## MEXICO — Article IV Consultation (October 23, 2017) ## Source details **Canonical URL:** [MEXICO — Article IV Consultation (October 23, 2017)](https://www.imf.org/-/media/files/publications/cr/2017/cr17346-mexicoartiv.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17346-mexicoartiv.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17346-mexicoartiv.pdf.json) --- ### Overview and near-term macroeconomic assessment - Real GDP growth projected to slow to 2.1 and 1.9 percent in 2017 and 2018, respectively; with growth gradually converging to 2.7 percent over the medium term if NAFTA-related uncertainty is resolved. - Inflation projected to decline rapidly next year and to approach the central bank’s target of 3 percent as the one-off impact of the sharp increase in domestic fuel prices in January 2017 dissipates. - Main external risks: prolonged and heightened uncertainty regarding NAFTA negotiations, weaker-than-projected U.S. growth, and renewed volatility in global financial markets. - Main domestic risk: uncertainty about the political landscape following Mexico’s July 2018 general elections, which could adversely affect the investment climate. ### Recent developments (selected findings) - Growth and labor market - Real GDP growth reached 2.5 percent y-o-y in 2017:H1. - Unemployment declined to 3.3 percent in September 2017. - Private consumption and manufacturing exports drove activity; private investment remained sluggish and public investment contracted. - Inflation and monetary policy - Headline inflation stood at 6.4 percent y-o-y in September 2017; core inflation reached 4.8 percent in September 2017, compared with 3.4 percent at end-2016. - The central bank tightened policy with a cumulative 400-basis point increase in the policy interest rate to 7 percent (from December 2015 tightening cycle). - Median inflation expectation at a one-to-four-year horizon is stable at 3.5 percent. - External sector and capital flows - Current account deficit shrank from 2.2 percent of GDP in 2016 to 1.6 percent in 2017:H1. - Net FDI flows contracted to 2.2 percent of GDP in 2017:H1. - Peso strengthened from January 2017 until mid-September, then weakened somewhat amid renewed NAFTA uncertainty. - Financial sector - As of July 2017, Tier-1 capital ratio stood at 14.3 percent; return on equity at 19.7 percent; NPL ratio at 2.1 percent (record low). - Banking sector remains well capitalized, liquid, and profitable; credit growth moderated amid high borrowing costs and cautious underwriting. ### Outlook, risks, and scenarios - Baseline projections - Output growth: 2.1 percent in 2017; 1.9 percent in 2018; 2.7 percent medium-term convergence assuming resolved NAFTA uncertainty. - Inflation: expected to converge toward the 3-percent target by end-2018 as fuel price effects and earlier depreciation dissipate and monetary tightening continues. - Risks - Prolonged NAFTA negotiation uncertainty could weigh on private consumption and investment, especially export-oriented manufacturing. - Political uncertainty ahead of July 2018 general elections could adversely affect investment climate. - Tighter monetary conditions and policy uncertainty could slow credit growth and increase credit risk, particularly for SMEs and consumer lending. - Financial sector projections - Credit growth projected to slow but remain healthy at above 10 percent, supported by well-capitalized major commercial banks. - Credit quality vulnerable to NAFTA-related exposure and high interest rates impacting repayment capacity. ### Macroeconomic policies and policy recommendations - Fiscal policy - Government expected to meet its fiscal target in 2017 for the third consecutive year; public debt-to-GDP ratio projected to stabilize over the medium term. - Recommendations: - Close the tax compliance gap. - Further strengthen the fiscal framework. - Improve the efficiency of public spending to enhance long-term credibility and counter-cyclicality and to build stronger fiscal buffers. - 2017 public sector borrowing requirements (PSBR) projected to fall to 1.4 percent of GDP; government will save the entirety of a 1.5-percent-of-GDP one-off transfer from the central bank. - Expenditures projected to contract by 2 percentage points of GDP while revenues would shrink by 0.6 percentage points. - Structural primary