Adrián de la Garza
Macrofinancing Analysis Manager
Banco de México
View from the Top

Mexico Well-Positioned Despite Global Weakness

Thu, 09/01/2016 - 16:55

Q: How is the international economic and political picture affecting the country’s development?

A: In general, the international economic and political landscape this year does not support a stronger global economic performance in the near term. Aggregate demand remains weak both in advanced and emerging economies and growth forecasts have been consistently revised downward in several countries. Although there have been some periods of relative stability in financial markets, international financial indicators have often reacted sharply to unimportant news and temporary shocks, such as minor fluctuations in oil prices. Of course, bigger events like the Brexit referendum results have also spurred market volatility. The uncertainty surrounding the US presidential election and the different policies that may be pursued by the eventual winner may also be a factor that weighs on the minds of economic agents, particularly business leaders who may choose to postpone their investment decisions until the path ahead looks clearer.

Small and open market economies like Mexico, which are tightly integrated into global value chains, are unavoidably prone to international economic and political events. Weak global demand has adversely affected international trade, including that of our exporting sector. The decline in oil prices in 2014 and 2015 was reflected in a lower value for oil exports that limited the federal government’s oil revenues. Following these events, emerging market currencies recorded significant depreciations and the Mexican peso was no exception. It is important to bear in mind that, unlike most other currencies in developing economies, the peso is traded in forex markets 24 hours a day and is ranked first in operating volume among emerging market currencies and eighth overall. This underscores its ample liquidity and market depth.

Mexico’s authorities have taken prompt action to face challenges from abroad and the country is well positioned to weather these shocks. Amidst weak global demand, domestic consumption continues to reach record highs. The labor market has grown stronger, continuing to register higher rates of formal employment. Credit to the private sector has expanded steadily while interest rates remain near historic lows and bank portfolios are in good standing. In spite of the sharp depreciation of the peso, the inflation rate has remained consistently below the central bank’s target of three percent for over a year now. Several factors have contributed to these favorable economic results, including Banco de Mexico’s prudent and timely monetary policy actions, as well as the approval of several crucial and transformative structural reforms, which set Mexico apart from other emerging countries. The federal government has also acknowledged the need to adjust to these challenging times, particularly regarding the environment of relatively low oil prices, and has made a series of announcements that seek to strengthen its fiscal stance. Mexico’s international reserves also remain close to historically high levels, just below US$180 billion, and the International Monetary Fund (IMF) recently renewed and extended the country’s flexible credit line to almost US$90 billion. This constitutes an additional line of defense the government can use, if needed. Mexico is prepared to face the challenging international economic and political environment expected to persist in the short term.

Q: What impact do you expect from the current dollar to peso exchange rate?

A: Exchange rate movements are a shock absorption mechanism that allows countries to adjust more efficiently to fluctuations in the macroeconomic environment, particularly when currencies are allowed to float freely with little government or central bank intervention. Both currency appreciations and depreciations have advantages and disadvantages. If the peso were to appreciate against the dollar as in 2011, it would in principle be cheaper for Mexican companies to purchase their raw materials in dollars. This may benefit Mexican importers but it would become more expensive for companies abroad to buy Mexican goods and services, which would thus hurt exporters in our country. In that same scenario of a stronger peso, it would become more tempting for a Mexican family to take their children to the US on vacation, and US holidaymakers would visit Cancun or Los Cabos less due to higher costs. This means that US tourists would not be spending their dollars on hotels, tours and meals in Mexico, which could adversely impact Mexican employment and business revenue.

In the case of a peso depreciation such as that experienced in 2015-2016, the aforementioned effects would likely be reversed. For instance, we have seen significant increases in the number of international tourists visiting our country. Dollar remittances from abroad, which represent one of the main sources of income for many families in Mexico, also have grown significantly, both in dollar terms, largely thanks to the improvements in the US labor market, and especially in pesos due to the greater number of pesos that one dollar can now buy. These factors may have contributed to supporting domestic consumption throughout 2015 and 2016.

One potential negative effect of currency depreciation is a higher inflation rate, since the cost of goods denominated in foreign currency becomes higher for domestic consumers. These effects have been limited both in magnitude and in terms of the proportion of goods and services affected.

Q: What opportunities does Mexico have to strengthen its economic position following the approval of the newly signed TPP agreement?

A: Mexico has signed several trade agreements in the past few decades, which have sought to help Mexican companies broaden their horizons, diversify the set of goods and services offered in our country and reduce prices. An iconic example is NAFTA, which has been a boon to the Mexican economy and has considerably expanded the volume of trade and foreign investment here.

The TPP gives Mexico a window of opportunity to access the biggest market in the world, including 800 million potential customers in 12 countries that account for close to 40 percent of global trade. This kind of agreement provides incentives for local companies to improve their production and logistics and become more competitive. The automotive industry in Mexico experienced this after the introduction of NAFTA and the industry performed brilliantly thereafter. Mexico has consistently been among the top car manufacturing countries in the last decade and is improving, though there is still significant room for growth.

Mexico possesses competitive advantages that should help build an even stronger macroeconomic framework. After the global financial crisis, the country promptly took action to improve its economic stance. One event that showcased this was the addition of Mexican pesodenominated debt to Citigroup’s World Global Bond Index in 2010, shortly after the crisis. This index is used as a benchmark by major funds worldwide and has given Mexico the opportunity to attract more investment. More recently, even amidst global economic and financial turmoil, Mexico passed several key and broad structural reforms, which have already shown improvements making the domestic sector more dynamic and competitive. One such structural change was the financial reform. Among other benefits, it brought about significant modifications to then-existing regulations to facilitate the expansion of financial services to the nonbanking population who unfortunately still represent a large sector in the Mexican economy. This also means there are significant business opportunities yet to be exploited.

The banking sector is well capitalized and credit to enterprises and households has expanded steadily at rates three times that of the economy, which includes auto loans. In the midst of the volatility of international financial conditions, Mexico has performed well in comparison to its peers, illustrated by the evolution of various international indicators such as the Emerging Market Bond Index or its corporate counterpart. Even though Mexico’s public debtto-GDP rate remains relatively low in comparison with other countries, the federal government has recognized the need to improve its fiscal stance following an increase in debt levels in recent years and has announced measures to this end.

This macroeconomic environment has attracted renowned multinationals in the automotive industry as significant investments have taken place in the last few years and others are expected in the near future. Of course the impact of the TPP on the Mexican auto sector will depend on the final results of ongoing negotiations but even if changes emerge, I am positive that the automotive industry in Mexico will continue to prosper.