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Mexico’s non-petroleum exports …the driver of growth and its economic future

August 9, 2011 Economics

Contacts Felix Boni Director of Analysis E-mail: [email protected] Paulina Dehesa Analyst E-mail: [email protected]

Mexico’s non-petroleum exports …the driver of growth and its economic future We believe the Mexican economy is likely to experience a notable deceleration in growth over the next few months. The deceleration would be a consequence of an expected slowdown in its non-petroleum exports to the US which have been a major driver of Mexico’s overall economic performance during the current recovery from the 2008 recession. In this reports we quantify the nature of Mexico’s export growth, its relationship to the recovery in US imports and how those imports are related to the broader US economy. We also examine the ability of Mexico to broaden its export markets and how that might help offset weakness in the US. We expect continued weakness in the US economy, a major source of demand for Mexican exports. However, this process of deceleration fortunately might be relatively slow as exports have held up surprisingly well, as has Mexican GDP growth through 2Q11.

The structural increase in US imports during the 1990s and the early years of the last decade could be weakening, reducing their potential growth going forward.

We expect that imports will experience weaker growth vs. GDP while exports could rise as the high trade deficits of the past are no longer sustainable.

US imports are especially pro-cyclical declining more sharply than the overall economy in a downturn and rising more strongly during the recovery.

Much of the recent increase in US imports has been the result of this pro-cyclicality and could be coming to an end as growth falters.

For their part, Mexican non-petroleum exports are currently having a good run due to the strong post-recession rise in US imports.

Additionally, Mexican exports have grown at a substantially faster pace than overall US non-petroleum imports during the recovery.

It is not clear how much longer this gain in the market share of US imports will continue but certainly the performance over the last couple of years has been a major accomplishment.

Also helping Mexico has been its moderate success in reducing its dependence on the US as a market for its non-petroleum exports. Shipments to Canada and Asia have shown substantial growth.

Although still experiencing strength, Mexican non-petroleum export growth is declining from recent recovery highs and is showing a clear link to overall GDP growth.

Consequently, although Mexican GDP growth is likely to have been still strong in 2Q11 the rate of expansion is likely to experience important declines going forward.

The high volatility of US non-petroleum imports to GDP appears to be linked to pro-cyclical changes in US consumer goods spending and business investment on equipment.

US petroleum imports have not shown the same rebound as seen in non-petroleum imports, even in real terms. This could reflect reduced disposable income and lower levels of employment.

mailto:[email protected]

mailto:[email protected]


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Conclusions

In recent reports we have commented on the possibility of a deceleration in Mexico’s economic growth over the next few months. This would largely be a consequence of an expected slowdown in its non-petroleum exports to the US. We have seen non-petroleum exports as a major driver of Mexico’s overall economic growth during the current recovery from the 2008 recession. We expect continued weakness in the US economy, a major source of demand for Mexican exports. However, this process of deceleration fortunately might be relatively slow as exports have held up surprisingly well as has Mexican GDP growth through 2Q11. In our analysis we focus on four key factors:

First, the long-term evolution in US trade with rising deficits and now possibly a much smaller one.

Second, the recovery of US imports as they rebound from the 2008 recession.

Third, data suggesting that Mexico’s exports to the US are growing more quickly that US imports overall, implying a possible significant increase in market share.

Fourth, the moderate success that Mexico has enjoyed in diversifying its exports to economies other than the US.

The last two factors suggest that Mexican non-petroleum exports growth can continue to be strong even as US growth decelerates. Longer-term, however, weak underlying US growth, including weak US import growth, will be a negative factor for Mexico. It is not clear to what extent gains in Mexico’s share of US imports or continued diversification of Mexican exports will be able to offset this long-term structural issue.

US Foreign Trade

In Real Terms versus GDP We begin our analysis with an examination of the evolution of US foreign trade. This examination shows that imports as a percentage of GDP, on a real term basis, were rising strongly for at least fifteen years through the end of 2007. The ratio of imports to GDP tends to decline sharply in periods of significant downturns in growth. Likewise, the recoveries after the economy reaches its trough also tend to be very strong. Mexican exports are currently enjoying a boom partly due to the strong recovery in US imports that began with the economic rebound starting in 2Q09. However, now that US imports, as a percentage of GDP, have recovered most of what they lost, the sharp cyclical upswing could be ending and with it much of the source of the strength in Mexican exports.


