Following a series of economic crises in the 1980s, Mexico progressively abandoned its relatively closed, inward-looking economic development strategy. Periodic waves of liberalising structural reforms have underpinned its transformation from an economy once heavily dependent on crude oil exports, to one of the world’s most open, trade-orientated emerging economies. One of the most important steps in this process was the ratification of the North American Free Trade Agreement (NAFTA) in 1994. Not only did NAFTA cement Mexico’s progress towards economic openness, it also laid the foundations for further reforms in subsequent decades and deeply integrated continent-wide supply chains.
With greater economic openness, however, came additional exposure to external risk factors. Although Mexico rebounded relatively quickly from the homegrown financial crisis of 1994-95, growth was dampened in the early 2000s, following the entry of China into the World Trade Organisation, and in the late 2000s, in the wake of the global financial crisis of 2007-08. The economy bounced back, with abovetrend growth in the 2010-12 period, before slowing from 2015 onwards. This has been exacerbated by growing uncertainty stemming from US President Donald Trump’s stance on foreign trade. Some 80% of Mexican products are exported to the US, meaning that the emerging market’s economic fortunes are closely tied to those of its northern neighbour.
Reforms
Between 2013 and 2018 the government introduced a number of landmark reforms, most notably in energy and telecoms, as well as in education and tax. The energy reform opened up the sector to significant private investment for the first time in decades, while the telecoms reform increased competition, leading to a surge in investment and a fall in consumer prices (see Energy and ICT chapters).
Upon assuming office in late 2018, the administration of President Andrés Manuel López Obrador, better known by his acronym AMLO, essentially stalled implementation of an energy reform introduced by the previous government, launching a review of all hydrocarbons deals signed during that time in a bid to root out corruption. This resulted in the postponement of further licensing rounds until at least 2021, including the suspension of the fourth round of auctions for renewables. While the government has since moved forward with the implementation of an education reform that overhauls the one introduced by the previous government, there is no mention of a broad structural reform agenda in the National Development Plan 2019-24 (see analysis).
Performance
GDP growth slowed from 2.1% in 2017 to 2% in 2018. It is set to continue trending downwards in 2019, with analysts forecasting it will be the weakest year since 2013. Substantiating this prediction was an estimated 0.7% year-on-year (y-o-y) fall in GDP in the second quarter of 2019, according to the National Institute of Statistics and Geography (Instituto Nacional de Estadística e Geografía, INEGI). While private consumption as a share of GDP rose from 63.5% to 64.3% between January and June 2019, investment as a share of GDP dropped from 23.4% to 21.2% over the same period. Fiscal consolidation efforts weighed heavily on public investment, particularly those made by national oil company Petróleos Mexicanos (Pemex) during the 2015-17 period and in 2019. Private sector investment slumped from early 2018 onwards in the face of political and policy uncertainty surrounding the change in leadership. Meanwhile, Mexican exports have advanced significantly since 2017, supported by above-trend growth in the US; however, the contribution of net exports to GDP growth is limited by similarly rapid growth in Mexico’s import of semi-finished products. In 2010 some 50% of Mexican exports consists of imported intermediate goods, reflecting the development of regional supply chains post-NAFTA.
According to INEGI, in 2018 the primary sector – which consists of agriculture, forestry and fishing – accounted for 3.2% of GDP, while the secondary sector made up 29.2% and the tertiary sector 63.2%. According to the World Bank, the industrial sector’s contribution to GDP rose from 29.5% in 2016 to 31.2% in 2018, driven by a thriving manufacturing segment. In particular, the auto industry has been the most dynamic subsegment in recent years, accounting for 20.7% of manufacturing GDP and surpassing the food processing industry for the first time in 2018 (see Automotive & Aerospace chapter).
According to the IMF, Mexico was the 15th-largest economy in nominal terms out of 237 countries in 2018, with GDP of $1.2trn, and the 11th-largest by purchasing power parity. However, the country ranked 66th in GDP per capita, at $9807, reflecting its upper-middle-income status. Weak growth, which has averaged 2.3% per year since the early 1980s, has meant that the living standards of Mexicans have diverged further from those of the most advanced economies, while fast-growing emerging economies, such as China, are catching up.
