Itaú BBA - Less impulse from the U.S.

Scenario Review - Mexico

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Less impulse from the U.S.

September 10, 2015

We reduced our growth forecast for next year to 2.8% (from 3.0%).

• The economy grew at a modest pace in 2Q15, but improved somewhat from the previous quarter. We expect the growth momentum to improve from the second half of the year on. However, we reduced our growth forecast for next year to 2.8% (from 3.0%), in line with the downward revisions in our forecasts for growth in the U.S.

• The Mexican peso weakened further in August. We now see the currency ending this year at 17.0 pesos to the dollar (from 16.0 in our previous scenario) and ending 2016 at 17.5 (also from 16.0). Uncertainty related to China’s growth and lower oil prices, amid the potential tightening cycle in the U.S., are the reasons behind the weaker exchange rate.

• In spite of the depreciation, headline inflation reached a new historical low in August. Core inflation remained well below the center of the target. We continue to expect annual inflation to reach 3% by the end of this year and to remain at that level next year.

• A split board left the policy rate unchanged at 3.0% in July. The meeting was attended by only 4 of 5 members and one of them voted for a 25-bp rate hike as a preemptive reaction to the Fed’s liftoff. Governor Carstens has also recently mentioned that rate hikes before the Fed’s liftoff are possible, depending on exchange-rate volatility. We expect rate hikes only in 1Q16, after the Fed’s liftoff in December, once there are more clear signs that the domestic economy is recovering and inflation is an issue.

• President Peña announced changes in his cabinet, giving insights into the presidential race in 2018 (the PRI normally chooses its presidential candidate from the cabinet). Also, the government sent its 2016 budget proposal to congress on September 8, announcing further expenditure cuts.

Weak growth in 2Q15 but encouraging signs for the quarters to come

Activity remained weak in 2Q15, mainly dragged down by oil output and the slow recovery in manufacturing production. The GDP came in at 2.2% yoy, down from 2.6% in 1Q15. Sequentially, the GDP grew by a modest 2.0% qoq/saar. The industrial sector performed poorly (-0.1% qoq/saar in 2Q15) mainly as a result of declining mining activities (-12.9% qoq/saar) and weak manufacturing production (0.4% qoq/saar in 2Q15).

On the other hand, some indicators already suggest a recovery. Manufacturing exports expanded 6.5% from June to July following 3.5% growth in the previous month. Also, oil output is now stabilizing. Indicators linked to internal demand have evolved favorably. Retail sales grew strongly in June, creating a favorable carry-over for 3Q15. Labor conditions and historically low inflation remain supportive of private consumption: formal employment grew 4.4% yoy in July and the real wage bill expanded 5.8% in June. In addition, the flow of remittances remains solid (especially when converted to pesos) and consumer credit is starting to accelerate. Investment is also gaining ground – gross fixed investment was up by 9.8% qoq/saar in 2Q15.

We maintain our GDP growth forecast of 2.4% for 2015. However, we lowered our estimate for 2016 to 2.8% (from 3.0% in our previous scenario). A more moderate U.S. economic recovery in 2016 than we had previously been forecasting is behind our revision.

A weaker peso

The Mexican peso weakened further in August. Although the trade links between Mexico and the U.S. give support to the currency, the Mexican peso is not immune to the uncertainty over China, lower oil prices and the Fed’s upcoming liftoff. We now see the exchange rate ending this year at 17.0 pesos to the dollar (from 16.0 in our previous scenario) and at 17.5 in 2016 (also from 16.0).

The current-account deficit remained low in 2Q15. The current-account deficit for 2Q15 stood at USD 8 billion, slightly lower than the deficit of USD 8.1 billion in 2Q14, so the rolling four-quarter deficit stood almost flat from 1Q15, at USD 25.3 billion, or around 2% of GDP. The breakdown of the current-account deficit shows that the trade balance of goods is deteriorating (mostly due to lower net energy exports), while the balance of services and income improved (likely reflecting the weaker exchange rate). Considering that the energy balance has already shrunk considerably (it has even been negative this year), the impact of oil prices on the current account is now low.

Considering our new scenario for the exchange rate, we now see a current-account deficit of 1.8% of GDP in 2015 (2.5% in our previous scenario). For 2016, we also see an improvement, but the investment demand associated with the energy reform will limit the additional reduction (we now expect 1.7% of GDP).  

