Itaú BBA - A Bumpy Recovery

Scenario Review - Mexico

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A Bumpy Recovery

Fevereiro 10, 2014

Activity indicators available for 4Q13 show that the recovery seen in the previous quarter was short-lived.

•           Mexico’s economy weakened in 4Q13. We reduced our growth forecast for this year to 3.3% (from 3.6% in our previous scenario). For 2015, we see a 3.8% expansion.

•           Inflation spiked in January due to tax hikes. Core inflation continues to be limited. We see inflation at 3.7% by the end of this year and at 3.2% in 2015.

•           Global market volatility increased, so the peso weakened against the dollar. However, the Mexican peso is outperforming other currencies of the region. Considering the better prospects for FDI (due to structural reforms) and the exposure of the economy to the U.S., the peso will likely continue to outperform. We see the peso at 12.8 to the dollar by the end of this year and by the end of 2015.

•           The central bank left the policy rate unchanged in January, as widely expected. In the press statement, the board said that the balance of risks for inflation worsened, but members didn’t introduce a tightening bias. We see rate hikes only in 2015.

The Economy Slows During 4Q13

Activity indicators available for 4Q13 show that the recovery seen in the previous quarter was short-lived. The IGAE (monthly proxy for GDP) fell 0.04% year over year in November, surprising expectations on the downside. Sequentially, the index slowed to 0.8% qoq/saar (from 1.3% in October and 2.8% in September), in spite of a 0.39% gain between October and November.

External demand weakened during the last quarter of 2013, in spite of the solid U.S. data in that quarter. Manufacturing exports fell 2.2% from November to December, contracting 1% qoq/saar, after a 9.5% increase in 3Q13. Auto exports were down by 12% qoq/saar, while non-auto exports slowed to 4.5% qoq/saar (8.7% in 3Q13). 

The most recent consumption-related data was mixed. Retail sales improved markedly in November, but it is unclear how important the “el buen fin” (the Mexican version of “Black Friday”) was for the number. From October to November, retail sales were up 3.0%, following a 0.7% increase. On the other hand, in January, consumer confidence retreated 6.2% from the previous month, reaching its lowest level since early 2010, when Mexico was getting out of the recession. Imports of consumer goods (excluding fuels) fell by 0.5% from November to December (-9.9% qoq/saar) and domestic vehicle sales also weakened in the same month. While it is true that the labor market improved during the last quarter of the year (according to our own seasonal adjustment, formal employment increased by 3.4% qoq/saar, lifting the real wage bill by 3.8% qoq/saar), the tax hikes introduced this year will likely reduce the real disposable income of households (in fact, we read the drop in confidence in January as a consequence of extra taxes.) In addition, we can’t rule out that the higher formal employment growth reflects a “formalization effect” induced by the labor reform, as opposed to an actual expansion of aggregated employment.

On the investment side, there are signs of an incipient recovery. Gross fixed-capital formation declined by 0.4% month over month in October (the sixth consecutive decline). However, imports of capital goods gained 2.8% from November to December (5.7% qoq/saar). Construction activity was up 1.8% month over month in November. While the trend in construction is still weak, public capital expenditures (up by 50.7% year over year in nominal terms during 4Q13) will likely help to improve it.

We reduced our growth forecast for this year to 3.3% (from 3.6%). For 2015, our 3.8% forecast is unchanged. Mexico’s economy is taking longer to recover than we previously expected. Still, we are confident that the decoupling between Mexico’s exports and the U.S. industry will not last long. Thus we expect a rebound of the activity in the near term. Apart from higher U.S. growth, the economy will benefit from a more-expansionary fiscal policy and housing investment is unlikely to be as weak as it was last year. In 2015, the first meaningful impacts of the reform agenda will add to the above-trend U.S. growth.

A Temporarily High Inflation

The tax increases linked to the fiscal package approved last year raised headline inflation markedly in January. Higher taxes added to the increased prices for non-core items. On a year-over-year basis, inflation reached 4.48% (from 3.97% in December), above the upper bound of the target range (2%-4%). The increase was led by higher non-core inflation (8.58% from 7.84% previously).

However, even after the tax hikes, core inflation is only somewhat above the center of the target. In the January, core inflation reached 3.21% (from 2.78% in December). Inflation for core goods increased from 1.89% to 2.93% but continued below 3%. Core service inflation reached 3.47% (from 3.54%), but we note that the high figure will not last much longer, as it is due to unfavorable base effects.  

We expect inflation to end this year at 3.7%. In 2015, inflation will likely fall to 3.2%. We expect non-core inflation to fall, while core inflation continues to be limited. Next year, a favorable base effect associated with the tax hikes this year will help to bring inflation closer to the target center.   

The Peso Weakens Against the Dollar, but by Less Than the Other Currencies of the Region

The trade balance posted a strong USD 12.2 billion (seasonally adjusted and annualized) surplus during the last quarter of 2013, up from USD 4.2 billion the previous quarter. The improvement came mostly from the non-oil balance, which rose from a USD 5.3 billion deficit in 3Q13 to a USD 1.0 billion surplus, as weak internal demand more than offset the export slowdown. As a result, in 2013 the trade deficit was USD 1.0 billion (from a USD 0.1 billion deficit in 2012). This is the second-best trade balance result since 1996.     

The Mexican peso depreciated as global market volatility increased, but it is performing better than most currencies in the region. As Mexico is the emerging economy that benefits the most from higher U.S. growth, and the structural reforms raise the FDI prospects for the country, the Mexican peso will likely continue to outperform. We see the peso at 12.8 to the dollar by the end of this year and by the end of 2015.  

A Worse Balance of Risks for Inflation, but No Tightening Bias

As widely expected, Mexico’s central bank left the policy rate unchanged, at 3.5%, in its first rate decision of the year. The press statement brought a tone of more concern over inflation, but it did not introduce a tightening bias. In the press statement, the central bank did not sound alarmed over growth in spite of the weak activity readings seen recently. In addition, the board highlighted that the balance of risks for inflation has deteriorated, due to potentially higher global market volatility and possible second-round effects from the recent increase in headline inflation.

In the board’s view, Mexico’s economy continues to recover gradually, lifted by external demand and some recovery in private consumption and public expenditures. The board now sees a better balance of risks for activity: in the short term, the U.S. will help, while in the medium term, the structural reforms will benefit both demand and potential growth.  

The board linked the increase in inflation seen at the end of 2013 to higher non-core prices (regulated and non-processed food items) and to the tax hikes in the first half of January.  The board stressed that the increase in January was in line with the central bank’s forecasts, so there is no sign of second-round effects at this point. In its view, inflation will likely stay above 4% during the first months of the year but should go back to the target range afterwards. In 2015, inflation is expected to fall significantly, to the center of the target, as the transitory “shocks” that are now lifting inflation fade.

In the concluding remarks of the statement, the central bank pledged to carefully monitor the domestic economy, the potential second-round effects of the increase in headline inflation and the monetary policy stance of Mexico vis-à-vis the U.S., just as in the previous few decisions.  

We expect Mexico’s central bank to raise rates only in 2015 (together with the Fed), even though we are expecting a significant rebound of the economy this year. In our view, there is enough slack in the economy to absorb higher growth without leading to demand-side inflationary pressures. In addition, Mexico has dealt with many inflationary supply shocks without having to raise rates to avoid second-round effects, and we do not think that this time will be different. Finally, as market volatility retreats, Mexico’s central bank will become more comfortable with the inflation outlook.

João Pedro Bumachar


Forecasts: Mexico


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