement with the US and Canada, which has become a major economic motor for the country.

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After years of austerity, López Obrador, a nationalist and leftist, has ramped up social programmes and his signature infrastructure projects, including train lines and an oil refinery.

Figures released on Thursday showed weak first-quarter growth and a slowdown in activity in March with inflation accelerating.

Hitting next year’s deficit target of 3 per cent of GDP will require cuts equivalent to almost 3 per cent of GDP or new revenue.

Around one-third of that may come from the big projects ending, experts say, but the rest is unclear. Sheinbaum and Gálvez have both vowed to expand social programmes, with the former promising 150 new schools and the latter suggesting the government should pay for private health services.

“It’s going to be very complicated,” said Alejandra Macías, director of Mexican economy and public finances think-tank CIEP. “There’s lots of promises that really we shouldn’t believe . . . where will they get the money to pay for those promises?”

The most urgent priority is Pemex, the state oil company with a $100bn debt pile and negative free cash flow. After decades as Mexico’s cash cow, the firm is increasingly dragging on the budget and investors and analysts agree it needs to radically change its business plan.

Rating agency Moody’s said this month that addressing Pemex’s need for cash was crucial for the sovereign fiscal outlook.

The company has a bloated workforce, a poor governance and safety record and analysts say it does not have the capital or expertise to fully exploit Mexico’s remaining oilfields. López Obrador halted sharp increases in its debt, but oil production is at record lows and his aim of “energy sovereignty” has cost billions.

“The problem is very serious,” said Carlos Elizondo, a professor at the school of government at the Tecnológico de Monterrey university and a former independent Pemex board member. “The government can no longer finance these businesses . . .[or] we’ll have problems paying for other things.”

Gálvez has said she would sell some lossmaking refineries. Sheinbaum rejected that idea but has given little detail about how she would turn the operation around.

The next leader will also face rising pension costs that are now eating up one-fifth of the budget. The bulk of that is from worker pensions but in 2019 López Obrador also introduced a universal payment for the over 65s, now worth 6,000 pesos ($361) every two months.

That payment and other social programmes are key to his 55 per cent approval rating. He has also more than doubled the minimum wage over six years. Taken together, these policies have led to a more than 7 percentage point drop in the poverty rate, according to the government’s poverty measurement agency.

But growth per capita has been flat during his six-year term, despite huge interest from companies seeking to diversify supply chains away from China. To change that, Mexico’s next leader will have to confront problems that worsened during López Obrador’s rule, such as insecurity, a lack of clean energy and water, and creaking roads and ports.

“Mexico should be a leveraged play on US growth, because it’s got a cheaper workforce,” said Graham Stock, Emerging Markets Sovereign Strategist at RBC Bluebay. “It’s not seizing that opportunity because of low productivity and infrastructure bottlenecks.”

Sheinbaum has said she would plan 100 new industrial parks, roads and electricity generation projects. Gálvez has said she would implement an industrial policy focused on linking international supply chains to local ones.

In 2026 the next leader could have to defend USMCA, the North American free trade deal, against a second Trump administration, though observers believe President Joe Biden will also be tougher on Mexico if he wins a second term.

Sheinbaum has said she aims to get 1 per cent of GDP in new income from digitising tax collection and updating the technology at customs, a tall order for next year. The government has also been looking at ways to squeeze more revenue from corporates like banks.

Analysts agree that many of Mexico’s short-term economic issues have solutions, from encouraging private investment in infrastructure to paying down some of Pemex’s debt.

But the fate of the US economy — where Mexico sends three-quarters of its exports — is an added variable which could force the next leader to make more pragmatic decisions.

“It’s a pretty complex panorama,” Luis de la Calle, an economic consultant and former free trade agreement negotiator, said. “[But] that complexity also helps, because with more complexity, there’s more of an incentive to do things the right way.”