MEXICO S ECONOMIC OUTLOOK

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1 Information Analytics Expertise AUGUST 2014 MEXICO S ECONOMIC OUTLOOK Rafael Amiel Director, Latin America -IHS Economics rafael.amiel@ihs.com

2 Why has growth in emerging markets slowed? Cyclical forces Withdrawal of policy stimulus Weak export markets Capital rotation as US bond yields rise Excess capacity after investment booms Structural forces Slower labor force growth Slower pace of globalization End of commodity price supercycle Lack of market reforms 51

3 Vulnerable countries depend on external financing: Current-account and fiscal balances External financing (Percent of GDP, 2013) China Russia Poland Mexico India Indonesia Brazil South Africa Turkey Current-account balance Fiscal balance 52

4 Percent of world GDP The pace of globalization has slowed World imports share of GDP

5 Economic reforms shape Mexico s outlook Mexico s economy is closely linked to the United States through trade, capital flows, and remittances, and will benefit from a pickup in US growth. Exports and fixed investment will lead Mexico s acceleration in Consumer spending growth will strengthen in response to income gains. The automotive industry is expanding as vehicles assembled in Mexico continue to gain market share in the United States. Constitutional changes will open Mexico s oil and gas industries to substantial foreign investment and eventually reverse the downward trend in oil production. President Peña Nieto s agenda also includes reforming education and labor markets, increasing competition in communications industries, and broadening the tax base. 54

6 Growth moderates after rebounding from mild recession GDP Percent Change Brazil Argentina Venezuela Chile Colombia Peru Mexico Latin America & Caribbean

7 Mexico fundamentals and risks

8 Global Outlook is Positive but Downside Risks are Plentiful Synchronized business cycle with U.S. Good contagion and bad contagion Eurozone setback China hard Landing Oil Price Rise US recovery stalls Domestic Oil dependence: running out of time New administration: will reforms happen and impact positively or same old Security and operational risks remain high 57

9 Key risks to the global economy Risk China hard landing Eurozone setback Energy price shock US recovery stalls Signposts Loan defaults by developers and local governments trigger a banking crisis and a credit squeeze. Real estate market bubbles burst. The government responds with limited fiscal stimulus. Banking problems intensify, leading to a credit crunch. Greece exits the Eurozone. Spain needs a bailout. Contagion spreads to Italy, Portugal, and France. Conflicts in the Middle East and North Africa lead to an oil supply disruption. Transportation is temporarily affected. Oil prices soar initially, until markets adapt. Russia-Ukraine conflict cuts gas supplies to Europe. Businesses and households spend more cautiously. Recoveries in housing and auto markets relapse. 58

10 Mexico: high quality policy framework increases resilience to external shocks Credible inflation targeting regime A flexible exchange rate regime External sector, the bright side of Mexico Financial system: well capitalized with relatively good asset quality and no bubbles; room for improvement in risk management Public finances: still look good but action is required Public debt: relatively low and manageable in the short and medium-term Domestic market moving up slowly, but moving up. Labor market, not too bright 59

11 The Other Dependence Mexico is far from decoupling (Percent change from a year earlier) Q3 00-Q4 02-Q1 03-Q2 04-Q3 05-Q4 07-Q1 08-Q2 09-Q3 10-Q4 12-Q1 13-Q2 14-Q3 15-Q4 U.S. Ind. Prod. Mex. GDP US Real imports 60

12 The Other Dependence: a Closer Look Mexico is far from decoupling (Percent change from a year earlier) Q3 10- Q4 11- Q1 11- Q2 11- Q3 11- Q4 12- Q1 12- Q2 12- Q3 12- Q4 13- Q1 13- Q2 13- Q3 13- Q4 14- Q1 14- Q2 14- Q3 14- Q4 15- Q1 15- Q2 15- Q3 15- Q4 U.S. Ind. Prod. Mex. GDP 61

13 Recent Developments Industry accelerating driven by automotive sector Consumer confidence not picking up PMI on expansion territory Inflation within targeted band; not a threat Government spending accelerating Oil output stable at 2.5 million barrels per day Remittances bottoming up (USD 21.5 billion in 2013) FX Reserves continue to grow; all time peak July

14 Investment constraints growth in Mexico 50 Public Investment growth percent change over previous year Q Q Q Q Q Q Q Q Q Q Q Q Q Q2 63 Public Finances National Accounts 63

15 Investment constraints growth in Mexico Investment Q Q Q Q Q Q Q Q Q Q Q Q Q1 Total Private Public 64 64

16 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Investment constraints growth in Mexico Investment 2008=100, seasonally adjusted Total Construction Machinery & equipment 65 65

17 Construction stabilizes but no signs of growth yet 41 Empresas constructoras: Valor de la producción en términos reales miles de millones de pesos de diciembre Serie desestacionalizada Tendencia-ciclo 66

18 Some light at the end of the tunnel Construction percent change year on year Total Buildings Transport

19 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Some more light at the end of the tunnel New formal jobs created (thousands) year over year Construction (left scale) Total 68

