viernes, 15 de mayo de 2009

Twixt infection & inflation (Columna de hoy en The News)

When Finance Secretary Agustín Carstens said at the onset of the U.S. economic meltdown that Mexico's strong financial position assured that the local economy would only suffer a "mild cold," he never imagined his comment would become literally true. Since then, viral metaphors have been used regularly to describe what is going on with our ailing economy.

The economy plunged an ugly 10.1 percent in the first two months of the year, and although March data will show a milder decline (probably around 4 percent), that will be due to the favorable placement of Easter. All in all, GDP in the first quarter likely contracted at a rate of 8.1 percent versus the same period a year ago.

Now let's look at April. It was already bad that April would suffer from the unfavorable side of the Easter effect. That alone would have put April's data down at least 12 percent versus April 2008. But the combined effects of Easter and the flu crisis will produce a horrible beginning to the second quarter.

What will the cost of influenza be? Let's do the math.

Mexico City and the State of Mexico, which were virtually shut down for five days during the emergency, account for nearly 32 percent of overall GDP. The hardest hit sectors of the economy were restaurants, bars and hotels (2.8 percent of GDP); entertainment and leisure (0.4 percent of GDP), and transportation, roads and storage (15.7 percent). The education sector (5 percent), which was shut down nationwide for two weeks, will not show a significant drop, since output is measured by wages paid.

There were some offsetting factors. Sectors such as retail (15.7 percent) had a bumper week thanks to panic purchases, and the health sector (2.8 percent) will be up for obvious reasons.

All in all, our estimates show that for a period of about seven days, Mexico's GDP shrank approximately 0.9 percent, which may be equivalent to about 117 billion pesos ($8.7 billion). Most of this will hit April's output, so expect the April GDP data to be down by at least 13 percent, though some of this effect will be felt in May and beyond. All in all, second quarter GDP seems likely to be off at least 8.7 percent, reducing first half growth to -8.4 percent.

If we want growth to be recover to less than -5 percent for the year, then GDP must not shrink more than 1.6 percent in the second half of the year. My estimate for the third quarter is for a decline of 4.8 percent and a least painful -0.3 percent for the last quarter of the year. That is a growth rate of -2.6 percent for the second half and annual rate of -5.5 percent for the year.

That sets the table for the Banco de MAcxico to slash interest rates by more than the 75 basis points expected by the consensus, right? Unfortunately, we don't think so.

The reason for this is that although on the infection side, the economy is fighting the influenza virus and the contagious U.S. recession, on the inflation front the recent slide of the peso, panic purchases at stores during the influenza emergency, and the lack of competitive markets in Mexico have stopped Banxico from reining in price increases.

The April data was just plain bad: inflation rose 0.35 percent, and is up 6.17 percent for the year. April's inflation was not only higher than March's, but it was the highest for any April since 2005. The recession has not killed the inflation virus in Mexico yet.

Faced with the resilience of inflation in Mexico, but aware also that despite the reduction of 175 basis points in short-term interest rates, long-term interest rates have not fallen accordingly, Banxico will exercise its only option.

It will lower rates, but only by 75 basis points, from 6 percent, to 5.25 percent, leaving very little space for further cuts.

That's because interest rates in Mexico are almost negative in real terms. With inflation expectations for the next 12 months hovering at around 4.0-4.5 percent, lowering rates below 4.5 percent will be dangerous for the peso as local investors may fly to the dollar.

Banxico wants to stop cutting rates before that happens.

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