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United States
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United States: a hard recovery begins
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United States: growth of economy expected in third quarter.
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Available indicators suggest that the world’s largest economy has now left behind the deepest and longest recession since World War II. The third quarter will again show growth of the gross domestic product (GDP) in quarter-on-quarter terms following a year of consecutive drops. The improvement in risk premiums, the bottoming-out that seems to have taken place in the real estate market and price stability show a better picture that only three months ago.
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Recovery will be hindered by household debt and labour market.
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The road back to recovery, however, will not be easy. With the sharp drops that have taken place it is possible that in coming months there will be increases of some importance. Nevertheless, a consistent and vigorous upward trend is far from certain. The economy remains dependent on expansionist policies. Household finances have benefited from recent recoveries in financial asset prices but the process of reducing debt still has a long way to go. This means that a significant part of income is going into savings rather than consumption. Loans granted to households, which form the greater part of their debt, were down by 1.1% year-on-year in the second quarter whereas in the four years before the recession increases of 14% were predominant. The labour market will also continue to be a burden in coming months which will limit consumer incomes.
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Consumer confidence improving and retail sales on rise.
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Latest demand indicators confirm this incipient trend to recovery. Retail sales in August were up 2.7% over July. While government incentives to buy cars had considerable significance in this advance, the indicator excluding cars and petrol showed its best figure since February rising by 0.6% over the month before. This confirms the background strength of consumption in recent months. The question now is if this increase will continue when government incentives are reduced. Along the same lines of improvement, the consumer confidence index published by the Conference Board in August showed an upward move following two months in row of decreases going from 47.4 points to the level of 54.1.
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Business executives now optimistic but industrial production remains weak.
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On the supply side, the signs of recovery are more and more established although they are mainly confined to confidence indicators rather than real economic activity figures. The business sentiment index put out by the Institute for Supply Management in August went above the threshold of 50 points which is considered the point marking the beginning of an expansionist stage. The manufacturing index showed its eighth month with consecutive increases going to the 52.9 points level while services compensated for the drop the previous month by moving up to 51.3 points. Industrial production in August recorded its second month to show a rise but continued to show signs of slowing down and was still far from levels seen in the same period last year. In the same way, utilization of production capacity left behind its very low levels but did so rather weakly.
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Housing hits bottom. Prices rise for first time in three years.
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The housing market is now showing a pattern similar to that in the rest of the economy. It has now hit bottom but is beginning a recovery that is held back by past excesses. In the case of real estate, these excesses are the mortgage loan defaults that, following repossessions, increase the stock of properties on the market. Following three years of uninterrupted drops, the Case-Shiller price index showed an increase of 0.7% over the previous month, in seasonally adjusted terms. On top of the stabilization of sales came additions to supply. August saw 598,000 housing starts in annual terms. This confirms the gradual trend to recovery since the all-time low in April and it is likely that the sector will soon again be making positive contributions to economic growth.
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Labour market remains weak with unemployment rate at 9.7% along with more long-term unemployment.
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The labour market remains weak. Big drops in employment are a thing of the past but the adjustment has not yet hit bottom. Some 216,000 jobs were lost in August, the highest figure for one year but requests for unemployment benefits in that period showed a rise as did the unemployment rate which again went to 9.7% and it is likely that this upward trend will still continue for some months. The proportion of long-term unemployed remained close to highs and, in view of the significant number of involuntary part-time workers, hours worked and wages are still in the low range.
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CPI drops by 1.5% while underlying inflation stabilizing with move up to 1.4%.
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Poor demand and idle resources mean that inflation trends are still not being seen in spite of the price rise in oil and the high budgetary deficit. The general consumer price index (CPI) was down by 1.5% year-on-year in August while the underlying CPI (the general index less food and energy) eased its increase with a rise of 1.4% year-on-year. This easing was partly helped by the stagnation in housing rentals.
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High-price oil prevents bigger correction of trade deficit.
