MEXICO PREPARES FOR NEGATIVE ECONOMIC IMPACTS FROM IRAQ WAR.

The Mexican government is preparing for negative fallout from the war in Iraq, including a downturn in the economy and a deterioration in relations with the US.

The negative economic forecasts are linked directly to an expected poor economic performance in the US, whose GDP growth could be restricted by high interest rates and a projected budget deficit during the next several months.

The US economy has yet to recover fully from the impact of the attacks on the World Trade Center in New York and the Pentagon in Washington in September 2001, and that trend is expected to continue for some time. In its most recent report on the US economy, the US Commerce Department reported a "disappointing" GDP growth of 1.4% for the fourth quarter of the year, a result of slow consumer spending and a decline in exports.

The expected decline in the US economy during the next several months could continue to put pressure on Mexico, which depended on the US for 90% of its US$161 billion in exports in 2002. The US was also a major source of the more than US$13 billion in direct foreign investment that entered the country last year.

Economists reduce GDP forecasts

The war in Iraq has led most private economists to reduce their forecasts for Mexico's GDP growth in 2003. "If the armed conflict lasts three to five months, US GDP growth will be limited to 1% this year, which would put Mexico's growth at between zero and less than 1%," said Gerardo Cruz Vasconselos of the Instituto Mexicano de Ejecutivos de Finanzas (IMEF).

Even with a short war, most economists now doubt that Mexico will attain the 3% GDP growth target of President Vicente Fox's administration for this year. Mexico attained GDP growth of only 0.9% in 2002.

Analysts at BBVA Bancomer said a prolonged conflict in Iraq could cost the US Treasury as much as US$300 billion. "This would increase the US deficit and affect growth in the US and Mexico," said BBVA Bancomer.

Economist Raul Feliz of the Centro de Investigacion y Docencia Economica (CIDE) said economic fundamentals are strong enough for Mexico to attain a GDP growth of 2.6% this year if the war concludes soon, although a prolonged war could reduce the country's annual growth rate to about 1.5%.

Still, the Mexican business community remains pessimistic about economic prospects for this year. The monthly survey conducted by the Banco de Mexico (central bank) during March showed a decline in forecasts for GDP growth and an increase in inflation relative to those in the February survey. The survey among 30 organizations engaged in business analysis showed an average forecast for GDP growth of 2.5%, compared with about 2.8% in February. Annual inflation is now projected at 4.38%, compared with 4.27% in February.

The government has yet to release official data for the first quarter of the year, although the official statistics agency (Instituto Nacional de Estadicas, Geografia e Informatica, INEGI) reported a contraction of 0.23% in Mexico's GDP during January.

The Camara Nacional de la Industria de Transformacion (CANACINTRA), the organization most tied to manufacturing, says the Mexican economy has remained in a slump for the entire quarter. CANACINTRA estimates Mexico's GDP declined by 0.3% in January-March, which resulted in the loss about 25,000 jobs in Mexico.

The concerns of the private sector have not swayed the Secretaria de Hacienda y Credito Publico (SHCP), which insisted in a report released at the end of March that Mexico would still attain a 3% GDP growth this year.

In interviews with the Mexico City daily newspaper La Jornada, SHCP officials said it was "premature" to make new projections for 2003, because the trends for the international economy were not clear for the rest of the year. "For the moment, it is realistic to maintain our target of 3% GDP growth for this year," the SHCP officials said.

Exports expected to decline because of US slowdown

The government's foreign trade bank (Banco Nacional de Comercio Exterior, BANCOMEXT) is adopting a mixed stance regarding Mexico's exports.

The agency is not anticipating a reduction in demand for Mexican products as a direct result of the war in Iraq. "A prolonged economic slowdown will be a greater factor in slowing Mexican exports than the war itself," said Elena Espinosa, who manages BANCOMEXT's European desk.

Still, BANCOMEXT director Jose Luis Romero Hicks said the Fox administration's goal to increase Mexican exports by 4% this year may be in jeopardy because of the war.

Economy Secretary Fernando Canales Clariond was more blunt, predicting that the war would affect six economic sectors that account for 80% of Mexico's exports. Those sectors are electronics, automobiles, auto parts, textiles, footwear, and construction.

Some analysts said the government's report on balance of trade for February already showed some disturbing patterns. Economist Mario Correa of Scotiabank Inverlat was especially concerned about the 14.5% decline in imports of capital goods, which he said was an indication of reduced levels of direct investment.

The report also contained a misleading picture regarding Mexico's exports. The data showed Mexico attained its first trade surplus in four years, but the surge in exports was mostly the result of sharply higher oil prices. The value of oil exports was reported at US$1.66 billion, partly in anticipation of the war in Iraq.

