Mexico & Nafta - February 2009 (ISSN 1741-444X)

On 27 January the central bank (Banco de México) said that the economy would go into a major recession in 2009, forecasting a real GDP contraction of anything between 0.8% and 1.8% year-on-year. In recent years, the bank's gloomier forecasts have tended to be more accurate. The latest forecast came despite the bank's mid-January decision to cut interest rates, for the first time in three years, by half a percentage point to 7.75%.

Independent economists are downgrading their forecasts on an almost daily basis as the scale of the economic crisis in the US becomes more apparent. When the Mexican government drew up its 2009 budget in September 2008 it expected 3% real GDP growth in 2009; by the time the budget secured congressional approval in October it had reduced this forecast to 1.8%. At the beginning of January 2009, when the government launched its anti-crisis stimulus package (Acuerdo Nacional en Favor de la Economí­a Familiar y el Empleo - see below), the finance ministry was still expecting real annual growth of between 0.2% and 0.3% in 2009. Now, however, the central is expecting a contraction.

Despite the downgrade, the central bank forecast may still be on the optimistic side. The bank made little effort to disguise its surprise at the speed and scale of the US crash. It had been expecting the Mexican economy to have grown by 2% year-on-year in 2008. It now reckons that the economy went into recession in the final quarter of 2008 and ended up with growth of 1.5% year-on-year, at best. In October, the last month for which there are official statistics, GDP contracted by 0.88% year-on-year.

This was the first year-on-year contraction since 2001, the official statistics agency, Inegi, reported. The most depressed industries are mining (which includes oil production), electricity and construction. All of them have been declining for the past six months. The services sector has, so far, suffered much less. It fell by 0.2% year-on-year in December. Agriculture is having the worst time of all: its output was down by 4.7%, year-on-year.

There are clear indications that things got much worse in November and December. December was, for example, an awful month for retail sales (down 10.7% year-on-year according to the retailers association, Antad). Sales at department stores fell a staggering 22% year-on-year, despite a raft of special offers. On Antad figures, for 2008 as a whole, retail sales (which exclude the country's biggest retailer, Wal-Mart de México), were down by only 1.7%, underling the speed of the deceleration in the final quarter.

The car industry also had a rotten December and is bracing itself for worse to come. In December new car sales were down 20% year-on-year, and production was down by 3.5%. For 2008 as whole the industry had a respectable year. Production rose 4% year-on-year (to 2.10m vehicles) and exports rose 3% (to1.66m vehicles). The only problem is that domestic sales, which include imports, fell 6.8% year-on-year, to 1.03m vehicles. Eduardo Solí­s, the president of the Asociación Mexicana de la Industria Automotriz, is forecasting that production will fall by 20% overall in 2009.

The general assumption is that the recession in 2009 will be the steepest in Mexico since 1995, when the economy contracted 7% annually after a botched devaluation at the end of 1994. In the last US recession in 2001, Mexico contracted 0.3% year-on-year.

Some influential businessmen, notably Carlos Slim Helú, Latin America's richest man and the chief shareholder in Telmex and América Movil, have forecast that the recession will be the worst in 30 years.

Too exposed?
Mexico's main problem is that it is horribly exposed to what happens in the US. Trade (imports plus exports) were equivalent to 62% of total Mexican GDP in 2008. In the US trade is about half that, in GDP terms.

Demand and economic confidence in the US has fallen off a cliff. The US government is doing its best to kick start the economy but the comparatively small size of the government as a % of total US GDP (the government accounts for around 20% of US GDP) means that even substantial increases in government spending can easily be nullified by cutbacks in the private sector. In European countries, or in Brazil, the government has a much bigger role in the economy, so the public sector can have a more immediate effect on demand.

In Mexico, successive governments' enthusiasm for privatisation has reduced the public sector's role in the economy even further. Of course, the state oil monopoly, Petróleos Mexicanos (Pemex), is still hugely important, but its weak financial and operational position means that it cannot pull the economy out of recession single-handedly. The current government is stepping up investment in Pemex, but the increases are unlikely to have much effect on the overall economy. This makes Mexico different from Venezuela. Even the most glowering critics of President Hugo Chávez of Venezuela accept that if oil prices were to recover, Petróleos de Venezuela (Pdvsa) would lead the economy out of any slowdown.

