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Mexico – Increasingly Attractive Investment Fundamentals

By Scott B. MacDonald

Mexico's credit fundamentals are improving – albeit at a slower pace than in previous years. Reflecting this, Moody's has recently changed the outlook to positive and the Latin American country could benefit from any extended complications with SARS in Asia. Mexico remains a relatively low cost producer of many goods and has excellent proximity to the U.S. through NAFTA. Despite the slight contraction in first quarter 2003 real GDP, there are signs that parts of the economy are beginning to gain momentum, a trend which could strengthen when the U.S. recovery becomes more pronounced.
The Mexican economy is closely linked to the U.S. When the U.S. economy slowed in 2001 and 2002, it took the Mexican economy with it. Real GDP growth contracted in 2001 and was weak (0.9%) in 2002. We expect the economy to expand by 2.0-2.4% in 2003, with 3.5% growth possible in 2004. The maquiladora sector, which has struggled over the last two years, is beginning to see signs of recovery. The commercial banking sector is also beginning to see an increase in activity. Other key points to consider:

1. Inflation forecasts are heading down. In early 2003, inflation for the year was expected at 4.3%. The central bank's tight monetary policy, however, is having a positive impact, as consensus estimates for inflation have been lowered to 3.9%. Considering that Mexico's inflation levels were well over 10% throughout the 1990s, this is positive news. For the first 15 days of April, inflation was just 0.01%, the lowest biweekly reading since April 2002. Inflation had picked up in the late part of 2002 due to the steep depreciation of the peso bled through into prices.

2. Retail sales were up 4.2% in February, well above expectations and another sign that the worst of the recession may now be over. Sales growth in basic consumer goods has been relatively healthy for several months now. Big-ticket items have lagged. After having fallen year-on-year for five of the six months between August 2002 and January 2003, auto sales were up a respectable 2.1% in February. It is expected that auto sales are likely to continue to show ongoing strength in March.

3. Higher than expected oil prices have been a major windfall for Mexico and will help the government make its fiscal target of a budget deficit equal to 0.5% of GDP. Higher oil prices and better tax collection measures bore fruit in the first quarter of 2003, as federal revenues rose 21%. Mexico has now accumulated a 27.2 billion peso ($2.7 billion) surplus. The government budget estimates the price of Mexican oil will average between $23-24 a barrel, helping the state to take in 14 billion pesos more in revenue this year than initially forecast.

4. We expect Mexico's external accounts will remain off of investors' radar screens. Mexico's current account deficit will be equal to 2.5% of GDP, which should easily be financed by foreign direct investment (FDI). It will also be an improvement on 2002's current account deficit of 2.9% of GDP. FDI is forecast at $14 billion for 2003. In addition, Mexico has done its financing in the bond market already this year and does not need to return.

5. There should be increased political noise as Mexico heads to the July 6, 2003 congressional elections. However, the political risk associated with the election is low. Both the party of President Vincente Fox, the PAN, and the major opposition party, the PRI, share a broad consensus on economic policy. Indeed, the PRI long dominated Mexico's political life and the last three presidents, prior to Fox, advanced much of the structural reforms that provide the economy its current foundation. Consequently, if the PRI were to win the congressional elections in July this would not represent a major shift in terms of policy. It could result in more politicking between Congress and the Presidency in terms of making deals to pass key legislation in the second half of Fox's term. The PAN is coming in around 38% in opinion polls over 37% for the PRI, while the left-of-center PRD is polling around 20%. Such an actualization of the vote would leave the Congress much as it now - an arena where the PAN must form tactical alliances with the PRI to pass legislation.

Mexico has made considerable strides from the bad old days of debt default during the 1980s. Although challenges remain, Mexico remains one of the stronger sovereign performers, a trend that should continue. The trick for Mexico is to maintain fiscal discipline during the period that it takes the United States economy to regain stronger and sustained momentum. When the U.S. recovery eventually comes, the country just south of the Rio Grande will be a strong position to take advantage of improving macroeconomic conditions in North America.

Editor: Dr. Scott B. MacDonald, Sr. Consultant

Deputy Editors: Dr. Jonathan Lemco, Director and Sr. Consultant and Robert Windorf, Senior Consultant

Associate Editor: Darin Feldman

Publisher: Keith W. Rabin, President

Web Design: Michael Feldman, Sr. Consultant

Contributing Writers to this Edition: Scott B. MacDonald, Jane Hughes, Marc Faber, Jonathan Lemco, Russell Smith, Andrew Thorson and Robert Windorf

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