The dropout in economic activity resulting from the 11 September attacks are catching Mexico in the middle of a severe slump, as the economy adjusts to lower demand from the US.  Moreover, no other economy in Latin America – and perhaps in the world -- will suffer as much by the additional decline in the US provoked by the attacks.  In addition, the erosion of oil-related public sector revenues will reinforce the need to push through the much-awaited fiscal reform through opposition-dominated Congress.

Terrorist attacks deal harsh blow to Mexican economy
With the exception of Canada, perhaps no other country has felt the consequences of the 11 September terrorist attacks in the United States as directly as Mexico.  The spillover effects from the temporary halt in the US economy are manifold and have affected a number of sectors in the Mexican economy, ranging from airlines, transportation and tourism to manufacturing.  As in other countries, the airline industry has suffered a major blow amid stalled flights to the United States during the three days following the attacks.  Border industries in Mexico have been particularly hard hit by the attacks as tightened U.S. security boosted transportation costs and slowed output.  Officials closed land borders to Mexico for hours in the immediate aftermath of the 11 September events and upon reopening, the U.S. Customs Service significantly increased security checks.  The border delays resulted in production slowdowns at various companies producing in the maquiladora industry as they waited for shipments of inputs.   While longer term impact of the delays is not yet clear, businesses are likely to have to evaluate the efficiency of continued cross-border operations.  Next to the immediate impact, which will be reflected notably in September output numbers, Mexico also faces a number of blows to economic growth resulting from the terrorist attacks that will unfold subsequently: 

1.  US slowdown will further reduce export growth.  With 88.9% of total exports directed to the United States (2000 figures) Mexico is not only the most US-dependent economy in the region but also worldwide.  The aforementioned short-term frictions in bilateral trade should subside shortly (and may even trigger some extra growth in October exports as companies work off pent-up demand). However, higher costs in cross-border business via increased transportation costs and insurance fees are likely to become a more permanent part of the aftermath and may diminish the appetite of US businesses to establish production facilities in lower labour cost Mexico.  The potential impact on medium-term dynamism of bilateral trade growth depends on how the US reconciles increased security concerns with the proclaimed objective to intensify the economic relations between the two countries.  However, the reduction in US business and consumer demand for Mexican made goods will be more important to watch in the months ahead.  The anticipated global demand softening will exacerbate the expected drop in US demand and will add to the already existing slump in Mexico’s external sector.  According to the most recent trade data, the moving 12-month accumulative exports have reached US$ 165.2 billion in August, still higher than the amount registered in the same period last year, but the annualised growth rate in exports has dropped to 4.9%, the lowest rate since 1992.  Moreover, the trend in export growth is worsening.  In August, exports dropped a staggering 11.9% year-over-year, which represents the worst performance since 1986.  As a result, panellists have adjusted their forecasts for export growth forecasts for 2001 and 2002 dramatically downward.

 2.  Drop in oil price lowers public sector revenues and highlights need for fiscal reform.  As one of the region’s main oil-exporting nations, Mexico will also suffer from the plunge in oil prices observed in the aftermath of the attacks.  In 2000, oil revenues accounted for 9.8% of total exports.  More importantly, oil related revenues accounted for 36.1% of total public sector revenues.  Thus, a continued slump in oil prices could threaten the 0.65% of GDP fiscal deficit target for 2001.  However, while the price for the Mexican oil mix dropped slightly below the 2001 budgeted price of US$ 18 per barrel at the end of September, the year-to-date average price still remains 10.2% above that threshold.  Rather than endangering this year’s fiscal deficit target, a persistently subdued oil price may force the government to push for an excessively tight 2002 budget, which could exert further downward pressure on the economy.  Therefore, the administration may decide to step up its effort to press for the comprehensive fiscal reform, stalled in Congress for months now.  President Fox is confident that the government will reach an agreement with the key opposition Party of Institutional Revolution (PRI), whose support is essential to legislative approval of the bill.  Progress, however, may be contingent on surrendering a key piece of the government proposal, namely the application of the value-added tax (VAT) to food and medicine.  However, even if the current bill is watered down by concessions to the opposition, the tax reform would boost government revenues by the equivalent of 1.5% of GDP and could thus enable the government to advance on other key policy agenda items.  Panellists expect the government to exceed the fiscal deficit this year but are more optimistic for the coming year.

Note:  The above text is an abridged version of the LatinFocus Consensus Forecast briefing on Mexico.  For more details please click here.

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