University of Toronto
Project LINK
United Nations, Department
of Economic and Social Affairs
U.N. Headquarters, New York City
October 21-23, 2015
MEXICO
1. Recent Trends
In 2015, the
economy performs at rates similar to those in the previous year, but below
potential, with no major improvement. The economy started the year with
moderation, affected by the slowness in the U.S. and the budget cut implemented
by the Mexican government as a result of the shortfall in oil revenues.
Inflation has adjusted down significantly given the absence of new taxes and
the positive arithmetic effect of the comparison base. Monetary conditions
remain expansionary, keeping the external imbalance under pressure.
The economy
moderated in the second quarter, despite further advance in the U.S. recovery.
Domestic activity is still restrained by the limited production capacity. The
national industry continues to underperform as a result of the inefficiencies
generated by the prolonged absence of reforms in the past fifteen years. The fiscal adjustment
implemented by the government since the beginning of year has affected public
spending but also slowed private activities highly dependent on the federal
budget. Hence, GDP reported annual growth of 2.2% in the second quarter, after
increase of 2.6% in the previous quarter and 1.8% a year earlier.
Three main
factors affected the economy’s performance at the beginning of the year. First,
the U.S. economy reported a significant moderation with almost no annual growth
in the first quarter, which imposed restrictions to Mexican exports
–particularly manufacturing products. Second, oil production continued to fall
as a result of structural bottlenecks and lack of investment in the sector.
Third, the government cut the federal budget for about 0.7% of GDP for the
year, mainly forced by the fall in oil revenues generated by the combination of
lower prices and production.
After ending
at 4.1% in 2014 –a rate just above the 4% target’s upper limit, inflation has
adjusted down significantly since the beginning of 2015. In fact, since
February –for the first time in the past nine years– inflation hit its central
target of 3% and continued to decline toward 2.5% by September. The surprise
came because the target was reached even in an environment of expansionary
fiscal and monetary policies. Obviously, something else was explaining the
apparent inflation success. On the one hand, the inflation decline has to do
with the positive arithmetic effect generated by last year’s high comparison
base. On the other hand, consumer prices are moderating this year, mainly as a
result of more consistent increases in public prices and tariffs. Also, the
economy’s underperformance has kept consumer prices under control, consequently
keeping inflation subdued.
Monetary
conditions, on the contrary, have remained in the expansionary zone since last
year when the interest rate was cut to 3%. The nominal and real interest rates
have stayed below the neutrality level most of the time, thus making monetary
conditions stimulative for domestic demand. However, since the end of 2014 with
the rising probability of the monetary reversal in the U.S., the peso has been
under significant depreciation pressures. This year, with the proximity of the
beginning of the Fed’s rate hikes, Mexico’s interest rates will need to increase
even though the inflation rate is below target. In fact, domestic rates will
have to react to the loss of competitiveness in bonds that will come with rate
hikes in the U.S. Otherwise, prolonged unchanged rates will take a heavier toll
on the peso and, consequently, on future inflation.
The labor
market has advanced slowly as a result of the economy’s underperformance. Some
temporary jobs have been created by public spending, although private firms are
still cautious in hiring since they are still facing the burden of new taxes
introduced in 2014. Employment will improve as the economy strengthens, but the
creation of jobs will be limited since the increase in productivity generated
by reforms will displace low-skilled workers.
The country
has approved 11 structural reforms and most of them are already in place.
However, the economy continues to advance slowly and still shows structural
weakness. New reforms will benefit the economy’s potential capacity in the
medium term. However, the size of the economic impact will depend on the
magnitude of the structural changes produced by the main reforms. The key is
not the quantity but rather the quality of reforms. Mexico is moving in the
right direction of strengthening the fundamental sources of permanent growth,
but it will take time for the economy to increase its production capacity.
2. National Policy
Assumptions and International Environment
Our Baseline Scenario for the
Mexican economy is based on three main assumptions: economic policy, structural
changes, and international conditions.
The first assumption establishes the country’s
return to macroeconomic discipline as a necessary condition for preserving
stability and keeping the economy near the equilibrium. Economic policy, in
general terms, will be mainly focused on stability in order to create favorable
conditions for growth and employment. However, in order to generate growth and
employment, stability will not be sufficient. Therefore, economic policy must
have to be accompanied by public policies to directly promote social progress
and reinforce the fundamental sources of permanent growth (saving-investment,
productivity, and technological change), which in turn will increase the
country’s potential to grow. However, in the short run economic policy will be
focused on strengthening the domestic absorption in order to compensate for the
prolonged external weakness, which also implies a wider fiscal imbalance.
