ACTIVITY SET TO DECELERATE IN 2023

Growth momentum is expected to lose steam further in 2023. Activity will be dented by the weaker US economy, which is expected to affect Mexico´s manufacturing sector, tourism (7% of GDP in 2021), and remittances from expatriates (4% of GDP). In addition to durably high average inflation and tighter credit conditions, the latter will contribute to the slowdown of household consumption (65% of GDP). Moreover, export (39% of GDP) growth will also cool, reflecting weaker economic momentum in the US (destination of 78% of exports). Conversely, public expenditure is likely to accelerate somewhat, with higher social expenses and resources for president Obrador´s key infrastructure projects (including the Mayan Train and the Dos Bocas refinery). Regarding private investment, while manufacturing will remain a key destination of foreign investments – Mexico has enormous potential to benefit from the nearshoring narrative – the index is expected to underperform this year amid tightened global financing conditions and due to policy uncertainty. The latter includes the 2021 law strengthening the role of state-owned power utility company CFE at the expense of private firms. Indeed, in July 2022, the US and Canada separately requested consultations with Mexico under their USMCA trade deal over the latter’s energy policy. If an agreement is not reached, the US and Canada could request a resolution panel, which could prompt retaliatory tariffs.

TWIN DEFICITS (EXTERNAL AND FISCAL) WILL RISE MARGINALLY

The current account deficit should widen slightly in 2023. The trade deficit (0.8% of GDP in 2021) is expected to increase marginally since import growth will outpace the rise in exports on the back of decelerating global demand (affecting exports) and a durably high energy trade deficit (1.9% of GDP). Mexico is a net oil importer, with fuel imports outweighing crude oil exports. In addition, the secondary income surplus will also decline, underpinned by weaker remittances amid a deterioration in the US job market. Meanwhile, the services account deficit (0.9% of GDP in 2021) should remain broadly stable. While freight costs should moderate from a high comparison base, the travel surplus will likely curb amid fewer US visitors. Conversely, the primary income deficit is set to narrow (2.6% of GDP), notably due to lower profit and dividend repatriations by foreign firms. On the financing side, net foreign direct investment (2.5% of GDP) will continue to cover the external account shortfall comfortably. In addition, external debt (excluding FDI-related debt) stood at 38.7% of GDP in June 2022 (26% of GDP for the public-sector portion). Overall, Mexico should keep its solid external position supported by foreign currency reserves of USD 199 billion (covering roughly four months of imports) and a preventive USD 50 billion Flexible Credit Line with the IMF (renewed for two years in November 2021).

Concerning the fiscal accounts, the government is expected to maintain a prudent budgetary policy despite a mild increase in the nominal deficit. The 2023 budget suggests that public expenditure will exceed revenues. Higher interest payments can explain the former, increased allocation for priority programs, and a capitalization of state-owned oil company PEMEX, which aims to improve its refining capacity. Notably, the 2023 budget also departs from an optimistic 3% GDP growth forecast for the year, representing a downside for the budget balance. Last, stabilization funds are still largely depleted.

LACK OF LEGISLATIVE CONSENSUS HINDERS CONSTITUTIONAL AMENDMENTS

The leftist President Andrés Manuel López Obrador, who took office in December 2018, has maintained considerable popularity (his approval rating stood at 65% in November 2022). This is despite the challenging landscape, including the COVID-19 pandemic, the recent sharp rise in inflation, and recurring drug cartel-related violence. Moreover, his Morena party won four out of the six state governments contested in June 2022, bringing the number of Morena governments to 19 out of 31. The latter also indicates the party’s possible strength for the 2024 general election (Mexico’s presidency is limited to a single six-year term). Still, the ruling government coalition has the most vigorous representation in Congress, holding 277 (out of 500) seats in the Lower House and 72 (out of 128) in the Senate. Nonetheless, despite these absolute majorities, the approval of Obrador’s key reforms, such as the nationalization of the energy sector and electoral reform, is hindered by the fact that relevant constitutional changes require a two-thirds majority. Regarding the former matter, in April 2022, Congress voted down a significant electricity reform, which would have tightened state control over the power market. Nevertheless, in the same month, the Supreme Court upheld the law passed by lawmakers in 2021 that changed electricity dispatch rules to favor CFE, the state-owned electric utility, over private producers. In addition, the Lower House rejected the electoral reform bill aiming to convert the National Electoral Institute (INE) into a smaller and more robust body of elected officials (among other changes) in December 2022 amid criticisms that the move could undermine the country’s electoral independence. However, a few days later, Obrador obtained Congress approval for an alternative, a less sweeping overhaul of the electoral law, which will shrink INE’s budget and water down its faculties. The amendment, this time, would require only an absolute majority.