2018 ended in an environment of uncertainty in Mexico, both with regard to the external situation and the internal conditions. Despite the signing of the free trade agreement between the United States, Canada and Mexico (USMCA), which dissipated the main risk associated to the Mexican economy, other, equally important, risks still persist.
- The commercial dispute between China and the United States. The commercial war is generating global risks, impacting emerging currencies and fostering a global economic slowdown, from which Mexico is not exempt.
- The upward trend in interest rates implemented by the Federal Reserve in the United States. It was recently announced that the cycle is likely to continue in 2019 with two additional increases, which is not encouraging in a slowdown environment. As a result of these two external risks, global stock exchanges have fallen significantly in the past months, in a way not seen in more than a decade. In fact, two-thirds of private sector economists in the United States suggest that that country could enter an economic recession in a couple of years.
- A third external risk to consider is the price of the Mexican oil mix, which has already broken through the $ 50 per barrel barrier. Let us remember that the Mexican Federal Budget for 2019 was prepared considering a price of the mix of 55 dollars per barrel. Although the Organization of Petroleum Exporting Countries (OPEC) has decided to cut crude production by 1.2 million barrels per day, the expectations of lower global economic growth are affecting the global demand for crude oil, and, therefore, pressuring prices. This is important for the Mexican national economy, since close to 20% of the federal government's income comes from Pemex.
There are various risks in the domestic arena resulting from the economic policies of the new administration:
- The increase in the minimum wage proposed for 2019 is likely to generate inflationary pressures. This is already having an impact on inflation projections for the short and medium term, and obliged the Bank of Mexico to respond by raising the target interest rate by 25 basis points in December 2018, bringing it to 8.25%. On the positive side, such increases in minimum wage, in pensions for the elderly and other social support initiatives will influence private consumption, positively impacting economic activity in the short term.
- The second risk is related to the federal budget for 2019, where a fiscal balance has been emphasized with a primary surplus of 1% of GDP and without increases in debt. However, it seems that this proposal will not be fulfilled. Firstly, because the budget assumes a real rise in tax collection without increases in taxes or the taxpayer base in a scenario of lower economic growth. In fact, the main private banks and international organizations have reduced their 2019 growth prospects for the country. It is very likely that the Mexican economy will grow less than 2%. In my opinion, the growth will only be around 1.5%.
- The third domestic risk is related to the additional uncertainty that some decisions of the new administration could generate. The uncertainty associated with the cancellation of the New Mexico City Airport (NAIM) could grow with new measures against the market-based economy.
I am particularly concerned about the measures that could reverse the energy reform. A large part of foreign direct investment (FDI) comes from the energy sector. In addition, the message to foreign investment if the reform is revoked would be very adverse, not only for the energy sector but for the economy in general. The incoming government has already given the first signs of what it will do in this regard by suspending oil-field auctions and reducing the budget of the Energy Regulatory Commission (CRE) by more than 30%, as well as that of the National Hydrocarbons Commission (CNH). Additionally, by controlling (subsidizing) the price of gasoline again, the initiative to generate more competition in the sector with the introduction of private gas stations would be reversed. Greater economic competition always leads to lower prices for the end consumer. We have not observed this benefit so far because of the lack of infrastructure. There are more gas stations in Texas than in the entire country of Mexico.
Slow growth and inflation
In summary, in 2019 we can expect lower economic growth and high inflation. Growth will disappoint due to the global economic slowdown, mainly related to the United States, and the high interest rates prevailing in Mexico. In fact, it is likely that Banxico will continue to raise rates to mitigate the new inflationary pressures. Raising interest rates inhibits investment and credit becomes more expensive, which contracts aggregate demand, that is, the real economy.
On the other hand, inflation is expected to be high as a result of the announced wage increases and the persistent decline in the foreign exchange rate. I expect inflation to be around 4% towards the end of the year, although with many upside risks. In response to the above, it is likely that Banxico will raise the interest rate twice, taking it to levels close to 9%.
And what do we expect for the foreign exchange rate? As a result of the aforementioned risks, the foreign exchange rate is likely to remain at levels above 20 pesos per dollar. I believe that the announcement of the cancellation of the NAIM will have lasting effects and any additional adverse news will generate pressure on the exchange rate.
Finally, it will be important to analyze how the public finances evolve. Not only do I believe that the proposed fiscal balance will not be met, but that the public debt is likely to increase, reflecting a lower price of crude oil than anticipated and an economy that will not perform as well as estimated in the federal budget.