REMARKS BY MR. JAVIER GUZMÁN CALAFELL, DEPUTY GOVERNOR AT THE
BANCO DE MÉXICO, ON "MONETARY POLICY IMPLEMENTATION IN A
COMPLEX ENVIRONMENT", AT THE ABERDEEN NYC EMD POLICY MAKER
1
POWER LUNCH. New York City, October 11, 2016.
My sincere thanks to Aberdeen Asset Management for the invitation to
participate in this event.
The primary mandate of the Banco de México, enshrined in the country's
Constitution, is to aim at low and stable inflation. To this end, monetary policy
is conducted within a framework supported by two main pillars: an
independent central bank and an inflation targeting regime with a 3 percent
objective for the annual rate of growth of consumer prices. In this context, the
Banco de México seeks an efficient convergence of inflation to the target, that
is to say, at the lowest possible cost in terms of economic activity.
At present, monetary policy in Mexico is implemented in a rather complex
environment. On the one hand, the level of output is below the estimated
potential, and the available forecasts suggest that this gap will remain in
negative territory through end-2017. In addition, consumer price inflation
displays a favorable behavior and has been persistently below the 3 percent
target. However, on the other hand, the Mexican peso has recorded an
important depreciation over the last couple of years, and continues to be
subject to significant pressures. Naturally, this raises question marks about the
accompanying risks to inflation.
Let me elaborate on the macroeconomic situation under which monetary
policy is carried out at present.
After the decline observed in the second quarter of the year, economic activity
has resumed a moderate rate of expansion, fueled by private consumption and
services, on the demand and supply fronts, respectively. An accurate
assessment of the economy's position during the first half of this year is
challenging, among other reasons since national account figures are distorted
by seasonal factors which are difficult to correct. However, there are grounds
to believe that economic activity has begun a phase of deceleration.
The most recent information suggests a lower growth trend for both private
consumption and services, and the remaining components of aggregate
demand and supply remain stagnant. Although labor market indicators
provide mixed signals, they are generally consistent with a gradual
deceleration of economic growth. The overall rate of unemployment has
continued to fall, approaching levels observed prior to the crisis, but the pace
of employment growth has lost some momentum and nominal wage increases
remain contained. In this context, a negative output gap is observed.
It is reasonable to expect that the expansion of economic activity will continue
during the remainder of this year and in 2017. In fact, the anticipated upturn
of industrial output in the United States, if materialized, would contribute to a
more balanced economic recovery in Mexico through its impact on
manufacturing output and exports. In this respect, it is worth noting that there
are some early signs of a revival of production in the manufacturing industry,
and that this sector's external sales, though still sluggish, seem to have
stopped declining. On the other hand, the expansion of GDP is likely to remain
below potential and downside risks persist.
It is true that economic growth in Mexico has been low vis-à-vis the
population's needs. However, the shocks which have affected the economy
have to be taken into consideration for an objective assessment of its
performance. In particular, it is important to take into account that the
industrial sector in the United States has been in recession since early 2015,
and that GDP annual growth in that country has decelerated continuously
since the second quarter of that year. Notwithstanding the close long-term
correlation between these two aggregates and economic activity in Mexico,
the latter has shown resilience to this shock. The efforts of structural reform
carried out in Mexico in recent years are clearly an important factor behind
this result.
As noted previously, general inflation has shown a favorable performance. It
stands at 2.97 percent as of September of this year, thus accumulating 17
months below the 3 percent target, including 8 consecutive historical minima
in 2015. The importance of these results is underlined when it is taken into
consideration that since early September 2014 the peso has depreciated by
some 45 percent with respect to the U.S. dollar. Although depreciation of the
exchange rate has had some effect on inflation, so far, the pass-through has
been concentrated on the prices of merchandise, with no second round
effects.
General inflation is projected to increase gradually during the rest of this year
towards levels slightly above 3 percent, and to fluctuate around this figure in
2017, but it should be noted that the latter is subject to some uncertainty,
since the proposal to liberalize gasoline prices starting in 2017, which may
affect the evolution of inflation, is still under consideration by Congress. Going
further forward into the medium to long terms, survey-based inflation
expectations remain well anchored, although still a tad above the target.
While demand pressures on prices are likely to remain subdued given the
expectation of a negative output gap throughout next year, the outlook for
inflation presents, in my opinion, risks tilted to the upside. The possibility of a
rebound in the prices of agriculture and livestock, present for some time given
below-trend increases, is already materializing. However, recent experience
suggests that its effects on overall inflation should be transitory. Therefore,
the evolution of the exchange rate continues to represent the main risk for
inflation. The possibility of a higher pass-through to prices has increased as a
result of the additional peso depreciation in recent weeks and the potential
for further pressures on the peso in the short term, especially in view of the
upcoming presidential election in the United States.
Depreciation of the peso is explained by a combination of external and
domestic factors. Naturally, the anticipated normalization of monetary policy
in the United States has been a source of apprehension. In addition, as already
noted, uncertainty regarding the outcome of the electoral process in that
country has been reflected in the behavior of the peso, in view of the potential
implications for Mexico's economy. The situation has been further
complicated by weak oil prices, a generalized situation of uncertainty in
international financial markets, and the use of the peso as a hedging
instrument against risks in other emerging market economies and for
speculative purposes. On the domestic front, distress is mainly related to the
evolution of public finances and, to a lesser extent, the widening of the current
account deficit.
In a situation characterized by a negative output gap, low inflation and well
anchored inflation expectations, on the one hand, but higher risks for inflation,
on the other, the target for the overnight inter-bank interest rate has been
increased four times since late 2015 to date.
