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Cablegate: New Central Bank Governor On the Economy and Monetary Policy

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

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