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Quarterly Economic Overview - 2015 Q2

In the first quarter of 2015, Mexico's inflation-adjusted gross domestic product (GDP) was up 2.5% from the same period one year earlier, after increases of 2.6% in the fourth quarter of 2014 and 2.2% in the third quarter.  The growth rate in recent quarters has closely matched the economy's average annual growth rate of 2.5% in the two decades from 1993 to 2013.

The Mexican economy has been in an expansion phase since late 2009.  As would be expected at this mature point in the expansion, the main growth driver in recent quarters has been consumer spending.  With hiring continuing to expand, the unemployment rate has fallen sharply over the last year to just 4.4% in recent months.  Consumer confidence has strengthened, and inflation-adjusted retail sales in May were up a healthy 4.1% year-over-year.  Exports, which were the initial spur to the expansion, have recently softened in the face of weaker U.S. industrial demand.  Imports have accelerated.  Net trade has therefore become less of a source of growth.   Private investment in new buildings, machinery, and equipment continues to rise, but it has also softened a bit.  Falling petroleum production, weak oil prices, and decreased energy revenues forced the government to cut spending throughout much of 2014, weighing on growth, but outlays are now rising again.

Mexican stability indicators remain relatively healthy.  The June consumer price index (CPI) was up just 2.9% year-over-year, slightly below Banco de México's medium-term target.   That has allowed the central bank to keep its benchmark interest rate at a record low for more than a year.  Nevertheless, the monetary policymakers acknowledge that an expected hike in U.S. interest rates could drive the peso lower and boost inflation, so they continue to suggest that their next move will probably be to increase rates.  Meanwhile, the reacceleration in government spending has made fiscal policy expansive again.  After a government deficit of 2.3% of GDP in 2013, the deficit rose to more than 3.0% in 2014, and the budget for 2015 projects a similar deficit this year.  The deficit in the first quarter was roughly in line with those expectations.  For comparison, the Organization for Economic Cooperation and Development (OECD) recently estimated the U.S. deficit was 5.0% of GDP in 2014.  Mexico's public sector net debt (including government-owned agencies and enterprises) stood at approximately 39.5% of GDP at the end of 2014, while the OECD says U.S. net debt stood at 85.8% of GDP.

In the four quarters ended March 2015, foreign portfolio investment (net foreign purchases of Mexican stocks and bonds) totaled $37.3 billion, down from $43.9 billion in the previous four quarters.  Foreign direct investment (net foreign purchases of land, factories, office buildings, and other hard assets) totaled $8.4 billion, compared with $34.2 billion in the previous year.  In contrast, net international bank loans, personal transfers, and related transactions swung to an inflow of $17.3 billion in the year through March, after a small outflow in the previous period.  Because of negative net flows in miscellaneous categories, total financial inflows came to $46.0 billion in the year to March 2015, down 14.6% from the previous year.  In spite of the fall in inflows, however, Mexico's current account deficit continues to be financed easily.  The country's foreign reserves reached a record $196.0 billion in January, before falling modestly in recent months as Banco de México sold dollars for pesos in an attempt to slow the decline of the Mexican currency.  Declining petroleum production, low global oil prices, looser fiscal policy, and the threat of higher U.S. interest rates have pushed the peso down relentlessly over the last year, and the currency in June reached a new record low of $0.06460 (15.48 pesos per dollar).

In the coming quarters, Mexico's economic growth looks set to continue plodding along at an uninspiring pace, as stronger consumer spending and a potential rebound in manufactured exports are offset by the problems in Mexico's oil sector and moderating construction growth.  The International Monetary Fund now forecasts Mexican GDP growth will accelerate only slightly from 2.1% in 2014 to 2.4% in 2015, before reaching 3.0% in 2016.  The key risk is that tighter monetary policy and higher interest rates in the United States will spark a large, sudden outflow of capital that could potentially destabilize the economy and weigh heavily on growth, especially if Banco de México responds by hiking interest rates.

To understand Mexico's economic prospects in the longer term, it is first necessary to evaluate prospects for the U.S. economy.  After all, exports have made up almost one-third of Mexican GDP in recent years, and approximately four-fifths of those exports go to U.S. customers.  Therefore, some 26.0% of Mexican GDP comes directly from exports to the United States.  There are also other large financial flows from the United States into Mexico, such as portfolio investment, fixed investment, and bank loans, not to mention the billions of dollars that Mexicans working north of the border send to their families back home each year.  In sum, Mexico's economic health depends in large part on U.S. economic health.

So what is the U.S. economic outlook in the medium-to-long term?  The key point is that U.S. growth seems unlikely to match the strong 3.5% average rate seen in the first five decades after World War II.   That growth rate, which consisted of roughly 2.5% in annual productivity improvements on top of 1.0% in workforce growth, is erroneously seen by some observers as the country's "natural" growth rate.  In reality, the strength of the post-war expansion came in large part from temporary factors that gave a special advantage to U.S. producers.  For example, the country had come through the war with its industrial base not only virtually unscathed, but massively expanded and technologically strengthened through wartime mobilization.  At the same time, the country's main industrial rivals in Europe and Asia lay in ruins.  Even when those rivals began to rebuild, the rebuilding process itself was often a source of business for U.S. firms.  Another temporary advantage came a couple of decades after the war, when the Baby Boomers began to take their first jobs, massively expanding the U.S. labor force.  As they learned the ropes and gained skills, they also boosted U.S. productivity.  Since the mid-1990s, however, those temporary advantages have all petered out or gone into reverse.  U.S. economic growth now depends mostly on the country's long-standing endemic strengths, such as good population growth, strong property rights, and reasonably liberal economic policy.  U.S. growth has averaged just 2.5% per year over the last two decades, consisting of some 2.0% productivity growth plus 0.5% workforce growth.  Because of forces such as increased regulation, an aging population, decreased birthrates, and resistance to immigration, it seems that productivity and workforce growth could continue to fall, perhaps cutting future U.S. economic growth to about 2.0%.

For Mexico, the sad truth is that economic growth since the post-war period has slowed even more dramatically than in the United States.  From 1945 until its 1982 debt crisis, Mexico's GDP grew at an average annual rate of 6.3%, not far off the spectacular growth rates in today's developing Asian countries.  It should be no surprise that growth then slowed in the decade after the debt crisis.  After all, history shows that recovering from a debt-induced recession is typically long and drawn out, as governments, companies, and consumers work to cut their debt and adjust their finances.  (Those forces continue to impede the U.S. economy seven years after its 2008 mortgage crisis, exacerbating the long-term challenges described above.)  What is surprising is that the Mexican economy continues to plod along at a growth rate of just 2.5%.  That's surprising because, 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 privatized key companies, slashed its budget deficit, and cut its foreign debts.  Economists generally ascribe Mexico's continued slow growth 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, reducing 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.   If these problems are not fixed, the impending slowdown in U.S. economic growth seems likely to reduce Mexican growth as well.  Fortunately, however, Mexico does seem to have an opportunity to boost its growth.  As its Asian competitors face higher wages and stronger currencies, Mexico's relative international competitiveness has improved over the last decade.  Its numerous free-trade deals could now allow it to further diversify its exports.  Just as important, President Enrique Peña Nieto has pushed through a reform program that aims to eliminate many of the domestic economy's remaining problems.   If well implemented - and if low oil prices do not discourage new energy projects - these reforms could help accelerate Mexico's growth rate in the years ahead.

GDP 2015 Q1 Initial YOY

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