By Valerie Hernandez, International Banker
Few Latin American economies, if any, have prospered as much as Mexico’s during the year’s first half. With growth rates through April comfortably in positive territory, the country’s performance thus far in 2023 has been somewhat of a surprise, having repeatedly defied economists’ expectations with its sheer resilience and positive data releases. Given this solid performance, moreover, Mexico’s leadership is now hoping that a robust economy will prove vital against the likely worsening of conditions, as it anticipates rolling up its sleeves to withstand the spillover effects from the slowdown—even a potential recession—arising next door in the United States.
Late May saw the official national statistics agency, INEGI (National Institute of Statistics and Geography), publish 1-percent growth in gross domestic product (GDP) for the first quarter, marking the sixth consecutive quarter of positive growth for the country and underlying the solid performance delivered during the initial months of the year. Moreover, first-quarter (Q1) GDP soared by 3.7 percent on an annual basis. Yet, economists at the time noted that a slowdown in the US economy and rising interest rates during the latter half of the year would likely soften Mexico’s performance. “Overall, these numbers confirm a decent start to the year,” Pantheon Macroeconomics’ chief economist for Latin America, Andres Abadia, said when discussing the Q1 figures. “But sequential data is confirming a gradual deterioration in recent months.”
But that “deterioration” has yet to transpire. Indeed, during the month after the Q1 GDP release, the Mexican economy continued to defy expectations, with INEGI reporting 0.8-percent growth in April compared to the previous month, its strongest month-on-month showing in more than a year, returning monthly growth to positive territory following March’s 0.2-percent contraction. The annual increase using the IGAE (Global Indicator of Economic Activity) economic indicator—a proxy for GDP growth—was 3.3 percent using seasonally adjusted figures, INEGI stated.
The strong figures also followed a posting earlier in June stating that Mexico’s consumer prices for the first half of June had risen less than expected, by 5.18 percent compared to the same period a year earlier, and had fallen from the 5.67 percent recorded in late May. And on the employment front, total employment figures representing 58.5 million workers grew annually in the first quarter by 4.3 percent, while Mexico’s April unemployment rate remained at a low 2.8 percent, unchanged from March. “Mexico’s economy keeps surprising on the upside,” noted Alberto J. Rojas, senior economist for emerging markets at Credit Suisse Group, following the release of the April figures. “We continue to highlight that the chances of a soft-landing in Mexico are clearly increasing.”
So, is that soft landing all but guaranteed? Not quite. Recent data are mixed for the Mexican economy. Although employment and retail sales grew, industrial production was flat, and exports ticked down. Inflation moderated, and the peso strengthened further against the dollar. Even Mexico’s financial system stability committee has expressed caution regarding the economy’s direction over the coming months. “Looking ahead, the outlook remains uncertain,” the committee stated on June 29, noting the potential risk of deterioration emerging from a complex external environment. The committee also explained that while Mexico’s financial system remains resilient, some non-bank intermediaries face rising financing costs, although this will have a limited impact and does not represent a “systemic risk” for the country’s financial structure. Additionally, domestic demand will significantly support domestic economic activity over the coming months.
Thankfully, inflation is now on a solid downward trajectory, with May’s annual rate of 5.18 percent being a marked improvement on the 6.25 percent posted in April. Although this remains above Banco de México’s target of 3 percent, plus or minus a percentage point, it is a clear sign that confidence in the strength of Mexico’s future economic performance is growing. And with the central bank having even paused its cycle of rate hikes, which produced 725 basis points across 15 consecutive rate meetings, in June, confidence is certainly on the rise in Mexico. Rates were left unchanged for the second straight time at a record high of 11.25 percent during the central bank’s June meeting.
The central bank warned, however, that the risks to inflation remain on the upside as core inflation stays stubbornly high. As such, interest rates will remain around their present level for an extended period. “There is growing optimism the central bank is nearing peak rates, while the economy has seen a stable rebound from the pandemic, and the job market is improving,” according to Edward Moya, senior analyst at forex (foreign exchange) consultancy OANDA, as quoted in a June 1 Forbes article.
The peso also deserves special mention, as it has been among the best-performing currencies in 2023 to date, extending a longer-term trend that has seen it emerge as the world’s strongest currency against the US dollar over the last few years. And this strength continues today, with the Mexican currency averaging 17.7 to the US dollar in May, its highest monthly average since March 2016. According to a March report from the CME Group, several key factors have supported the peso versus other currencies, including:
- Strong capital investment flows into Mexico from the United States and China;
- Tight monetary policy from Mexico’s central bank, which proactively began to raise rates ahead of most other central banks;
- Exceptionally low levels of debt compared to other nations and smaller budget deficits.
The report also noted that the peso had outperformed its Latin American peers and other global reserve currencies since 2018, specifically following the US imposition of 10 percent to 25 percent tariffs on almost 60 percent of US imports from China. “The ensuing trade war set off a scramble to diversify supply lines coming from China into the US. Mexico was an obvious investment candidate for both US and Chinese firms,” the report stated. “For starters, Mexico is adjacent to the US. Secondly, Mexico is covered by the U.S.-Mexico-Canada (USMCA) trade agreement, a slightly modified version of its predecessor, North American Free Trade Agreement (NAFTA), which facilitates low-tariff trade within the bloc. These efforts intensified in 2020 and 2021 as COVID-related supply chain disruptions led to a six-fold increase in the cost of shipping goods from Shanghai to Los Angeles.”
And with those supply-chain disruptions far from resolved, Mexico’s economy could substantially benefit from continuing this “nearshoring” trend, particularly given the strength of its existing manufacturing relationships with the US market. Indeed, with Mexico’s exports in May being the second-largest ever recorded, it would seem that the country is already reaping the benefits of rejigged global supply chains that are bringing global firms back within proximity of the US consumer market. Total Mexican exports jumped 5.8 percent year-on-year in May to hit $52.9 billion, while imports also grew 1.4 percent to $52.9 billion.
As such, even a modest relocation of manufacturing production into Mexico is set to prove hugely positive for its economic growth over the next few years. “The recent increase in construction of industrial parks and warehouses in the northern part of the country, especially in Nuevo Leon, indicates nearshoring could be starting to unfold in Mexico,” a report published on April 4 by S&P Global Ratings suggested. “Disaggregated FDI data is consistent with that trend. The transportation and storage sector became the second-largest recipient of FDI last year—it surpassed $5 billion in 2022 and is more than twice what it was before the pandemic. Mexico’s economy ministry has also reported a record number of applications from manufacturing companies to start operating in the country, indicating a potential growing interest in shifting some production to Mexico.”
Overall, then, there is much to be cheerful about when assessing Mexico’s macroeconomic outlook for this year and next. According to a central bank survey among private-sector analysts for May, Mexico’s 2024 GDP is expected to reach 2.05 percent, modestly higher than the 1.68 percent projected in the same survey conducted in April. The OECD (Organisation for Economic Co-operation and Development), meanwhile, projects real GDP growth of 2.6 percent this year and 2.1 percent in 2024. “Consumption will be supported by the improvement in the labour market but will be dampened by high inflation,” the OECD noted in its “Mexico Economic Snapshot”, published in June. “Investment will benefit from the easing of bottlenecks in global value chains and the relocation of manufacturing activity to Mexico. Export growth will be held back by the United States’ economic slowdown. Inflation will decline to 5.9% in 2023 and 3.7% in 2024.”