Commentary: Mexico Poised for Growth, But Uncertainty Remains

The Mexican Peso rose sharply this after the Bank of Mexico cut its overnight policy rate by 25 bps, but ruled out any reductions.  Growth in Mexico and the United States has been largely disappointing this year, which the Bank attributes to substantial fiscal tightening on both sides of the Rio Grande.  According the Bank, the sequester cuts and uncertainty surrounding broader fiscal and monetary policy has hurt growth in the US.  In Mexico, government spending has dropped by 2.5 percent so far this year since the new presidential administration took office last January.  The outgoing administration had run modest deficits to support the economic recovery for the previous four years.  Fiscal reforms earlier this year attempted to normalize fiscal policy by plugging the deficit with a combination of cuts and tax increases.  Furthermore, the plans ended the heavy investment in public infrastructure which had propped up the construction industry during the recovery.  This shock, combined with uncertainty regarding US economic policy, has stunted Mexican growth this year.  Given the slowdown, the Mexican government plans to run a deficit of 1.5 percent of GDP for fiscal 2014.  Demand for Mexican debt remains high, and public debt stands at a sustainable 43 percent of GDP.  

It is also important to highlight the significant structural reforms which have passed the Mexican Congress this year.  The Bank of Mexico has praised the liberalization of the telecommunications market, accountability reforms in public education, and a reduction in the bureaucracy involved with hiring and firing workers.  The bank has also urged reform to the energy sector to allow more private investment in oil and electricity production.  President Peña Nieto hopes to pass legislation through Congress before the year is out to address these issues.  

Financial markets and inflation have behaved in an "orderly way" according to various releases by the Bank.  While interest rates have risen in anticipation of a reduction in asset purchases by the Federal Reserve, rates appear to have stabilized since September.  The Mexican Peso has depreciated somewhat since May , but there appears to be limited pass through effects on inflation.  In general, the Bank expects inflation to remain subdued worldwide as growth remains held back by broader policy uncertainty in the US and Europe.  

In this context, the Bank cut its benchmark rate a further 25 bps, but stressed that further rate cuts would be inadvisable in the foreseeable future.  In general, the Bank hopes to the rise in interest rates which it believes has curtailed private investment.  Here's to a happy 2014.