After more than seven years at the head of Bank of Mexico, Agustín Carstens, 59, leaves a country “more resilient,” he tells Global Finance Magazine, as he moves to a new post at the Bank for International Settlements. With the Americas at risk from rising protectionism, Carstens emphasizes the benefits of NAFTA. It’s better, he says, to tackle directly the negative impacts of globalization than to push back against widely beneficial economic integration.  

Author: Tiziana Barghini

Global Finance: In May, Mexico’s Central Bank reviewed its 2017 GDP growth expectations for the country to between 1.5 and 2.5 percent from 1.3 to 2.3 percent earlier. Do you still confirm this view? What are the main elements explaining expectations for a higher growth? What is your expectation for 2018?

Agustín Carstens: I can confirm the expectations for higher growth. In fact, in our latest projections, growth for 2017 will be somewhere in between 2.0 and 2.5 percent, and between 2 and 3 percent for next year. Delving into more detail, economic activity in Mexico continued expanding during the second quarter of 2017, for which annual growth was 3 percent, after 2.3 and 2.6 percent annual growth rates in the fourth quarter of 2016 and the first quarter of the current year, respectively. The recent expansion reflects positive momentum in exports and private consumption, even if investment continues to be weak. Besides, manufacturing exports have continued to pick up. Furthermore, global economic activity and commerce have recovered at the same time that the domestic market has proved resilient and consumer and producer confidence has gradually risen.

GF: How is your view on the main economic trends and challenges in the region?

Carstens: In spite of the relatively weak growth, we can acknowledge that in general, and with some outstanding exceptions, the region has shown more resilience to external shocks than in previous adjustment episodes. More flexible exchange rate regimes have served as significant shock absorbers. Despite the magnitude of the exchange rate depreciation, Latin American central banks have managed, in general, to keep inflation expectations under control.

The region has shown resiliency, but the challenge of achieving stronger economic growth still persists. The region should persevere in pursuing structural reforms and implement them as soon as possible.

GF: Mexican inflation has recently reached an eight-year high. You recently said that it is close to its peak. Can you confirm this and explain us why?

Carstens: During the past year, inflation has suffered from various shocks, particularly energy and non-food commodities. These shocks accelerated inflation up to levels beyond 6 per cent in 2017, after having reached an all-time low by end-2015. In relation to energy prices, I would like to highlight that, going forward, the gasoline-price liberalization process will have a positive impact on fiscal sustainability and help assure a more stable inflation, in spite of the short-term cost of increased inflation. Against this backdrop, Banco de México has implemented a timely strategy, taking the necessary measures to contribute to the adjustment of relative prices that have derived from this sequence of shocks in an orderly manner. The goal has been to keep medium- and long-term inflation expectations anchored, thus providing the right conditions for inflation to come back to the 3 percent target in the medium term. Since December 2015, Banco de México has increased its reference rate by 400 basis points, taking its monetary policy reference rate from 3 to 7 percent. In fact, Banco de México has been one of the central banks that have restricted their monetary policy stance the most in recent years. Considering the lag with which monetary policy operates, the tightening has already started to pay off, since various inflation indicators have recently paced down and even, in some cases, reverted their tendency. It is important to highlight the significant appreciation of Mexican peso vis-à-vis the US dollar that has taken place during recent months, which is one of the key channels of monetary policy transmission.

Hence, even though we expect that annual headline inflation will continue to be above 6 percent in the coming months, it seems to be approaching its peak. In fact, we expect that headline inflation will resume a downward trend in the last months of this year, which will become steeper during 2018, leading to convergence to the target of 3 percent by end-2018.

GF: Can you share your view of the medium-long term outlook of the Mexican economy in term of potential growth and productivity? What sectors of the economy –global or national– hold the most promise?

Carstens: In the past decade, Mexico has taken key steps to secure a strong macroeconomic framework in the medium and long term. However, going forward, it should be acknowledged that macroeconomic stability is a necessary, but not sufficient condition for strong and sustainable growth. In particular, the underlying microeconomic structure of the economy also matters, since, to a large extent, it determines how productive and efficient a country is. Hence, besides working towards achieving better macroeconomic management, Mexico has also pursued, for a long time, policies aimed at reforming the structure of the economy to enhance its medium-term productivity and efficiency. As part of this agenda, Mexico has undertaken during the past few years a series of far-reaching structural reforms aimed at improving human capital, enhancing infrastructure, boosting competition in domestic input and products markets, and strengthening institutions. Preeminent among these are reforms addressing the labor market; the anti-trust framework; education; and the financial, telecommunications, oil, and electricity sectors.

