Mexico: Low oil prices could constrain budget
Economic growth is set to fall well below potential in 2008 and 2009, before gradually recovering in 2010. The weak US economy and a fall in oil production will cut exports over the next several quarters, while the effects of the financial turmoil will depress domestic demand growth. Activity will recover through 2010 as global economic conditions improve. Inflation will return to near the target rate as commodity prices fall, activity slows and monetary tightening keeps expectations anchored, although the recent sharp depreciation of the peso will put upward pressure on prices.
Fiscal policy will be supportive in the near term, cushioning the shocks to demand. However, the balanced budget rule has resulted in spending too much of the oil windfall over the past years, and may now constrain fiscal policy if oil prices remain at lower levels. Gradual loosening of the monetary stance is justified unless the recent depreciation of the peso revives inflationary pressures. To boost longer term growth, reforms should focus on enhancing public spending efficiency, product and labour market flexibility, and competition.