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Eduardo Loria, School of Economics (UNAM) [email protected]; www.economia.unam.mx/cempe; www.economia.unam.mx/profesores/eloria/ MEXICO ECONOMIC OUTLOOK (2016-2018) By Eduardo Loria1 Center for Modeling and Economic Forecasting School of Economics, UNAM Mexico City Fall Meeting Toronto Canada, October 2016 1 Coordinator of the Center for Modeling and Economic Forecasting. School of Economics, UNAM. The contents of this report do not necessarily represent the institution’s point of view. Total or partial reproduction is allowed only if it is quoted. I am grateful to Emmanuel Salas and Jorge Ramírez for their collaboration. 1 Eduardo Loria, School of Economics (UNAM) [email protected]; www.economia.unam.mx/cempe; www.economia.unam.mx/profesores/eloria/ 1. Recent Trends In the contractionary environment that has plagued Latin America since the end of high-priced commodities period, Mexico has been an exception, maintaining a constant but very low growth rate, and the behavior of some of its macroeconomic variables is worrisome for future growth prospects. The first example of these worrisome tendencies in Mexico are the strong, external imbalances that have been observed during the last two years. Furthermore, the international turmoil has resulted in capital outflows of US11.368 billion: unprecedented volumes for a first semester and similar to the 1995 crisis. Manufacturing and exports have lost vigor, due to the low growth of US industry. Since the signing of NAFTA, the primary destination for Mexican exports -and thus the main growth engine- has been the industrial sector of the United States. US industry has suffered from an appreciation of the US Dollar, brought about by the uncertainty surrounding the normalization of that country’s monetary policy. Imbalances are not limited to the external sector and can also be perceived in the sharp increase of public debt. After the great recession of 2009, Mexico introduced expansionary, aggregate-demand policies that generated deficits. These deficits have led to a strong rise of public debt, negating the trend that this indicator had followed since the structural reforms of the 1990’s. While the exchange rate volatility of the past two years has not affected consumer prices, it has had an impact on producers and could bring inflationary pressure in the medium term. Consumer prices have remained at a historically low level (2.73% annualized to August), below the central bank’s 3% objective. This result is compatible with the negative and increasing output gap. In regard to the inflation target, although no demand pressures exist, inflationary leaks from producer to consumer prices are now perceived as an important pressure for the achievement of the target, since producer prices have grown 5.6%. Given the above context, contractionary fiscal and monetary policy has been deployed to contain these imbalances, systematically reducing growth forecasts for 2016 and 2017. Forecasts have not only been systematically reduced by private analysts, but also by the monetary and fiscal authorities themselves (see Figure 1). 2 Eduardo Loria, School of Economics (UNAM) [email protected]; www.economia.unam.mx/cempe; www.economia.unam.mx/profesores/eloria/ Figure 1 GDP growth forecast modifications, 2016 2.75 2.69% RATE OF GROWTH 2.65 2.55 2.44% 2.45% 2.45 2.35 2.28% 2.25 2.15 EJanuary NERO F EBRERO February M ARZO March AApril BRIL M AYO May JJune UNIO JU LIO July Source: Encuesta sobre las Expectativas de los Especialistas en Economía del Sector Privado. 2. Assumptions on National Policy and the External Environment 2.1 Contractive Fiscal Policy As mentioned above, the debt-to-GDP ratio (47.6%) and the speed with which it has risen have reached alarming levels. In the current context, this has prompted the rating agencies S&P and Moody’s to downgrade Mexican sovereign debt rating, which will result in higher financial debt payments. The Ministry of Finance has implemented a restrictive fiscal policy, based on increasing the efficiency of taxation, raising the domestic price of fuel and introducing several budget cuts for 2016 and 2017. We do not expect significant reductions on social expenditure, since the fourth of six years of the current presidency has just ended, and 2017 will bring local elections in states that are key for the next presidential hopefuls, like Estado de Mexico. 2.2 Contractive Monetary Policy During this year and in 2015, Mexico has been experiencing the lowest inflation rates on record. Inflation is now below Banxico’s 3% annual target, and these rates are consistent with the negative output gap (Figure 2). 