Mexico’s Economic OutlookAnimesh GhoshalDePaul UniversityPresented at US-Mexico Chamber of CommerceApril 28, 2015

Mexico’s Economic Outlook

•Mexico in 1982• Integration of US and Mexican

Economies•Concerns about China•Recent reforms•Prospects

Economic Situation in Mexico, 1982

Inflation 58.9%

Foreign reserves, in months of imports 0.58

Debt service as % of exports 53%

Debt service as % of GDP 9.7%

Trade in goods as % of GDP 24%

GDP, constant 2005 US $ $507 billion

GDP per capita, constant 2005 US$ $6914

Economic Situation in Mexico, 1982 and 2014

1982 2014

Inflation 58.9% 4.0%

Foreign reserves, in months of imports

0.58 4.38

Debt service as % of exports

53% 10%*

Debt service as % of GDP 9.7% 3.4%*

Trade in goods as % of GDP

24% 61%*

GDP, constant 2005 US $ $505 billion $1042billion*

GDP per capita, constant 2005 US$

$6914 $8519*

Linkages with World Economy and US

• Mexican peso most heavily traded emerging economy currency• 70% of banking system assets in foreign owned banks• Large portfolio inflows since 2010, since inclusion in World

Government Bond Index Citibank

• Manufacturing sector highly integrated into US supply chain• 80% 0f goods exports go to US• More than 50% of stock of foreign investment (FDI and

portfolio) held by US entities• Significant Mexican FDI in US• America Movil (Tracphone)• Cemex (Ready-Mix)• Grupo Bimbo (Entenmann’s)

Integration of US and Mexican Economies: GDP Growth Rates

19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

20102011

20122013

2014

-8

-6

-4

-2

0

2

4

6

8

GDP growth MexicoGDP growth United States

Correlation between US and Mexican growth

Pre-NAFTA Post-NAFTA

Real GDP 0.02 0.87

Manufacturing Output 0.11 0.75

Investment 0.16 0.75

Consumption -0.26 0.76

US Imports/Mexican Exports -0.04 0.92

US Trade with Mexico

19851986

19871988

19891990

19911992

19931994

19951996

19971998

19992000

20012002

20032004

20052006

20072008

20092010

20112012

20132014

0

50000

100000

150000

200000

250000

300000

350000

US importsUS exports

Concerns about competition from China• China joined WTO in 2001• Faced reduced trade barriers• Very low labor cost

• In 2003, hourly labor cost in manufacturing in China $0.62• in Mexico, $5.06

• China surpassed Mexico in US imports in 2003• Many maquiladoras shut down or moved to China, but…• Wages in China have been rising rapidly (10-20% a year since

2008)• In 2012, hourly labor cost in manufacturing in China $3.60• in Mexico $6.36And labor cost not the only cost

US Imports from Canada, China, Mexico

19851986

19871988

19891990

19911992

19931994

19951996

19971998

19992000

20012002

20032004

20052006

20072008

20092010

20112012

20132014

0

50000

100000

150000

200000

250000

300000

350000

400000

450000

500000

CanadaChinaMexico

“Labor Arbitrage” and Manufacturing CostsManufacturing Outsourcing Cost Index(Percentage of US Cost)

2005 2010 2015 (forecast)

Mexico 89 83 86

China 79 90 98

India 78 82 83

US “Vertical Integration” with Major Trading Partners, 2012

Exports($b)

Imports($b)

Total Trade($b)

Percentage of US Content in Imports

Canada 292 324 616 25%China 110 425 535 4%Mexico 216 277 493 40%Japan 70 146 216 2%

EU-27 265 380 645 2%

Recap of recent economic history• Macroeconomics very good• Inflation low (3.1%, and close to target of 3%)• Public finances healthy: budget deficit 3.6% of GDP in 2014, and

expected to fall; public debt less than 50% of GDP • Well integrated into international financial market• External situation generates confidence

• Current account deficit 2.3% of GDP; debt service easily managed

• But economic growth disappointing• Real GDP only doubled in 30 years, and smaller increase in per capita

income • Problem lay in microeconomics• Until recently, no public consensus on necessary steps

• But in last 2 years, a number of reforms enacted by government

Structural reforms since 2013• Reforms enacted in last two years should have significant

impact on growth:• Energy• Telecommunications• Finance• Competition• Education• Budgetary

Energy reforms• Most significant reforms in 75 years• Constitution amended to end PEMEX monopoly of oil and gas• Private sector

• can enter exploration and drilling for oil, with production sharing • can participate in natural gas distribution

• Comision Federal de Electricidad (CFE) to face more competition• Private participation allowed in electricity generation

• More autonomy for PEMEX and CFE• Expected impact through• Higher oil and gas production

• Oil output has fallen from peak of 3.5 mmbd in 2004 to 2.4 mmbd, and without reforms Mexico would become oil importer by 2024. Already net importer of natural gas, as output has fallen

• Lower electricity rates (currently much higher than in US)• Should help manufacturing

• New FDI into energy industries

Telecommunications reforms• Sector opened to foreign investment• New regulatory agency, IFETEL• Power to impose asymmetric rules on dominant firms

• Objective: to increase competition• Major investment program to improve internet connections• Studies (elsewhere) found broadband internet access

contributes significantly to economic growth

Financial reforms• New mandate for development banks• Extending credit to SMEs and agricultural sector

• Consolidated supervision for financial conglomerates• Bankruptcy process streamlined• In case of default, orderly allocation of assets

• Easier for consumers to switch banks• Improved reporting to credit bureaus• “Financial deepening”: ratio of bank credit to GDP—important

driver of economic growth• Mexico currently behind median figure for Latin America• Reforms expected to close gap

Other reforms• Competition• Many sectors of Mexican economy tight oligopolies

• Pharmaceuticals• Retailing of imported consumer goods

• New anti-trust rules should ease entry• Education• Poor quality serious weakness in Mexican economy• Reforms seek to improve quality of teachers (appointment, evaluation,

promotion). But strong opposition from unions.• Should increase human capital and productivity in long run

• Budgetary• New Fiscal Responsibility Law

• Clear targets for public sector borrowing • Limits on growth of current expenditures• Sustainable path for public debt• Stricter control on expenditure, avoiding overruns

Vulnerabilities• Integration into global economy provides benefits, but also

increases exposure to external shocks• Even with flurry of free trade agreements, Mexico remains

extremely dependent on US• Severe recessions in 2001 and 2009, could happen again• “Taper tantrum” following Bernanke’s statement in May 2013

• Peso rapidly fell by 9% against dollar

• Capital inflows a sign of confidence, but also increases risk• Foreigners now hold 55% of sovereign bonds, and 37% of peso

denominated public debt• Reduces funding cost for government and business• But danger of capital flow reversals and volatility of asset prices

Comparison with other major countries in Latin America (most recent data)

GDP growth

Inflation Budget balance (% of GDP)

Interest rate on 10-year govt. bonds

Mexico 2.6 3.1 -3.4 5.66Argentina 0.4 30.0 -3.1 naBrazil -0.2 8.1 -5.3 12.51Chile 1.8 4.2 -2.0 4.54Colombia 3.5 4.6 -2.1 6.68Venezuela -2.3 68.5 -15.9 11.03

Conclusion• Even with risks as noted, prospects good• Prudent macroeconomic policies • Foreign currency reserves of $190 billion should provide

adequate buffer against external volatility• Microeconomic reforms finally enacted (though

implementation not yet known)• In the last two presidencies, reforms proposed by PAN

government opposed by PRI, leading to deadlock• Now apparent political consensus, and proposals of PRI

government supported by PAN• So: economic outlook is bright!