Mexico: Deep recession in 2009, rebound in 2010

Growth will continue in Mexico, albeit at a lower level than in 2010: 4.9% in 2011 and 3% in 2012. However, structural GDP growth will be below the regional average.
Analisis Credito y Caución
Madrid - 30-ago-2011

Mexicos economy deteriorated dramatically as a result of the credit crisis - and particularly the deep US recession, because of its close links to the US business cycle. Real GDP growth decreased by 6.1% year-on-year in 2009 because of falling industrial exports [down 14%], decreasing workers remittances, the funds that expatriate workers send back to Mexico, a liquidity crunch with scarcer bank credits and external finance, and the outbreak of swine flu. Domestic demand also took a turn for the worse, with consumer spending and business sector activities decreasing. Both unemployment and underemployment rose sharply.

Despite all that, Mexicos recovery in 2010 was strong, with output growing 5.5%, thanks mainly to a resurgence of exports, up 24% year-on-year. This reversal of fortunes fully compensated for 2009s export losses as demand from the US picked up again. Domestic demand [private investors and consumers] also recovered, although not enough to compensate for its decline of 5% in 2009.

Growth continued into 2011: by 4.6% year-on-year in Q1 [0.52% on the previous quarter]. The growth in industrial production slowed to 4.2% in March after its higher rates in the first two months of the year. Overall exports rose by 24% in the first two months while, according to the Automobile Industry Association, the export of vehicles rose 17.8% in March to a record 192,783 units. Rising employment boosted consumer demand in Q1 and inflation has decreased so far this year, with year-on-year inflation standing at 3.4% in April. According to the Mexican Ministry of Economy, foreign direct investment [FDI] increased by 10.5% year-on-year in Q1, to US$ 4.8 billion, with the US accounting for 85% of this figure. In comparison, for the whole of 2009, FDI fell to US$ 15.3 billion, and then grew to US$ 18.7 billion in 2010.

Mexicos banks are, in general, well capitalised and liquid, with limited exposure to foreign currency risks. However, banks are performing below potential [bank assets as a percentage of GDP: only 46%], constraining the credit growth needed to stimulate private consumption. A cautious lending policy is also restricting financing options for small and medium-sized enterprises.

Solid economic policies

Overall, Mexicos budgetary and monetary policies are robust, with an acceptable public sector financial position. The budget deficit will improve from 3.2% of GDP in 2009 and 3.4% last year to around 2% of GDP in 2011, while public debt constitutes 36% of GDP. However, additional fiscal consolidation is urgently required to compensate for low tax revenues [Mexico has a narrow tax base of only 10%] and the structural decrease in oil revenues, which represent almost a third of public sector income.

To ensure financial stability during the recession, Mexicos central bank had injected substantial liquidity into the system. Despite inflation above the upper band of the central banks target range, the key interest rate was gradually lowered in the first half of 2009, to 4.50%, and has remained unchanged since then in contrast to all other major Latin American economies, like Brazil, which have repeatedly raised interest rates to combat inflation. Inflation decreased from 5.3% in 2009 to 4.1% last year, and has further decreased into 2011 to a much lower level than in other major emerging markets such as Brazil, China and India.

Lack of structural reforms impedes stronger growth

Despite a solid short-term economic policy, the economy suffers from structural weaknesses. Poor reform results are still impeding economic efficiency and longer-term GDP growth. The minority government need the oppositions support to pass reforms in parliament but, while the main opposition parties are cooperating with minor changes, they are unwilling to support vital structural reforms such as more flexible labour laws, an improvement in tax laws and a reduction of government regulation.

The energy sector in particular needs to be overhauled. While the state-owned petroleum company was granted more financial and managerial autonomy by the Mexican Senate in October 2008, a comprehensive reform of the oil industry is still the most pressing issue, due to dwindling production [see below] and the fact that oil accounts for more than 30% of fiscal income.

Mexico is the sixth largest crude oil producer in the world, but proven reserves have shrunk from 34 to 14 billion barrels since 1998, and will last for only 10 more years. Current production has dropped from 3.4 million barrels per day [b/d] in 2004 to 2.5 million b/d, and is expected to decrease further to 2.1 millions b/d in 2015.

Although offshore oil fields are said to be twice as large as land-based oil fields, the state-owned petroleum company currently lacks the know-how and resources to invest in exploration and production, mainly because it pays 90% of its revenues to the state budget. The Company therefore urgently needs permission to cooperate with foreingn investors for joint exploration, refining and distribution, but such a move is still met by fierce political opposition. The main hurdle is the fact that Mexicos constitution stipulates that the oil industry must remain under state control.

The massive drop in imports and exports in 2009 was fully offset by 2010s strong rebound in foreign trade, leaving the current account balance more or less unchanged. Current account deficits are easily financed by capital imports, especially FDI and incoming short-term portfolio capital. After a huge depreciation in 2009, the Mexican peso appreciated again in 2010 and gained more than 5% against the US$ in early 2011.

Reform efforts still too slow

With more than a year to go before the next presidential and congressional elections in July 2012, Mexico is facing a change of power. It seems likely that the ruling centre-right government will be ousted by the party that ruled Mexico for decades before losing power in 2000.

In the meantime, it is unlikely that the administration will get the necessary oppositional approval for any further structural economic reforms. Therefore Mexicos poor record on essential reforms will not change before a new president/government assumes power and a new Congress is constituted next year.

Growth will continue, albeit at a lower level than in 2010 [4.9% in 2011 and 3% in 2012]. However, structural GDP growth will remain below the regional average due to some unfavourable factors: poor infrastructure, inadequate education, corruption and the lack of structural reforms. Inflation will again increase in the second half of this year and into 2012. The biggest risk to Mexico remains a potential slowdown of the still fragile US economy.

Mexicos monetary policy has to find the right balance in the movement of interest rates to curb structurally high inflation rates while maintaining the countrys competitive position. While higher interest rates will help to contain inflation and attract short-term portfolio capital inflows, leading to a currency appreciation, an overly strong peso may damage Mexicos export competitiveness against other emerging markets.

Stable solvency and liquidity despite some downside risks

Solvency and liquidity indicators will remain stable. It is expected that the current account deficits will increase again in 2011 and 2012, while incoming FDI will comfortably finance these shortfalls. However, if domestic violence escalates further, it will have negative consequences for FDI inflow and the whole Mexican business environment. Another factor that has to be monitored is the behaviour of short-term portfolio capital that has been invested in Mexican assets and which can be easily withdrawn or reversed. Nevertheless, even in that worst case scenario, the country should be able to cope without major financial problems.

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