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In Graph 1 we show the evolution of imports and exports relative to GDP since 1993 on a real dollar basis. We believe there are three main conclusions that can be drawn. First, we would note the general long-term increase in imports to GDP. Second, we see a sharp volatility in the import-GDP relationship during cyclical downturns and recoveries. Third, the weakness of the current recovery has prevented the import to GDP ratio from resuming its pre-2008 long-tem advance. The possibility that US long-term growth will be weak suggests that the import-GDP ratio might have limited upside potential. As for exports, these were showing strength relative to GDP as the pre-2008 expansion was coming to an end and have done very well with the recovery beginning in 2Q09.

Graph 1

In Graph 1 note how the ratio of imports to GDP rose from 9% at the beginning of the period to nearly 17% at its maximum in 3Q07, as the economy was beginning to weaken due to the problems in the housing industry. Also note the sharp decline in the relationship to GDP at the beginning of the 2001 downturn and the even more noticeable drop as the economy began fell into steep recession in 2008-2009. That same volatility works in the positive direction given the increase vs. GDP when the recovery begins. This was certainly the case as the economy started again to grow in 2Q09. However, the weakness in the last two to three quarters tracks the deceleration in 1H11. What is potentially very significant, however, is that imports have not recovered their prerecession highs now four years after the previous peak. In contrast, during the 2000 downturn the previous high was surpassed in three and a half years. Also note the strong recovery in

There has been a general long-term increase in imports to GDP, with strong pro-cyclical moves in downturns and recoveries. However, the imports in the current recovery appear to be relatively weak, not yet exceeding the previous highs vs. GDP.


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exports in this post-recession cycle vs. the much weaker rebound after 2000. We believe it is very possible that imports will not return any time soon to their previous highs and that it is much less likely that they will resume the previous expansion vs. GDP. We expect that this will be due to a secular weakness in the USD and structural weakness in US purchasing power. A weaker dollar and weaker domestic demand could also explain, in part, the rise in exports. To put the recent evolution of US imports in a more precise statistical perspective, the following data are illustrative. From the trough in 2Q09 to a strong point in 3Q10, imports advanced at an annualized pace of 16% in real terms vs. a GDP growth of 3.14%. After 3Q10 the rise in imports, as well as GDP, has been anemic, increasing 2.3% and 1.3% on an annualized basis. For the entire post-recession period (2Q09 through 2Q11) imports and GDP have risen at annual rates of 10.7% and 2.5%, respectively. These have produced rates of relative growth of 5.1x (change in imports to change in GDP) for the 2Q09-3Q10 period, vs. a weaker 4.4x in the entire 2Q09-2Q11 period. During the last three quarters the ratio has been a meager 1.8x.

US Trade Deficit With a weaker US we expect that it will be difficult for the economy to return to the large current account deficits seen immediately prior to the 2007 peak. The evolution of net imports to GDP is seen in Graph 2. The deficit to GDP ratio began the period at 0.7% and reached a maximum of around 5.9% during 2005-2007. The deficit declined sharply during the recession reaching a minimum of 2.6%. However, with the weakening recovery, the deficit is still not much above the recession minimum now hovering at around 3%.


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Graph 2

Given the large US public sector deficit it is difficult to expect that the rest of world will be willing to finance a large US current account deficit as well, especially given low interest rates. The public sector deficit will have to be financed in large part by domestic savings; this precludes a larger external deficit. The large deficit will over the long run lead to a weaker dollar making imports more expensive and exports cheaper. As a result, we conclude that slower structural growth in US imports will limit the potential expansion in Mexican non-petroleum exports.

In Nominal Terms In the previous sections we looked at the evolution of US trade relative to GDP on a real term basis. Although the real term focus is generally preferable to nominal dollar analysis, we will now look at trade and other related variables from a current dollar basis. The major reason for this is that we have more detailed data in current dollars, most importantly including our data on Mexican exports to the US. Imports versus GDP In the following section we look at the current dollar evolution of US non-petroleum goods imports and GDP. We also look at some of the components of US GDP that are arguably more likely to generate goods imports: 1) consumer goods spending and 2) consumer goods spending plus the smaller spending on business investment in equipment and software. The movements in these categories have tended to be a bit

The evolution of net imports to GDP started at 0.7% in 1993 to its maximum around 5.9% in the 2005-2007 periods. During the recession, the deficit dropped to 2.6% of output. The current figure is not far above the recession minimum of around 3%. We expect it will be difficult to reach much higher levels

with the current large US public sector deficit.


