VZCZCXRO5937
PP RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #2670/01 1441943
ZNR UUUUU ZZH
P 241943Z MAY 07
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC PRIORITY 7142
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE
RHEHNSC/NSC WASHDC
RHMFIUU/CDR USSOUTHCOM MIAMI FL
RHMFIUU/CDR USNORTHCOM
RUEHC/DEPT OF LABOR WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RHEBAAA/DEPT OF ENERGY WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 03 MEXICO 002670 
 
SIPDIS 
 
SIPDIS 
SIPRNET 
 
STATE FOR A/S SHANNON 
STATE FOR WHA/MEX, WHA/EPSC, EB/IFD/OMA, AND DRL/AWH 
STATE FOR EB/ESC MCMANUS AND IZZO 
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GERI WORD 
USDOC FOR ITS/TD/ENERGY DIVISION 
TREASURY FOR IA (ALICE FAIBISHENKO) 
DOE FOR INTERNATIONAL AFFAIRS KDEUTSCH AND ALOCKWOOD 
NSC FOR DAN TOMLINSON, RICHARD MILES, DAN FISK 
STATE PASS TO USTR (EISSENSTAT/MELLE) 
STATE PASS TO FEDERAL RESERVE (CARLOS ARTETA) 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PINR PGOV MX
SUBJECT: MEXICAN ECONOMY SLOWS IN FIRST QUARTER 
 
 
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Summary 
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¶1. (SBU)  The Mexican economy is showing signs of slower 
growth, with the forecast for real GDP growth around 3.2% for 
2007, down from 4.8% last year.  In the first quarter of the 
year, the Mexican economy grew at its slowest rate in more 
than a year, in part due to the slower pace of the U.S. 
economy.  Most economists agree that Mexico can weather a 
gradual U.S. slowdown, at least temporarily, but that its 
economy is too closely linked to that of the U.S. for it to 
escape unscathed.  Slower growth in the U.S. weakens demand 
for Mexican goods in the U.S. -- the destination of 85% of 
Mexico's exports.  In the fourth quarter of last year and the 
first quarter of 2007, export growth to the U.S. tailed off 
from the double-digit quarterly growth rates registered from 
the beginning of 2004 until the third quarter of 2006.  The 
weakened demand is most notable in the manufacturing sector, 
which accounts for more than 80% of Mexico's total exports. 
The automobile sector in particular has suffered, with 
vehicle production down 12.4% in the first quarter compared 
with the first quarter of 2006.  Finance Secretariat 
officials have said that Mexico is better positioned to 
weather a U.S. slowdown than it was in the past because of 
stronger macroeconomic fundamentals and domestic demand. 
While this is true, it is the Calderon government's ability 
to diversify the economy and tackle much-needed economic 
reforms that will determine the country's future success. 
End Summary. 
 
------------------------------- 
U.S. Slowdown Dampens Growth... 
------------------------------- 
 
¶2. (U) The Mexican economy is showing signs of slower 
economic growth, with the forecast for real GDP growth around 
3.2% for 2007, down from 4.8% last year.  In the first 
quarter of the year, the Mexican economy grew at its slowest 
pace in more than a year, largely because of a drop off in 
automobile output and construction.  Real GDP expanded 2.6% 
from a year earlier, down sharply from the 4.3% growth 
registered in the fourth quarter of 2006. 
 