The high level of income inequality remains a concern for Mexico, which posted a Gini coefficient of 48.3 in 2016 and a poverty rate of 43.6% in 2017. Nevertheless, significant progress has been made since the turn of the century, and the Gini coefficient is down from 52.6 in 2000. While much of that progress was made before the 2007-08 global financial crisis, partly on the back of successful conditional cash transfer programmes – such as Prospera, which was cancelled by AMLO – recent years have also seen an expansion in the social safety net and access to public services through initiatives such as the Popular Health Insurance Scheme (see Health chapter).
Monetary Policy
Committed to avoiding a repeat of the 1994-95 financial crisis, Mexico has focused on responsible monetary and fiscal policy management. Banco de México (Banxico), the central bank, is operationally independent and adopted an inflation-targeting regime in 1999. The Mexican peso has been allowed to float freely since late 1994, with Banxico intervening – rather than targeting a specific exchange rate – in only rare instances. Given the potential for pass-through inflation arising from currency depreciation, Banxico takes such pressures into account when setting interest rates, but again, it is inflation rather than the exchange rate that is the ultimate target. Banxico targets headline consumer price inflation of 3% with a band of +/- 1%. Although inflation has been relatively benign for much of the 21st century, it accelerated in mid-2016 amid a near 40% depreciation of the peso vis-à-vis the US dollar between 2014 and 2016. The central bank hiked interest rates pre-emptively and left them at high levels through the first half of 2019, despite inflation having falling from its 16-year high of 6.77% in December 2017 to 3.78% by July 2019. The following August Banxico initiated an easing cycle, reducing the benchmark interest rate by 25 basis points to 8%, followed by an additional reduction of 25 basis points in September 2019 to bring the benchmark rate down to 7.75%. “We expect Banxico to cut the benchmark rate by 100 basis points in 2020 to end the year at 6.75% before reducing it by 75 basis points in 2021 to 6%,” Félix Boni, director of analysis at HR Ratings, a credit ratings agency based in Mexico, told OBG. “These cuts imply falling inflation rates and declines in real terms for the benchmark rate.”
Fiscal Policy
Mexico’s fiscal policy is anchored by the Fiscal Responsibility Law (FRL), introduced in 2006 and amended in 2008 and 2013. The FRL stipulates that the budget – excluding strategic investment – must be balanced in ordinary times. When strategic investment is taken into account, this essentially allows for a maximum general government deficit of 2% of GDP. As GDP growth slipped to 1.4% in 2013, the government cited extraordinary circumstances to activate the FRL escape clause; previously it had only ever done so in response to the global financial crisis, in the 2009 budget. Thus, the budget deficit was required to be eliminated by 2018. Facilitated by one-off contributions from the central bank, the government achieved its fiscal consolidation target in 2017, a year ahead of schedule.
In December 2018 the administration introduced its budget for 2019, reaffirming its commitment to fiscal discipline and introducing a range of austerity measures to reduce the cost of state operations. As a result of slowing economic activity throughout the first half of 2019, in addition to fiscal support required by Pemex, the government announced further austerity measures. In July 2019 the administration signalled that it would draw support from the Mexico Oil Revenues Stabilisation Fund to bridge shortfalls in tax and oil income to ensure the endof-year fiscal target is met. That same month the authorities also announced a range of stimulus measures, amounting to $25bn, or 2% of GDP, aimed notably at accelerating tendering for infrastructure projects and boosting the lending targets of development banks. In September 2019 the government released a blueprint for the 2020 budget, which forecasts a primary fiscal surplus of 0.7% of GDP, down from the preliminary estimate of 1.3%, and GDP growth of between 1.5% and 2.5%.
