Mexico—Mixed Inflation Results until mid-Feb 09. External Trade Dynamics Turned for the Worse in Jan. 09 and the Capital Account Data showed the Negative Impact of the External Shock on Capital Flows in 4Q08
According to the central bank, headline CPI increased by 0.17% 2w/2w to 6.25% y/y and core inflation went up by 0.29% 2w/2w to 5.81% y/y during the first two weeks of Feb. 09. Both readings are within the CB target range for the 1Q09 (6.25% to 5.75%), but came in above our expectations (H: 0.11% 2w/2w; C: 0.23% 2w/2w) and that of the consensus (H: 0.16% 2w/w; C: 0.22% 2w/2w).
The non-core CPI continued decreasing; however, at a lesser pace than a year ago, mainly due to softer inflation in the agriculture category. That is, the prices of fruits and vegetables declined sharply (-3.1% 2w/2w vs. -3% 2w/2w in mid-Feb 08), but the effect was contained by elevated meat and egg prices (0.7% 2w/2w vs. 0.1% 2w/2w in mid-Feb 08). Inflation in the administrative and concerted category continued in a downward path due to a sharp decline in electricity costs (-1.2% 2w/2w), despite higher prices of natural gas and gasoline in northern Mexico. This indicates that seasonal factors and administrative measures continued helping non-core inflation.
Core CPI, however, continued moving higher compared to a year ago mainly because of higher inflation in the goods category (proxy for tradable goods inflation). The latter was impacted by a sharp increase in prices in the “others” subcategory (0.54% 2w/2w vs. 0.24% 2w/2w in mid-Feb 08), especially jewelry as well as personal and household goods, despite a positive surprise in the prices of processed food (0.14% 2w/2w vs. 0.21% 2w/2w in mid-Feb 08). The service category printed a marginal lower inflation as costs in the housing and “rest” subcomponents eased, and regardless of sharply higher inflation in education (0.25% 2w/2w vs. 0.13% 2w/w2 in mid-Feb 08). These results provide some evidence that the weaker MXN is having an effect on goods inflation; however, its impact is being diluted somewhat by lower commodity prices, which ca be seen in the prices of processed food. Moreover, falling domestic demand is keeping service inflation on a normalization pattern. We expect the impact of lower commodity prices and shrinking domestic demand to have a more pronounce effect in the upcoming months, provided that the pass-through effect from low international prices of commodities, especially food, on domestic prices accelerates.
As we have stated before, administrative measures, together with decelerating domestic demand and seasonal factors (except for education), continued easing inflationary pressures in the beginning of February. Although core inflation, especially goods CPI, is still moving higher, most likely due to the FX pass-through, we take some comfort that upward pressures on processed food prices eased. Moving forward, we maintain our view that inflation and inflation expectations will likely continue improving (headline: 3.7% y/y; core: 3.8% y/y by year end) and the central bank will probably stay in the easing course, as the output gap will keep widening and international prices of food and fuel will stay low. Overall, we still expect the CB to lower rates to 6% by mid-year; however, the pace of the easing cycle will be data-dependant and the probability that Banxico does not go that deep was raised after last Friday’s monetary policy action (for more detail please read The Week Ahead Feb 23rd to 27th).
On the external front, INEGI reported that the trade balance for Jan. 09 printed a deficit of USD 1.6bn (USD 1.9bn in Jan. 08), which was lower than our forecast (-USD 2.6bn) and that of the consensus (-USD 2.2bn). Imports decelerated sharply (-30% y/y vs. -6% y/y 3MMA) to USD 16.8bn as all categories plunged: consumer (-44% y/y vs. -8% y/y), intermediate (-30% y/y vs. -9% y/y 3MMA), and capital imports (-10% y/y vs. 10% y/y). Concurrently, exports shrunk swiftly by 32% y/y to USD 15.2bn (-13% y/y 3MMA), driven by deep contractions in oil (-54% y/y) and non-oil exports (-26% y/y). Falling oil prices (-53% y/y), and to a lesser extend lower oil export volume (-5% y/y), impacted crude exports. Moreover, non-oil exports declined rapidly, driven by a sharp contraction in manufacturing exports (-27% y/y vs. -7% y/y 3MMA), especially that of the auto industry (-50% y/y).
