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Quarterly Economic Overview - 2012 Q1

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 investment.
GDP 2012 Q4 - Quarterly Report

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