of new rounds of monetary accommodation recently announced by the u. s. federal reserve and other central banks. in this environment, the mexican economy is forecast to continue growing at rates between 3 and 4 percent this year and the next. for an interesting study of the productivity gains of mexican manufacturing exports, see oviedo, m. ( 2012 ), “ the productivity revolution and the china ( manufacturing ) syndrome, ” barclays, emerging markets research, 6 september. for an evaluation of the current state of mexico ’ s financial system, see council for financial sector stability ( 2012 ), “ informe anual sobre el estado que guarda la estabilidad del sistema financiero en mexico y sobre las actividades realizadas por el consejo de estabilidad del sistema financiero, ” march. bis central bankers ’ speeches obviously, the substantive role that external conditions have played in mexico ’ s economic recovery makes their eventual weakening a fundamental risk. in particular, if u. s. industrial production slows, mexican manufacturing exports may decelerate notably. additionally, further difficulties encountered by the euro area countries in implementing measures aimed at an integral solution to their common problems could generate new bouts of financial volatility and engender adverse effects on world economic prospects, affecting mexico. inflation and monetary policy in recent months, annual inflation has been rising, and since last june, it has surpassed the upper limit of the variability interval of plus or minus one percentage point around the bank of mexico ’ s permanent 3 percent target. a central element behind this deterioration has been significant price increases registered by agricultural products, resulting mainly from international drought and the outbreak of bird flu in mexico. these effects have manifested themselves primarily in the non - core component of the national consumer price index ( inpc ), which includes those items that tend to exhibit the highest price volatility. a second, more prolonged trend driving the evolution of inflation are increasing annual changes in the inpc core component since the second half of last year. among other factors, this tendency has reflected some pass - through from the depreciated mexican peso vs. the u. s. dollar, as well as significant processed food price increases. according to private - sector forecasts, annual inflation could remain above 4 percent for the rest of the year. the worsened scenario is worrisome, as inflation imposes a significant cost on society. given the

equity and fixed income assets. especially significant have been flows directed to peso - denominated government bonds. mexico has been attracting an increasing proportion of total capital inflows devoted to emerging - market local bonds. currently, in mexico, close to half of all peso - denominated public debt securities with fixed coupons are held by foreign investors. factors behind the portfolio inflows may include mexico ’ s macroeconomic stability, capital account openness, a freely floating exchange - rate regime, and high liquidity enjoyed by the mexican peso in fx markets. resulting favorable financial conditions have supported credit to firms and, in general, the recovery of bank lending to the private sector. as financing costs have fallen, so has the required return on capital projects, promoting investment. it is often said that the main risk associated with buoyant capital inflows is the possibility of a “ sudden stop. ” indeed, this scenario is likely and it has occurred, on innumerable occasions, for reasons not exclusively related to the recipient country, including several times in mexico. a sudden stop of capital inflows has frequently implied the need for traumatic adjustments in domestic spending, employment and growth, as has been illustrated by the current collapse of foreign investment in the peripheral countries of the eurozone. the most serious risk associated with capital inflows is not the ever - present possibility of a reversal, but rather ignoring the likelihood of the event. to be sure, financial crises typically occur because people assume that easy credit will last forever. as a result, over - borrowing and asset price bubbles emerge, which eventually end in implosions that impair the functioning of the economy, as witnessed in the last global financial meltdown. hence, possible capital reversal calls for prudence on the part of economic agents in mexico. as in any economy, the need to detect financial bubbles poses a challenge for policymakers. although in accomplishing this task, authorities do not generally have knowledge that is superior to that of market participants, they should have stronger incentives for warning against possible excessive risk - taking. given the inherent difficulty of measuring systemic risk and the probability of unintended consequences from direct interventions in credit markets, moral suasion could, in principle, be an advisable policy tool. 5 the base - case scenario for mexico ’ s economic outlook, as posited by most analysts, assumes the continuation of favorable external conditions. this assumption does not seem unreasonable at this point in light