Health crisis
FORECASTSThe Covid-19 pandemic is still not under control in Mexico. The state of emergency to combat the health crisis declared at the end of March, along with most of the restrictions and support measures, were still in place in early July.
DROP IN INVESTMENTYet the government’s apparently contradictory decisions have maintained some confusion within the population. Despite the state of emergency, lockdown measures were set up later than in the other countries in the region, and they were never strictly enforced. The number of tests was also limited. On 14 May, the government began to gradually lift the lockdown measures, and each state was allowed to reopen based on a 4-colour coding system (green, yellow, orange and red, based on the virus’ spread and hospital occupancy rates). On 9 July, 14 states (including Mexico City) were still coded red and the 18 others were orange. Red states should have maximum lockdown restrictions, but in some states, including Mexico City, certain activities have reopened since mid-June, including public transport, factories and retail stores. The government also extended the list of “essential businesses” to allow key sectors such as construction and automobiles to reopen again.
All in all, the country reported more than 4000 new cases a day during the month of June, and this pace has accelerated since the beginning of July. The total number of cases per million inhabitants is about 2400, and Mexico ranks 59th among the hard hit countries.
Severe recession in 2020
Economic prospects have deteriorated continuously since the beginning of the year. Mexico is expected to be hit by a very severe recession in 2020, with real GDP contracting by more than 8%. A combination of factors is placing a heavy strain on economic activity, notably the impact of lockdown measures on domestic demand, the drop-off in oil prices, supply chain disruptions, the desynchronization of global value chains and the decline in external demand (mainly from the United States, which accounted for more than 80% of total exports in 2019). After contracting 1.4% q/q in Q1 2020 (-2.2% y/y), GDP plummeted in April (-19.9% y/y, according to the central bank’s economic indicator) and industrial output fell by nearly 30% (-35% for manufacturing production alone).
The central bank’s economic support measures will not be enough to absorb the shock. Since the beginning of the year, the key rate has been cut by a total of 225 basis points to 5%. Several measures were introduced to support liquidity as well as the most vulnerable households and companies, for the equivalent of 3.3% of GDP. Other measures could be announced before the end of the year (several more key rate cuts are expected).
From a fiscal perspective, in contrast, the government has yet to announce a massive economic stimulus plan, unlike the region’s other countries. The government had sufficient fiscal policy leeway at the beginning of the crisis: over the past five years, the public deficit has averaged 2% (2.3% in 2019) and public debt has held below 55% of GDP since 2017. The decision not to stimulate the economy reflects the electoral promise of President Andres Manuel Lopes Obrador (AMLO), who pledged to maintain fiscal austerity. Even if a recovery plan were to be launched in the months ahead, it is bound to be limited in size (less than 1% of GDP).
Limited capacity for a rebound
Growth prospects have diminished considerably for 2021 and beyond. Without a government stimulus package, domestic demand will falter. Moreover, the Mexican economy has already been slowing since year-end 2018 (GDP contracted 0.3% in 2019) and the factors behind the slowdown will continue to strain growth. Since taking power, the new government’s messages have been contradictory, making it difficult to interpret economic policy. Uncertainty over the participation of private players in the energy sector reform and in the vast infrastructure plan presented in early 2020 has helped erode the business climate. As a result, investment has declined constantly since November 2018. This decline accelerated from -5% in 2019 to -7% in Q1 2020 (-9.4% y/y in March). Net inflows of foreign direct investment (FDI) have also dwindled since mid-2018 (to an average of 2% of GDP since Q2 2018, from an average of 2.3% between 2014 and early 2018).
According to the IMF, the benefits of reopening supply chains and the start-up of the new trade agreement with the United States and Canada (effective 20 July) will not offset the negative impact of declining investment and uncertainty over economy policy decisions for the next two years. In its revised forecast released on 24 June, the IMF lowered its growth outlook for Mexico to -10.5% in 2020 and +3.3% in 2021, from -6.6% and 3%, respectively, in its previous forecast published in April.
Alarming public finances
FDI INFLOWS SLOWDOWNSimilarly, public finance trends are alarming in the short to medium term. The slowdown in economic activity and the drop-off in oil prices should drive up the public deficit to more than 5% of GDP in 2020 (from 2.3% in 2019). Moreover, it could prove to be very difficult to consolidate public finances once the crisis is over.
On taking power, the new government set several policy goals, including investing massively in Pemex, the state-owned oil giant; developing social welfare programmes; and increasing social welfare spending and public investment, while at the same time maintaining fiscal austerity. These objectives, which seemed hard to reconcile and accomplish before the crisis, now seem almost impossible.
Meanwhile, the financial and operational situation of the oil giant Pemex continues to deteriorate[1]. Plummeting oil prices only aggravated the group’s liquidity needs, and the government will have to step in repeatedly to provide substantial financial support in the months ahead, putting an additional squeeze on public finances in 2020 and 2021. According to Moody’s estimates at the end of April 2020 (based on the assumption that oil prices would average USD 50 a barrel in 2021 and USD 37 a barrel in 2022), the financial support that Pemex would need simply to cover its liquidity needs and the refinancing of debt reaching maturity (excluding investments initially provided for in the July 2019 development plan) should account for between 0.5% and 1.8% of GDP each year between 2020 and 2022. After integrating part of the planned investment, the necessary financial support would range between 1.5% and 2.8% of GDP.
In 2020, the government should be able to avoid borrowing further on the financial markets by drawing on its sovereign fund. Yet there will not be enough funds left over to renew the operation in 2021. Even if a presidential decree authorises the government to draw on other funds for the equivalent of 3% of GDP, the public debt ratio is likely to swell to more than 50% of GDP in 2020. Mexican debt is also exposed to changes in investor sentiment, since more than 30% of domestic debt (denominated in the local currency) is held by non-resident investors.