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Under the heading of the foreign sector, the trade deficit in goods and services in July was 31.91 billion dollars, some 4.4 billion higher than the figure for the month before, which, to the extent of 90%, was due to the worsening of the balance excluding oil and oil derivatives. In the past month, exports have held the limelight. First of all, following the low in April, exports of goods (excluding oil) showed a rise of 4.7% but imports, which in previous months had been weaker, were up in July to show a cumulative increase of 4.1%. Furthermore, trade flows are still at very low levels with exports and imports some 22.4% and 30.4% lower than in the same month last year respectively. This would indicate that, with the recovery of domestic demand and trade, imports seem to be showing more upward potential. Over the long term, the weakness of the dollar should help correct the trade imbalance which, however, is showing to be more persistent than earlier anticipated.
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Fiscal consolidation: when, how and how much?
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Early signs of economic stabilization underscore the need for fiscal adjustment
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The worsening of the public deficit in periods of crisis involves an increase in government debt that runs the risk of reaching unsustainable levels. Early signs of economic stabilization underscore the need to begin planning for fiscal adjustment. When to implement this, to what levels and what are the alternatives for reducing the deficit are three key questions in any adjustment plan.
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Part of the adjustment will be automatic but, generally, this is not enough to sufficiently reduce the deficit. The deficit has shot up mainly as a result of the automatic stabilizers, discretional fiscal stimuli and, in some cases, the decline in activity in the real estate sector. As their name would indicate, the stabilizers react automatically in the face of an economic slowdown, whether through a decrease in revenues or an increase in government spending, for example, on unemployment benefits. Hence, the part of the increase in the deficit caused by the automatic stabilizers decreases by itself with the return to the economy’s potential growth and, somewhat later, to full employment. Nevertheless, this adjustment may be affected if the crisis harms the country’s potential growth or if unemployment stays high for a long time. The loss of revenues as a result of lower economic activity in the real estate sector may also be quite lasting. With regard to discretional fiscal stimuli, some have a temporary nature, such as extraordinary spending on infrastructures, but others may be permanent, such as new social benefits for vulnerable groups or tax cuts. While the former will stop having an impact on the deficit when the projects in question are completed (although we cannot ignore maintenance costs), this does not apply to the latter.
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The start of fiscal adjustment should be determined by the circumstances of each country. For example, those economies that start out with a low level of debt will have greater margin for delaying fiscal correction. Fiscal consolidation must also be linked to the economy getting back to «normal», given that beginning the adjustment too early -as Japan did in the Nineties- could bring about a relapse. If we accept the generally agreed on forecasts for the advanced economies, we should expect the beginning of gradual fiscal consolidation in 2010. This would largely be thanks to the ability of the automatic stabilizers to reduce the deficit. Furthermore, in the second half of 2010, those economies that are further advanced in the cycle could begin to reduce or not renew the discretional policies so long as the recovery is showing a certain strength.
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In any case, and despite the large bulk of the adjustment should be postponed until recovery from recession, governments should begin to make quite clear their medium and long-term adjustment plans in order to strengthen their credibility. Germany has been one of the pioneers in imposing a constitutional ceiling on its medium-term fiscal deficit.
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A key part of this plan should involve the size of the adjustment, which depends on the desired level of public debt. The growth capacity of each country and forecasts for its population ageing, among other particular factors, will determine the supportable level of debt. An economy with high growth potential, at rates above the interest rate payable on its bonds, may allow itself to maintain higher debt levels and therefore will not need such a sharp adjustment. In the same way, the prospects for population ageing require a bigger fiscal correction seeing that government spending will increase in the future. In the countries of the Euro Area, the fiscal adjustment will also be guided by the terms of the Stability and Growth Pact which sets a limit on debt of 60% of GDP. By way of example, in the case of Spain, stabilizing the debt at this level in 2015 would require a gradual adjustment of the deficit until it reaches a fiscal balance of 0% in 2015 which would imply going from a primary deficit (excluding interest payments) somewhat above 9% in 2009 to a primary surplus of 3% in 2015 (see following graph for more details of hypotheses).
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Once the objective debt level is established, as well as the time horizon for the fiscal correction, it remains to be worked out how to carry out such a fiscal adjustment. There are essentially two ways: an increase in government revenues or a reduction in spending. Not all measures, however, have the same impact on economic growth. For example, higher taxes on labour or savings or a reduction in spending on education or infrastructures could bring about a worsening of potential growth through disincentives on savings and work and a decrease in a country’s human and physical capital. On the revenue side, a more neutral alternative from the potential growth standpoint, while often politically more costly, is to raise indirect taxes. Stronger measures to combat tax fraud is another option worth exploring both for reasons of efficiency and equity. With regard to spending, the adjustment should be carried out in non-priority areas. Some countries, such as Ireland, have also suggested a revision of the universal nature of certain social benefits in order to concentrate on those persons most vulnerable.