Private and government economists admit that Mexico is taking a huge risk by continuing to tie its economy to the global oil market. Even though prices could eventually reach US$40 per barrel because of the war in Iraq, the market could collapse just as quickly if the global situation stabilizes.

"The impact of the war on Iraq is more uncertain for Mexico than for other parts of the world," officials for the Inter-American Development Bank (IDB) said recently. "The high price of oil will not be sufficient to compensate for a decline in other exports."

For now, Mexico is taking advantage of the high oil prices to build up its reserves of foreign currency. The reserves, which have risen to more than US$50 billion, could provide a buffer against an economic collapse similar to the one that followed the devaluation of the peso in 1994.

Manufacturing, tourism feel pinch

Some sectors like the maquiladora industry are expected to suffer more directly from an extended US economic slowdown and other factors related to the war. The maquiladora sector has been unable to emerge from a prolonged slump since the end of 2000 (see SourceMex, 2001-08-22 and 2002-05-28).

The Consejo Nacional de la Industria Maquiladora de Exportacion (CNIME) said the sector reported zero growth in the first quarter of the year, along with the transfer of 15 plants to other countries and the loss of 15,000 jobs. "We expect this trend to continue for the rest of the year," said CNIME president Daniel Romo Mejia.

The problems for the maquiladora sector are compounded by the increased security measures implemented by the US government at the US-Mexico border in anticipation of the attack on Iraq. Code Orange, the second-highest of five levels of alert imposed by the US Department of Homeland Security, has caused major slowdowns in the flow of goods across the US-Mexico border.

The slowdowns have prompted protests from Mexican transportation companies, manufacturers, and produce exporters that are directly affected by the measure because more than 80% of Mexico's exports to the US are shipped by land. Manuel Gomez, president of the Camara Nacional de Autotransporte de Carga (CANACAR), said his industry stands to lose about US$300,000 daily as a result of the increased restrictions.

Similar complaints come from the Confederacion Nacional de Propietarios Rurales (CNPR), which said restrictions have affected shipments of tomatoes, onions, and fruit, which are moved to the US market via Arizona and California.

"The threat of terrorist attacks provides a convenient excuse for the US to impose protectionist measures," said Cristina Rosas, a researcher at Universidad Nacional Autonoma de Mexico (UNAM).

The tighter security measures have also affected government revenues. Revenues collected by the Caminos y Puentes Federales (CAPUFE) from pedestrians and vehicles seeking to cross into the US declined by 20% to 25% on the first day that the Orange Alert was implemented, a CAPUFE regional director told the official news agency Notimex.

US President George W. Bush's administration recently took other security measures at the US-Mexico border that affect Mexican citizens, such as empowering the Federal Bureau of Investigation (FBI) with the authority to detain and question any undocumented immigrants who attempt to cross the border.

Mexico's tourism industry, which had mixed results in 2002, is beginning to experience a slump this year because of the US economic slowdown and concerns that airlines and tourist resorts could become a target for retaliatory acts by sympathizers of Iraq.

Some Mexican tourism officials believe an extended war could have devastating consequences for the industry, which accounts for 10% of Mexico's GDP and employs about 2 million workers.

The Asociacion Mexicana de Hoteles y Moteles (AMHM) said concerns about travel have affected both domestic and international tourism since the US attacked Iraq. AMHM president Miguel Torruco Marques said the industry estimates losses could mount to US$750 million this year if activity does not pick up. Torruco said cities along the US-Mexico border are experiencing the largest decline in the number of visitors. For example, tourist activity is down about 30% in Tijuana, compared with the country's average of about 10%, the AMHM president said.

Some sectors that rely on tourism, such as aviation, are already feeling a major negative impact from the Iraq war. Mexican airlines reported losses of US$100 million during March, in large part because of a reduction in passenger traffic between the US and Mexico.

Mexican businesses concerned about US retaliation

The weak economic expectations are accompanied by concerns that the US government could somehow retaliate economically or politically against Mexico for not supporting a resolution in the UN Security Council backing the war against Iraq.

Among the chief concerns is that the Bush administration will punish Mexico by further delaying negotiation of an immigration agreement (see SourceMex, 2003-02-26).

The Fox administration's efforts to negotiate access for Mexican trucks to the US and limits on US exports of high- fructose corn syrup to Mexico are also expected to remain on the back burner for some time.

US officials have given mixed signals about any future actions the US might take against Mexico. Tony Garza, US ambassador to Mexico, hinted that a lack of support for the US position on Iraq could bring negative consequences for the Fox administration. "Will American attitudes be placated by half-steps or three-quarter steps? I kind of doubt it," said Garza in response to the reports that Mexico planned to abstain if the US had succeeded in having the UN Security Council take another vote on Iraq, prior to the war's onset.

