A number of forces buffeted the world economy during the first few weeks of 2016. The precipitous fall in oil prices and other commodities that began last year has continued, wreaking havoc on many emerging economies that have benefited from a commodity super-cycle that improved their current economy and helped them finance often large fiscal deficits over the past decade.
- The fall in oil prices, through its impact on the country’s terms of trade, has been partly responsible for the peso’s depreciation. Although inflationary expectations are well anchored and inflation remains at historically low levels, persistent exchange rate volatility could eventually translate into domestic price increases.
- While oil hedges guarantee government revenues during 2016, the expectation of lower oil prices in 2017 calls for cuts in government spending now in order to achieve next year’s fiscal consolidation goals with greater ease.
- PEMEX, Mexico’s state-owned oil enterprise, like other oil companies around the world, has seen its revenue decline; therefore, it must take advantage of the benefits afforded by the recent reform in the energy sector in order to increase its operational efficiency.
In response to these realities, Banco de México’s board approved a 50-basis point rate increase. The central bank stressed that this should not be interpreted as the beginning of a tightening cycle, adding that it will keep a watchful eye on the projections for inflation to guarantee that they are in line with its three percent inflation target.
Simultaneously, the Exchange Rate Commission (ERC) which is comprised of Banco de México and the Ministry of Finance, has announced that, whereas economic fundamentals will continue to determine the exchange rate, the ERC will cease its preannounced auction of U.S. currency which appeared to have been subject to speculation. Instead, if necessary, it will intervene in the market in a discretionary fashion, in order to address exceptional circumstances of low liquidity and preserve the orderly functioning of the market.
For its part, the Ministry of Finance has announced a 132-billion-peso (approximately $7.5 billion) reduction in fiscal outlays, equivalent to 0.7 percent of GDP, to help maintain the fiscal targets for the year, avoiding an increase in public debt, as well as the need to raise taxes. It will also help facilitate further adjustments in 2017 should oil revenues remain low.
About three quarters of the cuts will come from an adjustment program to be presented to the board of PEMEX in the coming days. The remainder will consist primarily of cuts to current outlays; social spending, resources devoted to security, and key infrastructure projects, will be unaffected. Thus, the fiscal cuts’ impact on aggregate demand will be softened.
In the face of a volatile external environment, Mexico has reaffirmed its commitment to follow a steady economic course. Strong macroeconomic fundamentals—low inflation, responsible public accounts, sustainable debt levels—coupled with the far-reaching reform agenda approved under President Enrique Peña Nieto, will allow the country to endure current financial shocks from the outside while setting the foundation for sustained long-term economic growth.
