Download Scenario Review - Mexico

Scenario Review - Mexico
May 2013
Is There a Threat to Reforms?
We expect two 25-bp cuts during 3Q13

The Pact for Mexico was put to a tough test recently. We are still confident that the
current administration will approve at least the key reforms in congress.

We believe that disappointing growth over the past few months is temporary, and so
our growth forecasts are unchanged.

Transitory factors increased inflation, while core inflation has remained very benign.
We expect inflation to end this year at 3.3%, helped by exchange-rate appreciation.

We expect the Mexican peso to reach 11.8 pesos to the U.S. dollar by the end of this
year and 11.5 pesos to the dollar by the end of 2014. This exchange-rate path will
likely bring back the U.S. dollar put auctions.

Due to the fast exchange-rate appreciation and with core inflation under control, board
members have reopened the door for interest-rate cuts. This is consistent with our
view that the central bank will lower interest rates again this year. We expect two 25bp cuts during 3Q13.
Pact for Mexico Feeling the Strain
The Pact for Mexico – a multi-party agreement to implement economic reforms in Mexico –
was put to a tough test recently. The opposition PAN party released videotapes showing
officials trying to use government social programs in Veracruz to promote the ruling PRI for the
local elections in July. As a result, the PAN together with the PRD (another opposition party in the
Pact for Mexico) refused to take part in Peña Nieto’s presentation of a financial-sector reform bill
formulated within the pact.
Challenged by the prospect of dissolving the pact, Peña Nieto canceled the presentation of
the bill and quickly met with leaders of the opposition parties. Soon after the meeting,
politicians agreed on mechanisms to avoid the use of public resources for election purposes.
The Veracruz episode highlights that there are weaknesses in the Pact, especially during
electoral periods. Further election-related conflicts as July approaches cannot be discarded.
Although much was already achieved on the reform front soon after Peña Nieto’s
government took office, the most politically sensitive reforms are yet to be sent to
congress. The government will likely submit the Energy sector bill and the tax reform bill during
the second half of the year. The key idea behind the Energy bill is to allow private sector
involvement in the Oil sector, which is quite controversial in a country that celebrates with a
holiday the nationalization of the oil industry. Meanwhile, the key proposal of the tax reform is to
introduce VAT on food and medicine, which would negatively impact poorer households.
Still, we are confident that political parties can find common ground to approve versions of
the Energy and tax bills that suit market expectations, although those expecting very
aggressive reforms might be disappointed. For example, politicians can agree to maintain the
state monopoly on oil exploration (which is far more politicized), while opening all other energy
activities to private capital. Also, part of the extra revenues from the tax reform can be used for
social spending. We also believe that the PAN has the incentives to support reforms. After all,
much of its electoral base is in favor of economic changes.
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Mexico – Friday, May 03, 2013
GDP Disappoints, but a Rebound Is on the Way
The IGAE (monthly proxy to GDP) grew below expectations in February, up 0.4% year over
year. On a sequential basis, activity expanded by a modest 0.19% from January, bringing quarterover-quarter and annualized growth down to 0.85% (3.5% in January). The number’s breakdown
was also disappointing. The Service sector grew 0.18% mom/sa and 1.9% qoq/saar (down from
5.4% in January). The small and volatile Primary sector fell 2.1% from January, but is still up by
34% qoq/saar. The industry was up by 0.5% mom/sa but is yet to recover fully from December’s
slump, so its trend remains weak, at -2.6% qoq/saar.
The trade balance numbers for March suggest that both external and internal demands are
recovering. Manufacturing exports gained a strong 3.2% from February, following a 5.7%