The current results marks a pronounced deterioration of Mexico’s external and growth dynamics as a consequence of the severe global and US economic slow down and low oil prices, as well as a rapidly fading domestic demand. In fact, total trade (exports plus imports) plunged by 31% y/y (-9% y/y 3MMA), which together with poor results in other activity-related indicators from the US (e.g. manufacturing output) and locally (auto data, retail sales, consumer confidence, oil output, and unemployment), indicates that Mexico’s economy contracted severely at the beginning of the year (-6.5% y/y in Jan. 09). In terms of monetary policy, this is clear evidence that demand-pull inflation pressures should continue moving to the downside, thus, providing Banxico with more room to maneuver.
Moreover, the current account balance printed a deficit of USD 6.2bn in 4Q08 (-USD 0.8bn in 4Q07), thus, swelling the total deficit to USD 15.5bn or 1.4% of GDP in 2008 from -USD 8.9bn or 0.9% of GDP in 2007. The 4Q08 print was better than our expectation (-USD 6.4bn), and that of the Bloomberg consensus (-USD 6.9bn).
In the 4Q08, a much wider trade deficit (-USD 8.2bn vs. -USD 2.9bn in 4Q07) was the main driver deteriorating the CAB dynamics, as expected. Net transfers, mostly family remittances, which for the last years have helped cushioned the CAB, showed a small decline (+USD 6.2bn vs. +USD 6.4bn in 4Q07) as poor economic and employment dynamics in the US further deteriorated the demand for workers of Mexican origin in the US. Moreover, the net non-factor service balance printed a slightly wider deficit (-USD 1.9bn vs. –USD 1.6bn in 4Q07) due to a drop in tourism (incoming -3.8% y/y; outgoing -2.8% y/y), and the net factor balance posted a narrower deficit (-USD 2.3bn vs. –USD 2.7bn in 4Q07) as a sharp drop in other expenses (-79% y/y) more than offset the fall in interest income (-24% y/y).
Meanwhile, the capital account posted a slightly wider surplus of USD 8.8bn in 4Q08 (+USD 8.6bn in 4Q07); therefore, bringing the capital account to a total surplus of USD 21bn or about 2% of GDP in 2008 (+USD 20.8bn or 2.2% of GDP in 2007). In the last quarter of 2008, a sharp increase in assets held abroad (+USD 12.6bn vs. -USD 4.7bn in 4Q07), in particular deposits in custody in foreign banks (+USD 8.1 vs. –USD 3.7bn in 4Q07), compensated the sharp decline in foreign investment (-USD 3.6bn vs. +USD 11.9bn in 4Q07). In the latter, FDI dropped to USD 2.2bn from USD 6.2bn in 4Q07. Moreover, portfolio investment fell to a deficit of USD 5bn from a surplus of USD 5.1bn a year earlier due to disinvestment in equities (-USD 1.1 vs. +USD 1.2bn in 4Q07) and money markets (-USD 3.9bn vs. +USD 3.9bn in 4Q07).
In sum, the current account deficit was fully financed by the capital account surplus in 2008, in particular foreign investment (USD 23.7bn). Although FDI declined sharply by 32% y/y to USD 18.6bn in 2008, it was sufficient to keep the BOP in positive territory. In 2009, the external shock and the gloomy global and domestic growth outlook should make the financing of a much wider current account deficit (-USD 25bn or 2.8% of GDP) a challenge. In this context, structural weakening pressures on the MXN are real; however, an appropriate counter-cyclical policy response to the current unfriendly context could help to ease excess volatility in the local currency, especially if economic policy is targeted to prepare the economy to get out of the slam as soon as conditions permit, or at least ease recessionary forces from abroad. Moreover, improving Mexico’s international competitiveness via structural reforms might be considered though the upcoming mid-term elections are a challenge to this alternative.