3 Eduardo Loria, School of Economics (UNAM) [email protected]; www.economia.unam.mx/cempe; www.economia.unam.mx/profesores/eloria/ Figure 2 OUTPUT GAP, % OF POTENTIAL GDP 3 2 1 0 -1 -2 -3 -4 -5 -6 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Own calculations, based on information of Inegi (2016). Nevertheless, the global appreciation of the US Dollar has been particularly hard on Mexico and, as mentioned above, the producer price index is showing signs of a spillover to consumer prices. This has led Banxico to address exchange-rate concerns with contractionary monetary policy, raising the interest rate twice this year and warning the hikes will persist if prices continue to be pressured by the exchange rate. 2.3 External Environment US industry is vital for the economic growth of Mexico, due to the high level of linkage in the chains of value. Weakness in this sector has had an impact on production and exports in Mexican manufacturing, affecting growth and the trade balance. Additional external factors that have impaired the performance of the Mexican economy include: a) the appreciation of the US Dollar; b) the uncertainty generated by the speed of the normalization of monetary policy in the US; c) the electoral period in the US; d) the fall of international oil prices; e) Brexit. 3. Forecast Summary Growth forecasts are based on a context of restrictive policy in both the monetary and fiscal fronts. In other words, we continue to expect budget cuts and an increasing interest rate, as the authorities seek to simultaneously contain external imbalances, lower the fiscal deficit and keep inflation levels in check. The exchange rate has become a key variable and we expect further volatility in the remainder of the year. The outcome of the US presidential election and the monetary normalization process will have 4 Eduardo Loria, School of Economics (UNAM) [email protected]; www.economia.unam.mx/cempe; www.economia.unam.mx/profesores/eloria/ short, medium and long term impacts on the Mexican economy, particularly on the exchange rate and economic growth. It is very likely that US industrials will recover, leading to a higher growth rate for Mexico in 2017. 4. Policy Issues and Uncertainties The US presidential election will have powerful effects on economic and social variables in Mexico, regardless of the outcome. While the Republican candidate has issued strong attacks and warnings, the Democratic platform also includes protectionist policies that have the potential to damage Mexican growth prospects. In fact, both candidates have proposed thorough revisions of NAFTA, which, though still unclear, are likely to follow a protectionist agenda. Both the normalization of monetary policy in the US and Brexit have resulted in capital outflows, so we cannot know how much more they could affect the balance of payments and the adjustment of interest rates, placing further pressure on an already low growth rate. Mexico is bound to follow the Fed rate, but perhaps this will be done in a more aggressive manner to keep international uncertainties at bay. The approval rating of President Peña Nieto has reached historic lows, weakening the rule of law in general and the implementation of structural reforms, as reflected by the teachers’ movement in the southeastern states. Indeed, the drop in the President’s approval rating could mean the administration of the country will go to a different party in 2018. Among the factors that add uncertainty to this environment we find a current account deficit that has reached 3% of GDP, notwithstanding the low growth. This is a troubling sign, because a trend has been set in the last few years and monetary authorities feel pressured to maintain their contractionary policy. As mentioned above, this is not an isolated problem, given the historic capital flight of US11.368 billion. It is for this reason that Banxico has requested additional measures of consolidation in public finances, in the form of further spending cuts, and the threat of additional rate hikes remains. Fears about Mexican sovereign debt, now 46.9% of GDP, have reached the rating agencies S&P and Moody’s. The lower rating will eventually translate into higher payments in total foreign debt. Lastly, the potential for further changes in the administration, like the September 17 resignation of the minister of finance, is a cause for concern. 5 Eduardo Loria, School of Economics (UNAM) [email protected]; www.economia.unam.mx/cempe; www.economia.unam.mx/profesores/eloria/ 4. Summary Table for Forecast 2013 2014 2015 2016 2017 2018 GDP and Expenditure : Constant Prices, Growth rate Private Consumption 2.2 1.8 3.2 2.7 3.4 3.7 Government Consumption 1.0 2.4 2.3 -13.6 -0.5 1.3 Gross Fixed Capital Formation -1.6 3.3 4.3 3.0 3.3 4.4 Exports of Goods & Services 2.8 4.9 -1.2 -0.3 3.8 3.7 Exports of Goods 2.5 4.5 -4.1 -3.5 3.5 3.4 Exports of Services 7.5 2.8 -5.0 -1.9 2.2 2.2 Imports of Goods & Services 2.5 4.5 -4.1 -3.7 2.0 1.8 Imports of Goods 2.8 4.9 -1.2 0.8 3.7 3.5 Imports of Services 20.3 -5.3 -6.8 -6.5 2.2 2.3 GDP 1.4 2.3 2.5 2.1 2.5 2.8 Key Economic and Global Indicators Inflation rate 3.9 4 2.1 3.3 3.4 3.1 Wage inflation (%) (1) 2.9 4.1 4.1 4.3 3.7 3.6 Unemployment Rate (%) 4.9 4.9 4.3 4.0 4.1 4.1 Output gap (2) 0.33 0.04 0.08 -0.38 0.07 0.08 Crude oil price ($ pb, annual average) 104 93.6 49.7 40.3 45 44 World trade (% change, volume) 3.3 3.2 3.0 2.9 2.9 2.8 National currency per US$ 12.7 13.3 15.8 18.4 18.2 19.0 Japanese yen/$ 0.13 0.12 0.13 0.18 0.17 0.18 Chinese yuan/$ 2 2.1 2.5 2.8 2.7 2.8 $/euro 17.0 17.7 17.6 21.0 21.0 22.0 (1) Manufacturing medium wages in real terms. (2) Percent of potential GDP I thank Emmanuel Salas and Jorge Ramirez for their extraordinary research assistance. 6