President López Obrador President López Obrador's policy decisions among risks for GDP growth.

Mexico’s economic contraction clouds pandemic recovery

GDP growth has stalled and faces more risks from supply chain disruptions and a mercurial government

A sudden drop in Mexican gross domestic product in the third quarter has analysts and investors asking: how fragile is the country’s recovery?

The growth of many economies — including the U.S. — slowed in the three months to the end of September as a third wave of COVID-19 cases hit, but Mexico’s estimated 0.2% quarter on quarter contraction announced on Friday was its first since the middle of last year.

At constant prices, the country’s GDP is probably only at 2016 levels and analysts say it faces further risks from supply chain disruptions and policy decisions by the government of President López Obrador.

The peso began to weaken against the dollar on Tuesday, sliding 2% against the greenback to Friday afternoon in New York, from 20.1718 pesos to 20.5782 per dollar. It put the currency on course for its worst week since mid-August and marked it out as one of the worst-performing emerging market currencies, with only the South African rand sliding further against the dollar.

Gabriel Yorio, deputy finance minister, said at a news conference that the government maintained its growth estimates for 2021 and 2022 and that consumption, investment and employment were almost at pre-pandemic levels.

“This figure does not interrupt the path of growth,” he said.

Playing in Mexico’s favor are record remittances and strong manufacturing exports — excluding a sharp drop in the car sector. Analysts at BBVA said the economy could still reach 6% growth this year and that the negative number was partly driven by a recent labor reform that severely restricted subcontracting.

But the global shortage of semiconductor chips hammering Mexico’s car plants, as well as an uncertain investment climate and a U.S. slowdown would continue to drag into next year, analysts said.

Private sector leaders say a proposed energy reform would do irreversible economic damage and make electricity dirtier and more expensive for companies and consumers if passed.

“What do I see on the horizon? A lot of challenges for Mexico,” said Gabriela Siller, head of financial and economic research at Banco Base.

With inflation now above 6%, the Bank of México has raised interest rates 25 basis points at each of its past three meetings. Analysts expect it to raise rates again in November.

Analysts at JPMorgan said manufacturing headwinds and fragile investment amid poor policy guidance were downside risks.

Uncertainty over nationalist López Obrador’s policy plans meant Mexico’s economy was already shrinking before the pandemic — with a 0.1% decline in 2019 preceding an 8.5% drop in 2020. Siller estimates that GDP will not fully recover to its 2018 peak levels until 2023, while GDP per capita could take until 2027.

“The bigger picture is that the recovery will still struggle from here,” said Nikhil Sanghani, emerging markets economist at Capital Economics. “The recovery will fare worse than in most other major economies in Latin America.”

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