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Aug 3rd 2009
From the Economist Intelligence Unit ViewsWire

Mexico's economy is mired in recession


Although they remain severely depressed, forward-looking indicators of consumer and business confidence in Mexico have shown the first signs of recovery, suggesting that the worst of the contraction in real GDP is now over. Consumer confidence continued to decline compared with a year earlier, but the pace of deterioration slowed in June to 10.7%, from 16-17% in April-May and levels of 20-25% in the first quarter of 2009. The consumer confidence index was four points higher than in May, with all components showing monthly gains. However, it remains by some distance its weakest since the series began in 2001.

Confidence in the manufacturing sector remains extremely weak, but has also demonstrated similar trends, falling by 22.6% in June, compared with 26-27% in April-May and 30-35% in the first quarter. The sub-indices tracking opinion on the current state of the economy and the business climate have continued to fare extremely poorly, but responses to questions on future economic or corporate conditions have improved. In fact, expectations for future corporate conditions were just 2.2 points lower than a year ago.

Corporate results better than expected
Meanwhile, in common with trends in many other capital markets, Mexican share prices have picked up in recent months, reaching an average of 24,573 in June—the highest level since September 2008 and up from a low of 18,840 in March. This partly reflects the release of first-quarter data by many firms. Although in many cases the financial results were poor, some large companies performed better than expected.

During the first quarter, the beverage company, Femsa (which is composed of Fomento Económico Mexicano; a convenience store chain, Oxxo; and Coca-Cola Femsa), in which Femsa owns a majority stake) reported a 4.8% gain in total revenue for its Mexican division, and a 3.2% increase in sales volume. Although peso depreciation escalated the cost of imports and debt, the company reported a 0.8% gain in operating income and its outlook remains positive. Meanwhile, Wal-Mart de México (Walmex) reported annual growth of 16% in net income during the second quarter of 2009. This was higher than the expected 12.8%. The sharp adjustment in demand appears to be driving firms to reach for cost-cutting strategies and efficiency gains, which are likely to be positive for inflation.

Real economy still mired in recession
The government has been quick to claim these indicators as evidence of an imminent economic recovery, owing to its policy of monetary and fiscal stimulus and a slowdown in the pace of economic contraction in the US. Reflecting this sentiment, the finance minister, Agustín Carstens, announced in July that although the government expects real GDP to decline by 5.5% in 2009, the economy is on a solid footing to experience a reasonably strong recovery in 2010, expanding by 3%.

But although financial-market indicators and consumer and business confidence appear to be picking up, data releases from the real economy have not yet displayed any signs of recovery. Industrial production fell by 10.6% year on year on a seasonally adjusted basis in May, worse than the 8.8% contraction in April and virtually the worst result during the current recession. This mainly reflected a 14.8% fall in manufacturing production, as the sector suffered from the effects of the swine flu outbreak, but also reflecting continued pressure from the US recession.

The biggest impact has continued to come from falling output in the auto industry and consumer durables, such as electronic products and electrical equipment. With inventories having been run down in recent months, the absence of improvement in annual trends indicates that domestic and external demand remain extremely weak.

Fiscal sustainability in question
Moreover, the continued weakness of Mexico's public finances, the result of the severe recession, is calling into question its fiscal sustainability. Public finances continue to be hinge exceedingly on volatile oil revenue, scant stable alternative revenue sources and a high level of inefficiency on the expenditure side. After an oil hedge agreement expires at the end of 2009, there will be significant concerns about the medium-term fiscal outlook. This has prompted increasing speculation of potential downgrades to Mexico’s sovereign ratings by major international credit-rating agencies. The Economist Intelligence Unit downgraded Mexico's sovereign risk rating in July from BBB to BB.