Itaú BBA - Higher growth and low inflation in 2016

Scenario Review - Mexico

< Volver

Higher growth and low inflation in 2016

diciembre 4, 2015

We expect GDP to grow 2.8% in 2016.

Please see the attached file for all graphs. 

• We expect GDP growth to increase next year, after an estimated 2.5% expansion in 2015. The weaker exchange rate and the recovery of the U.S. economy will likely boost manufacturing exports to the U.S. The recovery of external demand would spill over to the domestic economy, helping to maintain the solid momentum of private consumption. We expect that investment will benefit from the implementation of the energy reform. Finally, we expect oil output – a major drag on growth this year – to remain stable.

• As the Fed raises the policy rate, an additional weakening of the Mexican peso is likely. However, we don’t expect the U.S. dollar to appreciate much further from the current levels. In fact, the Mexican peso has already been more stable recently, encouraging the central bank to ease intervention. We see the currency at 17.5 pesos to the dollar by the end of 2016, from an estimated 17.0 by the end of 2015. 

• Inflation continues to surprise to the downside, and is now close to the lower bound of the target on an annual basis. Although, at the margin, inflation is more pressured, we expect it to end 2016 at 3%, from 2.5% by the end of this year (2.7% in our previous scenario).     

• Even with a still incipient recovery, low inflation and a well-behaved exchange-rate, the central bank will likely start to raise the policy rate in 1Q16, after the Fed’s liftoff in December. In 2016, we project four 25-bp rate hikes.

Stronger growth ahead although risks remain

We believe that GDP growth will firm up in 2016 with a more balanced economy. The economy is already displaying stronger momentum. The GDP surprised to the upside in 3Q15, increasing by 2.6% year over year (above the 2.4% in the flash estimate). On a quarterly basis, GDP grew by 0.8%, the highest growth rate since 3Q13. In 2016, the weaker exchange rate and the recovery of the U.S. economy will likely boost manufacturing exports to the U.S. A recovery of external demand would spill over to the domestic demand, helping to maintain the solid momentum of private consumption. We expect that investment will benefit from the implementation of the energy reform. Finally, oil output – a major drag on growth this year – has already become more stable.

We see growth accelerating to 2.8% next year (unchanged from our previous scenario) from 2.5% this year (upwardly revised from 2.2%). We have revised our 2015 growth forecast as a result of the positive surprise in 3Q15 GDP and the upward revisions in the historical series.

However, there are downside risks for next year: fiscal tightening is likely to continue depressing public capital spending, in particular of Pemex, which may put oil production on a declining path again. Also, U.S. industry – key for Mexico’s intermediate goods – has yet to rebound.

Some additional exchange-rate weakening is likely

The Mexican peso will likely weaken further ahead, as the Fed raises interest rates. However, we do not expect sizable additional depreciation, as in our view, much of the Fed’s upcoming hiking cycle is already priced in. In fact, the exchange rate has been more stable recently, in spite of the renewed decline of oil prices.

With lower pressure on the currency, the Foreign-Exchange Commission (formed by members of the central bank and of the Ministry of Finance) “softened” intervention. On November 19, the commission suspended the USD 200 million daily auctions without minimum price. The USD 200 million daily auctions with minimum price (1% depreciation from the previous day’s fixing) were extended until January 29. If the USD 200 million auctioned is fully sold, the central bank will auction another USD 200 million, with a minimum price of 1.5% above the previous fixing. Thus, previously the central bank was selling at least USD 200 million per day and at most USD 400 million. Now, there is no floor for sales.

We still see the exchange-rate ending this year at 17.0 pesos to the dollar and weakening further to 17.50 pesos to the dollar next year.

The current-account deficit widened recently. The current-account deficit for 3Q15 stood at USD 8.9 billion, much higher than the USD 3.1 billion deficit recorded in 3Q14. The rolling four-quarter deficit stood at USD 29.9 billion, or 2.8% of GDP, worsening from the USD 24.1 billion deficit in 2Q15 or 2.1% of GDP, mainly as a result of a lower energy balance.

We now expect the current-account deficit at 2.4% of GDP this year (from 1.8% in our previous scenario), but narrowing to 2.2% in 2016 (from 1.7%, previously). With the energy balance stabilizing and manufacturing exports recovering, some reduction of the current-account deficit is likely. On the financial account, we note that net direct investment is already “gaining space” from portfolio flows: a trend that will likely continue as the Fed raises interest rates and the government advances on the implementation of the structural reforms (especially the energy reform).

Inflation to reach the center of the target

Inflation continues to surprise to the downside, and is now close to the lower bound of the target on an annual basis. At the margin, inflation is running higher, lifted by the depreciation of the peso. Inflation reached a new record low in the first half of November (2.27%), as core inflation has remained subdued (2.35%). Inflation for services is now at the lower bound of the target, reaching 2.02%, mainly as a result of more favorable telecom prices. 

We expect inflation to end 2016 at 3%, from 2.5% at the end of this year (2.7% in our previous scenario). We note that at the margin inflation has been running above the center of the target. With lower exchange-rate depreciation next year, inflation would moderate.

A relief for the exchange-rate market

Amid a still incipient recovery and low inflation, the recent stabilization of the exchange rate reduces the odds that the central bank will follow the Fed. In October, the central bank left the tone of the statement announcing the decision unchanged from the previous meeting, in spite of the more hawkish tone of the Fed’s statement the day before. Afterwards, Governor Carstens said explicitly that the response of the Mexico’s central bank to the Fed shouldn’t be automatic.

We continue to expect the first interest rate increase in Mexico only in 1Q16, after the Fed’s liftoff in December. By the end of next year, we expect the policy rate to finish at 4.0%, 100 bps above the current level. 


 

João Pedro Bumachar

Jesus Gustavo Garza-Garcia


 

Please see the attached file for all graphs.  


 

 



< Volver