balance projected to show a surplus for the first time since 2010; public debt-to-GDP ratio projected to decline to 53.8 percent from 58.4 percent in 2016. - Monetary and exchange rate policy - Authorities should stand ready to ease monetary policy to support activity as soon as inflation is firmly on a downward path and as long as inflation expectations remain in check. - Continued clear communication would further enhance policy credibility and guide market expectations. - Structural and macro-financial policies - Re-invigorate structural reform agenda emphasizing: - Strengthening the rule of law. - Fighting corruption. - Reducing informality. - Financial sector: ensure stability while fostering competition and financial deepening; monitor risky lending practices associated with SME and consumer lending. ### External position and reserves - Current account deficit projected to narrow to 1.8 percent of GDP this year and to hover just above 2 percent by 2022. - At these levels, the current account is broadly in line with medium-term fundamentals and desirable policy settings. - The peso was 10 percent stronger in real effective terms relative to its 2016 average at end-August 2017. - Staff assessment: the peso is currently broadly in line with levels suggested by fundamentals. - Net international investment position would continue to strengthen in 2017 and remain negative at just below 40 percent of GDP over the medium term. - Foreign exchange reserves are adequate according to a range of indicators and established minimum benchmarks. - The FCL arrangement continues to provide an effective complement in reducing risks. - External financing needs would be lower in 2017–18, mainly due to lower public sector amortization. - Given the strong presence of foreign investors and exposure to capital flow reversals and increased risk premia, reserves levels above minimum benchmarks are warranted. ### Fiscal framework, public debt, and revenue mobilization - Fiscal anchors and targets - Agreement that fiscal policy should aim to keep public debt-to-GDP on a downward trajectory. - Authorities’ draft 2018 budget aims at a PSBR of 2.5 percent of GDP, resulting in public debt reduction to 53.3 percent of GDP. - Staff estimate: keeping PSBR at 2.5 percent over the medium term would stabilize debt around that level. - Staff recommendation: a primary surplus slightly above the debt-stabilizing level of 0.9 percent of GDP over the medium term to put public debt on a downward path and ensure with a high probability it remains below 50 percent over the long term. - Revenue mobilization and tax policy - Strengthen non-oil tax collection; VAT performance especially weak with a large compliance gap. - Staff recommendations: - Narrow scope for VAT exemptions and intensify efforts to reduce tax evasion and broaden the tax base. - Increase revenues from property taxes to bolster local governments’ resources over the medium term. - Stand ready to adjust corporate income tax policy to mitigate potential risks to revenues from contemplated reform of the U.S. corporate income tax. - Public expenditure efficiency and composition - Public investment projected to fall to 2.6 percent of GDP in 2018, with PEMEX accounting for 1.6 percent of GDP. - Recommendations on wage bill, payroll, education, health, and social assistance to improve efficiency and create space for infrastructure spending. ### PEMEX and long-term fiscal pressures - PEMEX - PEMEX’s financial situation stabilized since record losses of 2015. - In 2016:Q4, PEMEX posted its first quarterly profits since 2010, met its annual production target, and is on track to meet this year’s target. - Continued implementation of PEMEX’s multi-year business plan necessary: efficiency improvements, divest non-core assets and subsidiaries, and enter joint ventures with private sector. - Demographics and pensions/healthcare - Median age reached 28 years in 2015 and is expected to rise to 42 years by 2050. - Mexican population expected to start declining in 2065. - Federal pension deficit projected to increase from 1.5 percent in 2015 to 2 percent in 2030. - Staff estimates: raising retirement age to 67 years and contribution rates to 17 percent would boost replacement rates to around 50 percent. - Public healthcare spending projected to rise from 3.3 percent