The economic news from the US is unbrokenly bleak. Figures from the Cámaras Industriales de México show that Mexico's manufactured exports fell for the third consecutive month on a year-on-year basis in December. In value terms they fell to US$2.09bn, compared to US$16.09bn in December 2007, down 11.5% year-on-year.  This was the biggest ever fall recorded by Inegi. Over 85% of Mexico's manufactured exports go to the US.

Although Mexico trade deficit is still small, it is growing fast. In 2008, it came to US$16.8bn, despite record oil export prices in the first half of the year. The government's oil hedge will protect oil revenues in 2009, but the decline in manufactured exports will have a major effect. If remittances and foreign investment weaken further, the country could run into balance of payments problems again.

The big problem for Mexico is that the US private sector appears to have lost its collective nerve. At the end of January, The Wall Street Journal reported that none of the 13 US commercial banks which had received a combined US$148bn in bailout cash from the US government had increased their loans since taking the aid. Overall, they had cut back on total lending.

This lack of confidence in the US is having a similarly negative effect on Mexico. In December 2008, Mexican bank lending fell by 1.88% month-on-month. If this pace of decline continues (implying a 25% fall in bank lending over a year) the Mexican economy could be in for a much rougher time than even the central bank expects.

Another straw in the economic wind is the sharp deterioration of credit quality in Mexico. Overdue consumer loans are starting to rise: in November they accounted for 8.49% of the total; rising to8.75%, in December even though overall consumer lending fell by 2.7% to M$472.8bn (US$33bn).

Government starts to panic
As the scale of the crisis becomes more apparent, the government is becoming less assured. On 27 January it announced, after widespread protests (led by fishermen and farmers), that it would not increase the price of diesel at the rate previously announced. Diesel prices were slated to rise by M$0.20 a month from February (on top of an earlier increase in January), but will now only rise by M$0.05 a month. The finance ministry estimates the cost of the change at M$9.6bn (US$670m), which will be met by economising elsewhere. The Left argues that the government should rescind the increase altogether and cut diesel prices.

What is clear is that the government is not committing the financial resources the US has done to mitigating the effect of the crisis. Arguably, as the local banking system appears to be in better shape than many of the banking systems in other members of the Organisation for Economic Cooperation and Development (OECD), the Mexican government does not need to spend as much as US and European countries do.

Stimulus package
On 7 January, President Felipe Calderón Hinojosa announced a M$60bn (US$4.4bn) economic stimulus package. The key elements in the package included a cut in the price of cooking gas and a freezing of petrol prices, in additionl to measures aimed at preserving jobs. The finance ministry claimed that the package, formally known as the Acuerdo Nacional en Favor de la Economí­a Familiar y el Empleo, would boost GDP by about 1% (or M$120bn) this year.

The bulk of the money for the package is coming from the M$100bn windfall produced in 2008 by higher-than-budgeted oil prices. The package has been endorsed (grudgingly) by the private sector, most trade unions and most local governments.

Some tax economists argue that the government's recent switch from a conventional income tax (ISR) to the new Impuesto Empresarial a Tasa Unica (Ietu), which is calculated on sales rather than profits, will have a depressing effect on business activity. The Ietu was initially set at 16.5% in 2008 and was due to rise to 17% in 2009 and 17.5% thereafter. The finance minister, Agustí­n Carstens, argued that the government would be wrong to cut the Ietu because Mexico's tax take is already so low as a percentage of GDP. (Stripping out oil revenues, which account for almost 40% of the government's fiscal income, Mexico's tax take is barely in the teens as a percentage of GDP).

The biggest expense in the stimuls program is the freezing of petrol prices and the 10% cut in cooking gas prices. These moves will inject M$45.4bn into consumers' pockets, the finance ministry says.

Mexico's petrol prices have been rising because of the weakness of the peso against the dollar: Petrol in Mexico costs the equivalent of US$2.66 a gallon. In the US the price is around US$1.75 a gallon. Mexico imports most of the fuel it uses while exporting lower-value crude oil. Mexicans grumble that they had to pay more for fuel when oil prices were rising (in 2007 and the first half of 2008), but saw no relief when oil prices halved in the second half of 2008. This was because the peso promptly started to slide against the US dollar.

Altogether, the package has 25 elements. Besides the moves to reduce energy costs, the government is also offering companies support to avoid redundancies. The plan envisages M$2bn fund to help companies retain staff they would otherwise sack because of the effects of the global economic crisis, with another M$2.2bn to support companies taking on temporary workers.

