The Mexican economy continued to expand at an annual rate of 2.5 percent through most of 2015 and early 2016, though is expected to weaken in 2016 to about 2 percent following a modest contraction of economic activity in the 2nd quarter. The expansion of economic activity now fully relies on private consumption as weak investment and export demand are no longer contributing to growth. Increased external competitiveness following a substantial depreciation of the Mexican peso with respect to the U.S. dollar has not yet led to a boost in external demand. Strong vertical supply relations between U.S. and Mexican manufacturers cause that recent softness in U.S. industrial production is transferred to Mexican manufacturing industry and exports.
A significant depreciation of the Mexican peso against the US dollar took place over the past two years as a flexible exchange rate is effectively employed as an external shock absorber. The pass-through of currency depreciation to domestic prices has thus far been limited as inflation moved to slightly below the central bank’s target of 3 percent, though the possibility of such pass-through following additional currency depreciation remains a major concern for the monetary authorities that, in response, hiked the monetary policy rate to 4.25 percent.
A persistent trend of increasing debt-to-GDP for almost a decade now (from 29 percent in 2007 to an estimated 50.5 percent by the end of 2016) in combination with falling oil revenue, a fragile financial situation of the National Oil Company PEMEX as well as disappointing economic growth led rating agencies to put Mexico’s sovereign (investment grade) rating on a negative outlook. In managing the decline in oil revenue, the government benefitted from a tax reform implemented in 2014 that substantially raised non-oil revenue and started to cut (non-mandatory) expenditures in 2015 and 2016. An additional tightening of public expenditure in 2017, aimed at achieving a primary surplus for the first time in nearly a decade, should stall the increasing public debt burden.
Monetary and fiscal policy responses to adverse external shocks will weigh down on aggregate demand in the short term. A further decline in the volume of oil production, due to falling output from aging fields and insufficient investments in replacing exploration and exploitation capacity, will continue to trim down annual growth rates by about half a percentage point. Nevertheless, economic and financial stability, further progress in the implementation of an ambitious structural reform agenda, as well as the increase in external competitiveness following the depreciation of the currency is expected to boost private investment and exports lifting economic growth in the medium term.
The Mexican economic continues to face a complex external environment in which persistently low oil prices, a normalization of U.S. monetary policy, a slowdown in global trade and economic growth and a diversity of geopolitical events may heighten risk aversion and financial volatility posing challenges to the country’s economic and financial stability and growth outlook. Policy priorities will remain focused on prudent monetary, financial, and fiscal policies to create the conditions for stronger growth in the medium term.
Last updated: September 26, 2016