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Mexico’s Low Oil, Low Growth Environment

Mexico’s low oil, low growth environment

Mexico’s central bank has cut its 2015 growth forecast for the second time in three months, in wake of concerns over the decline in oil production and weaker-than-expected growth from the United States.

When President Enrique Peña Nieto took office in December 2012, expectations for a stable economy in Mexico were high. Nieto promised to reform the Mexican financial system, which has under-performed relative to its Latin American neighbors.

Mr. Peña Nieto promised to ramp up yearly growth to 5% or more, but instead Mexico’s projected growth has slowed. Indeed, Mexico’s Finance Minister Luis Videgaray had to slash the growth forecast last year and the year before.

Recently, a sharp decline in global crude prices has hurt Mexico’s market and dealt a blow to Peña Nieto’s economic reform strategy: the opening up of the oil and gas industry. Oil accounts for 13% of Mexico’s exports, and a third of budget revenues.

The Mexican government depends on proceeds from state oil and Pemex for about one third of their budget. However, Pemex production has hit record lows and posted a loss of more than $6 billion.

Earlier this year, Mexico’s central bank lowered the country’s 2015 growth forecast from a range of between 2.5% – 3.5% to a range between 2% – 3%, citing a lack of economic vitality, as Mexico’s economy posted its biggest decline in two years.

Agustín Carstens, Bank of Mexico Governor commented:

We have seen the US economy growing slower than expected and in Mexico economic growth has also been lower. Something that stands out is the fall in production at [state oil company] Pemex, which has consequences that are hard to make up in the short term. Investment has also shown lower dynamism. Taking all these factors, the board has decided to revise our economic growth forecasts.

Some of the hypothesized risks the economy could face have, indeed, come to pass — including an enormous drop in oil production and growing ambiguity about future prospects for crude output.

In addition, a drop in demand from the United States, which has in turn affected transitory factors, hit Mexico’s export division. If this trend continues, Mexican domestic spending will cease to show signs of a much-needed stabilizing recovery.

The drop in oil values and a change of strategy severely problematizes Peña Nieto’s pledge to increase oil production by 500,000 barrels a day by 2018. Currently, Mexico produces about 2.3 million barrels a day.

Furthermore, due to the low-price oil environment, the Mexican peso has weakened, undermining Mexico’s attractiveness for foreign investment. At the same time, the prospect of higher U.S. interest rates limits the demand of emerging-market resources.

Typically, an increase in interest rates in the U.S. reduces investments for higher-risk assets from emerging markets. Going forward, the central bank must pay close attention to the exchange rate’s impact on inflation and temper realistic expectations for a stable recovery.

In order to safeguard Mexico’s financial stability, the central bank will be open to federal budget cuts, as stated by Mr. Carstens. For all interested businesses and investors, Mexico hopes to expect oil prices to stabilize and recover in the coming months.

It is possible that the Mexican economy will see improvements if the U.S. economy stabilizes it’s growth and investments trickle into Peña Nieto’s reforms. On the other hand, if oil production continues to decline, the government could be forced to tighten spending further into 2016.

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