Nobody should be surprised. As the US’s economy flounders, Mexico, more than 80% of whose exports are purchased by its northern neighbour, is taking the hit.
Soon after the US Federal Reserve cut its key benchmark federal funds rate in January, Mexico’s government cut its 2008 growth forecast from 3.7% to 2.8%, a 24% slash. The country’s stock market index also hit a 10-month low, and fewer new jobs are forecast for 2008 weaker export demand in the US can hurt Mexican factories and thus cost jobs.
Yet not all is in turmoil. When announcing the lowered growth prospects, Mexico’s deputy finance minister, Alejandro Werner, acknowledged that Mexico would have to lower its ambitious goals for 2008 but added that the country would face a US recession “in the best possible conditions”.
This is true. Latin America’s largest economy has defences at the ready that may allow it to survive rocky economic times better than in previous crises. Among these defences are stronger consumer spending, an ambitious infrastructure plan pushed by President Felipe Calderón’ administration, and steady growth in the retail and tourism sectors. And the housing market is thriving more than that of any other Latin American country, as a national shortage of new homes fuels growth.
Internal strength
“Mexico’s internal market has gained strength over the past five years,” says Adolfo Albo, chief economist for Mexico at Spanish-owned BBVA Bancomer. “There’s no doubt that will buffer the impact of US economic deceleration.”
When the US economy last shrank notably in 2001, Mexico’s economy contracted by 0.3%, it grew by less than 1% in 2002 and continued to suffer in 2003. The fall was mostly due to Mexico’s economy moving to the beat of industrial production in the US, particularly since the 1992 North American Free Trade Agreement.
“It wasn’t a financial crisis then, rather just a normal cyclical response to the US downturn,” says Mr Albo. “Today, Mexico’s economy is more diversified, more prepared. It should be able to handle a shake-up without a crisis.”
Both Mexican central bank governor Guillermo Ortiz and minister of finance Agustín Carstens claim that consumption has risen thanks to better-paying jobs, the billions of dollars sent home by Mexicans living abroad and overall macroeconomic stability.
A recent report by Citigroup-owned Banamex, one of Mexico’s leading banks, backs up one of their claims: it expects private consumption to grow by 4% this year. Messrs Ortiz and Carstens also point to economic growth of about 3.2% in 2007, fuelled by positive reports from across several key industries, including agriculture, construction and real estate.
Telecommunications also show positive signs, particularly in the wireless phone and internet services markets.
“Mexico has plenty of strengths and plenty of untapped markets in its favour,” says Héctor Chávez, chief economist at Spain’s Banco Santander in Mexico. “It’s still a country that is considered a good investment for foreigners who want to avoid a lot of risk.”
Manufacturing, which is by far the most vulnerable sector in the face of a US downturn, showed weakness last year, growing by only a little more than 1%. The slip is worrying, but important manufacturing segments are showing resilience: production is steady at factories specialising in car manufacturing, auto parts, electrical parts and large household appliances.
“We should prepare for little growth or even a contraction in manufacturing,” says Mr Chávez. “But we believe a more dynamic and diversified internal market can mitigate the damage.”
The outlook is mixed for Mexico’s financial sector. Insurance and real estate businesses continue to grow fast, as these market segments remain untapped. The demand for consumer credit has softened a little. In December, consumer lending grew by 19%, slower than in previous months. But the slight drag is seen as an adjustment to healthy lending in 2005 and 2006.
Commercial banks in Mexico are expected to offset any steep drop in credit demand by offering more competitive credit card and mortgage rates.
Slow recovery
One problem is that the rate of business loans has only recently recovered from Mexico’s 1994-95 financial crisis and has yet to return to pre-1994 levels.
“The government argues that Mexico now has a much higher credit penetration than during the 2001 recession,” says Jonathan Heath, chief economist for Mexico at UK-owned HSBC. “That’s true, but if you take a more extended look back at business loans, you’ll see that Mexico is still far behind other countries in Latin America in terms of credit levels.”
A close eye is also being kept on corporate liquidity levels. “We need to make sure that corporations here will be able to survive on lower levels of cash,” says Alberto Johns, director of Moody’s in Mexico. “We might see large banks in the US restrict free cash flows to businesses.”
In monetary policy, Mexico’s central bank, Banco de México, is expected to keep its key rates unchanged and make changes only in the case of high inflation. For now, the bank expects inflation to rise above 4% in 2008, fuelled mostly by higher food prices. If inflation jumps, it may either raise the rate or leave it unchanged.
To control inflation, Mr Calderón has struck accords with retailing heavyweights such as US-owned Wal-Mart de México to lower the price of food staples, including rice and milk, during March.
The administration has also put in motion a large-scale plan to bolster the country’s infrastructure. The six-year programme aims to modernise highways, dams, bridges and ports, among other projects, and will cost nearly $30bn annually. It will tap both private and public funding, with the latter expected to be supplied thanks to fiscal revenue raised by recent tax reforms.
Although a US downturn may not hit Mexico as hard this time, there are some trouble spots. Remittances from Mexicans living abroad, mostly in the US, amounted to $24bn, up from $23bn in 2006. However, the increase reflects significantly lower growth in remittances when compared with double-digit growth in previous years.
The change is largely due to fewer Mexicans willing to cross an increasingly tight US-Mexico border and the US’s sluggish home construction market, a major source of employment for immigrants. In Mexico, fewer money transfers mean less purchasing power.
A steep slowdown in the US will also put pressure on Mexico’s state-owned oil industry and its oil monopoly, Petróleos Mexicanos (Pemex). High oil prices still favour Mexico, but slackening US demand prompted a drop in the number of exported barrels by more than 5% in the first half of 2007. Also, export volumes lag behind production levels.
Close watchers of Mexico’s energy sector predict that oil income will drop from $470m in 2007 to $360m in 2008. But rising exports to Europe and South America could cushion Mexico from the sagging US economy. “Europe is still growing, so there are strong external petroleum markets apart from the US,” says Mr Chávez.
Political collaboration
The political climate might help. No major elections are scheduled for 2008, which raises the chance that political parties may collaborate on long-awaited structural reforms.
So far, Mr Calderón has managed to keep investor confidence high by pushing some reforms (albeit piecemeal in form) through Congress, which experienced gridlock during much of his predecessor Vicente Fox’s administration of 2000-06.
Investors are now waiting to see if there will be a breakthrough with pro-market labour reforms and initiatives to finally open up Mexico’s state-run energy sector to more foreign investment. “The political conditions are in place to move reforms along,” says Mr Chávez.
“The Calderón administration has a number of people in charge who are market-focused and also have a good deal of political experience. It’s a combination that might get reforms passed. Those initiatives might not be ideal, but they will be politically acceptable.”
All the while, the wildcard of just how far the US economy may fall remains. Overall, US growth is not meeting expectations and key indicators remain weak.
“There’s a good deal of international uncertainty,” says Mr Albo. “The outlook for the US economy ranges from a mere cyclical downturn to a prolonged recession.” Mr Heath at HSBC agrees. “Although a deep crisis is not part of the scenario, we don’t know exactly how big a slowdown to expect,” he says. But barring a severe collapse in the US, Mexico may be insulated from the worst.