increase. Thus manufacturing exports continued rebounding from the January slump (-8%
mom/sa). Imports of capital goods fell by 2.9% from February but increased by a solid 12.6%
qoq/saar during 1Q13, pointing to a pickup in investment. Finally, imports of consumer goods exoil jumped 1.8% from February and 39.7% qoq/saar, likely supported by exchange-rate
appreciation.
We continue expecting Mexico’s economy to grow by 3.5% this year. For 2014, our 3.6%
forecast is also unchanged. Apart from trade figures, other indicators for March such as formal
employment, manufacturing PMIs and auto production hint that the economy is gradually
recovering.
High Headline Inflation, While Core Continues at Record-Low Levels
During the first half of April, headline inflation increased sharply, reaching 4.72% year over
year (from 4.38% in the second half of March). Inflation is therefore running far above the target
range. Apart from base effects, there was another temporary factor driving inflation higher: this
was the first CPI number to incorporate the new weightings derived from the 2010 householdbudget survey. Because the weight of electricity fell in the index, the electricity discounts (that take
place in April and in May and are later reversed in October and November) contributed less toward
reducing sequential inflation than they did in 2012, boosting year-over-year inflation (if the weight
of electricity had been held constant, inflation would have been around 10 bps lower).
On the other hand, annual core inflation remained benign, at 3.0%, right at the midpoint of
the target range. Within the core, goods inflation continued its downward trend (to 3.73%), helped
by exchange-rate appreciation, while inflation for services ticked up (to 2.39%) but remained below
the target’s midpoint.
We continue to expect inflation at 3.3% this year. For 2014, we expect inflation to rise to
3.5%. Inflation will likely peak in May. Starting in June, it will probably start to fall rapidly, as base
effects will be favorable and the expiration of the electricity discounts will add less to inflation than
it did the previous year. Apart from temporary factors, exchange-rate appreciation will also likely to
help disinflation. The tax reform will probably lift inflation a bit next year.
Exchange-Rate Appreciation Will Lead to More Interest Rate Cuts
Faster exchange-rate appreciation have led us to bring forward our forecasted rate cuts.
We now see the central bank lowering rates by 25 bps in July and by another 25 bps in
September. In our last scenario review for Mexico, we introduced a forecast for a 50-bp cut during
4Q13. Our year-end forecasts for the base interest rate are unchanged, at 3.5% for both the end of
2013 and the end of 2014.
We expect the exchange rate to end this year at 11.8 pesos to the dollar (down from 12.0 in
our previous scenario). For 2014, our exchange rate forecast is unchanged, at 11.5 pesos to
the dollar. In this scenario, a moderate intervention in the exchange rate market is likely.
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Mexico – Friday, May 03, 2013
Recently, Mexico’s foreign exchange commission announced the suspension of the daily auctions
of up to $400 million that were triggered every day that the peso weakened by at least 2%. The
auctions were implemented by the end of 2011, when the uncertainty regarding the euro-zone
crisis led to a sharp increase in volatility, threatening financial stability and inflation control. Now,
the conditions motivating the auctions are no longer in place, according to the commission. In our
view, once the peso trades below 12.0 to the dollar, the foreign exchange commission will likely
announce a reserve accumulation program through U.S. dollar put auctions. This mechanism was
last introduced in 2010, with a monthly notional volume of $600 million. We don’t expect that
volumes would be significantly higher this time. Not a long time ago, Mexican policymakers have
expressed concerns with the fiscal costs associated with high levels of international reserves, and
- as the central bank continues to accumulate the foreign exchange flows of the public sector reserves are significantly higher today than they were in 2010.
