July 9: Setting things right in Mexico

Judging by the response of investors last week, both local and international business is ecstatic about the result of Mexico’s election – a close win for Felipe Calderón, the candidate of President Vicente Fox’s centre-right National Action Party (PAN). Mr Calderón, they will argue, understands better the mainly micro-economic obstacles that are depressing Mexico’s potential. His party will be the biggest in both houses of congress and with the Institutional Revolutionary Party, the machine that ruled Mexico for 71 years until its defeat in 2000, weakened and divided, he is in a good position to negotiate a congressional alliance to support his programme.

Yet it is important that Mexico addresses the complaints raised by Andrés Manuel López Obrador, the defeated left-wing candidate. Mr López Obrador is organising demonstrations to back up his case. Marchers will assemble at points in 300 electoral districts on Wednesday before converging on Mexico City. And next Sunday Mr López Obrador’s supporters will repeat last Saturday’s protests in the Zócalo, Mexico City’s main square. But Mr López Obrador will press his case through legal channels.

And although the federal electoral institute can order a manual recount only in specific legal circumstances, the federal electoral court does have more extensive powers. A full recount would be the best way to satisfy all Mexicans that the vote was fair. Whatever the merits of their case, millions of Mr López Obrador’s supporters believe that their candidate was the victim of foul play. Their complaints must be taken seriously. Mexico has a long history of vote tampering and electoral fraud, and although much has improved in recent years, millions of Mexicans are still suspicious of the integrity of the electoral machine. As one Mexican editorialist put it this weekend to “ridicule or demonise these aspirations is to invite dissidence through non-legal channels.” (For a full range of views see the the Washington Post’s blog.)

Legitimacy could be a particularly serious problem because the vote was so divided along regional lines. With the PRI failing to win one state in the electoral race – and finishing in third place in most places – Mexico is now split in two. In the better-off north (the region that has benefited more from closer economic integration with the US in recent years), Mr Calderón was very dominant. But Mr López Obrador won overwhelmingly in Mexico City and the poorer south. There, Mr Calderón won only in Yucatan.

In the longer-term a reform of electoral rules to allow second round run-off would help Mexico resolve similar situations in a less stressful way, since it would be likely to produce a clearer majority for one or other of the leading candidates. In the short term, a full painstaking manual recount is going to be the only way to ease tensions.

Varig still limping along

There have been yet more delays in finding a solution for Varig, Brazil’s flag-carrying airline under creditor protection with at least R$8bn in debt. Creditors were due to meet this week to approve or reject a rescue offer from VarigLog, the airline’s former cargo subsidiary sold in January to a group backed by Matlin Patterson, a US distressed equity fund.

Had creditors approved the offer, Varig would again have been offered at auction in what would have been little more than a formality (a previous auction on June 8 failed to find a buyer).

But the creditor meeting was cancelled after Deloitte Touche Tohmatsu, hired by the judiciary to manage Varig’s creditor protection programme, severely criticised VarigLog’s offer. Deloitte said the offer, which would inject about $485m into Varig in exchange for 90 per cent of its shares – and leave a rump company with the debts and just 5 per cent of the “new” Varig’s shares – would be a worse deal for Varig’s creditors than declaring the airline bankrupt.

Expect more to-ing and fro-ing as VarigLog tweaks its offer. Meanwhile, Varig is being forced to cancel more and more flights each day and its fleet is dwindling to a handful of aircraft. Without a solution soon, it must surely go under.

Venezuela and Mercosur

How Mercosur is changing – albeit not quite in the way that its critics have been demanding. With all the fanfare that has accompanied Venezuela’s triumphant accession to the South American trade bloc, there is little escaping the fact that it is still riven with imperfections and asymmetries. Overall, the prospect of a completely unified regional market – the vision that inspired its creation 15 years ago – is still some way off. Venezuela’s adhesion makes this goal even more distant.

Yet – ironically perhaps – in the short term at least Venezuela’s entry could help ease tensions in the pact. The reason? Venezuela’s oil and its president’s largesse. The pact’s malcontents – Paraguay and Uruguay – have complained bitterly about their treatment, and are even demanding permission to make free trade agreements with other countries, given the prohibitive access to markets in their own backyard. In an interview with the FT last week, Paraguay’s president, Nicanor Duarte Frutos, accused Brazil and Argentina of selfishness and hypocrisy for their protectionism. Meanwhile, Uruguay and Argentina are locked in a legal battle in the International Court of Justice in The Hague that Mercosur was unable to solve – a ruling is due next week to decide whether Uruguay should suspend the construction of two controversial pulp mills on its border with Argentina that are bringing greatly needed investment to its economy. Venezuela money could help offset those concerns. Paraguay’s Mr Duarte is already asking Venezuela to buy $3bn of its debt with Brazil from the transnational Itaipú hydroelectric project at cut-down interest rates.

More Chavista financial engineering

Nowhere is Venezuela currying favour more effectively than in Argentina. In the last year it has bought over $3bn of debt from the Argentines, who are delighted to take advantage of President Hugo Chávez’s willingness to buy their debt at below-market rates. Now, a novel scheme has been dreamed up whereby the two countries plan to issue a joint bond, which President Néstor Kirchner has proudly hailed as the “Bond of the South”. Such an instrument would be virtually without precedent in international capital markets – although the US has guaranteed bonds issued in Israel and Egypt in the past.

The idea is that Venezuela would take care of actually issuing the bond, thereby securing better yields because of its lower risk rating and also the ability to be traded on international markets. For now Argentina is unable to issue debt in a foreign country without risking the seizure of funds by the “hold-out” investors who did not enter the restructuring deal last year. But the fine print of the instrument has yet to be hammered out, and analysts confess to being confused as to how it would work. Technocrats in Argentina’s finance ministry are said to know no better, although they have two or three months to come up with something, by which time officials have said the bond will be ready. Some $2bn is expected to be issued this year.

The implications are intriguing, not least for what is understood by “sovereign risk”. A kind of “regional risk” may be in the making – while this could be the first step towards grand designs to establish a pan-continental bank.

And Venezuela’s link-up with Colombia

Mr Chávez is meanwhile also keen to build energy links with Colombia, despite ideological differences between the two governments and despite the fact that earlier this year Venezuela left the Andean Pact (the pact it had formed with Bolivia, Peru and Ecuador as well as Colombia). Construction began at the weekend of a 230km pipeline that within a year will carry 150m cubic feet per day of gas from Colombia’s Ballenas field in the La Guajiraregion to Venezuela’s Lake Maracaibo area. Eventually, in about fiveyears, when the Colombian gas field dries up and if Venezuela gets its act together to develop its huge natural gas reserves, the flow of gas is expected to reverse. An extension of the pipeline could then deliver gas to Panama.

The $335m bilateral project is an example of how two leaders in the region are able to let pragmatism and economic common sense over-ride political differences.

Notes by Richard Lapper, Adam Thomson, Jonathan Wheatley, Benedict Mander and Andy Webb-Vidal Edited by Richard Lapper.

richard.lapper@ft.com