Mexico Economic Outlook

The overall perspective for the Mexican economy in 2007 is positive, according to the data and to most analysts. Deepening convergence to US monetary and production cycles, sustainable low-inflation economic growth, improving structural competitiveness and implementing long-overdue comprehensive energy and labor reforms will test the leadership skills of the new president, Felipe Calderón, and the effectiveness of his administration.

On the monetary policy instance, the Mexican central bank just decided to hold interest rates unchanged at 7.25%. The monetary authority recognizes the risks to achieve its 3% inflation target and hence, monetary policy should remain restrictive. However, it seems that higher inflation is something related to supply shocks that tend to decrease with time. In other words, inflationary pressures may lead to further tightening of monetary conditions over the next few months. Short term interest rates are expected to be largely determined by domestic inflation behavior, while long term interest rates will remain heavily influenced by developments in the US markets.

Mexico is enjoying the soundest business cycle since the late sixties. In spite of a slight deceleration in 2007, Mexico will continue to register solid gains through 2008, extending the crisis-free economic expansion to a full decade. Investment growth is leading to increased job creation and consumption. The business cycle is now reinforced by local credit boom but US industrial deceleration is leading to a slowdown in Mexican manufacturing.

The external sector remains sound, supported by rising export revenues, large remittances and further increases in tourism income. Nevertheless, the gradual cooling of the US economy will limit overall export gains, pointing to persistent, though moderate current account deficits. The overall impact of these shortfalls, when combined with relatively solid foreign direct investment inflows and decreasing government external debt, sets the stage for small currency depreciation.

Mexico’s fiscal policies remain a weak link in the overall outlook. Tax collection is lackluster, exacerbated by the institutional inability to reduce the size of a substantial informal economy.
In case we observe a further decline in crude oil production, the fiscal position may be even worst, as oil revenues account for more than a third of government revenues. The current fiscal situation may be improved in case Calderon’s party gets majority in the Congress. In turn, the president has already approved an important law for the government workers’ pension fund. The new law not only addresses one of future fiscal contingencies but also shows the administration’s political skills in negotiating with a more receptive opposition in congress, and raises hopes of a more extensive array of reform measures.