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Mexico's economy continues to keep an unhurried
pace. But after managing to survive the
political turmoil of early 2007, and in the wake
of the second year of the new federal
administration, Mexico's economy faces an
unwanted, untimely, yet imminent new challenge
as the U.S. economic woes worsen.
Luck, as far as economic cycles is concerned,
has not favored either of the two recent
conservative Mexican Presidents. Vicente Fox's
promises for a 7% annual growth economy were
quickly shattered by the 2001-2002 U.S.
recession. And today, President Felipe
Calderon's economic pledges to the people will
now thrive in a riskier economic and political
environment.
Back in 2001-2002, Mexico's growth stalled and
actually went negative. Literally hundreds of
thousands of jobs were lost as hundreds of
foreign-owned operations fled to China and
thousands of domestic companies went out of
business. Is Mexico on the threshold of another
economic crisis like the one it suffered seven
years ago?
Not quite. Conditions are different today, but
not necessarily better. While the negative
economic effects of a recession today would be
milder than in 2001, the negative political
effects are substantially riskier.
They might call it "sluggish growth", downturn,
correction, slowdown, but by any other name, for
practical purposes, there is no doubt that the
U.S. economy is already experiencing a
recession. In the last quarter of 2007, the U.S.
economy only grew 0.6% and totaled 2.2% for the
year. Although technically a recession is
defined as six consecutive months with zero or
negative growth, it is only fractions away.
Most analysts hope that the downturn will be
mild, but there are signs that it might not.
Housing foreclosures continue to surface eroding
home values, the stock market is in turmoil,
there is a softer job market, energy prices are
higher and consumers have turned to a
wait-and-see mode. Extreme actions by the Fed
and the government are just too little, too
late. And the Fed is running out of room to
lower interest rates further as it approaches
the "2% wall" while inflation limits its
actions. The worst scenario is "stagflation", or
no growth with inflation.
In this article we will review the quantitative
performance indicators and forecast for the
Mexican economy. We will do this along with an
analysis of the nine main pillars of Mexico's
economy, where they stand and how they will be
affected by the slowdown in the U.S.
An Anemic Dinosaur
Back in the 80's, oil represented over 70% of
Mexico's total exports. Today, it barely exceeds
15%, but its importance as a source of income
for the federal government continues to be
crucial as it provides over 40% of its revenues.
PEMEX, a 70 year old state monopoly, is like an
anemic dinosaur. It has been the cash cow of
federal administrations, unions and the former
ruling political party PRI alike. Many times it
has been associated with corruption practices.
It has not built a refinery in 20 years (Mexico
imports 40% of its gasoline). Its long-term
reserves are going dry and its daily production
has decreased to barely 3.0 million barrels per
day, down from 3.4 million three years ago.
Were it not for the continuous increases in
international oil prices, PEMEX would already be
a defunct specimen.
The evident solution is privatization. But the
Mexican Constitution, the powerful oil union and
a popular ownership delusion wrapped in
patriotic pride, extensively exploited by the
leftish political parties, have prevented PEMEX
from accomplishing any form of economic
evolution or adaptation to change.
Even partial privatization such as opening
refining, distribution, whole-selling and
transportation would be of great benefit. This
would create income for PEMEX and alleviate
very high and inefficient operation costs. It
would also enable PEMEX to invest in exploration
and production.
President Calderon has recently managed to spark
oil reform discussions in the parliament. Some
factions of the leftish political parties are
starting to open up and there might be some
positive results soon. But Calderon is taking a
political risk if reform progresses without the
support of the leftish political parties.
However, even if partial reform invigorates
PEMEX a bit, this institution is economically
unviable. It will meet its fate with extinction
and full privatization once the Mexican people
decide that its cost is not worth the pride of
ownership.
Meantime, the U.S. slowdown will help PEMEX keep
its finances afloat in 2008-2009. Historically,
even if there is only a partial direct
correlation, the last four recessions in the
U.S. have been fueled by and have coexisted with
very high oil prices.
A Huge Stack of Bricks
The notion that Mexico's economy and markets are
intrinsically linked to the U.S. it has at least
an important exception: The housing industry.
