In the fourth quarter of 2011, Mexico's gross domestic product
(GDP) was up 3.7% from the same period one year earlier, after
year-over-year increases of 4.5% in the third quarter and 3.2% in
the second quarter. In all of 2011, Mexican GDP was up
3.9%. For comparison, Mexico's average annual growth rate
from 1990 to 2010 was just 2.8%.
At its beginning, Mexico's current expansion came mostly from
rebounding exports. Now, domestic demand is the driving
force. In the first ten months of 2011, for example, gross
fixed investment was up 8.3% from the same period one year
earlier. In the first eleven months of the year, retail sales
were up 3.5%, even after stripping out price increases.
Rising exports and increased industrial production have helped cut
unemployment from a cycle peak of 6.0% in September 2009 to 5.0% in
December 2011. That alone would have buoyed consumer spending
in Mexico. In addition, it appears that a recent weakening in
the value of the peso has helped out by boosting the impact of two
key financial flows into Mexico: remittances sent by family
members working in the United States, and the repatriation of U.S.
profits by drug cartels. Of course, the mass emigration of
Mexican workers is a symptom of the country's remaining economic
challenges, and the existence of violent drug cartels is a threat
to the economy. Nevertheless, every dollar that enters Mexico
from these sources now buys many more pesos than in the recent
past, providing added economic stimulus. The weak peso means
businesses face higher costs for imported goods, and when they
eventually try to pass those added costs on to consumers,
consumption spending will probably suffer. However, that
process has only begun recently.
Mexican stability indicators remain generally healthy, but some
trends bear watching. In January, the consumer price index
was up 4.0% year-over-year, marking the fourth straight month of
acceleration and bringing inflation to its highest in more than a
year. The producer price index has been rising more than
twice as fast, suggesting there is plenty of inflation pressure in
the pipeline. Banco de México continues to hold its benchmark
interest rate at a historically low 4.50%, and its policymakers
have signaled they could cut rates as insurance against the risk of
a global financial crisis emanating out of Europe. With
inflation now well above the central bank's target of 3.0%,
however, more observers are discounting any chance of a near-term
rate cut. On fiscal policy, the government continues to show
discipline. Official data show Mexico's public sector deficit
fell to 2.4% of GDP in 2011, after deficits of 2.7% in 2010 and
2.3% in 2009. For comparison, the Organization for Economic
Cooperation and Development (OECD) recently estimated the U.S.
deficit was 10.0% of GDP in 2011. Mexico's public sector net
debt stood at 26.5% of GDP at the end of 2011, while the OECD says
U.S. net debt stood at 73.8% of GDP.
Central bank data show foreign direct investment into Mexico
(net foreign purchases of land, factories, offices, and other hard
assets) rose to $10.0 billion in the four quarters ended September
2011, compared with a revised $3.8 billion in the previous four
quarters. Portfolio investment (net foreign purchases of
Mexican stocks and bonds) fell to $32.9 billion from $38.9 billion
in the previous period, but it remained historically high.
Coupled with modest international bank lending and other
transactions, these inflows have easily financed Mexico's current
account deficit and boosted the country's foreign reserves.
Until mid-2011, these capital flows also put strong upward pressure
on the peso. Based on figures from the U.S. Federal Reserve,
the peso's spot-market value at the end of May 2011 reached
$0.08581 (11.65 per dollar), up 25.7% from its mid-recession low in
March 2009. In the second half of 2011, however, the
worsening European debt crisis and slowing economic growth in Asia
sapped confidence. Capital flows into Mexico weakened, and
the peso pulled back sharply. At the end of December 2011,
the peso stood at just $0.07260 (13.78 per dollar), though it has
been rebounding so far in 2012.
For the moment, Mexico's economic prospects look positive, in
large part because the export sector is now reaping the benefit of
increased "in-sourcing" during the mid-2000s. In that period,
the Chinese yuan began to appreciate, Chinese wage rates
skyrocketed, and rising energy prices made transportation more
expensive, prompting many firms to move production from Asia to
Mexico. Much of the new productive capacity came on line
during the Great Recession of 2008-2009, so the trend was
masked. Now, however, with the North American economy in
recovery, Mexico finds itself particularly well positioned to meet
the rebound in demand. Cyclical trends are also working in
Mexico's favor. The United States is the destination for
approximately 80% of Mexican exports, so the recent reacceleration
in the U.S. economy will likely support Mexican exports, industrial
production, and hiring in the coming months, even as Mexico's
domestic demand keeps growing. The International Monetary
Fund currently forecasts Mexican GDP will grow 3.6% in 2012 and
3.7% in 2013.
The main near-term risk for Mexico is that the United States and
other key developed countries could slip back into recession.
Such a scenario would be especially likely if the European debt
crisis worsens again. In addition, a severe drought has
already weighed on agriculture production, and if rain does not
come soon, the drag on growth could become more significant.
Mexico will also hold presidential elections in July 2012, raising
the risk of political instability and policy mistakes.
Finally, drug violence could become so bad that it weighs more
noticeably on economic activity. As bad as those risks are,
Mexico faces bigger, more intractable problems in the longer
term. If its oil production continues to decline and it is
unable to broaden its limited tax base, for example, it could
eventually face severe fiscal challenges. Most important,
Mexico's current strong growth is unlikely to be sustained unless
it implements key reforms, such as breaking up monopolies,
deregulating the labor market, opening more industrial sectors to
private investment, and otherwise increasing competition and