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Mexico Faces a Slow Economic Recovery After a Steep Recession

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Mexico Faces a Slow Economic Recovery After a Steep Recession

Mexico’s economic performance deteriorated steeply in 2020 which may be largely attributed to the COVID-19 pandemic and slow government action to curb disease spread. GDP contracted 8.5%, mainly due to steep declines in consumption and investment.

Atradius economic analysts predict Mexico’s GDP will partially rebound in 2021, increasing by 6.1%. The coronavirus pandemic exacerbated an already weak economic situation. Mexico entered 2020 in a mild recession, due to fiscal tightening and falling investments on the back of rising policy uncertainty.

Government leaders face growing concern over health and economic policies

Due to the severe spread of the coronavirus pandemic and the resulting economic downturn, the handling of the crisis by the government has drawn harsh criticism. Compared to most other countries in the region, Mexico took less stringent measures on a national level to contain the spread of the disease.

Some of the poorest countries in Latin America—including El Salvador, Guatemala, Honduras and Venezuela—were among the quickest to respond, most likely in recognition of the extremely limited capacity of their healthcare systems to deal with a protracted public health crisis.

While President López Obrador’s popularity has subsequently dropped, approval rates remain high, at about 60%. This is due to some popular measures taken since his inauguration in December 2018, such as raising the minimum wage, reducing government salaries (including his own) and advancements in several high-profile corruption cases. The president’s party thus remains well-positioned for mid-term elections in June 2021. General disillusionment with traditional parties underpin this expectation.

High crime rates and endemic corruption continue to undermine the business environment and state functions in Mexico. The economic repercussions of the coronavirus pandemic particularly hit workers in the informal sector, who amount to about 60% of the total labor force. Consequently, rising poverty could become a major social and political issue if government action is not taken.

Limited fiscal measures in place to counter the downturn

Mexico’s high vulnerability to the lasting effects of the COVID-19 pandemic stems from its relatively weak healthcare system, the close synchronization of its economy with the U.S. business cycle and its relatively high dependence on the services sector. These factors make Mexico more susceptible to external shocks, especially with the stagnant tourism sector.

The 2021 outlook for most sectors in Mexico ranges from fair to bleak, with particular difficulty ahead for construction, engineering, and steel. The automobile sector, Mexico’s leading source of exports, suffered from a sharp fall in external demand and severe supply chain disruptions over the past year.

To help mitigate these impacts from the COVID-19 pandemic, the central bank cut interest rates several times in 2020, to a still relatively high 4% in February 2021, while the probability of further monetary policy easing has declined. Inflation is expected to remain at the upper end of the central bank’s 2%-4% target range, mainly due to higher fuel prices and shortages from supply-side disruptions.

A protracted recovery expected in 2021

Due to meager fiscal support and comparatively high-interest rates, Mexico’s economic recovery is expected to be protracted, and GDP will likely not return to its pre-pandemic level until 2024.

Other issues include persisting economic policy uncertainty, concerns about contract enforcement and rule of law under the current government, which may continue to have a negative impact on business confidence and private investments.

Exports in the manufacturing sector should receive a boost from higher U.S. growth prospects, while an infrastructure plan may contribute to a partial recovery of investment. However, this recovery expectation remains subject to a timely containment of the pandemic, including the speed of the vaccination campaign. The government debt ratio is expected to level off in 2022 despite weaker government finances.

The peso exchange rate against the USD sharply depreciated in March 2020, which may be largely due to high capital outflows and the deterioration of the oil price. However, it appreciated again since May, and by the end of 2020, it had almost recovered its lost ground. While the exchange rate is likely to remain volatile in 2021, it is expected to continue its appreciating trend, supported by a global recovery in manufacturing.

There are glimmers of hope for Mexico’s economic recovery in 2021, aided by accelerating growth in U.S. markets on the back of massive fiscal stimulus and vaccination rollouts globally. As long as Mexico can stay on a path toward growth, a partial economic rebound could be possible in 2021.

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Greetje Frankena is a deputy chief economist at Atradius based in Amsterdam.