The latest data available from the World Bank showed that net government lending and borrowing equalled -0.9% of GDP in 2017, while total government revenue (excluding grants) stood at 20% and total government expenditure at 20.4%. Two rounds of fiscal stimulus over the past decade have seen a run-up in the government’s net debt burden, from 28.8% of GDP in 2007 to 45.4% of GDP in 2018. Fiscal consolidation efforts were sufficient to put the debt burden on a gently declining path from 2016. Should the government remain committed to its conservative fiscal approach, and economic growth picks up again in the coming years, the debt burden should at the very least remain stable.
“Given the regime currently governing Mexico’s fiscal policy and barring a major devaluation of the peso, a significant increase in the debt-to-GDP ratio is unlikely,” Boni told OBG. “This effectively calls for the budget deficit to be no more than 2% of GDP – including investment spending of up to 2% of GDP.”
Financial Shielding
Mexico’s external financing needs, as measured by its current account, are relatively modest, at -1.8% of GDP in 2018, and covered almost in their entirety by net foreign direct investment (FDI) inflows. Given the openness of the economy, liquidity of its currency and the extent of foreign holdings of Mexican assets, the country is vulnerable to swift changes in market risk. Against a background of weak economic growth and emerging budget pressures, concerns have grown over the first three quarters of 2019 that Mexico could lose its investment-grade rating in the near future. If a market consensus was to develop that such a move was imminent, this could spur capital outflows.
In recent years the authorities have maintained relatively conservative fiscal and monetary policies, which have helped to attract continued capital inflows. International reserves held by the central bank amounted to $180.4bn in August 2019, enough to cover 4.3 months of imports and equivalent to 110% of short-term debt. In addition, the country benefits from a $74bn flexible credit line arrangement with the IMF. This two-year facility has been renewed on each occasion since its launch in March 2009, with the administration of AMLO signalling the desire for a further renewal once the current arrangement expires in November 2019.
Trade Balance
Together, Mexican exports and imports accounted for 80.3% of GDP in 2018, reflecting its status as one of the most open, trade-dependent emerging markets in the world. The size and proximity of the US has meant it has long been the destination for the bulk of Mexican exports, a trend reinforced by the signing of NAFTA. In 2018 the US alone accounted for nearly four-fifths of Mexican exports, but less than half of its imports.
Many US corporations have developed continent-wide supply chains, moving important parts of their production capacity to Mexico to take advantage of the lower wage costs there. At first, this consisted primarily of low-value-added light manufacturing operations in border areas. Gradually, however, supply chains have become more sophisticated, and higher-value-added manufacturing clusters have evolved in the north and centre of Mexico, notably in the automotive and aerospace industries.
In the automotive industry, for example, some vehicle parts may cross the border seven or eight times before finally being sold. Mexican exports have a high – albeit falling – import intensity, meaning that relatively little value is often added to imported goods before they are re-exported.
In aggregate, Mexico recorded a relatively narrow trade deficit of $13.6bn, or 1.1% of GDP, in 2018. While the trade balance in non-petroleum goods has improved in recent years, from $7.3bn in 2017 to $9.5bn in 2018, this has been offset by a growing trade deficit in petroleum products, which rose from $18.3bn in 2017 to $23.2bn in 2018. Although Mexico remains a net exporter of crude oil, it is a sizeable importer of natural gas, petroleum and other refined products. The authorities have been trying to move the country away from its dependence on the US as an export market and its reliance on imports of refined products. Since coming into office, the administration of AMLO has prioritised the development of domestic refining capacity, and in July 2019 construction commenced on the $8bn refinery at Dos Bocas in the south-eastern state of Tabasco.
Mexico boasts the widest network of free trade agreements in the world, covering 44 countries. In further pursuit of diversifying its export markets, Mexico agreed to an updated free trade agreement with the EU in April 2018, and entered into the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) with 10 other Pacific-Rim countries the following June. Since its longest land border is shared with the US, however, sustained investment in transport infrastructure will be crucial to underpin the diversification of export markets. To this end, the government is investing in major train projects in the south, as well as $5.2bn in its ports, including a planned expansion of the Port of Veracruz and the Port of Manzanillo.
