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

The booing and hissing of the finance minister, Agustí­n Carstens, when he threw the first ball to open an international baseball tournament on 8 March is the most public evidence of Mexicans' growing concerns at the state of the economy. The latest statistics point to an economy in deep trouble on almost every front. Unemployment is heading towards its highest level for a decade, business confidence has collapsed and the balance of payments is beginning to creak ominously. As the latest data from the US economy show no sign of a recovery, Mexico will not pull out of its dive any time soon.

The worrying (and unusual) aspect of the crisis is that until recently the authorities were gloomier than the private sector. That has changed. Now the private sector is forecasting that the economy will contract by anything between 3% and 4% annually in 2009. The Banco de México is forecasting that the economy will contract by at most 1.8% annually. 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 the budget in September 2008 it expected 3% GDP growth in 2009, by the time the budget was approved by congress in October the government's growth forecast was down to 1.8%. At the beginning of January, when the government launched its Acuerdo Nacional en Favor de la Economí­a Familiar y el Empleo, the finance ministry was still expecting GDP growth in 2009 of between 0.2% and 0.3%. Now Carstens admits that the economy will go into recession in 2009.

The debate is over the scale of the recession. In 2001, when the US dipped into a brief (two quarter) recession, Mexico's economy contracted by 0.3% in the year. The US managed marginal growth of 0.8% in 2001, down from 3.7% in 2000 and 1.6% in 2002. This year, the US economy could contract by anything from 0.5% to 2.5% annaully. Applying the 2001 multiple would suggest that Mexico could contract by anything between 1.5% and 7.5%. In 1995, the Mexican economy's last really disastrous year, the economy contracted by 6.2%.    

The latest industrial output figures are awful. The car industry has started 2009 even worse than its executives expected. Eduardo Solí­s, the president of the Asociación Mexicana de la Industria Automotriz (Amia), had forecast that production would fall by 20% in 2009. In the first two months of 2009 production was down by 44% (or 150,000 vehicles) at 189,080. In 2008 the industry had a respectable year. Production was up by 4% (at 2.102m vehicles) and exports were up by 3% (at 1.661m vehicles). The big problem in 2008 was that domestic sales, which include imports, were down by 6.8% at 1.025m vehicles.

In February 2009, the car industry was now back to 1995 production levels. Its big problem is that US demand for vehicles has collapsed while domestic demand has remained weak. In the first two months of 2009 domestic sales were down by 29%, year-on-year, at 131, 242. Exports, which go mostly (70%) to the US crashed by 50% in the first two months of 2009 compared with the same period of 2008 at 128,894. Exports to the US and the European Union were down by 52% (at 89,242 and 16,879 respectively), while exports to Asia fell by 72% to under 2,000 vehicles. Exports to Canada were down by 13% and exports to Latin America by 43%.

The Amia points out that the industrial confidence index in Mexico stood at 425 in February and over that past three months has fallen at its fastest rate since the index was first constructed in 1967. The Asociación Mexicana de Distribuidores de Automotores wants the government to do more (by offering tax cuts) to encourage local buyers to purchase consumer durables.

The motor industry built just 107,547 units in Februray. This was 38% down on February 2008. As a result of the dismal start to 2009, Amia is now forecasting that production will be 25% down in 2009.

The general assumption in Mexico now is that the recession in 2009 will be the steepest contraction since 1995, when the economy slumped by 6.2% after a botched devaluation at the end of 1994. Some influential businessmen, notably Carlos Slim Helú, Latin America's richest man and the chief shareholder in Telmex and América Movil, forecast that the recession will be the worst for 30 years.

The Mexican economy's problem is that it is horribly exposed to what happens in the US. Trade (imports plus exports) was 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 in total US GDP (the government accounts for around 20% of GDP) means that even substantial increases in government spending can easily be nullified by cutbacks in the private sector. In European countries, and Brazil, the government has a much bigger role in the economy, and so can have a more immediate effect on demand.

The lack of private sector confidence in the US is having an effect on Mexico. In December 2008, Mexican bank lending fell by 1.88% on November. If this pace of decline continues (implying a 25% fall in bank lending over a year), the Mexican economy could face a 1995-style slump. 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 were 8.49% of the total, rising to 8.75%   in December, even though overall consumer lending fell by 2.7% to M$472.8bn (US$33bn).

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.

The official statistics agency, Inegi, reported that Mexico's manufactured exports in December were US$16.09bn, 11.5% down year-on-year. December was the third consecutive month showing a year-on-year fall. Although the trade deficit is still small, it is growing fast. In 2008, it came to US$16.8bn, despite the 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.

Carstens starts to worry
On 4 March Carstens admitted that the Mexican economy was in a much more difficult position than he had expected. He pondered whether the anti-crisis plan would be enough the get the government out of the current hole. Carstens called on companies not to lay people off or cut their wages.

