The Mexican Sources of Isolation from the International Financial Turmoil

The Mexican economic performance is linked to US Economy given its economic integration. In fact, the last US economic slowdowns have affected the economic growth prospects of Mexico. This is the reason why we should be worry about it. However, according to the government the effect of this disorder this time will be limited; the treasury secretary Agustin Carstens said: “Mexico is not involved in the current crisis in the United States; in addition to that, given the fiscal and monetary policy in Mexico, our country does not depend on external financing”.

Recent data supports the government lecture. The probability of grater monetary astringency has fallen because less inflationary pressures principally by the downtrend of house rents, low prices in vegetables, and less pressures form international commodity prices. The aggregate demand has not weakened; the retail sales show stable levels. On the supply side, the coincident indexes of service and agricultural sectors have shown stable variations (IGAE). In financial sector; the mortgage, private, and consumer credit interest rates keep its historically low levels; and in the case of the principal organization that provide mortgage credits (INFONAVIT) keep its peace to provide half million mortgages credits in 2008 (the highest level). The follow graph, based upon the most current of data, shows a set of indicators to see the recent evolution in aggregate demand, credit supply, output and prices dynamics.

Macroeconomic Indicators in Mexico
(Annual percentage rate)
	2007		2008
	June	July	June	July
Real Wages Increases	0.8	0.3	-0.7	n.d.
Home Rents	2.9	2.9	2.9	2.8
Retail Sales	3.7	4.1	1.5	2.8
Industrial Activity	0.4	3.2	-0.4	-0.2
Services Activity	3.7	5.6	1.8	4.2
Agricultural Activity	9	7.2	1.1	9.7
Mortgage Rate 1/	14.9	14.7	14.1	14.2
Private Credit Rate 1/	7.5	7.5	7.9	8.3
With Data of August
	July	Aug	July	August
Non-oil exports	13.3	9.8	15.9	-2.7
Total private financing	32.07	34.4	21.6	18.7

1/ Interest rate

Sources: INEGI (www.inegi.gob.mx ), Bank of Mexico (www.banxico.org.mx ), Department of Labor and Social Welfare (http://www.stps.gob.mx/).

According with this information, we are no longer seeing the typical sensibility to US business cycle. The industrial activity will be the most affected; however this time the Mexican economy has automatic stabilizers such as fiscal discipline; monetary policy room; relatively low levels of inflation; savings, private and public debt in local currency; an adequate pension system; less prices pressures from international markets; healthy financial organizations; and a dynamic services sector.

At the end, the weak US economic activity and the squeezed of international credit will have an important effect over the Mexican economic outlook. However, Mexico is more suitable to deal with this short of financial crisis and avoid the recession. And a set of economic reforms would supported and minimize its impact and the probability of recession; the kind of reforms to give alternative sources of economic growth could reached through improving the competition legal framework, giving more flexibility to labor market, encouraging better banking practices and competition, giving financial access to uncovered sectors, promoting infrastructure investments, improving the implementation of monetary policy and using appropriately the public expenditures.

Is important take in consideration that the institutional economic reforms materialized in the Washington consensus, have provide economic flexibility no only to Mexico but many countries in the world (particularly developing countries). This time internal forces in these countries will be the main factor to avoid a world recession. More importantly, in these countries there leeway to compensate the weak economic conditions that developed countries will face in the following years. 

The Likelihood of Succeed in US Financial Rescue

The Mexican Financial Crisis in 1994 had more negative characteristics than the US Financial Crisis have now; therefore, the likelihood of succeed of an eventual US financial rescue is high (The Mexican recovery was a relatively successful experience).

Mexican crisis was not only a banking system crisis, it was also a exchange rate crisis, a fiscal crisis, private sector crisis and central bank confidence crisis. Mexico find its way to overcome the recession (as conventionally is known), trough out adjustments in the way how the economic agents get financial credit, creating a productive sector more focused in external demand, and changing the financial architecture to recovery the financial health. The process was painful principally because the inflation eased very slowly.

In 1994, the bank system suffered by exchange rate policy failures, affecting all the credit flow toward the economy. The total loan bank portfolio showed a downtrend for ten years after the crisis; from 42% in proportion of GDP in 1994 to 9.8% in 2003. This drove our economy to asymmetric and inequality growth; the prosperity reigned among corporation dedicated to export, and high levels of inflation, benefiting those who were hedging instruments against inflation and affected the purchasing power of the working population. However, the net effect was positive; GDP growth 5% in average in the period 1996-2003 and the levels of employment growth too.