of GDP in 2015 to 8.7 percent by 2065. ### Monetary and exchange rate policies - Recent stance and assessment - The Bank of Mexico (Banxico) has kept its policy rate at 7.0 percent since July. - Staff estimates the current monetary stance is tight given that the ex-ante real policy rate exceeds 3 percent, close to the upper bound of Banxico’s estimated fluctuation range for the neutral rate. - In 2016, staff estimated the real neutral rate at 1-1.5 percent. - With inflation projected to decline rapidly in early-2018, fiscal policy set to remain contractionary, and a negative, albeit small, output gap, staff recommended a reduction in the policy rate as soon as inflation is firmly on a downward path and inflation expectations remain well anchored. - Communication and intervention - Continued clear communication by Banxico would further enhance the effectiveness of monetary policy. - Agreement that exchange rate flexibility should remain the key shock absorber. - FX interventions in the spot market or through NDFs settled in local currency are better suited to respond to disorderly market conditions associated with excessive volatility. - In March, the Foreign Exchange Commission introduced a framework for auctions of up to US$20 billion of non-deliverable forwards (NDF), to be settled in pesos, but only US$1 billion have been auctioned so far. ### Financial sector, credit, and corporate sector findings - Credit and banking indicators - The credit cycle is decelerating after solid credit growth in 2015-16; real bank credit started decelerating since end-2016. - Household leverage: household credit-to-GDP ratio at 16 percent compared to 37 percent average for other emerging economies (BIS data). - NPLs and provisioning: - NPL ratio for residential mortgages remained steady at 2.4 percent. - Loan-to-value ratio for mortgages around 70 percent. - NPL ratio for corporate loans fell to 1.6 percent in August. - High loan loss provision at 155 percent. - Banking sector buffers: ample net-interest margin and robust fee income would help absorb significantly higher credit losses from severe shocks. - Nonfinancial corporates - Corporate leverage is declining; profitability improved; cash levels sufficient to meet short-term debts. - Maturity structure of borrowing has largely been termed out as bond issuance has moderated. ### Structural reforms, governance, and anticorruption - Structural reform priorities - Perseverance in structural reform implementation necessary to boost potential output and inclusiveness. - Priority areas: governance, security, the rule of law, and informality. - National Anti-Corruption System (NACS) - National System of Anticorruption became operational in July 2017; appointment of a special prosecutor still pending. - Incidence of corruption (INEGI, 2015): prevalence of corruption in administrative procedures: 12.6 (Mexico all states); prevalence in relations with state governments: 17.3; municipal governments: 12.6. - IMF staff: Implementation of the NACS critical to end the corruption trap, improve economic efficiency, and increase productivity. ### Risk Assessment Matrix (selected risks and policy responses) - Significant further strengthening of the US dollar and/or higher rates - Relative Likelihood: H - Impact: H - Policy Response: Exchange rate flexibility and provision of liquidity to mitigate disorderly market conditions. - Policy uncertainty and divergence - Relative Likelihood: H - Impact: H - Policy Response: Exchange rate flexibility; temporary FX interventions and liquidity provision. - Retreat from cross-border integration (protectionism) - Relative Likelihood: H - Impact: H - Policy Response: Exchange rate flexibility; temporary FX interventions; structural reforms to boost competitiveness. - Termination of NAFTA - Relative Likelihood: H - Impact: H - Policy Response: Exchange rate flexibility; temporary FX interventions; diversification of trading relationships. - Further declines in oil production at PEMEX - Relative Likelihood: L - Impact: M - Policy Response: Implement joint ventures to benefit from technology transfer. - Slower-than-anticipated fiscal consolidation in electoral cycle - Relative Likelihood: M/L - Impact: M - Policy Response: Maintain consolidation effort; use positive revenue surprises to reduce the deficit faster. ### Debt