Latin America Advisor

A Daily Publication of The Dialogue

Is Mexico Doing Better or Worse Than Expected?

Mexico’s central bank president, Agustín Carstens.

Mexico’s unemployment rate fell to a lower-than-expected 3.56 percent of the economically active population in May, the lowest unemployment reading since December 2007, according to data released on June 26 by state statistics agency INEGI. On June 22, Mexico’s central bank, led by Agustín Carstens, raised its key interest rate but hinted that it may be the last hike in its current tightening cycle. Are Mexico’s economic indicators showing signs of promise? What headwinds will the economy face over the next year, and what steps should the central bank take to fortify the economy against potential setbacks? What is the outlook for inflation and the Mexican peso?

Rogelio Ramírez de la O, president of Ecanal in Mexico City: “Mexico’s economic indicators are better than were generally expected some months ago, despite a stagnant industrial output. Activity has been surprisingly resilient, given the expectation that the government would make a sharp fiscal adjustment this year. Such a fiscal adjustment is not visible in the national accounts for the first quarter, when real government consumption rose by 1.3 percent year-over-year, in contrast to an expected contraction. Such a lesser need of fiscal tightening is thanks to the Bank of Mexico’s replication of last year’s transfer of unrealized foreign exchange gains calculated on the stock of international reserves (1.2 percent of GDP). The transfer this year was even higher, at 1.5 percent of GDP, and it changes everything. The strengthening of the peso owes much to this suddenly improved fiscal outlook, and especially the frenetic increase in interest rates by the Bank of Mexico. For traders, this is a ‘no brainer’ scenario of high rates, a strong peso and not much of a slowdown in growth. It has even led Dr. Carstens to suggest that this may be the end of rate increases, and led to Finance Minister José Antonio Meade to suggest a rate reduction is in the cards for early next year. If this materializes, Mexico would have a mini-cycle of high growth during part of 2017-2018, which will improve economic sentiment at the time of the presidential election in 2018. The question is whether it would be sustainable into 2019. My guess is ‘no,’ because the fiscal situation has not changed structurally, and Pemex’s real situation remains precarious. And, if the presidential election is contested, as expected from the experience in the State of Mexico, the peso would weaken again sometime in 2018. Another headwind is the way in which the NAFTA renegotiation will affect market perceptions.”

Alberto Ramos, managing director and head of Latin America economic research at Goldman Sachs in New York: “Mexico’s macro picture remains uninspiring and complex—modest growth, declining oil production, high inflation, high interest rates, binding restrictions on fiscal spending, a testy and challenging relationship with its dominant trading partner, and lingering security and corruption issues. However, the macro-financial risk profile is admittedly now less skewed than it was in late 2016, and we acknowledge that there have also been a few bright spots and positive developments. Real GDP growth was admittedly more resilient than expected in late 2016, but it remains modest in absolute terms, and the balance of risks remains skewed to the downside. Furthermore, inflation surged to multi-year highs, leading the central bank to hike the policy rate aggressively and by a lot more than the Federal Open Market Committee. The labor market remains strong, with record-low levels of unemployment and solid formal sector job growth, but real wage growth dipped into negative territory, given the surge in inflation, and consumer-credit growth is decelerating. Finally, domestic political risk remains significant, given growing rejection of the political establishment and broad demand for change, which increases the probability that the 2018 presidential election could empower an administration that shifts policies away from the current orthodox conventional path and toward the populist/heterodox camp. Going forward, we expect inflation to peak in July/August, and to return to within the target band by the second quarter of 2018. The macro fundamentals of the Mexican peso remain solid. The peso is no longer a low-carry currency, the moderate current account deficit continues to narrow and portfolio flows have been resilient, despite significant domestic and external uncertainty. But as always, positive sentiment toward the peso could be undermined by a potential increase in domestic uncertainty ahead of the mid-2018 presidential elections and/or noise around the upcoming renegotiation of the NAFTA agreement. Barring unforeseen shocks to inflation or the exchange rate, we expect the central bank to leave the policy rate unchanged at 7 percent for the foreseeable future, since at this stage bringing inflation down to the target is the best contribution the central bank can give to support the business cycle.”

Andrés Rozental, member of the Advisor board, president of Rozental & Asociados in Mexico City and senior policy advisor at Chatham House: “There are lies, damned lies and statistics, say some economists. Mexico’s unemployment figures are a poor reflection of actual worker engagement in Mexico, because they follow parameters that don’t tell the whole story. To begin with, about half of the labor market in Mexico is in the informal sector, which means that even the very occasional street merchant is considered to be employed, though it might only be for a few hours a week. Since there is no national unemployment insurance scheme, it’s also very difficult to measure unemployment the same way as in other OECD countries. Self-sufficient rural employment that doesn’t contribute to the country’s economy as a whole is also often counted as ‘employed.’ Notwithstanding these facts and that employment figures are generally viewed with skepticism, there is no doubt that Mexico’s economy has improved in the first half of 2017 when compared to the drastic downgrades we saw just after Donald Trump was elected president of the United States. Growth has been revised upward, and new job creation as measured by the Mexican Social Security Institute has slowly inched up to the million jobs a year figure that most economists consider the minimum to place new entrants into the formal labor market. There are, however, considerable obstacles to achieving both the growth and employment rates that Mexico needs going forward. Some of these relate to the political uncertainty for the 2018 presidential elections, the threat from the Trump administration to apply punitive tariffs and taxes on Mexican exports to the United States, the uncertain future of NAFTA and low oil prices. As long as the highly integrated nature of the bilateral economic relationship with our other two North American partners remains stable and predictable, and there is no political reversal to Mexico’s open economy, the country should be able to perform even better in the years ahead.”

Tapen Sinha, professor of risk management at the Instituto Tecnológico Autónomo de México: “The single biggest external threat that the Mexican economy faced in the past decade came directly from the United States: the 2008 financial crisis. The deep recession in the United States caused Mexican exports to fall, the stock market to fall by 50 percent and real GDP to drop by 6 percent. At the end of it all, another potential crisis also came from the United States. This was in the form of a direct threat by the incoming president of the United States, Donald Trump. During his campaign, Trump made various statements, starting from building a wall (that Mexico would pay for), to canceling NAFTA, to deporting undocumented Mexicans back to Mexico. All of this rattled the Mexican economy. First, the exchange rate was affected. The Mexican peso fell by 20 percent in two months by mid-January. This in turn pushed up the import prices, and the inflation went outside the announced target rate of the central bank of Mexico (Banxico) of 3 percent, +/-1 percent. It rose to 6.5 percent. Consumer confidence and business confidence also fell by 20 percent. Banxico took the risky step of raising the interest rate—now at 6.75 percent. It was risky because escalating the rate too high could push the Mexican economy into a recession. Fortunately, most of Mr. Trump’s words did not translate into action. The consumer confidence index in Mexico went back to the pre-election level, and business confidence shot up to a level not seen since 2013. The inflation outlook has not changed. Now it is expected to be in Banxico’s range by the end of 2017. The GDP growth is also expected to be in the 2 percent range. The future threat to the economy would be the Mexican presidential election producing a populist winner in 2018.”

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