Mexico's 2.8% Q2 Growth Masks Possible Economic Problems

By Mike Caggeso

While Mexico's economy grew at a 2.8% in the second quarter - snapping a four-quarter streak of economic deceleration - experts are only cautiously optimistic about the country's ongoing growth. There are several reasons for this.

First, several sectors reported strong earnings. Agriculture production was up 3.8%. Services rose 3.7%, led by a 7.1% leap in the mobile phone industry, Bloomberg News reported. However, much of the growth came out of a huge increase in demand for Mexico's industrial exports, namely automobiles. The top three Mexican-manufactured cars and trucks are those for Ford Motor Co. (NYSE: F), General Motors Corp. (NYSE: GM) and DaimlerChrysler (NYSE: DAI) — all of which are in dire straights after higher gas prices and increased competition loosened their grip of the U.S. market to below 50%.

Second, as our sub-prime meltdown and the ensuing stock market troubles has rippled into other markets, Mexico has taken the brunt of the pain because its market is closely tied to ours. On top of the millions of potential workers that cross the U.S. border, 80% of Mexico's exports are sent to the United States.

If we can't buy, they can't produce

Adding to the pain, Mexican stocks and bonds fell sharply last week. Also, the peso sank to its lowest level against the dollar in more than a year on Thursday, falling to 11.239 to the greenback.

"If the U.S. situation continues to deteriorate, things will get worse" for Mexico, Eugenio Aleman, senior economist at Wells Fargo & Co. in Minnesota, told The Los Angeles Times. "It's going to be a tough year."

Signs of Hope, Trouble

Mexico's Finance Minstry forecasts about 3.3% GNP growth for the year, a drop from last year's 4.8% growth.

Even if the U.S. credit market continues to damage Mexico's growth, one thing that has been helping Mexico's GNP is, oddly, its surging credit market.

Since 2002, the number of credit cards in Mexico has tripled, The Houston Chronicle reports. Mexico's financial institutions are doling out credit cards left and right, prompted not only by consumer demand, but also because there aren't laws that cap the rates and fees they can charge. As of June, the average annual interest rate on Mexican credit cards was an astonishing 31.7%, according to the Bank of Mexico.

As a result, this newfound and quickly spreading purchasing power could give the retailers like Wal-Mart de Mexico SAB de CV (OTC: WMMVY) a nice boost, as well as top banks such as Grupo Financiero BBVA Bancomer, S.A. de C.V., Grupo Financiero Banamex, S.A. de C.V.  and Grupo Financiero Banorte S.A. de C.V.

But disaster can strike down the road when interest-compounded balances are too high to pay off.

This chain of events almost mirrors the U.S. recent sub-prime mortgage debacle. Mexican creditors are not only handing out too many loans to people unable to pay them, but with an unregulated and astronomical interest rate.

Not only would Mexico have itself to blame for entrenching itself in debt, it would also have to suffer more blows should the United States stumbles into a recession.

Until that situation occurs, if it occurs, there are still some strong investment plays for Mexico. The iShares MSCI Mexico Index Fund (NYSE: EWW) aims to capture 85% of Mexico's total market capitalization. Also, the iShares Latin America 40 Index (NYSE:ILF) consists of highly liquid securities from Mexico, Brazil, Argentina and Chile.

In the private sector, Carlos Slim, newly crowned richest person in the world, has turned Telmex (NYSE: TMX) , Telcel and América Móvil (NYSE:AMX) into market-dominating telecommunications companies. And television network Grupo Televisa (NYSE:TV) , who own a 70% market share, has seen its ADR leap 32% in the past year.