Sustainability Analysis — key findings and numbers - Public debt trajectory and financing needs - Public gross nominal debt: 2015: 42.9; 2016: 53.7; 2017: 58.4; 2018: 53.8; 2019–2022: 53.3, 53.3, 53.3, 53.2, 53.2 (percent of GDP). - Gross financing needs (percent of GDP): 2016: 12.7; 2017: 14.0; 2018: 8.8; 2019: 9.1; 2020–2022: 10.3, 10.0, 10.5, 10.3. - Under baseline, public debt expected to stabilize: after peaking at 58.4 percent of GDP at end-2016, projected to decline to 53.3 percent by 2018 and remain around this level in the medium term. - Probabilities and stress tests - Fan charts: more than a 75 percent probability that debt will be below 60 percent of GDP over the medium term under symmetric risk distribution. - Under asymmetric scenario, at least a 70 percent chance debt path will remain below 60 percent of GDP. - Combined shock would raise debt to 66.9 percent of GDP; gross financing needs would reach 14 percent of GDP in 2022. - Permanent real exchange rate depreciation of 25 percent increases debt by around 3 percentage points of GDP and increases gross financing needs by 0.5 percentage point of GDP in the first year (using a pass-through elasticity of 7 percent). - Net public debt - Staff estimates net public debt (gross debt minus public assets) would decline from 50.1 percent in 2016 to around 45 percent in the medium term. - External debt and risks - External debt increased to 39.4 percent of GDP in 2016; under baseline expected to remain stable just below 40 percent of GDP in the medium term. - External debt composition: 26.6 percent of GDP owed by the public sector; 17.8 percentage points by the federal government. - A 30 percent depreciation could increase external debt up to 55 percent of GDP. ### Selected key numeric indicators and projections (exact figures from source) - Real GDP growth: 2.5 percent y-o-y in 2017:H1; staff projection 2.1 percent (2017), 1.9 percent (2018), converging to 2.7 percent (medium term). - Inflation: headline 6.4 percent y-o-y in September 2017; core 4.8 percent in September 2017; central bank target 3 percent. - Policy interest rate: 7 percent after cumulative 400-basis point increase. - Median inflation expectation (1–4 year horizon): 3.5 percent. - Current account deficit: 2.2 percent of GDP in 2016; 1.6 percent in 2017:H1. - Net FDI flows: 2.2 percent of GDP in 2017:H1. - Public sector borrowing requirements (PSBR) projected: 1.4 percent of GDP in 2017. - One-off central bank transfer: 1.5 percent of GDP (entirety to be saved in 2017). - Public debt-to-GDP ratio: 58.4 percent in 2016; projected 53.8 percent (2017). - Banking sector (July 2017): Tier-1 capital ratio 14.3 percent; return on equity 19.7 percent; NPL ratio 2.1 percent. - Projected credit growth: remain healthy at above 10 percent. - Crude oil export price, Mexican mix (US$/bbl): 2017: 43.64; 2018: 44.04; 2019: 44.34; 2020: 44.84; 2021: 45.54; 2022: 45.5. - Consumer prices, end of period (selected): 2017: 6.1; projected 2018–2022: 3.0 (2018), 3.0 (2019–2022 as per some tables). - Months of reserves to imports: 2017 (Proj.): 4.7 months. ### Data, statistics, and technical cooperation - STA assessed development of quarterly sectoral accounts; INEGI and Banxico agreed to collaborate on quarterly stocks and flows by institutional sectors. - In 2017, Banco de Mexico migrated to BPM6 for balance of payments and international investment statistics. - Mexico observes the SDDS; a data ROSC update was completed on June 24, 2015 and published as IMF Country Report No. 15/176. - Selected data periodicity (as of Oct. 10, 2017): Exchange Rates latest observation Sep. 2017; International Reserve Assets latest observation Sep. 2017; Consumer Price Index latest observation Aug. 2017; GDP/GNP latest observation Q1 2017. *International Monetary Fund. MEXICO — Article IV Consultation, October 23, 2017.