By Rodrigo Campos and Noe Torres

NEW YORK/MEXICO CITY (Reuters) – Mexico’s judicial reform has triggered investor concerns about uncertainty over the rule of law and the strength of the government’s institutions, yet with the reform now priced in, some analysts argue there may be buying opportunities forming.

Latin America’s second-largest economy – a bellwether for emerging market sentiment more widely – has found itself at the maelstrom of international and domestic politics that has inflicted considerable pain on its financial markets.

Last week, the Senate passed the reform that will change the structure of the judicial power by shifting the appointment of judges from nomination by the executive to popular elections.

The Morena-led government – which won a landslide victory in June for President-Elect Claudia Sheinbaum – has pushed for the reform, saying it will address corruption and inefficiencies in the justice system. Its critics say the reform could politicize the administration of justice and drive away investors with institutional uncertainty.

“Any departure from the traditionally held views that Mexico benefited from strong institutions – that’s a big change,” said Trang Nguyen, global head of EM credit strategy at BNP Paribas.

“So it’s U.S. election risk, U.S. growth risk, and Mexico risk. That’s not an easy combination for investors to handle.”

Mexico’s equity market is down over 9% this year at local index level, and nearly 20% in dollar terms compared to a 6.2% gain in the wider emerging market stock index.

Dollar bond spreads at 335 basis points continue to be wider than its Latin American peers by some margin, with Brazil coming in and 222 bps -with Peru and Chile even tighter.

The Mexican peso, having been among the best performing currencies globally versus the dollar earlier this year, has suffered a rapid demise. The currency touched a two-year low above 20 per dollar and has tumbled near 12% since the June election, on track for its largest yearly decline since 2016.

And there might be more pain to come. Citi last week posted a trade with a target of 21 pesos per dollar over the next month.

“With this (judicial) reform, the Mexican government sends a worrying signal about Mexico’s institutional fragility, putting at risk the relationship with our commercial partners, the flow of capital and economic growth,” Coparmex, Mexico’s largest employers’ organization, told Reuters in a statement.

The reform “would affect key projects for our economy,” the organization said.

Credit rating agency Fitch warned the approval of this and other reforms, if implemented, “may negatively affect institutional quality and Mexico’s checks and balances.” 

Some warn the ramifications could be felt well beyond the country’s borders.

Marco Oviedo, senior strategist for Latin America at XP Investments, said the reforms may contravene principles of the trade agreement between Mexico and its top two export markets, the U.S. and Canada (USMCA), which is up for review in 2026. In case of disputes, it won’t be independent institutions who will get to rule on any issues, but government entities, Oviedo said.

“We would need a lot of luck, or the government would really have to change course for this to be corrected,” he said.

The economy ministry told Reuters this judicial reform “does not contravene Mexico’s obligations under the USMCA,” while incoming Secretary of the Economy, Marcelo Ebrard, told reporters “all investments are protected by law in Mexico, there is no provision in the judicial reform that could put a (single) investment at risk.”

“I see no reason to think that there will be an impact on investments,” he said.

The perception of the rule of law in Mexico has been low for decades, according to the World Bank’s world governance indicators, which gives little room for any drop to significantly alter the framework for investors.

Still, developments in other countries haven’t stopped investors from throwing cash at emerging markets.

“Concern over democracy and politically-compromised courts has not deterred a generation of investment in low-cost manufacturing locations such as China, Vietnam, Morocco, and Bangladesh,” said Tellimer analyst Hasnain Malik in a note.

He argued the case for being bullish on Mexican stocks due to “valuation multiples (both PB and PE) at a discount (to) the 5-year median, positive real interest rates, and recent underperformance.”

“There is a possibility that when the President Elect takes over, she can do other positive things, like fiscal adjustment or delay the implementation (of the judicial reform),” said Shamaila Khan, head of fixed income for emerging markets and Asia Pacific at UBS, speaking of Sheinbaum.

“There are a number of things she could do to mitigate some of the impact, which are currently not priced. There’s a possibility of some more positives coming out over the coming weeks. So yes, we think that there may be an entry point forming.”

(Reporting by Rodrigo Campos in New York and Noe Torres in Mexico City; additional reporting by Libby George in London; editing by Karin Strohecker)

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