Mexico: External conditions and economic outlook Manuel Sánchez BNP Paribas New York, March 21, 2016 Since mid-2014, international risk aversion has risen, affecting emerging markets especially hard EMBI global1 Basis points 600

500 447.0

400

300

200 Jul-14 Jul-15 Jan-15 Jan-16 Jun-14 Jun-15 Oct-14 Oct-15 Apr-15 Sep-14 Feb-15 Sep-15 Feb-16 Dec-14 Dec-15 Aug-14 Aug-15 Nov-14 Nov-15 Mar-15 Mar-16 May-15 * 1/ JP Morgan’s index tracking total returns for traded external debt instruments in the emerging markets. It includes U.S. dollar-denominated Brady bonds, loans, and Eurobonds with an outstanding face value of at least $500 million. */ To March 16 Source: JP Morgan Mexico: External conditions and economic outlook 2 Portfolio capital flows to emerging economies has become negative Total portfolio flows to emerging economies1 Billions of U.S. dollars 45

30

15

0 -0.2

-15

-30 Jul-14 Jul-15 Jan-15 Jan-16 Jun-15 Jun-14 Oct-14 Oct-15 Apr-15 Sep-14 Feb-15 Sep-15 Feb-16 Dec-14 Dec-15 Aug-14 Aug-15 Nov-14 Nov-15 Mar-15 May-15 1/ Net purchases by nonresidents of emerging-market shares and bonds posted to the balance of payments. Emerging economies are Argentina, Brazil, Bulgaria, Chile, China, Colombia, the Czech Republic, Ecuador, Egypt, Hungary, India, Indonesia, South Korea, Lebanon, Malaysia, Mexico, Morocco, Nigeria, Peru, the Philippines, Poland, Romania, Russia, Saudi Arabia, South Africa, Thailand, Turkey, Ukraine, the United Arab Emirates, and Venezuela. Source: IIF

Mexico: External conditions and economic outlook 3 … while prices for commodities and financial assets have continuously fallen Prices for commodities, shares, and currencies in U.S.-dollar terms June 2014 = 100 120

100

80 73.4 70.5

60 IMF all commodity price index MSCI emerging markets share price index 1 Emerging-market currency prices in dollar terms2 45.8 40 Jul-14 Jul-15 Jan-15 Jan-16 Jun-14 Jun-15 Oct-14 Oct-15 Apr-15 Sep-14 Feb-15 Sep-15 Feb-16 Dec-14 Dec-15 Aug-14 Aug-15 Nov-14 Nov-15 Mar-15 May-15 1/ Float-adjusted market capitalization index based on U.S. dollars for Brazil, Chile, China, Colombia, the Czech Republic, Egypt, Hungary, India, Indonesia, South Korea, Malaysia, Mexico, Morocco, Peru, the Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. 2/ Non-weighted average of dollar exchange rates for the Mexican peso, Chinese yuan, Russian ruble, Turkish lira, Korean won, South African rand, Brazilian real, Indian rupee, Polish zloty, Hungarian florin, Malaysian ringgit, Thai baht, Chilean peso, Indonesian rupee, Philippine peso, Colombian peso, and Peruvian sol Source: Banco de México, Bloomberg, Haver Analytics and the IMF

Mexico: External conditions and economic outlook 4 Mexico’s exchange rate has recently been hit by volatility above that of other emerging-market currencies

Mexico and emerging economies: U.S. dollar exchange rate in local currency terms June 2014 = 100 150

Mexico 140 Emerging economies excl. Mexico1 133.9 130 129.2

120

110

100

90 Jul-14 Jul-15 Jan-15 Jan-16 Jun-14 Jun-15 Oct-14 Oct-15 Apr-15 Sep-14 Feb-15 Sep-15 Feb-16 Dec-14 Dec-15 Aug-14 Aug-15 Nov-14 Nov-15 Mar-15 Mar-16 May-15 * 1/ Non-weighted average for the Chinese yuan, Russian ruble, Turkish lira, Korean won, South African rand, Brazilian real, Indian rupee, Polish zloty, Hungarian florin, Malaysian ringgit, Thai baht, Chilean peso, Indonesian rupee, Philippine peso, Colombian peso, and Peruvian sol */ To March 17 Source: Bloomberg Mexico: External conditions and economic outlook 5 The correlation between the exchange rate and oil prices has strengthened Mexico: Oil price and exchange rate U.S. dollars per barrel and pesos per U.S. dollar 110 20 Mexican oil mix price 19 MXN / USD 90 18

17.4 17 70

16

50 15

32.0 14 30 13

10 12 Jul-14 Jul-15 Jan-15 Jan-16 Jun-14 Jun-15 Oct-14 Oct-15 Apr-15 Sep-14 Feb-15 Sep-15 Feb-16 Dec-14 Dec-15 Aug-14 Aug-15 Nov-14 Nov-15 Mar-15 Mar-16 May-15 * */ To March 17 Source: Banco de México and PMI