What is clear is that the Mexican government is not committing the financial resources the US has done to mitigating the effect of the crisis.

The government's M$60bn (US$4.4bn) economic stimulus package (Acuerdo Nacional en Favor de la Economí­a Familiar y el Empleo) announced on 7 January, is small by Organization of Economic Cooperation and Development standards. It is designed to boost GDP by about 1% (or M$120bn). 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 by business leaders (grudgingly), most trade unions and most local governments.

The key element in the package is a freezing of petrol prices. Mexico imports most of the fuel it uses, while exporting lower-value crude oil. The other major element in the package is a 10% cut in cooking gas prices. Together with the petrol price freeze, these measures will inject M$45.4bn into consumers' pockets, according to the finance ministry.

Employers' organisations argued 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 and drew attention to the fact that even the government itself admitted that the package would not stimulate the economy by more than 1.4% of GDP.

Unemployment: In January 2009, for the first time in five years, there was a 1.7% year-on-year fall in the number of people in formal employment. In December, according to the national social security agency, the IMSS, the number of people working in the formal (social security paying) economy dropped by 327,136. In 2008 there was a net loss of 29,589 formal jobs as a whole. Between January 2008 and January 2009 there was a 242,000 fall in the number of people in proper 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.

Inflation: In February consumer price inflation was 0.22%, bringing the annual rate to 6.2%, well above the central bank's target of 3%. The February rate was much the same as January's 0.23%. In December 2008, prices had risen by 0.69%, bringing the annual inflation rate to 6.53%, the highest for eight years.
Underlying inflation, which excludes volatile fresh food prices, rose 0.49% in February, up on January's 0.43%, to bring the 12-month rate to 5.78%. The rise in underlying inflation was the highest for any February since 2003 and reflects the weakness of the peso.

Intervention: The Banco de México and the finance ministry changed their tactics to protect the peso on 6 March but the market's initial reaction was a thumbs down, though the peso did pull back from the M$15.5 levels it hit on 9 March when international financial markets had a decent day on 10 March.
The Banco de México's change of tactics involved trying to head off speculators by immediately offering US$100m to the market. The problem is that this was gobbled up.

The central bank had surprised traders by intervening in the foreign exchange market at the beginning of February and then again at the end of the month. The bank clearly wanted to brake the decline in the peso against the dollar and delay the breach of the M$15 to the dollar level. The central bank and the government argued that the peso had been under attack from speculators who wanted to push it to M$15 to the dollar, pointing out that the peso had fallen by a lot more (7%) than either the Euro (4.5%) or the Brazilian Real.

The central bank argues that there is no chance of a balance of payments crisis in Mexico this year. The central bank expects a current account deficit of US$24.1bn in 2009 but reckons that there will be a US$27.47bn surplus on the capital account. The main element in the capital account surplus, according to the finance ministry, will be the US$9.2bn profit on the oil price hedge. The government is also expecting to borrow almost US$14bn from the World Bank and the IDB.

On the other hand foreign investors, who have benefited from the strength of the peso in recent years, may be changing their view of Mexico given the political and economic outlook. Non-residents hold M$317bn (US$21bn) in Mexican securities. Between September 2008 and January 2009, they sold about M$50bn worth. They could easily sell another M$150bn (US$10bn) worth before the mid-term elections. This outflow would negate the profits on the oil price hedge and mean that the central bank would have to run down its reserves to cover the current account deficit.

Interest rates: In mid-January the Banco de México cut rates by half a percentage point to 7.75%. This was the first cut for three years.   On 20 February, the central bank cut rates by a further quarter of a percentage point to 7.5%

• The balance of payments

In 2008 the country ran a current account deficit of US$15.53bn. This was more than twice the size of the deficit in 2007. At 1.4% of GDP, the deficit is still financeable, but warning lights are beginning to flash. The deficit in 2009 is likely to be significantly higher than in 2008, even though the government has cleverly fixed the price of 70% of its oil exports at US$70 a barrel. The current (10 March) export price for Mexican oil is US$40 a barrel. Oil accounts for about 11% of total exports. The collapse in the export of manufactured goods to the US will have a much more serious effect. Remittances are also likely to be down, but only by between US$3bn and US$4bn we guess. In 2008 remittances were worth US$25.1bn, down 3.6% on 2007.

The country had a trade deficit of US$16.8bn in 2008 and the cost of paying interest and dividends (factor services) came to US$17bn. In 2008 export revenues came to US$291.8bn, up 7.3% on 2007. In 2007 exports were 8.9% up on 2006. The main reason for the increase in 2008 was a 17.7% rise in oil export revenues: non-oil exports were up by a much more modest 5.4%. The capital account had a surplus of US$20.96bn even though foreign direct investment fell by 19.9% to US$18.6bn. Reserves at the Banco de México rose by US$7.45bn over the year to US$85.4bn.