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Mexico has suffered its most severe recession since the 1994 currency crisis. Real GDP fell by 9.7% year-on-year in the second quarter of 2009, reflecting lower oil prices and lower exports, the outbreak of influenza and declining tourism revenues and worker remittances. Supported by the rebound in oil prices and increasing exports to the United States, the fail in activity slowed down and activity is now starting to recover. As monetary and fiscal stimulus are gaining traction, the recession is projected to bottom out in the third quarter of 2009 and GDP growth should rise gradually in 2010.

The central bank has reduced the policy rate from 8.25 to 4.5% since February 2009 and the government implemented a fiscal stimulus package amounting to around 1.6% of GDP. Going forward, the central bank will have little room for further monetary easing as inflation is projected to remain close to the upper bound of its inflation target range. The automatic fiscal stabilisers should be allowed to work freely in 2010, but the fiscal stimulus should be gradually withdrawn if the recovery takes hold as projected. Consolidation measures proposed by the government to contain revenue shortfalls are necessary to avoid adverse financial market reactions.

The recession is deep but some indicators are pointing upward

The collapse in world trade has hit Mexico hard through a sharp decline in oil prices and plummeting manufacturing exports to the United States. Output has contracted for four consecutive quarters, with the cumulative loss in output reaching around 10%, and unemployment is rising fast. Recently released indicators suggest that output may have bottomed out in the summer of 2009. Exports, in particular to the United States, are increasing and oil prices hate picked up, contributing to an improvement in the current account balance.

The planned fiscal consolidation is necessary

The authorities have implemented fiscal stimulus measures that amount to around 1.6% of GDP in 2009, including additional infrastructure spending, temporary employment subsidies, increases in social transfers and a freeze of energy prices. The measures are fully financed by revenues from an oil price hedge and the sale of assets in the oil stabilisation funds. The 2010 budget proposal foresees a deficit of 0.5% of GDP, which corresponds broadly to the cyclical shortfall of fiscal revenues. This allows the automatic stabilisers to operate freely and will support the economic recovery. The 2010 budget proposal incorporates consolidation measures --mainly tax increases, with spending cuts par fly offset by higher social transfers for the poorest--that address the permanent shortfall in fiscal revenues due to lower projected oil production. With two of the three major debt rating agencies signalling a negative outlook, the risks from adverse market reactions of a larger deficit in 2010 justify the consolidation measures, especially as economic prospects appear to be brightening. As activity gathers momentum, the government foresees the budget deficit to narrow to -0.3% of GDP in 2011.


The central bank has eased the stance of monetary policy

Since February the central bank has reduced the policy rate by 375 basis points. Despite a large and widening output gap, core inflation has remained high and started to co me down only in March 2009. With both headline and core inflation still well above the central bank target of 2-4% in September, the central bank will have little room to r educe the policy rate further. Against the background of the appreciation of the peso with respect to the US dollar over the past six months, the monetary stimulus to the economy remains relatively weak and should not be withdrawn before the recovery is well under way, probably in mid-2010. Given the large output gap, the planned increase of the value-added tax rate by 1% in 2010 as part of the fiscal consolidation measures should not lead to renewed inflationary pressures and does not require a monetary policy reaction.

A gradual recovery in 2010

Activity is expected to pick up through the second half of 2009 and gradually gain momentum into 2010, helped by the increasing demand for Mexican exports from the United States. The unemployment rate is projected to peak at close to 6.5% in mid-2010, but should then gradually fall. Inflation will react to the large output gap with a lag and come down to around 4% by the end of the year. As exports recover more swiftly than domestic demand and imports, the current account balance is projected to remain positive throughout the forecast period.

Risks to the outlook are on both sides

A downside risk to the projection would be a sharper and more protracted increase in the unemployment rate, which would weigh on private consumption and delay the recovery. On the upside, a faster than expected pick-up in activity in the United States would help exports and growth.
Mexico: Demand, output and prices

                         2006     2007   2008  2009   2010    2011

                        Current      Percentage changes, volume
                         prices           (2003 prices)

Private consumption     6 712.0     3.9   1.6   -8.0    1.8    3.3
Government consumption  1 080.4     2.1   0.6    2.3   -2.1   -0.9
Gross fixed capital     2 165.2     7.2   5.0  -11.9    1.3    5.9
Final domestic demand   9 957.6     4.4   2.2   -7.8    1.2    3.4
  Stockbuilding (1)       541.6    -0.5   0.1   -2.1    0.7    0.0
Total domestic demand  10 499.2     3.8   2.4   -9.7    1.9    3.5
Exports of goods and    2 901.3     5.6   1.5  -19.2    7.8   10.2
Imports of goods and    3 028.5     6.9   4.6  -23.1    4.8    8.2
  Net exports (1)        -127.2    -0.6  -1.0    2.1    0.7    0.4
GDP at market prices   10 372.0     3.3   1.4   -8.0    2.7    3.9
GDP deflator                 --     4.5   6.6    6.5    4.1    4.7
Memorandum items
Consumer price index         --     4.0   5.1    5.4    4.2    5.0
Private consumption          --     4.8   6.8    7.3    4.4    4.8
Unemployment rate (2)        --     3.4   3.5    5.7    6.3    5.9
Current account              --     0.8  -1.5    0.0    1.0    1.4
 balance (3)

(1.) Contributions to changes In real GDP (percentage of
real GDP In previous year), actual amount In the first

(2.) Based on National Employment Survey

(3.) As a percentage of GDP

Source: OECD Economic Outlook 86 database

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Publication:OECD Economic Outlook
Geographic Code:1MEX
Date:Nov 1, 2009
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