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more volatile than overall GDP and thus can help explain the much greater volatility in goods imports. In Graph 3 we present the evolution of these variables on an indexed March 1998 basis. Our analysis involves comparing the relative changes of index pairs (e.g., US imports to US GDP, Mexican exports to US imports and Mexican exports to US GDP). In previous graphs we showed percentage changes, in real terms. In Graph 3 we show the absolute indexed evolution. With the exception of the trade data, all the information comes from quarterly GDP reports, while the trade numbers come from monthly trade data.

Graph 3

In 2Q08 the non-petroleum imports index reached 1.21x of the GDP Index. This fell sharply to only 0.90x by 2Q09, the trough of the downturn. With the recently reported 2Q11 data (and our estimate for June trade) the ratio had rebounded to 1.20x virtually reaching the high point of the previous cycle. It is not clear how much higher non-petroleum imports could go vs. GDP. The data series presented in Graph 3 suggest that the major drivers of US non-petroleum goods imports are spending on consumer goods and business equipment. Relative to GDP change these fell sharply during the recession being especially pro-cyclical. Likewise they have now recovered to the levels vs. GDP reached at the peak of the previous expansion. At the pre-recession peak these items represented 0.96x GDP and fell to a low of 0.89x. With the 2Q11 report they reached their previous high against GDP.

The data shows the great volatility of non-petroleum imports and the lesser volatility of consumer and business spending. Of the four variables, the GDP is the least volatile of all. In 2Q08 the non-petroleum imports index reached its maximum of 1.21x to the GDP index. One year later this ratio fell to 0.90x. By 2Q11 we estimate that the ratio recovered to 1.20x.


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Petroleum versus non-Petroleum Imports Significantly, it appears that non-petroleum imports have recovered more strongly than petroleum imports which represented roughly 20.2% of total goods imports in nominal terms and 11.5% in real terms in the quarter that ended in June. In nominal terms, non-petroleum imports were 2.5% above the previous maximum reached in the summer of 2008. In contrast, petroleum imports were still 18% below their previous peak. Of course, this can be explained in part by lower petroleum prices vs. the peak reached in the previous cycle. However, the data presented in real USD terms shows similar results. We estimate that for the quarter ending in May real petroleum imports were 14.5% below the previous peak and non-petroleum goods imports were 1% above. It would appear that given economic stress, including lower levels of employment (fewer people driving to work) gasoline usage is lower than at the previous peak. Also, there have been increases in domestic oil production which could be lowering dependence on imported oil. In any event, it does appear to be the case that non-petroleum imports have rebounded more strongly than have imports of petroleum. The data in nominal terms are presented below in Graph 4.

Graph 4

Non-Petroleum Import Growth

In this section we look at the evolution of US non-petroleum goods imports directly (i.e., non-indexed basis) in nominal USD terms as well as percentage changes. The results are seen in Graph 5. Note the extreme sensitivity to significant changes in the overall growth rates and the rapid recovery. Given the size of the decline in the 2008 recession, the rebound

US non-petroleum imports have recovered much more strongly than petroleum imports. In the 2Q11, non-petroleum purchases from abroad were up 2.5% from the previous maximum reached in July 2008. Meanwhile, petroleum imports were 18% below their previous peak.


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has been especially strong with increases early on of around 40%, on a quarterly annualized basis. Although the decline in the growth rate has been erratic the trend is definitely downward. With information through June it had fallen to 9.4%.

Graph 5

Thus the perspective for US goods imports would suggest that the best of the recovery has ended and that growth going forward is likely to be closer to GDP than during the years prior to the 2008 recession. We now turn to how well Mexican exports have done. We view their performance given this historical context and with an appreciation of how well they might do in the future in light of our expectation that US import growth is likely to be relatively modest.

Mexican non-Petroleum Exports to the US The evolution of Mexican non-petroleum exports to the US can be seen below in Graph 6. The data there are presented on an indexed basis, as they were in Graph 3 above. The graph shows an extraordinarily positive development, perhaps one of the most positive for Mexico in recent years. Mexican exports have not only grown dramatically in the recovery to the 2008 recession but they have grown even with respect to US non-petroleum goods imports. In 2Q98 our index of Mexican non-petroleum exports (base of March 1998) had reached 1.03x of our US GDP index and a similar 1.03x vs. our non-petroleum imports index (in nominal USD terms). By 3Q08 the ratio to GDP and US imports had risen to 1.26x and 1.05x, respectively. The sharp increase vs. GDP was not reflected in a similar increase vs. imports,

We estimate that in 2Q11 the increase in US non-petroleum goods imports, in nominal USD, fell to 9.4%. In contrast, in 1Q11 imports had risen by 20.7%. The trend is downward


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as imports in general vs. GDP had risen substantially as we previously discussed. With the recession, the ratio of our Mexican export index to US GDP had fallen to 0.95x but the ratio to US imports actually increased marginally to 1.06x. Mexican exports were holding their own vs. overall US non-petroleum imports in what would be a precursor of their success during the recovery. With the recovery, and through June, our relative indices reached a strong 1.40x to GDP vs. 1.26x at the previous cyclical peak; and 1.17x to imports, vs. 1.05x.