Many of these reforms are now being implemented and are expected to improve Mexico’s competitiveness and productivity since many of them deal with sectors that provide inputs used across the board. They are also expected to provide additional efficiency gains via the adequate regulation of sectors that behave like natural monopolies due to their network structure. This reform effort has been and will continue to be of paramount importance to modernize the Mexican economy. It is important to take into account that these reforms cannot bear fruit quickly, its implementation takes time, and the results will be seen in the medium term. Nevertheless, reforms allow Mexico to achieve greater flexibility and efficiency in the allocation of its productive resources, which, in turn, is key to attain higher economic growth. It is worth noting that Mexico is one of the few countries among the G20 and OECD members that have been able to register positive growth rates in 31 quarters since 2009, hence continuously contributing to the growth and prosperity of the region.

GF: How important is the revision of the NAFTA agreement for Mexico? What can go wrong?

Carstens: The renegotiation of NAFTA is of significant importance. This is a vital opportunity to modify and modernize a treaty that has proven beneficial for all three countries, and that has many areas of potential improvement, which will continue to support North America as one of the strongest and most prosperous regions in the world. The enactment of NAFTA in 1994 had a transformative effect on the Mexican economy. NAFTA implied much more than a tariff reduction scheme. It also involved profound regulatory and institutional changes that had the aim of promoting integration among member countries. A significant consequence of NAFTA for the Mexican economy has been deeper integration with the United States through a relationship that is not merely of trade partners, but also of production partners. This can be seen in the growth of intra-industry trade. In fact, the enactment of NAFTA had a significant positive impact on several key economic indicators in the Mexican economy. For instance, growth and productivity have been boosted by exploiting the comparative advantages of each country. Many jobs related to exporting activity have been created, and consumers have benefited from access to a greater variety of goods at a lower cost. Therefore, I believe that with a revamping of the treaty, in hand with a simplification of its current rules, additional opportunities for a more profound integration could be achieved to have more exporters that can reap the benefits of belonging to a free-trade zone.

Furthermore, reviewing the nature and benefits of the globalization process is of particular importance, against the backdrop of the rhetoric favoring a more protectionist stance as a potential solution to address distributional issues and to protect specific groups of the population. However, the increased complexity in cross-country links implies that the imposition of protectionist measures may have larger deleterious effects by not only distorting consumption and reducing trade patterns, as in traditional models focused on trade in final goods, but also by increasing the costs that affect the international organization of the production process.

Hence, what it is of utmost importance is to abstain from seeing this revision as an opportunity to reverse integration. Gains from globalization have been large; this process has provided new opportunities for improving efficiency, employment, and welfare. Furthermore, by promoting a more efficient reallocation of production stages, globalization and the emergence of global value chains generate welfare gains that go beyond the traditional mechanisms triggered by other forms of international trade. We must underscore that protectionism is not the answer. We must keep in mind that NAFTA is an advantageous scheme of cooperation, and that in today’s global economy, it is vital to work hand in hand with other countries, towards enhancing our relationships through time. Turning our backs to economic integration in North America today would be very costly for all the countries involved and their future generations.

GF: How do you see technology impacting governance by central banks? Does it make your job easier or harder?

Carstens: Technology has made possible new avenues of financial innovation. We could say that these financial innovations help complete markets or produce new ones, thus creating or increasing value and improving ways to transfer and share risks. However, they are evolving rapidly, which requires a careful and conscious analysis on how central banks and financial regulators must proceed. Many of these innovations are subject to different market failures, and there are a few aspects of how we look at them from a policy perspective that are particularly important. Some have to do a bit more with how they relate with the microstructure of the market, while others are more correlated to its macroeconomic implications. For instance, central banks and regulators should take due consideration of the tradeoff between minimizing risks and achieving a certain degree of standardization and, on the other hand, fostering innovation. Also, there must be an equilibrium between prudence and the obligation to protect the consumers. Technological progress in the financial system cannot only be a product of innovation. It must be done at a pace that avoids hazards to the financial system that could affect our society in the end.

Another central aspect has to do with how central banks must keep pace with the huge variety and sophistication of cyber risks by investing sufficiently in technology and human resources. Then, we have the interplay between technological innovations and financial stability or the implementation and transmission of monetary policy. For example, the way some fintechs develop could interplay with financial stability by amplifying cycles or making shocks more systemic. Consider too how central banks should be thinking of the implementation of monetary policy given the degree of disintermediation induced by innovation. So, to conclude, innovation can bring about many benefits but also poses new challenges to central bankers, and policy makers, more broadly. We should address them to help materialize these benefits.   

