Manuel Sánchez: Mexico's reforms progress and economic outlook
Remarks by Mr Manuel Sánchez, Deputy Governor of the Bank of Mexico, at the 2015 Institute
of International Finance (IIF) Latin America Economic Forum, Busan, Republic of Korea,
28 March 2015.
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I would like to thank the Institute of International Finance for the invitation to participate in this
conference. It is an honor to share the panel with such distinguished speakers and to be in
South Korea, an economy that has shown extraordinarily rapid development in the last few
decades, achieving the level of an industrialized nation in an amazingly short lapse of time.
Mexico has benefited greatly from economic ties with South Korea. In particular, this country is
the second most important source of investment from Asia to Mexico, especially in
manufacturing, commerce and mining, and it is also a significant trading partner.
In this talk, I would like to touch first on structural reforms recently undertaken in Mexico and,
second, comment on Mexico's economic outlook. As usual, my views are entirely my own and
do not necessarily reflect those of the Bank of Mexico or its Governing Board.
Mexico's progress on structural reforms
Mexico has embraced an ample program of structural reforms encompassing labor, education,
the financial system, telecommunications, and energy, among other areas. The general aim is
to promote greater market flexibility, investment in both human and physical capital, and
competition, thereby boosting total factor productivity growth, the stagnation of which has
inhibited long-term overall economic expansion.
Legislative changes necessary for the reforms have been passed by Congress, and the country
is currently in the process of implementing them. Challenges are inherent in this task. As all of
us know, the effectiveness of reforms anywhere in the world rests heavily on the details.
Today, I would like to bring you up to date specifically on the telecommunications and energy
reforms, given the essential role these sectors play in the overall economy and consumer
wellbeing.
The telecommunications sector has been characterized by limited access and high cost. In both
telecoms and broadcasting services competition has been scant, with each sector dominated
by one company.
In particular, the privatization of the government telephone operator more than two decades
ago transferred exclusive fixed-line rights to one buyer, without adequate regulation favoring
serious competition. In the following years, new providers of telecoms services encountered a
playing field that was not at all level. While some price reductions occurred thanks to incipient
competition, services remained expensive and their quality low by international standards.
The telecommunications reform seeks to remedy these problems by facilitating greater
competition and, until an acceptably competitive environment is achieved, by clamping
restrictions especially on dominant players, defined as those companies with a market share
greater than 50 percent in telecoms or broadcasting, or those judged by the regulatory authority
to have significant power in specific market segments.
To promote competition, barriers to the entry of new players were reduced. Now, 100 percent
foreign ownership is permitted in telecoms and 49 percent in broadcasting. Also, licenses
generally allow operators to offer a broad basket of services, provided that certain
nonconcentration requirements are met. In broadcasting, two new national digital television
networks have recently been granted through a public bidding process.
In the case of telecoms, the new law eases customer mobility across operators. For example,
they have to unblock handsets when contracts expire or the consumer pays for the equipment.
Also, operators must implement portability for fixed and mobile telephone numbers within
24 hours of receiving the request and free of charge.
To regulate market power in the overall industry, several measures have been undertaken.
First, the new Federal Telecommunications Institute has authority that includes the sphere of
competition. It will be helped by the fact that some legal recourses previously used by operators
to circumvent the former authority's resolutions indefinitely are no longer allowed.
Second, a price restriction has been imposed on all telephony operators in the form of the
elimination of national long distance fees, which in a world of digital networks and the internet
were increasingly obsolete.
Third, an asymmetric regime containing price and activity caps applies to dominant players, as
long as they continue to be deemed as such. Notably, the main fixed and mobile telecoms
provider cannot charge other operators for calls and text messages terminating in its network.
This mobile operator is not allowed to charge fees to customers when they receive calls while
outside their local service areas, nor can it price discriminate when customers call other
companies' phone numbers. The dominant player must also allow the sale and resale of mobile
services to other concessionaries and the leasing of the last-mile network. It cannot offer TV
services.
In broadcasting, the dominant firm must allow competitors the lease of its infrastructure and
cannot buy exclusivity for audiovisual content considered significant. This broadcaster is not
permitted to own capital in the dominant telecoms provider.
This reform has already yielded benefits. A declining trend in relative telecoms prices has
deepened, and service providers have increased the variety of packages offered. In fact,
competition between operators focuses increasingly on the speed and quality of data services
provided through both fixed and mobile means. Another encouraging sign is the interest of
international players in the Mexican market.1
To turn to our second focus, the energy sector has also suffered from high prices and
frequently, insufficient supply. Crude oil production has been declining continuously since 2004.