While the US remains of prime importance to Mexico, the foreign trade policies of the administration of US President Donald Trump has put a strain on the bilateral relationship. In June 2018 the US introduced a 25% tariff on steel and a 10% tariff on aluminium, which were subsequently lifted for Canada and Mexico in May 2019. In late 2018 the US president threatened to withdraw from NAFTA as a tactic to renegotiate the agreement on terms perceived to be more favourable to US interests. This was followed by the introduction of a 25% tariff on all automotive imports in 2019. While this threat is still operative at the global level, it is understood that the successful renegotiation of NAFTA in late 2018 should see Mexico escape any such tariff. Concerns remain, however, as US President Trump threatened to impose a blanket 5% tariff on all Mexican imports from June 10, 2019 if Mexico has not taken sufficient action to stem the flow of illegal immigrants crossing the US-Mexico border. These tariffs were to be progressively ratcheted up to 25% in five-percentage-point increments on the first of each of the four following months in the absence of sufficient progress; however, the tariffs were suspended the Friday before they were set to come into force.
Following bouts of US brinkmanship, the successful renegotiation of NAFTA will see it replaced by the new US-Mexico-Canada Agreement (USMCA). Ironically, many of the new elements of the USMCA were versions of those agreed to by Mexico and Canada as part of the CPTPP negotiations, from which US President Trump exited upon assuming office in January 2017. The major bespoke elements relate to stronger protections for workers and the environment, as well as new content requirements in the automotive industry. While the USMCA was ratified by Mexico in June 2019, as of end-September that year there remained doubts as to whether the two other countries would sign ahead of Canada’s federal election in October 2019 and US presidential elections in November 2020.
China
Unlike many of Latin America’s commodity exporters, Mexico’s economic links with China are relatively underdeveloped. In 2018 China received about 1.6% of Mexican exports, while it accounted for nearly 18% of Mexican imports. Although Mexico has a wide network of free trade agreements, it will likely be precluded from concluding one with China if and when the USMCA is operative due to a clause stipulating that other signatories can quit the agreement within six months should the signatory conclude a free trade agreement with a “non-market economy”, widely understood to mean China.
An important reason why economic links between Mexico and China have not developed is that they are in direct competition for the US market as manufacturing exporters. When China entered the World Trade Organisation in 2001, Mexican exporters suffered due to the wage competitiveness of Chinese workers. Since then average wages in China have overtaken those in Mexico, as the former moves further up the value chain. In addition to Mexico’s proximity to the US market, zero tariffs under NAFTA was considered a crucial advantage. However, the uncertainties around US trade policy vis-à-vis both China and Mexico that have arisen in the first three quarters of 2019 are likely to discourage producers from making long-term investment in supply chains.
Investment
According to the IMF, investment as a share of GDP fell from 24.11% in 2008 to 23.00% in 2018, with a further drop to 22.96% expected in 2019. Fiscal constraints and weak tax collection limit the government’s scope to boost public investment, while continued uncertainty around the government’s sector policies – notably energy – is discouraging both domestic and foreign private investment. Persistent structural challenges such as the weak rule of law and security risks also hamper investment.
In the World Bank’s “Doing Business 2019” report, Mexico fell five places from the previous year to rank 54th out of 190 countries. While the country was positioned as high as 8th in terms of accessing credit, it dropped to as low as 103rd for registering property and 116th for paying taxes. According to the Transparency International’s Corruption Perceptions Index 2018, Mexico ranked 138th out of 180 countries, falling from 90th in 2014.
Increased economic openness has facilitated and attracted increased FDI inflows, particularly as corporations optimise their supply chains in order to benefit from Mexico’s relatively lower-value-added production and competitive wages. FDI flows in recent years have thus been dominated by manufacturing, notably in the automotive segment, although the energy and telecommunications reforms have also begun to attract investment. According to the UN Conference on Trade and Development, gross FDI inflows to Mexico amounted to some $31.6bn in 2018, bringing the accumulated stock of FDI to 39.7% of GDP, down from its 2016 peak of 43.9%.