GF: Is there a single issue of the Mexican economy keeping you up at night?

Carstens: As I mentioned before, the ambitious structural reform agenda that Mexico has undertaken has contributed to stability and growth, but much remains to be done. To continue with its implementation remains crucial; however, we must also have a helpful, honest and self-critical diagnosis to determine what the current impediments to growth are, how our performance can be enhanced, and how we can create conditions for greater welfare.

Besides, the diagnosis must also be made with a global scope. The current anti-trade and anti-globalization movements have questioned the benefits of global interconnectedness. While there seems to be compelling evidence that globalization plays an important part in enhancing productivity and living standards, this process necessarily entails the reallocation of resources away from less productive tasks to more productive ones, which may lead to an unequal allocation of its benefits among different industries and sectors of the population. This is not, in any sense, different from what we have learned from previous episodes of trade liberalization. Hence, not only must the new opportunities and gains from globalization be emphasized, but also the policy challenges entailed by new developments, to ensure that everyone shares in these gains. In a nutshell, given that there are substantial welfare gains to benefit from, confronting these redistributive policy challenges is better than simply pushing back trade and economic integration.  

GF: What are the key financial issues that Mexico faces as a nation?

Carstens: I would like to stress that the Mexican financial system is well capitalized, with adequate liquidity levels and in compliance with Basel III requirements. This puts the financial system of the country in a strong position to withstand adverse shocks. We have strengthened the financial sector prudential oversight and established a Financial Stability Council.

Nevertheless, external shocks that could be detrimental to the stability of the system cannot be discarded. For instance, the recent episodes of high volatility in exchange rate markets during the US Presidential Election have been a type of stress test to the Mexican financial system. Fortunately, this has proved that the financial system is resilient and prepared to face periods of external volatility and downside risks. Nevertheless, we must remain vigilant and maintain these standards going forward.

One of the key challenges for Mexico is how to increase financial deepening and access, without undermining the soundness of the financial sector. A significant percentage of the Mexican population does not have access to financial services. In fact, improving this situation was one of the goals of the 2014 financial reform, one of the elements of Mexico’s structural reform agenda.

GF: How much a drag on the economy is the impact from violence in Mexico? What is the impact on the Mexican economy from corruption?

Carstens: Business executives from all over the country interviewed by Banco de México have mentioned a possible worsening in the perception of public safety among the downside risks that stand out for the Mexican economy. In particular, in the northern part of the country, private-sector executives reported that the perception of increased insecurity in some areas of the region continued to affect the performance of the tourism sector. Going forward, it is necessary to strengthen the macroeconomic fundamentals of the country and to continue to implement policies at the local and national levels that allow the different regions to achieve a more rapid and sustained growth. In this context, to prevent insecurity and corruption from becoming a drag on economic growth, it is essential to strengthen the rule of law and ensure legal security for all economic actors. In this regard, making operational the National Anti-Corruption System is an essential step going forward in the fight against corruption. The system will contribute to a well-organized and coordinated strategy among governmental agencies to prevent, detect and sanction administrative responsibilities as well as acts of corruption, and to audit and control public resources.

GF: You will be leaving your post as Governor of Banco de Mexico later this year to take over the top job at the Bank of International Settlements. What is the achievement that makes you more proud of your tenure at the Mexico Central Bank? What do you consider your largest challenge at the BIS?

Carstens: Even though Banco de México was founded 92 years ago, it has only been independent for 23 years. In this period, we have managed to reduce substantially inflation, making it more stable at lower levels and more resilient to external and internal shocks. To have contributed in the consolidation of this process is what I consider my main achievement. The job is still not fully done, but during my tenure we made substantial progress.

Even though I am still focused on my duties at Banco de México, I can say that my new position at the BIS presents a stimulating challenge in the current conjuncture. I consider that globalization and the deep interconnectedness of trade and financial openness, together with technological advances, will pose interesting questions and challenges to financial regulation and monetary policy, as well as how central banks deal with it. Furthermore, it represents a test for the institution itself, regarding how it serves it membership as well as how it becomes more global and inclusive. The BIS has a governing body, the Board of Directors, that decides over the strategic vision of the Institution and comprises major developed and emerging market economies. Nevertheless, in light of global economic developments, the Board recently changed one of the BIS statues to allow more flexibility and improve its composition to have a more balanced representation and enhance its governance.