Waiting for the U.S. To Grow

MEXICO CITY — Many Mexicans cannot remember having lived through a recession like the current one.
Economists are forecasting Mexico’s economy will shrink by 7 percent this year, its worst economic setback in eight decades and one of the deepest contractions of any Latin American nation.

With the country battered by a sharp drop in remittances, weak demand for exports from the United States, its main trading partner, a plunge in oil prices, the costs of containing the spread of swine flu and ongoing drug trade violence, Mexicans are hoping for relief now that the U.S. economy appears to be on the mend.

Mexico has not experienced the likes of the projected 7 percent decline in GDP in 2009 since the Great Depression. Yet the Finance Ministry anticipates a rebound in 2010, with a forecast growth rate of 3 percent. A number of private economists concur.

“We are expecting a moderate recovery provided there is a boost from the United States,” said Alejandro Díaz-Bautista, an economics researcher at the Colegio de la Frontera Norte. “Nevertheless, one of the most important factors that will condition economic growth in the short and medium term will be public spending in 2010 and 2011.”

In sectors like construction – a barometer for growth in Mexico – the situation has forced broad layoffs and project cancelations. “The inventory in all the areas of the industry is running out because of the lack of new projects caused by the shortage of financing,” said Miguel Tirado Harrison, commercial director for homebuilder Baita.

Tirado Harrison said he does not foresee a quick comeback for the sector, an important source of employment in a country with a chronic shortage of jobs.

“The recovery will have to wait until 2011,” he predicted. However, he added that he believes homebuilders with cash to start projects now would come out ahead if and when demand picks up in two years.

On the budget front, the federal government is caught between Main Street and Wall Street.

Faced with concerns that a higher federal deficit could prompt ratings agencies to downgrade Mexico’s bonds – leading to higher interest rates on its debt – the government of President Felipe Calderón Hinojosa has outlined an austerity plan. It puts forth both budget cuts – three small ministries are slated for elimination – and higher income taxes, along with an added 2 percent tax on consumption, including food and medicine, and a special 4 percent tax on telecommunications.

Mexicans already pay a 15 percent value-added tax on goods and services, but food and medicine are excluded from VAT. The proposed higher taxes have been met with opposition even though the administration pledged that the money would be spent on social programs.

“It’s a drastic adjustment,“ Calderón told reporters.

But the Mexican president defended his budget plan, insisting that the country “cannot eradicate extreme poverty or guarantee access for all Mexicans to healthcare and quality education if we do not have solid public finances.”
Finance Minister Agustín Carstens has already warned that the federal deficit could top $23 billion, driven by the largest drop in oil-derived income and tax revenue in more than three decades.

Mexico’s public finances continue to depend heavily on the oil industry, which covered some 40 percent of the federal budget in 2009. The 2010 federal budget was based on a projected average price of oil of nearly $54 a barrel, down 24 percent from the $70 per barrel used in the 2009 budget.

Remittances, which netted Mexico $25 billion in 2008, are expected to fall by 10 percent this year as Mexican workers lose their jobs in the United States.

The other pillar of the Mexican economy – exports, of which 80 percent are sent to the United States – has been pummeled by the U.S. recession. The auto industry has seen its output plunge by 25 percent through June, according to the Mexican Automotive Industry Association.

But experts caution that more exports to the United States will not resolve Mexico’s fundamental problems. Although government authorities foresee a rebound in manufacturing – tied to renewed U.S. demand – the Central Bank of Mexico has said that additional factory production will create only 300,000 jobs for the economy in 2010. Mexico has lost an estimated 735,000 jobs in 2009.

Nor will tax hikes make up for lower oil revenue. Sales and income taxes comprise a mere 13.9 percent of Mexico’s gross domestic product. Comparable tax receipts in Brazil, for example, represent 35.8 percent of GDP.

“A good tax reform would increase the tax base, but every time this has been tried, there has been grumbling,” said Germán Rojas, an economist with the Instituto Tecnológico Autónomo de Mexico.

Both the Institutional Revolutionary Party (PRI) and the Party of the Democratic Revolution (PRD) have consistently opposed lifting the tax exemptions for food and medicine, Rojas said. Calderón’s National Action Party does not control Congress.

“We are going to be able to sell more to our neighbor, hence there will be an economic rebound in Mexico,” said Rojas. “But we are at the start of the recovery.”