* ### 1.9 percent in 2018, and to gradually rise towards 2.7 percent over the medium term. Inflation is ### MEXICO — Article IV Consultation (October 23, 2017) ### Overview and near-term macroeconomic assessment - Real GDP growth projected to slow to 2.1 and 1.9 percent in 2017 and 2018, respectively; with growth gradually converging to 2.7 percent over the medium term if NAFTA-related uncertainty is resolved. - Inflation projected to decline rapidly next year and to approach the central bank’s target of 3 percent as the one-off impact of the sharp increase in domestic fuel prices in January 2017 dissipates. - Main external risks: prolonged and heightened uncertainty regarding NAFTA negotiations, weaker-than-projected U.S. growth, and renewed volatility in global financial markets. - Main domestic risk: uncertainty about the political landscape following Mexico’s July 2018 general elections, which could adversely affect the investment climate. ### Recent developments (selected findings) - Growth and labor market - Real GDP growth reached 2.5 percent y-o-y in 2017:H1. - Unemployment declined to 3.3 percent in September 2017. - Private consumption and manufacturing exports drove activity; private investment remained sluggish and public investment contracted. - Inflation and monetary policy - Headline inflation stood at 6.4 percent y-o-y in September 2017; core inflation reached 4.8 percent in September 2017, compared with 3.4 percent at end-2016. - The central bank tightened policy with a cumulative 400-basis point increase in the policy interest rate to 7 percent (from December 2015 tightening cycle). - Median inflation expectation at a one-to-four-year horizon is stable at 3.5 percent. - External sector and capital flows - Current account deficit shrank from 2.2 percent of GDP in 2016 to 1.6 percent in 2017:H1. - Net FDI flows contracted to 2.2 percent of GDP in 2017:H1. - Peso strengthened from January 2017 until mid-September, then weakened somewhat amid renewed NAFTA uncertainty. - Financial sector - As of July 2017, Tier-1 capital ratio stood at 14.3 percent; return on equity at 19.7 percent; NPL ratio at 2.1 percent (record low). - Banking sector remains well capitalized, liquid, and profitable; credit growth moderated amid high borrowing costs and cautious underwriting. ### Outlook, risks, and scenarios - Baseline projections - Output growth: 2.1 percent in 2017; 1.9 percent in 2018; 2.7 percent medium-term convergence assuming resolved NAFTA uncertainty. - Inflation: expected to converge toward the 3-percent target by end-2018 as fuel price effects and earlier depreciation dissipate and monetary tightening continues. - Risks - Prolonged NAFTA negotiation uncertainty could weigh on private consumption and investment, especially export-oriented manufacturing. - Political uncertainty ahead of July 2018 general elections could adversely affect investment climate. - Tighter monetary conditions and policy uncertainty could slow credit growth and increase credit risk, particularly for SMEs and consumer lending. - Financial sector projections - Credit growth projected to slow but remain healthy at above 10 percent, supported by well-capitalized major commercial banks. - Credit quality vulnerable to NAFTA-related exposure and high interest rates impacting repayment capacity. ### Macroeconomic policies and policy recommendations - Fiscal policy - Government expected to meet its fiscal target in 2017 for the third consecutive year; public debt-to-GDP ratio projected to stabilize over the medium term. - Recommendations: - Close the tax compliance gap. - Further strengthen the fiscal framework. - Improve the efficiency of public spending to enhance long-term credibility and counter-cyclicality and to build stronger fiscal buffers. - 2017 public sector borrowing requirements (PSBR) projected to fall to 1.4 percent of GDP; government will save the entirety of a 1.5-percent-of-GDP one-off transfer from the central bank. - Expenditures projected to contract by 2 percentage points of GDP while revenues would shrink by 0.6 percentage points. - Structural primary balance projected to show a surplus for the first time since 2010; public debt-to-GDP ratio projected to decline to 53.8 percent from 58.4 percent in 2016. - Monetary and exchange rate policy - Authorities should stand ready to ease monetary policy to support activity as soon as inflation is firmly on a downward path and as long as inflation expectations remain in check. - Continued clear communication would further enhance policy credibility and guide market expectations. - Structural and macro-financial policies - Re-invigorate structural reform agenda emphasizing: - Strengthening the rule of law. - Fighting corruption. - Reducing informality. - These reforms would help boost