RaboResearch - Economic Research

Mexico: growth holds up well despite austerity

Country Report


Mexico flag

Growth is holding up well despite the fallout from low oil prices and the resulting fiscal austerity, which strongly and negatively affects public investment but at the same time supports the credibility of the government’s economic policies. Despite an improved medium term outlook the oil sector’s remains drag on the government’s income in the short run.

Strengths (+) and weaknesses (-)

(+) Sound and prudent fiscal policy

For almost two decades, Mexico has been running a small budget deficit, accompanied by a relatively low level of public debt and a fiscal rule targeting a balanced budget.

(+) Strong competitiveness

Mexico’s proximity to its main export destination (the US) combined with relatively low labor costs results in a good competitive position, augmented by rising labor and transportation costs in China.

(-) Narrow income base of the government

Mexico’s government income base is narrow, as almost 60% of the workforce is not registered in the tax payment system and 40% of the government’s income is oil sector related.

(-) Widespread corruption and power of cartels hinder the business environment

Widespread corruption in all layers of society has a negative impact on the business environment and makes the fight against drug cartels difficult. Moreover the penetration of cartels in the society and the economy adds to the risk of doing business in Mexico. 

Key developments

1. Short-term growth holds up, medium outlook improved

Mexico’s economy is holding up well despite the challenges posed by the low oil prices and growth is expected to edge up to 2.8% in 2016 (figure 1). Low oil prices put a drag on growth, as they precipitated significant budget cuts. However, the private sector looks set to keep economic growth steady. The manufacturing sector continues to expand, although exports have been affected by weaker-than-expected demand from the U.S. in the first half of 2015. The current account is projected to worsen somewhat as Mexico’s declining domestic oil production leads to higher hydrocarbon imports. 

Figure 1: Growth slowly edging up
Figure 1: Growth slowly edging upSource: EIU
Figure 2: Current account remains negative
Figure 2: Current account remains negativeSource: EIU, Rabobank

Meanwhile, the medium term growth prospects have improved following the successful implementation of key structural reforms in 2015. Back in 2014, Mexico completed the legislative process for reforms in the energy, telecommunications and financial sectors coupled with stronger anti-trust legislation and reforms of the labor market and education. The telecommunications reform has already paid off, as Mexico witnessed a decline in service prices. The oil sector reforms boasted some mixed results, as low oil prices reduced interest in investment in the sector. Looking forward, higher investment in the oil sector as a result of the recent oil reforms (see next paragraph) is expected to raise GDP growth. Moreover, the recently concluded Transpacific Partnership could further intensify trade flows with the US (and other countries) and lead to increased FDI into Mexico. Rising interest rates in the US pose a key economic risk, as it would likely induce capital outflows and put pressure on the Peso. For now the depreciating Peso has not caused inflation (figure 3) giving Banxico (the central bank) scope for accommodative monetary policy.

Figure 3: Diverging trend inflation and Peso
Figure 3: Diverging trend inflation and PesoSource: Macrobond
Figure 4: Oil production falling
Figure 4: Oil production fallingSource: Macrobond

2. When the oil sector is hit, the government feels the pain.

After the oil price slump of 2014, oil prices have declined further to USD 30 in January 2016, which will severely affect Mexico’s economy and government finances. In its December 4 meeting the OPEC completely abandoned its production ceiling, despite concerns from some of the weaker members, signaling that low prices will stay around for a while. Currently oil still makes up 6% of Mexico’s GDP and the government relies for over 40% of its revenues on oil. Meanwhile, the state dominated sector is struggling to adjust to a new reality of competition after the sector was opened up to (foreign) competition this year. This will help the country attract new and contemporary (deep water) investment, but also weighs on the fortunes of state oil giant Pemex. Even before the declining oil price, Pemex was downgraded by Moody’s as the quarterly losses kept mounting. A deal on reducing pension liabilities of the company was somewhat successful, but will bring no avail in the short run. This also weighs on the sovereign which sees it’s income from the public oil giant dry up. On a more positive note, Mexico’s oil price hedges are paying off and will help support public spending.

3. Welcome austerity with ring-fenced security spending

The 2016 budget, like the one of 2015, will see sizeable cuts as a result of declining oil receipts. This can be viewed as a credible sign that Mexico is serious about preserving fiscal prudency. The budgets cuts fall predominantly on public investment, where Pemex bears the brunt of the fall in capital spending. Also government departments have seen double-digit cuts in their investment budgets and now increasingly rely on public private partnerships for investment. Security spending has been largely ring-fenced in the cuts. The ministry of Interior, the army, navy and secret service have seen little cuts. This is a good signal because the security situation remains one of Mexico’s main challenges. The number of homicides rose in 2015, as a result of a power struggle between cartels in Guerro. The security situation remains something to watch in 2016.

Factsheet of Mexico
Factsheet of MexicoSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Mexico has a long history of both debt and financial crises. The last crisis, which took place in 1994/95, triggered a political landslide. The Institutional Revolutionary Party (PRI), which had run Mexico for almost the entire 20th century, lost its absolute majority in the lower house in 1997. Since 2000, Mexico twice elected presidents from the National Action Party (PAN), a business-friendly and conservative party. The PAN, however, did not succeed in implementing the necessary (economic) reforms. The PRI, through Peña Nieto, regained the presidency in 2012, with the opportunity to reform the country, especially since PAN is taking a pragmatic approach to being in the opposition. Another heritage of the crises is that Mexicans are cautious about entering into debt. Mexico’s political relation with the US is currently rather good, especially since both economies have become more and more integrated. Political themes are migration, security, energy, drugs and the environment, and do sometimes lead to small disputes. The strong economic ties are reflected by the trade agreement (NAFTA) and the fact that the US is Mexico’s main export partner. Mexico’s cheap labor is used to produce manufactured goods, which are then exported to the US. This type of business is typical for the northern part of the country, where the business climate is more developed than in other parts of the country, save the Yucatán peninsula. However, the north is also the battleground for the country’s war of drugs, which is hampering primarily socio-political, but also economic progress. 

Economic indicators of Mexico
Economic indicators of MexicoSource: EIU


Jurriaan Kalf
RaboResearch RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
+31 88 726 7864

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