Ironically, while housing is the main source of
economic woes in the U.S., in Mexico it is a
booming sector. Low-income housing has enjoyed
double-digit growth since 2002, including an
annual increase of 16% in 2007. This took
Mexico's overall housing industry to a level of
approximately US$35 billion for the year. About
1.16 million mortgages provided a new roof for 5
million people in 2007.
The low-income housing deficit is estimated at 6
million units and the federal government is
determined to erase it by 2012. Low-income homes
are financed by private and public financial
institutions. The going annual interest rate for
loans denominated in pesos is about 12% for
units that range between 400 and 600 ft2 in
size, and between US$16,000 and US$40,000 in
value.
The broad market allows lenders to choose the
more financially sound buyers and foreclosures
average less than half that in the U.S. Mexico's
overall housing market conditions and the
financial returns are so attractive that even
some high-profile U.S. investors are betting on
it.
Bear in mind that ten years ago, less than 10%
of all home in Mexico were financed. Credit was
extremely tight and selective for all types of
homes. The recent availability of loans in
Mexico awakened a significant sector of the
economy. The housing industry is injecting
billions of dollars for construction materials
and jobs. And, since there is a huge backlog,
demand is strong and sustainable.
Besides the positive economic impact, the boom
in low-income housing brings another not less
important benefit- a social change for millions
of people who are moving from self-built
shelters to formal, planned dwellings. This
motivates people to work harder, to attain a
higher quality of life and accelerate their way
to middle-class status. Home mortgages are
indeed very effective and indispensable in the
development of a country like Mexico.
The U.S. economic deceleration will definitely
contribute to slow the housing industry in
Mexico in 2008 to single-digit growth, perhaps
to 8%. Millions of expatriates living in the
U.S. provide funds for low-income housing in
Mexico, many in the form of cross-border
mortgages with borrowers residing and working in
the States.
"Superpeso's" Unnoticed Supporter
Indeed, about 12 million Mexican expatriates in
the U.S. make up one of the strongest, and often
overlooked, pillars of the Mexican economy. They
generate more foreign income for Mexico than
tourism. This source of foreign exchange can be
singled out as one of the main reasons behind
the surprising strength of the Mexican peso in
the last decade.
According to official figures, documented and
undocumented expatriates working in the U.S.
sent over US$24 billion to their relatives and
friends in Mexico in 2007.
Now, the official "Remittances" account is
certainly understated because it only includes
amounts that flow through the formal financial
system. A lot more flows as cash in the I
pockets of thousands of workers that cross the
border daily to work in the U.S., and the
relatives that periodically visit their family
back in Mexico. An estimate for remittances of
US$30 billion is still conservative.
A slowdown in the U.S. economy, coped with a
crackdown on illegal immigration will certainly
take away an important share off remittances,
possibly as much as 5% to 7% in j 2008.
Maquiladoras' Armor
Unlike the 2001 crisis, this time around
conditions are very different in the maquiladora
industry. Consider that back in 2001
maquiladoras in Mexico had built a significant
bubble of product incompatibility. Many products
and production lines simply did not belong in
Mexico anymore. When the bubble burst, it was
clear to the management of maquiladoras that
very labor intensive products, products with
high-volume and low-mix | production runs, plus
products with a high value/weight ratio, also
products without the need of intellectual
property protection simply belonged in China.
China was the place where they could be
manufactured for half the cost. The exodus was
significant and over 250,000 jobs were lost in a
few months.
Throughout the 2003-2005 recovery, maquiladoras
in Mexico got smarter and adopted product lines
that had a much better fit with Mexico. The U.S.
and Europe "rediscovered" Mexico as an ideal
location for low-volume / high-mix manufactures.
This included items with very low time tolerance
in logistics cycles, bulky-expensive goods,
development of
new products, goods with higher value added and
many other production niches.
The goods currently being made by maquiladoras
in Mexico represent a whole new generation of
product lines that have already, for the most
part, survived the "China challenge". So, the
industrial capacity of the maquiladora industry
is not going to suffer a structural change like
the one it endured in 2001 as a result of the
economic slowdown in the U.S.
