As the world anxiously watches the unfolding US election, many analysts are speculating about its impact on Mexico’s economy. Will trade relations be upended? Will the peso come under pressure from political uncertainty? While these are valid concerns, the bigger story might not lie north of the border. Mexico’s real challenge stems from its domestic policies – a challenge that could shape the nation’s economic future more than any external events.
Monetary tightening versus fiscal expansion
OMFIF held a roundtable with Irene Espinosa Cantellano, deputy governor of Banco de México, to discuss the bank’s approach to navigating the country’s macroeconomic challenges and its strong commitment to controlling inflation. Both headline and non-core inflation showed improvement, dropping to 4.6% from 5.6% and to 6.5% from 10.4%, respectively (Figure 1).
However, core inflation, driven by rising service costs, remained stubborn, with wage growth outpacing productivity due to Mexico’s aggressive minimum wage policy. This complicates inflation management, as persistent price pressures remain.
Figure 1. Mexico’s inflation management presents mixed picture
Mexico’s inflation trends, %, July–September 2024
Source: Banco de México, OMFIF analysis
In response, the Banco de México has maintained tight monetary policy, allowing only gradual rate cuts. The board anticipates that the current inflationary environment will allow for further adjustments to the reference rate, if it remains restrictive. The central bank’s caution reflects concerns that easing too soon could destabilise inflation expectations.
On the other hand, the Ministry of Finance appears to be pulling in the opposite direction. Mexico’s fiscal deficit is expected to surge to 6% of gross domestic product in 2024, the highest in two decades. Increased public spending, driven by large infrastructure projects and growing current expenditures, is fuelling domestic demand and hindering the central bank’s ability to control inflation. This tension between the two institutions is unmistakable and may complicate the Banco de México’s goals for monetary stability.
Fiscal pressures are a growing challenge
Mexico’s fiscal outlook presents substantial risks. While infrastructure investments are nearing completion, they won’t provide the anticipated fiscal relief. Instead, funds will be redirected to cover operational costs, leaving little room for addressing future economic shocks. The lack of fiscal consolidation restricts the government’s ability to enact meaningful policy changes.
Tax reform is essential to increase revenue in a country with one of the lowest collection rates among Organisation for Economic Co-operation and Development members. Mexico’s tax revenue is about 16% of GDP, compared to the OECD average of 34%. However, the incoming administration has ruled out any major reforms, making any increases unlikely. This will leave the country exposed to higher deficits, especially if economic growth continues to underperform, further straining government finances.
Navigating these fiscal challenges will be critical for the incoming government, especially given how fiscal policies are clashing with the central bank’s inflation mandate.
Nearshoring: a missed opportunity?
Amid these challenges, nearshoring presents a significant opportunity for Mexico to attract foreign investment. Geopolitical shifts in global supply chains offer the country a chance to position itself as a manufacturing hub. However, concerns around the rule of law and political stability are major obstacles. Judicial reforms, which have weakened the independence of the judiciary by giving more power to the administration, have raised red flags among investors, leading many to adopt a ‘wait-and-see’ approach.
Despite these challenges, investment in physical assets like infrastructure has increased, but much of it has come from reinvested profits rather than new capital inflows. The potential to fully capitalise on nearshoring will require a secure and investor-friendly environment – something Mexico’s current policies are struggling to guarantee.
In the coming years, the Banco de México’s ability to control inflation will be tested by fiscal expansion unless the government reduces spending or boosts revenues through reform. Without better alignment between monetary and fiscal policy, inflation may remain elevated, undermining growth prospects. Furthermore, Mexico’s long-term economic growth depends on its ability to attract nearshoring investments, but this will only be possible if the country can address concerns about rule of law and political stability.
Yara Aziz is an Economist, Economic and Monetary Policy Institute, OMFIF.
