Mexico - Economic Briefing March 2003

War Concerns Cloud Outlook (continued)

Peso continues to loose further ground amid concerns about impact of weaker U.S. growth in Iraq war
In February, the peso continued the weakening trend observed in recent months but at a slower pace than in December 2002 and in January. After having lost 2.4% of its value in December 2002 and 4.7% in January 2003, the rate of nominal devaluation slowed to 1.0%, as the peso finished the month just a notch above the 11 pesos per US$ mark. The Central Bank is unlikely to intervene in the foreign exchange market, even though it is legally entitled to do so. However, the monetary authorities involved in such a decision have repeatedly declared that Mexico would not intervene directly. Moreover, the current exchange rate weakness is likely to be temporary, as it is driven by concerns about a war with Iraq. A Middle East conflict, so the argument goes, could further impede U.S. economic growth. Given the high Mexican dependence on the U.S. market as a destination for exports and the increasing importance of exports in the economy as a whole, market participants fear that a blow to the U.S. would feed through to an even greater economic shock in Mexico. Since this logic also works the reverse, Consensus Forecast panellists remain optimistic that the currency will recover lost ground towards the end of the year, as the anticipated recovery in the U.S. takes a firmer hold. The Consensus sees the currency finishing 2003 at 10.83 pesos to the US$, compared to 10.68 pesos to the US$ expected last month.

Current account deficit shrinks in Q4
What is bad news for the currency comes in handy for the country’s external balances. In times where the Mexican economy faces stiff competition from China as a manufacturing base for labour intensive goods, a more competitive exchange rate is particularly welcome. In the final quarter of 2002, the current account incurred a deficit of US$ 4.7 billion. While this exceeded the third quarter deficit of US$ 3.1 billion, the figure was well below the US$ 6.2 billion deficit reached in the same period 2001. In fact, last year, every single quarter resulted in a lower current account deficit compared to the prior-year period. Consequently, the annual current account deficit dropped from US$ 18.0 billion in 2001 to US$ 14.1 billion in 2002, or from 2.9% to 2.2% of GDP. For this year, the Consensus expects this trend to revert again with the current account deficit reaching US$ 17.9 billion, as the resumption of domestic activity will rekindle imports at a faster pace than exports.