Mexico: External conditions and economic outlook 6 … which has coincided with the deterioration of Pemex’s credit risk premium, lately attenuated by improved oil prices Mexico: Sovereign and Pemex credit risk premium 5-year CDS, basis points

450 Mexico

Pemex 350 360.5

250

150 164.3

50 Jul-14 Jul-15 Jan-15 Jan-16 Jun-14 Jun-15 Oct-14 Oct-15 Apr-15 Sep-14 Feb-15 Sep-15 Feb-16 Dec-14 Dec-15 Aug-14 Aug-15 Nov-14 Nov-15 Mar-15 Mar-16 May-15 * */ To March 11 Source: Bloomberg

Mexico: External conditions and economic outlook 7 In contrast, market interest rates have remained relatively stable Mexico: Government bond interest rates %

7

3-year 10-year

6.2

6

5

4.9

4 Jul-14 Jul-15 Jan-15 Jan-16 Jun-14 Jun-15 Oct-14 Oct-15 Apr-15 Sep-14 Feb-15 Sep-15 Feb-16 Dec-14 Dec-15 Aug-14 Aug-15 Nov-14 Nov-15 Mar-15 Mar-16 May-15 */ To March 11 * Source: Banco de México

Mexico: External conditions and economic outlook 8 Nonresident holdings of peso-denominated government securities have stayed roughly constant in peso terms since 2015 Mexico: Nonresident holdings of peso-denominated government securities1 June 2, 2014 = 100

115

110

109.4

105

100

95 Jul-14 Jul-15 Jan-15 Jan-16 Jun-14 Jun-15 Oct-14 Oct-15 Apr-15 Sep-14 Feb-15 Sep-15 Feb-16 Dec-14 Dec-15 Aug-14 Aug-15 Nov-14 Nov-15 Mar-15 Mar-16 May-15 * 1/ Cetes, Bondes D, Bonos M and Undibonos */ To March 10 Source: Banco de México Mexico: External conditions and economic outlook 9 … while those holdings relative to the total outstanding have declined moderately Emerging economies and Mexico: Nonresident holdings of local-currency-denominated government securities % of total outstanding 34

February

31 30.7

28

Emerging economies excluding Mexico1 Mexico 2 25 January

23.3

22 Jul-14 Jul-15 Jan-15 Jan-16 Jun-14 Jun-15 Oct-14 Oct-15 Apr-15 Sep-14 Feb-15 Sep-15 Feb-16 Dec-14 Dec-15 Aug-14 Aug-15 Nov-14 Nov-15 Mar-15 May-15 1/ Unweighted average of ratios for Brazil, Colombia, Hungary, Indonesia, Israel, Malaysia, Peru, Poland, Russia, South Africa, South Korea, Thailand and Turkey. 2/ Total outstanding includes Bonos M, Cetes, Bondes D, Udibonos and BPA Source: Finance ministries, central banks and other national authorities

Mexico: External conditions and economic outlook 10 So far, the most negative external impact on Mexico’s output stems from U.S. manufacturing Mexico and the United States: Manufacturing production Annual % change, s.a. 6

4

2.2 2 1.5

0 Mexico U.S.

-2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2011 2012 2013 2014 2015 2016* s.a. / Seasonally adjusted */ Only January for Mexico and January-February for the United States Source: INEGI and the U.S. Federal Reserve

Mexico: External conditions and economic outlook 11 Consequently, Mexico’s exports to the U.S. have slowed and even contracted Mexico: U.S. dollar value of manufacturing exports Annual % change, s.a. 30

20

10

-0.5 0

-7.5 To the United States -10 To the rest of the world

-20 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2011 2012 2013 2014 2015 2016* s.a. / Seasonally adjusted */ Only January Source: Banco de México Mexico: External conditions and economic outlook 12 However, as in the U.S., mining has been the most significant drag on industrial production Mexico: Industrial GDP Annual % change, s.a.

4

0.2 0 -0.5

-4.1 -4

Industrial Mining Construction -8 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2011 2012 2013 2014 2015 s.a. / Seasonally adjusted Source: INEGI

Mexico: External conditions and economic outlook 13 The key drivers of an ongoing upturn in the economy are services and private consumption Mexico: GDP Annual % change, s.a.

6

GDP Private consumption Services 4 3.7 3.5

2.5

2

0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2011 2012 2013 2014 2015

s.a. / Seasonally adjusted Source: INEGI

Mexico: External conditions and economic outlook 14 … while private investment has decelerated

Mexico: Investment Annual % change, s.a.

