IMF Executive Board Concludes 2007 Article IV Consultation with MexicoPublic Information Notice (PIN) No. 07/140
December 13, 2007
Public Information Notices (Pins) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, Pins are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2007 Article IV Consultation with Mexico is also available.
On December, 3, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Mexico.1
The economic expansion has continued albeit slowed by developments in the United States. Despite some pickup in the second and third quarter, growth is projected to be close to 3 percent for 2007 as a whole. During the last 12 months inflation has been closer to 4 percent, boosted by a series of supply shocks to world food prices, than to the 3 percent target. Wage growth so far has not accelerated, and medium-term inflation expectations have been broadly stable-although remaining ½ point above the 3 percent target. In that context and citing the need to avoid second-round effects and to guide downward inflation expectations, the Bank of Mexico acted to raise short-term interest rates to 7¼ percent in April, and further to 7½ percent in October.
The external position remains solid, notwithstanding a decline in oil production and slower pace of growth in remittances. The current account deficit is projected to increase to ¾ percent of GDP for the year as a whole. The Bank of Mexico has continued to abstain from discretionary intervention in the foreign exchange market, following the rule for its foreign exchange sales announced in 2003. Mainly reflecting public sector oil export earnings, official reserves have risen by US$5 ½ billion in the first three quarters of 2007 and are about 1½ times short-term external debt on a residual maturity basis.
Fiscal policy is on track to achieve balance for 2007, on the traditional budget measure, as required by the new Fiscal Responsibility Law. The non-oil augmented fiscal deficit for 2007 is projected to be close to 7 percent of GDP, broadly similar to recent years' level. Within this, a 0.4 percent of GDP decline in net oil revenues, reflecting declining oil production, is being offset by a reduction in operational outlays, while investment and social expenditures increase. The public debt to GDP ratio has been steadily declining, and the average maturity of central government traded domestic debt has increased-with the government recently able to issue 30-year nominal fixed rate bonds, albeit in small amounts-although total public sector debt rollover needs are still relatively high.
Mexican financial markets have weathered recent global financial volatility well. As in other emerging markets, the global repricing of risk that began in late July led to a modest rise in bond spreads, as well as a decline in equity prices and some depreciation of the currency (although the latter two movements have now been largely reversed). Domestic financial markets have continued to function normally, without need for policy intervention by the authorities. Commercial banks remain well capitalized, profitable and liquid, and nonperforming loans are still low. The main potential concern remains rapid growth of bank credit to the private sector (29 percent annual growth through September), primarily to households. Credit to enterprises has recently picked up, but remains very low.
Executive Board Assessment
Executive Directors commended the improvements in macroeconomic and financial policies that have helped Mexico to reduce significantly external and internal vulnerabilities over the years-with sustained low inflation, a declining public debt ratio, and a reduction in external debt to low levels. They also welcomed the recent reform breakthroughs, including on tax policy and public pensions, as essential, forward-looking steps to addressing longer-term challenges.
At the same time, Directors noted that Mexico still has a long way to reach its full economic potential, emphasizing the need to accelerate output and productivity growth and to further reduce poverty and inequality. They therefore welcomed the National Development Plan's emphasis on building a more inclusive society that bridges the gap with fast-growing economies while creating more and better job opportunities.
Directors considered that Mexico's near-term outlook remains solid. They observed that Mexican markets have weathered the recent global volatility well, owing to Mexico's healthy fundamentals. Nevertheless, Directors expected that economic growth in the short run could remain somewhat below potential, as the recent deterioration of the U.S. economic outlook could spill over to Mexico.
Directors noted that monetary policy has succeeded in anchoring inflation and inflationary expectations at a low level, although still somewhat above the 3 percent target. In that context, they considered the current policy stance broadly appropriate, while noting that the Bank of Mexico now has the challenging task of weighing upside risks to inflation from supply shocks against downside risks to inflation from the weakening external environment. Directors welcomed the recent steps to enhance monetary policy communication-including the publication of a forecasted inflation path-which should facilitate adjustment to shocks, and guide inflation expectations closer to the target.
Directors considered the independently floating exchange rate regime as appropriate and serving Mexico well, and the real effective exchange rate as broadly in line with fundamentals. They noted that this transparent regime has facilitated continuous and smooth adjustment to shocks, thus contributing to internal and external stability. Directors also noted that the level of international reserves appears adequate, and saw no immediate need for a change in the non-discretionary rule governing the accumulation of reserves.
Directors welcomed the recent tax policy and public pension reforms as key to addressing long-term fiscal challenges. They recommended that the upfront revenue gains from the tax policy measures be used cautiously, including in light of the projected medium-term decline of oil production and associated fiscal revenue. In that context, Directors noted the importance of implementing the plan to strengthen tax administration, and resisting any pressures to increase inertial expenditures. They welcomed the authorities' focus on capital expenditures, while recommending the targeting of subsidies to those most in need.
Directors supported the recent and prospective steps to enhance efficiency and accountability in public spending, at both the national and subnational levels. They encouraged the early implementation of a modern integrated financial management information system and noted the importance of improving subnational fiscal and debt statistics.
While commending the recent steps to prevent medium-term fiscal difficulties, Directors noted the fiscal risks from a possible sharp decline of oil production during the next administration. In that context, they recommended giving a longer-term orientation to fiscal policymaking, developing comprehensive measures of the public sector balance sheet, and supplementing the balanced budget requirement with a focus on steadily reducing the large non-oil fiscal deficit. A number of Directors recommended establishing an indicative limit for the non-oil augmented fiscal balance over the medium term.
Directors observed that Mexico's financial system remains sound and well regulated. They commended the authorities' progress to address the issues identified in the 2006 FSAP Update and their intention to continue moving on that broad agenda. Directors noted the need to remain alert to potential risks, such as those arising from the use of structured instruments and the planned expansion of development banks' activities. They also recommended continued close monitoring of consumer credit growth, which would be facilitated by improved data on consumer balance sheets and housing market developments.
Directors commended the recent successes in building consensus in Mexico to re-energize the reform agenda, and hoped that this success would be extended to other areas. Directors noted the potential for Mexico to reap large gains-including in reducing fiscal risks-from an early implementation of reforms of the state-owned oil sector. Several Directors highlighted the importance of allowing investment partnerships with other oil companies and investors in the oil sector. Directors also emphasized the benefits of enhancing competition, especially in such key network sectors as telecommunications, to generate positive spillovers throughout the economy and to promote equity.