MexECON Blog

Quarterly Economic Overview - 2014 Q2

In the first quarter of 2014, Mexico's inflation-adjusted gross domestic product (GDP) was up 1.8% from the same period one year earlier, after increases of just 0.7% in the fourth quarter of 2013 and 1.4% in the third quarter.  Despite the acceleration at the beginning of the year, however, Mexican economic growth remains sub-par.  For comparison, the country's average annual growth rate in the two decades from 1993 to 2013 was 2.5%.

Mexico's international trade has strengthened a bit in recent months, as the U.S. economy began to rebound from its soft spot during the winter.  Exports in the last few months have been running approximately 4.0% above their levels one year earlier.  The main problem for Mexico is that several key domestic sectors remain weak.  A recent change in government housing policy continues to weigh on residential construction, while tight fiscal policy is restraining government spending on public works.  As a result, construction activity in the first four months of 2014 was down 2.5% from the same period in 2013.  It was down almost 6.0% from its most recent peak in mid-2012.  Relatively slow hiring and new sales taxes at the beginning of 2014 have also been a headwind for consumer spending.

Although the economy has been sluggish, Mexican stability indicators remain healthy.  The new sales taxes may have boosted consumer prices at the beginning of the year, but inflation has now moderated.  In January, the consumer price index was up 4.5% from one year earlier.  In May, the index was up just 3.5%, and policymakers at Banco de México continue to believe inflation will fall to their goal of 3.0% in the coming years.  The policymakers felt enough confidence about falling inflation that they launched a surprise interest-rate cut in early June, bringing their benchmark rate down to just 3.00%.  Meanwhile, fiscal policy remains disciplined.  Official data show Mexico's public sector deficit came to 2.3% of GDP in 2013, after a deficit of 2.6% of GDP in 2012.  The deficit in the first three months of 2014 was running ahead of previous year's pace, owing mostly to higher spending, but the shortfall is still on track to come in much lower than in most major developed countries.  For example, 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 March 2014, foreign portfolio investment (net foreign purchases of Mexican stocks and bonds) came to a strong $48.2 billion.  Foreign direct investment (net foreign purchases of land, factories, office buildings, and other hard assets) totaled $22.6 billion, after being slightly negative in the previous four quarters.  Net international bank loans, personal transfers, and other miscellaneous transactions were modestly negative in the year through March, but Mexico's total net financial inflows still came to a solid $52.8 billion, compared with $45.2 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 March rose to a new record of $182.8 billion.  Despite the good trends, however, investor concern about tighter monetary policy in the United States has been weighing on the peso.  The currency has trended downward since mid-2013, and at the end of May 2014, it was trading at a spot-market value of $0.07732 (12.93 pesos per dollar).

Looking forward, the Mexican economy seems ready for a modest acceleration in the coming months.  If the U.S. economy continues to gain traction as recent reports suggest, Mexican exports should strengthen further and eventually prompt increased hiring.  Many Mexicans also appear to be adjusting to the higher sales taxes this year.  Consumer confidence seems to be on the rebound, and retail demand may be showing the first signs of a slight rebound.  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.  However, there are significant downside risks.  Of course, the long anticipated acceleration in U.S. demand may not materialize.  In addition, the January tax hikes and ongoing reductions in energy subsidies could continue to have some impact on activity.  The government's budget for 2014 includes accelerated spending and an expanded deficit, but fiscal policy could continue to be a headwind, as it was in 2013.  Not only could public works remain frozen, but residential construction still shows no sign of recovering.

In the longer term, Mexico's outlook is probably more 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, the recent slowdown in growth illustrates that Mexico needs to focus anew on making itself more dynamic and efficient in its own right.  President Enrique Peña Nieto's reform program therefore 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 Q1 Revised 2

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