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To sum up, the inevitable fiscal adjustment should begin gradually with the economic recovery, which in many cases should take place at the end of 2010. The size and form of the adjustment will depend on the economic characteristics of each country and, as almost always happens in economics, on the political situation of the moment.
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This box was prepared by Clàudia Canals
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International Unit, ”la Caixa” Research Department
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Japan
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Japan: again relying on foreign sector
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Japan grows by 2.3% thanks to recovery of exports but investment remains weak.
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Japan’s economy came out of the recession in the second quarter but saw it growth revised downward putting it at a rise of 2.3% quarter-on-quarter annualized as against the 3.7% previously given out. The improvement in exports, which grew by 28.1% in the same period, was unable to compensate for the worse figure for capital goods investment and public investment. The latter underlines the limits of expansionist policy in Japan which represents a situation opposite that of China. As opposed to that Asia giant, the public finances began the crisis in a precarious state because of stimuli introduced in the deflationary period in the Nineties. With the recent fiscal stimuli in 2009 the public debt comes close to 200% of the GDP.
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China’s recovery boosts exports but government funds running out.
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The good news came from the foreign sector. China’s recovery is becoming stronger and US retail sales had a smoothing effect on price quotations for Japanese companies involved in exports. Weaknesses remain in the area of domestic demand. Latest indicators do not suggest a continuation of the increase in consumption and retail sales in July showed a drop of 2.4% year-on-year whereas car sales in August indicate that government incentives have managed to slow the worsening but have not been able to foster an upward move in demand.
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Industrial production continues to recover and investment spending improving prospects.
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On the supply side, the improvement in the world picture continued to aid recovery although figures are still a long way from May-June 2008 levels. In this context, industrial production in July continued to rise and stood 18.8% higher than the low in February. This is a recovery that, in absolute terms, only compensates for 30% of the drop since June 2008. Also along the same lines, investment spending showed signs of recovery but always with an eye to exports. An early indicator of this, machinery orders, showed a second month of increases with spending aimed at meeting domestic demand which showed a boost of 21.8% year-on-year in July while those to meet foreign demand were down 4.2%.
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Unemployment hits all-time high of 5.7% while wages remain at low levels.
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In turn, the housing market continued on its downward course. Sales in the Tokyo area in August wiped out their modest recovery with a drop of 8.2% year-on-year while prices continued to go down. In a situation of increasing weakness, supply continued to show a worse picture with housing starts in July down by 32.0% year-on-year. Clearly showing the weakness of demand, the labour market today is one of the most fragile components of Japan’s economy. The unemployment rate in July rose to 5.7%, an all-time high since the start of this indicator in 1953. Some 400,000 jobs were lost in July, of which 120,000 were in manufacturing. This is a sector that, in spite of the recovery in industrial production, continued to reduce its total number of employees. Wages showed a slight improvement in July but remained 6.5% below the same period last year.
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CPI drops by 2.2% while underlying inflation down 0.9% because of weak domestic demand.
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The weaknesses in employment and domestic demand helped increase deflationary tendencies. The July CPI showed a drop of 2.2% year-on-year, the biggest decrease since the start of this index in 1971. As opposed to other large economies, the underlying CPI (the general index less energy and food) in Japan is also dropping and in the same period lost 0.9% year-on-year adding up seven months of decreases in a row. The weakness of domestic demand will make it difficult for prices to go back to positive terrain in coming months.
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Exports showing slower recovery but trade surplus holding.
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The foreign sector continues to recover from the sharp drops in the first quarter although trade continued well below levels for last year. Japan’s exports which, with a high level of capital goods of high value added, are half-way between a return to levels before the crisis. Nevertheless, the figures for June indicate that the recovery in exports is slowing down whereas the increase in imports is gaining strength thus limiting the upward move of the contribution of the export sector to economic growth.
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China
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China: stable recovery
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China on recovery path closely followed by India.
