FACTBOX-Key political risks to watch in Mexico

By Kevin Gray

MEXICO CITY, May 3 (BestGrowthStock) – Raging drug violence, a
tepid economic recovery, flagging momentum on economic reforms
and declining oil output are all risks to watch for this year
in Mexico, which needs to keep up investor confidence to
maintain its debt ratings and emerge from recession.

DRUG WAR

Since President Felipe Calderon came to power in late 2006
and launched an army-led campaign against drug traffickers, he
has had some success in removing cartel leaders, but turf wars
between rival gangs have spun out of control, worrying
Mexicans, foreign investors, tourists and the U.S. government.

The last four months have have been the deadliest of
Calderon’s rule with some 2,800 drug murders, and a jump in
civilian deaths is beginning to chip away at public support for
his army-led crackdown. [ID:nN2212185]

The drug war death toll since Calderon took power now
stands at almost 23,000 and the violence is intensifying as
drug hitmen have targeted government officials in some states.

In one recent incident, the police chief for the western
state of Michoacan barely survived a well-coordinated attack as
she left an event with the state governor. A truck blocked the
road as armed gunmen launched grenades and shot at her convoy
with rifles powerful enough to pierce her bulletproof car.

U.S. President Barack Obama strongly backs Calderon’s drug
war and is providing Mexico with more than $1 billion in
funding to train police and buy anti-drug equipment and
helicopters.

The drug war has not hit Mexico’s peso or bond yields and
despite daily reports of daylight shootouts, beheadings, and
even terrorized border towns [ID:nN25214985], polls show voters
are more concerned with economic issues than drug crime.

However, some foreign companies are starting to reconsider
future investment plans, [ID:nN25249751] and Mexico’s key
tourism industry is also under pressure. [ID:nN13234162]

Two months ahead of elections in nine states, Calderon’s
popularity is near all-time lows and his party is trailing the
opposition Institutional Revolutionary Party, or PRI.

Most Mexicans support the drug war but the longer the
bloodshed goes on, and the worse it gets, the weaker Calderon
looks and the more he risks losing support for his government.

Recent incidents where groups of minors were killed sparked
street protests blaming Calderon for failing to curb the
violence. Calderon admits that whoever wins the presidential
election in 2012 will still be facing off with drug gangs.

What to watch:

— Any escalation in intimidation tactics such as murders
of senior officials or deliberate attacks on the public.

— Companies scaling back investment plans because of
security concerns.

— More protests or signs that Calderon is losing support.

FEEBLE ECONOMIC RECOVERY

Mexico’s economy is rebounding from a deep recession last
year that saw the economy contract 6.5 percent and force the
government to slash public spending and raise taxes.

The government has raised its 2010 growth forecast to 4.1
percent from 3.9 percent, and the central bank is eyeing growth
as high as 5 percent. [ID:nN28182579]

Economic growth was less than expected in February as the
service sector declined. [ID:nN27116241] Mexico has renewed a
$48 billion credit line with the International Monetary Fund
and is also building up a war chest of dollar reserves to ward
against pressure on the peso when the United States starts
raising interest rates. [ID:nN18246645]

Unemployment is only just starting to edge back from
14-year highs, which is weighing on consumer confidence and
spending, along with the tax hikes. [ID:nN25190729]

Some analysts worry that Mexico’s recovery will be slowed
if the U.S. economy — which buys most of Mexico’s exports —
falters. Mexico is already lagging behind the likes of Brazil,
whose economy is more balanced around commodity importers like
China and benefits from stronger domestic demand.

Mexico is still bruised from getting sovereign debt
downgrades last year from two credit ratings agencies, leaving
Mexico only one notch above the lowest investment grade.
Fitch and Standard & Poor’s said they were concerned about
Mexico’s public finances given declining crude oil output and
dismal prospects for passing any far-reaching fiscal reforms.

Calderon hoped a flurry of infrastructure projects like
roads, bridges, ports and airports would give the economy some
momentum but most, like a planned new $6 billion port on the
Baja California peninsula, have yet to get off the ground.

As it tries to stoke growth, the central bank will need to
be vigilant on inflation, which rose to 5.06 percent in the
year through March, due partly to tax hikes and higher fuel
prices. [ID:nN24159336]

To help stimulate an export-led recovery, the bank may also
look to keep the peso from appreciating to ensure local
exporters remain competitive. [ID:nN06583990]

What to watch:

— Any dimming of the government’s growth outlook.

— Gloomier views on the U.S. economy this year.

— Any sign that high unemployment is sending more Mexicans
across the border illegally, straining U.S. relations.

STRUCTURAL REFORMS

Investors are impatient for Mexico to pass significant
reforms to boost its low tax take, relax labor laws and allow
more foreign investment in the state-controlled oil sector.

Calderon looked nimble on the legislation front early in
his term, passing moderate pension, fiscal and energy bills,
but since his party lost mid-term elections last year he is
seen unlikely to be able to push anything substantial through
the opposition-led Congress for now.

Investors want to see deep overhauls to energy laws and
reforms to weaken monopolies in other industries. The antitrust
proposal, however, may struggle in Congress. [ID:nN12134584]

Since last year’s credit rating downgrades by Fitch and
Standard & Poor’s, the government is under pressure to do
something to boost investor confidence for the year ahead.

What to watch:

— The details of any government tax reform proposal and
how the opposition-led Congress receives it.

— Signs of opposition parties taking lead on new reform
initiatives in order to benefit should they win power in 2012.
— Any revisions to credit outlooks from rating agencies.

FALLING OIL OUTPUT

Mexico’s oil production, a boon for the country in the
1980s and 90s, has slid drastically in the last few years, with
output down nearly a quarter from 2004 peaks, due mainly to a
lack of new projects to replace the flagging Cantarell field.

Output fell for the fifth straight year in 2009, and while
it has stabilized in recent months, production is expected to
continue to slide in the medium-term. [ID:nN127124903]

The government says it will pump an average 2.5 million
barrels per day in 2010. But some analysts fear another decline
this year if output at state oil monopoly Pemex’s flagship
Chicontepec project remains sluggish. Government regulators
have urged Mexico to cut its Chicontepec oil and gas production
forecasts by a third. [ID:nN16157981]

Mexico’s prospects for starting production in the crucial
deepwater oil sector look dim. [ID:nN11209249]

A top exporter to the United States, Mexico relies on oil
to fund around a third of the federal budget. The decline in
output and exports was a key factor behind last year’s debt
downgrades.

A 2008 law was supposed to open the door to lucrative new
contracts to bring foreign oil companies into Mexico’s oil
industry for the first time in decades, to boost deepwater
exploration efforts and output for unconventional fields.

But more than a year later, the contracts have been stalled
by a legal challenge with the Supreme Court by the lower house
of Congress. Energy ministry officials say the planned new
contracts will remain under wraps until the court rules in the
case.

What to watch:

— Any resolution to the court challenge to new contracts.

— Any deep sea oil finds by Pemex, which has yet to
confirm seismic tests indicating large amounts of deepwater
reserves.

— Further declines in Pemex’s monthly oil output data or
bleaker government forecasts for the coming years.

Stock Trading
(Editing by Kieran Murray)

FACTBOX-Key political risks to watch in Mexico