Effects of the US Crisis in MexicoEffects of the US Crisis in Mexico

By Pedro Aspe, Sergio Sánchez and By Pedro Aspe, Sergio Sánchez and Fernando AportelaFernando AportelaOctober 14October 14thth, 2011, 2011

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ContentsContents

I.I. US Current Conditions: “The View from the Tropics”US Current Conditions: “The View from the Tropics”II.II. The Transmission MechanismThe Transmission Mechanism

1.1. Mexico’s economic cycle and its link to the US Mexico’s economic cycle and its link to the US manufacturing cyclemanufacturing cycle

2.2. Exports and Imports: Mexico is a very open economyExports and Imports: Mexico is a very open economy3.3. Labor FiguresLabor Figures4.4. Foreign Direct InvestmentForeign Direct Investment5.5. Tourism TrendsTourism Trends

III.III. Mexican Policy ResponsesMexican Policy Responses1.1. Fiscal policyFiscal policy2.2. Monetary policyMonetary policy3.3. The Taylor RuleThe Taylor Rule4.4. Mexico’s currency depreciation vs. Latin AmericaMexico’s currency depreciation vs. Latin America

IV.IV. OpportunitiesOpportunities1.1. China’s Competitiveness Trend and its ConsequencesChina’s Competitiveness Trend and its Consequences2.2. The Demographic Bonus in MexicoThe Demographic Bonus in Mexico

i.i. Migration into US is and will be “cap” by demographic Migration into US is and will be “cap” by demographic factorsfactors

ii.ii. Development of a significant domestic marketDevelopment of a significant domestic marketV.V. Final RemarksFinal RemarksAppendixAppendix

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I.I. US Current Conditions: “ The View US Current Conditions: “ The View from the Tropics”from the Tropics”

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Employment in the Recovery: a major problem

Continuing weakness of the labor market: – Unemployment rate at 9.1%.

– 8.75 million jobs lost in the recession, only 1.89 million recovered.

– 6.0 million unemployed for 27 weeks and overNonfarm jobs (monthly, percentage change since the end of recession)

Source: (percentage change since the end of recession) Bloomberg, Wall Street Journal, IMF.

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Housing Sector and Bank Lending in the Recovery: two additional problems

Source: (percentage change since the end of recession) Bloomberg, Wall Street Journal, IMF.

Home prices (quarterly) Bank lending (monthly)

Housing prices are still declining and bank lending’s growth rate is negative.

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Exports and Corporate Profits: two good news from the Recovery

Exports, goods & services (quarterly) Corporate profits (quarterly)

Source: (percentage change since the end of recession) Bloomberg, Wall Street Journal, IMF.

Corporate profits and exports are performing at least as well, as they did in several other recoveries.

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II.II. The Transmission MechanismThe Transmission Mechanism

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Mexico’s economic cycle and its link to the US manufacturing cycle Mexican manufacturing follows closely

this US sector. Nevertheless, since 2009 Mexican dynamism has been stronger.

Production is at pre-crisis level in Mexico and below in the US.

Employment in Mexico has recovered from pre-crisis levels.

Mexican exports have shown significant increases.

Source: INEGI, Federal Reserve, Bureau of Labor Statistics.

Manufacturing production index (2007=100)

Mexican Exports (2007=100)

Employment (Mexico)

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Exports and Imports: Mexico is a very open economy

Mexico is the second manufacturing exporter to the US, only after China.

80% of Mexican Exports are traded with the US.

Mexico has 21 preferential trade agreements and, except for Chile, is the most open economy in Latin America.

Mexico’s total exports account for 30% of GNP, while exports just to the US account for about 24% of GNP.

Percentage of US imports (year to date, July 2011)

Source: INEGI, Chile’s Central Bank, World Trade Organization

Mexico’s exports as % of the GNP

Percentage of US exports (year to date, July 2011)

Note: Trade data includes manufacturing exports.

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Labor Figures

Employment in Mexico has recovered since the 2008 crisis. Nevertheless, that is not the case in the US:

Unemployment rate (August 2011): 5.8% in Mexico vs. 9.1% in the US.

New jobs (Jan-Sept 2011): 600,000 (1.2% of labor force) in Mexico vs. 1.07 million (0.7% of labor force) in the US. Manufacturing employment (2007=100)

Source: INEGI,. Bureau of Labor Statistics.

