We explain why we think recession odds for Mexico are higher than most think. Car exports, gross fixed investment and cyclical indicators all stood in recession ground according to latest data. On the policy side, fiscal and monetary tightening are a no-no and we all know Donald Trump will not help ahead if his winning chances spike.
After a promising 1Q’16 in which GDP expanded 2.8%, economic activity is set to decline in the following quarters starting in Q2. We believe that growth could reach the lower end of government’s expectations and that there is an increasing risk of a weaker than expected growth for 2017. In fact, the chances of recession, although still small, are slowly mounting.
The recovery of the Mexican economy after the 2008 financial crisis started to slow down in 2013 and 2014 due to a weaker recovery in the US, Mexico’s main export destination.Last year, exports to the U.S. constituted 71% of total Mexican exports and 24.7% of Mexico’s GDP.
Mexico proved to be resilient to the sharp decline in oil prices and US’ weak economic growth last year. In 2015, Mexico’s economic growth at 2.5% increased with respect to the 2.25% expansion in 2014. This was possible due to a strong domestic consumption, which is not a typical driver for the Mexican economy.
Mexico’s atypical consumption last year resulted from a low interest rate at 3%, combined a 16% depreciation (from MXN 14.8 to 17.2/$) that boosted remittances 4.8% to a record of $24.8 billion, without affecting inflation – which remained at the historical low of 2.1%. Low inflation made possible a real salary increase that was complemented with declining unemployment. Still by May this year, the retailers association reported a 7.8% accumulated real growth in sales after 8.17% growth in 2015.
But signs the Mexican economy will decelerate in the coming months became evident in June, when the institute of national statistics, INEGI, reported that its general index for economic activity, IGAE, a proxy for economic growth, contracted 1.2% in April, the largest monthly decrease since January 2009. In April, the industrial activity contracted 0.7%, while services decreased in 1.4%.
In Banxico’s June survey, the private sector reacted to IGAE’s last numbers and revised its growth expectations for 2016 to 2.36% from 2.44% in May’s survey. This contrasts with the growth estimates of Mexican officials. Estimates from the Ministry of Finance currently stand at 2.2-3.3% growth for 2016 and 2.6 – 3.6% for 2017, which had to be revised from 2.6 – 3.6 and 3.5 – 4.5%, respectively. But even more conservative estimates from Banxico’s 2-3% and the IMF’s 2.4% might fall short.
Although low inflation, depreciation and increasing remittances continue to coexist, the inflation trend is now tilted to the upside and the cost of money is increasing.
Since Banxico increased its interest rate in 25bps replicating the Fed in December, the central bank has hiked 100bps more taking the interest rate from 3 to 4.25% in 6 months. Although monetary policy takes months to influence economic growth, it mixes with the effects of a contractionary fiscal policy that has seen tax increases in 2015, coming from 2014 fiscal reform, and cuts for 2015, 2016 and 2017 budgets worth MXN 560 billion ($31 billion) equal to 3% of the GDP.
But pressures for 2016 and 2017 growth rates in Mexico not only come from monetary and fiscal policies. US growth will continue to be key in Mexico’s economic activity and the Fed’s last monetary policy meeting continued to deliver bad news. Fed revised downwards its estimates for an economy growing more slowly this year and the next. Fed officials’ median expectation for 2016 and 2017 was 2%, down from 2.2 and 2.1%, respectively.
LATAM PM’s Take: The combined effects of Mexico’s fiscal and monetary policy and weak US growth will take a toll in an economic growth that we forecast in 2.3% for 2016 and 2.0% for 2017. Further risks include weaker than expected US and global growth could affect the Mexican economy further. Volatility coming from Brexit and US presidential election could also increase risk aversion and Mexican peso depreciation forcing Mexican officials to act again with a tighter monetary policy and contractionary fiscal policy. On the flip side a better performance of the US and global economies and the effective implementation of the structural reforms could stimulate private investments and a renewed private consumption. Finally, a continued rally in oil prices could revert the current trend in fiscal expenditure.
All in all, we believe that negative catalyst overshadow positive ones. Donald Trump’s chances of winning are still low, but that could begin to change in the following months and create FX and confidence pressures. (Ironically, FX depreciation would benefit exports, but volatility and uncertainty are a no-no.) Manufacturing exports are falling on an annualized basis and they are currently our main concern, and gross fixed investment fell 2.1% in April. Moreover, both of INEGI’s cyclical indicators have deteriorated recently and currently stand below 100 points-pointing now towards recession. If all this was not enough, fiscal spending is being cut and monetary conditions are being tightened. Again: a no-no.