Itaú BBA - No More Cuts

Scenario Review - Mexico

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No More Cuts

junio 6, 2013

Slow public expenditures also reduced growth in 1Q13.

Dear clients and friends,

We are proud to present our "Scenario Review - Mexico" monthly report. In this series we will discuss the outlook for the main macroeconomic variables of Mexico.

We hope you enjoy reading it,

Best Regards,

Ilan Goldfajn

No More Cuts

•           Temporary factors led to a sharp slowdown of the economy in 1Q13. We expect a rebound over the next few quarters that will bring growth to 3.2% this year and 3.6% in 2014.

•           As markets start to price in an earlier reduction of monetary stimulus in the U.S., the peso has depreciated. We now expect a slower pace of exchange-rate appreciation (to 12.0 pesos to the dollar by the end of this year and to 11.8 pesos to the dollar by the end of 2014). We no longer expect rate cuts. 

•           A temporarily weaker peso will add to inflation this year. We have revised our inflation estimate for 2013 to 3.5%. Our inflation forecast for 2014 is unchanged, at 3.5%.

•           The government has recently announced a bill to reform the financial sector. Meanwhile, divisions within the PAN have emerged, posing a new risk for the set of reforms expected to be sent for congressional approval in the second half of the year. 

A Temporarily Slow Economy in 1Q13

The IGAE (a monthly proxy for Mexico’s GDP) fell by 1.8% year over year in March, bringing 1Q13 growth down to 0.8%. Industry was the main drag on activity during the first quarter (-1.5%), but services also performed poorly (1.9%). The slowdown from the 4Q12 was mostly due to calendar effects (2012 was a leap year, and the Easter week fell in April that year). In fact, on a sequential basis, activity in 1Q13 was weak but not as bad as the year-over-year figure suggests. The IGAE expanded by 0.25% from February, following a 0.21% gain in the previous month. GDP therefore expanded by 1.8% qoq/saar in 1Q13.

Slow public expenditures also reduced growth in 1Q13. Nominal primary expenditures fell by 7.7% year over year in the quarter.

We expect activity to rebound in 2Q13.We view the weakness in growth in 1Q13 as transitory, and not only because of the calendar effects. The markets for labor and credit remain supportive enough to ensure stronger growth rates in consumption. Also, the public budget set for this year hints that public expenditures can’t continue declining for long.

A better outlook for the U.S. economy also works in favor of a recovery ahead. We recently revised our growth expectations for the U.S. economy, for which we now expect stronger sequential growth rates over the next few quarters.

We expect Mexico’s economy to grow by 3.2% this year. In 2014, we see growth at 3.6%. Next year, growth will likely be positively influenced by reforms.

No Additional Rate Cuts as U.S. Rates Rise and Curb the Pace of Peso Appreciation

The balance of payments data show that the current-account deficit is widening in 2013 but is still at a comfortable level. The current account balance posted a USD 5.5 billion deficit for 1Q13, bringing the four-quarter rolling deficit to USD 14.4 billion (1.2% of GDP), up from USD 11.4 billion in 2012. The wider current-account deficit is mostly due to lower trade balances.

Regarding the capital account, foreign portfolio investment moderated in the first quarter but remained strong, at USD 13.9 billion. During the last four quarters, foreign portfolio inflows were USD 71.1 billion, down from USD 81.3 billion in 2012. Foreign direct investment amounted to USD 5.0 billion in 1Q13 and USD 13.8 billion over the last four quarters. However, net direct investment (that is, foreign direct investment excluding Mexican investments abroad) remained low in 1Q13, at USD 1.3 billion. Over the last four quarters, the net direct investment account saw net outflows of USD 9.9 billion.

We now see the exchange-rate trading at 12 pesos to the dollar by the end of this year. For year-end 2014, our exchange-rate forecast now stands at 11.8 pesos to the dollar. Previously, we projected the exchange rate at 11.8 pesos to the dollar by the end of 2013 and at 11.5 pesos to the dollar by the end of 2014. The peso weakened sharply against the dollar in May as markets started to price in an earlier reduction of monetary stimulus in the United States. In spite of higher rates in the U.S., we still see room for an appreciation of the peso, which will likely continue to benefit from the debate over structural reforms. In addition, we note that a better outlook for the U.S. economy combined with the recent negative surprises in China will likely help the peso to outperform its peer currencies.

