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Mexico’s Output Gap to Keep Inflation on Target, Cordero Says

Mexico’s economy has room to grow before reaching its capacity and government subsidies for gasoline insulate the country from rising oil prices to keep inflation in check, said Finance Minister Ernesto Cordero.

“We are behind our potential GDP growth and that’s why international inflation hasn’t passed through to the Mexican consumer,” said Cordero, in an interview yesterday at the Inter-American Development Bank’s annual meeting in Calgary. “Mexico still hasn’t reached the point of operating at high capacity.”

Mexico is the only major Latin American country that hasn’t boosted borrowing costs in the past year as consumer prices rise at the third-slowest pace in the region after Chile and Peru.

Mexican inflation slowed to 3.1 percent in the 12 months through mid-March from 3.6 percent in February. Annual inflation this year will stay within the central bank’s target range of 2 percent and 4 percent as the economy grows as much as 5 percent, said Cordero.

Surging oil, wheat and corn prices are boosting inflation in developing nations from India to Brazil as the global economic recovery strengthens. Mexico subsidies gasoline, so crude prices won´t affect Mexican consumers, says Cordero. Higher crude prices will bolster government revenue from oil exports by Petroleo Mexicanos, the state-owned oil company known as Pemex, says Cordero.

Pemex, Latin America´s biggest oil producer, generates about a third of government revenue, and the rise in crude price will offset the gasoline subsidies, said Cordero. The government will raise gas prices “little by little” this year, he said, declining to give a projection.

Revenue Gains

“The main risk of high energy prices is that it could be a deterrent to an economic recovery,” said Cordero. “There´s probably going to be some revenue gain from oil prices but certainly heavily watered down by the subsidy of gasoline.”

Tighter fiscal policies are the best way to control inflation, said Cordero.

Mexico’s government reduced payrolls and cut 27.2 billion pesos ($2.2 billion) in federal expenses during 2010 as part of its plans to narrow the budget deficit, according to a document sent by the government to Congress that was e-mailed to Bloomberg News by the Finance Ministry. The reductions were applied across all federal government agencies, the report said.

Mexico’s federal budget targets a narrowing of the deficit to 0.5 percent of gross domestic product in 2011 from 0.7 percent of GDP in 2010. Mexico’s government last year decided to cut 40 billion pesos in spending between 2010 and 2012. An oil windfall won’t slow government efforts to tighten fiscal policy, said Cordero.

Controls Don’t Work

“The way to proceed is with a tighter fiscal policy to not overheat aggregate demand,” said Cordero. “The extra revenue we have from oil will go to a stabilization fund so it won´t go to aggregate demand exactly. So we won’t get more room for fiscal policy.”

Cordero says he doesn´t believe in capital controls. Nations including Brazil and Colombia are trying to curb gains in their currencies and fight inflation after near-zero borrowing costs in advanced economies such as the U.S. and Japan spurred demand for higher-yielding assets in emerging markets.

“Those countries that implemented capital controls have no evidence that it had any impact in stopping the currency from appreciating and we believe that this creates very strong distortions in the economy,” said Cordero. “Interest rates and tighter fiscal policy is the way to do it.”

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