Cautious optimism-Inflation perspectives in Mexico

Published in Plaza de Armas (www.plazadearmas.com.mx), April 11th 2011

The last week we had two encouraging news for the national economy. The first one was the increase in the economy growth estimates for 2011 from 4.0% to 4.3%, announced by Hacienda (the Treasury Department in Mexico). The other one was that the annual inflation in March was 3.04%, the lowest in the last 5 years.

However, we also had statements from the Head of the Mexican Central Bank, within the National Bank Convention, where he said that we must take the optimism with caution in the presence of “not comfortable” conditions in the external environment. Let’s review this information to understand its causes and its implications.

The increase in the growth perspective is based in internal and external results. The Global Economic Activity Index, which works as an early GDP index, has a growing trend. We have also growths in non-oil exports, in internal demand, and in the US economy, as I mentioned last week. It is true that growth will be less than the one we had last year, but last year’s growth was result of the dramatic fall we had in 2009. So far, optimism seems sustained in hard data.

News about inflation has different explanations. The data publicly announced is based in the National Consumer Prices Index, comparing it with the value it had 12 months earlier. Mexican Central Bank explains it is the result of a price decrease in some fruits and vegetables, mobile phones and cars, mixed with an increase in tortilla, gasoline, avocado and electricity. Here we begin to find some of the not comfortable circumstances referred by Dr. Agustin Carstens, which we will detail a little ahead. I just want to make two observations about national inflation: first, March 2011 had the lowest inflation rate in the last 9 months, and it matched with the fact that inflation in March 2010, the other reference point to estimate the most recent annual inflation value, was the 5th highest month in the last four and a half years; so, the fall in inflation is the result of a decrease in monthly inflation as well as a high reference point. The other observation I want to make is that the other component for inflation, the National Producer Prices Index, had in March a 4.11% annual inflation, the second highest level in the last year and a half. It is not sustainable in the medium term a situation where consumer prices go down while producer prices increase; this will bring inflationary pressures in the short term. Therefore, this other component of optimism has a lot of nuances, national and internationally.

So, let’s talk about the other international factors. We have a world inflationary pressure due to two factors: the increase in food prices (especially grains) and the increase in oil. Food prices have had increases for the last 8 months, in some cases as steep as the increase of 65% in the last 4 months for corn. Rice and wheat have had also important increases. Fortunately, UN’s Food and Agriculture Organization announced a price decrease in March that they qualify as a “truce” since there are still many factors that keep uncertainty about future food prices. Cereal international stocks are in historical low levels, and although crops perspectives are positive for 2011, won’t be enough to replace stocks. That gives us expectations of high prices for 2011-2012. If we see the quotes for different grain futures, corn projections are an increase up to July with a later decrease, meanwhile wheat and rice keep their increasing perspectives up to May 2012. Evidently, besides inflationary prices we have very important social risks since we are talking about very basic food produces world wide, and a lack of them would have very strong consequences. In Mexico we have seen a notorious increase in tortilla price in the last months, with a 50% increase in December, and an increase of 6% during this year’s first quarter.  Although there are different support programs, it is difficult to foresee a price reduction in the short term. This is another inflationary pressure that began to reflect in March.

The oil price will keep its growing trend, particularly with all the political and social instability that we have had since January in North Africa and Middle East. All this has created a world scenario where many countries have begun to increase their interest rates to control their inflationary pressures. For example, the European Central Bank announced last Thursday an increase of a quarter of point to leave its rate at 1.25%, since they want to reduce their inflation from 2.5% to 2%. This is the first adjustment they make since 2008. China also made a 4th adjustment in 6 months since their inflation is 4.9%, while their goal is 4%. Other countries that have increased their interest rates in March are Chile, Brazil, Colombia, Uruguay, South Korea and India among others. This may accomplish its purpose to control inflation, but a “side effect” is to compromise the economic growth rate; so we are beginning to live a delicate balance in the world.

Mexico keeps estimating they will review next year its interest rate since authorities consider that the level of economic growth has not been enough to create an overheating; I estimate that all the external factors may lead to a review during the second semester of this year, and possibly a review in the inflation estimates that is 3% +/- 1%. It will also be necessary to monitor if there are changes in the current world economic growth dynamic produced by the increase in interest rates.