potential output and foster inclusiveness. - Financial sector: ensure stability while fostering competition and financial deepening; monitor risky lending practices associated with SME and consumer lending. ### Implementation of reforms and prior advice - Authorities adhered to fiscal consolidation path until 2018 and committed to save the entirety of the one-off central bank transfer in 2017 (consistent with 2016 Article IV recommendation). - Continued liberalization of fuel prices started in January 2017; progress on energy sector reform with licensing rounds and farm-out contracts. - National System of Anticorruption became operational in July 2017; appointment of a special prosecutor still pending. - Government announced creation of three new special economic zones in September 2017 to stimulate investment in less-developed regions. ### Key numeric indicators and projections (selected exact figures from source) - Real GDP growth: 2.5 percent y-o-y in 2017:H1; staff projection 2.1 percent (2017), 1.9 percent (2018), converging to 2.7 percent (medium term). - Inflation: headline 6.4 percent y-o-y in September 2017; core 4.8 percent in September 2017; central bank target 3 percent. - Policy interest rate: 7 percent after cumulative 400-basis point increase. - Median inflation expectation (1–4 year horizon): 3.5 percent. - Current account deficit: 2.2 percent of GDP in 2016; 1.6 percent in 2017:H1. - Net FDI flows: 2.2 percent of GDP in 2017:H1. - Public sector borrowing requirements (PSBR) projected: 1.4 percent of GDP in 2017. - One-off central bank transfer: 1.5 percent of GDP (entirety to be saved in 2017). - Public debt-to-GDP ratio: 58.4 percent in 2016; projected 53.8 percent (2017). - Banking sector (July 2017): Tier-1 capital ratio 14.3 percent; return on equity 19.7 percent; NPL ratio 2.1 percent. - Projected credit growth: remain healthy at above 10 percent. *International Monetary Fund. MEXICO — Article IV Consultation, October 23, 2017.* ### 13. Mexico’s external position remains broadly consistent with medium-term ### 13. Mexico’s external position remains broadly consistent with medium-term fundamentals and desirable policy settings ### External position and reserves - Current account deficit projected to narrow to 1.8 percent of GDP this year and to hover just above 2 percent by 2022. - At these levels, the current account is broadly in line with medium-term fundamentals and desirable policy settings. - The peso was 10 percent stronger in real effective terms relative to its 2016 average at end-August 2017. - Staff assessment: the peso is currently broadly in line with levels suggested by fundamentals. - Net international investment position would continue to strengthen in 2017 and remain negative at just below 40 percent of GDP over the medium term. - Foreign exchange reserves are adequate according to a range of indicators and established minimum benchmarks. - The FCL arrangement continues to provide an effective complement in reducing risks. - External financing needs would be lower in 2017–18, mainly due to lower public sector amortization. - Given the strong presence of foreign investors and exposure to capital flow reversals and increased risk premia, reserves levels above minimum benchmarks are warranted. ### Risk assessment and trade exposure - Both the authorities and staff saw the balance of risks tilted to the downside. - Key downside risks identified: - Prolonged uncertainty regarding the pace and outcome of the NAFTA negotiations could weigh on growth, consumer sentiment, capital flows, and bilateral trade. - Renewed volatility in global financial markets, increased risk premia, and a sharp pull-back of capital from emerging markets; Mexico is particularly exposed due to a high share of non-resident holdings of government paper. - Emerging geopolitical risks that could disrupt growth and risk sentiment towards emerging markets. - Domestic risks: perceived weak governance and rule of law, and political uncertainty as elections approach, potentially adversely affecting confidence and investment. - Agreed upside factors: a modernization of NAFTA and perseverance with structural reforms would provide upside risks to investment and growth. ### Recent credit developments (Box 1) - The credit cycle is decelerating after solid credit growth in 