MEXICO

Mexico’s current account deficit is entirely covered by FDI inflows and the country benefits from easy access to capital markets, besides enjoying a Flexible Credit Line from the IMF. FX reserves amounted to USD177bn at the end of 2019, after reaching a low of USD169bn in 2017, notably as the central bank has intervened in the FX markets to support the peso in a context of high US foreign-policy uncertainty. However, higher remittances in H1 2020, an unexpected reaction to the Covid-19 crisis, helped boost FX reserves to a five-year high of USD189bn. Import cover now stands at 4.4 months, a comfortable level.

Mexico’s monetary policy has been extremely cautious and restrictive, pursuing three goals: (i) anchoring inflation expectations so they converge towards the 3% target, (ii) aligning with the Fed’s tightening momentum and (iii) smoothing effects on the currency due to uncertainties related to Trump’s economic policy. Yet this monetary policy appears to have hindered growth. During the Covid-19 crisis, Banxico eased rates from 7.25% to 5% but its stance remains less accommodative than peers as the interest rate is still higher than four years ago. The central bank has room to cut rates again and we expect the interest rate to be even lower by the end of 2020.  

Mexico enjoys relatively sound public finances. The public debt-to-GDP ratio has increased from 42% in 2010 to close to 53.8%, which led the administration to commit to public primary surpluses, even during the Covid-19 crisis. Due to the strong recession, we forecast that the debt-to-GDP ratio could exceed 60% in 2020. Household debt stands at a reasonable level. Credit to the non-financial sector is lower than in other emerging economies.

Mexico’s structural business environment is the second best in the Latin American region, losing its first place to Chile last year according to the 2020 World Bank Doing Business Survey. It ranks 60th worldwide out of 190 countries (down from 54th in 2018). However, key shortcomings remain in its World Governance Indicators, specifically the areas of rule of law (152nd) and control of corruption (170th). Future challenges include improvements to the tax system and raising the female labor participation rate, which is lower than the Latin American and OECD averages. Mexico’s tax collection rate stands at 13% of GDP vs. at least 16% of GDP in its regional peers and 25% of GDP in high-income countries. Successive administrations have also failed to curb escalating corruption and crime that stifle economic and social outcomes. Since the election of AMLO, the business environment hasn’t stopped deteriorating. Recent policy moves include: (i) changes to the rules in the electricity sector, penalizing renewables projects to favor the national power company CFE, which has triggered complaints and threats of arbitration and (ii) obliging the central bank of Mexico to purchase from banks US dollars whose origins have not been verified. While the proposed legislation aims to help lower income groups who receive remittances, this obligation for Banxico to accept and convert such funds would reduce its independence and would represent a significant weakening in Mexico’s anti-money laundering/combating the financing of terrorism (AML/CFT) controls. - December 2020