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Mexico’s Economy: Waiting for U.S. Recovery

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When the U.S. economy begins to recover, Mexico will be the first nation in Latin America that starts to emerge from the crisis.

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The pessimistic economic forecasts about Mexico have proven to be right. Day by day, the Latin American nation is becoming increasingly affected by the economic crisis. Its GDP for the first quarter of 2009 fell 8.2 percent from last year, according to INEGI, the National Institute of Statistics and Geography. Agustin Carstens, Mexico’s finance minister, recently declared that the government has adjusted its expectations for 2009. It now expects the GDP to contract by 5.5 percent, compared with the government’s previous estimate of 4 percent.

Carstens added that the prospects for the country for the rest of the year are also not encouraging when it comes to data about production, employment and other indicators, because they will be compared with the positive figures for last year “before the deepest period in the crisis.” This is the worst slide in the Mexican economy since 1995, when the GDP collapsed by 9.2 percent amidst the “tequila crisis.” That crisis was set off at the end of 1994 when the Mexican government made the decision to devalue its currency, leading to capital flight to several countries and the virtual suspension of voluntary external financing. The United States then made $20 billion in funding available to Mexico, and by the end of 1995, the situation had already normalized.

According to Mauro Guillén, director of Wharton’s Lauder Institute, “Mexico’s problem is its overdependence on the North American market. Almost 90% of its exports are sent to the giant to the north (the U.S.).” Nevertheless, he adds, “although the situation is very delicate, at least the banks don’t have problems. This is the big difference from 1994-1995.” Juan Carlos Martínez Lázaro, a professor at the IE Business School, agrees with Guillén and adds that the swine flu outbreak has aggravated a decline that was already going to be very significant. “The forecasts were calling for the economy to fall, at first by 3 percent, but then they talked of about 4.5 percent. Now, it is considered a given that the economy is going to fall by 5 percent, and there are some studies that estimate that the fall will be closer to 7 percent. There is going to be a very strong contraction in the Mexican economy.”

SWINE FLU

The first quarter data from INEGI does not take into account the swine flu that has hit Mexico and its capital hard. In addition to killing many people, this illness has left behind thousands of infected people and forced authorities to close over a period of two weeks schools, universities, offices, restaurants and hundreds of public spaces in the capital in order to avoid the spread of the virus.

Martínez Lázaro notes that the flu is especially damaging to the service sector, but “it is probably suffering less than the export-oriented industries in the economic crisis.” He says the service sector was the Mexican government’s “ace up the sleeve” for dealing with the recession. “The government had put its hopes in the idea that internal demand would make up for the collapse of the external sector, but the flu had a terrible impact. Not just on foreign tourism – benefiting, on the one hand, countries around the Caribbean such as Cuba and the Dominican Republic – but also paralyzing schools, businesses, shows, etc., which has had a brutal effect. The service sector represents almost 65 percent of the Mexican GDP.”

So, it is not surprising that analysts estimate that the GDP for the second quarter will worsen as a result of the flu. Ignacio Trigueros, professor at the Autonomous Technological Institute of Mexico, and an analyst at the Econolatin Network, notes that similar epidemics and experiences in other countries would suggest a brief and insignificant impact lasting three or four months. Trigueros estimates that the country’s GDP will drop by about 0.3 percent as a result. Other experts argue that the impact could reach 0.5 percent, which would mean losses of some $2.2 billion in coming months.

To cite one example, when the alarm sounded about swine flu, Mexico City-based companies in the tourism, trade and service sectors estimated a daily loss of 42 million euros. Experts say that the government responded unevenly. According to Robert Tornabell, finance professor at ESADE, “The government’s rescue plans are insufficient because what was required was an emergency plan.” Nevertheless, Martinez Lázaro believes that things have been well managed. “When the problem emerged, the President took charge personally; he has performed very well, communicating a sense of calm to television audiences. He is dealing with a terribly complicated situation in an appropriate way.” Along the same lines, Carlos Malamud, chief Latin American researcher at the Real Instituto Elcano, says that cooperation between the federal government, the state governments, the Federal District (Mexico City) and local governments made it possible to achieve greater efficiency. “They took very tough measures that enabled them to deal with the question. They reacted well to a situation that was new and surprising. Something that could have had catastrophic consequences was turned into something relatively manageable.”

NEXT TO AN ELEPHANT

The severe recession in the United States has led to a drop in external demand, and in revenues from exports, tourism and Mexican remittances. More specifically, the country’s public account deficit will reach $25 billion.

“Sleeping next to an elephant has its dangers,” Tornabell says regarding Mexico’s strong dependence on its northern neighbor. He explains that Canada, the other partner with the U.S. in the North America Free Trade Agreement (NAFTA), complains that acid rain arrives from the steel industry in the U.S. However, thanks to the United States, Canada will manage to sell all of its production of oil and natural gas. On the other hand, Canadian factories survive on demand from the United States. “The same thing can be said of Mexico. NAFTA has been a success since it has brought new U.S. industries to the border, creating jobs and, what’s more important, technology transfer. That is to say, it has improved productivity as well as know-how of the factories because they have very demanding procedures.”