But, the maquiladora industry will be affected
by changes in demand. Since maquiladora plants
are, for the most part, links in the supply
chain that serve the U.S. market (90% of exports
go to the U.S.), a decrease in consumption and
manufacturing in the U.S. will automatically
translate into a reduction of factory I orders
for maquiladoras in Mexico.
Employment in maquiladoras follows, but
generally over reacts to the level of
manufacturing in the U.S. A sluggish 2008 in the
U.S. economy will probably mean a net loss of
around 20,000 to 30,000 jobs in maquiladora
plants. Currently, there are approximately two
million jobs in the maquiladora and PITEX
manufacturing facilities.
FDI Interlude
Foreign Direct Investment (FDI) in Mexico
reached! US$23.2 billion in 2007. This is the
highest figure since 2001 when Citibank acquired
Banamex.
The U.S. continues to lead DPI in Mexico, with
almost half of the total, distantly followed by
the Netherlands, Spain and France. The states of
Mexico, Nuevo Leon, Chihuahua, Baja California
Norte and Puebla were the leading recipients.
DFI in Mexico in 2008 will decline. Besides the
economic deceleration, the electoral year in the
U.S. will bring a sentiment against
"exportation" of jobs. In extreme political
actions, the democrats have even vowed to
renegotiate NAFTA or nullify the agreement all
together.
In addition, Mexico's competitiveness for DFI
continues to erode as a result of bureaucratic
requirements, the new alternate flat rate income
tax, increasing utility costs and the absence of
structural reforms for energy, telecom and
labor.
Our estimate is that DFI for 2008 will be about
US$18 billion at best, but it could go as low as
US$14 billion in a worst case scenario.
The Underemployed and The Underground
Researching employment statistics in Mexico
unveils many paradoxes. The government manages
the numbers in a number of ways. For example,
the official unemployment rate in Mexico is 4%,
but an unemployed person by official definition,
is somebody who cannot find a job. Uncounted are
those who do not seek employment or are grossly
underemployed. Turns out that by almost any OECD
countries' definition, Mexico's real
unemployment rate is closer to 30%.
Bizarrely, from a purely economic perspective,
we must place the group that includes the
underemployed and those in the underground
economy among the nine economic pillars of
Mexico.
Like the Mexican expatriates in the U.S., they
comprise a group that is not under ideal
standards at all, but nevertheless make a
significant contribution to the overall Mexican
economy. This is true, even if they don't ring
the official GDP and tax register of Mexico's
formally recognized finances.
The "informally employed" includes mostly
good-willing people who go out there to perform
chores to try to make a living. But hidden in
this group are many that have activities outside
the law, such as people that make a living
trading and distributing illegal imports and
drugs.
The informally employed rate of growth is more
than double that of the formally employed.
Actually, in 2007 about 600,000 people joined
the informally employed ranks. The main reason,
of course, is that Mexico does not create enough
jobs and/or enough qualified workers.
According to MEXICONOW, Mexico needs to create
about 1.2 million new jobs per year to employ
new entrants into the potential labor force.
But, in 2007 Mexico only created a mere half a
million formal, permanent jobs. The rest joined
the informally employed migrated to the U.S. or
are simply unproductive.
The U.S. slowdown will undoubtedly fuel Mexico's
informal sector for many reasons, including
returning expatriates and a reduced supply of
formal jobs at home. We may be potentially
looking at an additional 650,000 net informally
employed individuals in 2008.
The Captive Formals
The long-awaited-for fiscal reform resulted in
additional income tax burdens and "taxable meets
and bounds" on the registered individual and
corporate tax payers. Mexico's fiscal reform of
2007 is arguably the ideal solution to the
country's financial woes, but it is a reform
after all and a reality in spite of the minority
position of President Calderon's party in
congress. This initiative is perceived as a good
precedent for future reforms.
Mexico's "captive" tax payers contributed about
25% of the federal revenues in 2007. The new
single-rate, alternative income tax (IETU) is
expected to increase the federal budget by about
USS6 billion. Formal tax payers have managed to
keep their income tax payments at "competitive"
levels, by taking advantage of many legal
loop-holes in Mexico's fiscal legislation.
