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Mexico's Rapid Recovery Attests to Strong Fundamentals

Auto factory in Puebla, Mexico. Manufacturing exports have led country’s recovery, along with rebound in domestic demand (photo: Imelda Medina/Reuters)

ECONOMIC HEALTH CHECK

Mexico's Rapid Recovery Attests to Strong Fundamentals

IMF Survey online

August 8, 2011

  • Mexico is expected to continue on a firm recovery, but global risks persist
  • Priority to gradually adjust policy stance balancing domestic, external conditions
  • Advancing structural reforms key to enhancing growth, employment creation
  • Need to address long-term fiscal challenges

Mexico’s strong growth is expected to continue this year and next, but risks linked to the global outlook persist, the IMF said in its annual health check of Latin America’s second largest economy.

The IMF report said that Mexico had rebounded strongly from the global crisis, which attested to the country’s strong fundamentals and skillful policy management.

According to the report, which was discussed by the IMF’s 24-member Executive Board on July 27, manufacturing exports have led the recovery, with a rebound in domestic demand sustaining the momentum. Strong growth is expected to continue this year and into 2012, at about 4 percent and 4 percent respectively, bringing output in line with potential.

In addition, three successive Flexible Credit Line arrangements—an insurance option created in 2009 for the IMF’s strongest performing members—have supported Mexico’s macroeconomic policies by providing a significant buffer against potential global tail risks, the IMF report said.

Monitoring spillovers

About 80 percent of Mexican exports go to the U.S. market, and Mexico’s industrial production closely tracks that of the United States. This reflects the high degree of integration of Mexican manufacturing into the U.S. industrial production chain. Therefore, a more prolonged slowdown in the United States, particularly if it involved manufacturing, could be a drag on Mexico’s growth, said the IMF.

According to the IMF, the direct impact of renewed financial problems in Europe would likely be contained for Mexico; but any consequent surge in global risk aversion could adversely affect even strong performers, such as Mexico, given its close integration with international capital markets.

Gradual policy adjustment

With growth in Mexico expected to continue on a strong footing, a key challenge for the authorities is how to gradually adjust policies, balancing domestic conditions against potential global downside risks.

As fiscal consolidation is judiciously underway and past stimulus gradually withdrawn, the IMF said that the task of balancing domestic conditions and the potential impact of increased global downside risks would fall on monetary policy. With inflationary pressures at bay and inflation expectations firmly anchored, the central bank has room to decide on the best timing for the policy response to domestic and international developments.

The IMF noted that the authorities should continue gradually rebuilding fiscal buffers, which allowed Mexico to pursue a countercyclical policy response during the recent global crisis, to provide an additional insurance against potential global downside risks. Consideration could also be given to enhancing Mexico’s strong fiscal framework by focusing on a structural balance measure.

Revenue mobilization

Over the longer term, age-related (health and pension) spending pressures and declining oil revenues as a share of GDP will pose fiscal challenges requiring a combination of non-oil revenue mobilization efforts, including at the subnational level, and expenditure rationalization.

Reforms should be undertaken in the near future to prepare for these medium-term challenges.

Sound financial system

Mexico’s prudential framework is ahead of new international financial standards, with banks well positioned to implement them, the IMF report said.

The country has also been a leader in the setting up of a Financial Stability Council to monitor systemic risks and help coordinate efforts to address potential financial vulnerabilities.

Promoting growth

Mexico’s strong economic policy framework will continue ensuring macroeconomic stability over the medium term. But to boost Mexico’s growth potential and employment creation, the IMF identified some areas for further reform efforts.

• Boosting competition. Concentration remains high in key sectors of the economy. The recent passage of strengthened antitrust legislation is welcomed. Measures to further improve the productivity of energy companies would also be important to enhance growth.

• Improving education and labor flexibility. Measures to boost the quality of education could significantly increase investment in human capital in Mexico. Also, expediting reforms to enhance labor flexibility would be an important step toward creating a more dynamic labor market.

• Broadening access to credit. Advancing initiatives to facilitate credit availability for small and medium-sized enterprises could help support investment and growth of these firms, increase their productivity, and bolster employment creation.

• Reinforcing domestic security. The authorities’ ongoing efforts to fight organized crime are critical to foster investment and growth.


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