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Is Mexico Economy on Rebound?

Is Mexico's economy rebounding after hitting a bottom? Three experts share their insights.

Inter-American Dialogue 

Mexico's gross domestic product shrank by the most in 14 years during the first quarter of this year, but President Felipe Calderon said [recently] the economy has shown signs of bottoming out, and Finance Secretary Agustin Carstens has predicted GDP will grow by 3 percent next year. Do you agree with this assessment? What sectors of Mexico's economy are showing recovery? Can the tourism sector rebound from the double blow of global recession and swine flu? Do you think Mexico will lose its investment grade status?

Shelly Shetty, senior director of Latin American sovereign ratings at Fitch, Inc.: Mexico's economic contraction will be severe in 2009 with real GDP declining by 5.5 percent with clear downside risk. An economic recovery in Mexico would really depend on the extent of the pull from the United States given Mexico's strong trade, financial and other links with its northern neighbor. While we expect the US recovery to begin in the second half of this year, it is likely to be relatively weak, which in turn will dampen Mexico's growth prospects. Fitch currently projects a modest recovery in Mexico for 2010 with real GDP growth of less than 2 percent. Last November, Fitch assigned a negative outlook to Mexico's Foreign and Local Currency Issuer Default Ratings of 'BBB+' and 'A-', respectively, to reflect the country's vulnerability to the US recession, lower average oil prices and reduced flow of international credit. Even though Mexico's economic prospects remain weak and its fiscal challenges are increasing, we do not foresee Mexico losing its investment grade status. Mexico's investment grade ratings continue to be underpinned by the country's institutional strengths such as the independence of the Central Bank, the inflation-targeting regime, a flexible exchange rate, and its Fiscal Responsibility Law. A prudent liability management strategy, flexibility of issuing long-term financing in the domestic debt markets, and a modest external debt burden with a smooth external amortization profile give the Mexican government ability to navigate through these difficult times. Moreover, Mexico is unlikely to face a balance of payments crisis due to the availability of $47 billion of the International Monetary Fund's Flexible Credit Line and another $30 billion through the Fed swap, which provide good 'firepower' to the Central Bank. Finally, despite asset quality pressures the Mexican banking sector will face this year, the system is relatively robust and unlikely to pressure the Central Bank's external liquidity as has been seen in other emerging markets. Thus, Fitch believes Mexico's investment grade ratings are well intact, although the negative outlook implies the ratings could be downgraded (but remain within the investment grade rating category).

Claudio Loser, senior fellow at the Inter-American Dialogue and former head of the Western Hemisphere Department at the International Monetary Fund: Mexico has not experienced a decline in output of the magnitude observed this year since the Tequila crisis erupted in late 1994. GDP has declined sharply so far and may show a decline of 7 to 8 percent for the year. In practice, per capita income would get back to the levels observed during the period 2000-04. The current crisis has been very different from those in the past, as the macroeconomic conditions and government policies tended to be much stronger. However, with most of its trade and finance linked to the US economy, Mexico was hit the hardest among Latin American countries. Its recovery will thus depend on what happens north of the border. Its regained competitiveness, as a result of a devalued currency, helps but little will happen unless the US starts to recover. In this regard the Mexican authorities are right. Sectors such as automobiles and tourism will tend to improve soon. Nonetheless, private enterprises have had to deal with major difficulties in their financing. Moreover, the government faces a widening fiscal deficit because of lower activity, and most importantly, a secular decline in oil output and generally lower oil prices. Under these conditions, and with violence on the rise, the government will need to work very hard and investment will need to increase. It is very likely, though, that Mexico will see a decline in its ratings, even though it is most likely to retain investment grade, as its financial system remains fairly strong and well managed.

Lisa M. Schineller, director of sovereign ratings at Standard & Poor's: Standard & Poor's expects the Mexican economy to undergo its deepest recession in decades, with a contraction of real GDP of more than 7 percent this year. This is deeper than the 6.2 percent decline in 1995 during the Tequila crisis and during the 1980s debt crisis. We expect only a modest recovery of about 2.5 percent in 2010 consistent with weak recovery in the United States. The Mexican economy looks to have contracted by double digits in the second quarter given the A-H1N1 flu outbreak compared with the first quarter when real GDP declined 8.2 percent year-on-year. Given that strong hit, we expect recovery during the third quarter and second half of this year, but there are no widespread data yet to indicate a definitive pick-up. Just released fixed investment data for April declined 17.8 percent over a year earlier, continuing a strong downward trend since the second half of 2008. Car production in June plummeted 48 percent year-on-year and worker remittances were down 20 percent in May, year-on-year. Consumer confidence was down 10.6 percent year-on-year in June, and though up month-on-month still firmly in pessimistic territory. Mexico's foreign currency sovereign credit rating is 'BBB+', which is a full three notches in the investment grade category. However, Standard & Poor's revised the outlook on its ratings to negative on May 11 indicating the risk of a downgrade. The negative outlook reflects a challenging fiscal outlook, in the context of modest growth over the coming years and the ongoing decline in oil production, which may not be adequately addressed by the government following the July 5 congressional elections. Mexico's limited fiscal flexibility and structural fiscal vulnerabilities include budgetary dependence on oil revenue, the absence of significant fiscal savings and a low non-oil tax base. Standard & Poor's could lower the ratings if the government does not address the factors that limit its fiscal maneuvering room later this year. 

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor newsletter.


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