The outlook for Mexico's economy is typically dependent on two dominant factors: the Mexican political cycle and the U.S. economic cycle. That was certainly true in 2018 and it will continue to prevail in 2019.
These two factors created significant headwinds for the Mexican economy over the past two to three quarters, but much of the struggle is now behind us. It is likely that the political environment in Mexico and the activity levels in the U.S. economy going forward will start to generate tailwinds for the Mexican economy that could provide benefits for years to come.
During the transition phase of the six-year Mexican political cycle, the economy tends to underperform. The exact reasons for this may vary, but typically there are delays in the execution of large parts of the federal budget as the new administration cancels or changes the projects initiated under the previous administration, and then begins to implement its own plans. This causes uncertainty for both investors and consumers, and such uncertainty restricts economic activity.
The general election was last July. It was one of the largest in Mexico's history and it followed one of the country's most violent campaign seasons. The subsequent deterioration in investor sentiment and confidence was due to the cancellation of infrastructure projects (most notably a new airport in Mexico City), a cut in the salaries of public workers and a reduction in the federal bureaucracy.
Along with the federal employees that lost their jobs, there was a large number of private companies that rely on federal contracts, which were also negatively affected. All these cuts were part of a much-needed austerity program intended to reduce rampant federal spending — and the accompanying high levels of inflation — and strengthen the country's balance sheet going forward. But they cause some pain in the near-term.
The austerity is relatively new, and Mexico is still struggling with a rate of inflation that is persistently higher than the target level. They are attempting to resolve this problem with a policy interest rate that has reached the restrictive level of 8.25 percent. High rates of inflation restrict investment in the long run but using higher interest rates to combat inflation deters investment in the near-term. A combination of time and deft policy decisions is the only solution, but here again, there is pain in the beginning.
If administered properly, the prescribed political and economic reforms should benefit Mexico's economy in the future. But they impeded economic growth in the second half of last year, and their effects will continue to be felt in the first half of 2019.