The first increase, of 25 basis points, took place as a response to a
corresponding adjustment in the target range for the federal funds rate in the
US. The reasons are straightforward. In view of close links between the
Mexican and US economies, an environment of widespread nervousness in
international financial markets, a very open capital account in Mexico and high
peso-dollar exchange rate levels, a narrowing of the interest rate differential
between the US and Mexico could have resulted in disorderly capital outflows,
and risks for inflation and financial stability.
Subsequent increases in the monetary policy interest rate in Mexico of 50 basis
points each in February, June and September are explained by a number of
common factors: the expectation of an upward trend for inflation even in the
absence of further shocks; risks for inflation and its expectations deriving from
a sharp depreciation of the exchange rate; the possibility of a higher than
anticipated level for the peso-dollar rate for a significant period; potential non-
linear effects of the exchange rate on prices; and the adverse signaling that
could result from the absence of decisive action in the face of evident perils
for inflation. Naturally, adjustment of the monetary policy stance has been
considered fundamental to fulfill the constitutional mandate of the Banco de
México, based on the premise that maintaining a low and stable inflation rate
represents the best contribution of the Central Bank to economic growth.
In spite of the accumulated tightening of the monetary policy stance in Mexico
since late last year, the impact of the higher target for the reference rate on
domestic economic activity has been alleviated by a flattening of the yield
curve. Interest rate increases have been concentrated on the short end of the
curve, while rates for longer maturities have actually declined.
Looking forward, it is difficult to evaluate the possible trend of the monetary
policy rate in Mexico in the very short term, especially in view that some of the
factors that have recently affected the most the peso-dollar rate, and
particularly the electoral process in the United States, could dissipate or
accentuate in coming weeks. Looking beyond this special period, against the
background of an output gap that is expected to remain negative throughout
next year, interest rates in Mexico are likely to be significantly affected by the
evolution of interest rates in the United States.
Markets continue to anticipate a further tightening of the monetary policy
stance in that country, although at a very gradual pace. To the extent that it
responds to the need to contain inflation and maximize employment, this
should be good news for the world and Mexico's economies. Furthermore, as
the experience with the increase of the federal funds rate in late 2015 shows,
if well communicated, it need not be a source of disruption in international
financial markets. However, for the reasons I underlined above, should
conditions similar to those prevailing at present persist, an increase in the
federal funds rate without a monetary policy response in Mexico would give
rise to major risks.
More generally, in accordance with the Central Bank's mandate, monetary
policy in Mexico will continue to focus on the attainment of the inflation
target. This implies a careful monitoring of all determinants of inflation and its
medium- to long-term expectations. However, special attention will be paid to
the exchange rate in light of its potential pass-through to consumer prices,
without implying an objective for the exchange rate, and to the relative
monetary policy stance between Mexico and the US. In addition, considering
the uncertainties related to estimates of the output gap, a careful assessment
of demand pressures on prices will also be carried out. In any event, the Banco
de México will adjust its monetary policy stance with all due flexibility, at the
moment and in the magnitude that conditions require it, to consolidate the
efficient convergence of inflation to the 3 percent target.
Obviously, efforts on the monetary policy front alone would be insufficient to
preserve macroeconomic stability. Action is also fundamental on the fiscal
side, especially in view of the concern surrounding the current situation and
outlook for public finances.
The economic program for 2017 presented to Congress by the Ministry of
Finance envisages a surplus in the primary balance for the first time since 2008.
Accordingly, the Public Sector Borrowing Requirements (PSBR), the most
comprehensive measure of the deficit, should display next year a reduction
equivalent to 1.2 percent of GDP with respect to 2015 (and 1.7 percent with
respect to 2014). As a result of these measures, the historical balance of the
PSBR as a share of GDP is projected to peak this year and to follow a downward
trend subsequently. It will be essential to adhere strictly to these
commitments and to be ready to take additional measures if needed.
The implementation of the above fiscal actions should also alleviate concerns
deriving from the increase in the current account deficit. Even though part of
the needed adjustment has taken place through depreciation of the real
exchange rate, macroeconomic policy support is required to ensure an orderly
performance of the economy. Indeed, since the increased external deficit is
explained mostly by the decline in public revenues, in turn the result of the fall
in both prices and output of oil, fiscal policy represents the most adequate
instrument to tackle this imbalance. In addition to this, and from a medium- to
long-term perspective, structural reform is essential to increase oil output and
exports, which should in turn make the rebalancing efforts more sustainable.
Action on the monetary policy front should only be considered if the current
account deficit poses risks to the accomplishment of the inflation target
through its effects on the exchange rate.
Intervention in the foreign exchange market can also play a role in coping with
the challenges deriving from exchange rate volatility. The Foreign Exchange
Commission, integrated by representatives of the Ministry of Finance and the
Banco de México, has made clear that anchoring of the Mexican peso will be
sought through the preservation of strong economic fundamentals. However,
it has also been underlined that discretionary intervention in the foreign
exchange market cannot be discarded should exceptional circumstances arise.
To conclude, I just want to note that while Mexico's economy has performed
relatively well in a rather difficult environment, as evidenced by the resilience
of economic activity and the low rate of inflation, the need to strengthen its
economic fundamentals has increased. This implies action on several fronts:
adherence to a monetary policy approach emphasizing prudence, a
strengthening of public finances that ensures a sustained decline in the share
of public debt in GDP, the implementation of any policies required to ensure
the preservation of financial stability, and continued strengthening of the
domestic sources of growth.