Mexico Economic Overview

Mexico has the second fasted growing economy after China. Most of the people who live in Southern California have some knowledge about Mexican culture. It is also next to the US and that's why we decided that it would be the easiest to open or move some business to Mexico.

Mexico is federal republic operating under centralized government. Operational risk in Mexico is moderate. Broad consensus on the largely pro-market thrust of economic policy and Mexico's participation in NAFTA help underpin legal guarantees for investors, although deficiencies in the courts weaken enforcement. The tax regime will need to undergo reform in the medium term in order to raise the acutely low tax take, but political sensitivities will impede progress. Low standards of health and education are reflected in skills shortages. Violent crime is a problem for business but rebel movements are unlikely to impinge on the private sector or undermine political stability. The physical infrastructure, especially the electricity sector, is in need of fresh investment.

Mexico's political environment will become increasingly hostile in the approach to the July 2006 presidential election and the momentum of policymaking will be weak. There has been an escalation of political tensions surrounding a decision on April 7th by the legislature to strip the popular mayor of Mexico City, Andrea Manuel, Lopez Obrador, of his immunity from prosecution. Legislative output has remained at a virtual standstill. Full-year figures for 2004 show that higher than expected oil earnings offset below-budget non-oil earnings, preventing a deterioration in the fiscal results. The latest data confirm that real GDP expanded by 4.9% year on year in October-December and 4.4% in 2004 as a whole. Although export earnings growth has remained strong, it has been outweighed by growth of import spending, leading to a progressive widening of the merchandise trade deficit.

Mexico: Country outlook

COUNTRY VIEW

FROM THE ECONOMIST INTELLIGENCE UNIT

Economic performance is expected to remain closely tied to the economic cycle in the US, which purchases over 80% of Mexico's exports. This leaves Mexican growth particularly vulnerable to a sudden downturn in US demand. The Economist Intelligence Unit's central forecast is for GDP growth to slow at a measured pace in 2005-06. Tight monetary policy will help to bring inflation down to within the target range of 2-4% by the end of the forecast period. High oil prices and workers' remittances will contain the current-account deficit.

The political environment will be increasingly charged in the run-up to the July 2006 presidential election, which is already dominating the political scene. Although Andres Manuel Lopez Obrador, the leftist mayor of Mexico City, remains the clear favourite, he can be confident of winning only around one-third of the vote. On balance, the opposition Partido Revolucionario Institucional (PRI) seems in the strongest position to win the presidency, given its powerful nationwide machinery, built up through 71 uninterrupted years of government prior to 2000. Whoever wins, a major change in policy direction is not in prospect. In the remainder of the term of the president, Vicente Fox Quesada, which ends in December 2006, few significant legislative initiatives can be expected. Hostilities between the ruling centre-right PAN and the PRI will perpetuate legislative gridlock. Consequently, pressing reform issues--including fiscal, labour market, energy and political reform aimed at improving governability--will be left to the government of the 2006-12 sexenio (six-year presidential term). The 2006 presidential election will be the first major test of the Instituto Federal Electoral (IFE, the electoral authority).

Mexico's relations with the US are the dominant foreign policy. Tensions have arisen in recent weeks over US moves to tighten controls on illegal immigrants, including tougher checks on the issuance of driving licences and the extension of a controversial exclusion wall along the California-Mexico border. Conditions for migrant workers will remain at the top of Mexico's agenda, while strategies for improving security along the 3,000-km bilateral border will continue to be a priority for the US as part of its war on terrorism. The likelihood of an increase in nationalist discourse as the Mexican presidential election draws close will also provide scope for friction. However, policy initiatives and the influence of Mexico's large emigrant community in the US will favour the strengthening of bilateral ties. Further afield, Mexico's central challenge will be to develop relations that will help the productive sector to capitalise on the country's network of free-trade agreements (FTAs), particularly with the EU and Japan. Deepening trade ties with these markets will require the surmounting of logistical challenges.

Policy trends: In 2005-06 a continued emphasis on containment of the fiscal deficit and inflation control will help to consolidate the macroeconomic stability that Mexico has won in the past decade, and to encourage a gradual deepening of local capital markets. Yet, despite sounder fundamentals than a decade ago, the economy remains sensitive to political developments. Consequently, financial market volatility is in prospect as the election campaign intensifies. The reduction in external vulnerabilities over the past decade, combined with liability management operations to reduce payments falling due around the election, will ensure that a major crisis is averted. However, political uncertainties will harm investment prospects, to the detriment of medium-term development. Policies needed to raise GDP growth rates above the sluggish levels that have characterised most of the past four years will continue to be impeded by political constraints. Although cross-party support for broadly pro-market policies is solid, the more thorough structural reform needed to improve competitiveness involves politically sensitive issues--in particular energy, fiscal and labour market reform--that successive governments have been unable to broach. Resistance to private-sector involvement in the energy sector and to increasing labour market flexibility will remain strong among legislators from the PRD, and some within the PRI, providing limited scope for the increased investment needed to improve competitiveness. Legislators will also be reluctant to broaden the tax base, as a result of which tax reform, which would reduce fiscal dependence on the energy sector, will make little headway.

International assumptions: Although we forecast that global growth will remain robust in 2005-06, major risks exist to this forecast, particularly

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