Mexico: Mid-Year Update

With a semester under his belt, President Felipe Calderon is showing his mettle. The Mexican president faces a daunting task. Six years of status quo under former-President Fox, the partial displacement of the drug trade from Colombia and the deceleration of the U.S. economy made for a rough honeymoon. However, President Calderon came through with flying colors. He implemented difficult reforms in spite of a fragmented congress. He assembled a team of some of the best administrators, delegated responsibilities and engaged the opposition in dialogue. President Calderon is perhaps Mexico’s last hope to avoid a return to the boom-bust experiences that marked the latter half of the 20th century.

Mexico is in a delicate situation. It is dependent on the U.S. for trade flows and remittances. More than 90% of Mexican trade is with the U.S. Oil revenues are declining, due to a lack of investment over the past six years. Remittances comprise an ever-important part of Mexico’s current account balance. Over the past six years remittances surged four fold—reaching $23 billion in 2006. Much of the increase in remittances was associated with the U.S. construction boom and the slowdown in housing starts is depressing flows. The Mexican Statistics Agency (INEGI) reported a 26% decline in remittances since May 2006—the peak of the U.S. construction boom. At the same time, a credit-fueled consumption boom is increasing the import bill. Mexican banks and financial institutions doubled credit as a percentage of GDP since the start of the decade—allowing Mexican households to buy more homes, cars and durable goods. This is leaving the Mexican economy extremely vulnerable to a U.S. slowdown.

Fortunately, Mexico is making up for the current account shortfall with capital account inflows. Foreign direct investment (FDI) is strong, as Asian companies take advantage of the Maquila manufacturing base to penetrate the U.S. market. Some Asian firms are capitalizing on the low shipping costs into the U.S., particularly for bulky products. U.S. auto producers are also moving more of their production into Mexico in order to skirt high medical and retirement benefits. However, the inflows are not relegated to FDI. The emerging market boom is pushing capital into Mexico’s equity and debt markets. The capitalization of the Mexican bolsa is now 44% of GDP, and hedge funds are active players in the local currency market. Last of all, narco-related revenues are boosting the nation’s errors and omissions. The narco industry moved aggressively into Mexico during the Fox regime, and the new Administration is fighting back. President Calderon deployed thousands of troops to problematic areas, deported cartels leaders to the U.S. and confiscated assets. Nevertheless, the cartels are not standing still. They are gruesomely decapitating the heads of local leaders and members of the press, in a macabre show of force. Unfortunately, Mexico is not only suffering from the problems with U.S. economy. It is the new front line in the war against drugs.

President Calderon and his economic team are well aware of the threats facing Mexico, and they are trying to address the problems. The government is spearheading a set of fiscal reforms to reduce its dependency on oil revenues. It is taking measures to subcontract exploration services to foreign firms, particularly Petrobras. The government is trying to promote greater competition, attacking some of the large monopolies in telecommunications and the media. This was a taboo topic in a country that is known for having some of the richest men on the planet thanks to their ability to collect monopoly rents. Finally, the Mexican government is boosting investment in public works, such as roads and ports. Mexico is clearly running against the clock. The high level of international liquidity is providing an opportunity for the Calderon Administration to work double-time and make up for the lack of progress during the last six years.

