Finanzas: Mexico 2017, reasseassing the risks & potential scenarios
Falling consumer confidence; a weak currency; rising inflation; public debt mismanagement; souring relations with a powerful neighbor. The news out of Mexico this year has done nothing to improve its economic outlook, rather it has prompted economists to slash their GDP growth forecasts for this year and next. Looking deeper, Mexico is not only facing strong economic headwinds from Donald Trump’s protectionist rhetoric, but also internally from higher inflation, exchange rate volatility, tighter monetary policy and ballooning public debt.
Mexico without a doubt faces the greatest risk in the region from the anti-trade and anti-immigration policies championed by U.S. President Donald Trump. At the beginning of the year, the media and markets have been paying close attention to the developments between the U.S. and Mexico. In particular, the governments of the two nations have attempted to implement tactics aimed at strengthening their bargaining power in the future renegotiation of NAFTA or of trade policies in general.
But hopes for a quick resolution of trade-related uncertainty faded rapidly and this prompted extreme fluctuations in the Mexican peso. In mid-January, the markets seemed to be preparing for the worst as the peso weakened sharply, briefly touching 22.0 MXN per USD. A few weeks later, market sentiment improved, with the peso gaining part of the ground lost and appreciating toward 20 MXN per USD. Nonetheless, considerable volatility is to be expected as uncertainty related to future negotiations persists.
Tariffs on exports to the U.S. and the construction of a wall at the northern border are not the only challenges that the Mexican economy is facing. More visible and immediate is the surge in inflation at the outset of this year, which stemmed from the adjustment of domestic gasoline prices. Inflation jumped to 4.7% in January (December: 3.4%) and our latest Consensus Forecast has it averaging 5.0% this year, with the majority of analysts seeing it remaining above the Central Bank’s 4.0% upper limit of its 3.0% inflation target for the reminder of the year. While in 2016 the Central Bank had been raising rates to curb the peso’s depreciation, its focus now is on avoiding second-round effects from the currency weakness and gasoline price increases. The monetary policy rate is currently at 6.25% and given the latest inflation projections, further interest rate hikes are very likely. On top of that, Mexico’s Central Bank considers the interest-rate differential between the U.S. and Mexico a key variable for future moves. So, hikes made by the Fed this year will translate into Banxico raising interest rates too.
Mexico’s fiscal deficit narrowed more than expected last year and the primary fiscal deficit—before interest payments—came close to being eliminated. However, despite the positive results on the budget front, debt management seems to be particularly problematic. Public debt ended 2016 at 50.9% of GDP, which is now at its highest level since the late-1980s. As was in the case of 2015, the rising debt stock mostly reflects the peso depreciation, as it raised the local-currency value of external debt. At this this level, Mexico’s debt stock is risking the credibility of the government’s debt management in what is set to be an already difficult year.
In terms of economic activity, revised data suggest that 2016 ended on a relatively positive note. A second estimate for Q4 showed GDP increasing 2.4% year-on-year (previous estimate: +2.2% year-on-year), yielding growth for the year as a whole of 2.3%—a deceleration from 2.6% in 2015. And while the headline number does not appear particularly alarming, the underlying trends suggest that growth in the Mexican economy is not a robust phenomenon. GDP growth in Q4 2016 was largely driven by services, which accounts for nearly 60% of the economy and is mainly supported by still healthy private consumption. Around 30% of the economy is produced by the industrial sector, for which growth was flat in the final quarter of 2016. Finally, agriculture continued to post a solid expansion at the end of last year, but given that the sector accounts for just 10% of GDP, its contribution to overall economic growth is not large. Although economic activity continued to expand in Q4, it remains highly vulnerable to a shock to consumption, which appears to be sole driver.
Assessing the Outlook
2017 does not look to be an easy year for Mexico. The 36 analysts that we polled in our latest survey expect the economy to slow from 2.3% in 2016 to 1.6% this year. But, most importantly, the 2017 GDP growth forecast has been cut uninterruptedly since July 2016, including significant slashes in December, January and February. The cuts mainly reflect broad-based pessimism among analysts, as substantial risks are casting a dark shadow on Mexico’s economic outlook. Among the main headwinds to growth are a slowdown in private consumption, tighter fiscal and monetary policies and, chiefly, uncertainty regarding the U.S. position on foreign trade.
