Moody's: Dampened economic prospects will add pressure to fiscal accounts

Tuesday, January 29, 2019

On 21 January, the International Monetary Fund (IMF) lowered its 2019 and 2020 real growth forecasts for Mexico (A3 stable) to 2.1% and 2.2%, respectively, from 2.5% and 2.7% as of October 2018. These growth dynamics are credit negative for Mexico in that they add pressure to Mexico's near-term fiscal performance: lower growth will challenge the government's ability to meet relatively austere 2019 budget targets, while growth fueled by public spending beginning in 2020 will likely generate wider public-sector deficits.

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The IMF's downward revision to its growth expectations for Mexico is in line with a general dampening of expectations for Mexico's 2019-20 economic prospects shared by the vast majority of market participants - including us - owing to a strong contraction in private investment in fourth-quarter 2018, which is unlikely to rebound in 2019. And while growth will likely accelerate in 2020, this would be fueled by higher government social spending and public investment, rather than a pick-up in private investment.

Negative investment and growth prospects in 2019 follow a contraction in private investment that began in August 2018, with industrial production and high frequency indicators tied to investment decelerating through the end of the year. We believe this fall in private investment reflects reduced investor confidence in the direction of policy and overall business conditions under the new administration that took office in December, following the generally unanticipated cancellation of the Mexico City (Texcoco) airport late last year.

Additionally, a less dynamic global manufacturing sector - notably in the US (Aaa stable) - and high rates of contraction in the construction and domestic mining sectors (mainly related to the very significant decline in state oil company Petroleos Mexicanos (PEMEX)'s (Baa3 stable) crude oil production, which the new administration has pledged to reverse) will further constrain investment dynamism in 2019. And, while consumption supported growth in 2018, we expect that consumption will slow this year, given that investment has not picked back up.

Despite government pledges to increase public investment and social spending, we do not expect government outlays to begin rising in earnest before 2020. A relatively austere 2019 budget which incorporates a primary surplus of 1% of GDP will constrain spending this year. Moreover, to accommodate new policy priorities while maintaining a somewhat restrained fiscal position, administrative expenses - including civil servant pay - have been slashed significantly in this year's budget. This has prompted an outflow of technocrats and mid-level civil servants which would constrain the administration's capacity to execute spending.

Public spending is therefore unlikely to be a significant growth driver during the first part of the year. That said, it is important to note that the 1% of GDP primary surplus envisioned in the 2019 budget incorporates real growth of 2% this year. While in line with the IMF's latest revision, 2% growth is today at the upper bound of market consensus growth forecasts for Mexico this year, which have fallen to 1.8%, from 2.2% in October. If growth indeed falls below 2%, which we believe is increasingly likely, this will add pressure to an already tight budget this year.

Even though we expect private investment to provide only limited growth uplift next year, government investment in already planned for oil refineries and rail projects, along with increased social spending, could result in modestly higher growth in 2020. Increased pension spending and social transfers will reinvigorate consumption next year. However, with higher government spending likely to put additional pressure on its fiscal accounts, Mexico's credit profile could deteriorate.