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While last month China amazed us with grawth of 7.9% year-on-year grouth ratein the second quarter, this month the most recent indicators do nothing but confirm its recovery. At the same time, India surprises with a growth rate of 6.0% year-on-year in the second quarter, above the 4.1% in the first quarter.
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China’s retail sales in August were up 15.4% year-on-year, slightly above July and in line with the strength of other indicators. The purchasing managers index (PMI) for August stood at 54 points as against 53.3 in July and at levels above 50 since March. Finally, automobiles sales were up by 81% year-on-year in August which puts China on the way to surpass the US as world’s top auto market in 2009.
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Industrial production grows by 12% with bank lending still on rise.
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On the supply side, industrial production in August was up by 12.3% year-on-year, higher than the 10.8% in July and coming close to the rates of 15%-16% in past years. Bank lending continues to grow and, with an increase of 34.1% year-on-year in August, put the average so far this year at around 30%, double the 2008 figure. This growth in credit and the major fiscal stimulus introduced by the government are behind the recovery. In any case, changes of a more structural kind, such as the boosting of domestic consumption, will be keys to future growth.
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Trade still somewhat lagging.
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The foreign sector is also beginning to recover strength although not as fast as domestic demand. In particular, exports were down by 23.4% year-on-year in August, similar to the 22.9% figure in July and imports dropped by 17% year-on-year in August, higher than the 14.9% in July. Nevertheless, an early seasonally-adjusted estimate of quarter-on-quarter growth of exports indicates values of around 3% in the third quarter.
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In a context of recovery, the drop in prices has been slowing down. In August, the CPI went down by 1.2% year-on-year as against 1.8% in July and 1.7% in June. The drop in the price of housing along with the big rise in commodity prices in 2008 meant that price indices are now still in negative terrain.
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Shanghai stock market up again.
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Finally, the Shanghai stock market returned to the growth path started at the beginning of the year and leaving behind the correction occurred in August. In the first half of September the Composite index was revalued by 13% although it did not recover the values seen in July.
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Brazil
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Brazil: GDP and oil again doing the samba
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Brazil leaving recession behind.
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Brazil stands between gains and losses. Since the beginning of September the Brazilian economy is all good news and not only because of a return to growth but also because of new oil discoveries in the Pre-sal marine area.
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Consumption takes the reins while investment and exports still hurting.
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After half the year in negative terrain, the GDP grew by 1.9% quarter-on-quarter in the second quarter of 2009 which makes Brazil one of the first countries in the G-20 to come out of the recession. Private consumption, boosted by credit and fiscal stimuli, rose by 2.1% between March and June thus confirming its role as the main engine behind the incipient recovery. Investment and public spending held stable. On the other hand, foreign demand was able to add its grain of sand thanks to renewed demand by China for Brazil’s raw materials. On the supply side, industry was the most dynamic sector with growth of 2.1% in seasonally-adjusted quarter-on-quarter rate as against 1.2% for the services sector.
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In year-on-year terms, growth stopped dropping but was unable to avoid ending up down by 1.2%. On the one hand, responsibility for this was weak investment which continues to drop by double digits compared with 2008, at 17% year-on-year. On the other hand, the cause was foreign demand pulled down by exports which dropped by 26.4% compared with the same period last year. Public consumption in turn gradually reduced its contribution to growth in contrast to private consumption which confirmed its strength with an advance of 3.1% year-on-year.
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Industry showing signs of advance.
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In any case, Brazil is leaving behind a technical recession notable for its brevity and latest figures only add reasons for believing that the year 2009 will end up much better than it began. Consumer confidence is now coming close to levels before the recession and retail sales continued advancing in July with year-on-year growth of 5.7%. These were supported by some relief in the labour market and credit which saw an increase of 20.8% compared with July 2008 thus setting new all-time records as a percentage of GDP (45%). Vehicle exports again dropped but the impact of tax exemptions showed up as an increase in domestic registrations of 5.5% year-on-year.
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On the supply side industry is gradually slowing its drop and leading indicators point toward a progressive improvement in the second half-year. In August, after a year of falling behind, the purchasing managers index (PMI) went above the 50 points threshold that indicates recovery. Industrial production grew for the sixth consecutive month in July although it was down by 10.4% at year-on-year rate.
