Country Report Mexico August 2008

Outlook for 2008-09

• Eighteen months into his six-year term, the president, Felipe Calderon, has just a small window of opportunity to advance a controversial energy reform before attention focuses on the 2009 mid-term election.
• A high level of violence stemming from organised crime represents a serious challenge to Mexico's deficient security forces. Mr Calderon's authority will be partly dependent on his ability to achieve improvements in this area.
• Rising oil revenue will facilitate a countercyclical increase in expenditure in 2008 without jeopardising the fiscal balance. However, energy reform to raise oil output will be needed to contain contingent liabilities in the longer term.
• The Economist Intelligence Unit continues to expect real GDP growth to expand by 2.3% in 2008 but we now project a sharp slowdown to 1.6% in 2009 (previously 2.5%), in line with downward revisions to our US forecast.
• We now expect inflation to end 2008 at 6.2%, significantly higher than the 4% target ceiling. Our projection of a decline to 4.4% at end-2009 is vulnerable to a risk of wider contamination from food and producer price pressures.
• We continue to expect the Mexican peso to depreciate against a firmer US dollar, ending 2008 at Ps10.93:US$1 and 2009 at Ps11.34:US$1.
• In light of downward revisions to our projections for oil prices and US growth, wider trade deficits will push the current-account deficit to 1.1% of GDP this year and 1.2% next (previously 0.8% and 1% respectively).

Monthly review

• The opposition PRI has released its own proposals for hydrocarbons reform. There are many similarities with the government's draft, suggesting that the two parties will manage to work together to pass joint legislation.
• Banxico has raised its reference interest rate by 25 basis points for the second consecutive month, to 8%. This followed the release of the second-quarter inflation report, in which the bank downgraded its forecast for inflation.
• The peso lost 3% in a week in early August, the biggest drop in a year mostly characterised by continued appreciation. The drop reinforces our expectation of greater volatility amid increasingly bearish oil market sentiment.
• Leading indicators have pointed to a continued slowdown, with the economic activity indicator rising by just 1.6% year on year in May. Secondary activity (manufacturing construction and mining) fared particularly poorly.
• Annual inflation reached 5.39% in July on the back of continuing pressures from food and commodity prices.