There is a saying that goes, ‘When the U.S. sneezes, Mexico catches a cold.’ However, the U.S. economy is coughing, but Mexico is hale and hearty. The divergence from previous patterns is attributed to structural factors affecting the U.S. economy, higher oil prices and the stewardship of the Calderon Administration. To begin with, the torrential rise in medical and pharmaceutical benefits in the U.S., as well as the economic slowdown, are squeezing manufacturers, thus forcing them to decamp to neighboring countries with more business-friendly environments. The transformation is most evident in the automotive sector, where U.S. manufacturers continue to close factories north of the Rio Grande. Ford recently announced a $3 billion investment in Mexico to covert its truck assembly plants into factories that will produce its new Fiesta vehicle. The fuel-efficient car, which was developed in Europe, will soon double Ford’s Mexican exports to the U.S. The same is occurring in other U.S. manufacturing sectors, such as aerospace. This is the reason why Mexican exports continue to grow, despite the U.S. malaise. It is also the reason why Mexico’s current account deficit during the first quarter was less than $1.5 billion, more than half of the initial forecast. Hence, Mexico is weathering the external storm.
Soaring oil prices are also helping. The 40% increase in crude prices since the start of the year was an important factor in reducing the trade deficit to $61 million in May, versus expectations of a $300 million shortfall. The amazing thing is that Mexican oil production is falling. Daily petroleum output fell 10% y/y in May to 2.79 million barrels of oil. However, production at the Cantarell field plunged 38% y/y during the same period to a less than 1 million barrels of oil per day. This is the reason why the Calderon Administration is fighting to overhaul the energy sector. Unfortunately, the measures are mired in congress. The reforms require constitutional changes that will allow foreign participation in the energy sector, but some political and labor groups will be adversely affected since they will have to surrender a large part of the royalties they are currently receiving. Nevertheless, failure to implement the reforms will eventually lead to the collapse of the energy sector and a blow to the country’s balance of payments. This is why many Mexican analysts are still optimistic that the two sides will reach a compromise.
The prudent management of the Mexican economy by the Calderon Administration is another reason why the country is averting the fallout from the meltdown on its northern border. Finance Minister Agustin Carstens and Central Bank President Guillermo Ortiz are a virtual dream team of Latin American policymaking. The government continues to keep the fiscal accounts in check, through the implementation of new tax reforms. At the same time, the central bank is tightening monetary policy to keep a tight grip on consumer prices. Banxico recently hiked interest rates a quarter of a point to 8%. Although consumer prices rose 5.26% y/y in June, they were among the lowest in the region. Unfortunately, the major risks for Mexico do not lie north of its border. They sit within its confines and on its southern flank.
President Uribe’s success in dismantling the FARC and the various drug cartels, forced the narcotics industry to look for new grounds. The problem is that it decamped for Mexico, transforming the country into a virtual battle ground. Government figures report that there were more than 4,700 drug-related murders during the last two years. Judges, policemen and newspaper reporters are massacred on a regular basis, destroying the social fabric in the same way that Colombia suffered for the last two decades. There is not much that Mexico can do, other than to take a hard line against the illegal elements. Hopefully, the economic problems in the U.S. will reduce the level of disposable income for consumers, depressing the demand for all legal and illegal substances. Other than that, Mexico is doing well. A series of external effects and sound policymaking is allowing Mexico to avert the problems it experienced in the past when the U.S. economy entered a downturn.