MexECON Blog

What's Driving Mexico Toward Recession?

Analysts and investors have finally taken note of Mexico's dramatic economic slowdown this year.  In the first half of 2013, Mexican gross domestic product (GDP) was up just 1.0% from the same period one year earlier, marking a significant shortfall versus the average growth rate of 2.6% over the last two decades and a sharp slowdown from the average increase of 4.3% from 2010 to 2012.  While taking note of the slowdown, however, few observers seem to understand how broad-based the problem is.  Media stories still seem to emphasize the recent weakness in Mexican exports.  An updated estimate of second-quarter GDP on Thursday will provide additional detail, but even the data available today shows that the Mexican slowdown is also coming from strong domestic headwinds.

On the external side of the economy, U.S. purchases of Mexican goods and services rose smartly in the first years after the global financial crisis of 2008 and 2009, in part because of pent-up demand and normal post-recession inventory rebuilding, but also because of Mexico's recently improved competitiveness versus Asia.  Unfortunately, those positives have now given way to the challenges of a U.S. economy still trying to recover from its massive real estate bubble.  Many U.S. consumers remain focused on cutting or controlling debt, while financial institutions remain reluctant to lend.  U.S. businesses are still cautious about investing and hiring, and governments at all levels are struggling to get control of their budgets.  Measured in dollars, Mexican exports grew at an average rate of 17.3% from 2009 to 2012, but they were up just 1.2% in the first seven months of 2013.  Measured in pesos, exports in January through July were actually down some 3.9% from the same period in 2012.

Exports 1307 B

What people are failing to appreciate is that, in addition to these external challenges, Mexico is also dealing with big domestic problems.  Those problems range from tight government spending and a change in housing policy to a drop in consumer spending:

  • Government Spending Cuts.  As in many countries, government spending in Mexico can be disrupted by a change in administration.  For example, the incoming leadership may freeze outlays while they put new priorities into place, or lower-level bureaucrats may slow spending while they try to gauge what their new chiefs want.  It also appears that weak oil prices and production earlier this year have capped Mexican revenues, prompting officials to tighten spending in order to keep the deficit under control.  Whatever the specific reason, Mexican government spending has fallen sharply ever since the inauguration of President Enrique Peña Nieto last December.  Official data show public sector spending on capital projects in the first six months of 2013 was down 4.2% year-over-year, while subsidy and transfer payments were down 4.9%.  Taking account of inflation, the declines have been even sharper.  The government announced this week that it would accelerate outlays totaling some 27 billion pesos (approximately $2.1 billion), but many analysts consider the spending plan too little, too late to have much impact in 2013. 
  • Changes in Housing Policy.  Just as important, the Mexican government last year eliminated some housing support policies that had previously encouraged the construction of thousands of units of new houses each year.  Under the previous policy, home builders were encouraged to develop vast tracts of land far from city centers and with limited transportation networks and other infrastructure.  Many of those projects are now considered wasteful, and some have even been abandoned.  The replacement policy emphasized building multi-story developments in city centers.  Unfortunately, a lack of available land and other problems have made it difficult for builders to start many projects.  Many builders are in distress, and residential construction has slowed to a crawl.  Overall construction in Mexico has fallen in eight of the last twelve months, and in July, it was down 6.3% year-over-year.  Not counting public works and activity in the construction trades, the erection of new buildings has fallen in nine of the last twelve months, and it was down 7.5% year-over-year in July.
  • Weaker Consumer Spending.  With exports soft, public works projects frozen, and housing construction at a standstill, it should be no surprise that Mexican firms have slowed hiring.  The unemployment rate has been stuck at around 5.0% for more than a year, and consumer confidence has dropped sharply.  A surge in inflation earlier in the year also unsettled many consumers, while those families that rely on money sent from relatives working in the United States are seeing an ongoing drop in remittances.  Mexican consumer demand has therefore dropped sharply.  In June, for instance, retail sales were down 1.9% from June 2012.

The key implication of this analysis is that even if U.S. economic growth accelerates and Mexican exports strengthen in late 2013, as many observers expect, the problems in domestic demand mean the economy may not rebound very much and could even soften further.  In fact, the July index of leading economic indicators suggests Mexico is already slipping toward recession.

The problems in Mexico's domestic sector could in theory be addressed by the new administration.  For example, the government could ratchet up spending by even more than it announced this last week.  In fact, its proposed budget for 2014 calls for a significant increase in spending and a big expansion of the deficit.  If the government follows through on those initiatives and takes steps to resuscitate housing, it could give a big boost to the industrial sector and encourage consumers to start spending again.  At this point, however, it appears that the government is more focused on consolidating its hold on the bureaucracy, demonstrating continued fiscal discipline, and pushing through longer-term reforms.  Those are worthy goals, and the government has already been surprisingly successful in pursuing them.  However, one wonders whether the government should be doing more to rescue the domestic sector that still forms such an important part of the economy.

Patrick Fearon, CFA
Vice President, Fund Management

Special - 130918 Drivers Toward Recession Figure 1

Special - 130918 Drivers Toward Recession Figure 2

 

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