Monetary Policy in Mexico

Santander’s 15th Annual “Cinco de Mayo” Mexico ConferenceNew York City, 7 May 2015

1

Javier Guzmán Calafell, Deputy Governor, Banco de México

2

The implementation of monetary policy in Mexicorests on four main pillars:

Central Bank Independence.

An inflation targeting regime pursuing inflation of 3%.

An efficient convergence of inflation to the target.  

Transparency and accountability.

1. 2.

3. 4.

Monetary Policy in Mexico

3

Monetary policy and the strengthening of public finances haveallowed the reduction of inflation to levels around the target...

Monetary Policy in Mexico

Source: Banco de México.1/ Target for the overnight interbank interest rate adopted on 21 January 2008.2/ Data through the first fortnight of April.3/ Data through 5 May 2015.

Overnight Interest Rate and Headline InflationAnnual %

0

4

8

12

16

20

24

28

32

36

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Headline inflation

Overnight interbank interest rate1/

Variability Interval

April 2/May 3/

4

…and other important accomplishments:

Monetary Policy in Mexico

A decline in the volatility of inflation.

A sharp reduction in the pass through of the exchange rate to prices.

A substantial decline in the persistence of inflation.

A lower dispersion of inflation expectations.

5

Thus, the impact of the recent depreciation of the peso ondomestic prices has been modest.

Monetary Policy in Mexico

Source: Banco de México.1/ Data through the first fortnight of April.2/ Data through 5 May 2015.

Foreign Exchange and Consumer PricesAnnual %

‐3

0

3

6

9

12

15

18

21

Sep‐14

Oct‐14

Nov‐14

Dec‐14

Jan‐15

Feb‐15

Mar‐15

Apr‐15

May‐15

FX (MXN per USD)

Headline CPI Non‐food Merchandise

Durable Merchandise April 1/May 2/

6

Similarly, the increase in prices derived from the 2014 taxreform and other supply shocks proved to be transitory.

Monetary Policy in Mexico

Source: Banco de México.1/ Data through the first fortnight of April.

Deviation from 3% Target in Headline InflationPercent points

‐0.5

0.0

0.5

1.0

1.5

2.0

Jul‐1

3

Aug‐13

Sep‐13

Oct‐13

Nov‐13

Dec‐13

Jan‐14

Feb‐14

Mar‐14

Apr‐14

May‐14

Jun‐14

Jul‐1

4

Aug‐14

Sep‐14

Oct‐14

Nov‐14

Dec‐14

Jan‐15

Feb‐15

Mar‐15

Apr‐15

April 1/

7Monetary Policy in Mexico

s.a./ Seasonally adjusted.Source: Banco de México with data from INEGI.

Output GapPercent of potential, s.a.

Looking ahead, the main challenge for monetary policy is to consolidate theprogress made in the reduction of inflation. Although economic activity isexpected to strengthen gradually, no demand pressures on inflation areforeseen for this year.

‐10

‐8

‐6

‐4

‐2

0

2

4

6

8

2007 2008 2009 2010 2011 2012 2013 2014 2015

IGAE

4Q 14Feb

95% Confidence Interval

GDP

8

In addition, supply shocks, though frequent, have only atemporary impact on prices.

Monetary Policy in Mexico

Inflation Expectations and Inflation ShocksAnnual %

Sources: Banco de México and INEGI.1/ Inflation data through the first fortnight of April.

0

2

4

6

8

10

12

14

16

‐20

‐10

0

10

20

30

40

50

60

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

April 1/

Inflation Expectations:12 months ‐>

2 years ‐>4 years ‐>

<‐ Fruits and Vegetables

99

Therefore, the main risk for inflation (and financial stability) in coming months will probably derive from the implications of normalization of monetary policy in the US.

Federal Funds RateAnnual %

Sources: FOMC, Bloomberg and Blue Chip.

Monetary Policy in Mexico

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

Federal Funds RateFOMC Projections (18‐Mar‐15)Blue Chip (10‐Apr‐15)OIS‐implied (5‐May‐15)Futures (5‐May‐15)

10

These challenges are heightened by Mexico’s financial openness…

Financial OpennessChinn‐Ito Index1/, 2012

*/ Average for the major advanced economies: Canada, France, Germany, Italy, Japan, United Kingdom, and United States.1/ Measures a country's degree of de jure financial account openness (0‐1 scale), based on the IMF's Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER).Source: Chinn and Ito (2006) : "What Matters for Financial Development? Capital Controls, Institutions, and Interactions“, JDE 81(1):163‐192 (October).