The US economy outlook show differences. The exchange rate pass-trough toward core inflation is not important, the debt levels is not increased exponentially as happened in México (the reference interest rate in México skyrocketed from its lowest point in February 1994 in 9.4% to its peak in November 1995 in 53%); the corporation debt has been well handle and not liked to other curries and they have been succeeded in the incursion of international markets.

What we will see in US economy is changes in the credit behavior of its economic agents; enterprises will use more interfirm credit (as usual in Mexico) and the consumers will adjust the way how they finance their purchases; the financial sector will become more small; and an important source of growth will be exportations (as the last quarters). At the end US economy will recovery and it will show sustainable growth rates in line with an adequate growth in all its sectors; including high levels of employment.

As Tomato price; Corn “crazy” price exists

Tomato price shows more volatility than other commodities. In fact, central banks in the short run don’t affect its behavior as supply conditions do, and in México, it eventually threat the central bank’s inflation target (due its high weigh in the consumer prices index; the estimator of inflation); phenomenon named as supply price shocks, very usual in prices of vegetal products.

Even though tomatoes market doesn’t have a future market as other markets have, it shows the kind of volatility as grain markets with different timing and regularity given its characteristics such as yield variability, meteorological sensibility, logistics circumstances and size of the market. In the world, Tomato market is not an unique integrate market. Its perishability imposes market constraints; it’s not easy export Mexican tomatoes to Argentina or Europe because it only exists weeks after its production. Therefore in the world we see a set of markets with its own behavior. For instance, a single test to measure the long-run relationship between tomatoes prices in Mexico and Chile (co-integration) resulted that there are not relationship (for results of Johansen co integration test, feel free to ask me for the information).

The prices of Tomates in México have also a seasonal behavior. The harvesting period in Mexico is during the second half of the year, between August and December, so the output is concentrated mainly in the period February-August (the season of low prices). However it has a stochastic seasonal behavior, because the output is conditioned principally to the degree of goodness of the weather, previous price, and price behavior of productive substitutes.

The cyclical behavior showed by grain market is similar to tomato markets but more ample. It is because its ability to be stocked, low costs of transportation and negative crops that can be compensated by positive crops in many parts of the world. In fact, in the last decades we have observed complete cycles of prices; with a dynamic pattern similar to business cycle.

We are not well accustomed to high prices phases, as we are not accustomed to recession phases. High prices in commodities could stay for long time given that its fundamentals had changed (higher energy and labor prices –the agricultural activity intensive in both economic factors), and the prospects of eased demand has not changed yet (even with financial turbulence the prospects of food demand for developing countries is high). We can’t blame financial markets as principal factor behind high prices, there are fundamental reasons. For example: oil reserves located in regions with geopolitics tensions and extracted by government companies with non market behavior; and agricultural prices controls, affecting the prices as prime incentive in any economy.

Graph Annexes

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The Governmental inference in Agricultural Profile in Jalisco

The agricultural production in México is more diverse now than two decades ago. Institutional changes allowed a major diversification of food supply. Using Herfindahl–Hirschman concentration index with data of planted area in Jalisco (1980-2006), we find that concentration has fallen as is shown in the follow figure. The range of index is [0, 1], where in the limit of zero there is absolute diversification and one is absolute concentration (one unique product is planted).


However the concentration still is high, principally by selective prices and other kind of governmental interference, despite of the downtrend in the concentration index. In Jalisco the 55% of planted area in 2006 was still concentrated in products influenced mainly by agricultural policies; principally corn, sugar cane, and sorghum. For example, the area planted with corn wouldn’t be financially sustainable without “diesel agropecuario”, a program to sell diesel to farmers with a price 30% below market price; Procampo, a scheme to give liquidity during planted period, equally to 10% of production total costs; plus a coverage scheme in prices, reducing the price volatility inherent to commodity products.

However other products don’t have this kind of government support, mainly those products with more add value, high productive potential and better social outcomes, in the case of Jalisco, products such as artichoke, tomato, flowers, garlic, blackberries, and strawberries. ¿What are the kind of supports that farmers need to be more diverse in their area planted? I think in two very important: credit access and risk coverage tools.