Tornabell adds that the Mexican dependence on the United States is absolute. “They sell practically all of their oil and natural gas to that country. Most tourism comes from there, and so forth.” That’s why experts call for a greater diversification of the Mexican economy. When it comes to tourism, Tornabell notes, “[Mexico has] to diversify so that there is more tourism from Europe and, especially, from Spain. Mexico can compete because the peso has depreciated; the currencies of Brazil and Mexico have depreciated significantly as a result of the crisis. Although Mexico doesn’t offer prices as low as those in Cuba and the Dominican Republic, the tourism Mexico offers has a cultural ingredient that is valued by Spain, Germany and France. It is something more than tequila, beaches and sun.” He adds, “A treaty with Brazil would help both countries, and it would reduce dependence on the United States. It would also tighten relations with Europe, using Spain as a bridge, so that the relationship would be a two-way street.”

Nevertheless, Mexico has a serious problem, notes Tornabell. “Every year, oil output drops, and so does output of natural gas. If the situation continues this way, Mexico will wind up being a net importer of oil. It has not invested enough for Pemex, the state petroleum company, to increase its capital, its technology or to do offshore exploration in the Gulf of Mexico, where there is petroleum.” Tornabell notes that Mexico could face a fate “similar to Great Britain, which had great oil wells in the North Sea, and they are drying up. After 20 years, [the British] are importing. After 70 years of exploration, Mexico’s petroleum has reached its limit.”

On the other hand, the remittance channel, the country’s main source of revenues, is also failing. Through this channel, notes Martinez Lázaro, “Mexico once took in $25 billion from the United States. Last year, remittances contracted by 10 percent, and during the first quarter, there was a [further] drop of about 5 percent. Remittances are fundamental for managing the balance of payments.” According to a report issued by the IMF in May, entitled, Economic Perspectives: The Americas, remittances to the region began to slow down in the middle of 2006. And with the deepening deterioration of the global economy, the deceleration intensified recently, and remittances wound up contracting in some countries. Nevertheless, in the case of Colombia and Mexico, the report notes, “The strong devaluation of their currency in recent months has cushioned or counteracted the decline in the value of the dollars in remittances, but this gain has been lessened by the continuous declining in the value of remittances in dollar terms.”

Mexico’s problem, adds Martínez Lázaro, is that in addition to all of this, you have to add the decline in oil prices and export volumes, “which are between 10 percent and 15 percent, something very important from the fiscal point of view [because they represent about 30 percent of tax revenues]; the drop in the value of manufactured goods; and the decline in foreign investment of about 36.5 percent compared with last year. All of the complications with the flu just make the situation more challenging.”

Nevertheless, Trigueros sees a ray of hope on the cloudy horizon. “In the data about manufacturing exports, there is no warning now about a rapid decline, the way we saw one at the end of last year. On the other hand, over the first quarter, public investment was gaining strength, which will surely have a positive impact on the construction industry. This has been reflected in the improvement of some opinion indicators from the beginning of the second quarter, although this was not of a sufficient magnitude to suggest that the contraction of the economy has stopped.”

When the impact of the flu is taken into account, says Trigueros, “it is very probable that the economy won’t hit bottom until the third quarter, which seems feasible given that various factors in the recent past generated great uncertainty about the international environment, such as the health of the financial system in the United States, which has continued to decline at the same time that more positive conditions could be forecast in the domestic financial environment.” In part, that’s because the resources that the U.S. government has made available to Mexico through lines of credit with the IMF and the Federal Reserve could soften the damage done by the contraction in capital flows over the rest of the year. Likewise, “The calendar of public finances indicates that the government exerted an abnormally high amount of pressure on domestic financial resources during the first quarter.”

Regarding inflation, Trigueros continues to see some problems related mostly to the weakening of the peso from levels registered for most of last year. However, in his opinion, the prospects for 2010 are quite favorable. “It is anticipated that at the end of this year, the level of inflation will be about at the goal set by the central bank and that, as a result, the cycle of monetary loosening will last several months.” In any case, Trigueros estimates that the recovery in the global economy is going to be slow, “so the contraction in the Mexican economy this year could be about 5 percent.”

Finally, Martinez Lázaro notes the government’s battle against drug trafficking is affecting the economic situation. He explains that this “fight to the death” seems to have much in common with Colombia’s war during the 1990s. However, Malamud believes that drug trafficking can have different components. In Colombia, it involves terrorism (the Marxist FARC rebels), and in Mexico, corruption. In Mexico, he says, “there is no political component, which makes it easier to fight. With the arrest of more than twenty politically appointed officials last week, it is obvious that the level of corruption extends throughout the entire political system.”

Tornabell believes that the government needs to take additional measures to liberalize the economy. “If oil continues to be owned by the government, that means they will eventually wind up not having any oil.” In addition, he says, “Mexico needs to create more jobs, and it can achieve that in the oil and natural gas industry, and in tourism. The country has a very capable business community, good universities and people who are well trained.”     

Martinez Lázaro notes that Mexico’s dependence on the United States is a double-edged sword. “It hasn’t gone well [recently], but you also have to realize that when the economy of the United States begins to recover, Mexico will be the first nation in Latin America that starts to emerge from the crisis.”

Republished with permission from http://www.knowledge.wharton.upenn.edu -- the online research and business analysis journal of the Wharton School of the University of Pennsylvania.

 

 

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