Monetary Policy in Mexico

1.00

1.00

0.71

0.69

0.69

0.65

0.45

0.45

0.41

0.41

0.41

0.16

0.16

0.16

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

Advanced

*

Peru

Korea

Mexico

Chile

Russia

Turkey

Poland

Brazil

Indo

nesia

Colombia

India

China

S. Africa

11

… and the relatively high participation of non‐residents in the domestic government securities market...

Non‐residents Share of Holdings% of total outstanding local currency government bonds

*/ Average of Brazil, Hungary, Indonesia, Malaysia, Mexico, Poland, Russia, South Africa, Thailand and Turkey, weighted by non‐residents’ dollar‐value of holdings.1/ Data for Mexico through March 2015.Source: Banco de México and Credit Suisse.

Monetary Policy in Mexico

45.1

40.0

39.8

36.1

34.5

32.1

30.8

29.7

20.9

20.3

19.6

17.6

16.8

15.2

0

5

10

15

20

25

30

35

40

45

50

Malaysia

Indo

nesia

Poland

Peru

Hungary

Mexico

EM‐10*

S. Africa

Turkey

Brazil

Russia

Thailand

Colombia

Korea

Feb1/

12

…although it is important to note the long‐term nature of theseflows in Mexico’s case, since a sizable portion originates frominstitutional investors.

Non‐residents Holdings of Mexican Peso‐denominated BondsPercent1/

1/ As of 31 March 2015. Total outstanding nominal value of bonds held by non‐residents: MXN 1,423 billion.Sources: Bloomberg, SEC, Toushin Funds, Ministry of Finance Japan, Norges Bank.

Monetary Policy in Mexico

5.3%

7.6%

0.5%1.7%1.4%1.5%1.0%1.7%

14.7%

0.1%2.1%

14.3%

47.9%

NORGES BANK INVESTMENT MANAGEMENT

FRANKLIN RESOURCES

PIMCO ADVISORS

LOOMIS SAYLES

STANDARD LIFE INVESTMENTS

LEGG MASON

STONE HARBOR INVESTMENT PART

BLACKROCK

Japan Ministry of Finance

Japan Pension Funds

Toushin Funds (Japan)

Other US based funds

Not identified

13

The implementation of market‐based mechanisms for the provision ofliquidity has contributed to curb volatility of the exchange rate.

Monetary Policy in Mexico

Source: Banco de México.

Foreign ExchangeMXN per USD

Implied Volatility in 1‐month USD/MXN OptionsPercent

Source: Banco de México.

12.5

13.0

13.5

14.0

14.5

15.0

15.5

16.0

Sep‐14

Oct‐14

Nov‐14

Dec‐14

Jan‐15

Feb‐15

Mar‐15

Apr‐15

May‐15

11‐Dec‐14:USD 200 mn

allocated

May

6‐Mar‐15:USD 200 mn

allocated

11‐Mar‐15:USD 52 mndaily

5.0

6.0

7.0

8.0

9.0

10.0

11.0

12.0

13.0

14.0

15.0

Sep‐14

Oct‐14

Nov‐14

Dec‐14

Jan‐15

Feb‐15

Mar‐15

Apr‐15

May‐15

11‐Dec‐14:USD 200 mn

allocated

May

6‐Mar‐15:USD 200 mn

allocated

11‐Mar‐15:USD 52 mndaily

14

However, the stance of monetary policy in Mexico will need tobe adjusted at some stage. The timing is subject to a number ofuncertainties:

Monetary Policy in Mexico

The date of the first adjustment of the reference interest rate in the US, aswell as the pace of subsequent increases.

The impact of normalization of monetary policy in the US on the peso‐dollar rate, domestic interest rates, and other financial variables.

The moment when monetary policy actions in the US will be reflected inthese variables (e.g. will markets anticipate?).

In view of these uncertaintes, monetary policy must be ready to respondin a timely and flexible way as needed.

15

Mexico is well prepared to face the challenges posed by thenormalization of monetary policy in the US.

Monetary Policy in Mexico

1. Prudent monetary and fiscal policies (expenditure adjustments of0.7 percent of GDP announced for both 2015 and 2016 to meet thefiscal targets in the face of lower oil prices and output).