Other administration sources offered reassurances that the US-Mexico relationship would change little. "The United States and Mexico have a broad and very deep relationship, and that relationship will certainly continue," said Sean McCormack, a spokesman for the Bush administration's National Security Council (NSC).

Mexico is assisting with US security efforts along the US-Mexico border by dispatching 18,000 soldiers to secure airports, seaports, border posts, and bridges with direct links to the US. This move is unprecedented because Mexico has never used its army to help defend its neighbor to the north. "It's a new mission: Mexico looking out for the United States," one Mexican army officer said.

The business sector had initially urged Fox to support the US position to avoid economic retaliation.

Fox declined to follow this course, instead reassuring businesses that the US had no intention of punishing Mexico. "Our relationship with the United States, our closest partner, our neighbor and friend, should not change," Fox said.

A coalition of business organizations eventually threw its support behind Fox's position but also signed a joint declaration asking for the president to work with the US to avoid retaliation. The statement was signed by the leaders of CANACINTRA, the Confederacion Patronal Mexicana (COPARMEX), the Confederacion de Camaras Nacionales de Comercio (CONCANACO), and the Consejo Coordinador Empresarial (CCE).

Even with the reassurances that the US would not retaliate against Mexico, there were rumors that US officials were working behind the scenes to undermine the Mexican delegation at the UN. One report suggested that the US was pressuring Fox to replace Mexico's UN Ambassador Adolfo Aguilar Zinser and expel key Iraqi diplomats from Mexico.

US officials immediately denied the reports, but some Mexican opposition senators said they had no doubt there was US pressure. "Mexico should not accept under any circumstances these types of pressures," said Sen. Jesus Ortega of the center-left Partido de la Revolucion Democratica (PRD).

The reports prompted senators from the three major political parties to offer a vote of confidence to Aguilar Zinser.

Fox's office also issued a statement saying that the president had no intention of removing Aguilar Zinser from the post.

Aguilar Zinser was recalled to Mexico City in late March, but only to consult with Fox and Foreign Relations Secretary Ernesto Derbez about Mexico's strategy in upcoming weeks. Mexico will have special influence in its temporary role as president of the UN Security Council during April. The presidency of the council is rotated each month among its members.

Derbez said Mexico will use its position to seek a new unity in the council. "We will try to get the council working again, to come up with resolutions by consensus that are positive [for Iraq and its people], said the foreign relations secretary. (Sources: The Boston Globe, The Washington Post, 03/12/03; The New York Times, 03/12/03, 03/23/03; Epoca, 02/17/03, 03/24/03; Reuters, 02/13/03, 02/17/03, 03/05/03, 03/12/03, 03/20/03, 03/22/03, 03/27/03; Los Angeles Times, 02/26/03, 03/28/03; The Dallas Morning News, 02/15/03, 03/13/03, 03/19/03, 03/21/03, 03/29/03; Associated Press, 03/11/03, 03/15/03, 03/18/03, 03/23/03, 03/27/03, 03/28/03, 03/31/03; CNI en Linea, 03/31/03; Notimex, 02/25/03, 03/25/03, 03/30/03, 04/01/03; El Sol de Mexico, 02/26/03, 03/26/03, 03/31/03, 04/01/03; Spanish news service EFE, 03/18/03, 03/21/03, 03/27/03, 03/31/03, 04/01/03; Agencia de noticias Proceso, 02/25/03, 03/18/03, 03/19/03, 03/24-26/03, 03/28/03, 03/31/03, 04/01/03; La Cronica de Hoy, 02/14/03, 02/17/03, 02/20/03, 02/26/03, 02/27/03, 03/12/03, 03/14/03, 03/20/03, 03/24-28/03, 04/01/03, 04/02/03; El Financiero, 02/14/03, 02/21/03, 03/04-06/03, 03/14/03, 03/19/03, 03/21/03, 03/24-28/03, 04/01/03, 04/02/03; Milenio Diario, 02/21/03, 02/26-28/03, 03/27/03, 03/28/03, 03/31/03, 04/01/03, 04/02/03; El Universal, 02/25/03, 02/28/03, 03/12/03, 03/13/03, 03/20/03, 03/25/03, 03/26/03, 03/28/03, 03/31/03, 04/01/03, 04/02/03; La Jornada, 02/26/03, 03/03/03, 03/13/03, 03/14/03, 03/19-21/03, 03/25-28/03, 03/31/03, 04/01/03, 04/02/03; Reforma, 03/12/03, 03/13/03, 03/17/03, 03/19-21/03, 03/24/03, 03/26-28/03, 03/31/03, 04/01/03, 04/02/03)