Mexico's second-half push: facing slow growth and stalled reforms, President Vicente Fox must buckle down to save his administration.

More evidence that the economies of Mexico and the United States are closer than ever: Car buyers enjoying zero-percent interest rates at dealerships kept auto sales--if not necessarily production--afloat on both sides of the Rio Bravo.

Interest rates in Mexico have dropped to historic levels, hitting 4.3% on 28-day government bonds at the beginning of August 2003. Car sales, meanwhile, defied sluggish growth in the first three years of the millennium, rising by 9.7% in 2001 and 6.4% last year when 977,558 vehicles were sold, according to the Mexican Auto Industry Association. Figures for the first half of 2003 indicate car sales will top the million mark this year, putting Mexico in the elite club of the world's million-new-cars-a-year nations.

The limping recovery and low interest rates put car sellers on both sides of the border in an unusual position. Instead of giving away the car but selling the financing, they suddenly found themselves back in the car business, giving away the credit instead. "The auto industry was very aggressive in marketing. Companies were letting people buy cars on credit with zero interest rates," says Edgar Camargo, head of economic research at the Bank of America in Mexico. "Nobody had ever seen that before in Mexico."

Much like the United States, cars aren't enough. Mexico's gross domestic product (GDP) grew by a slim 0.9% last year after shrinking by 0.2% in 2001. Economists remain pessimistic about growth this year. Analysts polled by LATIN TRADE predict the economy will expand by just 1.9% in 2003, less than two-thirds of the government's original target.

Economic observers are cautiously optimistic about Mexico's medium term, however, forecasting 3.6% growth in 2004, which tracks forecast U.S. economic growth point by point. "The new financial stability makes Mexico an attractive place for investment," says Esteban Rojas, an analyst at Mexico City's Arks brokerage. "Mexico is in pretty good shape to grow when the U.S. economy takes off."

The most visible effect of the stagnant economy is the shortage of new jobs, a grave problem in a nation where an estimated one million people enter the workforce each year. Many young people feel their only options are to enter the informal economy or migrate to the United States.

Particularly bad for Mexico has been the slump in U.S. manufacturing of the last few years. A large part of Mexico's development in the 1990s was in assembly plants, owned by parent companies n the United States, which made prodacts exclusively for the U.S. market. When things slowed down in the United States, the Mexican factories were the first to suffer.

Bad timing. Mexican President Vicente Fox's critics blame the government for the lack of growth, but economic analysts say slow times are the result of external factors outside of the administration's control. "Fox had the bad luck of coming into office just two months after the recession started in the United States, in October 2000," says Jonathan Heath, chief Mexico analyst for the consulting firm LatinSource.

Reports for the first two quarters of 2003 show that while there is a general recovery in the U.S. economy, the manufacturing sector is still lagging. "Mexico doesn't just need the U.S. economy to recover generally. It needs the U.S. manufacturing sector to recover," says Cuauhtemoc Gonzalez, head of economic research at CEESE a private-sector think tank funded by Mexico's Business Coordination Council.

Despite the lack of growth, Fox has achieved levels of financial stability unheard of in Mexico. He filled top positions in the Finance Ministry and Central Bank with U.S.-educated professionals who have strong financial backgrounds, often chosen for their expertise over their loyalty to the president or his party, National Action (PAN).

The technocrats running the economy have squeezed liquidity out of the market. Inflation, which often ran in triple-digits during the 1980s and was still as high as 18.6% in 1998, dropped to 5.7% last year. Banco de Mexico has set an inflation goal of 3% for 2003 with a 1% margin of variance. Analysts began the year predicting the Central Bank would be way off the mark; over time, they have shifted their forecasts to be in line with the government's target, to 3.9% on average.

Analysts say the services and construction sectors will grow this year too. They also believe the manufacturing sector should expand in the medium term but say that with the competition of cheap unskilled labor in the Far East, particularly from China, growth will be almost all in skilled assembly--a boon for ordinary Mexicans, if the country can train them fast enough.

"There is always going to be role for manufacturing in Mexico, but it is critical to move up the value-added food chain," says Deborah L. Riner, chief economist at the American Chamber of Commerce of Mexico. "There is a need for highly skilled individuals that bring more knowledge to the workplace."

For growth to really spiral upward, there needs to be structural reforms, particularly in fiscal, energy and labor law, economists say.

A complicated and inefficient income tax system means Mexico has one of the lowest levying rates in Latin America, recuperating only 11% of GDP. To fund the federal budget, the government bleeds state-owned oil company Petroleos Mexicanos (Pemex) of over half its revenue, taxing it US$27.1 billion of its $46.7 billion income in 2002. Pemex is subsequently strapped for cash to upgrade its technology, expand its operations, and exploit Mexico's natural resources.

Recent Pemex investigations into gas fields around the Burgos Basin in the northeast of Mexico, for instance, concluded they have the potential to produce 1.4 billion cubic feet of natural gas a day. But Mexico instead is importing natural gas and using expensive fuels such as diesel to generate electricity, making the private sector pay through the teeth for power. Factories have begun to shut down as rising energy prices make it uneconomic to continue operating.

Pemex has offered contracts to big private oil firms to help it explore and exploit the Burgos Basin. Companies including Shell, British Petroleum, Exxon Mobil and ChevronTexaco have shown interest in the tenders.

Up in arms. However, some legislators are up in arms about the proposed contracts and have called on the Supreme Court to declare them illegal. Mexican ownership of energy resources is equated with national sovereignty and safeguarded by the Constitution, which defines them as having strategic national interest.

Business lobbies, meanwhile, are calling for an amendment in the Constitution to allow foreign investment in the energy sector that can give cheaper power to the private sector. They are also campaigning for a change in labor laws to create a more flexible workforce. Companies argue current legislation restricts them from hiring as they have to take on hefty obligations to employees, such as paying at least three months back-pay to anyone they lay off.

Fox has promised to introduce new legislation in these areas since his 2000 election campaign. But the president failed to make alliances with the opposition parties that dominated Congress and nearly all the PAN's bills were blocked or rewritten. "If Mexico wants to get growth of 6%-plus we are going to need a solid tax system, cheaper power and a more flexible workforce," says Alberto Equihua, chief economist at Coparmex, the Mexican Employers Federation.

And there's the rub: Fox's political support is slipping at a crucial moment. When Mexicans went to the polls on the showery Sunday of July 6 they dealt a hefty blow to the PAN. Three years after the charismatic cowboy and former Coca-Cola executive won the presidency, ending 71 years of one-party rule, his party has lost nearly a quarter of its seats in the lower house of Congress.

Pundits called the election a referendum on Fox's leadership and say the results showed major disillusionment with his administration. "We must redouble efforts to successfully face the demands of citizens" a shaken-looking Fox told the nation in a television address after initial vote counts. "[We must] eliminate marginalization and strengthen employment."

The debate is open as to whether the new Congress will play along. Fox's PAN holds 151 of the 500 seats in the lower house. Some commentators speculate that the former ruling Institutional Revolutionary Party (PRI), which holds 222 seats, will help Fox come up with the votes he needs to pass reforms nearly every analyst believes are essential. They have their eye on the next presidential ballot, in 2006.

Skepticism remains strong. "Hoping the reforms will be passed is wishful thinking," says Equihua. Of course, many were surprised at Fox's ascendance after so many decades of PRT rule. The CocaCola cowboy, bolstered by growth to his north, could surprise them again.