Alejandro Díaz de León, governor of the Bank of Mexico, speaks to Global Finance about navigating the pandemic as an emerging market and Mexico’s economic outlook.
Global Finance: Recently, you said that emerging markets face a much more challenging task than advanced economies in recovering from the pandemic. Why so?
Alejandro Díaz de León: The Covid-19 crisis has been unique. The pandemic caused a synchronized global economic recession with large shocks in the financial and real sectors. These shocks have become longer lasting and had heterogeneous effects across countries, sectors and groups in society.
These differences persist in the recovery phase and are related to the availability of vaccines. The extent of the stimulus programs has also been a source of heterogeneity.
The Covid-19 crisis has stressed the differences in policy between Advanced Economies (AEs) and Emerging Market Economies (EMEs). AEs pursued massive fiscal stimulus, while EMEs have faced larger sovereign rating downgrades and capital outflows. EMEs faced policy trade-offs and more limited policy.
These differences can be illustrated by the most recent projections for global growth published by the International Monetary Fund (IMF). AEs’ projections for 2021 were revised upward from 5.1% to 5.6%, whereas EMEs’ forecasts, excluding China, were revised downward from 5.9% to 5.4%.
GF: What is the main risk for the Mexican economy in the coming 12 months: inflation or lack of growth?
Díaz de León: In 2021, the recovery of economic activity has been heterogeneous across countries depending on their vaccination campaigns and on the magnitude of their fiscal support. In Mexico, vaccination has been advancing, allowing for a reactivation of services, while Mexican external demand has also benefited from the large fiscal stimulus implemented in the US. However, the latter can also represent a risk for inflation and may induce tighter financial conditions.
Although the shocks of increased inflation are expected to be transitory, due to their variety, magnitude and the extended horizon over which they have affected inflation, they may pose risks to the price formation process. In this context, Banco de Mexico reduced monetary accommodation to avoid adverse effects on inflation expectations and to enable an orderly adjustment of relative prices.
The pandemic’s effects on growth and inflation are unprecedented. Uncertainty about the pace of normalization of the economy remains high, and global and local supply chains remain critically affected and may be subject to a profound adjustment process. Thus, the main risk we face is supply resilience and flexibility, as well as optimal resource allocation. This will determine growth and inflation dynamics.
GF: Did the health crisis change the economy in a permanent way?
Díaz de León: The pandemic is still underway and high uncertainty persists, making it too early to tell which shocks are transitory and which are permanent.
The pandemic led many workers to drop out of the labor force, and uncertainty, the economic downturn and demand shifts have disincentivized investment. However, progress in vaccination campaigns worldwide has allowed for a faster pickup of activity than previously anticipated, and a more favorable outlook for the medium term. The first milestone is to bring the pandemic under control to help labor markets and economic activity be closer to normal. In some sectors, the pandemic also forced firms to be more flexible and adopt new methods of work, which could have positive effects on productivity.
The pandemic also introduced significant challenges to global value chains. Asymmetries in countries’ lockdowns and in production restrictions induced large bottlenecks in different sectors, raising concerns about the resilience of just-in-time global supply chain models. The extent to which supply chains and economic blocs might become less global and more regional is an open question.
GF: Is there something that should prompt central banks to change their policies?
Díaz de León: Inflation and inflation expectations in AEs have been below their targets for a lengthy period, allowing their central banks to be more patient and have more room to keep monetary accommodation.
In this context, EMEs may have more time before facing tighter global financial conditions and potential episodes of volatility.
Nonetheless, most EMEs must deal with higher inflation levels due to pressures on commodity prices, supply shocks and exchange rate depreciation. Central banks in these economies have a constrained space to maintain monetary stimulus. The most important challenge these economies face is to prevent the price formation process to be negatively influenced by the recent rise in inflation, and to contribute to an orderly adjustment of relative prices and financial markets.
Looking ahead, EMEs will face the additional challenge of dealing with the monetary stimulus withdrawal in AEs, which could translate into periods of volatility and tighter global financial conditions.
GF: The governing board of the Bank of Mexico approved measures to start providing the votes of individual board members after its monetary policy meetings. How will this help monetary policy going forward?
Díaz de León: The publication of all members voting intentions in the monetary policy statement [press release], before the minutes are released two weeks later, prevents voter identity to become a source of uncertainty and speculation about the future course of policy, while also increasing transparency and accountability.
The board also decided to publish inflation forecasts in every monetary policy statement. This makes it easier to explain the bank´s policy decision and to communicate more adequately its reaction function, allowing economic agents to be in a better position to anticipate monetary policy actions. These forecasts are a key reference for inflation expectations and price formation in the economy.
GF: What is the economic outlook for Latin America overall?
Díaz de León: Forecasts for economic growth in 2021 have been recently upgraded for Latin America. For example, the IMF’s July World Economic Outlook (WEO) Update increased its forecast for the region by 1.2 percentage points, from 4.6% to 5.8%, as compared to the April WEO. These revisions have been mainly associated with favorable spillovers from the improved outlook for the US, increases in commodity prices and progress in the vaccination campaigns.
Inflation has become a more relevant risk factor in the region. While inflationary pressures are expected to be transitory, they can pose a risk for price formation.
Fiscal and monetary policies in the region face the challenge of significant social scarring and limited policy space. In this context, EMEs are also facing other serious challenges. The pandemic further deepened social tensions and polarization, making it harder to put in place a shared vision of the future and the reforms and policies needed to promote development.