Growth has slowed considerably in early 2001 in response to the hard downturn in the US economy. The Gross Domestic Product (GDP) growth in 2001 is forecast to slow to 2%, from 6.9% in 2000. A rebound of growth in 2002 will depend on an upturn in the U.S. economy and continued conventional economic management. A tightening of monetary policy should enable inflation to fall to under 7% by the end of 2001. With hopes in 2002 of a further reduction in inflation, provided the peso depreciates gradually.
The first year of the Fox administration, combined both the fiscal and monetary tightening that will characterize the administration, this will limit GDP growth to only 2% in 2001. A pick-up in growth to 4.5% can be forecast for 2002 as private consumption and export-oriented industrial output rebound with the beginning of a turnaround in the US economy. A sharper slowdown than currently forecast is possible if the US economy goes into recession.
A slowing domestic economy, combined with tight monetary and fiscal policy, will ensure that inflation continues to fall in 2001-02, although not as quickly as officials have targeted. With inflation already at single-digit levels and the peso likely to depreciate during the next year, further large reductions in inflation will be difficult to achieve. To reach its inflation target of 6.5% for 2001, Banxico will have to tighten monetary policy again following several tightening moves over the past 12 months. Even considering a relatively tight fiscal deficit target ceiling of 0.6% of GDP, year-end inflation will probably be around 7.5% in 2001 and about 5% in 2002.
Positive investor sentiment towards Mexico, fuelled by expectations of an investment upgrade, has resulted in a strengthening of the peso in 2001. However, with the trade deficit widening on the back of the US slowdown and a possible cooling of sentiment towards Mexico, the peso seems bound for depreciation against the US dollar of more than 10% in total during 2001-02. The depreciation would be more severe except for rate cuts by the US Federal Reserve (the US central bank), which began in January and are likely to continue during the year in reaction to a slowing US economy.
Both exports and imports will grow at a much slower rate in 2001-02 than in the previous two years, reflecting a slowdown in the US economy as well as in domestic demand. Mexican exporters are facing an unfavorable environment for their products for the first time since the beginning of NAFTA in 1994. In 2000 growth in the import bill outstripped export earnings growth, a trend that will continue into the next year. Were the peso to depreciate more suddenly than currently forecast, export earnings growth could trend higher than import growth, resulting in a downward revision of the forecast for the current-account deficit. If the peso depreciates as expected, the current-account deficit will widen in 2001 and will further expand in 2002.
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