Can Fox Deliver on His Promise?

MEXICO CITY —  New President Vicente Fox is taking over a fast-growing economy fueled by rising foreign investment, a stable peso, cooling inflation and a balanced government checkbook.

Who could ask for more?

Fox himself does, and therein lies the risk as the former Coca-Cola executive, who took office Friday as the first opposition party president to rule Mexico in 70 years, embarks on his six-year term. He has promised to take the Mexican economy to greater heights, despite worrisome conditions looming beyond his borders and formidable political obstacles at home blocking the legal reforms upon which growth depends.

“Expectations are 12 feet high,” said economist Walter Molano, a Latin America specialist with BCP Securities in Greenwich, Conn. “There is a big possibility of a letdown. He’s going into a situation where there is no precedent.”

Indeed, the whole world is looking on--hoping Fox will avoid the economic disasters that typically befall Mexico’s incoming chief executives. More important, observers hope he will prove to be the leader Mexico needs to finally deliver on its economic promise and elevate it from the ranks of poor nations.

To do so, Fox and his cabinet will need prodigious political and management skills to tackle pressing problems in crucial industries, notably, shortages of bank credit and electricity and turmoil in telecommunications and the foreign-owned maquiladora factories.

The newly installed president may soon have to deal with a drop in crude oil prices, which would significantly hurt Mexico, a major oil exporter. The doubling of crude prices over the last two years has helped the government get its fiscal house in order. A drop, which many oil experts expect next year, would undermine that happy circumstance.

Most ominous, Fox will face the consequences of a slowdown in the U.S. economy, where growth is expected to drop to 3% or less from this year’s 5%. That picture is darkening by the day as American consumers slow their spending, business trims investment and stock prices tumble.

This will almost inevitably lead to less investment by U.S. companies in Mexican factories and offices and a shrinking of the U.S. appetite for Mexican exports--the main engine of this country’s economic boom.

Fox and the central bank also must keep a close eye on the peso, which many observers say is overvalued by as much as 15%, exacerbating a major Mexican economic vulnerability: its growing trade deficit.

In short, it won’t be easy to meet those sky-high expectations.

For now, all signs are go. In fact, the Mexican economy is healthier than it’s been in 30 years, said Alfredo Coutino, a macro-economist with the Ciemex-WEFA consulting firm in Philadelphia. Fox is the first president since the 1960s to enter office amid economic, social and political tranquillity, Coutino said.

The economy will expand by 7% this year, and official unemployment--which understates the actual joblessness--has dipped to a historically low 2%. “Everyone who wants to work can find a job in Mexico,” said Jonathan Heath, chief economist at LatinSource, a consulting firm in Mexico City.

The Mexican inflation beast for now is tamed, with consumer prices expected to rise an average of less than 9% this year, down from 12.3% last year. Inflation could dip as low as 7.5% next year. Six years ago it was in the 50% range.

Unlike many of his predecessors, Fox sets up shop at Los Pinos--the stately presidential palace near Chapultepec Park--with no foreign creditors pounding at the door. In fact, the country’s fiscal accounts have improved so much that it is the only major Latin American country to enjoy the World Bank’s “less indebted nation” status.

But Fox built his victorious presidential campaign on promises that Mexico’s growth and prosperity will not just be sustained, but accelerated and broadened under his watch--promises that many economists warn could prove difficult to deliver.

Fox says he will create 1.25 million jobs a year by spurring foreign investment to $20 billion annually from the current $13 billion, for example. But the slowdown in the United States--the main source of Mexican direct investment--will probably inhibit, not accelerate, job growth.

“Mexico will have less of a boom if the U.S. economy slows down. The money will stop coming,” said Guillermo Estebanez, an economist with Bank of America’s foreign-exchange unit in San Francisco.

Fox has promised sweeping education initiatives to deal with another big weakness--the scarcity of skilled and semi-skilled labor. Peter Greer, an auto analyst with A.T. Kearney in Detroit, said the shortage is hitting Mexico’s rapidly expanding auto industry hard and could inhibit future investment if not addressed.

The skilled-labor shortfall is also starting to translate into double-digit wage inflation in the retail and manufacturing sectors, said Heath of LatinSource.

“Mexican engineers are as good as any in the world. There’s just fewer of them,” Greer said.

Whatever form Fox’s education policies take, Greer and others fear it could take years for them to produce significant numbers of better-trained workers for the employers that need them.

Continued economic well-being also hinges on reforms that Fox must shepherd through an opposition-controlled Congress to liberalize foreign investment in electricity, banking and oil and gas refining, all daunting tasks.

