MexECON Blog

Quarterly Economic Overview - 2014 Q3

In the second quarter of 2014, Mexico's inflation-adjusted gross domestic product (GDP) was up 1.6% from the same period one year earlier, after increases of 1.9% in the first quarter and just 0.7% in the fourth quarter of 2013.  For comparison, the country's average annual growth rate in the two decades from 1993 to 2013 was 2.5%.

The modest improvement in Mexican economic growth in 2014 has come mostly from stronger exports.  With the U.S. economy rebounding from its soft spot during the winter, Mexican exports have recently been running almost 5.0% above their levels one year earlier.  The acceleration in exports has given a significant boost to the manufacturing sector.  Almost as important, the construction sector is finally recovering from a long period of extreme weakness.  Residential building increased in six of the first seven months of 2014, while commercial construction and public works activity have stopped falling.  Unfortunately, the consumer sector has been a mixed bag.  Consumer spending dropped sharply in the first quarter, when a series of increased sales taxes took effect.  Spending then began to recover, giving a boost to growth in the second quarter, but it appears that a soft labor market and continued concern about high prices are serving to limit the gains.

Mexican stability indicators remain relatively healthy, but inflation is high enough to discourage consumers.  The September consumer price index was up 4.2% from one year earlier, almost matching the high inflation rate at the beginning of the year, when the new sales taxes boosted prices.  Policymakers at Banco de México continue to believe inflation will fall to their goal of 3.0% in the coming years, but it is instructive that they have recently been signaling that their next policy move will probably be to increase interest rates rather than cut them.  That would begin to reverse their surprise rate cut in June.  Meanwhile, fiscal policy has become expansive.  Official data show that Mexico's public sector deficit is on track to widen to approximately 3.6% of GDP in 2014, compared with a deficit of just 2.3% of GDP in 2013.  The government's proposed budget calls for the deficit to stabilize at 3.5% of GDP in 2015.  For comparison, the Organization for Economic Cooperation and Development (OECD) recently estimated the U.S. deficit was 6.4% of GDP in 2013.  Mexico's public sector net debt (including government-owned agencies and enterprises) stood at 36.9% of GDP at the end of 2013, while the OECD says U.S. net debt stood at 81.2% of GDP.

In the four quarters ended June 2014, foreign portfolio investment (net foreign purchases of Mexican stocks and bonds) came to a strong $67.3 billion, compared with $61.1 billion in the previous four quarters.  Foreign direct investment (net foreign purchases of land, factories, office buildings, and other hard assets) totaled $7.8 billion, compared with $21.2 billion in the previous year.  Net international bank loans, personal transfers, and other miscellaneous transactions came to $13.9 billion in the year to June.  Because of negative net flows in miscellaneous categories, total net financial inflows came to $70.8 billion, compared with $61.3 billion in the previous year.  With these inflows, Mexico's current account deficit continues to be financed easily, and the country's foreign reserves at the end of June rose to a new record of $190.3 billion.  Despite the good trends, however, investor concern about tighter monetary policy in the United States has been weighing on the peso.  The currency had been trading for most of the year around a spot-market value of $0.07635 (13.10 pesos per dollar), but it has recently been trading below $0.07400 (13.51 pesos per dollar).

Looking forward, the Mexican economy will probably accelerate a bit further in the coming months.  Continued growth in the U.S. economy sets the stage for more increases in Mexican exports and manufacturing, while the construction sector looks set to keep recovering.  Looser fiscal policy will probably also play a role, as it will lead to increased public works spending.  Finally, many Mexicans appear to be adjusting to the higher sales taxes this year, though the labor market is still not rebounding strongly enough to prompt a big improvement in consumer spending.  The International Monetary Fund therefore forecasts that Mexican GDP growth will accelerate from 1.1% in 2013 to 3.0% in 2014 and 3.5% in 2015.  A key risk is that tighter monetary policy and higher interest rates in the United States could lead to a large, sudden outflow of capital.

In the longer term, Mexico's outlook remains positive, though the economy still faces challenges.  Since 1982, Mexico has implemented a range of reforms geared at liberalizing markets, increasing competition, and creating a stable operating environment for business.  Opening the economy to foreign trade via the North American Free Trade Agreement (NAFTA) was probably the most dramatic reform, but Mexico has also implemented almost a dozen other free-trade deals.  It has also privatized key companies, balanced its budget, and reduced its foreign debts.  And yet, the country's average economic growth of just 2.5% over the last two decades is far below the growth rates achieved by Asian countries such as Indonesia, at 4.5%, India, at 6.8%, and China, at 9.8%.  Economists generally ascribe the continued slow growth in Mexico to structural problems that still have not been addressed.  For example, key industries such as telecommunications and energy are highly monopolized, with the effect that supply is restricted, prices are high, and innovation is discouraged.  Militant unions have a stranglehold on the country's schools, holding back quality and, along with heavy migration to the United States, restricting the supply of skilled workers.  In the financial sector, lending is discouraged by a history of nationalizations, past financial crises, and a legal system that makes it difficult for lenders to seize collateral from delinquent clients. Finally, draconian tax and regulatory burdens for larger firms discourage start-ups from growing or innovating.   Mexico's competitive position versus other countries has improved 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.  However, Mexico now needs to focus on making itself more dynamic and efficient in its own right.  President Enrique Peña Nieto's reform program aims to toughen performance standards for public school teachers, encourage increased bank lending, bring heightened competition to the telecommunications sector, and open the energy sector to private companies.   The government is still working to implement the reforms, but things seem to be moving in the right direction.  If the reforms are well implemented, they could help boost Mexico's growth rate in the years ahead.

Patrick Fearon, CFA
Vice President, Fund Management

 GDP 2014 Q3 Initial YOY

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