IMF Executive Board Concludes 2010 Article IV Consultation with MexicoPublic Information Notice (PIN) No. 10/39
March 16, 2010
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 2010 Article IV Consultation with Mexico is also available.
On March 10, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Mexico.1
Mexico had significantly strengthened policy credibility and public and private sector balance sheets before the onset of the crisis. Strong economic performance, with growth averaging over 3.5 percent in 2003-07, was underpinned by robust macro policy frameworks along with the flexible exchange rate regime. Considerable progress was made in improving debt profiles, and the strong regulatory framework gave rise to a sound banking sector.
Nevertheless, Mexico’s resilience was severely tested during the global crisis. The surge in risk aversion following the collapse of Lehman Brothers in September 2008 triggered a sharp retrenchment of financial flows from emerging markets, including Mexico, resulting in liquidity strains and marked currency depreciation. Meanwhile, reflecting close U.S. linkages, Mexico experienced a rapid decline in manufacturing exports in the first half of 2009. Unanticipated large losses on corporate foreign exchange derivate positions disclosed in late 2008 further weighed on confidence, while the H1N1 virus outbreak in mid-2009 put an additional drag on activity. Against this background, output contracted by 6½ percent in 2009, while the peso fell 25 percent against the dollar in the nine months to mid-2009.
Prompt and effective policy measures were adopted in response to the crisis. Macroeconomic policies were eased significantly, providing a fiscal impulse of 2.5 percent of GDP in 2009 and reducing policy rates by a total of 375 bps, to 4.5 percent, since mid-2008. Targeted assistance was also extended to financial intermediaries to address funding shortages. At the same time, Mexico’s Central Bank (Banxico) made substantial interventions (US$31.4 billion in total) to maintain orderly liquidity conditions in the foreign exchange market, and secured contingent financing through the Federal Reserve swap line ($30bn, expired in February 2010) and the Fund Flexible Credit Line ($47bn, effective till mid-April 2010) to further support confidence. On the back of these strong policy measures, growth has resumed since mid-2009, the peso exchange rate has rebounded, while domestic financial stability has been maintained.
Building on the recent momentum, activity is expected to accelerate in the near term, leading to projected growth of 4 percent for 2010. Inflation was pushed up to 4½ percent in January 2010 by one-off increases in taxes and administered prices, but is expected to return to the 3 percent target by end-2011 reflecting the considerable economic slack. With domestic demand gradually strengthening, the current account deficit is projected to widen slightly to 1½ percent of GDP in 2010.
The authorities have also undertaken a series of measures to further bolster fundamentals and rebuild buffers. The FY2010 budget included a substantive tax reform, designed to offset the revenue losses from lower oil production, while allowing for a temporary easing of the balanced budget rule in response to the cyclical downturn. Requirements on corporate disclosure of derivative exposures has been tightened, while structural reforms to enhance growth potential—most recently reforms of the electricity sector—are being advanced. In addition, the authorities have announced plans to increase foreign exchange reserves gradually through a combination of retaining public sector foreign exchange cash flows and the use of an options-based mechanism.
Executive Board Assessment
Executive Directors commended the authorities for their sound policy frameworks and progress in strengthening public and private sector balance sheets, which had enabled an effective counter-cyclical policy response and helped preserve stability during the crisis. Their swift action to secure contingency credit lines—from the U.S. Federal Reserve and the Fund—has also helped maintain external confidence. The economy is starting to recover, following the deep output contraction in the first half of 2009. However, the uncertain global outlook could pose downside risks, underscoring the need to increase room for policy maneuver and strengthen efforts to address medium-term fiscal and growth challenges.
Directors considered that the 2010 budget is appropriate. The tax package represents an important step toward achieving medium-term fiscal sustainability, while the temporary easing of the balanced budget, in accordance with the exceptional clause of the fiscal rule, would help cushion the impact of the withdrawal of fiscal support. Directors welcomed the progress in fiscal reforms over the past three years. Given the expected structural declines in oil revenues and rising current spending pressures, they welcomed plans to seek expenditure savings and further strengthen tax administration. Further efforts would be needed to advance on oil sector reforms, broaden the tax base, and simplify the tax system. Moving to a structural budget rule would help reduce procyclicality and spending volatility, further strengthening policy credibility. Directors saw the removal of the caps on savings in the oil stabilization funds as a step in the right direction.
In light of the still weak demand conditions, Directors agreed that monetary policy should remain supportive until the recovery is firmly established. The central bank’s effective communication has helped limit the effects on inflation of the recent changes in taxes and administered prices. Nevertheless, second-round effects would need to be carefully monitored.
Directors agreed that the flexible exchange rate has played an important role in the adjustment process, and welcomed the transparent, rules-based intervention mechanisms. Noting persistent market concerns about Mexico’s low reserve coverage relative to balance sheet indicators, many Directors saw merit in the authorities’ plan to explore options for further strengthening foreign exchange buffers. A number of other Directors pointed to the need to take due account of the costs and externalities of reserve accumulation.
Directors noted that the financial system remains resilient, underpinned by strong regulation and supervision. They welcomed the authorities’ prompt action to address emerging issues in some small nonbank institutions, and encouraged continued close monitoring of developments in this sector. Directors supported the intentions to broaden the regulatory perimeter, set up a committee for assessing systemic risks, and reform the financial sector resolution framework.
Directors emphasized that the challenge of reinvigorating growth has gained new urgency in a weak global environment. They encouraged the authorities to expedite structural reforms to boost growth, building on recent important steps to improve productivity in the electricity sector. Key priorities include advancing on strengthening the competition framework, streamlining the regulatory framework, and enhancing labor market flexibility.