Mexico: Economic integration, challenges and outlook Manuel Sánchez United States‐Mexico Chamber of Commerce, Los Angeles August 5, 2016 Contents 1 Economic integration with the U.S. 2 Growth and financial developments 3 Monetary policy and inflation Mexico: Economic integration, challenges and outlook 2 Mexico is increasingly integrated with the United States1 Highly dynamic bilateral exports and imports Significant FDI and technology transfers Substantial remittances Benefits on both sides of the border Business and job creation Wider and better consumer choices Higher living standards 1/ For a discussion of the U.S.‐Mexico economic relationship, see Villarreal, M.A. (2015). U.S.‐Mexico Economic Relations: Trends, Issues, and Implications. Washington, DC: Congressional Research Service, pp. 1‐9 Mexico: Economic integration, challenges and outlook 3 California and Mexico have long been important trade partners California and Mexico: Merchandise trade Billions of dollars 50 45.1 Exports from Mexico to California 40 Exports from California to Mexico 30 26.8 20 2015 2014 2013 2012 2011 2010 2009 2008 10 Source: U.S. Department of Commerce Mexico: Economic integration, challenges and outlook 4 Perhaps there is no better indicator of binational economic ties than industrial integration The United States and Mexico: Industrial and manufacturing production YoY % change, s.a. 20 10 0 ‐0.6 ‐1.2 ‐10 U.S. industry Mexico's manufacturing 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 ‐20 * s.a. / Seasonally adjusted */ Data until 2Q16, with Mexican manufacturing in that period based on the April‐May average Source: INEGI and the U.S. Federal Reserve Mexico: Economic integration, challenges and outlook 5 Structural reforms undertaken by Mexico have opened up broad mutual opportunities1 Hiring and firing flexibility should benefit labor productivity Wider and cheaper access to telecoms services is already resulting from the entrance of new players The unprecedented opening of the energy sector to private investment will yield lower key input prices An enhanced rule of law, better public security, and improved physical infrastructure could further leverage the positives 1/ For an online progress report of Mexico’s structural reforms, see Presidencia de la República, Reformas en Acción, http://reformas.gob.mx/ Mexico: Economic integration, challenges and outlook 6 Since 2014, Mexico has grown at close to historically average rates, with a dip in 2Q16 Mexico: GDP %, s.a. 6 Quarterly annualized change Annual change 4 2 1.4 0 ‐1.2 ‐2 ‐4 Q1 Q2 Q3 Q4 Q1 Q2 2012 2013 s.a. / Seasonally adjusted */ Preliminary estimate Source: INEGI Q3 Q4 Q1 Q2 2014 Q3 Q4 Q1 Q2 2015 Mexico: Economic integration, challenges and outlook Q3 Q4 Q1 Q2* 2016 7 In the past two and a half years, an expanding services sector has been offset by slowing industrial production Mexico: GDP Annual % change, s.a. 6 Industry Services 4 2.4 2 0 ‐0.5 ‐2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2012 2013 s.a. / Seasonally adjusted */ Based on April‐May IGAE average Source: INEGI Q4 Q1 Q2 2014 Q3 Q4 Q1 Q2 2015 Mexico: Economic integration, challenges and outlook Q3 Q4 Q1 Q2* 2016 8 Softer Mexican industry has been affected by two shocks: a contraction in oil extraction ... Mexico: Mining and oil production Annual % change, s.a. 4 0 ‐2.2 ‐4 ‐3.9 ‐8 Mining Oil production ‐12 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2012 2013 2014 s.a. / Seasonally adjusted */ Mining production is based on April‐May IGAE Source: INEGI Q3 Q4 Q1 Q2 2015 Mexico: Economic integration, challenges and outlook Q3 Q4 Q1 Q2* 2016 9 and decelerating U.S. industrial production The United States and Mexico: Industrial and manufacturing production YoY % change, s.a. 6 4 2 0 Mexico's manufacturing ‐0.6 U.S. industry ‐1.2 ‐2 Q1 Q2 2012 Q3 Q4 Q1 Q2 2013 Q3 Q4 Q1 Q2 2014 Q3 Q4 Q1 Q2 2015 Q3 Q4 Q1 Q2* 2016 s.a. / Seasonally