2015-16. - Real bank credit started decelerating since end-2016, notably payroll and corporate loans; the bank credit gap has turned negative. - Slowdown drivers: weakening credit demand due to higher interest rates and tightening of lending standards by banks. - Consumer credit growth in past few years partly driven by financial inclusion and competition—credit deepening. - Household leverage remains low: household credit-to-GDP ratio at 16 percent compared to 37 percent average for other emerging economies (BIS data). - NPL ratios and indicators: - NPL ratio for residential mortgages remained steady at 2.4 percent. - Loan-to-value ratio for mortgages around 70 percent. - NPL ratio for corporate loans fell to 1.6 percent in August. - High loan loss provision at 155 percent. - Corporate credit indicators improved in 2017: debt-to-equity and EBIT-interest coverage ratios improved. - Banking sector buffers: ample net-interest margin and robust fee income would help absorb significantly higher credit losses from severe shocks. ### Mexico’s trade linkages with the United States (Box 2) - Analysis uses gross trade statistics and trade in value added (VA) data from OECD’s TiVA database (1995–2011). - U.S. is Mexico’s top export market: 70 percent of exports in 2011; Canada 8 percent in 2011. - On the import side, the U.S. remains the top source though its share has been shrinking since early 2000s. - Exports concentrated in a small number of core industries: machinery, electrical and optical equipment, transport equipment, mining, and trade and tourism-related activities remain major value-added exporters. - In 2011, four sectors accounted for 60 percent of the value added exported to the U.S. - In value-added terms, Mexico’s exposure to NAFTA has been stable: in 2011 roughly 14 percent of Mexico’s GDP ended up being consumed by the U.S. (and around 1 percent in Canada), the same figure as in 1995. - Three sectors (Machinery, Electrical Equipment and Transport Equipment) had roughly half of each sector’s total value added exported and consumed in the U.S. in 2011; mining and trade and tourism industries are much less reliant on U.S. final consumption. ### Fiscal policy: anchors, targets, and recommendations (Section A) - Agreement that fiscal policy should aim to keep public debt-to-GDP on a downward trajectory. - Public debt and gross financing needs: overall robust to standard shocks; medium- and long-term adjustment needs manageable. - Continued reduction in public debt would create room to address medium-term needs for social and infrastructure spending. - Given current conditions, Mexico has some fiscal space but it should not be used to stimulate the economy. - Authorities’ draft 2018 budget aims at a PSBR of 2.5 percent of GDP, resulting in public debt reduction to 53.3 percent of GDP. - Staff estimates: keeping PSBR at 2.5 percent over the medium term would stabilize debt around that level. - Staff recommendation: a slightly more ambitious medium-term fiscal target beyond 2018 would help ensure market confidence, rebuild fiscal buffers, and expand fiscal space. - Specifically, a primary surplus slightly above the debt-stabilizing level of 0.9 percent of GDP over the medium term would put public debt on a downward path and ensure with a high probability it remains below 50 percent over the long term. - Authorities view: current PSBR target attains government objective of a downward public debt path while creating space for infrastructure needs. ### Revenue mobilization and tax policy - Strengthening non-oil tax collection beyond current achievements would help prevent reversal of consolidation gains and bolster fiscal space. - 2013 tax reform revenue gains partially compensated sharp decline in oil revenues, but tax revenue-to-GDP ratio is among the lowest in the OECD. - VAT performance noted as especially weak, in part due to a large compliance gap amounting to a significant share of VAT revenue currently collected. - Staff recommendations: - Narrow scope for VAT exemptions and intensify efforts to reduce tax evasion and broaden the tax base. - Increase revenues from property taxes to bolster local governments’ resources over the medium term. - Stand ready to adjust corporate income tax policy to mitigate potential risks to revenues from contemplated reform of the