MexECON Blog

Quarterly Economic Overview - 2014 Q4

In the third quarter of 2014, Mexico's inflation-adjusted gross domestic product (GDP) was up 2.2% from the same period one year earlier, after increases of 1.6% in the second quarter and 1.9% in the first quarter.  Economic growth has been positive and relatively steady in recent quarters, but it remains somewhat below standard.  In the two decades from 1993 to 2013, the Mexican economy grew at an average annual rate of 2.5%.

With U.S. demand finally gathering strength, Mexican exports have recently been running approximately 5.0% above their levels one year earlier.  Exports of autos, auto parts, and other manufactured goods have been rising especially fast, giving a boost to Mexican factories.  That has prompted increased commercial investment, while private homebuilding remains in a strong recovery.  The expansion in these key industries helped cut the unemployment rate to a six-year low of 4.4% in December.  Consumer spending therefore continues to trend upward.  Nevertheless, weak public works spending and quickly rising imports have limited overall growth.

Mexican stability indicators remain relatively healthy, though risks are higher than they have been in some time.  Inflation is one potential concern.  In January 2014, the consumer price index (CPI) jumped 4.5% from the same month one year earlier, mostly reflecting new sales taxes.  The inflation rate then moderated, but it has not come down as much as some observers expected, and the December CPI was still up 4.1% year-over-year.  Policymakers at Banco de México believe inflation will soon fall to their goal of 3.0%, and that has encouraged them to maintain their benchmark interest rate at a record low since early summer.  Nevertheless, the policymakers acknowledge that inflation may not fall as expected, so they continue to suggest that their next policy move will probably be to increase interest rates.  Meanwhile, fiscal policy has become expansive.  The government's budget for 2015 projects a public sector deficit of slightly more than 3.0% of GDP, roughly equal to the deficit in 2014 but significantly more than the 2.3% deficit in 2013.  For comparison, the Organization for Economic Cooperation and Development (OECD) recently estimated the U.S. deficit was 5.1% of GDP in 2014.  Mexico's public sector net debt (including government-owned agencies and enterprises) stood at approximately 38.0% of GDP at the end of 2014, while the OECD says U.S. net debt stood at 85.5% of GDP.

In the four quarters ended September 2014, foreign portfolio investment (net foreign purchases of Mexican stocks and bonds) totaled a strong $56.1 billion, but that was only moderately better than the $53.2 billion recorded in the previous four quarters.  Foreign direct investment (net foreign purchases of land, factories, office buildings, and other hard assets) totaled $13.2 billion, down from $23.3 billion in the previous year.  Net international bank loans, personal transfers, and related transactions came to $13.8 billion in the year to September.  Because of negative net flows in miscellaneous categories, total net financial inflows came to $62.9 billion, up slightly from 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 September rose to a healthy $190.6 billion.  Nevertheless, it is obvious that capital flows into Mexico have softened.  Investors are clearly concerned about the decline in global oil prices since the summer and the potential for tighter monetary policy in the United States in 2015.  Reflecting those concerns and the cooling in capital flows, the peso fell sharply over the last half of 2014, ending at a six-year low of $0.06887 (14.52 pesos per dollar).

Going forward, Mexico's economic outlook remains positive, though not necessarily inspiring.  Continued growth in the U.S. economy has set the stage for further 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 should lead to increased public works spending.  Finally, Mexicans appear to have adjusted well to the new sales taxes imposed in 2014, and the improvement in the labor market is encouraging higher consumer spending.  The International Monetary Fund therefore forecasts that Mexican GDP growth will accelerate from 1.1% in 2013 to 2.4% in 2014 and 3.5% in 2015.  Nevertheless, any acceleration in consumer and government spending is likely to be limited, and relatively high inflation will cut into spending power.  The recent drop in oil prices is also a key risk, even though oil makes up a only a moderate share of Mexican exports.  The real problem with low oil prices is that the government relies on oil revenues to cover much of its budget.  The government has hedged all of the country's expected oil production for 2015 at $76.50 per barrel, well above current market prices, but consumers, business leaders, and investors are all worried that the drop in the market will eventually cause problems.  Meanwhile, tighter monetary policy and higher interest rates in the United States could spark a large, sudden outflow of capital that would potentially destabilize the economy and weigh heavily growth. 

In the longer term, the outlook for Mexico is also moderately positive.  Against long odds, President Enrique Peña Nieto has pushed through a reform program that aims to toughen performance standards for public school teachers, encourage increased bank lending, boost competition in telecommunications, and open the energy sector to private companies.   It is still unclear how well these reforms will be implemented, but if they are implemented well, they should help accelerate Mexico's growth rate in the years ahead.  Any reforms that can improve Mexico's competitiveness now would be especially important, given that key Asian competitors such as China are currently facing increased labor costs and appreciating currencies, among other challenges.  All the same, it is important to remember that Mexico still faces some difficult structural impediments to growth.  For example, 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. In addition, draconian tax and regulatory burdens for larger firms discourage start-ups from growing or innovating.   As important as anything, investment remains stuck at approximately 22.0% of GDP, versus some 33.0% of GDP in India and 48.0% in China.  Boosting investment is likely a requirement before Mexico can expect to grow as fast as the largest, most dynamic emerging markets.

Patrick Fearon, CFA
Vice President, Fund Management

GDP 2014 Q3 Initial YOY

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