LatinFinance sat down with Mexico’s Minister of Finance and Public Credit, Rogelio Ramírez de la O, for a wide-ranging conversation mid-March that touched on the impact of the Ukraine war on emerging markets and the global economy, the global interest rate cycle, Mexico’s economic forecast and the country’s sustainability agenda, among other things.

The following transcript has been edited for length and clarity.

LatinFinance: We are witnessing today a war involving a major power, which is also at the center of the global commodities markets. How bad could the knock-on effects be of the war in Ukraine and how concerned are you about the economic spillover effects for emerging markets and for Mexico, in particular?

Rogelio Ramírez de la O: The outlook in and of itself was already difficult for emerging markets before the situation in Ukraine because of the outlook for Fed rate increases. Needless to say, this has always been a big blow on all of the markets, but particularly emerging markets. This is especially true at the time when the Fed has for a very, very long time been with artificially low rates. I mean ‘artificially’ in the sense that they were forced below their levels by quantitative easing of proportions unimaginable in any prior event. That by itself is enough to make the emerging markets outlook appear more difficult. It would be foolish to argue to the contrary. The situation in Ukraine only makes it slightly worse because it brings about a series of inflationary shocks.

Image: Rogelio Ramírez de la O

Of course, independent of the fact that some emerging markets could have a positive impact because they are commodity producers, even then, on the whole for emerging markets, it seems that the current cycle, for as long as it lasts, is going to represent a challenge. It can only make emerging market governments sharpen their strategies, to be aware of what the risks are around the corner, and to be careful with debt management and fiscal policy.

  “I can’t imagine rates moving up for too long and to too high levels, because the signs of economic weakness are going to appear again around the corner in a very short period”   

Emerging markets in general terms would have to have conservative fiscal policies, especially those – and some of our peers in Latin America – that use debt to some high proportion of their capacity. As soon as we turn around and we see the need for fiscal consolidation, in some cases, and they also have to be conservative in terms of monetary policy. All of this is at a time when unemployment levels are high and the level of social demands haven’t been satisfied and the real sector of the economy has suffered the impact [of the pandemic] that hasn’t yet been overcome.

Therefore, we need to be realistic. We have ahead of us a period of uncertainty that demands extra careful attention to market events and to our own policies. We are doing that in Mexico: we are being very conservative in what we aim for in terms of fiscal policy. Our central bank has gone ahead and hiked interest rates, and we expect them to maintain, relatively speaking, a conservative stance, as it has always done.

LF: Other things being equal, all signs point to a sharp slowdown for the global economy as soon as the second quarter of this year. Do you agree with this assessment? How bad could it get? And how justified are fears of 1970s style stagflation?

RDLO: Before the Ukraine situation, we had already seen that fiscal, monetary and real economic cycles had become a lot shorter than they used to be. The cycles began and ended within much shorter windows of time. This was a reminder that authorities, especially the monetary authorities, were over-using monetary policy at both ends: as a booster when the recovery started and then as a corrector as they saw inflation – or sometimes the markets even themselves corrected ahead of the authorities.

So, the business cycles today are very, very short. Remember that in the US, by 2016 there was stagnation and then by 2020 we saw the need to change course. In between, we saw an election in the US that led to a supply-side problem because there were tax reductions and there was a positive response by markets to the new agenda. Then very quickly it changed course and the changes in course were very abrupt and forced central banks to act while at the same time they have been over-exhausting their arsenal for policy. They have now exhausted their capacity to move rates down. They have capacity to move rates up. But for the same reason that cycles are so short I can’t imagine rates moving up for too long and to too high levels, because the signs of economic weakness are going to appear again around the corner in a very short period. So, for that reason, because the world economy was really in a relatively feeble state, expecting a long inflationary cycle isn’t justified by the fact that economies, once the monetary stimulus is removed to any significant extent – we’re not even talking about removing the whole of what it received, the economies would most likely weaken again and that by itself will depress prices.

