Enrique Covarrubias
Chief Economist
Grupo Financiero Actinver
View from the Top

Coordination Between Fiscal and Monetary Authorities is Essential

By Gabriela Mastache | Mon, 04/06/2020 - 11:27

Q: What is Actinver’s view regarding the impact of the COVID-19 emergency on the Mexican economy?

A: The economic prognosis is changing rapidly. This is a global economic crisis that started in China and impacted Europe and the US. As the situation advances in these large economies, Mexico needs to start making internal decisions. It is necessary to consider that the combined GDP of the US, the eurozone and China, the most affected countries, represents around 80 percent of global GDP and 80 percent of the capitalization of global markets. When we started to understand the magnitude of the crisis, we revised our growth expectations for Mexico to a -2.7 percent contraction from +0.7 percent GDP growth for 2020. Unfortunately, this will not be the last of it. Many of the latest statistics, especially from the US, are breaking records. For instance, last week, the US registered a very worrisome number regarding weekly unemployment applications. The US normally posts around 200,000 applications per week, which reflects a healthy employment market. However, for the week ended March 28, there were 6.65 million initial jobless claims, breaking an all-time record. We estimate that the US economy, following the current trajectory, will experience a -4.2 percent fall in GDP in 2020. For Mexico, we now estimate a contraction of -6.2 percent. This is a rapid and abrupt decline. At a global level, I do not believe that countries have the tools to fully thwart this contraction, but we need to analyze the fiscal and monetary strategies that will be implemented to mitigate the final impact.

It is important to note that the COVID-19 crisis arrived at a very unfortunate moment for the global economy. When 2020 started, the world was coming out of a series of trade wars that generated a significant deceleration in industrial activity around the world. With the exception of China, almost every major manufacturing country was experiencing an industrial recession.

COVID-19 is taking a toll not only on the industrial sector but also on the services sector. This means that we have a situation in which industrial activity was already affected and consumption, which was helping boost economic performance, is now being impacted.

The trade wars also generated a lack of global coordination in every aspect. When US President Trump entered office, he left the Paris Accord and created a conflict in which all environmental authorities, including those related to epidemiological surveillance, stopped working jointly. Also, the trade wars left global trade authorities diminished, leaving countries with no clear economic and fiscal coordination between them.

In addition to the trade wars and the lack of environmental coordination, we need to consider Middle Eastern pressures, where the lack of coordination, among other things, has prevented stable oil prices. This generates conditions that mean trouble for energy companies, as well as for global banks that provide loans to these companies. As a result, we are seeing the opposite behavior of what we would expect: instead of low oil prices becoming a source of more competitive economic production, they have become a source of chaos and financial stress.

Q:  What measures and fiscal policies could Mexico’s government implement to soften the economic blow of the health emergency?

A: First, and most importantly, there is no economic cost that can compensate the loss of human lives. Any measure that requires people to stay indoors to protect the population is vital. We understand that this will impact the economy in the short term but we have to do it.

Working with this premise, fiscal and monetary authorities need to coordinate their efforts, and they have been doing this really well. It is the first time since the new administration arrived that we are seeing coordination between these authorities. The Exchange Commission is an obvious mechanism of cooperation. But the most important element of cooperation was noticeable in Banxico’s response to the current juncture. When the exchange rate depreciates, the central bank normally increases interest rates, because a depreciated exchange rate impacts import prices and this leads to inflation. For the central bank to lower interest rates, it needs an implicit commitment from the federal government that it will do whatever is possible to limit inflationary pressures. We are seeing this coordination with the implementation of a prudent fiscal policy with a lax monetary policy. More importantly, both the fiscal and monetary authorities have shown their commitment to take any measure to calm the markets.

Though consumption in Mexico has been fairly successful in recent years given certain characteristics of the local market like the demographic bonus, formal employment and remittances, overall investment has not been the best performing indicator. We have a new free trade agreement (USMCA) that is about to begin, but if we do not create conditions for investment to flow into the country, we will not detonate growth. This needs to be done using a combination of factors that include improving the rule of law, announcements that foster investments, and efficient investment from the government.

Overall, the federal government has a good opportunity: 2020 will be a year where markets will allow the government to incur a budgetary deficit. With lower interest rates, the federal government has space to spend more and this represents a golden opportunity to show markets that the government can generate a virtuous cycle of government spending, fostering growth and employment, better salaries and improving tax collection that allows for more spending. 

Q: How will the retreat of international stock markets impact the performance and recuperation of public companies?

A: 2019 was an unusual year not only economically but also for markets. There had been a disconnection between stock exchanges and macroeconomic fundamentals. A useful indicator in this sense is the Purchasing Managers Index (PMI). The US PMI has been falling since 2018, meaning that purchasing managers were less optimistic regarding the future of their companies. Yet, in 2019 the US stock markets experienced surges while the economy was already showing signs of deceleration. As such, we were already expecting an adjustment in 2020.

Investors at Actinver are using this moment to accumulate positions in cheaper global stock markets. Additionally, though it is a moment for caution, it is also a moment for local investors to take advantage of an environment where there are still high interest rates. One of the most important rules for investors to remember is that when things go right, everything is expensive. However, when things go bad, everything is cheaper. Which is why today is the moment to build portfolios with a medium- and long-term vision.

Photo by:   MBP
Gabriela Mastache Gabriela Mastache Senior Journalist and Industry Analyst