(Bloomberg) — Mexico’s economy was finally, for the first time in years, the talk of Latin America.
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Multinationals raced to build factories along the US border. Consumers, flush with cash from wage hikes and government social programs, spent in force. The Mexican stock exchange, long a laggard in global markets, was briefly outperforming even the red-hot S&P 500, and the economy consistently posted the fastest growth rate among major nations in the region.
It seemingly set up perfectly for Claudia Sheinbaum, the heir apparent to President Andres Manuel Lopez Obrador and clear frontrunner in Mexico’s June 2 election.
But just as quickly as Latin America’s second-largest economy took off, it began to cool. Growth that exceeded 3.4% year-on-year for five consecutive quarters suddenly slowed to 2.5% in the final three months of 2023, missing expectations. On Thursday, official data is expected to confirm that it expanded only about 1.6% in the first quarter of 2024 from a year prior, falling short of projections again.
Already facing questions about her ability to follow in the footsteps of one of the world’s most popular leaders, Sheinbaum is now staring down economic struggles that could blunt her political strength in the earliest days of her presidency, should she win. The US economic slowdown and the fact that Lopez Obrador’s policies are in some ways contributing to the sluggishness only intensify the challenges Mexico’s next president will have to confront.
AMLO, as the populist but penny-pinching president is known, has loosened the purse strings during his final year in office, spending big on flagship government initiatives from its Maya Train to pension programs and wage increases. That has boosted consumption and propped up growth, but it has also contributed to stubbornly high inflation that has prevented the central bank from cutting interest rates as quickly as regional peers.
High rates, in turn, have fueled the strength of the so-called “super peso,” which has ranked among the world’s best-performing currencies over the last two years. It has so far this year made the largest gains against the US dollar of the 31 major currencies tracked by Bloomberg.
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Long a point of pride for the president, the super peso once thrilled bondholders and mom-and-pop shop owners alike. Now, however, there is widespread recognition — even from AMLO — that it poses risks to the economy. The strength of the currency has raised costs for companies that relocated to Mexico, made Mexican exports less competitive, blunted the purchasing power of remittances from abroad and even helped stall the country’s post-pandemic tourism boom.
“The peso is strong in part because rates are too high. Rates are high because inflation is high, and one of the reasons why inflation is high is because fiscal policy is expansionary in a year in which activity is already above potential,” said Felipe Hernandez, Latin America economist at Bloomberg Economics. “If AMLO was not spending this much, rates could be lower and the peso could be weaker.”
Without policy changes to shore up Mexico’s fiscal situation and set the stage for additional rate cuts, growth is likely to slow toward 2% in 2025, the first full year of the new president’s term, Hernandez projects. Others are even more pessimistic: JPMorgan Chase & Co. foresees moderate growth around 1.5% in 2025, slower than its 2.1% forecast for this year. Grupo Financiero Base SA currently foresees 1.6% growth in 2024 and an expansion of just 0.8% next year.
“This is what the next government will inherit,” Hernandez said.
The finance ministry maintains that gross domestic product will expand between 2.5% and 3.5% this year. “We don’t see a pressure or a signal that would lead us to review” that estimate, Rodrigo Mariscal, head of the ministry’s economic planning unit, told journalists on April 30.
Fiscal, Nearshoring Risks
Sheinbaum, who holds a 27-point lead in the race according to Bloomberg’s Poll Tracker, has pledged to further bolster social welfare programs and make substantial infrastructure investments while maintaining limits on government spending.
Her advisers have also outlined plans to capitalize on nearshoring — the phenomenon that has led companies including Tesla Inc. and Mercedes-Benz Group AG to announce plans to build plants in Mexico as they seek proximity to US consumers, helping the country supplant China as its northern neighbor’s top trading partner.
But there’s no guarantee that AMLO’s approach will work for his successor. Mexico is set to register its largest budget deficit since the 1980s this year, likely forcing the next president into a fiscal bind that will necessitate spending reductions or other adjustments amid an already-slowing economy.
Sheinbaum has been vague about her fiscal plans, suggesting that Mexico can avoid tax increases or spending cuts by focusing on improved revenue collection. But fiscal reform “is going to be necessary at some point, and that always causes a drag on the economy,” said Steven Palacio, an analyst for JPMorgan.
After slowing at the end of 2023, the nearshoring momentum still hasn’t recovered, with industrial output declining 0.4% in the first quarter of the year, according to preliminary gross domestic product data. Exports also dropped 5.3% in March from a year ago.
Longstanding problems, including erratic power supply, limited industrial space, water scarcity and a public security crisis, continue to limit Mexico’s ability to attract foreign corporations. And AMLO’s emphasis on state-owned companies, particularly in the energy sector, has sparked warnings that the country may miss its opportunity to use nearshoring to transform its economy and achieve higher long-term growth if it doesn’t adopt more business-friendly policies.
“Everything goes hand in hand: If there is no opening to the private sector, it will be very difficult to take full advantage of the nearshoring potential, because there will be infrastructure deficiencies that will limit the capacity of nearshoring, especially in services such as water and electricity,” Palacio said.
A Quick Rebound?
A slowdown in 2025 for now appears inevitable.
“It is the first year of the administration and public spending tends to go down, and they will also have to cut the deficit,” said Gabriela Siller, director of economic analysis at Grupo Financiero Base. “This will mean that there will be no fiscal space for large infrastructure works and thus growth will be affected.”
Still, there are reasons to believe that an early rebound is possible, according to Palacio, who sees the sluggishness over the first three months of 2024 as transitory.
Mexico’s outlook has been clouded by weaker growth forecasts in the US, and while the world’s largest economy is expected to slow in 2025, analysts have reduced the odds that it will face a recession later this year. Mexican consumption and consumer sentiment, meanwhile, remain strong.
“If you look at one of the main growth drivers of the last two, three years, which is private consumption, and you look at the consumer outlook, it’s still intact and quite strong,” Palacio said, underlining the effect of growth in real wages, employment and subsidies.
Sheinbaum made a similar argument during a press conference last week, touting AMLO’s policies as a driver of growth and waving off major concerns about headwinds from the US economy.
“Social programs and wage increases have allowed us to reduce poverty and inequalities, but at the same time, they have allowed for an enormous dynamism in our domestic market,” she said. “And that is going to help us a lot in 2025, whatever happens in the US.”
–With assistance from Maya Averbuch and Robert Jameson.
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