I’m afraid we have to expect very large corrections. Before prices and inflation come down stock markets and other asset markets will probably have to suffer because, otherwise, how would consumption fall when it is so highly correlated with asset prices, particularly in those markets like the US or the UK, where the asset price component is very strong in the consumption function?

So therefore, I think that we will not be right in saying that this is just a copy of the 1970s cycle, which was a very different thing.

  “We would have extra revenue from crude oil exports which can be used to offset the cost of the gasoline price subsidy at the pump. They would cancel each other”  

LF: What concrete effect will the current geopolitical turmoil have on your macro forecasts for the year? How do you expect the current situation to impact growth expectations for the year?

RDLO: Well, growth expectations for the year 2020 were already impacted for the same reason that I was describing: the shortness of the business cycle. Remember, we were all bouncing back in activity at very high rates in the year 2020, and the year 2020 didn’t even end when we were already on a downward course. That by itself frustrated our own assessment of the year 2021. In terms of growth, we were expecting growth 6.1% at the time that we submitted our expectations embedded in the budget for the Congress in September. This was a realistic assessment of the growth outlook, 6.1%. But then Mexico grew 5% instead. This is, of course, at the same time that Mexico has been making changes in several sectors and approaches. One of them probably explains 90%, if not all, of the difference between the 6% and the 5% outcome. But nonetheless, the fact that the economy was already on a reversal from the high bounce that we had during the first half of 2021 meant for 2022 we have this legacy, at least for the first quarter, where we see the contraction signals, or at least stagnation signals.

Having said this, we see the rest of 2022, in Mexico at least, on a more constructive path from the third quarter onwards, that is, setting aside – and this is a big setting aside, but I have to do it for the purpose of analyzing this with some kinds of method – the degree of the problems in Ukraine, because we don’t know how long we should be factoring that in. For the second quarter onwards in Mexico, we continue to see the continuation of the recovery that was interrupted in the second half of 2021. I’m not even talking about really surpassing the previous levels by a high degree, though we will surpass it. But this is mainly the continuation of a cycle that was interrupted in second half of 2021. We expect for 2022 not to be similarly disappointed when we see the final figure. We’re at the point of preparing our pre-criteria for economic policy that has to go to Congress and it will be not right for me to drop a figure here when Congress is going to expect the official forecast, but I will say it’s higher than the consensus of bank analysts and other analysts are forecasting today. We are looking at this in a more constructive way with good reasons to do so.

LF: You’ve mentioned the tools at the disposal of the Mexican central bank to fight inflation. What additional measures will the government consider helping in the battle against rising prices?

RDLO: We’ve been doing a fair deal of work here with respect to energy prices.

President [Andrés Manuel] López Obrador, ever since he started campaigning, has been very consistent that energy prices were very high in Mexico and that was probably one of the reasons why he saw the energy sector in Mexico as a sector that merited very special attention. When he was elected in 2018, he had already committed to capping the gasoline price at the pump for no more increases above the inflation rate. He gave himself this scope to adjust up by the inflation rate measure. In the previous years the gasoline prices have been high, quite enough for us to maintain higher prices at the pump than in the US. That, for us, was a good basis for us to commit to the capping of the gasoline prices at no more than inflation. This was sufficient for us to be able to still maintain an excise tax and positive revenue on the excise tax on gasoline for 2019, 2020 and 2021.

In 2022, even that provision of an excise tax that had been calculated previously based on the low oil prices of about $50-$60 per barrel has been destroyed by the facts. Now we have to commit fiscal resources to honor the cap. The level of the special tax on gasoline has already been exhausted. We are now bringing extra resources to cope with the pressure on gasoline prices. As we import two-thirds of gasoline consumed in Mexico, obviously we are importing the impact in the US gasoline market. We produce the other part of the gasoline supply domestically with our own oil and our own refining. Because we have a relatively low lifting cost for oil, and the processing and so on and so forth, the cost would be lower than the US cost. As we do not input market pricing into the price for the oil that is processed – or it would not be if we input the international market price for oil into the price – so it’s really up to us how we input. However, our [oil] state enterprise, Pemex, would insist in pricing the oil that gets processed at market prices, rather than hard costs, as they call it.

