October 2014 Global Economics Pablo F.G. Bréard 1 (416) 862-3876 [email protected] Executive Briefing MEXICO Capital Market Dynamics Foreign Exchange ► The Mexican peso (MXN) has been weakening against the US dollar (USD) since early October. Exogenous factors beyond local control are the key determining issues shaping a volatile and bearish phase in emerging-market currencies. A broad-based preference for the USD fuelled by attractive growth and interest rate differentials in the United States, coupled with “flight-to-liquidity” corrective forces, has placed the peso on the defensive. The MXN, highly sensitive to US economic and monetary developments, will likely trade within a 13.50–14.00 range over the next six months. Moreover, Banco de México counts on sizable international reserves (US$191 billion) to counteract unexpected weakness triggered by repatriation of foreign portfolio flows. Sovereign Debt & Credit Ratings ► Mexico is the world’s 11th largest economy measured by purchasing power parity terms – the third largest in the Americas after the US and Brazil, and enjoys the benefits of a well-developed domestic bond market. The Mexico-US treasury bond spread of 370 basis points (bps) offers an attractive highyield investment alternative to US-based portfolio investors. Despite higher financial market volatility over the past three months, the cost of insuring sovereign debt assets in the CDS market remains low at a 12-month average of 85 bps. Mexico’s sovereign credit ratings hold a “stable” outlook, with the prospect of a rating/outlook upgrade high in 2015. Faster growth and sizable foreign capital inflows linked to structural reforms will enhance Mexico’s creditworthiness. Credit ratings stand as follows: Moody’s (A3), Standard and Poor’s (BBB+) and Fitch (BBB+). Economic Outlook Growth ► The Mexican economy is on a cyclical rebound, and expanded at an annualized 4.2% q/q rate in the second quarter. The growth outlook is promising supported by strengthening domestic demand, declining fiscal drag and growing investment; even the construction sector is showing signs of modest recovery following six weak quarters. The Mexican central bank projects that the economy will grow between 3.2% and 4.2% in 2015. The economic impact of major investments linked to reforms in energy, telecommunications and utility sectors will begin to show during the first half of 2015. The US economy, estimated to expand by 3.2% in 2015, remains a major driver of export sector revenue (the US receives 80% of Mexican exports), particularly in the auto sector. Inflation & Monetary Context ► The monetary regime, based on an inflation targeting scheme (permanent target of 3% +/- 1%) and a flexible exchange rate arrangement, remains well entrenched. Inflationary pressures will persist throughout 2015, fuelled mainly by wage adjustments, agricultural price pressures and pass-through currency effects. Yearly headline inflation will remain near 4% through the end of 2015. In light of persistent price pressures and in anticipation of a faster growth trajectory in the coming years, the central bank will begin normalizing monetary conditions during the second quarter of 2015, taking the policy rate to 4% by year end. Fiscal & Current Account Balance ► The fiscal outlook faces some challenges. The consolidated public sector deficit will likely close 2015 at 3.5% of GDP given the government’s push to increase social spending and infrastructure (mainly transport and energy) capital expenditures. On the external side, the trade deficit is widening somewhat, yet the auto industry is experiencing a strong production and export boom. The current account deficit is projected to close this year at a manageable 2% of GDP, easily financed by foreign direct investment. Institutional Framework & Political Environment Governance ► The administration of President Enrique Peña Nieto has embarked on the implementation phase of an ambitious structural reform agenda involving key sectors of the economy as well as legal and regulatory frameworks. Nevertheless, Mexico’s foreign trade intensity and capital account openness make the country susceptible to shifts in monetary policy conditions in advanced economies and bouts of financial market volatility in developing markets. Improving the quality of education and combatting organized crime have become key demands of the Mexican people. The government will deepen economic ties with Pacific Alliance members. Financial Sector ► Commercial bank lending activity remains relatively soft due the weak economic cycle and low bank penetration. Lending to the private sector grew a mere 3.4% y/y in August. Looking ahead, consumer and mortgage finance activity will gradually recover on the back of stronger economic growth and approval of structural reforms to foster competition, improve property rights, and consolidate financial sector regulation and supervision. The banking sector remains systemically robust with a capitalization ratio of 16%, a non-performing loan ratio of 4% and total provisioning of 128% of past-due loans. Deposit-taking institutions account for 50% of total financial sector assets while pension and mutual funds’ assets represent another 30% of the total. Executive Briefing is available on scotiabank.com and Bloomberg at SCOT October 2014 Global Economics Executive Briefing INTERNATIONAL ECONOMICS GROUP Pablo F.G. Bréard, Head 1 (416) 862-3876 [email protected] Erika Cain 1 (416) 866-4205 [email protected] Estela Molina 1 (416) 862-3199 [email protected] Neil Shankar 1 (416) 866-6781 [email protected] Scotiabank Economics Scotia Plaza 40 King Street West, 63rd Floor Toronto, Ontario Canada M5H 1H1 Tel: (416) 866-6253 Fax: (416) 866-2829 Email: [email protected] Rory Johnston 1 (416) 862-3908 [email protected] Tuuli McCully 1 (416) 863-2859 [email protected] This report has been prepared by Scotia Economics as a resource for the clients of Scotiabank. Opinions, estimates and projections contained herein are our own as of the date hereof and are subject to change without notice. The information and opinions contained herein have been compiled or arrived at from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness. 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