Employment (2007=100)

Notes: Using Social Security Affiliates in Mexico and Non farm payroll in the US.

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Foreign Direct Investment

Foreign Direct Investment (FDI) received by Mexico increased 26% in 2010 with respect to 2009 (the worst year).

Not surprisingly, investments in manufacturing represents 57.7% of total FDI.

Source: INEGI

Foreign Direct Invesment (million USD)

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Tourism Trends

Tourism into Mexico showed a rebound in 2010. During that year, revenues from tourism were 9.2 billion.

Mexico had 12.6 million tourists in the same period.

Tourism revenues (billion USD) Number of tourists (million people)

Source: Mexico’s Central Bank, INEGI

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III.III.Mexican Policy ResponsesMexican Policy Responses

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Fiscal Policy

Fiscal deficit in 2011 is expected to be 2.2% of GDP, including Pemex’s investment (at 84.9 dollars per barrel), and 0.2% of the GDP without it. But in 2008 and 2009 Mexico had a Balanced Budget.

Government debt remains at 30% of GDP

81.3% is internal debt and only 18.7% is external.

Total sub-sovereign debt in Mexico was 2.4% of GDP in 2010.Total Public Sector Budget Balance % of

GDP

Source: OECD, International Monetary Fund.

Total Central Government Debt % of GDP

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Fiscal Policy: Balanced budget policy under historically high oil prices Since 2009, Government budget has been approved with a

deficit reaching its peak in 2011 (2.7% of GDP, according to the Ministry of Finance forecast).

When revenues have surpassed the budgeted figures, extraordinary expenditures have been applied.

Extraordinary oil revenues have represented between one and two thirds of overall extraordinary revenues. As it is well known, this does not represent a good indicator of sound public finances.

Source: Mexican Ministry of Finance.

Government Budget (MXP billion) Extraordinary entries (MXP billion)

-200

-100

0

100

200

300

400

2008 2009 2010 2011E

Extraordinary revenues

Extraordinary expenditures

Extraordinary oil revenues

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2008 2009 2010 20110.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%Revenues Expenditures

Deficit (% GDP)

E

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Fiscal Policy: Balanced budget policy under historically high oil prices In 2007, the Government enacted a new budget law that

allowed oil surpluses to be used for fiscal stabilization purposes.

Nevertheless, even if during 2010 extraordinary revenues summed up to MXP 163 billion, the balance of stabilization funds was reduced.

Under historically high oil prices, balanced budget policy seems fairly reachable, but is a biased indicator of fiscal contention.

Source: Mexican Ministry of Finance.

Mexican Mix oil prices (USDB)

0102030405060708090

100

2008 2009 2010 2011E

Price used for budget purposes

Average observed price

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Monetary Policy

Mexico has shown a consistent monetary policy. Its Central Bank became independent in 1994. The Central Bank Law laid a legal foundation with the following principal strengths: the governor was to be appointed for a fixed term, it established staggered terms of office for other board members, and it took measures to ensure that the Bank’s financial base could not be undermined.

Mexico’s monetary policy regime has undergone significant evolution in the last two decades, with the adoption of the inflation targeting (IT) scheme in the early 2000s, representing a key milestone.

It is under the IT regime, along with the support of prudent fiscal policies, that Mexico’s Central Bank has succeeded in controlling inflation in the last decade.

1Tang, M. and Yu, X., Communication of Central Bank Thinking and Inflation Dynamics, IMF working paper series, August 2011

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The Taylor Rule

In the period from January 1999 to January 20081, among the seven largest Latin American economies (Brazil, Argentina, Mexico, Chile, Colombia, Venezuela and Peru), only Mexico followed the Taylor principle, although not continuously.

Exchange rate major adjustments seem to be a relevant variable for interest rate decisions

1De Carvalho, A. and Moura, M., “What Can Taylor Rule Say About Monetary Policy in Latin America?”, 2010

Mexico’s actual and Taylor-implied policy rate

Note: *Using actual inflation; **using expected inflation.

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Mexico's currency depreciation vs. Latin America Currently, Mexico is the only country in Latin America with

sustained currency depreciation since the 2008 crisis (post-Lehman), relative to the US dollar.

Mexico has achieved a higher degree of competitiveness from the weaker peso, higher global transport costs, and lower unit labor cost differential between Mexico and other Asian countries.