All in all, even if we did some management with the domestic processing of the gasoline and the accounting of the costs, we still need to use the proceeds from the higher crude oil price accruing into our export bill to use it as a cushion against our cost of capping the gasoline price.

This is now in the high order of the agenda, it’s the first time that we may make it such an explicit hedge to be used. It’s a natural hedge. But it’s the first time that we use it in such an explicit way. On the calculations that we’ve done so far, it matches one to one – that is, we would have extra revenue from crude oil exports which can be used to offset the cost of the gasoline price subsidy at the pump. They would cancel each other, to some extent, or to a very large extent. This would mean that whatever the windfall gain from the crude oil exports, it is going to be injected into consumption.

This would also help it will help with inflation with the Bank of Mexico’s reading of inflation and how much they have to react to that. And it will also help with social stability. Another lesson that we’ve learned, not from our own experience, but by looking at other countries in Latin America, is that whenever we want to think that we can move gasoline prices freely, we’re wrong. We’re going to have a much more costly situation in terms of social instability if we tamper with a situation like that, in such a fragile social situation.

LF: Mexico plans to raise some 3.76 trillion pesos (around $182 billion) in aggregate in both in local and international markets this year to cover the financing public sector borrowing needs, including Pemex debt. To what extent is that amount likely to have to be readjusted taking into account rising prices and, if so, if an adjustment is necessary, how much do you anticipate having to adjust the funding needs?

RDLO: No, we’re not going to adjust it. It’s been tailored, first of all, to the needs and to the overall fiscal balance within a specific numeric target. We want to be very strong about meeting that target because it has become identified with the true commitment and the conviction of this president that we have today in Mexico.

To the extent that we need to do extra funding, it will be in the peso market. We want to encourage more peso market funding. But for the overall aggregate of external and domestic financing for the public sector, which is mostly under budget control, we are not planning to amplify the level of debt intake in either of the two markets. In the external $3.8 billion dollar funding plan we don’t anticipate changing any of that.

Mexico is a large issuer and it’s a large participant in the markets. Its policy for debt management has historically been very visible, but we are also in several instances leading the way for SOEs [state-owned enterprises] in Mexico, and other issuers, to help them through the difficult chapters of debt reissuance or debt refinancing to be able to cope with difficult market conditions whenever this happens, which is more often than not.

We have met investors in London and in New York. We’re also meeting with some of the ratings agencies, trying to explain and to help them understand what Mexico’s agenda is with respect to both policy and debt management.

To briefly explain, Mexico has a target for debt stabilization to GDP. This debt target has been considered an ambitious one, especially during the pandemic, where we were able to cope successfully with – probably a record in Latin America – not taking on debt to the extent that other countries did, which let our debt ratio to be maintained at 50% of GDP, which we consider sustainable through the end of this administration, which is 2024.

The definition of the objective of debt stabilization is central to the President López Obrador’s agenda, partly because he sees this as strong identification card of principle and fiscal rectitude. We are trying to optimize other items in the fiscal agenda in order to make them consistent with such an ambitious objective.

We want to have some more new items on the agenda of debt issuance, particularly SDG [sustainable development goals] bond issuance which we think is very high in the minds of investors and regulators all over the world. For these particular bonds, we want to push for an inclusion of social objectives, apart from the green objectives which everybody shares. We see that the United Nations inclusion of social objectives in its broad definition has given us the background that we need to press for social objectives within bond issuance.

LF: On the topic of SDG and ESG-linked bond issuance, is the ESG bond program ready and how much would you expect to be issued under this program this year?

