Manuel Sánchez: Mexico in a weak global environment
Remarks by Mr Manuel Sánchez, Deputy Governor of the Bank of Mexico, at Morgan
Stanley's Mexico's Moment Investor Conference, Mexico City, 17 June 2013.
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It is a privilege to participate in this conference dedicated to examining investment
opportunities in the Mexican economy. I appreciate Morgan Stanley's invitation to share a
few thoughts with you on the economic situation and outlook in Mexico.
My remarks will be divided in three parts. First, I will briefly review the status of the Mexican
economy in the current context of global economic softness; second, I will analyze recent
developments in Mexican financial markets in connection with the monetary policies of
developed countries; and third, I will describe some challenges to monetary policy and
inflation in Mexico.
Developments in the Mexican economy
Mexico's economic performance of this year has been limited by the weakness of the world
economy. On the one hand, the United States has shown signs of recovery, confirmed by
indicators such as those related to personal consumption, the housing sector, lending, and
the labor market. Yet, growth has been dampened by a contraction in public spending,
reflecting fiscal consolidation efforts, as well as by a recently lower contribution from net
exports.
Forward-looking indicators reveal that economic activity in the United States may continue to
strengthen. So far this year, analysts' consensus forecasts posit GDP expansion higher in
2014 than for this year. However, this expected growth is still insufficient for the U.S.
economy to return to its secular trend, something that continues to challenge current
economic policy.
On the other hand, the euro zone remains in recession, despite progress on financial
stability. In addition, emerging economies appear to be slowing, as shown by the
performance of industrial production and exports. Even if PMIs from the manufacturing and
services sectors imply that expansion in these economies will continue, both indicators
exhibit a declining trend.
In short, global growth forecasts for 2013 have been revised slightly downward, and those for
2014 are unchanged, all remaining below the average rates seen before the crisis.1
So far in 2013, Mexico's economic output has continued the upturn begun four years ago,
although at a slower pace. Moderation in the Global Economic Activity Indicator (IGAE)
stems from stagnation in industry and a contraction in agriculture, the latter largely resulting
from March frosts. The lack of strength in manufacturing reflects weakness in the sector's
exports, both those directed to the United States and especially those to other markets.
In contrast, the services sector has remained highly dynamic. Lending to the private sector,
in particular consumer lending, has kept growing, albeit at lower rates. Additionally, the
number of formally employed workers has continued to increase, but the unemployment rate
remains somewhat above the historic average.
Some indicators imply that lower external demand has likely had negative repercussions for
domestic spending. Retail sales have lost momentum and gross fixed investment has
recently slowed.
Nevertheless, most prospective indicators, including the manufacturing and
nonmanufacturing PMIs and other leading indicators, still suggest that economic performance
may improve. Consistently, analysts have revised their forecasts for Mexican GDP growth
downward for the current year but, in general, they have kept their forecasts the same for
2014.2
Even though downside risks to near-term growth forecasts appear to have increased for this
year, for next year upside risks may remain. In particular, if the recovery in U.S.
manufacturing consolidates in the following months, the upswing could fuel manufacturing in
Mexico, with favorable effects on other sectors of the economy.
In the medium term, economic expansion in Mexico will continue to depend on productivity
growth, the lack of which has been the biggest drag on income improvement. Progress on
the nation's structural reform agenda is encouraging, including changes affecting the labor
market, government accounting, education, and competition and telecommunications.
Finally, approval of a financial reform initiative submitted recently to Congress could yield
additional benefits.
Capital inflows and financial markets
During the last three years, emerging markets saw significant capital inflows, which appear to
have accelerated during the first four months of 2013. In Mexico, the largest proportion of
flows went to peso-denominated government bonds.
The relative abundance of external funds for emerging markets seems to reflect three
fundamental factors. First, loose monetary policy in developed nations, which in the case of
the United States has implied policy interest rates cut to near zero and significant quantitative
easing, has triggered a search for higher yields.
Second and not completely unrelated to the preceding factor, global risk aversion has
remained relatively tame since 2010.
