Publish in Perspectives - Monday, August 1, 2016
Negative rhetoric coming from Donald Trump, the Republican nominee in the United States, has strengthened the hand of populist forces in Mexico, experts warn. Right, his rival, Hillary Clinton. (Photos: GOP, HillaryClinton.com)
Uncertainty from US elections is hurting the outlook for Mexico’s economy.
BY LATIN AMERICA ADVISOR
Mexico’s central bank on June 30 raised interest rates by 50 basis points, double what was expected, as a warning to currency speculators that the government will act to protect the peso, a move Wall Street economists called ‘bold.’ Mexico’s currency has fallen 7 percent against the U.S. dollar this year and has come under increased pressure following the United Kingdom’s vote last month to leave the European Union. Meanwhile, remittances sent home from abroad have been robust and are benefiting from the currency differential, and consumer credit flows have remained strong, according to government data released last month. Are Mexico’s officials handling monetary policy appropriately? How has the outlook for the country’s economy changed for this year and next, in light of recent developments? As the second half of the year gets underway, what factors and risks have become most worrisome for Mexico’s economy?
Amy Glover, director at McLarty Associates: Mexico has handled monetary policy responsibly for the past 20 years, and the macroeconomic stability of the country is a major strength. Globally, there is a lot of uncertainty, and uncertainty means risk. Markets will remain jittery until the U.S. presidential election is decided and a clearer trajectory for the U.S. economy becomes apparent. Mexico is heavily dependent on the U.S. economy, which means the fortunes of both countries are inevitably linked. In the context of ‘Brexit’ and the economic downturn in China, however, being in North America is just about the best geographical location one could hope for. The structural reforms set in motion at the beginning of the Peña Nieto administration were visionary in scope and are fundamental to introducing greater flexibility into the economy. The continued implementation of the reforms will be critical to the long-term success of the economy and to a reduction in socioeconomic inequality. Unfortunately, the lack of robust economic growth in recent years has diminished popular support for reform. Some tangible benefits have already been felt, such as lower telecommunications and industrial electricity prices, but it may take years to boost the rate of economic growth appreciably. Negative rhetoric coming from the Republican nominee in the United States has strengthened the hand of populist forces in Mexico that would prefer less global interaction, clouding the outlook for Mexico’s own presidential election in 2018. Mexico deserves applause for being one of the most fervent free trade proponents in the world. While protectionism is on the rise in the United States and Europe, successive Mexican governments have understood that market opening and improving competitiveness is the way to go. The country has demonstrated leadership both in North America and in Latin America, via the Pacific Alliance. Mexico is one of the strongest economies in the region and will remain so if it continues on the path of ambitious political and economic reform.
Sergio Luna Martínez, director of research at Banamex: We expected Banxico to hike 50 basis points, not on the back of currency depreciation in itself, but rather on the reading by policymakers of what that depreciation implies. As the eighth-most traded currency, the value of Mexican peso conveys a lot of information, not only on both local fundamentals, but also the state of the world economy. Let’s start with the latter. The Brexit was an example of how global shocks affect emerging markets. It implies recessionary risks—thus suggesting looser monetary policy—but it also implies higher risk aversion, requiring more interest rate premiums. Unless you are a safe haven, you faced a trade-off. Banxico opted for the latter. In the second half of this year, these risks factors are unlikely to ease—an example is the U.S. election. As a gauge of global risk, the peso is thus set to remain weak. Banxico in this sense also acted preemptively. On the foreign exchange and local fundamentals, I think Mexico’s central bank was equally clear. We need to aim for primary fiscal surpluses. The more we do on this front, the less we need to offer in extra interest rate premiums. In terms of the yield curve, it implies a flattening with the front end increasing while the long end compresses, which is essentially what has happened. I think this is a better indicator of the effectiveness of monetary policy than the level of the exchange rate.
Jana Nelson, vice president for Mexico, Central America and Caribbean at Speyside Corporate Relations: The Mexican peso is the most liquid emerging-market currency, at $135 billion traded daily. It is often used to hedge risk in other markets, which means that when the global economic outlook is negative, the peso suffers the most. The Mexican central bank has aggressively defended the currency with interest rate hikes and by culling the sale of reserves, an announcement made in February. The economic indicators released in recent weeks (year-on-year exports, manufacturing and non-manufacturing index and consumer spending) point to a further slowdown of the already sluggish economy, and suggests that economic weakness is greater than originally anticipated. Add to the equation a tighter monetary policy and a less lax fiscal policy, and a recession might be on the long-term horizon. On the other hand, especially as compared to the rest of Latin America, the Mexican economy and its outlook for the second half of the year is stable. The recent hike in the interest rate is unlikely to generate high inflation. The central bank’s goal of 3 percent is still far from actual inflation at 2.2 percent. Unemployment is at 3.9 percent, the lowest since 2008, and very attractive to qualified human capital from abroad. The Mexican peso’s roller coaster ride since early 2015 is being adroitly managed by the central bank. Yet, the main challenges to the Mexican economy, as a whole, still remain—loss in government revenue due to low oil prices; rent-seeking behavior in economic reforms; and high cost of doing business due to corruption and insecurity.
Jonathan Heath, independent Mexico City-based economist: Two issues have become more pressing for the Mexican economy over the past year: a steadily increasing public debt-to-GDP ratio, in spite of recurring promises to the opposite, and a structural change in the country’s balance of payments, leading to a higher and more vulnerable current account deficit. The first issue has forced the government to reduce public expenditures in order to cut the fiscal deficit by 0.5 percent of GDP in each of the last three years of this administration. The second has led to an accumulated increase of 45 percent in the exchange rate, but with no visible results in an increase in exports. This has caused the current account deficit to go from an average of 1.1 percent of GDP between 2000 and 2013 to an expected 3.2 percent (or higher) deficit this year, making the country susceptible to a sudden stop shock, at a time where the Federal Reserve has initiated a new cycle in its monetary policy. Mexico’s central bank has responded with an accumulated 100 basis point increase in its monetary policy rate, aimed at assuring capital inflows. While expressing concern over future inflationary pressures, the real worry is in the forming balance of payments disequilibria. Both restrictive monetary and fiscal policy responses come, however, at a time when inflation is below target and the economy is decelerating rapidly. As a result, consensus forecasts for growth are being revised downward, and the probability of an ensuing recession has increased.