The central bank has communicated that March’s interest rate cut was not the beginning of
an easing cycle. However, the recent round of monetary easing in Japan on top of low
interest rates in the U.S. and the positive news flow on reforms has led to a faster-thanexpected exchange-rate appreciation and, as a result, has reignited the debate over rate
cuts. In fact, the minutes accompanying the March decision revealed that the interest rate
differential was an important factor behind the rate cut. According to the minutes, most board
members agreed that if the central bank leaves the reference rate unchanged while additional
monetary policy easing continues abroad, monetary conditions in Mexico would tighten: excess
capital flows would pour in, distorting asset prices, including the exchange rate.
At the last monetary policy meeting, the
central bank left the policy rate
4.9%
unchanged, but the statement that
Peso/Dollar
1 Year Swap Rates - Mex vs. U.S.
13.4
accompanied the decision suggested that
4.7%
13.2 there is room for a cut if inflation
moderates. In the closing paragraph, the
4.5%
13.0
central bank said that the board will take a
12.8 close look at whether there have been any
4.3%
second-round effects from the recent relative
12.6
price adjustments; at the same time, it will
4.1%
Interest Rate Differential
12.4 also look closely at Mexico’s monetary stance
Exchange Rate (RHS)
vis-à-vis other countries. This could be read
3.9%
12.2
as implying a neutral bias, but the board
3.7%
12.0 seems very confident that inflation will recede
Sep-12
Nov-12
Jan-13
Mar-13
May-13
into the target range. More specifically, the
Source: Bloomberg, Itaú
board said that the “important increase” in
headline inflation was due to temporary factors and that the “price-formation process is unaffected
and consistent with the convergence of inflation towards 3%”. Board members also emphasized
the benign behavior of core inflation, with prices for goods benefitting from lower commodity
inflation and exchange-rate appreciation, while service inflation (which is the part of inflation that
“best reflects the domestic drivers of inflation”) stays close to 2%. The central bank expects
headline inflation to start a downward trend in June, falling into the 3%-4% range during the
second half of the year and to 3% in 2014. In addition, for most of 2013 and 2014, the bank sees
core inflation below the target’s center.
Reducing the interest-rate gap to
smooth peso gains
In a radio interview, Central Bank Governor Carstens said that “an additional (rate)
movement” would be considered once inflation is back within the target range. This is a far
more explicit signal that the high headline inflation is the only factor standing in the way of a cut at
this point.
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Mexico – Friday, May 03, 2013
João Pedro Bumachar
Economist
Forecasts: Mexico
Economic Activity
Real GDP growth - %
Nominal GDP - USD bn
Population
Per Capita GDP - USD
Unemployment Rate - year avg
Inflation
CPI - %
Interest Rate
Monetary Policy Rate - eop - %
Balance of Payments
MXN / USD - eop
Trade Balance - USD bn
Current Account - % GDP
Foreign Direct Investment - % GDP
International Reserves - USD bn
Public Finances
Nominal Balance - % GDP
Net Public Debt - % GDP
Source: IMF, Bloomberg, INEGI, Banxico, Haver and Itaú
2008
2009
2010
2011
2012
2013F
2014F
1.2
1,094
109.5
9,993
4.0
-6.0
883
111.3
7,935
5.5
5.3
1,034
112.9
9,166
5.4
3.9
1,159
114.3
10,142
5.2
3.9
1,177
115.6
10,184
5.0
3.5
1,336
116.8
11,444
5.0
3.6
1,526
117.9
12,937
4.8
6.5
3.6
4.4
3.8
3.6
3.3
3.5
8.25
4.50
4.50
4.50
4.50
3.50
3.50
13.54
-17.3
-1.7
2.5
85.4
13.06
-4.7
-0.7
1.9
90.8
12.36
-3.0
-0.2
2.1
113.6
13.99
-1.5
-0.8
1.9
142.5
13.01
0.2
-0.8
1.1
163.5
11.80
-5.0
-1.4
2.0
193.0
11.50
-7.0
-1.5
2.5
208.0
-0.1
18.2
0.0%
-2.3
29.0
0.0%
-2.8
30.6
0.0%
-2.5
32.2
0.0%
-2.6
33.7
0.0%
-2.0
33.5
-2.0
33.2
Macro Research - Itaú
Ilan Goldfajn – Chief Economist
Tel: +5511 3708-2696 – E-mail: [email protected]
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Mexico – Friday, May 03, 2013
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