MEXICO REPORTS RECORD-LOW ANNUAL INFLATION OF 4.4 PERCENT FOR 2001.

Mexico managed a record-low annual inflation rate of 4.4% for 2001, but this statistic was overshadowed by negative economic indicators. The annual rate for 2001, reported by the Banco de Mexico (central bank) in early January, was the lowest since inflation records were first kept in 1968 and

Analysts attributed the low inflation to the appreciation of the Mexican peso, a decline in the cost of agricultural products, and the economic slowdown in Mexico, which helped to limit consumer spending.

"Inflation declined in recent months because of the decline in consumer spending and the strength of the Mexican currency," said analyst Eduardo Gonzalez Nolasco of Grupo Financiero Banamex-Accival (Banacci).

Contributing to the low annual rate was the very small increase of 0.14% in the consumer price index (Indice Nacional de Precios al Consumidor, INPC) during December. The small increase reflected a decline in retail activity during the normally busy month of December. "These are the lowest increases registered for the month of December," said the Banco de Mexico.

Inflation expected to rebound in 2002

Some economists anticipate a rebound in inflation during 2002, particularly because of the tax reform approved by Congress at the end of 2001. Under the tax reform, cellular telephones, tobacco products, alcohol, soft drinks produced with high-fructose corn syrup, and other goods and services will be assessed a higher tax (see SourceMex, 2002-01-09). Analysts say the higher prices for these items could have repercussions for consumer prices in general.

"We had a lot of price decreases in December that could easily be reversed," said economist Jonathan Heath of LatinSource in Mexico City. "The increases you did not have in December, you're likely to have in January. And maybe even a little bit more."

Guillermo Ortiz Martinez, chief governor of the Banco de Mexico (central bank), predicted the taxes could boost the INPC to 1% in January and possibly above 1% in February. "This does not mean that inflation is about to explode," Ortiz said at a meeting of business and labor leaders in Mexico City in mid-January. The Banco de Mexico has projected annual inflation at 4.5% for 2002.

In addition to the new taxes, the behavior of the peso could also affect the inflation rate in early 2002, particularly since the Mexican currency may have become overvalued relative to the US dollar. If the peso weakens significantly this year, the price of imports will increase, contributing to a spike in consumer prices. In November, imports totaled only US$14.2 billion, a decline of 11.1% from the same month in 2000.

The same factors that contributed to a low inflation rate, such as weak retail demand, were a double-edged sword for the Mexican economy, said economist Joost Draaisma, World Bank representative in Mexico. "The low inflation could be an indication that Mexico's economic slowdown is much deeper than originally anticipated," Draaisma told the daily business newspaper El Financiero.

Other reports reflect weak economy

Full statistics for consumer spending are not yet available for 2001, but other economic reports released by the government indicate the extent of the slowdown in the Mexican economy. For example, the Secretaria de Hacienda y Credito Publico (SHCP) reported a decline of 3.7% in industrial production in November 2001 relative to the same month in 2000. The largest declines were in the manufacturing and construction sectors, traditionally an important source of employment for many Mexicans.

Banco de Mexico statistics suggest at least 417,000 jobs were lost between November 2000 and November 2001 because of the downturn in the US economy and its direct impact on Mexico. The central bank and the SHCP also attributed the loss of jobs to an increase in salaries, which discouraged companies from expanding their work forces.

The Fox administration has adopted a mildly optimistic stance regarding the employment picture for 2002. Labor Secretary Carlos Abascal Carranza said the government is projecting the creation of about 300,000 new jobs this year, although he acknowledged this would not be sufficient to make up for the positions lost in the past year.

Abascal said the Secretaria del Trabajo y Prevision Social (STPS) plans to devote more than 4.17 billion pesos (US$453 million) in the first half of the year to assist unemployed workers with retraining, self-employment, and job- search programs.

In addition to the reduced consumption in the US, the Mexican economy also was affected by a weaker-than-anticipated global oil market. The SHCP reported Mexico's trade deficit for January-November at US$8.43 billion, compared with a negative balance of US$6.53 billion the first eleven months of 2000. The expansion of the deficit was attributed in large measure to a decline of 42.7% in the value of petroleum exports. Oil prices have fallen because of reduced demand in the US, where consumption of oil products has declined because of the economic slowdown.

The Fox administration is counting on increased direct investment to help reactivate the economy, which is projected to grow by 1.5% in 2002. This compares with forecasts of zero or negative GDP growth in 2001. But officials say the prospects for investment are not sufficiently bright to help bring about the necessary economic growth. In a recent report, Economy Secretary Luis Ernesto Derbez forecast direct foreign investment at US$15 billion in 2002, compared with US$25 billion in 2001.

Still, some Fox administration officials are hoping foreign investment will increase because of the encouraging ratings by the ratings agency Fitch IBCA for Mexico. In mid- January, Fitch announced it had awarded Mexico an investment grade rating. Moody's Investors Service gave Mexico an investment grade rating in March 2000 (see SourceMex, 2000-03- 08). But another respected agency, Standard & Poor's, continues to rate Mexico one notch below investment grade.

"Mexico's credit fundamentals have been buttressed by the country's increasing integration with the US economy and impressive management of economic policy in recent years," said Fitch analyst Shelly Shetty. She said several factors were considered in raising the rating for Mexico, such as the sharp decline in Mexico's foreign debt as a percentage of GDP, a decline in interest rates, and a low annual inflation rate.

Private economists are skeptical about the Fitch ratings, raising concerns about the inability of Congress and the Fox administration to agree on a tax reform that would provide the government with sufficient revenues to operate. "It's not a good sign that Congress and the executive branch couldn't agree on the most important issue facing the country," economist Mario Correa of Scotiabank Inverlat told The Dallas Morning News. [Note: Peso-dollar conversions in this article are based on the Interbank rate in effect on Jan. 16, reported at 9.20 pesos per US$1.00] (Sources: Notimex, 01/09/02; Unomasuno, 01/10/02; El Universal, El Financiero, 01/10/02, 01/11/02, 01/16/02; La Cronica de Hoy, The Dallas Morning News, La Jornada, Novedades, Milenio Diario, Reforma, 01/10/02, 01/16/02)