Exchange Rate (Sept/15/08=1) Inflation (annual change, %)

Source: Bloomberg.

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IV.IV. OpportunitiesOpportunities

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China Competitiveness Trend and its Consequences

Manufacturers are moving away from outsourcing and are starting to embrace near sourcing.

China is loosing competitiveness– Wage and benefit rises of 15%

to 20% annually in USD in the last decade.

– Transportation costs and the continued appreciation of the yuan.

Unit labor costs (USD / Hours)Transportation costs (USD)

Monterrey to Chicago

4-5 days ground (53-ft truck container)

Shanghai to Chicago22 days marine and

ground (40-ft shipping

container)

Source: Bloomberg, Boston Consulting Group , JP Morgan, ILO, Mexican Ministry of Finance.

Exports to the US (annual growth %)

3

8

13

18

23

28

33

38

43

Jun-

10

Jul-1

0

Aug

-10

Sep-

10

Oct

-10

Nov

-10

Dec

-10

Jan-

11

Feb-

11

Mar

-11

Apr

-11

May

-11

Jun-

11

Jul-1

1

China Mexico

9.6%

0.5

1

1.5

2

2.5

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

China Mexico

238%

17%

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Fertility rate in Mexico and the demographic dividend

Mexican fertility rate is approaching advanced economies level.

Favorable dependency ratio: more people at working-age (15-64 years) than dependents.

Accumulation of savings and wealth development of a larger domestic market.Total fertility rate

Average number of children, women 15-49 years

Population data

1.60

1.70

1.80

1.90

2.00

2.10

2.20

2.30

2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Source: INEGI, CONAPO, World Bank.

Dependency ratio (% of working-age population)

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Demographic transition

Mexico will not have more than 138 million people.

Life expectancy has increased 4 years in two decades.

Infant mortality has gone down significantly.

Life expectancy (years) Infant mortality rate (per thousand)

Total Population Growth (thousands)Population data

- 400

- 200

200

400

600

800

1 000

2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Source: INEGI, CONAPO.

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Migration and Remittances

Mexico received a total of USD 21.27bn in remittances in 2010, an increase of 0.12% over the year before.

This source still represents the second largest source of foreign currency

Migration to the US will decline steadily overtime.

Less than 100,000 illegal border-crossers and visa-violators from Mexico settled in the US in 2010, down from about 525,000 annually from 2000 to 2004.

Source: INEGI

Remittances (billion USD) International migration (thousands)*

300

350

400

450

500

550

600

2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

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V.V. Final RemarksFinal Remarks

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Final Remarks

1. The ongoing Banking and Real Estate crisis in the US had made the recovery very anemic. Banks in the US have been capitalized but their negative impact on the economy will last some years. The household debt problem in the US has not been solved and its impact will affect the economy in the years to come.

2. The Mexican recovery has been led by investment and exports, backed by an expansionary fiscal deficit around 2% of GNP and a monetary policy which has followed the Taylor rule. With a low debt/GNP ratio and a small fiscal deficit Mexico’s macro picture is in good shape.

3. However, in order to sustain and enhance this recovery, Mexico will have to maintain its international competitiveness making additional reforms to enhance productivity growth in areas like Energy, Fiscal, Basic Education, Science and Technology and Labor.

4. Given the recent events in Japan, Europe and the US, Mexico has to move fast on its Reforms to be prepared for a prolonged period of Global Stagnation.

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AppendixAppendix

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Historic Oil Production

Oil Production (daily thousand barrels)

Source: PEMEX.

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Insecurity

*Source: Instituto Ciudadano de Estudios sobre la Inseguridad A.C., United Nations Office on Drugs and Crime Homicide Statistics.

Murders per 100,000 inhabitants, 2010 *

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Europe banks CDS

Credit Default Swaps 5 years

Source: Bloomberg.

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Sovereign Debt CDS

Credit Default Swaps 5 years

Source: Bloomberg.

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Risk for French Banks has risen

There are three main factors that are contributing to the vulnerability of French banks: large balance sheets with high leverage, significant liquidity needs and reduced capital rebuild prospects due to the economic slowdown.

Financial leverage (%)

Source: Bloomberg.

Note: Financial Leverage = Average Total Assets / Average Total Common Equity (first semester of 2011)