Manuel Sánchez: Mexico's economic integration and outlook
Remarks by Mr Manuel Sánchez, Deputy Governor of the Bank of Mexico, at the
United States-Mexico Chamber of Commerce, California Regional Chapter, Los Angeles,
9 December 2011.
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It is an honor to be in Los Angeles to address the United States-Mexico Chamber of
Commerce. I would like to thank the organizers of the 14th Annual Mexico Economic Review
and Political Outlook 2011 for the invitation to speak to you today.
Because California is one of the U.S. states most interconnected to Mexico, it is natural to
begin my review of the Mexican economy by examining its ever-increasing integration with
that of the United States. After that, I would like to describe the effects of current international
conditions on Mexico and discuss its economic outlook.
My main message is that, while the strength of the current economic upturn in Mexico may
be limited by that of the United States, the benefits of its long-term association with its
northern neighbor continue to be substantial. Also, Mexico will realize its upside potential for
sustained economic growth if it strengthens its fundamentals and promotes pending
structural reforms. As usual, my remarks are entirely my own responsibility and do not
necessarily reflect those of the Bank of Mexico.
Expanding economic integration
During the last three decades, Mexico has been undergoing a process of expanding
economic integration with the United States. Deeper relations between the two countries
have been built on their geographic proximity, especially as a result of the opening up of the
Mexican economy, which began in 1983 with a phase of unilateral reduction of tariffs and
other barriers to trade. Ever greater openness has been achieved through the
North American Free Trade Agreement (NAFTA) since 1994, which included Canada, the
United States and Mexico. Despite the important role that Canada plays in intraregional
transactions, in what follows I will focus on the growing economic links between the
United States and Mexico.
Enhanced economic integration between these two countries is multifold. The most dramatic
reflection of this relation is the consistently high growth of their bilateral trade in goods and
services, which surpasses that of their respective GDPs. Specifically, highly dynamic
Mexican exports to the United States have implied markedly more Mexican imports from
north of the border. Additionally, bidirectional tourism has been increasing, and workers'
remittances from the United States are an important source of inflows in Mexico's balance of
payments. At the same time, foreign direct investment between the two countries and from
other nations has being growing in view of advantages from business opportunities arising
from their greater commercial interaction.1
The benefits of this association have accrued to both nations, but being the less developed
economy, Mexico has profited in particular. One direct effect of Mexico's opening to trade
has been a trend towards product specialization and efficiency, a result of fiercer competition
from abroad as well as multiplied opportunities to send goods to the world's largest market.
Of course, this transformation has not been a zero-sum game, as suggested by the
complementary roles that the two countries have played in certain expanding sectors, such
as Mexico's in-bound maquiladora and auto industries. More importantly, and as predicted by
theory, both economies have benefited from a wider availability of goods and services at
lower prices.2
Mexico's economic integration with the United States has not prevented it from expanding
transactions with other nations and regions. In fact, the rapid growth of flows to and from the
United States has coincided with a decline in the relative importance of the United States as
a trade and investment partner. This observation is consistent with a previous finding that
any possible trade diversion stemming from NAFTA has been more than surpassed by total
trade creation.3
An implication of the tight links between the two nations is that the Mexican economy is very
cyclically synchronized with the United States, especially in manufacturing production, for
which the correlation is more than 0.9. This effect has been enhanced during the last fifteen
years, a time period in which Mexico has undertaken sounder fiscal and monetary policies,
thus avoiding previously recurrent currency crises.
The global financial turmoil in 2008 and 2009, the epicenter of which was the United States,
affected Mexico more profoundly than many other emerging markets, given its close ties with
the larger country. The persistence of some structural problems and the unusually weak
ongoing recovery in the United States have led some to advocate the diversification of
Mexico's international economic relations away from its northern neighbor. While this notion
may be sensible if it is the result of a natural market evolution, it becomes risky if it implies
the application of policy measures that introduce distortions and inefficiency.
Some diversification of Mexico's trade and investment relations may continue to occur as a
natural outcome of more global trade opening and better transport and communications
possibilities. However, being next to the largest and most diversified economy of the world is
a strong advantage that should not be artificially limited.
Financial volatility and economic rebound
Since the end of August 2011, international financial markets have been buffeted by
heightened risk aversion and a generalized flight to quality resulting from the perceived
worsening of the financial and fiscal problems in the euro area and, to a lesser extent, the
fear of another recession in the United States. The general result has been a tendency
toward volatility and lower asset prices in many stock, bond and currency markets.
In the case of Mexico, the most notable financial impact has been increased instability and
substantial depreciation of the Mexican peso against the U.S. dollar. From the end of August
to the end of November 2011, Mexican peso depreciation reached more than 10 percent, a
rate that is similar to that experienced by other currencies, such as the New Zealand dollar
and the Brazilian real. Against the backdrop of widespread risk aversion, very few currencies
other than the U.S. dollar have played the role of safe havens.
