By Michael O'Boyle
MEXICO CITY (Reuters) - Investors frustrated with years of gridlock on economic reforms in Mexico now believe the best chance for progress lies with the party that has done most to prevent change over the last decade.
Enrique Pena Nieto of the opposition Institutional Revolutionary Party, or PRI, has a commanding poll ahead of the presidential election in July and, if its support holds, the PRI could win the first ruling party majority in Congress in 15 years.
Pena Nieto, 45, has pledged an ambitious reform agenda that backs some of the very policies his party has blocked since 2000, when a victory by the conservative National Action Party, or PAN, ended seven decades of PRI rule.
The reforms include boosting tax revenues and allowing more private investment in the state-run oil industry. The failure of Mexico's political leaders to reach a deal on those issues is blamed for holding back the economy.
Growth has averaged about 2.2 percent during the past eight years - barely half the rate for Latin America and the Caribbean as a whole.
Investors say failure to liberalize the labor market, improve a paltry tax take and attract more foreign investment could condemn Mexico to years of weak growth and threaten its credit rating.
They hope that PRI leaders who blocked reforms over the past decade will push them through if they win back power.
"The PRI knows good and well that this is going to blow up in their faces," said Alonso Madero, who manages $4 billion in fixed income assets at Actinver in Mexico City.
"Eventually it will be in their interest to approve many things they rejected in the past," he added.
STRONGER PESO EYED
The PRI currently holds just under half the 500 seats in Mexico's lower house. But it only has a quarter of seats in the 128-member Senate due to a poor showing in 2006 elections.
A clear victory for Pena Nieto next year could restore to the PRI the congressional majority it lost in 1997. Ever since then, bickering between Mexico's three major parties has scuttled a host of economic and political reforms.
Legislative inertia sapped confidence in President Felipe Calderon's PAN, which has been battered by a drugs war that has claimed more than 45,000 lives in the last five years. The PAN could still mount a strong campaign in the presidential election but is very unlikely to win a majority in Congress.
Provided it ousts the PAN, the PRI could change its position and back a value-added tax on food as part of a wider overhaul of public finances.
"If they want to hold onto the presidency for a couple of terms, it's clear they need to do something different to move the economy in the right direction," said Will Landers, the head of BlackRock's $8.5 billion Latin American equity fund.
The risk of a fresh economic slump in the United States, where Mexico sends nearly 80 percent of its exports, makes the need for reforms in Mexico even more pressing.
Polls show Pena Nieto with a big lead over his rivals although the gap has narrowed this month as he has stumbled with a series of gaffes.
If Pena Nieto does win, J.P. Morgan economist Gabriel Casillas expects Mexico's peso currency to rocket back by about 18 percent next year to 11.80 per dollar, spurred by a wave of inflows into bonds and stocks due to optimism on reforms.
Behind Pena Nieto's campaign is Luis Videgaray, a protege of former finance minister Pedro Aspe, who helped lead a reform drive in the 1990s. Videgaray is respected by investors who see him as Pena Nieto's likely pick for finance minister.
During Aspe's time, Mexico became a emerging-market darling, negotiated the North American Free Trade Agreement and privatized pension funds. But investors have since turned their attention to faster-growing economies like China and Brazil.
WEAK TAX TAKE
Mexico's weak tax revenues have been a major worry, and past administrations have chosen to bleed the state-run oil giant Pemex rather than levying new taxes.
With nearly a third of the economy off the books and ample corporate loopholes, Mexico has one of the lowest tax takes in Latin America. Excluding oil income, the state collects taxes worth around 11 percent of gross domestic product.
Oil revenues fund nearly a third of the federal budget and the country's dependence on finite crude supplies was the main reason credit rating agencies downgraded Mexico in 2009.
Pena Nieto devoted a whole chapter of his new book "Mexico - la gran esperanza (the great hope)" to fiscal reform, pledging to simplify taxes and expand the taxpayer base.
He has yet to offer details of his plans, but argues that a shake-up could bolster Mexico's economic potential and fund an overhaul of its ailing justice system.
"For these transformations to become reality, a bigger public budget is needed," Pena Nieto wrote.
Doubts still linger about whether the 45-year-old will be able to carry out his reform plans, with his calls to open up Pemex to private investment in exploration, production and refining likely to face strong opposition from unions.
Since Mexico nationalized the oil industry in 1938, public support for the policy has helped shield Pemex and its bloated workforce from allegations of corruption and inefficiency.
"Pena Nieto is promising a lot of things he will not be able to deliver when it comes to private investment in Pemex," said Mexico City political analyst Fernando Dworak.
(Additional reporting by Miguel Angel Gutierrez; Editing by Dave Graham and Kieran Murray)
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