By Peter G Hall, Vice-President and Chief Economist
Last week’s sunny weather in Mexico stood in stark contrast to the storm clouds that have billowed over the world economy in the opening days of 2016. Emerging markets have been particularly hard hit by stock market volatility, plunging prices for key commodities and currency turbulence, casting a pall of uncertainty on the fledgling global recovery. Doomsayers are having a field day, with some predicting a 2008-style crash. Did the balmy climes I experienced in my annual Mexican tour belie an economy in turmoil, or is it weathering the turbulence well?
Any oil producing nation should be worried. With prices down 70 per cent in the past 18 months, oil revenues have plummeted in Mexico. All things being equal, the price hit alone was estimated to cost Mexico $14 billion, but declining production cost an additional $4 billion. Consequently, the trade balance for goods has deteriorated significantly over the past year, throwing the new peso into turmoil. Last Thursday it hit its lowest level ever at 18.73 to the USD. Stock markets aren’t looking great either, down 10 per cent in just two months. Not exactly inspiring.
With indicators this volatile, analysts pay rapt attention to capital movements. Mexico has been a bit of an emerging market darling, attracting large portfolio inflows in the 2012-14 period. However, the shine was off come mid-2014, and current inflows are very weak. Mexico ranked surprisingly high on our Country Vulnerability Index, almost entirely because of three-year average portfolio investment liabilities. Continued weakness on this front could drive the currency even lower.
However, the news is not all bad. Far from it, actually. Scan Mexico’s GDP data, and you’ll find a consumer that’s anything but gloomy. In the past three quarters, real growth has averaged 3.2 per cent, and retail sales show little sign of abating. Private construction investment gained significant momentum through year-end, growing smartly in 6 of the past 7 quarters. Similarly, recent investment in machinery and equipment is up at a double-digit pace compared with year-ago levels. Manufacturing activity is adding to growth, and as a gauge of overall economic health, electricity output is rising at a 5 per cent pace in addition to being a good deal cheaper, thanks to reforms. Oil may be hitting exports hard, but the remaining 89 per cent of exports are more than compensating, lifting total exports through November, 2015 by 4.5 per cent. Doubtless, the low peso will boost exports in 2016 across the board.
While this performance may not be enough to attract the hot money, direct investment is still flowing in. The auto sector alone is pulling in billions, with significant projects by Kia, BMW, Audi and Toyota at various stages of completion. In several discussions last week, foreign investors across industry sectors expressed keenness toward their current investment plans. In all cases, they were experiencing very strong production growth and planning to expand their Mexican footprints. Sure, they were concerned about market mayhem, but it didn’t seem to be deterring their 2016 business plans.
As for possible portfolio investment volatility, Mexico has strong institutional credentials to show. Although oil revenues are a key part of the federal fiscal plan, they are declining as a share of overall revenues. Moreover, Mexico has been shielded from the price rout’s worst effects by a long-standing hedging program, which will ensure a price floor of about $50 US per barrel this year. Add to that the country’s impressive debt-to-GDP ratio of 45 per cent, and in a relative sense, things are looking good. Then there’s monetary policy, which has effectively managed inflation in recent years, and remains on the watch for early signs that the weak peso might push local prices upward.
In my 3-city visit to Monterrey, Queretaro and Mexico City last week, optimism was obvious. Mexico is well aware of the effects that rapid rate rises stateside can have on its economy. Even so, businesses seem set to move forward, and international investors of all stripes seem to be giving the country good marks.
The bottom line? In a world where volatility is clouding opportunity, Mexico’s near-term outlook seems sunnier. Canadians active in the market likely know this first-hand. Those with potential to do business there should take note.
This commentary is presented for informational purposes only. It is not intended to be a comprehensive or detailed statement and no representations or warranties, express or implied, are made as to its accuracy, timeliness or completeness.