ECONOMIC HEALTH CHECK
Mexico’s Economy Shows Steady Growth Fueled by Key Reforms
November 17, 2014
- Growth forecast at 2.4 percent for 2014, 3.5 percent for 2015
- Ambitious structural reforms in key sectors will provide additional boost to economy
- Strong linkages to U.S. economy could pose a risk to continued growth trajectory
Major reforms in the energy, telecommunications, education, and financial sectors have been designed to unlock potential growth in Mexico.
Robert Rennhack, the senior reviewer for the Mexico team, told IMF Survey that these reforms “are really quite profound and can transform the economy.” In an interview, he explains the results of the recent checkup of the Mexican economy.
IMF Survey: Economic activity in Mexico has picked up, and GDP is projected to grow by 2½ percent in 2014. Broadly, what are some of the factors contributing to this pick-up in activity?
Rennhack: The Mexican economy is recovering. It had grown by just 1.1 percent last year, and now it's likely to recover further, with growth forecast at around 2½ percent this year. We’re expecting that to happen because the United States is growing much more rapidly than we had thought and Mexico has very close ties to the U.S. economy. In fact, a lot of Mexico’s manufacturing exports go to the United States, so better growth in the United States translates into better growth for Mexico. The second reason is that the construction sector in Mexico is beginning to recover. It had collapsed in the last year for a variety of reasons, and now we're seeing signs of a recovery. Also, monetary and fiscal policy in Mexico are supporting growth.
IMF Survey: What are some of the risks to growth going into 2015, and how is Mexico prepared to manage them?
Rennhack: We expect growth in Mexico to pick up to 3½ percent next year, in large part on the back of a sustained U.S. recovery, the continued pick-up in construction, and the stance of demand policies. There is also excess capacity in the economy right now, and we expect some rebound as more of the capacity is utilized.
In addition, you'll get some bounce to growth because of the effect of structural reforms. Mexico has adopted about ten structural reforms, and many of these reforms should begin to contribute to higher investment, probably starting in the second half of the year.
One risk is that the implementation of the reforms is somehow delayed. The secondary legislation has been approved by Congress, and now the reforms are in the phase of issuing the necessary regulations. It will be key to sustain this momentum.
Another potential risk is security, which has been a drag on growth. The government has adopted several measures aimed at improving the situation, which is quite complex, and will maintain its efforts to address this issue.
IMF Survey: What are some of the structural reforms, and how are they affecting growth?
Rennhack: They've adopted many different structural reforms that are really quite profound and can transform the economy. Most importantly, they've completely changed the energy sector. For 75 years this was run by a state-owned monopoly. There was virtually no private sector participation in the energy sector. Now they've opened the door for private participation in virtually all dimensions of the energy sector.
So the private sector can invest in oil exploration, development, and production. Private firms will be able to refine oil and sell it at the retail level, generate their own electricity, and invest in natural gas. So this is a complete transformation, and given Mexico's vast energy reserves this should lead to much more investment in the sector and ultimately raise production.
The telecommunication sector is being completely reformed. Previously this had been dominated by several large firms that accounted for 80 percent or so of the market. Now the government has implemented regulation that creates an incentive for the dominant firms in the sector to shrink, and also opens the door for competition in the sector. This could bring down the cost of internet services, and a whole array of communication services. By lowering the cost of information this reform could promote growth.
A comprehensive financial sector reform has been adopted that changes many different laws. All of these changes point in the direction of improving the access of small businesses to the financial system, and trying to raise credit as a share of GDP. There was also anti-trust reform for markets outside of telecommunications. Many of Mexico's markets have been dominated by lack of competition. So through greater anti-trust enforcement the government can promote competition that can lower costs and expand investment and growth.
Labor market reform is another area where Mexico has moved forward, creating a number of incentives to move workers into the formal labor sector, which has higher productivity. The country also embarked on a comprehensive education reform that creates much more performance-based assessment of teachers and also introduces a number of other steps to improve the quality of education.
I think those are the key reforms. All of these have the potential to boost growth by making the economy more efficient and by stepping up energy production. We estimate a boost to growth on the order of a half a percentage point to a point per year over the medium term. The fact that Mexico introduced a lot of reforms together allows for them to benefit from the synergies of the reforms. So overall this is very positive for the Mexican economy.
IMF Survey: You mentioned labor force reforms. How will these reforms impact female labor force participation?
Rennhack: The labor market reform introduces more flexibility into labor contracting and work arrangements, which should facilitate greater participation by women in the formal labor force. In addition, the government is taking several steps to promote financial inclusion. When the Managing Director visited Mexico in June we held a very interesting session with heads of micro-financial institutions, small credit unions, and women entrepreneurs who had started businesses from the ground up.
They told their stories of how they were able to use these small micro-finance institutions and credit unions to get their businesses going. Many of them have turned their businesses into fairly large enterprises today. There was a very moving story about how access to credit is key for people to unlock their potential, and women, in particular, have been able to benefit from this.
IMF Survey: Since the global financial crisis many countries have introduced reforms to the financial sector. What has Mexico done in this area, and what impact has this had on investor confidence?
Rennhack: Among the reforms to the financial sector is the adoption of BASEL III capital requirements that strengthen the financial system. The authorities are implementing the liquidity requirements that are required by BASEL. They have strengthened their bank resolution framework, and they have also introduced better information requirements for non-bank financial intermediaries.
Also, the authorities are trying to strengthen the credit bureaus, so that the information on credit—on borrowers from the banking system—is better. And they are trying to promote competition in the banking system.
So all these things are designed to strengthen the banking system and promote the access to credit through non-banks. These will have the effect of improving investor confidence over time.
IMF Survey: Mexico has had a Flexible Credit Line since 2009. What role has it played in Mexico's economic performance?
Rennhack: Mexico has been able to access the Flexible Credit Line (FCL) because it has an extremely strong policy framework, and has been adopting structural reforms for the past few years. These are the factors that really drive its economic performance.
The FCL can play a very useful role as a form of insurance, as it provides an additional buffer for the international reserves to help guard against the effects of tail risks in the global economy. It also signals to the rest of the world that Mexico has top-notch economic policies.