Mexico - Economic Briefing January 2004

Link to U.S. Economy Seems Lost

The dissolving of the link between the Mexican and the U.S. economy remains a dominant factor in economic developments.  Since the inception of NAFTA, Mexico had experienced strong growth, driven by demand for cheap labour from the U.S..  However, the failure to create new investment opportunities and increasing competition from abroad, particularly China, has derailed this beneficial link.  As a result, the Mexican economy continues to ail along, despite record U.S. growth.   The U.S. manufacturing sector, which had lagged behind the overall economy, is beginning to recover at a more pronounced pace, which could provide the Mexican economy with the needed impetus to leave the slump behind.

Economy continues slump in third quarter
Supply and demand data published for the third quarter shortly after last month’s Consensus Forecast, confirmed the 0.4% annual gross domestic product (GDP) expansion released earlier.  The third quarter reading represents a disappointing improvement over the 0.2% growth registered in the second quarter.  Moreover, seasonal factors inflated the annual data.  According to seasonally adjusted data, the economy actually contracted 0.36% over the preceding quarter, following on 1.19% growth in the second quarter.

Consumption keeps up economy but investment enters negative territory
The improvement in the annual growth rate was broad-based and seized both the domestic side of the economy and external sectors.  On the domestic side, the positive development in consumption stands out.  Private consumption added 3.8% over the third quarter 2002, following on a meagre 0.9% improvement in the second quarter.  Public consumption growth actually slowed.  However, the relatively small slowdown (Q3: +2.5% year-on-year; Q2: +2.8% yoy) was more than compensated for by private consumption, which accounts for a much higher share of total consumption.  Accordingly, total consumption registered more than triple the 1.1% annual growth rate observed in the second quarter (Q3: +3.7% yoy).  Gross fixed investment also improved, increasing 0.7% over the third quarter 2002, following on a 3.6% contraction in the second quarter.  Investment, however, suffered from a massive adjustment in inventories, which sent total investment (i.e. incl. gross fixed investment) into a double-digit contraction and thus constituted the key factor working against a more positive development in the total economy.  On a positive note, however, the adjustment in inventories, also sows the seeds for a more pronounced pickup in the near future, as businesses can hardly sustain the pronounced drop in inventories for long, particularly given the current rebound in private consumption. 

External sector improves over second quarter but remains weak spot in recovery as demand from U.S. only slowly feeding through to maquiladora industry
The external sector improved over the second quarter but remained in negative territory, as exports continued to suffer from a lack of demand in the U.S. economy.  As a result, exports declined 0.5% over the same period last year, compared to a 3.5% contraction observed in the second quarter.  Imports, which serve principally as input for the assembling plants generating most of the export revenues, also declined but improved from the 5.2% contraction in the second quarter to a 1.4% drop in the third.  The current improvement in external accounts is rather disappointing given that the U.S. manufacturing industry had finally shown signs of a rebound. 

Economic growth below expectations
The subdued economic developments observed in the third quarter are likely to have carried over into the fourth quarter.  In October, economic activity expanded a meagre 0.5% over the same month last year, according to the global indicator for economic activity (IGAE, Indicador Global de la Actividad Económica).  The actual reading was well below last month’s Consensus Forecast, which had the economy growing at an annual rate of 1.3%.  Moreover, the reading was not even half the 1.3% expansion observed in September.  However, according to seasonally adjusted data, the economy expanded 0.25% over the preceding month compared to a 0.13% expansion in September.  Because of the disappointing October reading, Consensus Forecast panellists have cut their fourth quarter projection to 2.0% from 2.3% expected last month and full year growth is seen at just 1.2%, down 0.2 percentage points.  Moreover, hopes for a solid recovery this year are also dimming.  The Consensus sliced 0.2 percentage points from last month’s 2004 GDP growth forecast to 3.1%.   

Congress approves 2004 Budget in last minute after two months of bitter discussions
On 30 December, just a day before the constitutional deadline expired, the Congress approved the 2004 budget.  The approval followed a lengthy period of negotiations about a tax reform package introduced by President Fox, which sought to broaden the coverage of the value added tax (VAT) to items such as food and medicine, which are currently exempt. The proposal met strong opposition from the country’s left-siding politicians, which lamented the social costs of the government’s initiative, despite specific compensation proposed for lower income groups.   While finally voted down, the bill showed a clear rift emerging in the Mexican society, with the left-wing represented by the Democratic Revolution Party (PRD, Partido de la Revolución Democrática) and the right represented by Fox’s conservative National Action Party (PAN, Partido Acción Nacional).  In fact, the rift also appears to go right through the country largest party, the Party of Institutional Revolution (PRI, Partido Revolucionario Institucional), which had governed Mexico for over 70 years until President Fox assumed power in 1998.   The party fired its leader in Congress, Elba Esther Gordillo, after she had – prematurely – pledged the support of her party for the tax bill.   

Congress opts for conservative budget
Owing to the entrenched negotiations over the last two months of the year, the final budget turned out more conservative than the original proposal.  In total, the Mexican government plans for revenues of 1,608 billion pesos (US$ 140.1 billion) and to spending of 1,632 billion pesos (US$ 142.2 billion), approximately one percentage point of GDP less than in 2002.  The resulting fiscal deficit of 24 billion pesos (US$ 2.1 billion) is equivalent to 0.3% of GDP.  Moreover, the current budget is based on rather conservative estimates as the comparison with the Consensus Forecast shows (see table).