20 Mexican industry accelerating driven by manufactures Industrial Production - Seasonally Adjusted (Jan 2003=100) Apr-03 Apr-04 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 May-11 May-12 May-13 May-14 Mexico Brazil 69 69

21 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Producers Are Bullish on Mexico s S-T Outlook 58 PMI Manufacturing Headline Index Seasonally Adjusted Above 50 indicates expansion 70

22 Mexican consumers are not Consumer Confidence (January 2003= 100) Jul-07 Mar-08 Nov-08 Aug-09 Apr-10 Jan-11 Sep-11 May-12 Feb-13 Oct-13 Jul-14 Mexico USA 71

23 Low unemployment rates Unemployment Rate (Percent of Labor Force) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

24 Under these conditions, consumption cannot drive growth Consumption % change over previous year Q Q Q Q Q Q Q Q Q Q Q Q Q1 Total Private Public 73

25 2003-Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q1 as percent of GDP At 20% of GDP, investment cannot sustain a very fast pace 50% Investment 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Mexico China India Brazil 74

26 The bright side of Mexico: external accounts

27 External Accounts: The Bright Side Foreign Exchange Reserves ( Billions of U.S. Dollars) Feb-06 Jan-07 Dec-07 Nov-08 Nov-09 Oct-10 Sep-11 Aug-12 Aug-13 Jul-14 76

28 External Deficit Entirely Financed by FDI External Financing (Billions of U.S. dollars) Current account deficit FDI 77

29 Exchange Rate: Another Overshooting, Another Correction Exchange Rate (MXN Pesos per USD) Jul-14 Oct-13 Jan-13 Apr-12 Jul-11 Sep-10 Dec-09 Mar-09 Jun-08 Sep-07 Dec-06 Mar-06 Jun-05 Nominal PPP Bilateral 78

30 Exchange Rate: Volatility is the norm Recent depreciation local currency versus US dollar (30-April 2013 =100) May 3-Jun 6-Jul 8-Aug 10-Sep 13-Oct 15-Nov 18-Dec 20-Jan 22-Feb 27-Mar 29-Apr 1-Jun 4-Jul 6-Aug Colombia Brazil Mexico Chile Uruguay Peru Argentina 79

31 Manageable Fiscal Deficit; but Reforms must yield positive results Fiscal Balance (As percent of GDP) Overall Balance Excludes Pemex Investment 80

32 Public Finances Uruguay Cuba Brazil Bolivia Argentina Ecuador Nicaragua Chile Panama Peru Honduras Colombia El Salvador Paraguay Costa Rica Venezuela Dominican Republic Haiti Guatemala Mexico Central government: tax collection * *includes social security contributions. Source CEPAL

33 GDP: Income approach (Percent of Total) Compensation to workers Interest + rent + proprietors' income + corporate profits+ depreciation Indirect business taxes Mexico Brazil United States

34 Manageable debt and growth outlook

35 Total External Debt/GDP in 2012; 100% and up = Critical Region CYP NLD UK ESP USA DEU FRA BEL ISL PRT IRL ITA GRC MEX 84 84

36 Government Debt/GDP in 2012; 60% and up = Critical Region CYP NLD UK ESP DEU FRA BEL ISL PRT IRL ITA GRC USA MEX 85 85

37 Final Comments Linked business cycle with U.S. economy will continue to dominate Mexico s dynamics, bad contagion ahead Unless energy reform materializes, gloomy outlook is foreseen for the oil sector: lower oil production will hurt oil-export revenues and government fiscal accounts, Solid external position and favorable debt metrics support; exchange rate volatility is not endogenous. Peso converging to PPP equilibrium Inflation not a threat Operational and security risks remain high, but may have peaked Tougher U.S. immigration stance will continue to have a negative impact on remittances to Mexico and to worsen unemployment rates 86

38 Contact us Americas: IHS.CARE ( ); Europe, Middle East, and Africa: +44.(0) ; Asia and the Pacific Rim: ; No portion of this report may be reproduced, reused, or otherwise distributed in any form without prior written consent, with the exception of any internal client distribution as may be permitted in the license agreement between client and IHS. Content reproduced or redistributed with IHS permission must display IHS legal notices and attributions of authorship. The information contained herein is from sources considered reliable but its accuracy and completeness are not warranted, nor are the opinions and analyses which are based upon it, and to the extent permitted by law, IHS shall not be liable for any errors or omissions or any loss, damage or expense incurred by reliance on information or any statement contained herein. For more information, please contact IHS at IHS CARE (from North American locations), or +44 (0) (from outside North America). All products, company names or other marks appearing in this publication are the trademarks and property of IHS or their respective owners.

39 Mexico Underlying Production Function Trends TFP Growth accelerates above historical rates Capital Labor TFP Capital ratio rise as investment remains elevated Capital stock (% of GDP, LHS) Investment (% of GDP, RHS) Labor force adds nearly 20 million through forecast Labor Force (Millions, LHS) Participation Rate (Percent, RHS) Unemployment rate Unemployment Rate - NAIRU Unemployment Rate - Actual and WES forecast 88

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