Mexico - Economic Briefing August 2003

No Recovery Possible Without Rebound in Demand from the U.S.

Despite a favourable monetary setting – interest rates have dropped to new historic lows – the Mexican economy remains far from a recovery, as the slump in the manufacturing industry proves more persistent than expected. Heavily dependent on demand from the U.S. economy and facing stiff competition from manufacturing facility build-ups in China, the manufacturing sector is experiencing a protracted recession, precluding a robust rebound of the overall economy.

Economic growth below expectations
In May, economic activity remained unchanged over the same month last year, according to the global indicator for economic activity (IGAE, Indicador Global de la Actividad Económica). The actual reading was well below last month’s Consensus Forecast, which had the economy growing by an annual rate of 1.0%, but was ahead of the 0.9% contraction observed in April. However, seasonally factors distorted the improvement in the annual growth rate from April to May. According to seasonally adjusted data, the economy expanded 0.47% over the preceding month in April but declined 0.53% in May.

Continued recession in manufacturing industry forestalls recovery
The slump in the manufacturing industry remains the core problem facing the Mexican economy. Heavily dependent on demand from the U.S. economy and facing stiff competition from manufacturing facility build-ups in China, the sector is experiencing a protracted recession. Despite hopeful signs in the first quarter this year, when the sector -- helped by a weak comparison base in the prior year -- expanded by almost 1%, the manufacturing industry bounced back into negative territory in the second quarter, with contractions of 6.9% in April and 3.5% in May. Other constituents of the industrial sector, namely mining, construction as well as electricity, gas and water continue to grow, albeit at very meagre rates, which are insufficient to make up for lacklustre demand from the United States. Hence, total industrial output dropped 2.3% in May (April: -4.8% year-on-year). Agriculture expanded at an annual rate of 0.6% in May (April: +2.7% year-on-year) and services added 1.1% (April: +0.6% yoy).

Investment activity continues to decline in May
In the light of the weak outlook for the Mexican economy, businesses are ever more reluctant to embark on new projects. Accordingly, investment activity remains deeply mired in recession. In May, gross fixed investment dropped 5.3% over the same month last year, only marginally better than the 5.8% contraction observed in April. The decline is particularly pronounced in machinery and equipment, where activity dropped by a double-digit rate for the second consecutive month; construction activity, on the other hand, still managed to remain in positive territory.

Unemployment shoots upward in June
Unemployment data for June confirm the dismal state of the Mexican economy. In June, open unemployment shot up to 3.2% from 2.7% recorded for May, the highest rate in more than four years. The unexpected surge is the strongest since January this year, when unemployment rose over the preceding month due to seasonal factors. In seasonal adjusted terms, the increase was the highest since 1995, when the Mexican labour market adjusted to the impact of the Peso crisis. On 5 August, the National Statistical Institute (INEGI) reported that coincident and leading indicators also took a nosedive in May after a positive reading in April. The only positive news came from INEGI’s consumer confidence index. At 100.5, the index for July was a notch better than the June reading. However, the trend of diminishing increases in the past months is alarming and if continued, consumer confidence will drop in August.

Outlook cut yet again amid weaker than expected second quarter
Owing to the disappointing economic indicators for April and May, the Central Bank expects gross domestic product (GDP) to have expanded a meagre 0.3% in the second quarter over the same period last year, which would imply an annual growth rate between 1.7% and 1.9% in June. The Central Bank also lowered its 2003 GDP forecast from the previous 2.4% to 2.0%. The downward revision represents the second cut this year and reflects the latest weakness observed in manufacturing and employment. The new Central Bank forecast is now a full percentage point below the official government growth projection for this year, which is still at 3.0%. However, officials from the Finance Ministry have indicated that the government might reduce the current growth projection “close to the Consensus” following the release of second quarter growth figures on 15 August. Meanwhile, the Consensus continues to slide, as the weak second quarter renders a more pronounced recovery in second half of the year more unlikely. Compared to last month’s expectation, Consensus Forecast panellists have cut yet another 0.3 percentage points from the 2003 GDP outlook, expecting the economy to expand only 1.7% this year. In addition, the chances for a solid rebound the next year are also dimming, as reflected by yet another downgrade to the 2004 outlook by 0.2 percentage points to the current 3.5%.