Speculations, Bubbles and Corn Price

The spot price obviously doesn’t always match with future price, particularly in price of corn. During summer cycle the data in future market of corn prices are volatile, principally because the future prices is sensible supply expectations, and given that supply is relate to climate conditions, the market develop into a weather market: with a behavior very erratic. Eventually the market future prices become less speculative because the corn output is more predictable (we know with more certainty corn yields in September than June; because there are more information about climate damage or goodness), causing that prices in future contracts and spot prices are more related than previous periods.

In the current period, it’s possible relate the eased in future price in corn contracts with less speculative positions by investments funds in this market as consequence of a co-movement associated to oil market (some say it is out of any rationality investments). But we can also relate it to fundamental factors, principally unexpected supply positive shocks in recent weeks: the wet weather associated with secondary effects of hurricane Gustave, causing exceptionally positive rains in the “corn belt” of United States.

However, in the next quarter of the year we can’t only associate the easing of future corn price by the correction of irrational positions of financial intermediaries (bursting the bubble) or as result of narrowing the credit by central bank actions. I think there are also real factors that would give support to the current still high prices (in fact the markets think in this way) and supported expectations of high prices in recent periods (historical low levels in corn inventories). And at the end of the day, inventories, demand and supply conditions will be matter most.

In fact, the total funds invested in commodity markets reached $400bn at the end of the first quarter of 2008 (including all commodities such as Oil, Copper, Gold, Wheat, Corn and Zinc); the market value in one market, the biggest, The New York Stock Exchange reached $25 trills in 2006, 62 times larger than commodity markets; and the value of international bond market; reached in 2006 a value estimated in $45 trillion, more than 100 times all commodity markets; this is the reason why small movements, small influx from this market during the weather market period can affect the valuation of future prices. However, the spot price is determinate by fundamental factors as we’ll see in the coming months.

The graphs added invite us to infer about the outlook in corn market, now when the market will face the facts directly during harvest period in the last quarter of the year.

The lack of agricultural insurance in Mexico

The last weekend I visited Buenos Aires Ejido near to Ameca, my hometown in Jalisco, México. I wanted to take a look over the beautiful corn fields that I had seen previously. However, the situation was sad; the ejido was hit by a frozen storm that changed suddenly the yield expectations. Three weeks ago the expectations reached 10 tons per hectare in average (almost the yield obtained in U.S.), but after the storm the expectations were reducing by half. Weather conditions is one kind of risk that corn peasants face continually; drought, floods, biological diseases, and volatile input prices are also production risks that corn peasants face during summer cycle, the most planted in Mexico.

The problem to corn peasants is that they face large fixed costs; the quantity of inputs is more related to the area planted than the yield. The costs in the surface damaged by the storm will be the same than the area not affected; however, in the last the income will be twice as low as the affected even though the inputs employed in both cases were the same. To see the differences, in 2007 the production cost estimated by a state financial agency called FIRA was $10,824 per hectare in Jalisco and the farmer corn price was of $2,500 per ton; considering this information we see in average the net income in the region of Ciudad Guzman was of $186 (a ratio income/costs of 2%), and the net income in La Barca was of $7,126 (a ration income/costs of 66%), very different results not seen typically in the most of economic activities.

These eventualities are part of the agricultural cycles, making highly risky be peasant. In the period of 1996-2006 the difference between the maximum yield and the minimum yield in Jalisco was 2.9 tons (Minimum in 1997=2.25; 2005=4.54); 2.12 in Guanajuato (Minimum in 1997 =3.27; Maximun in 2004= 5.39); and 1.71 in Nayarit (Minimum in 2005=2.17; 2002=3.88). These kinds of changes are not observed in other economic activities; imagine aggregate manufacture production in any region suddenly fall 50% year to year; in fact during the 1994-95 recession in Mexico the manufacturing production index fall, from its peak 108 (November 1994) to its lowest point of 92 (April 1995), a decline of 15%, the worst fall in the last two decades; a typical negative rate in any cycle and any area of corn production in Mexico.

Considering these eventualities, insurance mechanisms provided by governmental and private organizations are the usual solution; and in other countries, the operation of future markets or access to one of them is a solution pursued by producers and governments. However in Mexico the producers don’t have access to this kind of financial tools to minimize the risks. ASERCA (www.aserca.gob.mx) have attempted modulate the price risks faced by producers through indirect price coverage; however the production risk is not adequately tamed or covered, this is the main risk and the direct subsidies have not been the solution. Given the importance of agricultural in the political debate and in fighting against the poverty in Mexico, find a market solution must be considered as way to improve the production conditions as way to mitigate poverty in Mexico, elevate food supply, and reduce the income volatility of our farmers.