OECD Economic Outlook, Volume 2022 Issue 2

Mexico

Real GDP growth is projected to slow from 2.5% this year to 1.6% in 2023, but to edge up to 2.1% in 2024. Consumption will be supported by the gradual improvement in the labour market but dampened by high inflation. Exports will continue to benefit from high integration in global value chains, but their dynamism will be mitigated by the slowdown in the United States. Inflation will edge down to 5.7% in 2023 and 3.3% in 2024.

Measures to respond to increases in energy prices should target the most affected households and SMEs and provide incentives for energy savings. Monetary policy should remain tight to anchor inflation expectations. Independent and adequately funded competition authorities and regulators would contribute to boosting competition and productivity. Improving access to and the quality of childcare would support female labour force participation and reduce educational inequalities.

The outlook for activity is worsening and inflationary pressures remain high

After robust growth during the first three quarters of 2022, high-frequency indicators show activity declining in some sectors. Mining and construction output recently contracted although auto production remains resilient, on the back of easing supply constraints. External demand has held up, but is expected to soften as growth in the United States weakens. Inflationary pressures remain high and broad-based. Annual headline and core inflation stood at 8.4% in October. Medium-term inflation expectations have risen.

Mexico

1. The shaded area represents the central bank's inflation target range.

2. Private sector inflation expectations for the next 12 months.

Source: Bank of Mexico.

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Mexico: Demand, output and prices

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Fiscal policy remains prudent and monetary policy will need to remain restrictive

A retail fuel price stabilisation mechanism was put in place to reduce cost pressures and support household purchasing power. Estimates suggest that this is lowering inflation by between 2 and 4 percentage points. The associated budgetary cost is estimated at 1.4% of GDP in 2022. It is assumed that this mechanism remains in place during the projection period. Higher oil revenues cover the cost of the stabilisation mechanism but greater pass-through of global fuel price changes to domestic retail prices would lower the future budgetary cost of the mechanism and provide better incentives for energy savings. This would create some fiscal space to strengthen social programmes and provide more targeted support to vulnerable households. The government has also taken steps to mitigate price pressures for basic goods, including the temporary elimination of import tariffs for basic goods, cooperation with the private sector to freeze the prices of 24 key products (mainly food) for six months and measures to increase production of basic grains.

Fiscal policy remains prudent and continues to prioritise some social programmes, particularly non-contributory pensions, and priority infrastructure projects in the South. The budget deficit is expected to increase to 3.6% of GDP in 2023, from 3% of GDP in 2022, with the official measure of public debt expected to stabilise around 50% of GDP. Mexico has also started to rebuild fiscal buffers, by gradually replenishing the stabilisation fund, which now has 0.1% of GDP in resources available. This is a welcome step to increase the ability to react in the event of a negative shock.

To respond to mounting inflationary pressures and anchor inflation expectations, the central bank has gradually increased the policy rate, to 10%. With widespread price pressures expected to persist, further interest rate increases are warranted. The policy rate is assumed to increase to 10.75% by the first quarter of 2023 and to remain at that level until the beginning of 2024, when it would start to be gradually reduced.

Growth will be moderate in the near term

The economy is projected to expand by 1.6% in 2023 and 2.1% in 2024, slightly above potential. Domestic consumption will be a key driver of growth and services related to tourism will continue to recover gradually. Exports will continue to benefit from deep integration in manufacturing value chains, particularly in electronics and automotive sectors, but will suffer from slower growth in the main trading partners. Inflation will moderate in 2023 and 2024, as the impact of higher interest rates takes effect and ample spare capacity limits wage pressures. However, the inflation outlook remains very uncertain. Inflation may be higher for longer, eroding purchasing power, particularly of vulnerable households, calling for greater tightening of monetary policy. Episodes of financial volatility may trigger greater risk aversion, reduce net financial inflows and increase financing costs. On the upside, swifter near shoring of production processes to Mexico, to facilitate access to the United States market, could imply stronger exports.

Boosting productivity is a key priority

Broadening tax bases would help to respond to increasing spending needs in education, health and infrastructure, to safeguard the commitment to debt sustainability, and to boost productivity and growth. Reducing the regulatory cost of formalising a business, particularly at subnational level, and continuing to improve labour dispute resolution mechanisms would support stronger formal employment. Allocating more resources towards primary education would mitigate the pandemic’s adverse effects on educational outcomes. Promoting public urban and interurban transport as well as renewables energy would reduce emissions and the use of fossil fuels.