Mexico faces a critical need for more electric power plants and the natural gas supplies to fuel them, said Eduardo Lopez, Latin America specialist at Petroleum Finance Co. in Washington. Since Mexico cannot afford to finance the additional power capacity, it must liberalize investment laws to let foreign money do it, Lopez said.

But such moves could require constitutional amendments, Lopez noted, initiatives that face stiff opposition from competing parties and labor unions that equate foreign investment in Mexican energy with loss of jobs and national sovereignty.

Meanwhile, the volume of bank loans in Mexico has shrunk each year since 1995--a huge obstacle to the development and growth of small and medium-size businesses. Fox should try to jump-start the moribund bank and mortgage lending industry, said Coutino of Ciemex-WEFA. Again, relaxing the restrictions on foreign investment is touted as the answer.

Although the Mexican telecommunications industry has made big strides in broadening the availability of service, the country still has among the fewest phone lines per capita in Latin America.

Fox can help by re-energizing the Cofetel telecommunications regulatory agency, which has not done enough to spur competition, and reduce the dominance of Telefonos de Mexico, or Telmex, the former state-owned monopoly, said Chris Neal of Boston-based Pyramid Research.

Specifically, Fox should try to settle a U.S. complaint against Mexico before the World Trade Organization in which U.S. carriers AT&T; and WorldCom say that Telmex charges anti-competitive interconnect fees on local and long-distance calls. Both carriers have lost millions trying to penetrate the Mexican market, Neal said. In the process, competition that would enhance phone service has been impeded, the Americans say.

Fox also has floated an ambitious plan to lure new maquiladoras away from the U.S.-Mexico border area to Mexico’s interior. It remains to be seen how Fox will accomplish that at a time when maquiladoras, the foreign-owned factories that make products for export, are howling about higher taxes and threatening to move to Asia.

John H. Christman, director of maquiladora services at Ciemex-WEFA’s Mexico City office, said Fox can do that by reducing taxes and paying for roads or other needed infrastructure for companies that agree to locate in the south.

“We certainly hope Fox takes a proactive, pro-business approach to the industry. The current administration has not helped,” Christman said.

So one way or another, many of Mexico’s answers--and questions--lie north of the border.

The looming U.S. slowdown threatens what many consider Mexico’s most serious economic vulnerability, a growing current account deficit, which is the sum of the trade deficit added to the cost of foreign debt.

Encouraged by a strong peso, Mexican consumers are snatching up imported goods at an even faster rate than exports are leaving the country. That creates a currency imbalance that the government must finance, which was easy to do this year because of the flood of oil dollars and the continued stream of foreign investment.

It was a galloping current account deficit that helped trigger Mexico’s 1994 peso devaluation and ensuing economic crisis. Most agree that Mexico is in significantly better economic shape today and less vulnerable to such turmoil.

Yet a drop in crude oil prices next year and the slowing of foreign investment could force the Mexican government to borrow to finance the trade deficit, taking on debt that could jeopardize its hard-won economic stability. This could also jeopardize Fox’s ambitions social-spending programs.

“Fox has promised a lot of stuff, and he wants to expand social spending. But if oil revenues go down--and no one is expecting them to go up--he will have to increase taxes by a similar amount. . . . We will see how he gets there,” said BofA’s Estebanez.

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Fox’s Mexico

With the economy growing, inflation on the wane and a pro-business Cabinet, Vicente Fox has free-market solutions in mind to elevate Mexico from the ranks of poor nations. But the problems are enormous, including a tradition of suspicion toward foreign investment. Admirers say Fox, free from the grip of the country’s old ruling party, might be the one to pull it off.

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MEXICO’S ECONOMY

Inflation is falling ...

2000 (third quarter): 8.9%

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... and the GDP is rising.

2000 GDP (third quarter): 7.0%

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KEY CABINET MEMBERS

Treasury

Francisco Gil Diaz, ex-CEO of Avantel, tax official

Labor

Carlos Abascal, headed employers council

Economy

Luis Ernesto Derbez, ex-World Bank economist

Energy

Ernesto Martens, airline, glass executive

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A FEW TASKS FOR FOX

* Autos: Attract auto-parts factories to supply the booming foreign-owned auto plants and create a domestically owned industry. Provide training for technical workers.

* Maquiladoras: Attract more foreign-owned export plants to Mexico’s job-hungry interior to narrow a geographic wealth gap with the north.

* Banking: Enact legal reforms that will spur banks to make loans, offsetting the lack of bank credit that has stymied development of small and medium-size businesses.

* Energy: Let foreign investors help build the power plants Mexico desperately needs and introduce competition to the petrochemical and refining industries.

* Telecommunications: Free telecom regulators from the influence of former monopoly Telmex to lower phone rates, foster competition and improve the paltry number of phone lines per capita.

Sources: LatinFocus, Ciemex-WEFA research, Times research