The outbreak of swine flu couldn’t have come at a worse time for Mexico, really.
The government has been struggling to revive the country’s economy, trying to reduce interest rates while fighting inflation and a weakening local currency. You can see the rather dramatic recent movements in the Mexican peso against the US dollar in the charts below. Five year is on the left and the past three months on the right.
Swine flu clearly won’t help matters.
Tourism inflows to the country, the third-biggest source of foreign currency after oil exports and money sent from Mexicans living abroad, will likely be reduced at a time when economic data from the country has already been quite weak. Furthermore, the aggressive outbreak won’t help Mexico’s cross-border trucking trade dispute with the US and will probably help decrease trade ($216bn imported to the US from Mexico in 2008) between the two countries.
Here’s some comment from RBS Securities’ economist Benito Berber and currency strategist Flavia Cattan-Naslausky on the matter:
The peso has already adjusted sharply from last week. This corrects an over-extended short dollar position not seen since last September. There is some perception that the Mexican authorities have delivered a proper response thus far including the decision to close schools through May 6th. Stabilization or further adjustment will depend on whether the number of reported cases in Mexico starts to fall. It is too early to tell and the WTO has yet to give a firm pronouncement.
The direct and immediate impact on the peso comes from lower tourism-related income. Tourism revenue inflows in Mexico in 2008 totalled USD13.3bn and outflows related to Mexicans travelling abroad totalled USD8.5bn. Both are expected to go down. Netting out these flows provides a net inflow of USD4.8bn is equivalent to 19% of annual worker’s remittances, not a negligible amount.
And on consumer demand and that sticky inflation:
Another important impact on the economy will be on consumer sentiment. Retail sales, a barometer for private consumption collapsed by 8.6% yoy in February, much sharper than expected. The swine flu will only exacerbate concerns on domestic demand as people are being asked to stay in their homes and to specifically avoid shopping centers and movie theaters. Equity market flows will also get hit, look for sharp decline in consumer equity prices, i.e. Walmex. Our 2009 GDP growth forecast of -4%yoy could quickly come under pressure if the epidemic worsens.
There will also be a direct impact on private consumption on inflation. We expect inflation pressures to quickly subside. While bi-weekly April inflation already showed some signs of deceleration particularly in the core-services component, headline inflation remained high due to the FX pass-through. This trend on inflation may be quickly reversed as people stay home. We therefore re-affirm our 3.2%yoy inflation forecast by year-end from the current 6% level.
Inflation expectations, which have drifted higher above 4% should begin to moderate soon. The impact will be for markedly dovish monetary policy. [Mexico's central bank] Banxico will cut 75bp on the May 15th meeting to 5.25%. While we expect Banxico to lower the rate to 4.50%, there is risk for a lower rate. FX volatility should not be an impediment for lower rates.
And on their currency and GDP forecasts, and the impact on emerging markets in general:
For now, we maintain our current FX forecasts for USD/MXN 14.50 and 14.10 for Q3 and Q4, respectively reflecting a much weaker second half of the year for risky assets and global growth. For the shorter term, one thing to consider is that Mexico has a good amount of ammunition with the USD30bn swap line and USD47bn IMF FCL to stabilize the peso should the flu outbreak further pressure FX. Banxico has only sold UD3.2bn of the IMF funds in one auction last week.This should keep USD/MXN stable at the current level and cap upside risk.
In fact the focus at this stage is shifting from the MXN to global FX and the risk trade. The outbreak occurred during spring break and has appeared in different parts of the globe. The safer currencies, USD and JPY are gaining while EMFX is decidedly weaker. Agricultural commodity currencies could underperform in the spill-over. Interestingly, CLP has taken a sharp turn and trading through 600 (Chile struggles with challenges in salmon industry). The BRL’s attempt to trade below key support levels has been cut short. The same is for COP which has outperformed the region for the most part of the last week. Note that the SARS outbreak in Asia in 2003 was essentially localized save for Canada as a result of heavy tourism traffic between the two regions. Still, the negative impact was mostly on the Asian currencies. The verdict of the propagation of the disease is still not out so that the pressure on EMFX will likely extend for some more time.
In other words, the ultimate impact on Mexico will depend on the government’s response to the outbreak and how quickly it spreads to other lands.
To that end, if you want to see how the pandemic’s developing, someone has put together an excellent swine flu map on Google.
And for local blog coverage of the outbreak see Latin America finance blog Inca Kola or the The Mex Files.
Related links:
Citi, Banamex and the peso – FT Alphaville
Flu outbreak to loom over US-Mexico truck dispute – Reuters
A Mexican-US fallout wave - FT Alphaville