The economy is forecast to grow 3.3% in 2022 and 2.5% in 2023, following a 5.9% expansion in 2021. Exports will continue to benefit from the strong recovery in the United States.

Consumption will be favored by the gradual improvement in the labor market and the increase in the proportion of the vaccinated population. Investments will benefit from planned infrastructure projects. Inflation will decline, following the notable increase in 2021.

If the recovery falters or the pandemic reactivates, both social investment spending and public investment will have to increase further, delaying the gradual reduction of the fiscal deficit. Monetary policy will have to be gradually tightened if inflation does not converge towards the 3% target.

Improving the regulation applicable to companies at the subnational level, reducing the administrative burdens and monetary costs of creating and formalizing a company, would contribute to increasing investment and the creation of formal employment.

In general terms, the recovery has been generalized with an upward trend in agriculture, industry and services. Services show a lag in those sectors with high rates of human contact, such as leisure and hospitality. Tourism, an important source of employment and income for several regions, is 27% below pre-pandemic levels.

Consumption is at 2% of its pre-Covid level, while investment is slowly recovering and remains 8% below its pre-pandemic level. The vaccination campaign is progressing steadily, with great heterogeneity between regions.

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For its part, inflation has risen considerably. Given Mexico's high integration into international value chains, significant pressure is being exerted on both headline and core inflation.

Internal factors such as the recovery in demand for some services, additional pressures on some items, such as agriculture and livestock, and rises in gas prices are accentuating inflationary pressures. The standard unemployment rate is at 4.2%, 0.8 percentage points above the level at the end of 2019.

Although the fiscal stance remains prudent, it is less restrictive than envisaged in the 2021 budget, literally supporting the ongoing recovery. The public deficit is projected to increase to 3.2% of GDP in 2021 (from 2.9% of GDP in 2020), to remain virtually unchanged in 2022 and to decline thereafter. It is estimated that the public debt will stabilize around 51% of GDP.

In order to support the recovery, the Central Bank reduced official interest rates by 325 basis points since February 2020 and granted ample lines of liquidity and credit. 

Given the significant increase in inflation, the Central Bank raised interest rates by 25 basis points at its June, August, September and November meetings, leaving the exchange rate at 5%. 

If price pressures continue and inflation does not gradually converge towards the 3% target, further increases in the exchange rate would be justified. The interest rate is expected to rise to 5.25% by the end of 2021.

The recovery will continue and domestic consumption will be a major growth engine. exports will continue to benefit from deep integration into value chains.

Inflation is projected to decline gradually in 2022 and 2023, as recent changes in monetary policy take effect, supply chain disruptions diminish, and extensive idle capacity limits wage pressures.

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However, the inflation outlook remains highly uncertain and not without risks. Inflation could remain at higher levels for longer than anticipated, and this would erode purchasing power, especially of vulnerable households, and require a greater-than-anticipated tightening of monetary policy, weakening the recovery.

If there were a significant increase in infections, it would be necessary to re-impose containment measures, which would drag down economic activity. Episodes of financial volatility in other emerging market economies could increase risk aversion, reduce the arrival of net financial flows and increase Mexico's financing costs.

On the positive side, if growth in the United States were stronger than anticipated, exports and job creation could be stronger. Integration into supply chains could be further deepened, thanks to the updated trade agreement with the United States and Canada.

The recovery in tourism could be stronger than expected, boosting job creation in some regions.

Relaunching investment and increasing productivity are key priorities. Expanding access to financial services, fostering competition in financial markets and speeding up the legal execution of contracts, would allow SMEs to invest more, grow and increase productivity.

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Original notes