Gross Domestic Product (GDP) growth slowed to 2 percent in 2017 as uncertainty, including that arising from the ongoing North American Free Trade Agreement (NAFTA) renegotiations and the electoral process, depressed investment. Significant tightening of fiscal and monetary policy in recent years also weighed on domestic demand. Private consumption, however, has held up reasonably well despite the fall in real wages associated with an inflationary spike in 2017.
A strong recovery of external trade created a vigorous contribution to GDP growth. Increased external competitiveness derived from the accumulated currency depreciation and strengthened U.S. industrial production have been invigorating Mexican exports.
The pass-through of currency depreciation to inflation took hold in 2017, and together with the liberalization of gasoline retail prices and an increase in the excise tax on fuel, helped drive up annual inflation to 6.8 percent by end-2017, the highest level in 16 years. This prompted the Central Bank to resume its monetary tightening cycle in late-2017 and early-2018, leaving the policy interest rate at 7.5 percent by end-February 2018.
Aided by a significant contribution from Central Bank profits, amounting to 1.5% of GDP, the public sector achieved a primary surplus and comfortably met its 2017 deficit target. This was sufficient to put the debt-to-GDP ratio on a declining path. Over the next couple of years, the country is likely to continue recording primary surpluses, meeting the 2.5 percent overall deficit target in accordance with the fiscal rule. This should be sufficient to marginally reduce the debt-to -GDP ratio.
As policy uncertainty relating to NAFTA renegotiations and the political electoral cycle eases, investment growth is expected to accelerate from late-2018 onwards. This should support a pick-up in economic growth over the forecast period towards its long-term potential rate. Implementation of the energy reform has been successful in attracting private participation to the sector, and the downward trend in investment and production in the oil sector is expected to be reversed, boosting potential output growth.
Barring further major currency depreciation, inflation is expected to moderate through 2018 to approach Banco de Mexico’s upper tolerance band of 4 percent by the end of the year, and the 3 percent target rate during 2019. This should allow the Central Bank to ease monetary policy, at least relative to the US, from late-2018 or early-2019, thereby helping underpin a resurgence in investment.
Last updated: April 16, 2018