Expect No More Than a Partial Economic Rebound in 2021 for MexicoBy Karel van Laack | Wed, 08/25/2021 - 05:00
As difficult as 2020 was, Mexico is expected to see only a partial economic rebound this year, with its recovery process likely stretching into 2024. There are many reasons why Mexico finds itself at this juncture. While the brunt of the downturn can be blamed on the COVID-19 pandemic, the virus is not the only factor in play.
At Atradius, part of our role as providers of trade credit insurance and debt collection services is to assess risk. In Mexico, what we see is economic policy uncertainty and concerns about contract enforcement and rule of law under the current government that will continue to have a negative impact on business confidence and private investments, ultimately hampering growth.
The source of much of the uncertainty swirling around the country is the federal administration under President Andrés Manuel López Obrador. Even before the pandemic — and the handling of the crisis by the government has drawn severe criticism for its comparatively weak national response to contain the spread of the virus — there were issues rattling the business community that remain in place today.
These concerns include López Obrador’s economic policy direction; doubts over the enforcement of contracts, despite the government’s claims they would be respected; the administration’s reversal of landmark energy reforms; and the suspension of oil auctions amid other moves to reassert the dominance of the state-owned oil company PEMEX. Some of these last measures have ended up in the courts, as private companies have launched legal actions to prevent their implementation.
Outside of government policy, high crime rates and endemic corruption continue to undermine the business environment and state functions in Mexico. The economic repercussion of the pandemic particularly hit workers in the informal sector, who account for about 60 percent of the total labor force. Consequently, we believe rising poverty could become a social and political issue.
Although Mexico’s economic performance deteriorated steeply in 2020 due to the coronavirus pandemic — GDP contracted 8.7 percent, mainly due to steep declines in consumption and investment — the virus only exacerbated an already weak economic situation. In fact, Mexico had entered 2020 in a mild recession due to fiscal tightening and falling investments on the back of rising policy uncertainty.
Mexico’s high vulnerability to the effects of the pandemic stems from its relatively weak healthcare system, the close synchronization of its economy with the US business cycle (making it more susceptible to external shocks) and its relatively high dependence on the services sector (including tourism). The automobile sector, Mexico’s leading source of exports,
suffered from a sharp fall in external demand and severe supply chain disruptions. At Atradius, our performance forecast (ranging from “Excellent” to “Bleak”) for both the automotive and services sector is “Bleak.” This means we see a credit risk situation that is poor and a business performance that is weak compared to its long-term trend.
To mitigate the economic impact of the coronavirus, the central bank cut interest rates several times in 2020, to a still relatively high 4.25 percent in June 2021. Additionally, it took measures to support credit lines for consumers and SMEs. But the fiscal policy support has been very limited so far, at just 1 percent of GDP, as the government remains committed to fiscal discipline for the time being. This is despite a sustainable government debt rate of 47 percent of GDP in 2019.
In the absence of comprehensive government support, some states and the private sector have stepped into the void. States have offered to suspend tax payments for businesses and, together with the Inter-American Development Bank (IDB), the Mexican Business Council launched a loan scheme for SMEs.
Due to the meager fiscal support and comparatively tighter monetary policy, the recovery will be protracted, and Atradius believes that GDP will only return to its pre-pandemic level in 2024. In 2021, GDP is forecast to partially rebound, increasing by 5.6 percent after plummeting by 8.5 percent in 2020 on the back of the pandemic.
Exports from the manufacturing sector should receive a boost from higher US growth prospects, while an infrastructure plan will contribute to a partial recovery of investment. However, this recovery expectation remains subject to a timely containment of the pandemic, now experiencing a third wave, and the successful roll-out of the vaccination campaign.
Inflation will remain at the upper end of the Bank of Mexico’s 2 percent to 4 percent target range, mainly due to higher fuel prices and shortages due to persistent supply-side disruptions.
After increasing from 47 percent of GDP in 2020 to 57 percent of GDP in 2021 due to the repercussions of the economic contraction, the government debt ratio is expected to level off in 2022. The government debt structure is generally favorable (70 percent in local currency). The main vulnerability is a relatively high share of debt held by non-residents (45 percent) but refinancing risks are mitigated by a favorable maturity structure (average maturity of more than 18 years for external debt) and prudent debt management. The vulnerability to oil price declines has been mitigated by fiscal reform and an oil price hedge.
The main risk for government finances remains the contingent liability related to heavily indebted state-oil company PEMEX (11 percent of GDP). The financial situation at PEMEX has become more uncertain following the shift from exploration to loss-making refining. Due to the company’s net losses, financial debt increased further in 2020. President López Obrador has prioritized supporting state-owned energy companies financially over further liberalizing the market. In December 2020, he announced the spending of another US$24 billion to support PEMEX and its refineries.
After a sharp depreciation against the US dollar in March 2020 on the back of high capital outflows and oil price deterioration, the peso exchange rate has since recovered most of its lost ground. While the exchange rate will remain volatile in 2021, it is expected to continue its appreciating trend, supported by a global recovery in manufacturing.
Exchange rate fluctuations serve as a shock absorber for the economy, helped by two factors: the fact that Mexico’s foreign currency debt held by the public and private sector remains limited, and by exchange rate hedging.
For the time being, a healthy banking system and solid external balances will underpin the country’s shock resistance.