¶3. (U) A key factor behind this subdued performance is the 
slower pace of the U.S. economy, which only grew 1.3% in the 
first three months of the year.  Most economists agree that 
Mexico can weather a moderate, gradual U.S. slowdown, but 
that its economy is too closely linked to that of the U.S. 
for it to escape unscathed.  Slower growth in the U.S. 
weakens demand for Mexican goods in the U.S., the destination 
of 85% of Mexico's exports, according to Mexican trade 
statistics.  In the fourth quarter of last year and the first 
quarter of 2007, export growth to the U.S. tailed off to 8% 
and 2%, respectively, over the same quarters a year before. 
These rates compare unfavorably with double-digit quarterly 
growth rates from the beginning of 2004 until the third 
quarter of 2006.  The weakened demand is most notable in the 
manufacturing sector, which accounts for more than 80% of 
Mexico's total exports.  Industrial production rose only 0.2% 
in March, after growing 0.1% in February and 1.5% in January. 
 The automobile sector in particular has suffered, with 
vehicle production down 12.4% in the first quarter compared 
with the first quarter of 2006.  April saw a rebound of 11% 
over the same month in 2006, but it is still too early to 
project the beginning of a complete recovery.  That said, 
auto output is expected to increase over the next 5 years as 
Asian companies continue to grow and efficiency pressures 
push the Big 3 (Ford, GM, and Chrysler) to expand production 
in Mexico.  However, a decrease in the U.S. demand for 
automobiles produced in Mexico would hurt the already 
weakened manufacturing sector. 
 
 
MEXICO 00002670  002 OF 003 
 
 
--------------------------------------------- - 
...But Mexico More Resilient Than in the Past 
--------------------------------------------- - 
 
¶4. (SBU) Finance Secretariat (Hacienda) officials have said 
publicly and privately that Mexico is better positioned to 
weather a U.S. slowdown than it was in the past because of 
stronger macroeconomic fundamentals and domestic demand. 
Mexico's fiscal deficit and public debt ratios are down, and 
inflation has fallen to around 4%.  Bond spreads are at 
record lows, and the current account deficit is manageable. 
Reynoso told econoff that the floating exchange rate has 
helped, but he noted that the real difference is that now a 
depreciation of the peso does not hit wages. 
 
¶5. (SBU) Marco Oviedo Cruz, Hacienda's Director of Financial 
Planning (strictly protect), told econoff that domestic 
growth will act as a counterweight to the expected decline in 
exports.  While domestic demand cannot permanently stave off 
a downturn, Oviedo Cruz said it can act as a buffer for 2-3 
quarters.  He added that the increase in credit to the 
private sector, particularly loans to homebuyers, and the 
likely decline of domestic yields would help propel domestic 
consumption.  The Managing Director to the President on 
Strategy at the Mexican Stock Exchange, Alejandro Reynoso 
(strictly protect), added that another important factor is 
the government's ability to maintain a modest fiscal deficit. 
 Oviedo Cruz and Reynoso both said a prolonged U.S. slowdown 
would be more harmful to Mexico than a short, steep downturn. 
 
 
¶6. (SBU) Oviedo Cruz and Reynoso agreed that a decline in oil 
prices would not have a significant impact on Mexico's 
economy.  Oil only represents a small component of total GDP, 
and revenue shortfalls could be covered by slightly 
increasing the deficit and reducing government spending. 
Oviedo Cruz said that oil prices are more of a concern for 
public finances, which would eventually affect domestic 
growth.  HSBC's chief Mexico economist noted that he is more 
concerned about the impact of falling oil production than he 
is about oil prices. 
 
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Comment 
------- 
 
¶7. (SBU) A stronger, more dynamic economy will help Mexico 
weather the U.S. slowdown, but the Calderon administration's 
ability to diversify the economy and pass much-needed 
structural reforms are key to the country's international 
competitiveness and future success.  The government is overly 
dependent on volatile oil prices and must to find ways to 
direct more investment into the state-owned energy company to 
keep production levels from falling.  Bank lending has 
increased, but financing for agriculture and small- and 
medium-sized businesses remains scarce.  To improve Mexico's 
competitiveness, foreign investors and many experts on Mexico 
also have called on the government to reform the labor code, 
improve respect for rule of law, encourage competition in 
sectors dominated by only a few firms, and improve the 
quality of the educational system. 
 
¶8. (SBU) On the positive side, prospects for economic reform 
have improved since the Calderon administration took office 
last December, due largely to the President's political 
dexterity and the Finance Secretary's strong negotiating 
skills.  The government passed a major pension reform for 
public sector workers earlier this year, and fiscal reform is 
in the works.  Separately, Hacienda officials expect the 
economy to pick up pace in the second half of the year as the 
U.S. economy recovers.  End Comment. 
 
 
 
MEXICO 00002670  003 OF 003 
 
 
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