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Quarterly Economic Overview - 2013 Q2

In the first quarter of 2013, Mexico's inflation-adjusted gross domestic product (GDP) was up just 0.8% from the same period one year earlier.  That marked the country's first below-average growth rate since the current expansion began in 2009.  The rise was far weaker than Mexico's average growth rate of 2.6% from 1992 to 2012, and it was a sharp deceleration from the increases of 3.2% in each of the previous two quarters.  Growth remained muted in the second quarter, though a modest acceleration may be in the cards for later in the year.

One reason for the first quarter's big slowdown in year-over-year growth was that the Mexican economy surged in the first quarter of 2012, making for a tough base of comparison.  More fundamentally, however, the problem was international trade.  Mexican exports have flattened out over the last year, while imports have continued to grow.  At the same time, investment in new housing has been held back by a change in government support programs, and government spending was disrupted by the inauguration of Mexico's new president at the end of 2012.  These problems have weighed on the whole industrial sector.  They have also helped keep unemployment relatively high, with joblessness rising to 5.1% in both April and May.  Consumer confidence has weakened, and consumption spending has softened considerably.

Despite the slowdown in growth, Mexican stability indicators remain generally healthy.  Inflation has increased recently, with the May consumer price index up 4.6% from one year earlier, but that stemmed mostly from food supply shocks that are likely to be transitory.  Policymakers at Banco de México remain confident that inflation is trending toward their goal of 3.0%.  Therefore, in order to respond to the slowdown in growth and a surge in the value of the peso, they were able to cut their benchmark interest rate to 4.00% in March.  In fiscal policy, the government continues to demonstrate more discipline than most other major countries.  Official data show Mexico's public sector deficit came to 2.6% of GDP in 2012, virtually unchanged from a revised 2.5% in 2011.  For comparison, the Organization for Economic Cooperation and Development (OECD) recently estimated the U.S. deficit was 8.5% of GDP in 2012.  Mexico's public sector net debt stood at 26.5% of GDP at the end of 2012, while the OECD says U.S. net debt stood at 86.5% of GDP.

Portfolio investment (net foreign purchases of Mexican stocks and bonds) totaled $62.4 billion in the four quarters ended March 2013, compared with $51.5 billion in the previous four quarters.  Bank lending and other financial flows totaled $11.5 billion, almost reversing an outflow of $15.5 billion in the prior period.  In contrast, however, foreign direct investment (net foreign purchases of land, factories, office buildings, and other hard assets) showed an outflow of $9.9 billion over the last year, while other miscellaneous flows showed an outflow of $25.4 billion.  The total net financial inflow in the four quarters through March came to just $38.5 billion, marking a significant decrease from the inflow of $51.3 billion in the previous year.  Even though the total inflow has slowed, it was still enough to cover Mexico's current account deficit and boost the country's foreign reserves to a record $168.4 billion at the end of April.  It was also enough to put upward pressure on the peso.  Data from the U.S. Federal Reserve show the peso's average spot-market value surged to a 21-month high in April, reaching $0.08193 (12.21 pesos per dollar).  By mid-May, however, it was becoming increasingly clear that the Federal Reserve could start unwinding its extraordinarily loose monetary policy in the coming months and quarters.  Because loose monetary policy from the Federal Reserve and other major central banks in the developed countries was a key spur to investment in higher-yielding countries such as Mexico, the result was a sharp sell-off in Mexican assets.  The Mexican stock market plunged, and the peso in late June stood at just $0.07500 (13.33 pesos per dollar).

Now that the U.S. economy has shown it can continue to grow even in the face of tighter fiscal policy and lackluster hiring, there is some reason for optimism about Mexico's near-term prospects.  Several sectors of the Mexican economy already appear to be in a tentative rebound from their soft spot at the beginning of 2013.  If the U.S. economy keeps growing or accelerates, there is a chance that exports and industrial activity will strengthen further later in the year.  Mexico's bureaucracy is also now adjusting to the new president, so government spending is likely to start growing again.  Indeed, officials in late June promised they would soon release a new public infrastructure plan that will dramatically boost outlays on projects such as roads, railroads, and airports.  If these developments boost hiring, and if inflation really cools as anticipated, Mexican consumers could start spending more.  Nevertheless, the recent swoon in the markets is a reminder that Mexico is vulnerable to events abroad.  A new flare-up in Europe's debt crisis or a premature tightening in U.S. monetary policy would probably undercut the Mexican economy.  There is also some risk that the new president's reform agenda could be disruptive in the short term.  Finally, Mexico's extraordinary economic rebound since 2009 is now quite mature, so growth will naturally tend to moderate from here.  The International Monetary Fund (IMF) currently forecasts Mexican GDP growth will slow from 3.9% in full-year 2012 to just 3.4% in both 2013 and 2014 and 3.3% in 2015.

In spite of the short-term risks, Mexico's longer-term prospects are improving.  Mexican competitiveness has improved remarkably since the middle of the last decade, in large part because of surging wages in China, an appreciation of the Chinese currency, and higher international transportation costs.  Now, Mexico's new president, Enrique Peña Nieto, is pushing an ambitious reform agenda geared at making the country itself more dynamic and efficient.  Critically, President Peña Nieto first crafted a consensus for reform among all three of the country's major political parties.  This "Pact for Mexico" aims to tackle problems ranging from declining oil production to extensive monopolization in key sectors of the economy.  In early June, President Peña Nieto signed into law a major reform that will bring heightened competition to the telecommunications sector, and he is expected to unveil reforms of the energy sector and public finances in the near future.  If these initiatives bear fruit, it would help sustain good growth rates and ensure continued economic stability.

Patrick Fearon, CFA
Vice President, Fund Management

GDP 2013 Q2 - Quarterly Report

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