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In fact, Brazil is looking toward 2010 optimistically. Everything indicates that the recovery will gain strength in the third and fourth quarters of 2009 to the extent that the reconstruction of inventories will take investment out of the hole and the gradual improvement of the foreign sector comes from exports. At the same time, it is expected that a situation with an expansionist monetary policy, a labour market improving and contained inflation will continue to spur on private spending which will have to deal with the progressive removal of fiscal stimuli between September and the end of the year. If this scenario is confirmed, the governing party will face the presidential elections in October 2010 in a much more comfortable position. Even so, it is to be expected that an increase in public spending, in keeping with the electoral process, will also contribute to the increase in growth in 2010.
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Mexico
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Mexico: light at the end of the tunnel
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Mexican economy awaiting US recovery.
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The world economic recession and especially its effect on the US manufacturing industry dragged the Mexican economy into a recession that, if forecasts are not mistaken, from which it will soon emerge. The main reason for optimism also comes from the other side of the border. It is expected that a return to growth in the United States and the renewal of a restructured motor vehicle sector will boost Mexico’s exports and therefore its GDP toward the end of 2009.
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Fiscal reform in Mexico causing much debate.
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Latest figures point in this direction. Industrial production in July moved ahead compared with the previous month recording its lowest year-on-year drop so far this year (7%). In turn, IMEF manufacturing index in August reached its highest point in thirteen months (51.5) going for the second consecutive month above the 50 points threshold that indicates recovery. All of this suggests that the contractile stage of manufacturing activity either ended with the first half-year or is about to be ended. If this is so, it would be well received by a labour market that suffered again in August with an unemployment rate of 6.3%.
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With regard to demand, there is a long way still to go. Domestic spending showed signs of improvement with retail sales beginning to moderate its correction, while still dropping by 5.1% year-on-year in June but the consumer confidence index dropped again in August by 9.1% year-on-year and 4.5% compared with July. Investment also was down by 12.7% year-on-year in June. In spite of all, restrictions on credit seem to be easing and inflation, while above the official objective, continues on a downward path so that it is not expected that the Bank of Mexico will make any move at least until it has crossed the line of 2010, when it is expected growth will be resumed and inflationary pressures may appear.
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Furthermore, it should be kept in mind that, although economic prospects for 2010 are favourable, Mexico must face up to a series of structural reforms long overdue in order to improve the trend to long-term growth. Notable among these reforms is a fiscal system that, above all, should reduce its dependence on the performance in oil. The government’s proposal is already on the table and everything points toward a fiscal correction in 2010, in spite of the fact that some people feel this to be rash in a situation of a potentially fragile recovery. In any case, the July elections somewhat reduced president Calderon’s margin for manoeuvre, so that what is most likely is a further delay in measures of a more structural nature, at least until after the presidential elections in 2012. If this is so, it could generate some doubt about the sustainability of the fiscal deficit over the medium term and end up reducing the rating on the country’s sovereign bonds.
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Raw materials
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Oil and gold resume increases
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Crude oil price depending on weak dollar and recovery of emerging economies.
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Following a slight respite, oil prices again took on an upward path. Between August 20 and September 18 crude oil dropped by 2.8% although in the second half of that period the tendency shifted upward taking the price to 71.92 dollars a barrel (1-month delivery, Brent quality), thus accumulating a rise of 84.0% in the current year. This level was still below the 95.9 dollars in September 2008 but as of October it should begin to show year-on-year increases compared with drops in the final quarter of 2008.
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The Fed’s expansionist policy, Treasury borrowing and the persistence of the US foreign imbalance will continue to push the dollar down which will benefit commodities. The settling down of Chinese recovery and that of the main emerging economies, as well as the perception that the worst of the recession is over will have an effect in the same direction. With supply being able to meet increased demand, oil should remain at current levels with slight increases in 2010.
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Commodities ease price increases because of drop in base metals.
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Commodity prices have taken a break. The Economist index for commodities rose by a low 0.3% between July 20 and September 18 putting the increase for the current year at 22.4%. Gold and precious metals increased their advances because of the weakness of the dollar whereas base metals showed drops.
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In this respect, the recovery of world industrial activity should increase scrap production which forms an important supply of base metals. This would continue to moderate the Chinese boom in imports seen in the first half of the year although without breaking its basic strength in coming months.
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