The employers organisation argues that the package could have been better and clearer. Ricardo González Sada, the president of the Confederación Patronal de la República Mexicana (COPARMEX), said that the big omission was the absence of a fiscal stimulus policy, as has been introduced by the US, China, Japan and Spain. He noted that even the IMF is recommending that governments throw a minimum of 2% of GDP into the economy. He noted that the government itself admits that its package will not stimulate the economy by more than 1.4% of GDP.

Sada also argued that the government should do more to prevent the Ietu deterring business investment. He suggested that the Ietu should only be levied after investment, wages and interest payments have been made.

Confidence in Mexico is plummeting as the effects of the US crisis start to bite. On 8 January the national statistics agency (Inegi) and the Banco de México published the consumer confidence index for December 2008: the index stood at 84.1 (100 was the level of consumer confidence in 2003), a staggering 20.4 points down on the year earlier level.

The main factor driving down consumer confidence is the jobs outlook. According to the national social security agency (IMSS), in December 2008 the number of people working in the formal (social security paying) economy fell by 327,136.  In  calendar 2008 there was a net loss of 29,589 formal jobs as a whole. In January 2009, for the first time in five years, there was a 1.7% year-on-year fall formal employment level, the equivalent of 242,000 jobs. Now there are about 14m people working in the formal economy.

The grim December and January data reversed Mexico's previously decent employment data. While the US lost 553,000 jobs in November 2008, Mexico managed to create 375,000 in the first 11 months of 2008. However, in November 2008, despite the start of the Christmas rush, only 38,000 jobs were created. In April 2008, usually an average sort of month for job creation, 80,000 new posts were created. The Asociación Mexicana en Dirección de Recursos Humanos fears that Mexico will only create 200,000-250,000 jobs in 2009. Mexico currently has 1.98m unemployed people, or 4.2% of the workforce. With expected real GDP growth of only 1.8% in 2008, the labour market outlook is clouding.

Inflation: In January, consumer prices rose 0.23% on a monthly basis, bringing the 12-month inflation rate to 6.28%. In December 2008, monthly consumer prices rose 0.69%, bringing the annual inflation rate to 6.53%, the highest in eight years. In 2007 annual inflation was 3.76%.

Underlying inflation, which excludes volatile fresh food prices, rose 0.43% month-on-month in January 2009, bringing the 12-month rate to 5.76%. Core inflation, which covers 100 basic products, was 8.06% for the 12 months to January: this was down, however, on the final result of 8.32% for 2008.

Intervention: On 4 and 5 February the Banco de México surprised traders by intervening in the foreign exchange market to halt the decline in the peso against the US dollar. The central bank and the government argued that the peso had been under attack from speculators who were trying to push it to M$15 to the dollar. Between 9 January and 4 February, the peso fell 7% against the dollar. Over the same period the Euro/Dollar exchange rate fell 4.5% while the Brazilian Real and the Korean Won had weakened by less than 1% against the US currency. The central bank's intervention was reasonably successful. It pulled up the peso by about 2.2% against the dollar. The finance minister, Agustí­n Carstens, said that the government may repeat the move in the future.

Remittances: Remittances in 2008 came to US$25.14bn, down 3.6% on 2007. Nonetheless, the figure was considerably higher than many had expected. The finance minister, Agustí­n Carstens, had forecast an 8% fall in remittances in 2008. One reason remittances were a bit higher was that the peso was so weak and remittances senders in the US realised that they got more bang for their buck by sending the money home than by keeping it in the US.

Tequila: Tequila production in Mexico rose 10% annually in 2008 to reach a record volume of 312m litres. Tequila exports rose 1.7% annually.

Trade: In 2008 total merchandise exports were valued at US$291.8bn, whiel imports were valued at US$305.6bn. The trade deficit in 2008 rose 67% year-on-year to US$16.8bn, the highest for 14 years, despite the surge in oil prices in the first half of the year.

Consumer confidence: Consumer confidence in Mexico is now at its lowest level since records began, according to Inegi. It reported that confidence was down to 81.9 points at the end of January. In January 2008, the index was 20.8 points higher.

GDP contraction: The consensus GDP forecast of private sector economists polled by the central bank is -1.16% in 2009.