Despite improved fundamentals Mexico is being hit by the financial turmoil and world economic downturn. As in other emerging markets, there has been a reduction in net capital inflows, which contributed to a large depreciation of the peso in the last quarter of 2008 and in the first months of 2009, although since then the peso has stabilized at a lower level. Access to foreign capital has become more restricted and costly. With a relatively small and well regulated financial sector Mexico has been able to weather the initial shock. The global recession has, however, hit the real sector through the trade channel, reflecting the heavy dependence on the US market. Another shock is the collapse of oil prices, which is depressing fiscal revenues, though these prices have recovered with respect to the minimum levels observed at the end of 2008. Business and consumer confidence have fallen considerably. The outbreak of influenza is also likely to contribute to the downturn. Growth is set to drop substantially this year and start to recover slowly next year. The authorities have responded with liquidity measures, foreign currency interventions, lower interest rates, external borrowing and fiscal stimulus. There might be some room for more monetary easing, if the economy deteriorates further, while fiscal stimulus should be better targeted. The scope for further fiscal measures is limited by uncertainties of future oil revenues, higher cost of funding and the risk of inefficient spending. Although banks remain sound, the authorities should closely monitor bank portfolios, which may be adversely affected by the worsening economic outlook.