MEXICAN ECONOMISTS EXPECT DISMAL ECONOMY THROUGH 2010

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TAGS: ECON EFIN EINV ETRD MX
SUBJECT: MEXICAN ECONOMISTS EXPECT DISMAL ECONOMY THROUGH 2010

REF: A) MEXICO 467; B) MEXICO 413; C) MEXICO 42; AND D) MEXICO 45

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1. (U) Summary. Macroeconomics has become a hot topic
among Monterrey businessmen as they try to determine the length
and depth of the U.S. recession and its impact on Mexico. The
Mexican economy is closely linked to the United States, and the
U.S. recession has been transmitted to Mexico through declining
exports, falling direct foreign investment, and other factors.
Mexican economists generally expect the Mexican economy to
remain weak through 2010, the Mexican peso will not recover, but
inflation will moderate. They do not have high hopes for
President Calderon's anti-recession package of infrastructure
spending and reduced energy prices. End Summary.



Economists Forecast Weak Mexican Economy Until 2010




2. (U) In recent weeks Econoff has attended five different
presentations by prominent economists to packed houses of
business professionals. Although the current crisis is not as
bad as the economic slump of 1995, since government finances and
the banking system are sound, there has been a substantial
impact. The U.S. recession has particularly affected the
Monterrey area, which focuses on exports of bulky consumer
durables, such as cars and electronics, to the United States
(see reftel A for the effect on employment throughout Mexico).




3. (U) Due to the close economic ties between the U.S. and
Mexico, particularly in areas such as trade, investment and
remittances, the Mexican economy is likely to follow the lead of
the United States. Former Mexican Central Bank Deputy Governor
Everardo Elizondo and American Chamber of Commerce economist
Deborah Riner both noted that Mexican economic growth is closely
correlated with the U.S. Industrial Production index. Just as
the U.S. industrial production index is falling sharply, the
Mexican GDP is, after a lag, following suit. Riner commented
that the U.S. economy sets the parameters for Mexican growth.
Elizondo stated that the Mexican economy will show negative
growth at least in the last quarter of 2008 and in the first
quarter of 2009, and internal Mexican demand will not recover
until 2010. Riner commented that under her optimist scenario
Mexican GDP would fall 1% in 2009, and slowly grow at 1.7% in

2010. Several businessmen attending the Riner presentation
thought that these projections were far too rosy.




4. (U) Elizondo and Riner detailed several reasons for the
continued weakness of the Mexican economy. Since Mexico exports
almost 80% of its goods to the U.S., obviously a weak U.S.
economy adversely affects Mexico. Riner also expects
remittances to decline but not to drop drastically, and she
projects that foreign direct investment in Mexico will fall from
$25 billion USD in 2007 to $19 Billion in 2008, dropping to
$17.5 billion in 2009 until rebounding slightly to $19 billion
in 2010. Elizondo emphasized that Mexican consumer spending
accounts for approximately 70% of the GDP, and he expects that
tight credit and low consumer confidence will hold down consumer
spending in the near term. Moreover, Mexican consumers have
lost spending power, since wages rose 4.5%, while inflation
increased by 6% in 2008.




5. (U) The Mexican peso has depreciated 40% in value
against the U.S. dollar, and the economists do not expect the
peso to recover (see reftel B). Following the trend of other
currencies, the Mexican peso has devalued sharply since the
second half of 2008 due to the global flight to the safety of
U.S. greenbacks, falling Mexican industrial and petroleum
exports, small declines in remittances, an outflow of portfolio
investments, and the demand by Mexican corporations for dollars
to cover substantial losses in derivatives. Elizondo, Riner,
Cemex economist Gerardo Cruz Vasconcelos, and Actinver
Investment House economist Francisco Suarez all project that the
Mexican peso will not recover its value through 2010. Moreover,
there are some worrisome long term trends. In the summer of
2008 the Government of Mexico cleverly hedged and ensured that
Mexico will receive $70 per barrel of oil through 2009, far
above the current world price of oil. However, starting in 2010
Mexico will only receive the market price, and its oil
production is also declining significantly (see reftel C).
Lower manufacturing exports, foreign direct investment and lower

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remittances will reinforce the trend towards a weaker peso.
Riner, for example, projects higher current account deficits of
$10 billion in 2007 (1.0% of GDP),$16 billion in 2008 (1.5% of
GDP),$25 billion in 2009 (2.8% of GDP),and $42 billion in 2010
(4.7% of GDP).