The second assumption considers the effective
implementation of the already-approved structural reforms, particularly in the second
half of the ongoing administration (2016-2018). The fiscal reform will continue
to improve the efficiency of the tax system, while the energy reform will
increase the production capacity in the oil industry. The government will also
implement changes that do not require Congress approval, particularly those
reinforcing institutions and the application of the law. In the medium and long
term, there is a possibility of deepening the reform process, which will increase the country’s production
capacity throughout the next decade.
The third assumption includes the improvement
of the global economy. The U.S. economy will continue to strengthen in the
coming years. Growth this year will be around
2.5%, and will stay around 3% in the next two years. In the medium term, with
most of fiscal problems resolved, the U.S. economy is expected to advance at
rates consistent with its potential growth. We expect the Fed to start
normalizing the policy interest rate between the end of this year and the
beginning of next, moving the rate at a very gradual pace toward neutrality to
let the economy advance in an environment of price stability.
Domestically,
monetary policy will have to return to a management consistent with the
“inflation targeting” approach in
order to keep inflation under control and preserve the currency stability. In
the short term monetary policy will remain loose, even with the first rate hike
by the end of the year. It will move to neutrality next year, with the possibility
of turning restrictive in case of a significant inflation rebound generated by
the steady peso depreciation. The central bank will return to the use of the
dual mechanism of external-shock absorption through the flexibility of the
exchange rate and interest rate. In case of unexpected volatility, this
automatic mechanism could be accompanied by discretionary monetary
interventions to restore market stability. In the following three years fiscal
policy will still remain in deficit, although decreasing. At some in the medium
term, fiscal policy is expected to be managed by the
effective application of the structural rule in order to better contribute
to macroeconomic stability.
The international market of oil will remain affected
by geopolitical events in the short term. In the longer term prices will start
to adjust down as production capacity and supply will increase. The price for
the light crude in New York (WTI) will average around $50 dollar per barrel
(dpb) this year, around $45 next year, and will recover a little in 2017. The
price for the Mexican crude will average around $47.50 dpb this year, just
below $45 next year, and it will move toward $50 in the medium term.
3. Forecast Summary
Our Baseline
scenario foresees an economy with no much improvement this year, advancing at still-limited
rates since the impact of reforms will only be felt in the medium term. The medium-term
recovery will be the result of some positive factors: a domestic market gaining
some steam by the improvement in purchasing power, some strengthening of the external
demand, and positive effects generated by new reforms. Even though growth will
still remain restricted by the limited potential capacity, the economy will
advance at a rate of 2% this year, after 2.1% in 2014. In the medium term, the
economy will advance at rates determined by the increased production capacity.
Inflation will end this year just
around the 3% central target, pushed by the significant currency depreciation
and the still expansionary monetary policy. For next year, inflation will be
higher given the economic recovery and the realignment of prices generated by
the peso depreciation. Under these circumstances, policymakers will keep
normalizing monetary conditions to put the interest rate at its neutral level
at least. Rates could also enter restrictive territory if volatility worsens as
a result of a market overreaction to the Fed’s monetary normalization.
New reforms will certainly
benefit the economy’s potential capacity. However, the size of the economic
impact will depend on the magnitude of the structural changes produced by main
reforms. The greater the economic opening the bigger the impact on potential
growth. Mexico is certainly moving in the right direction of strengthening the accumulation
of capital, which in the end will increase productivity and promote
technological progress.
The flexible exchange rate mechanism will be
preserved, with the hope that the foreign exchange market will adjust the
Mexican peso at a speed equivalent to at least the differential of inflations
between Mexico and the U.S. However, in the medium term there exists the
possibility of a significant arrival of foreign direct investment attracted by
new reforms. Therefore, the current account deficit will increase –in absolute
and relative terms– as a result of the economy’s dynamics and also as a
consequence of some currency misalignment.
The new
production capacity generated by reforms, together with the positive effects
from the U.S. recovery, will determine growth in the future. However, in order
to promote a growth path free of imbalances, in the long run the economy should
be functioning around its new steady state rate (3.5%-4%).
4. Uncertainties
Some downside risks remain in the horizon,
which could generate a pessimistic scenario in the near future. On the domestic
side, there is an important downside risk that has to do with a potential
increase in the country’s vulnerability to financial shocks. Persistent fiscal
and external imbalances and the associated potential loss of policy credibility
could make the country more vulnerable to speculation and financial crises. As
a result, the economy’s capacity could be hurt significantly, with significant consequences
for social well being.
On the external side, we identify three main
risks. First, since the Mexican economy is highly
dependent on the U.S. performance, the main risk comes from a potential
weakening of the northern neighbor. Under that scenario, the U.S.
weakness will have significant impact on the Mexican economy. Second, a scenario of a return to recession
in Europe and more severe fall in oil prices would impose severe constraints to
Mexico's performance in coming years. Third, the potential collapse of the
Chinese housing market with severe consequences on the economy and the global
financial system, thus affecting the U.S. economy and consequently Mexico.
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