RDLO: We have already issued SDGs. We want to insert the word ‘S ‘within the acronym [ESG] because we’re strong with social programs, and these social programs are in line with the United Nations definition, that is green social financing poverty, health, education. A number of programs of the government are focused on those developments, including planting trees in the southeast on a very large scale, or using scholarships for poor students, attending to a sector of disabled young people, strengthening the school system with grants whereby the communities would administer the grants, and so on and so forth, so it’s a variety of highly regarded aims to contribute towards improving social equality.

On that agenda, we are going to push for a greater inclusion of the social aims into the taxonomy of sustainable bonds. We have already done two bond issues in euros for US$2.3 billion. We have capacity in this agenda to do $22 billion social, green, sustainable bonds. We obviously can’t use all of that capacity at once, but we are in a clear mind about what we can do and how we would like to do it. We will be careful with debt management, but, overall, this is a new field where we think we can deploy greater attention and probably be ahead of some of our peers in devising ways to include this bond issuance as a different category, a new category in the market.

LF: When it comes to ESG issuance the sovereign has been something of a trailblazer but there are nevertheless concerns that we hear from investors that the administration is doubling down on fossil fuels, rather than embracing efforts to fight climate change. Do you think enough is being done to bring renewable energy front and center of the agenda in Mexico? What more can or should be done in this regard?

RDLO: I think the perception is probably wrong only because it derives from very specific actions that received press attention, whereas the whole approach to energy in Mexico has been more holistic. One of the first actions of this president was to re-equip our dams that were neglected as producers of hydro energy. We have a program to re-equip – and I’m saying ‘re-equip,’ for the last 25 years they were not taken care of with the appropriate turbine equipment, so we are now ordering turbine equipment in order to maximize the use of hydroelectricity. This is state-generated.

We use coal to a very minor degree. Our coal use is 4% for energy generation, whereas the US is 19%. We only used coal, for example, last winter in 2021 when Houston froze and we were unable to transport gas. We mobilized fuels that have not been used in order to keep generation going. We did not have the problems of blackouts that you saw elsewhere, because we were able to mobilize that. We were able to do so only with one company, the state company that had been taken aside during the electricity reform that was aimed at reducing the participation of this state company within the electricity generation. That was the one driver that we had available to mobilize and all what is available to generate and to keep the generation.

These are markets that don’t really lend themselves to easily to market forces and pricing in the market at all times because someone has to be responsible for guaranteeing the public service at all times, not just the market. For that reason, our approach to energy is a pragmatic approach. We definitely want hydro energy when we are using more geothermal energy, which is the cleanest ways to generate. We still regard our high dependency on gas fuel energy – something that we have to still maintain because gas is, relatively speaking, compared to other fuels, a polluter. But, nonetheless, we see our transition towards fully clean energy on a much longer time scale than would probably be considered desirable in other minds.

However, we do not neglect the importance of renewable energy. We want to reinforce the message here that our electricity state entity has already issued a green bond because it’s committed to the turbine equipment in the hydro plants, and it has at least one plan for a large solar generator in the north of Mexico. We are blessed by strong sunshine in the north of Mexico, and we will take advantage of it, but we have to be realistic. We have to be careful in how much resources we have and how we combine them, because we must not forget that solar and wind energy are not producers when we have cloudy days, or we don’t have enough wind. Someone has to stay there next to them to be ready to generate when there’s no sunshine and when there’s no wind. That has a cost, it requires capacity, it calls for someone to be there and to have the investment ready.

  “We are going to push for a greater inclusion of the social aims into the taxonomy of sustainable bonds”   

LF: Is there a need to your mind for a more clearly articulated ESG or sustainability strategy for Pemex?

RDLO: Yes. I mean, it’s always the case because Pemex has a legacy of a completely diversified platform. It has been a vertically-integrated company from the extraction of crude oil and gas to the final chain of refined products. It used to be even more than that as it used to do chemicals. It’s no longer aiming at chemicals, because that capacity was not maintained, and it would be very costly to recreate that from scratch now. But still, for the refining part of the business, it still has a legacy of fixed capacity in large amounts that needs to be modernized and used. In as much as we would not like to depend on imported gasoline for such a high proportion of our consumption, which I think it would be a good idea for a country as big as Mexico geographically and in population not to depend so heavily on imports of gasoline if it is the producer of the oil. And so, yes, there is a need.

