Inflation and the rate hikes are likely to dominate Mexico’s economic landscape this year, although foreign and domestic investment might address long-term challenges. Barbara Pianese reports.
According to the World Bank, Mexico’s economy grew by 4.8% in 2021, after plunging by 8.2% in 2020, the largest decline in the country’s economic activity since 1932.
During the Covid-19 pandemic, the private sector and the population did not have the support they had in other countries, says Carlos Morales, director of Latin America Sovereigns at Fitch Ratings.
The Mexican government committed funds worth about 1.9% of gross domestic product (GDP) to mitigate the impact of the pandemic, according to International Monetary Fund (IMF) calculations. In contrast, the Brazilian government committed 7.2%.
Workers in the informal sector have been especially hard hit because they did not benefit from legal and social protections. “Between April 2020 and September 2021, 400,000 small businesses closed down due to insufficient help from the government, while unemployment increased substantially,” says Arturo Huerta, professor of economics at the Universidad Nacional Autónoma de México (UNAM).
Between April 2020 and September 2021, 400,000 small businesses closed down due to insufficient help from the government
GDP per capita at the end of 2020 was close to what it was in 2009, according to Deloitte, which expects the figure to recover from 2023 onward.
On the other hand, “the country managed to have a primary fiscal surplus in 2019 and 2020”, Mr Huerta adds.
Patchy recovery
Mexico’s macroeconomic stability is supported by relatively low debt-to-GDP ratios. Public net debt to GDP stood at 50.1% in 2021, according to data from the Ministry of Finance.
“We have seen that, even across administrations, fiscal prudence has remained,” says Mr Morales.
Following the pandemic, the economy recovered at a varied pace across different economic sectors. Agricultural and industrial activities have resumed their pre-pandemic level of growth, while services are still running below that threshold, according to a report by Deloitte. Consumption has gradually recovered, supported by strong remittances, the recovery of employment and US demand.
“Mexico is a very large and diversified economy. The automotive sector has been affected by global supply disruptions but overall exports performed quite well,” says Fitch’s Mr Morales.
The exchange rate is floating, without any interventions from the government or the central bank. “This reduces the stress on the external balance sheet. And Mexico has a track record in rather large foreign reserves. So, it’s quite resilient to external shocks,” he adds.
Mexico has a precautionary credit credit line with the IMF of up to $50bn that the country has never used, given its strong external finances, says Mr Morales.
Despite the uptick in 2021, the outlook for this year is less promising: Deloitte estimates that the economy will grow by 1.8%. In January, the IMF cut its 2022 economic growth forecast for Mexico to just 2%, from 2.8%. The adjustment follows lower-than-expected growth in the US, Mexico’s main trade partner, amid an environment of rising inflation and higher interest rates.
To prevent inflation from spiralling, last year the Mexican government opted to subsidise fuel prices. For the same reason, the Central Bank of Mexico started raising its reference rate in June 2021. In June 2022, it increased its benchmark interest rate by a record 75 basis points to 7.75%, due to inflation in the intervening 12 months hitting 7.99%. The central bank has already warned it would raise rates if necessary to curb inflation.
There are contrasting opinions as to the effects of higher interest rates on the economy. “Both the public and the private sector are not highly leveraged. So, we don’t feel that they will be in a significant crisis,” says Jorge Arce, president and CEO of HSBC Mexico.
According to UNAM’s Mr Huerta, the central bank’s interest rate hike policy will reduce the potential of production capacity and employment generation. “Such a decision will lead us to a recession with inflation, which will have severe economic, political and social costs,” he explains.
Muted growth
Mexico stands out as having one of the weaker recoveries in Latin America following the pandemic, according to Mr Morales. “Emerging markets with similar income levels typically grow at around 3%, whereas we estimate Mexico’s medium-term growth at 2%,” he says.
While many components of the country’s GDP have improved, “private investment is the laggard with business confidence remaining weak”, he adds.
In 2021, president Andrés Manuel López Obrador, elected in 2018, proposed a reform to change electricity dispatch rules to favour state-owned utility Comisión Federal de Electricidad over private renewables. In April, the reform bill was defeated in Congress.
“Even if the electricity reform did not pass, the possibility of increased government intervention in the energy market continues to affect investment appetite in the sector,” Mr Morales says.
HSBC’s Mr Arce says: “We are in limbo as the government has to clarify how it is going to regulate this industry. And when that happens, we are going to see a lack of private investment in that sector, which probably is the one that requires the most investment.”
Mexico is an important exporter of petroleum products but also a major importer of petrol. It imported 56% of its total petrol consumption in 2021. “The government should invest in national energy production, and in order to do that it needs to work with a fiscal deficit,” says Mr Huerta.
Over the past three decades Mexico has underperformed in terms of growth, financial inclusion and poverty reduction compared with similar countries. Its economic growth averaged just more than 2% a year between 1980 and 2018.
“If we take a look at the past six years, first we had the decline of oil prices, then increased tensions with the US and, more recently, the government’s interventions in the energy sector. This has affected business confidence and private investment,” says Mr Morales.
Public investment has also been lagging and is mainly focused on a few large-scale projects such an oil refinery inaugurated in July, the intercity railway Tren Maya and a new airport, says Mr Arce.
Mexico has the lowest public investment among Organisation for Economic Co-operation and Development countries, spending just 1.3% of GDP in 2019. The figure has been low since 2015 and falling since 2019.
Nearshoring opportunity
The current disruption in global supply chains might be a good opportunity for the US to relocate production from Asia to Mexico, while boosting the latter’s growth prospects. “We talk to clients all the time and there is interest in expanding their operations in Mexico. We have great logistics and a good workforce,” says Mr Arce.
Foreign direct investment inflows into Nuevo León, a northern state bordering the US, rose from $3.1bn in 2020 to $4bn in 2021, an annual increase of 30%.
But focusing on a growth strategy led by exports and capital inflows is not the solution, says Mr Huerta. “We don’t have conditions to grow through exports because international trade has decreased. Moreover, we already export 80% of our production to the US and this has not generated economic growth in Mexico,” he explains.
Mexico registered a $1.88bn trade deficit in April with growth in imports outpacing that of exports, according to the National Statistics Institute. Exports rose 16% from the same month a year earlier, to $47.48bn, and imports increased 25.7% to $49.36bn.
“We import more than 52% of primary agricultural products. We may export avocado, tomatoes and fruits, but we rely on imports for a number of everyday products such as beans, corn and wheat,” says Mr Huerta.
Mexico’s open economy is underpinned by a number of free trade agreements. The North American Free Trade Agreement (Nafta) between the US, Canada and Mexico came into force in 1994 and was later replaced by the US-Mexico-Canada Agreement in 2020. In May, the country launched negotiations on a new free trade agreement with the UK.
However, the free trade agreements with the US has not benefited local industry, says Mr Huerta. “The manufacturing sector was 21% of the GDP in 1981, and now it is 17%. In order to grow the economy, we need to have low interest rates and increase public spending,” he says.
According to other observers, Nafta helped Mexico transition from being a natural resource exporter to a manufacturing exporter that now focuses on automobiles, electronics and aerospace.
It is difficult in today’s global economy to recreate the conditions of the desarrollo estabilizador, the country’s economic golden age in the 15 years to 1970. However, Mexico needs to position itself for strong economic growth to be competitive in the global market.
