Mexico's economy, already in recession, is being dragged even lower by a brutal drug war that is frightening off some investors and hurting the Mexican currency.

From manufacturing centers on the U.S. border to the southern beach resorts of Cancun and Acapulco, Mexicans have seen regular beheadings, shootouts and kidnappings as gangs fight over smuggling routes into the United States.

The turf wars killed 6,300 people last year and the U.S. government, fearing that the violence will spill over onto its soil, is boosting security along the border.

Some U.S. investors have pulled money out of Mexico worried that drug cartels are overwhelming security forces, and a recent study by the United States Joint Forces Command said Mexico could be at risk of a rapid and sudden collapse.

The issue of security has effected economic growth in Mexico, Finance Minister Agustin Carstens said recently.

If we could resolve this issue it could give the economy an extra shine of at least 1 percent, he said.

Central bank Governor Guillermo Ortiz blamed the peso's fall to a 16-year low against the dollar last month on investor alarm even as the Mexican and U.S. governments and international economists insist Mexico is far from becoming a failed state.

Evidently the insecurity has had an impact on investors' behavior, Ortiz told a recent banking conference.

Mexico's government says the economy will shrink 2.8 percent this year, tumbling into recession on a sharp drop in U.S. demand for Mexican exports. Many economists say the slump could be even more dramatic.

The turf war between Mexican drug cartels has become the biggest test facing President Felipe Calderon, a strong-willed conservative who took power in late 2006.

U.S. President Barack Obama will visit Mexico this month, and is sending high-tech gear and hundreds more agents to the border to fight the smuggling of drugs, weapons and cash.

In Mexico's border states, where violence has been the most intense, business people say that on top of a collapse in exports to the United States and falling domestic sales, some are forced to pay protection money to gangs.

They demand that you pay into a bank account or they'll kill you, said a bar owner in the northern city of Monterrey who gave his name only as Emmanuel. Aside from the fear, it's an economic blow, its like paying taxes twice.

Others say some foreign firms are putting off investments as they see Mexico as too unsafe.

There are U.S. companies that have held back new product lines that were due to be installed in our assembly-for-export factories this year, said Jorge Pedroza, director of the maquiladora association in Ciudad Juarez.

At least 4,500 businesses closed down in Chihuahua state last year because drug cartel extortions pushed them into bankruptcy, said a group in Ciudad Juarez representing companies ranging from law firms to pharmacy chains.

Ciudad Juarez sits across the border from El Paso, Texas. It has seen the worst violence in Mexico's drug war with 1,600 deaths last year, although it appears to be calming after the deployment of an additional 5,000 soldiers and 2,500 federal police at the start of March.

Police captured senior Juarez cartel member Vicente Carrillo Leyva, who had a $2 million reward on his head, on Wednesday when he was exercising in a park in Mexico City.

EMPTY RESTAURANTS

Mexico is in its deepest recession since the Tequila crisis of the mid-1990s and the government has asked the International Monetary Fund for access to a credit line of $47 billion to prop up the peso currency and shield the economy.

Tourists, a big source of foreign exchange earnings, are still coming to Mexico, attracted by the weak peso currency and most are so far unfazed by the drug violence. The number of tourists is up slightly so far this year despite travel warnings by the U.S. and Canadian governments.

But in cities like Tijuana and Ciudad Juarez on the U.S. border, where troops patrol the streets and drug violence has been rampant, the tourism industry has suffered and hotel occupancy rates are below 50 percent.

Americans who used to come for the border night life, cheap tequila and sex are staying away and even local residents are too afraid to go out to restaurants, bars and clubs at night.

Still, many business people blame gory news reports for exaggerating the extent of drug killings.

Fears in the United States of a spillover of the violence from Mexico have scared off some visitors to Laredo, Texas.

We had three bus loads of tourists cancel their visits to Laredo in February because of false new reports about shootouts here, said Laredo's mayor, Raul Salinas.

But some companies are still investing in Mexico, attracted by low labor costs and access to the U.S. market.

Swiss chocolate maker Barry Callebaut and Europe's largest toy maker Lego opened new factories in the northern state of Nuevo Leon this year.

We made a long-term decision and the drug violence is not something we considered an issue, said Barry Callebaut's chief executive, Patrick De Maeseneire.

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