We no longer expect rate cuts. In fact, the central bank has communicated clearly that the key rationale for a potential rate cut would be the lax monetary policies abroad. Thus, now that the reduction of monetary stimulus in the U.S. could come sooner than expected, the board is unlikely to lower interest rates. In our previous scenario, we expected the central bank to deliver two 25-bp rate cuts during 2Q13.

Transitory Factors Keep Headline Inflation Above the Target Range

Mexico’s consumer price index showed a 0.35% decrease in the first half of May. The deflation was mostly due to seasonal factors (namely, the electricity discounts that take place in April and in May and are later reversed in October and November).

In spite of the sequential deflation, headline inflation increased on a year-over-year basis, reaching 4.72% (up from 4.58% in the second half of April). Inflation is therefore running far above the target range, but this is mostly due to base effects. Also, we note that the May CPI figure incorporates the new weightings derived from the 2010 household budget survey. Because the weighting of electricity in the CPI has been reduced, the discounts mentioned above contributed less to reducing sequential inflation than they did in 2012 and thereby boosted inflation on a year-over-year basis.

Annual core inflation remained benign, at 2.89%, below the midpoint of the target range. Within the core, goods inflation came in at 3.54% (3.53% in the previous fortnight). Inflation for core goods excluding food, alcohol and tobacco is running at 2.87% year over year, helped by exchange-rate appreciation, while inflation for core food items remains above the target range (at 4.38%). Inflation for services fell by 1 bps (to 2.34%), remaining below the midpoint of the target range.

Starting in June, inflation will probably start to converge to the target range. The base effects will be favorable and the expiration of the electricity discounts will add less to inflation than it did the previous year.

We now expect inflation to end this year at 3.5% (previously, we saw inflation at 3.3%). For 2014, our inflation forecast is unchanged at 3.5%. Slower exchange-rate appreciation than we previously expected is the main reason behind the revision.

The Government Presents the Financial Sector Reform

In May, President Enrique Peña Nieto, together with the leaders of Mexico’s major political parties, announced a bill to reform the financial sector. The government had intended to unveil the bill a few weeks earlier, but the announcement was put on hold after PRI state officials in Veracruz were accused of using public funds for electoral purposes. Political tensions eventually abated, allowing the government to move forward with the reform agenda.

The basic goal of the reform is to increase lending while reducing borrowing costs. Because credit is scarce in Mexico, there is substantial room to increase productivity by making financing more accessible. The proposed bill would strengthen bankruptcy laws (improving the process for the execution of guarantees, for example) in order to reduce uncertainty for lenders. A unified national credit bureau would also be created, in an effort to help lenders to assess better each household credit risk. At the same time, the bill would also seek to foster higher competition within the financial system by, for example, improving price transparency for users of the system and increasing “loan portability”. Regulatory agencies would also be strengthened. Finally, the bill aims to increase the participation of the development bank in lending activities.

The political divisions that have emerged within the PAN (one of Mexico’s main opposition parties) represent a new risk for the energy and tax reforms, both of which are expected to be submitted for congressional approval during the second half of this year. While the progress of the financial sector reform can be read as another sign that politicians in Mexico can find enough common ground to advance reforms, political factors could always disrupt this accord. The PAN has recently been shaken by a power struggle between the party’s chairman, Gustavo Madero, and the party’s Senate leader, Ernesto Cordero (who is also a former finance minister). The dispute has accentuated the divide between those PAN lawmakers who support the Pacto por México (the Madero camp) and those who believe that the PAN, in Cordero’s words, “can’t be a satellite of the PRI”. In response to the situation, Madero has decided to change the leadership of the party in the Senate. The support of the PAN will be a key to making the constitutional changes necessary for a meaningful energy sector reform.

João Pedro Bumachar

Forecasts: Mexico


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