Inflation reaches a new historical low

In spite of the persistent weakening of the currency, inflation reached a new record-low level. It stood at 2.59% in August (from 2.74% in July). Meanwhile, core inflation came in at 2.3% (from 2.31%). Prices for core goods increased by 2.36%, compared with an increase of 2.47% in July. Within core goods, inflation for items other than food, beverage and tobacco is rising, reflecting the first-order impacts of the depreciation, but is also below the target center. Inflation for core services is near the lower bound of the target (at 2.25%).

We still expect inflation to end this year and next at 3%. 

Split board left the policy rate unchanged in July

The minutes of the most recent monetary policy committee meeting revealed a split decision to leave the policy rate unchanged, at 3.0%. The meeting was attended by only 4 of 5 members and one of them voted for a 25-bp rate hike (but we note that members normally identified as more hawkish were present at the meeting) as a preemptive reaction to the Fed’s liftoff. Contrasting with the previous decision, only one board member was openly against raising rates before the Fed (instead of the majority). However, even this member discussed the conditions under which a hike before the Fed’s liftoff would be advisable (“disorderly adjustments in the market”). This more-conservative view is consistent with the message given by Governor Carstens recently: that rate hikes before the Fed could come, depending on exchange-rate volatility.

However, we continue to expect the Mexican central bank to start a hiking cycle only in 1Q16, somewhat later than the Fed’s liftoff. 

Peña Nieto announces cabinet changes

President Peña Nieto announced several changes in his cabinet: Foreign Affairs Minister José Antonio Meade moves to the Ministry of Social Development, replacing Rosario Robles; Rosario Robles replaces Jesús Murillo Karam as the Minister of Land Development; Tourism Minister Claudia Ruiz Massieu moves to the Foreign Affairs Ministry; Current Chief of Staff of the Presidency, Aurelio Nuño, moves to the Ministry of Education; and José Calzada, former Governor of the State of Querétaro, replaces Enrique Martínez as Minister of Agriculture.

In all, we note that the key strategic Ministries (Finance and Interior) did not suffer any changes, signaling the trust of the president in two of his closest allies (Luis Videgaray and Miguel Angel Osorio Chong). Both ministers have recently been in the spotlight due to the weak performance of the economy for the first, and the escape of Joaquín “El Chapo” Guzmán from a maximum-security prison and the disappearance and murder of 43 students in the State of Guerrero for the latter. Also, the Minister of Telecommunications and Transport, Gerardo Ruiz Esparza, kept his post after some speculation about a possible move following several controversies regarding the tender process of some infrastructure projects (e.g., the Mexico City-Querétaro train).

We highlight José Antonio Meade’s move to the Ministry of Social Development. He is an economist who has worked in both the PAN and PRI governments, with ample experience in the public sector (he has been Minister of Finance, Energy and Foreign Affairs), and a well-respected politician. Meade will be in charge of one of the largest public budget in the country, trying to reverse the current trends in poverty statistics. Finally, we note that Aurelio Nuño is now in the spotlight, assuming a key position, since he will be in charge of the education reform negotiations with the Teachers’ Union (the largest in the country), which has opposed several of the implemented reforms (e.g., teacher evaluations). Any of these Ministers are now in the spotlight as possible PRI candidates for the 2018 presidential election. The PRI normally chooses its candidate from the cabinet.

The Ministry of Finance announced an oil-price hedge for 2016, worth 49 dollars per barrel, by purchasing a put option. Last year the federal government hedged the Mexican oil-mix price at 76.4 dollars per barrel. The cost of the hedge was USD 1.1 billion (up from USD 773 million last year) covering 212 million barrels. This is the eleventh straight year of the oil-price hedge strategy. Nevertheless, the strike price of the put option fell significantly, pressuring the fiscal accounts.

In this context, on September 8 the Ministry of Finance delivered its 2016 budget proposal. The government is requesting a budget deficit of 3.0% of GDP (down from the 3.5% deficit approved for this year), through a 1.15% of GDP in budget cuts (higher than the 0.8% of GDP previously indicated). No new or increased taxes were proposed in the budget as expected.

The 2016 budget proposal signals a commitment of the government to maintain fiscal stability but there are challenges ahead. The economic acceleration that the government is expecting (to 2.6%-3.6% range) may not materialize. If economic growth disappoints there could be negative surprises to revenues and the government could be pressured to further adjust expenditures or relax the fiscal target. In addition, Pemex budget will be negatively impacted by the expenditure cuts, which may lead to a further decrease of oil production and, consequently, oil fiscal revenues.

The government announced changes to the second phase of Round One of the oil explorations blocks. The aim of the modifications is to attract more interest from firms in the tender process, after a disappointing first phase. However, lower oil prices remain a challenge for the implementation of the energy reform.


João Pedro Bumachar

Jesus Gustavo Garza-Garcia



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