Graph 6

From the trough in 2Q09 Mexican non-petroleum exports to the US have risen 26% on an annual basis vs. a 20% advance for total US non-petroleum goods imports. It is not clear to us how much longer Mexican non-petroleum exports to the US will continue to grow more strongly than US non-petroleum imports. Still, two key variables for the Mexican economy going forward will be the growth in US non-petroleum imports and the participation of Mexican exports in that growth. Looking directly at total Mexican non-petroleum exports on a current dollar seasonally adjusted basis (Graph 7) we see that the rate of growth is showing moderate but clear signs of deceleration. Through June the annualized quarterly rate of growth was 12.6% (vs. 1Q11). In February growth was 25% while during the quarter that ended in May of last year exports had expanded at a 41% annualized rate vs. the previous three month period.

Mexican exports have grown impressively during the recovery from the 2008 crisis, even with respect to US non-petroleum goods imports. Based on our indices, Mexican exports in 2Q11 reached 1.40x to GDP and 1.17x to imports. In contrast, in the previous peak the ratios were 1.26x to GDP and 1.05 to US imports.


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Graph 7

Within Mexican non-petroleum exports, a major driver is the automotive sector. Manufacturing exports represent roughly 95% of total Mexican non-manufacturing exports. For their part, automotive exports represent 28% of the non-petroleum total. These are now 34% above the prerecession peak, while non-automotive manufacturing exports have surpassed the pre-crisis high by a smaller although still solid 10%.

Graph 8

Thus far we have focused on the growth of the US market and Mexican exports to its northern neighbor. However, another part of the story, with significant long-term implications, is the diversification of Mexican exports

Mexican non-petroleum exports through June are 17% above their pre-recession peak. The growth rate is declining noticeably although somewhat erratically. Growth in 2Q11 was around 13% vs. previous levels of 70% and 40%.

Automotive exports –representing 28% of the non-petroleum exports– are 34% above of the previous cyclical high. Although non-automotive manufacturing exports have also surpassed the prerecession peak, they are only 10% higher.


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to other markets. In Graph 9 we show the evolution of that diversification. We conclude that the early NAFTA years and the strong growth of the US economy during the Clinton years led to a rising US share of Mexican non-petroleum exports. However, with slower US growth in the most of the first decade of the new century, combined with the dramatic expansion of the emerging markets, Mexico has made important strides in diversifying its export markets. Most notably, we would point to a 67% rise in exports to Canada vs. the pre-recession peak while exports to Asia have risen 36% vs. the 12.9% overall increase, including a 10.6% rise in exports to the US. (Data based on 12mma from July 2008 through to May 2011).

Graph 9

We conclude our report with an examination of the relationship between Mexican non-petroleum exports and Mexico’s GDP (including an estimate of 2Q11 growth). In Graph 10 we show the 12 month moving average change in exports and GDP. As the exports are stated in nominal USD we show the growth of Mexican GDP not only on a real peso basis but also in nominal USD terms using an average quarterly exchange rate. The relationship appears to be quite strong and helps to explain both the depth of the decline during the recession and the equally strong nature of the recovery. Not surprisingly, the relationship appears to be especially strong on a nominal dollar basis for GDP. The numbers suggest that with the 1Q11 report an important inflection point was reached and we expect it to continue with the 2Q11 report. Given the weakening nature of the US economy we would have to assume that the downward trend will continue through 2H11.

In the past few years, the Mexican exports have diversified into other markets, reducing the shares of the US market. In 12mma, these exports to US were 79%, in contrast with the peak 10 years ago of 90%.


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Our 2Q11 estimate assumes YoY real peso growth of around 4.5% with seasonally adjusted annualized growth of 6.85% vs. the very weak 2.1% growth in 1Q11 vs. 4Q10.

Graph 10

The relationship between Mexican non-petroleum exports and Mexican GDP in nominal USD terms seems to be very strong. With the weakness of the US economy, we can assume that the trend will continue through the second half of 2011.


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