Inadequate pipeline infrastructure has limited lower-price gas imports, as well as lower-cost,
more efficient distribution. Electricity prices in Mexico remain well above those in its key trading
partners.2
Behind these problems lie decades of state control, with little or no benefit from outside
participation. The energy reform seeks to confront this reality by allowing private participation in
virtually all aspects of the sector. This includes public bidding for oil and gas exploration and
production contracts, and permits for production of oil products and petrochemicals, transport,
storage, distribution, and sale of hydrocarbons and hydrocarbon products. Also, permits are to
be granted to generate and sell electric power, as well as import electricity using Mexico's
National Electric System.3
The reform contemplates a wholesale market for the purchase and sale of electricity, with retail
operations also possible. Electricity transmission and distribution remain in the hands of the
state, with the outsourcing of private contractors permitted.
As to oil and gas exploration and extraction, four different types of contract are on offer, namely
licenses, profit-sharing, production-sharing, and services. In the first three, private companies
can register the value of the expected profits backed by the contracts on their books.
In the wake of the so-called round zero in which Pemex applied for certain fields and was
allocated some of them, the first round of public bidding has begun. Two auctions have been
announced, one for exploration and production, and another for production only, both in
shallow-water oil fields under production-sharing contracts. The auction allocations are
expected in a matter of months. Fiscal and economic conditions in the contracts have been
revised according to suggestions by auction participants, and in accordance with recent
developments in oil markets. Three additional phases of this round will ensue, with the types of
extraction increasing in level of difficulty or cost.
Additionally, contracts have been auctioned and awarded to deliver gas in private pipelines,
including a pipe from Texas to Chihuahua and another from Chihuahua to Durango. The first
permit granted to a private agent to import electricity from a power station connected
exclusively to the National Electric System has also been conceded.
Significant foreign and domestic private investment could potentially materialize in this new
environment. The changes should eventually allow more efficient energy-sector production and
lower domestic gasoline and electricity prices through competitive markets.
The economic outlook
The Mexican economy shows signs of moderate recovery after a slowdown in 2012. The upturn
is driven by industrial production, with manufacturing taking the lead, fueled by exports to the
United States. Construction has recently picked up as well, while mining is still faltering, due
mainly to oil production, on the decline since 2004.
Domestic spending has also improved somewhat, with private investment showing more
strength, and consumption gains unable to obtain traction. Analysts' consensus forecasts for
this year and next call for the economy to gradually pick up steam, pulled by positive
U.S. performance.4
Downside risks to the growth outlook include continued stagnant consumer confidence, the
potential impact of social unrest, and possible further reductions in the oil production platform.
Mexican financial markets face two challenges. First, the sharp fall in crude oil prices since last
summer has made the country's fiscal position weaker, since oil still accounts for approximately
one-third of budgeted public-sector revenue. In view of the most likely scenario that oil prices
remain low for some time to come and the decreasing oil production trend, the federal
government recently sent investors a sign of fiscal responsibility by announcing cuts to 2015
budgeted spending, amounting to 0.7 percent of GDP, despite the fact that oil revenue for the
year is almost fully hedged.5
Second, the U.S. Fed is widely expected to begin normalizing monetary policy this year.
Volatility has hit the Mexican foreign exchange market, with the peso depreciating significantly,
along with most other world currencies. However, the adjustment in Mexico has been orderly,
with abundant liquidity prevailing in market operations.
Furthermore, during 2015, holdings of peso-denominated government bonds by nonresidents
have remained stable. While somewhat higher than last year, interest rates continue to be
relatively low for all terms. Nevertheless, as U.S. monetary policy normalization is around the
corner, some portfolio adjustment and further bouts of volatility cannot be ruled out. Therefore,
financial authorities must remain on watch.
So far in 2015, inflation has returned to a path of convergence with the Bank of Mexico's
3 percent permanent target, after a year of straying due to temporary factors such as tax hikes
and agricultural price pressures. The recent decline in inflation has been supported by the
disappearance of the effect from last year's tax increases and fading pressures from
agricultural prices, along with lower key telecoms and electricity prices.
The better inflation performance must be maintained. Upside risks include more significant
pass-through from a weaker peso down the road, as well as the resurgence of spikes in
noncore inflation prices and eventual aggregate demand pressures. Close monitoring of these
risks is all-important in view of the fact that analysts' long-term inflation expectations remain
above the 3 percent target. Sustained convergence with the target must be consolidated.
Final remarks
Mexico is on a path that should help take it to the resolution of fundamental issues obstructing
productivity and long-term growth. In particular, recent telecoms and energy reforms seek to
foment investment and competition in these sectors, which may boost the efficiency of the
economy. The degree of success of these and other reforms should be defined in terms of
enhancing the economy's potential. This will depend heavily on the quality of implementation, in
the sense that these reforms actually lead to greater market flexibility and investment, and
generate substantially effective competition.
Moderate cyclical economic recovery in Mexico is underway on the back of stronger U.S.
performance. Persistently lower oil prices and upcoming U.S. monetary policy normalization
pose challenges to both Mexico's economic upturn and markets. Further volatility cannot be
excluded, and thus the authorities must remain on alert.
Finally, inflation has recently fallen to the Bank of Mexico's target. However, convergence to
this objective must be consolidated so that it becomes a permanent phenomenon.