VZCZCXRO4655
RR RUEHCD RUEHHO RUEHNG RUEHRS
DE RUEHME #0348/01 0332301
ZNR UUUUU ZZH
R 022300Z FEB 10
FM AMEMBASSY MEXICO
TO RHEBAAA/DEPT OF ENERGY WASHINGTON DC
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHC/DEPT OF LABOR WASHINGTON DC
RUEHC/SECSTATE WASHDC 0309
RUEHC/USAID WASHDC 0005
INFO ALL US CONSULATES IN MEXICO COLLECTIVE

UNCLAS SECTION 01 OF 02 MEXICO 000348 
 
SENSITIVE 
SIPDIS 
STATE FOR  WHA/MEX. WHA/EPSC, EEB 
NSC FOR RESTREPO, FROMAN, LIPTON 
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GWORD 
TREASURY FOR NANCY LEE, IA 
ENERGY FOR WARD, LOCKWOOD AND DAVIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD ENRG ELTN EAIR PGOV SENV MX
SUBJECT: NEW CENTRAL BANK GOVERNOR ON THE ECONOMY AND MONETARY POLICY 
 
¶1.  Summary.  In his first speech as central bank (BOM) governor on 
January 27, Agustin Carstens addressed the state of the global 
economy and its impact on Mexico's recovery.  He also discussed the 
BOM's monetary policy and projections for inflation in 2010 and 
¶2011. Carstens said the temporary pass-through impact of gasoline 
price increases and higher taxes should peak in April or May, after 
which policymakers will be able to better gauge whether the price 
increases are having second-round effects. Demand-side inflationary 
pressures may not appear until next year, he said, but will be 
closely monitored.  He also announced that the BOM's Foreign 
Exchange Commission is thinking about implementing a foreign 
reserves accumulation program in order to gradually withdraw from 
the IMF's flexible credit line. While Carstens' plan to boost 
reserves through dollar purchases may cause short-term market 
concerns, over the longer term it will bolster confidence following 
recent sovereign ratings downgrades. End Summary. 
 
 
 
 
 
The Global Economy 
 
 
 
¶2. Carstens said that there are signs of a global economic 
recovery, though it is still vulnerable given the risks that 
financial shocks could pose.  Financial markets are improving, but 
some institutions need to absorb significant losses.  There is 
currently moderate inflation in the world. The IMF revised its 
world economic growth projections for 2010 to 3.9%.  Emerging 
economies will be the main drivers for this growth.  To offset the 
impact of the crisis, countries have accommodated their monetary 
policies to lower their interest rates.  Some countries have begun 
withdrawing their fiscal stimulus. 
 
 
 
¶3.  The U.S. economy has also registered positive economic figures, 
particularly its industrial output, which is strongly correlated 
with the Mexican economy.  U.S. GDP will likely grow between 2.5 
and 3% in 2010.  Notwithstanding, unemployment in the U.S., more 
restrictive credit conditions, and high savings or payment of debts 
will affect consumption.  There is concern and uncertainty about 
what the impact will be on the global economy of removing the 
fiscal stimulus, as well as the way industrial countries will 
address their large fiscal deficit.  Lower interest rates in 
industrial countries have triggered carry-trade to emerging 
economies, including Mexico.  Carstens noted how countries remove 
and modify fiscal stimulus and monetary policies, and these capital 
flows' reaction could later cause volatility. 
 
 
 
Mexico's Economic Recovery 
 
 
 
¶4.  The recovery in the U.S. has had a positive impact on Mexico. 
Mexico's manufacturing exports have begun to grow, and the recovery 
has been passed to the services sector, which was also hit by the 
crisis and the H1N1 flu outbreak.  Financial conditions are 
improving and credit to construction, housing, consumption, and 
businesses is slowly growing.  Mexico has had a relatively vigorous 
economic recovery in 3Q09 and 4Q09, growing 3% and 1.2% 
quarter-on-quarter.  Retail sales and industrial output are also 
growing.  Public investment, thanks to the GOM's countercyclical 
measures, has risen, but private investment has yet to recover. 
 
 
 
¶5.  After having fallen 7% in 2009, Banxico expects GDP to grow 
between 3.2% and 4.2% in 2010 from its previous projection of 
2.5-3.5%.  (Note:  The IMF also recently boosted Mexico's 2010 GDP 
growth outlook to 4.0% from 3.3% previously.  End Note.) Formal 
employment is recovering and by the end of 2010 between 500,000 and 
600,000 formal jobs will have been created (from the former 
 
MEXICO 00000348  002 OF 002 
 
 
projection of 350,000-450,000).  The current account deficit will 
be moderate, reaching 1.2% of GDP in 2010. 
 
 
 
Inflation Forecast 
 
 
 
¶6.  The new tax measures and the elimination of fuel subsidies are 
expected to have a one-time effect on inflation during 2010. 
However, the negative impact of these factors will likely dilute 
towards the end of 2010 and beginning of 2011, so that the BOM 
achieves its 3% inflation target by year-end 2011.  Year-end 
inflation for 2010 was left unchanged at 4.25%-4.75%.  Medium and 
long-term inflation expectations are well anchored, but the BOM 
will monitor them closely to see that there isn't a pass-thru to 
consumer prices, or that businesses do not transfer costs -- for 
those products or services not affected by the tax measures or 
higher fuel prices -- to consumers.  The BOM will also be vigilant 
that there is not a change in the current capital inflows that 
could increase the volatility of the exchange rate. 
 
 
 
Gradual Exit from IMF Credit Line 
 
 
 
¶7.  Finally, Carstens announced that the central bank will soon 
announce a mechanism to accumulate foreign reserves to withdraw 
gradually from the IMF's flexible credit line (US$ 47 billion). 
Carstens stated that a specific exchange rate would not be 
targeted, but rather a specific minimum or maximum cap in reserves. 
Mexico is seeking to increase the level of international reserves 
as shield against an eventual capital outflow from Mexico once 
other economies begin to withdraw their monetary and fiscal 
stimulus.  The BOM and Hacienda are currently discussing the 
optimum level of reserves and the best mechanism to accumulate 
them. 
 
 
 
Comment 
 
 
 
¶8. Carstens' plan to boost reserves through dollar purchases may 
cause short-term market concerns, largely because it calls into 
question expectations of a strong peso rally this year. However, 
over the longer term it will bolster confidence following recent 
sovereign ratings downgrades. Even though in absolute terms the 
level of foreign reserves Mexico holds is quite similar compared to 
other BBB-rated countries, its ratio to GDP is not large.  Mexico's 
near-record US$91.2 billion in currency reserves is equal to about 
8.3% of GDP compared with 15% for Brazil and 24% in Peru. On the 
other hand, even though it was thought that holding reserves was 
really expensive before the crisis, the financial turmoil proved 
that it was not enough. An abrupt strengthening of the 
peso-probably boosted by truck loads of foreign investment-could 
trigger the BOM to implement a U.S. dollar purchase preannounce 
mechanism as the ones that were in place in the past, and this 
could limit peso appreciation vis-a-vis the US dollar in the medium 
term. End Comment. 
PASCUAL