Pemex is beginning to take care of that agenda. It’s doing it while it is also coping with other problems, as you know: the financial issues for Pemex, and the offsetting of the fall in the large fields production, where the pressure has nearly disappeared. The agenda is very difficult – not impossible, but it’s difficult and it’s costly. But it has started with a new refinery. It is investing in a coker that would reduce fuel emissions that would be the way for other refineries. It is an agenda that would need time, but it is being addressed in Pemex now and, as far as we are concerned – we are members of the board, we don’t have the chairman position, but we are members of the board in Pemex – we voice the need for a more balanced energy source mix.

LF: How is what you’re doing in the ESG arena going also help private companies do the same thing? What is the government doing to support the private sector in its ESG plans?

RDLO: We are in close contact with the banking community, and we also speak with the nonbanks. We are, for example, quite interested in the fintech sector because we regard it as a vehicle to include small savers. We think it deserves to be put under lighter regulation, to the extent that we can guarantee that things are well built.

We think the private sector is aware of what the different categories are in the market for differentiating one company from another. To the extent that we have them in our public sector contracts or in our public sector deals, we regularly keep a check list of to what extent they are aware of the need to cover these new areas in bond issuance. Though I have to be clear that we can’t force anyone to think in any particular direction at any particular time. We confide with them, and we think that they’re going to be doing the right thing because we’re all in the same world of communication and we’re all receiving the same message coming across. This is a very strong message coming across. Mexico, especially being the neighbor [of the US], which has a very high regard for best practices, will not escape the private sector, will would not pretend that it hasn’t heard the message.

LF: What is the strategy of the federal government to increase foreign direct participation in the energy sector?

RDLO: I think it’s an open ticket, to be very frank with you. We have had issues with some foreign participation in specific contracts that, in our view, would be very hard to explain in their rationale. If it had been all [contracts] it would not have mattered, except that the cost of those contracts were gravitating on the budget. They began to hurt and that’s why we addressed some contracts and that’s the approach we keep doing.

It’s not just the forum participation in the energy sector, it’s also foreign participation in other contracts. For example, we had to renegotiate and PPPs for prisons whereby we were paying for the service – in the model of the PPP you pay for the service at a certain full capacity and if it doesn’t get full you still pay for it – and then the cost of paying for it was, if I recall well, higher than a Four Seasons stay for a prisoner. So, we had to do these revisions, these renegotiations. We did it all in an open dialogue, it’s ongoing and that’s the approach we are following. This is the model we will follow and in this and other cases.

LF: There’s been quite some disruption in the banking sector over the last year. Are you concerned about potential drag on the economy from the top end of the banking system, with the sale of Banamex, to the bottom end with nonbank financial institutions where there have been billions of dollars of defaults already?

RDLO: We have had our initial share of some of these nonbank institution situations. What we see is that they were unregulated. To my own surprise, some of these institutions – for example, granting payroll loans – had the choice of being regulated or unregulated. This was a silly thing, obviously shocking to see. Obviously, what would you prefer? To be regulated or unregulated? Obviously, you choose not to be regulated. And then they blow up.

We’re not going to rescue anyone. We have set the line. We’re very sorry that these situations occur. We’re going to tighten the regulation. We will probably put a special focus on payroll loans. But so far what we’ve seen is it’s better that they learn with the example of their peers going to the laundry rather than with the example of someone coming to rescue them on grounds that were common in the past. We are familiar with some cases, and we think – at this point, with the information that we have at this point – we don’t need to be specifically alarmed by that because it’s a sector that was not under our regulation and it’s a sector that, in some instances, can have a new owner.

LF: Thank you.