Unfortunately, the taxing authority continues to
zero-in-on the usual tax payers. There are no
significant initiatives to collect taxes from
those in the informal sector or to reduce public
spending.
Tongue-in-cheek, Mexico's main economic pillar
(formal individual tax payers and the corporate
private sector) will continue to support
President's Calderon's leadership and
negotiating skills. They will be quite attentive
to the narrow window of opportunity to pass
additional reforms (energy, labor, telecom,
education) before the 2009 mid-term general
elections.
The U.S. slowdown is not going to contribute a
bit, and might even be an important deterrent in
this process.
Chasing Mickey Mouse
Mexico's international tourism industry
performance in recent years is to be commended.
And it certainly qualifies among the pillars of
Mexico's economy. In 2007, for instance, about
21 million international visitors generated
US$13 billion in foreign exchange. This is an
increase of 5.9% over 2006.
In an unsuited but tempting comparison, Mexico
is still short of Disney's worldwide
conglomerate of theme parks and resorts with
annual revenues above SUS20 billion and over 100
million visitors.
Mexico's full exploitation of its international
tourism industry is significantly undermined by
the international visitors' perception of
insecurity in the streets. Another drawback is
the lack of infrastructure that prevents further
and faster development of locations for tourism.
.
The declining value of the US$ versus the Euro
and other Asian currencies has opened a huge
window of opportunity for Mexico's tourism
industry. This makes conditions ideal to attract
to Mexico not only U.S. tourists who cannot
afford going to Europe, but also Europeans who
want to enjoy a bargain.
The U.S. slowdown will only have a mild effect
on this growing industry. Affordable vacations
for American, European and Asian tourists will
continue to drive the revenues of Mexico's
foreign tourism at a six to seven percent annual
growth rate in the coming years.
Trade Shortfall
Mexico's exporters of manufactured goods (not
including maquiladoras) represent another pillar
of the economy. In 2007, they achieved roughly
US$100 billion worth of foreign shipments of
auto parts, beer, vehicles, construction
materials, appliances, processed food and many
other products.
The 14-year old North American Free Trade
Agreement (NAFTA) continues to be controversial
both in Mexico and the U.S. It is a favorite
subject of politicians on both sides of the
border and there is going to be some
renegotiations. They will make a lot of noise
but produce only procedural changes and nothing
substantial.
Since the inception of NAFTA, Mexico's exports
of manufactured goods have grown fourfold. They
grew 8.8% in 2007 alone. There will be only a
marginal increase of 3% to 4% in 2008 as a
result of minimal growth in the U.S. economy and
an unfavorable peso export exchange rate.
Economic Forecast
In late January 2008, Mexican authorities
lowered the expected 2008 GDP growth rate to
2.8%, moving it from their previous forecast of
3.5% in late 2007. But according to various
economic analysts, 2008 GDP growth will likely
be under 2% and it will improve to between 3%
and 4% during 2009-2012.
There is really nothing critical or negatively
abnormal in Mexico's economic outlook on the
face of things related to the slowdown in the
U.S. Mexico's continuing exercise of sound
monetary and fiscal policies will maintain
macroeconomic variables well within manageable
ranges.
But on the other hand, neither does there seem
to be anything positively abnormal in Mexico's
performance in the next few years. There is no
outlook or agenda, for example,
for stronger growth (6%-7%), massive creation of
jobs or any significant turnaround on
insecurity.
The door for a worst-case scenario remains
slightly open. Shall the U.S. slowdown turn into
a deep year-long recession, the impact on
Mexico's economy will be grave. Under this
scenario, Mexico's recovery would extend well
into 2010-2011. This would be too late for the
new administration to produce real economic
results that permeate to the vast low-income and
no-income electorate. The next Presidential
election is in mid-2012.
Evidently, President Calderon has a major task
at hand. Continuing skillful cross-partisan
negotiations are a must for reforms. Tackling
Mexico's weaknesses in regulation and industrial
policy, persistence of powerful vested
interests, the high cost of monopolistic
utilities and a decaying educational system are
fundamental to increasing Mexico's global
competitiveness.
Time is of the essence.
By Sergio L. Ornelas,
MEXICONOW Editor
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