US fiscal cliff looms over Mexico

The recovery of Mexico’s economy after the global financial crisis faces a big threat from the US, on which it remains largely dependent, a senior policymakers told Emerging Markets on Saturday.

Should the US fall off the fiscal cliff at the turn of the year, the Mexican economy could be one of the first collateral casualties. This could lead to a reversal of capital inflows, with a destabilizing effect, Gerardo Rodriguez, Mexico’s undersecretary of finance and public credit, told Emerging Markets. “The balance of risks has deteriorated,” he said.

Mexico will post economic growth in the range of 3.5-4% this year and is aiming at 3.5% next year, according to government forecasts. “We are operating on the assumption that the US continues to grow at around 2%. Implicit there is that the fiscal cliff issue is managed well after the elections,” he said.

But trusting US politicians to resolve the fiscal cliff issue may prove a tricky bet. “We are growing pretty much at potential, with no relevant imbalances on the current account, on the fiscal and inflation fronts, which would lead you to think this kind of growth would be sustainable going forward,” said Rodriguez.

“Depending on the evolution of the international environment, the balance of risks has deteriorated because of what is going on in Europe and uncertainty regarding the fiscal cliff in the US.”

Mexico has met such challenges with a very orthodox policy response.

“We have been building buffers and positions for some time now in terms of resources, in terms of fiscal consolidation, also public debt management and catastrophic risk assurance,” he said.

Markets have been working on the assumption that the US is going to address the fiscal cliff challenge with a more gradual adjustment, he said. “That continues to be the central scenario. We are monitoring capital flows very closely, which are more related to the deterioration in Europe in sovereign debt dynamics and the situation of the banking industry.”

“This has generated inflows to emerging markets in general and Mexico in particular, which are a source of potential vulnerability to the extent that we could see a sudden stop of capital flows. This is an element that we continue monitoring,” he said.

Meanwhile, public debt management has been a source of strength in Mexico, according to Rodriguez, “as opposed to what you have seen in Europe and to what we have experienced in the past”. “We have been able to reduce external debt substantially, increased the average maturity of domestic debt, which is now more than seven years and higher than the OECD average.”

The World Bank has lauded Mexican policymakers. “Mexico is beginning to turn the corner in very positive ways. It was lagging in terms of recovery,” said Augusto de la Torre, the World Bank’s chief economist for Latin American and the Caribbean.

“Now its performance has improved dramatically. Mexican bonds are indeed trading as one the safest assets on the planet.”

Rodriguez rejected the suggestion that abundant capital flows were helping create a debt bubble in emerging markets. “This is not the case in Mexico,” he said. “We have no evidence to conclude that there can be a misalignment of financial variables in the case of Mexico.”