adjusted */ Mexican manufacturing is based on the April‐May average Source: INEGI and the U.S. Federal Reserve Mexico: Economic integration, challenges and outlook 10 Consistent with this picture, manufacturing exports to the U.S. have fallen Mexico: U.S. dollar value of manufacturing exports Annual % change, s.a. 20 15 10 5 0 ‐2.3 ‐5 To the U.S. ‐6.5 To the rest of the world ‐10 ‐15 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2012 2013 2014 2015 2016 s.a. / Seasonally adjusted. Source: Banco de México with data from the Ministry of Finance (SAT), Ministry of Economy (SE), Banco de México, INEGI. Merchandise Trade Balance. SNIEG. Information of National Interest Mexico: Economic integration, challenges and outlook 11 Mexican exports to the U.S. respond more to manufacturing output there than to the bilateral real exchange rate… The United States and Mexico: U.S. manufacturing output and bilateral RER Annual % change, s.a. 30 U.S. manufacturing output Pesos per dollar 20 16.2 10 0.1 0 ‐10 ‐20 Q1 Q2 2012 Q3 Q4 Q1 Q2 2013 Q3 Q4 Q1 Q2 2014 Q3 Q4 Q1 Q2 2015 Q3 Q4 Q1 Q2 2016 s.a. / Seasonally adjusted Source: Banco de México Mexico: Economic integration, challenges and outlook 12 although peso competitiveness may have contributed to a higher proportion of Mexican exports in the U.S. market Mexico: Nonoil exports % of U.S. nonoil imports, s.a. 35 30 29.8 25 25.3 Total 20 Nonautomotive Automotive 15 10 13.6 12.4 10.3 10.1 5 Q1 Q2 2012 Q3 Q4 Q1 Q2 2013 Q3 Q4 Q1 Q2 2014 Q3 Q4 Q1 Q2 2015 Q3 Q4 Q1 Q2 2016 s.a. / Seasonally adjusted Source: Own calculations with data from the United States Department of Commerce Mexico: Economic integration, challenges and outlook 13 Private consumption has been a driver of recent economic expansion Mexico: Private consumption Annual % change, s.a. 6 4 2 1.8 0 Q1 Q2 Q3 Q4 Q1 Q2 2012 2013 s.a. / Seasonally adjusted */ Based on April‐May data Source: INEGI Q3 Q4 Q1 Q2 2014 Q3 Q4 Q1 Q2 2015 Mexico: Economic integration, challenges and outlook Q3 Q4 Q1 Q2* 2016 14 This performance coincides with better labor market indicators Mexico: Unemployment and labor force participation % of EAP and % of population, s.a.1 5.5 65.0 Unemployment rate Labor force participation 5.0 62.5 4.5 59.5 4.0 60.0 57.5 3.95 3.5 55.0 Q1 Q2 2012 Q3 Q4 Q1 Q2 2013 Q3 Q4 Q1 Q2 2014 Q3 Q4 Q1 Q2 2015 Q3 Q4 Q1 Q2 2016 1/ EAP = Economically active population. Measures based on 15‐year‐old and older population s.a. / Seasonally adjusted. Source: INEGI Mexico: Economic integration, challenges and outlook 15 … as well as an upturn in remittances and consumer lending Mexico: Remittances and consumer lending Annual % change, s.a. 20 Remittances Consumer lending 15 10.4 10 8.9 5 0 ‐5 ‐10 ‐15 Q1 Q2 2012 Q3 Q4 Q1 Q2 2013 Q3 Q4 Q1 Q2 2014 Q3 Q4 Q1 Q2 2015 Q3 Q4 Q1 Q2 2016 s.a. / Seasonally adjusted Source: Banco de México Mexico: Economic integration, challenges and outlook 16 In contrast, investment has stumbled Mexico: Investment and capital imports Annual % change, s.a. 15 Gross fixed investment Capital goods imports 10 5 0 ‐1.0 ‐5 ‐7.3 ‐10 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2* 2012 2013 2014 2015 2016 s.a. / Seasonally adjusted. */ Gross fixed investment is based on April‐May average Source: INEGI and Ministry of Finance (SAT), Ministry of Economy (SE), Banco de México, INEGI. Merchandise Trade Balance. SNIEG. Information of National Interest Mexico: Economic integration, challenges and outlook 17 Forward‐looking indicators of economic activity have deteriorated Mexico: Purchasing Managers’ Indexes1 56 Manufacturing Nonmanufacturing 54 52 51.3 50 49.5 48 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3* 2012 2013 2014 2015 2016 1/ Adjusted by company size */ Only July Source: IMEF Mexico: Economic integration, challenges and outlook 18 Along with the U.S., Mexico is expected to experience a transitory deceleration in 2016 The United States and Mexico: