Effects of the US Crisis in Mexico

1. Effects of the US Crisis in Mexico By Pedro Aspe, Sergio Sánchez and Fernando Aportela October 14th, 2011

2. Contents • US Current Conditions: “The View from the Tropics” • The Transmission Mechanism • Mexico’s economic cycle and its link to the US manufacturing cycle • Exports and Imports: Mexico is a very open economy • Labor Figures • Foreign Direct Investment • Tourism Trends • Mexican Policy Responses • Fiscal policy • Monetary policy • The Taylor Rule • Mexico’s currency depreciation vs. Latin America • Opportunities • China’s Competitiveness Trend and its Consequences • The Demographic Bonus in Mexico • Migration into US is and will be “cap” by demographic factors • Development of a significant domestic market • Final Remarks Appendix

3. US Current Conditions: “ The View from the Tropics”

4. Employment in the Recovery: a major problem • Continuing weakness of the labor market: • Unemployment rate at 9.1%. • 8.75 million jobs lost in the recession, only 1.89 million recovered. • 6.0 million unemployed for 27 weeks and over Nonfarm jobs (monthly, percentage change since the end of recession) Source: (percentage change since the end of recession) Bloomberg, Wall Street Journal, IMF.

5. Housing Sector and Bank Lending in the Recovery: two additional problems • Housing prices are still declining and bank lending’s growth rate is negative. Home prices (quarterly) Bank lending (monthly) Source: (percentage change since the end of recession) Bloomberg, Wall Street Journal, IMF.

6. Exports and Corporate Profits: two good news from the Recovery • Corporate profits and exports are performing at least as well, as they did in several other recoveries. Exports, goods & services (quarterly) Corporate profits (quarterly) Source: (percentage change since the end of recession) Bloomberg, Wall Street Journal, IMF.

7. The Transmission Mechanism

8. Mexico’s economic cycle and its link to the US manufacturing cycle • Mexican manufacturing follows closely this US sector. Nevertheless, since 2009 Mexican dynamism has been stronger. • Production is at pre-crisis level in Mexico and below in the US. • Employment in Mexico has recovered from pre-crisis levels. • Mexican exports have shown significant increases. Employment (Mexico) Manufacturing production index (2007=100) Mexican Exports (2007=100) Source: INEGI, Federal Reserve, Bureau of Labor Statistics.

9. Exports and Imports: Mexico is a very open economy Percentage of US exports (year to date, July 2011) • Mexico is the second manufacturing exporter to the US, only after China. • 80% of Mexican Exports are traded with the US. • Mexico has 21 preferential trade agreements and, except for Chile, is the most open economy in Latin America. • Mexico’s total exports account for 30% of GNP, while exports just to the US account for about 24% of GNP. Percentage of US imports (year to date, July 2011) Mexico’s exports as % of the GNP Note: Trade data includes manufacturing exports. Source: INEGI, Chile’s Central Bank, World Trade Organization

10. Labor Figures • Employment in Mexico has recovered since the 2008 crisis. Nevertheless, that is not the case in the US: • Unemployment rate (August 2011): 5.8% in Mexico vs. 9.1% in the US. • New jobs (Jan-Sept 2011): 600,000 (1.2% of labor force) in Mexico vs. 1.07 million (0.7% of labor force) in the US. Employment (2007=100) Manufacturing employment (2007=100) Notes: Using Social Security Affiliates in Mexico and Non farm payroll in the US. Source: INEGI,. Bureau of Labor Statistics.

11. Foreign Direct Investment • Foreign Direct Investment (FDI) received by Mexico increased 26% in 2010 with respect to 2009 (the worst year). • Not surprisingly, investments in manufacturing represents 57.7% of total FDI. Foreign Direct Invesment (million USD) Source: INEGI

12. Tourism Trends • Tourism into Mexico showed a rebound in 2010. During that year, revenues from tourism were 9.2 billion. • Mexico had 12.6 million tourists in the same period. Tourism revenues (billion USD) Number of tourists (million people) Source: Mexico’s Central Bank, INEGI

13. Mexican Policy Responses

14. Fiscal Policy • Fiscal deficit in 2011 is expected to be 2.2% of GDP, including Pemex’s investment (at 84.9 dollars per barrel), and 0.2% of the GDP without it. But in 2008 and 2009 Mexico had a Balanced Budget. • Government debt remains at 30% of GDP • 81.3% is internal debt and only 18.7% is external. • Total sub-sovereign debt in Mexico was 2.4% of GDP in 2010. Total Public Sector Budget Balance % of GDP Total Central Government Debt % of GDP Source: OECD, International Monetary Fund.

15. Fiscal Policy: Balanced budget policy under historically high oil prices Since 2009, Government budget has been approved with a deficit reaching its peak in 2011 (2.7% of GDP, according to the Ministry of Finance forecast). When revenues have surpassed the budgeted figures, extraordinary expenditures have been applied. Extraordinary oil revenues have represented between one and two thirds of overall extraordinary revenues. As it is well known, this does not represent a good indicator of sound public finances. Government Budget (MXP billion) Extraordinary entries (MXP billion) E Source: Mexican Ministry of Finance.

16. Fiscal Policy: Balanced budget policy under historically high oil prices • In 2007, the Government enacted a new budget law that allowed oil surpluses to be used for fiscal stabilization purposes. • Nevertheless, even if during 2010 extraordinary revenues summed up to MXP 163 billion, the balance of stabilization funds was reduced. • Under historically high oil prices, balanced budget policy seems fairly reachable, but is a biased indicator of fiscal contention. Mexican Mix oil prices (USDB) Source: Mexican Ministry of Finance.