The international financial turbulence has also negatively affected the peso bond market,
although to a much lesser degree than the foreign exchange market. During
September-November 2011, the domestic yield curve tended to move up and to steepen
slightly, but this movement was not continuous, as it was interrupted by downward shifts. In
any case, interest rates for tenors of one year and longer remain below the maximum levels
observed in the first half of the year.
The relatively minor impact of the financial instability on Mexico's yield curve seems to reflect
the high proportion of long-term bonds within foreign holdings of peso-denominated
government securities. Furthermore, during the last few months, the amount of long-term
bonds held by foreigners increased slightly more than a reduction observed in holdings of
short-term securities. The important role played by long-term investors in the government
securities market seems to reflect their confidence in the sound management of public debt
as well as the flexible exchange rate regime. Two additional possible factors explaining the
prevalence of contained long-term interest rates are a decline in projected economic growth,
and stable and moderate inflation expectations in recent months.4
During 2011, the Mexican economy has continued a recovery process after surpassing, by
the beginning of the year, the maximum levels of economic activity observed prior to the
global financial crisis. Indeed, GDP quarterly growth has been successively rising and, in the
third quarter, the change in output was positive for each of the economy's three sectors. On
a year-over-year basis, GDP grew 4.4 percent in the third quarter.
The services sector, which accounts for about two-thirds of Mexican GDP, was highly
dynamic in the first nine months of the year, and particularly in the third quarter. This growth,
along with extraordinarily high agricultural production, more than compensated for a slight
deceleration in industrial activity in the third quarter.
Lower industrial growth reflected, notably, a slowdown in manufacturing production, which in
turn responded to lower growth from Mexican non-oil exports, particularly non-auto products,
to the United States. Apparently, a slowing of manufacturing production in the United States
had an almost instantaneous impact on Mexico's manufacturing production. October data on
foreign trade suggests that this deceleration has probably continued in the fourth quarter of
2011.
Domestic demand, as reflected by retail sales and investment, continued showing high rates
of growth, although investment levels remain below those observed before 2008, mainly
because of a virtual stagnation in the construction industry. Retail sales growth seems to
have been fueled by a recovery in employment, real wages, and consumer credit.
Monetary policy and outlook
During 2011, monetary policy continued to be consistent with the 3 percent inflation target
established by the Bank of Mexico at the end of 2003. The policy interest rate has been kept
at 4.5 percent since July 2009. As a result, in 2011 annual inflation has remained relatively
stable and close to, though slightly above, the target.5
The Governing Board of the Bank of Mexico has repeatedly stated that it will continue to
implement a monetary policy stance that fosters the convergence of inflation to the
permanent target. Risks must be closely monitored. At the moment, the main threat seems to
come from the possibility that a weaker Mexican peso, for example affected by continued
uncertainty in the euro zone, may translate into generalized inflation pressures. Although the
pass-through from exchange rate movements to inflation has fallen in recent years, the
potential impact of a considerable depreciation of the Mexican peso is unknown.
Other risks include the possible worsening of inflation expectations stemming from the
disappearance of favorable nonrecurring factors, such as low increases in agricultural
product prices, which this year have supported benign inflation. Another important challenge
for monetary policy continues to be the need to anchor inflation expectations around the
3 percent permanent target. To date, measures of expected inflation for all time periods, as
reflected in analyst surveys and the bond market, remain above the target.
Finally, the Bank of Mexico estimates that GDP growth will settle between 3.5 percent and
4 percent in 2011 and between 3 percent and 4 percent in 2012. This forecast assumes fairly
stable, moderate growth in the United States. Revised economic prospects in the U.S.
economy would likely trigger an adjustment in the same direction for Mexico's GDP growth.
Despite the significance of its close links to the United States, which are especially important
to cyclical economic activity, Mexico's potential long-term economic growth has substantial
upside if the nation continues to fortify its fundamentals, which include healthy fiscal
finances, low inflation, and a liquid and well-capitalized banking system. Its upside potential
will also be greater if it promotes pending structural reforms fostering productivity growth and
investment.
Concluding remarks
The increasing economic integration of Mexico with the United States during the last three
decades has benefited both countries significantly. Advantages to Mexico include greater
product specialization and efficiency, and for both nations, a wider variety of goods and
services at lower prices. Being next to the largest and most diversified economy in the world
is a strong advantage for Mexico which should not be underestimated.
Recently, international financial instability has affected Mexico mainly through substantial
currency depreciation, similar to that experienced by other emerging market currencies, and,
to a lesser extent, through slightly higher interest rates. Meanwhile, the Mexican economy
has continued a recovery process which has included more moderate growth in the industrial
sector, mainly reflecting slower exports to the United States.
Mexico's economic outlook remains dependent on the strength of the U.S. economy, but
long-term upside potential can be realized if Mexico's fundamentals are strengthened, and
pending structural reforms approved. Finally, monetary policy will continue to be consistent
with preserving the convergence of inflation to the permanent 3 percent target.