GDP forecasts Annual % change, average 20151 2016 2017 The United States 2.4 1.9 2.2 Mexico 2.5 2.3 2.6 1/ Observed Source: Consensus Forecasts and Latin American Consensus Forecasts, July 2016 Mexico: Economic integration, challenges and outlook 19 Mexico’s short‐term growth scenario faces risks A greater slowdown in U.S. imports and industrial production Deterioration in consumer and producer confidence A larger‐than‐expected fall in crude oil output Potentially greater financial volatility, yielding restrictions on financing possibilities To the upside, recent structural reforms could begin to yield more benefits Mexico: Economic integration, challenges and outlook 20 In 2016, the Mexican peso has depreciated more than other EME currencies Dollar in peso terms vs. dollar in terms of a basket of EME currencies1 January 1, 2015 = 1, 30‐day moving average 1.2 1.13 1.1 1.0 Jan‐14 Feb‐14 Mar‐14 Apr‐14 May‐14 Jun‐14 Jul‐14 Aug‐14 Sep‐14 Oct‐14 Nov‐14 Dec‐14 Jan‐15 Feb‐15 Mar‐15 Apr‐15 May‐15 Jun‐15 Jul‐15 Aug‐15 Sep‐15 Oct‐15 Nov‐15 Dec‐15 Jan‐16 Feb‐16 Mar‐16 Apr‐16 May‐16 Jun‐16 Jul‐16 Aug‐16 0.9 * 1/ Basket based on JP Morgan Index of emerging‐market currencies, which includes Brazil, Chile, Mexico, Hungary, South Africa, Turkey, Russia, China, India and Singapore */ To August 1. Source: Banco de México with data from Bloomberg Mexico: Economic integration, challenges and outlook 21 Exacerbated peso depreciation may stem from several factors The role of the Mexican peso as an international hedge mechanism1 A weakened fiscal position Longstanding rising trend of the historic balance of public‐sector borrowing requirements over GDP Drastic reduction of Pemex net oil export revenues Geopolitical jitters 1/ See BIS (2014). “Triennial Central Bank Survey of foreign exchange and derivatives market activity in 2013,” detailed tables Mexico: Economic integration, challenges and outlook 22 A stronger fiscal stance is necessary given increasing public debt Mexico: Public debt1 % of GDP 50 46.9 45.7 45 41.4 40 38.6 34.3 34.4 34.9 2011 35 2010 36.4 32.9 30 *2016 2015 2014 2013 2012 2009 2008 25 1/ Historic balance of public‐sector borrowing requirements. */ To June Source: SHCP (2016). Informes sobre la Situación Económica, las Finanzas Públicas y la Deuda Pública, Segundo trimestre de 2016 Mexico: Economic integration, challenges and outlook 23 … and worsening Pemex finances, which have a bearing on the current account Pemex sales revenue and budgetary expenditure First half for each year, billions of 2015 pesos 400 Sales revenue1 Budgetary expenditure 300 287.7 200 122.1 100 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 0 1/ Revenue from net foreign and domestic sales, minus taxes paid by Pemex. Excludes various sources of income, such as federal government transfers Source: Own calculations with data from SHCP Mexico: Economic integration, challenges and outlook 24 Holdings of peso government securities by nonresidents have fallen lately, driven by drops in those of short maturities Mexico: NR peso‐denominated government securities holdings Billions of pesos 2.5 Total 1 Coupon bonds 2.0 Zero coupon bonds 1.9 1.5 1.6 1.0 0.5 Apr‐16 Jan‐16 Oct‐15 Jul‐15 Apr‐15 Jan‐15 Oct‐14 Jul‐14 Apr‐14 Jan‐14 Oct‐13 Jul‐13 Apr‐13 Jan‐13 Oct‐12 Jul‐12 Apr‐12 Jan‐12 * Jul‐16 0.2 0.0 1/ Zero coupon bonds, coupon bonds, and inflation‐linked bonds */ To July 27 Source: Banco de México Mexico: Economic integration, challenges and outlook 25 Further bouts of international financial volatility could easily occur In the wake of Brexit, deeper monetary accommodation is foreseen in most developed countries Rising leverage worldwide1 Increasing proportions of debt with negative yields in advanced nations European banks face fragile financial conditions Concerns persist on Chinese economic health and policy interventions 1/ See BIS (2016). BIS Statistical Bulletin, June Mexico: Economic