6 Responses to "Mexico: Mid-Year Update"

  1. Anonymous   June 11, 2007 at 9:51 am

    Last April the WSJ reported – based on a Molano study – a sharp fall in remittances from the US to Mexico and other Latin American countries due to the US housing slump. So Walter: how painful is this going to be for Mexico and the rest of Latin America?  Latin America Feels Pain Of U.S. Housing Slump By JOEL MILLMAN April 23, 2007; Page A2 WSJ  OAXACA, Mexico — The slowing U.S. housing market already has taken a bite out of the U.S. economy. Now, the fallout is spreading to Latin America.  That’s because home construction is the principal gateway industry for immigrants entering the U.S. labor market. Those immigrants contribute the lion’s share of the estimated $50 billion in cash sent annually from the U.S. to family members and others in countries south of the border. That tide of cash appears to be ebbing.  Monthly remittances from the U.S. to Mexico have dropped every month since their peak of $2.6 billion in May 2006 — shortly before new-home construction in the U.S. plunged. In February 2007, the latest month for which data are available, remittances to Mexico had slowed to $1.7 billion.  Mexico, Latin America’s remittance leader, may be a leading indicator of a trend unfolding across the continent. In a recent study of 15 Latin American economies tracked by BCP Securities of Greenwich, Conn., all but three showed better than a 90% correlation between the ebb and flow of U.S. housing starts and the swelling and shrinkage of remittances as recorded by the nations’ central banks.  “The contraction in remittances will dampen domestic consumption and hamper [economic] growth rates” in countries ranging from Mexico to Colombia to those in Central America, said the study’s author, BCP Securities economist Walter Molano.  The slowdown could be double trouble for Mexico, where the economy has already started to slow because of weaker growth across a wide array of American industries that depend on Mexico for parts or final assembly. U.S. gross domestic product, the widest measure of economic output, grew at an inflation-adjusted annual rate of 2.5% in the fourth quarter of last year and is widely expected to clock in at about 1.9% for the just-ended first quarter of 2007. (The Commerce Department will report its preliminary estimate of first-quarter GDP on Friday.)  The recent falloff in remittances reverses a long-standing trend in which a slowdown in Mexico’s economy led to an uptick in remittance revenue as Mexicans migrated north to replace jobs lost at home, Morgan Stanley’s chief Latin America economist Gray Newman says.  But with U.S. housing market slowing, that safety valve may close. “If continued, Mexico’s consumers could find themselves with less of a shock absorber, which has helped smooth out business cycles in recent years,” Mr. Newman wrote in a report last week.  Record low unemployment during the Clinton years helped draw undocumented Mexican workers, then mainly employed in agriculture, into construction and other service industries. With the housing boom, wage differentials, which used to favor farm work, started to tilt toward the building trades, attracting even more labor from Mexico.  Data showing what appear to be fewer illegal crossings at the U.S.-Mexico border adds to the evidence of a housing-related plunge in remittances. Apprehensions of attempted crossers are down just over 10% during the first quarter of this year from the same period in 2006, according to federal law enforcement. The Bush administration claims the decrease is because of tighter border security. But those on the Mexican side say traffic has slowed for a simpler reason: There are fewer jobs waiting for those who make it across.  The pain of a U.S. housing slump affects people such as Donato Diaz in the tiny village of Santa Gertrudis Zimatlan, in southern Oaxaca state. He returned from the U.S. in 2000 after spending more than a decade building homes in California’s sprawling suburbs. Mr. Diaz used the money he made there to build his own construction-supply store. However, its fortunes depend heavily on cash transfers from Mexicans still working up north to family members here, who use the money to improve their homes. [Going South]  Mr. Diaz’s business is suffering now. In 2003, he says, he bought a dump truck to haul sand to construction sites. During the past few years, the truck made seven or eight deliveries a day. Now? “We do two loads a day,” Mr. Diaz says with a sigh.  Between 2000 and 2006, almost 20,000 Hispanic laborers entered the U.S. construction work force in just one occupation: cement mason. Another 72,000 became drywall hangers and 140,000 more as painters, according to figures from the U.S. Bureau of Labor Statistics. The vast majority of these new job holders were foreign-born and crossed the border illegally, according to the Pew Hispanic Center in Washington.  As housing starts slow, recent hires on construction sites are the first to lose their jobs — and the first to warn relatives back home not to bother with a risky border crossing until the job picture improves. How many Mexican workers have lost their jobs? Most immigrants send an average of $1,000 a month back home, and Mexico’s remittances are down by about $600 million, representing earnings from about 600,000 workers.  Many of these workers rely on day-to-day employment through small, family-owned subcontractors, whose hirings and firings don’t surface in overall job-loss statistics.  Trouble in the U.S. housing market could also affect other industries staffed by immigrant labor. The carpet industry, for instance, is dominated by various nationalities at different points in the chain: Many Mexican workers are employed in factories that make rugs, Central Americans dominate the carpet-installation business and Brazilians have carved out a niche in rug cleaning.  Little wonder, then, that remittances from the U.S. are dropping off almost everywhere in Latin America. Brazil received $330 million in remittances from the U.S. in February compared with about $446 million per month on average a year ago. Monthly remittances to Guatemala, which peaked last May at $361 million, dropped to $271 million in February.  The slowing housing market also weighs on remittances in other ways. U.S. homeowners are likely to compensate for rising mortgage payments by cutting back on services that employ large numbers of immigrants, such as housecleaning, landscaping and laundry. Homeowners may also cut out frills such as visits to restaurants and beauty salons, big employers of immigrants.  As Gordon Hanson, a labor economist at the University of California at San Diego puts it: “Among nonessential expenditures that higher mortgage payments might eliminate, getting the nails done might be at the top of the list.”

  2. Walter Molano   June 15, 2007 at 4:14 am

    The contagion from the slump in the U.S. housing market will vary across Latin America. Some countries, such as Colombia. Mexico and most of Central America, depend heavily on remittances to balance their current account needs. A fall in remittances will leave them with an imbalance in the balance of payments, forcing them to reduce demand, devalue their currencies, increase their capital account inflows or draw down reserves. Other countries, such as Brazil, Argentina, Peru, Chile, Venezuela, do not depend on remittances to meet their current account needs. Therefore, the slowdown will not have much of an effect. Last of all, some countries witnessed housing bubbles that were offshoots of the U.S. boom. That was very much the case in Costa Rica, Panama, The Dominican Republic, the Mexican coasts and Colombia. The slowdown in the U.S. housing market will create similar slowdowns across those countries–with Panama being the most at risk.

  3. Guest   June 15, 2007 at 8:01 pm

    Mexico is in a terrible state. It’s declining Oil production will force Mexico to import oil. That means a drain in its foreign reserves. Which means a drop in the value of the Peso, which means less imports from the U.S. Btw wasn’t NAFTA going to help Mexico to keep its workers in Mexico? What ever happened to “we rather export products rather than people?