Costs, and benefits?

Luis Rubio

The president is pushing quickly ahead on all fronts. In the economic sphere, he has neutralized, dismantled or weakened practically all the entities designed to regulate investments and the functioning of markets, including electricity, hydrocarbons as well as the boards of directors of the state’s “productive” enterprises and the development banks. Even before being inaugurated, he had already canceled the new Mexico City airport and announced the construction of projects of doubtful economic viability, such as the Dos Bocas refinery and the Mayan train. Each of these actions has implications for the federal budget and for the credibility of the government in its economic management and, nonetheless, has had no apparent cost. The president has, de facto, challenged the financial markets and economic orthodoxy without his decisions showing any negative consequences on the most obvious variables, starting with the exchange rate. The question is why.

The urban legend tells has it that when the current president was preparing to announce the cancellation of the airport, his main economic advisors warned him about the possible consequences of his decision, the first being a depreciation of the exchange rate. The president nonetheless went ahead with the announcement and absolutely nothing happened. On the contrary, the peso appreciated after the announcement, which, according to the rumor mill, discredited his advisors and strengthened the president’s conviction that his decisions are being accepted as necessary, as the product of sensible and reasonable moral and political considerations.

But President López Obrador’s decisions have been anything but sensible and reasonable. Worse still, his project for the concentration of power is advancing without pause, sweeping not only the feeble counterweights that were built over the past decades, but even threatens to follow the same path with respect to the Supreme Court of Justice. The eagerness to rebuild an almighty presidency continues unabated.

Emboldened, his cabinet adopts positions and determinations that affect contracts and practices that are common around the world, as exemplified by those related to the supply of gas to the CFE, Mexico’s utility, which stipulate that the company must pay for gas, whether it takes it or not. This practice (embedded in the respective contracts) is the way in which the private investors that paid for the construction of the gas pipelines recover their investment. That is, there is nothing exceptional about it and it’s key to the provision of electricity.

The bottom line is that the government has been modifying institutional structures, changing contracts or threatening their alteration, thus creating a highly uncertain environment for new investments. Who would want to risk their capital when the rules of the game are susceptible to being changed at any moment? Investors require certainty that the authorities’ ways of proceeding are predictable and reliable, since no one would invest in an unpredictable environment.

However, even though uncertainty grows and its sister cousin, distrust, is beginning to appear, nothing seems to affect the environment of apparent calm and stability, especially the exchange rate.

This has no precedent. In the past decades, every time a government even vaguely mentioned any change in the rules of the game, the effect would manifest instantly in the value of the peso against the dollar; none of that has happened in these months. The reason for this is very simple: stability does not come, as the president believes, from his own actions and honesty, but from financial agents abroad, who continue to buy Mexican government bonds.

They do so under two premises: first, because of the interest rate differential that Mexican bonds are paying, which, being higher than 5%, makes them very attractive. Second, those investments follow the signals of the rating agencies, which have maintained the government’s paper at investment grade. Nobody knows how long the latter will remain true but, as long as this does not change, portfolio investors will keep their appetite in these instruments. That is to say –a paradox for an administration that calls itself nationalist-, the stability of the government has become absolutely dependent on the financial markets.

In 1992, George Soros speculated against the British currency and humiliated its government. The feat was huge: The United Kingdom succumbed to the attack of a private actor when it presided over the then-called European Community, and then had to leave the ERM, the European Exchange Rate Mechanism, with its tail between its legs. Paul Lepercq, a keen commentator, wrote at the time that the matter had been so dramatic that, had it happened a century earlier, the financier would have been beheaded.

Financial markets are not guided by moral considerations: they only take advantage of arbitrage opportunities. As soon as the internal and external realities come together -which will inexorably happen- the broken dishes will show and, with them, the accounts receivable.