17. Monetary Policy • Mexico has shown a consistent monetary policy. Its Central Bank became independent in 1994. The Central Bank Law laid a legal foundation with the following principal strengths: the governor was to be appointed for a fixed term, it established staggered terms of office for other board members, and it took measures to ensure that the Bank’s financial base could not be undermined. • Mexico’s monetary policy regime has undergone significant evolution in the last two decades, with the adoption of the inflation targeting (IT) scheme in the early 2000s, representing a key milestone. • It is under the IT regime, along with the support of prudent fiscal policies, that Mexico’s Central Bank has succeeded in controlling inflation in the last decade. 1Tang, M. and Yu, X., Communication of Central Bank Thinking and Inflation Dynamics, IMF working paper series, August 2011

18. The Taylor Rule • In the period from January 1999 to January 20081, among the seven largest Latin American economies (Brazil, Argentina, Mexico, Chile, Colombia, Venezuela and Peru), only Mexico followed the Taylor principle, although not continuously. • Exchange rate major adjustments seem to be a relevant variable for interest rate decisions Mexico’s actual and Taylor-implied policy rate Note: *Using actual inflation; **using expected inflation. 1De Carvalho, A. and Moura, M., “What Can Taylor Rule Say About Monetary Policy in Latin America?”, 2010

19. Mexico's currency depreciation vs. Latin America • Currently, Mexico is the only country in Latin America with sustained currency depreciation since the 2008 crisis (post-Lehman), relative to the US dollar. • Mexico has achieved a higher degree of competitiveness from the weaker peso, higher global transport costs, and lower unit labor cost differential between Mexico and other Asian countries. Exchange Rate (Sept/15/08=1) Inflation (annual change, %) Source: Bloomberg.

20. Opportunities

21. China Competitiveness Trend and its Consequences • Manufacturers are moving away from outsourcing and are starting to embrace near sourcing. • China is loosing competitiveness • Wage and benefit rises of 15% to 20% annually in USD in the last decade. • Transportation costs and the continued appreciation of the yuan. Exports to the US (annual growth %) 9.6% Transportation costs (USD) Unit labor costs (USD / Hours) Monterrey to Chicago4-5 days ground (53-ft truck container) Shanghai to Chicago22 days marine and ground (40-ft shipping container) Source: Bloomberg, Boston Consulting Group , JP Morgan, ILO, Mexican Ministry of Finance.

22. Fertility rate in Mexico and the demographic dividend Population data • Mexican fertility rate is approaching advanced economies level. • Favorable dependency ratio: more people at working-age (15-64 years) than dependents. • Accumulation of savings and wealth development of a larger domestic market. Average number of children, women 15-49 years Total fertility rate Dependency ratio (% of working-age population) Source: INEGI, CONAPO, World Bank.

23. Demographic transition Population data • Mexico will not have more than 138 million people. • Life expectancy has increased 4 years in two decades. • Infant mortality has gone down significantly. Total Population Growth (thousands) Life expectancy (years) Infant mortality rate (per thousand) Source: INEGI, CONAPO.

24. Migration and Remittances • Mexico received a total of USD 21.27bn in remittances in 2010, an increase of 0.12% over the year before. • This source still represents the second largest source of foreign currency • Migration to the US will decline steadily overtime. • Less than 100,000 illegal border-crossers and visa-violators from Mexico settled in the US in 2010, down from about 525,000 annually from 2000 to 2004. International migration (thousands)* Remittances (billion USD) Source: INEGI

25. Final Remarks

26. Final Remarks • The ongoing Banking and Real Estate crisis in the US had made the recovery very anemic. Banks in the US have been capitalized but their negative impact on the economy will last some years. The household debt problem in the US has not been solved and its impact will affect the economy in the years to come. • The Mexican recovery has been led by investment and exports, backed by an expansionary fiscal deficit around 2% of GNP and a monetary policy which has followed the Taylor rule. With a low debt/GNP ratio and a small fiscal deficit Mexico’s macro picture is in good shape. • However, in order to sustain and enhance this recovery, Mexico will have to maintain its international competitiveness making additional reforms to enhance productivity growth in areas like Energy, Fiscal, Basic Education, Science and Technology and Labor. • Given the recent events in Japan, Europe and the US, Mexico has to move fast on its Reforms to be prepared for a prolonged period of Global Stagnation.

27. Appendix

28. Historic Oil Production Oil Production (daily thousand barrels) Source: PEMEX.

29. Insecurity Murders per 100,000 inhabitants, 2010 * *Source: Instituto Ciudadano de Estudios sobre la Inseguridad A.C., United Nations Office on Drugs and Crime Homicide Statistics.

30. Europe banks CDS Credit Default Swaps 5 years Source: Bloomberg.

31. Sovereign Debt CDS Credit Default Swaps 5 years Source: Bloomberg.

32. Risk for French Banks has risen • There are three main factors that are contributing to the vulnerability of French banks: large balance sheets with high leverage, significant liquidity needs and reduced capital rebuild prospects due to the economic slowdown. Financial leverage (%) Note: Financial Leverage = Average Total Assets / Average Total Common Equity (first semester of 2011) Source: Bloomberg.