2. A moderate current account deficit.

3. A well functioning floating exchange regime.

4. International reserves around record levels and a 66.2 billion USdollar FCL with the IMF.

5. A sound financial system.

Furthermore, the economy’s growth potential should be substantiallystrengthened by the major structural reform efforts underway.

16

The decline of inflation is a necessary, but not sufficient, condition to achieve adequate rates of economic growth.

Headline Inflation and Real GDP GrowthAnnual %

*/ Information through the first fortnight of April.Source: Banco de México and INEGI.

Monetary Policy in Mexico

‐20

0

20

40

60

80

100

120

140

160

180

‐10

0

10

20

30

40

50

60

70

80

90

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Headline Inflation ‐>

<‐ Real GDP Growth

April*4Q 2014

17

However, there are good reasons to expect a major change of trend in coming years. The economy’s potential is already evident in the evolution of exports…

US Imports fromMexico% of total

Source: Direction of Trade Statistics, IMF.

Monetary Policy in Mexico

9.0

9.5

10.0

10.5

11.0

11.5

12.0

12.5

13.0

13.5

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Dec

18

Light Vehicle Production and Installed CapacityThousand annualized units

*/ Seasonally adjusted data.Source: Banco de México with data from AMIA. Estimation of installed capacity based on manufacturers’ press releases and newspapers’ reports.

…and particularly in sectors such as the automobile industry.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2,040

2,575

3,110

3,645

4,180

4,715

5,250

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

Ford

VW

Chrysler GM

MazdaNissan

ChryslerFord

HondaToyota

Mazda Audi

Nissan‐Infiniti

Kia

Nissan‐Mercedes BenzBMW

VW

Toyota

Installed Capacity

Production*/

Monetary Policy in Mexico

19Monetary Policy in Mexico

And very importantly, a major process of structural reform has been launched to increase the economy’s growth potential.

Economic Reform ResponsivenessShare of OECD reform recommendations with significant action taken during 2013‐2014

Source: OECD (2015), OECD Economic Surveys: Mexico, January.

0

10

20

30

40

50

60

G7 OECD European Union Emerging OECD Southern Europe Mexico

20

Economic growth should also be supported by favorable demographics.

Labor Force1/ GrowthAnnual %

1/ Economically active population aged 15‐64.Source: International Labour Organization.

‐1.0

‐0.5

0.0

0.5

1.0

1.5

2.0

2.5

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

Peru

Mexico

Malaysia

Korea

Colombia

TurkeyIndonesia

ChileBrazil South Africa

Poland

Monetary Policy in Mexico

21

Real GDP Growth in Major EconomiesAnnual %

Monetary Policy in Mexico

Source: IMF (WEO, April 2015).

It is also worth noting that the external environment is expected to be less unfavorable to Mexico relative to other EMEs in coming years, given the projected evolution of the major economies…

‐2

0

2

4

6

8

10

12

14

2006

‐07

2008

‐10

2011

‐12

2013

‐14

2015

‐16

2006

‐07

2008

‐10

2011

‐12

2013

‐14

2015

‐16

2006

‐07

2008

‐10

2011

‐12

2013

‐14

2015

‐16

2006

‐07

2008

‐10

2011

‐12

2013

‐14

2015

‐16

United States Eurozone Advanced Economies China

PotentialActual

22Monetary Policy in Mexico

…and a low share a commodities in total exports.

Commodities Exports1/% of total merchandise exports, 2013

*/ The figure for Mexico corresponds to 2014.1/ Includes: Agricultural commodities, food, fuels and metals.Source: Banco de México and World Bank (World Development Indicators).

11.7 13.7 15.0

15.2 20

.4 22.9 25.0

38.7

53.6

61.6

62.2

82.4 85.4

86.1

0

10

20

30

40

50

60

70

80

90

CzechRep.

Korea Hungary Mexico* Turkey Poland Thailand Malaysia S. Africa Brazil Indonesia Colombia Peru Chile

23

Implementation of the structural reform measures has begun.

Accordingly, some results are already evident.

Furthermore, important efforts have been made to improve theinstitutional framework.

However, this is just the beginning of a long process.

Continuous efforts are required to ensure macroeconomic andfinancial stability.

In addition, the efficient implementation of reforms is a majorchallenge, and measures in other areas will likely be needed.

23Monetary Policy in Mexico

24