Total Public 12 Private

6 3.6 0.7 0

-6

-11.3 -12 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2011 2012 2013 2014 2015 s.a. / Seasonally adjusted Source: INEGI

Mexico: External conditions and economic outlook 15 The Mexican economy is expected to recover gradually, along with U.S. industrial production

The United States and Mexico: Growth forecasts Mean, %

U.S. industrial production 3 2.9 Mexican GDP 2.5 2.4

2

1 0.9

0 2016 2017 Source: Blue Chip, March 2016

Mexico: External conditions and economic outlook 16 The economic growth scenario holds risks

. To the downside  Slower-than-expected recovery for U.S. industrial production  A sudden swoon in Chinese economic momentum  A drop in Mexican oil production beyond current forecasts . To the upside  Greater-than-expected benefits from structural reforms

Mexico: External conditions and economic outlook 17 Mexico needs to confront an adverse international scenario by strengthening its economic fundamentals

. Strong macroeconomic stance  The finances of the public sector and Pemex adjusted to reflect lower oil prices  Convergence of inflation to the target safeguarded by monetary policy . Solid financial system maintained . Structural reforms that stoke greater productivity adequately implemented

Mexico: External conditions and economic outlook 18 After an unprecedented decline to an all-time low, inflation has slightly risen, approaching the target Mexico: Annual inflation 6 %

5

4

3 2.87

2

1

0 Jul-15 Jan-15 Jan-16 Jun-15 Oct-15 Apr-15 Sep-15 Feb-15 Feb-16 Dec-14 Dec-15 Aug-15 Nov-15 Mar-15 May-15

Source: INEGI

Mexico: External conditions and economic outlook 19 Benign inflation has been supported by positive relative price shocks

Mexico: Agricultural, energy and telecommunication services prices Annual % change 8.08 8

4

0 -0.65 Agricultural -4 Energy

Telecommunication services -6.94 -8

-12

-16 Jul-15 Jan-15 Jan-16 Jun-15 Oct-15 Apr-15 Sep-15 Feb-15 Feb-16 Dec-14 Dec-15 Aug-15 Nov-15 Mar-15 May-15

Source: INEGI

Mexico: External conditions and economic outlook 20 Also, the impact from peso depreciation on inflation has been modest, confined to tradable goods

Mexico: Exchange rate and prices of some durable goods Annual % change 30 Exchange rate 25 Furniture 23.9 Domestic accessories Domestic appliances 20 Textile accessories for home use

15

10 4.6 4.5 5 4.3 4.2 0

-5 Jul-15 Jan-15 Jan-16 Jun-15 Oct-15 Apr-15 Sep-15 Feb-15 Feb-16 Dec-14 Dec-15 Aug-15 Nov-15 Mar-15 May-15

Source: Banco de México and INEGI

Mexico: External conditions and economic outlook 21 To face adverse international conditions, monetary policy has been adjusted twice Mexico: Policy interest rate target overnight funding rate, %

4.0

3.75

3.5

3.0

2.5

2.0 Jul-14 Jul-15 Jan-15 Jan-16 Jun-14 Jun-15 Oct-14 Oct-15 Apr-15 Sep-14 Sep-15 Feb-15 Feb-16 Dec-14 Dec-15 Aug-14 Aug-15 Nov-14 Nov-15 Mar-15 Mar-16 May-14 May-15

Source: Banco de México

Mexico: External conditions and economic outlook 22 These interest rate hikes have sought to safeguard price stability

. Maintain the relative monetary stance vis-à-vis that of the United States . Prevent inflation expectations from getting out of line in the face of peso depreciation . Buttress economic fundamentals, action taken in conjunction with the announcement of preventive public- sector spending cuts

Mexico: External conditions and economic outlook 23 Last year’s improvement in inflation expectations depended crucially on declines foreseen in the noncore component Mexico: Inflation expectations Median, % Year-end 2016 Year-end 2017 6 6

4.6

3.9 4 4 3.4 3.3 3.0 3.2

Headline Headline 2 2 Core Core Noncore 1 Noncore1

0 0 Jul-15 Jul-15 Jan-15 Jan-15 Jan-16 Jan-16 Jun-15 Jun-15 Oct-15 Oct-15 Apr-15 Apr-15 Feb-15 Sep-15 Feb-15 Sep-15 Feb-16 Feb-16 Dec-14 Dec-14 Dec-15 Dec-15 Aug-15 Aug-15 Nov-15 Nov-15 Mar-15 Mar-15 May-15 May-15

1/ Implicit based on CPI weights Source: Banco de México, Encuesta sobre las Expectativas de los Especialistas en Economía del Sector Privado

Mexico: External conditions and economic outlook 24 Monetary policy will continue to be on guard for any obstacles that may hinder the consolidation of convergence of inflation to the target

Some risks to watch

. Amplified FX depreciation and greater pass-through to inflation, with second-round effects . Larger increases in noncore price components, with contamination to other prices . Aggregate demand pressures as the economy recovers, given uncertainty over measures of slack such as the output gap

Mexico: External conditions and economic outlook 25 Conclusions

. The adverse international scenario has hurt the Mexican economy through lower oil prices and slower U.S. industrial production, making it necessary for Mexico to fortify its economic fundamentals . Fiscal and monetary measures undertaken in February have been geared toward safeguarding price and financial stability in this difficult global environment . Current benign inflation represents an unprecedented opportunity to consolidate convergence of inflation to the permanent target

Mexico: External conditions and economic outlook 26 Mejoran las perspectivas económicas mundiales 27