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Mexico Recovering, But Crisis Spotlights Challenges, says IMF

Oil worker in Mexico: revenues from the industry will have to increase to help in recovery (photo: Newscom)

GLOBAL ECONOMIC CRISIS

Mexico Recovering, But Crisis Spotlights Challenges, says IMF

IMF Survey online

March 16, 2010

  • Past reforms helped country weather the global crisis
  • Recovery building momentum, but global risks a concern
  • Key challenges—raise revenues and boost growth

Policy reforms over the past decade helped Mexico weather the global economic crisis, but the pace of recovery will depend on a bounce back in both the United States and global economies, the IMF said in its annual assessment of the health of Mexico’s economy.

In issuing its report, known as an Article IV consultation, on March 16, the IMF said Mexico was nonetheless hit harder by the crisis than most countries in the region reflecting its close links to the United States, the crisis epicenter.

In addition to strong policies, external confidence in Mexico has also been supported by a precautionary credit line from the IMF of $48 billion, which the authorities have indicated they do not plan to draw.

Reforms helped Mexico get through the crisis

Reforms over the past decade, including in reducing public debt levels, introducing a balanced budget rule and an inflation targeting framework, and the clear commitment to the free float of the peso, helped Mexico weather the global crisis.

As a result, for the first time in years, Mexico’s government was able to use fiscal policy in order to help offset the downturn in the economy. The sizable interest rate cut by the central bank and targeted support by the government in various parts of the financial market also cushioned the global shocks.

The IMF said signs of a recovery in the Mexican economy have begun to strengthen, and growth is expected to climb to 4 percent in 2010, rising to 4.5 percent in 2011.

The pace of Mexico’s recovery will in part also depend on how both the U.S. and global economic situations fare in the coming year. The IMF said foreign direct investment and other inflows of capital are expected to resume, but risks to demand in the U.S. and global financing conditions could continue to weigh on Mexico’s economy.

Assuring fiscal sustainability presents an important challenge

A key challenge facing Mexico in the next few years is replacing the declining share of oil revenues—which make up one-third of federal revenue—with tax revenues. This challenge has been highlighted in recent years by the sharper than expected drop in oil production.

However, production levels appear to have stabilized and the authorities have taken important steps to increase tax revenues with the reform packages put in place in 2008 and 2010—including difficult measures approved in the 2010 budget, such as the increase in the VAT rate.

“We very much support the macro policy stance of the authorities. We believe the 2010 budget takes important steps to build revenues to support the medium-term fiscal position and the government’s ability to invest in priority sectors,” said Vikram Haksar, IMF mission chief for Mexico in an interview with IMF Survey. Key challenges going forward will be widening the tax base and to further increase fiscal revenues.

Banking system is sound

The banking and financial sectors in Mexico came through the crisis in good shape, the IMF said. Non-performing loans seem to have peaked at only 3 percent of total loans by end-2009. Banks are well capitalized and should be able to absorb a possible additional deterioration in credit quality in the event that the economic recovery was to prove more sluggish than expected.

Nonetheless, Mexico could be affected by changes to global financial regulation not least because most major Mexican banks are owned by global banks that are likely to face higher capital charges from regulators as a result of potential future reforms. In response, the Mexican government is planning steps to deepen domestic capital markets and strengthen monitoring of systemic risks.

Boosting growth a key priority

Long-term growth rates in Mexico have been relatively low. The challenge going forward will likely be intensified by the weaker international environment expected, with growth in key trading partners expected to be lower and global interest rates higher. In this context, it will be key to increase competition and reduce barriers to business activity and investment to boost productivity and allow Mexico to achieve its full growth potential.

Mexico intends to renew its credit line with the IMF

Separately, Mexico said last week it is interested in renewing its one-year precautionary $48 billion Flexible Credit Line (FCL) with the IMF, a facility created by the IMF to help economies with very strong track records. Mexico had access to the funds for the past year, but indicated that it did not intend to draw on the resources. The renewal of the credit line is meant to provide confidence to investors and financial markets in the event that global conditions were to deteriorate.

“Mexico has a sustained record of sound economic policies, and has very strong economic fundamentals, and institutional and policy frameworks,” said the IMF’s First Deputy Managing Director John Lipsky. “While Mexico has been hit hard by the global financial crisis, the Mexican authorities have responded strongly and effectively, and there are now clear signs that a recovery is underway.”

Lipsky said the IMF intends to move ahead quickly in seeking the approval of the Executive Board for Mexico’s request for the renewal of the flexible credit line.

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