Although the Trump administration is still in its early days, considerable uncertainty regarding the future of policy between the two countries is expected to have a tangible impact on Mexico’s economic growth. This uncertainty is also translating into a higher dispersion of GDP growth forecasts. The Consensus view among all of the 36 analysts we survey is that Mexico’s economy will decelerate this year. However, the degree of deceleration will depend on whether economists assume that President Trump will take a more pragmatic approach in dealing with Mexico or if he will pursue his most radical agenda towards Mexico.
Under a pragmatic approach, Trump would realize that U.S. businesses, particularly large retailers, stand to lose significantly from a trade war with Mexico. Consequently, Mexico’s economic growth trajectory would not vary significantly from the weak but steady growth recorded last year. Then, the main drivers behind the slowdown would be reduced to only domestic ones.
Among the panelists with this view are DIW Berlin, with a 2.2% GDP projection, Goldman Sachs (2.0%) and Oxford Economics (1.9%). According to Oxford Economics: “Our baseline forecast assumes that President Trump will not implement across-the-board tariffs on Mexican exports to the US or withdraw from NAFTA. We think that Mr. Trump is only likely to implement certain targeted and temporary trade restrictions as a negotiating tool, and pressure companies to invest in the US rather than in Mexico. But the mix of heightened uncertainty on trade, higher inflation stemming from a weaker peso as well as higher gasoline prices, and significantly tighter monetary policy will hurt the Mexican economy. We now expect that GDP will grow by 1.9% this year and 2.0% in 2018.”
A scenario with a substantial impact is one in which Trump would maintain a stringent stance against Mexico and manage to implement his full agenda with support of Congress. Under this scenario, the worst impact on Mexico would be a harsh renegotiation of NAFTA or the implementation of protectionist trade measures, which would severely affect Mexico’s external sector. Other damaging measures could include the implementation of capital controls on remittances and mass deportations of illegal Mexican immigrants. This would put the Mexican labor market under pressure. At present, many analysts consider this to be the most likely scenario with economic growth falling below 2% this year. Vector Casa de Bolsa whose GDP growth forecast for this year is just 0.6% is the most pessimistic panelist. They are closely followed by the Economist Intelligence Unit (EIU), with a 0.9% growth projection. According to the EIU:
“Uncertainty over the potential fallout from a Trump presidency in the US will have a tangible impact on economic growth in 2017-18 by putting investment on hold and depressing business and consumer confidence. The petrol price hike will have a pronounced immediate impact: we forecast an economic contraction in the first quarter of 2017, which will reduce average growth for the year to just 0.9%. This is a significant downward revision from our previous forecast of 1.8%. Our new forecast assumes that the US will impose modest symbolic tariffs on some imports from Mexico, but it is subject to further downward revisions if Mr.Trump chooses to enact a more protectionist agenda. This could include a more punitive renegotiation of NAFTA, a blanket tariff on all Mexican exports to the US, and fines for US companies moving jobs and production to Mexico. These policies raise the risk that the Mexican economy could fall into recession in 2017 – 18, although our baseline forecast is that they will not be applied in full”.
2016 was not a good year for Mexico and this year seems to be very uncertain. The Mexican economy decelerated last year, showing signs of cooling even before the impact of the Trump shock. Decelerating economic activity last year was principally the result of weak growth in the industrial sector, which came on the heels of declining oil production and lackluster growth in the manufacturing sector. Services, propelled by still strong private consumption, was the sector that contributed to overall economic growth. In addition, the three major credit ratings agencies revised Mexico’s credit outlook to negative last year and, although each had particular motivations for the downgrade, a common concern among them was the sharp increase the country’s debt burden in the past years, which climbed to 50% of GDP in 2016. The victory of Donald Trump has prompted the Mexican peso to plummet and relations between the two countries to sour, exacerbating analysts’ already pessimistic view of the country’s economic outlook. All panelists participating in our Consensus Forecast have downgraded their GDP growth forecasts for this year and the main factor behind it is a deteriorating domestic environment combined with a more challenging external one. The baseline scenario behind our GDP growth Consensus Forecast for Mexico considers some sort of NAFTA renegotiation, with the current bilateral relationship not changing radically this year. Nevertheless, the economic scenario painted by some analysts participating in our survey reflects that uncertainty remains very high and this is weighing on economic activity.
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