integration, challenges and outlook 26 Since last year, annual inflation has remained moderate, largely supported by unusually low noncore inflation Mexico: Annual inflation % 6 Headline 5 Noncore 4 Target 3 2.72 2 1.86 1 Jul‐16 Jun‐16 May‐16 Apr‐16 Mar‐16 Feb‐16 Jan‐16 Dec‐15 Nov‐15 Oct‐15 Sep‐15 Aug‐15 Jul‐15 Jun‐15 May‐15 Apr‐15 Mar‐15 Feb‐15 Jan‐15 0 * */ First half Source: INEGI Mexico: Economic integration, challenges and outlook 27 The rising path of core inflation reflects the effect of the exchange rate on tradable goods prices Annual core inflation % 6 Core Merchandise 5 4 3.68 3 2.99 2 1 Jul‐16 Jun‐16 May‐16 Apr‐16 Mar‐16 Feb‐16 Jan‐16 Dec‐15 Nov‐15 Oct‐15 Sep‐15 Aug‐15 Jul‐15 Jun‐15 May‐15 Apr‐15 Mar‐15 Feb‐15 Jan‐15 0 * */ First half Source: INEGI Mexico: Economic integration, challenges and outlook 28 An accelerating rise in the producer price index also reveals an impact from peso depreciation Mexico: Nonoil Producer Price Index Annual % change 6 5.62 5 4 3 2 1 Jun‐16 May‐16 Apr‐16 Mar‐16 Feb‐16 Jan‐16 Dec‐15 Nov‐15 Oct‐15 Sep‐15 Aug‐15 Jul‐15 Jun‐15 May‐15 Apr‐15 Mar‐15 Feb‐15 Jan‐15 0 Source: INEGI Mexico: Economic integration, challenges and outlook 29 Medium‐term inflation expectations as measured by analysts’ surveys have remained relatively stable, albeit above the target Mexico: Annual inflation expectations One to four years, median, % 4.0 3.5 3.36 3.0 2.5 Jul‐16 Jun‐16 May‐16 Apr‐16 Mar‐16 Feb‐16 Jan‐16 Dec‐15 Nov‐15 Oct‐15 Sep‐15 Aug‐15 Jul‐15 Jun‐15 May‐15 Apr‐15 Mar‐15 Feb‐15 Jan‐15 2.0 Source: Banco de México, Encuesta sobre las Expectativas de los Especialistas en Economía del Sector Privado Mexico: Economic integration, challenges and outlook 30 Also, market‐derived expectations appear to show a recent spike Compensation for inflation and inflation risk implicit in bonds % 4.0 3‐year 10‐year 3.61 30‐year 3.5 3.47 3.23 3.0 2.5 */ To August 2 Source: Own calculations with data from PiP Mexico: Economic integration, challenges and outlook Aug‐16 Jul‐16 Jun‐16 May‐16 Apr‐16 Mar‐16 Feb‐16 Jan‐16 Dec‐15 Nov‐15 Oct‐15 Sep‐15 Aug‐15 Jul‐15 Jun‐15 May‐15 Apr‐15 Mar‐15 Feb‐15 Jan‐15 2.0 * 31 Policy interest rate hikes have sought to avert deviations of inflation expectations and to anchor them on the target Policy overnight interest rate % 5.0 4.5 4.25 4.0 3.5 3.0 Jul‐16 Apr‐16 Jan‐16 Oct‐15 Jul‐15 Apr‐15 Jan‐15 Oct‐14 Jul‐14 Apr‐14 Jan‐14 Oct‐13 Jul‐13 Apr‐13 Jan‐13 Oct‐12 Jul‐12 Apr‐12 Jan‐12 Oct‐11 Jul‐11 Apr‐11 Jan‐11 2.5 Source: Banco de México Mexico: Economic integration, challenges and outlook 32 The resulting flattening of the yield curve seems to reflect confidence that inflation will continue to be contained Mexico: Government securities yield curve % 7 November 30, 2015 August 5, 2016 6 5 4 30‐year 20‐year 10‐year 7‐year 5‐year 3‐year 2‐year 1‐year 6‐month 3‐month 1‐month 1‐day 3 Source: Banco de México Mexico: Economic integration, challenges and outlook 33 Some risks to the consolidation of convergence of inflation to the 3 percent permanent target prevail The most notable danger is more weakening of the peso with a generalized impact on prices, knocking inflation expectations off track Rises in noncore prices could accelerate, returning to historic rates, possibly producing second‐round price effects Aggregate demand pressures could surface Mexico: Economic integration, challenges and outlook 34 Conclusions Mexico and the United States have benefited from increased economic integration Mexican economic activity has recently decelerated and confronts downside risks In a context of greater risk aversion, which could become exacerbated by geopolitical events, the fiscal stance should be fortified Monetary policy should continue to employ complete flexibility in order to consolidate the convergence of inflation to the target Mexico: Economic integration, challenges and outlook 35 Mejoran las perspectivas económicas mundiales 36