Third, individual characteristics of different countries contribute to explaining why capital
inflows have not been equal in all emerging economies. In particular, Mexico's attractiveness
could involve factors such as the openness of the capital account, the free-floating exchange
rate regime, the certainty of no discretionary intervention in the markets, moderate country
risk, and positive prospects for structural reforms.3
During the last few weeks, sentiment has changed in global financial markets. Favorable
U.S. economic data and various Federal Reserve officials' statements have fueled market
and analysts' expectations for an imminent start to the tapering of quantitative easing in the
United States.
Hence, the April employment report published in May approximately coincided with the
beginning of a rising trend in long-term government bond rates in the United States and other
nations. At the same time, the U.S. dollar has been appreciating with respect to many
currencies.
The resulting volatility in global financial markets has brought about considerable increases
in Mexican government bond yields. For some maturities, the upward shift in the yield curve
has offset the downward shifts seen in the first four months of the year. Like other
emergingmarket currencies, the peso has been depreciating against the dollar.
Adjustments in Mexico's financial markets have occurred in an orderly way. FX market
volumes have continued to be high, bid-ask spreads have remained slim, and foreign
holdings of peso-denominated bonds are still near record highs, although portfolio duration
has been declining throughout the year.
Recent global financial volatility is a foretaste of what could happen when the process of U.S.
monetary policy unwinding begins in earnest. Hence, it is likely that some turbulence may
continue.
Given this scenario, the Mexican economy is expected to confront any new episode of
uncertainty in a solid manner. However, it is important that creditors as well as debtors
remain wary of their FX and interest-rate risk exposures. At the same time, authorities need
to remain vigilant in order to ensure that financial markets operate normally at all times.
Inflation and monetary policy
In the last decade, monetary policy in Mexico has sought the convergence of inflation toward
the 3 percent permanent target. Progress in price stability over the same time has been
considerable.
Nevertheless, during the current year, inflation has posted somewhat higher levels, since
March surpassing the Bank of Mexico's upper limit in the variability interval of plus or minus
one percentage point around its inflation target. Higher inflation mainly reflects pressures in
the noncore component of the CPI, from agricultural prices as well as energy prices and
government tariffs.
However, the negative supply shock is expected to be transitory. At the same time,
moderation in core inflation continues to depend, to some degree, on a positive shock from
certain services prices. Nevertheless, core inflation has remained around 3 percent during
the last few months and is expected to stay around this level during the rest of this year and
next.
Up to now, there is no evidence of secondary effects from recent changes in relative prices.
Analysts' short-term inflation expectations have increased somewhat, but expectations for
the medium and long terms have remained stable, albeit above 3 percent. The Bank of
Mexico expects inflation to return to the variability interval in the second half of this year, and
to be very close to the permanent target in 2014.
Upside risks to inflation prevail, including greater-than-expected hikes to transportation
prices, additional agricultural price pressures, given avian flu, low precipitation and reduced
water levels in dams, and greater volatility due to uncertainty over U.S. monetary policy
normalization.
The persistence of higher inflation carries the risk of fueling second-round effects that may
contaminate the price and wage formation process. Thus, the Bank of Mexico Governing
Board has warned that it will remain alert to adverse supply shocks in order to keep them
from producing these effects so that the process of convergence to the permanent inflation
target remains on track.4
Concluding remarks
Recent indicators highlight slower expansion in the Mexican economy, largely caused by
global economic weakness. By next year, as the external environment improves, Mexico's
economic activity is expected to post a healthier pace. Also, in the medium term, structural
reforms could enhance productivity.
The financial volatility of the last few weeks has had significant implications for emerging
markets. Adjustments in Mexico have been orderly. In the face of the possibility that
uncertainty may continue, prudence should prevail on the part of creditors and debtors, and
the authorities should remain alert in order to ensure that at all times financial markets
operate normally.
Finally, an increase in annual inflation so far this year is due to negative supply shocks,
reflected especially in the noncore component of the CPI. Given the temporary nature of
recent pressures, it is likely that inflation will soon resume a downward trend toward the 3
percent permanent target.