As in many other policy areas, the current administration is taking a different approach than its predecessor to geographic investment promotion. In April 2019 the president announced the cancellation of special economic zones, of which seven were launched in the south of the country under the previous administration. Rather, the current administration has targeted fiscal incentives in the northern frontier region; that is, all municipalities bordering the US. Effective January 1, 2019, the corporate income tax rate in these areas was reduced from 30% to 20%, while value-added tax rate was halved from 16% to 8%. Individual taxpayers who generate at least 90% of their income within the designated northern frontier zone can also benefit from reduced income tax rates.
Labour Market
Despite the economic slowdown of recent years, the labour market has remained relatively robust. Due in part to a rather weak social safety net, the unemployment rate has recorded near historic lows of below 4% since mid-2016. While the aggregate participation rate is relatively unchanged, standing at around 60% for some years, this masks a gently declining male participation rate, which stood at 77.2% in June 2019, and a steadily increasing female rate, which reached a record high of 45.5% in June 2019. Perhaps the defining characteristic of the Mexican labour market, however, is the high level of informality, which registered 56.4% in June 2019. Although more than 4m formal jobs were created during the 2013-18 period, during which time the labour informality rate fell from 60.3% to 56.8%, progress has stalled more recently. One reason for this is because many employers themselves are operating in the informal sector, unregistered for the purposes of tax and social security. Another reason is that social contributions weigh heavily on low-income earners, representing a disincentive to register as formal employees. Rather than moving between employment and unemployment, it is more common for workers to move between formal and informal employment or self-employment, depending on the business cycle and labour market tightness.
Wages & Labour Reform
As inflation subsided somewhat during 2018 and nominal wage growth remained robust in a relatively tight labour market, real wage growth accelerated, reversing some of the decline recorded in the 2016-17 period, when inflation outpaced nominal wage growth. This trend persisted through the first half of 2019, with real wages increasing by 2.3% y-o-y in the second quarter. Nominal wage growth has been supported by significant increases in the statutory minimum wage, which was raised from MXN73.04 ($3.78) per day in 2016 to MXN102.68 ($5.31) per day in 2019, while the minimum wage in municipalities bordering the US was increased to MXN176.72 ($9.14) per day.
Although Mexico has a long tradition of unionism, trade unions were essentially co-opted into the apparatus of the then-governing Institutional Revolutionary Party, which held office without interruption for 71 years until 2000. The National Union of Education Workers, for example, was established in 1949 and is the largest teachers union in the Americas. With the impetus of labour rights to be guaranteed under the impending USMCA, and as a pre-requisite for its ratification, Mexico introduced a landmark labour reform on May 1, 2019. For the first time, workers have the legal right to bargain collectively with employers through independent unions and to elect their union representatives by secret ballot.
Outlook
Analysts are expecting 2019 to be the fourth successive year of economic deceleration, with the IMF forecasting growth will fall to 1.6% in 2019 before accelerating modestly to hover between 2% and 3% over the medium term. Some risks to growth include the continued slowdown of the US economy, to which Mexico’s fortunes are closely tied, and the rising uncertainty generated by ongoing regional and global trade tensions. This suggests that living standards will continue to stagnate in the years ahead, and Mexico is expected to make limited progress in the reduction of poverty and inequality. Trade tensions between the US and China could prove a double-edged sword for Mexico: slower growth in the US will dampen demand for Mexican exports, but the persistence of tariffs on Chinese exports to the US could improve the price competitiveness of Mexico’s exports – particularly if the USMCA is ratified – providing a degree of certainty around North American trade relationships.
Given the government’s commitment to maintain a conservative fiscal and monetary policy, and to keep private sector debt levels low, in addition to the substantial financial support provided by the IMF and central bank reserves, a full-blown financial or economic crisis is unlikely. While the outlook for Mexico’s economy is modest, the authorities’ prioritisation of infrastructure projects and fiscal incentives in the northern regions means that trade and industry are likely to prove fruitful for domestic and foreign investors alike, helping to sustain higher economic growth rates and accelerated improvements in the living standards of Mexicans in the longer term.
Read More from OBG