6. (U) Several economists project that inflation, which
reached 6.5% in 2008, far above the Central Bank's target of 3%,
would decline due to weakened demand. Riner forecasts that
annual inflation will fall to 4.37% in 2009 and 3.66% in 2010.
However, several business people were skeptical of this
favorable scenario. Mexico imports many goods, including
foodstuffs, from the United States, and the depreciation of the
Mexican peso will push the price of imported goods sharply
higher. Although Elizondo thought that weak demand would
restrain prices in the short run, if a store's inputs increase
40% in price, they cannot continue to maintain their price
levels for long. In addition, many goods made in Mexico contain
U.S. components, which will also push these prices higher.




7. (U) Another drag on the economy could be the increasing
IETU tax rates. The IETU, introduced by President Calderon in
2008 to increase tax collection rates, will increase its rate
from 16.5% in 2008 to 17% in 2009 and up to 17.5% in 2010.
Mexican taxpayers must calculate their tax both for the ISR
income tax (with higher tax rates and many more deductions) and
the IETU (focusing on sales with many fewer deductions) and pay
the higher of the two. Cruz Vasconcelos complains that since
businesses cannot deduct business losses the IETU tax will
increase tax collection during a recession, further dampening
demand and the economy. Note. Businessmen have complained
about the IETU since its inception, and Econoff has heard
complaints, but no rigorous economic analysis, demonstrating how
the IETU taxes would damage the economy. End Note.




8. (SBU) The depreciation of the Mexican peso should boost
exports and international competitiveness by companies utilizing
substantial Mexican content. For instance, a Mexican company
selling services could do well, since most of its costs are paid
to Mexican professional in pesos but its income is in U.S.
dollars. One such example is the Monterrey software based
development firm Dextratech, whose principal expense, salaries,
in denominated in pesos while its sales to U.S. clients are
denominated in appreciated dollars. Dextratech's overall volume
of sales has declined slightly, but profits have risen due to
the rising exchange rate. However, this phenomenon is of
limited benefit to many Mexican maquilas, since they use U.S.
inputs for over 70% of the value of their exports, so the
declining peso will be of marginal assistance. In addition,
some countercyclical industries are also doing well. For
example, the U.S. company Autozone, which supplies auto parts to
consumers, has increased sales as people repair their old cars
rather than purchase a new one.



Criticism of Calderon's Program to Reactivate the Economy




9. (U) The economists all agreed that President
Calderon's plan to reactivate the economy is too small to do the
job. President Calderon has proposed several plans to stimulate
internal demand, including spending on infrastructure, programs
to retain jobs, and freezing gasoline prices (see reftel D).
Riner pointed out that Calderon's entire program represents 1%
of Mexico's GDP, insufficient in her view to restart demand.
Riner also noted that the GOM is very slow to spend money on
infrastructure projects, a key component of Calderon's plan.
Cemex's Cruz Vasconcellos argued that Calderon's infrastructure
spending will only balance out declines in the construction
industry, not provide fresh stimulus to the economy. Although
Cruz Vasconcellos projects that Calderon's program will increase
infrastructure spending from 472 billion pesos in 2008 to 589
billion pesos in 2009, this will be more than counterbalanced by
falling construction of non-residential buildings. Indeed,
Cruz Vasconcellos projects that total spending by the
construction industry on residential, non-residential and
infrastructure projects, will fall from 1,593 billion pesos in
2008 to 1,554 billion pesos in 2009.


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10. (SBU) Comment. Econoff has found that Northern Mexican
businessmen are keenly interested in President Obama's economy
recovery package, which they see as their potential salvation.
They are not impressed with their own government's efforts,
which seem to focus on denying the economic difficulties of
2009, rather than designing a program large enough to reactivate
the Mexican economy. End Comment.
WILLIAMSON