U.S. corporate income tax. ### Rethinking Mexico’s fiscal objective (Box 3) - Stochastic simulations used to estimate PSBR ceilings that keep public-debt-to-GDP below certain thresholds, embedding growth and fiscal revenue shocks and restricting exceptional circumstances clauses. - Scenarios: PSBR ceilings of 2.5, 2.0, and 1.5 percent of GDP under two growth scenarios: - Baseline: potential growth at 2.7 percent over the long term (staff medium-term projection). - Pessimistic: potential growth at 2.3 percent (staff estimated potential growth for 2017). - Simulations assume PSBR ceiling can be relaxed up to 2 percentage points of GDP but must be brought below the ceiling within 3 years. - Key simulation results: - A permanent PSBR ceiling of 2.5 percent of GDP would keep public debt below 53.2 percent of GDP with 71 percent probability in the baseline scenario over a 25-year period. - Setting the ceiling at 2.0 percent or 1.5 percent of GDP would increase this probability to 95 and 99 percent respectively. - Under pessimistic potential growth assumptions, a PSBR ceiling of 2.5 percent implies a 52-percent probability of public debt remaining below 53.2 percent over 25 years; a PSBR ceiling of 2.0 percent or lower would keep public debt below 53.2 percent with 88 percent probability or higher. - Staff view: a more ambitious medium-term target would improve debt sustainability probabilities. ### Public expenditure efficiency and composition - Need to improve efficiency and quality of public expenditure to create space for infrastructure spending. - Public investment compressed substantially and projected to fall to 2.6 percent of GDP in 2018, with PEMEX accounting for 1.6 percent of GDP. - In 2013-14 total public investment was 5.3 percent of GDP, with PEMEX investing 2 percent of GDP. - Staff welcomed authorities’ efforts to contain the wage bill, projected to fall by 0.5 percentage point of GDP between 2015 and 2017 due to low wage increases and job cuts. - Recommendations on public wage bill and payroll: - Consider stricter standards and improved transparency in use of temporary personnel. - Consistent application of merit-based recruitment. - Establish a centralized payroll system (aligned with World Bank Public Expenditure Review recommendations). - Education and health spending efficiency improvements suggested: - Rebalance education spending composition towards investment in equipment and facilities. - More careful auditing of payroll to identify ghost workers and curb teacher absenteeism. - Improve teaching quality. - Consolidate procurement of pharmaceuticals and other goods and services in health. - Eliminate beneficiary duplication between insurance schemes. - Promulgate best practices to reduce disparities in service quality across insurance schemes and states. - Social assistance programs: - Significant scope to consolidate and better target programs by eliminating ineffective programs and consolidating overlapping programs. - Progress welcomed in creating a single database to curb duplication of social benefits. ### PEMEX and public finances - PEMEX’s financial situation stabilized since record losses of 2015. - In 2016:Q4, PEMEX posted its first quarterly profits since 2010, met its annual production target, and is on track to meet this year’s target. - Continued implementation of PEMEX’s multi-year business plan necessary: efficiency improvements, divest non-core assets and subsidiaries, and enter joint ventures with private sector to ensure long-term financial soundness. ### Long-term fiscal pressures and pension/healthcare gaps (Box 4) - Demographics: - Median age reached 28 years in 2015 and is expected to rise to 42 years by 2050. - Mexican population expected to start declining in 2065. - Pension system: - Shift from DB to DC system limits direct fiscal cost in principle, but grandfathering of pre-reform participants raises federal pension deficit. - Federal pension deficit projected to increase from 1.5 percent in 2015 to 2 percent in 2030. - Extreme inequities: replacement rates 80-100 percent for those grandfathered under DB, but about 30 percent for those entitled to DC pensions. - Pension adequacy ratios projected to drop dramatically between 2030 and 2065. - Staff estimates: raising retirement age to 67 years and contribution rates to 17 percent would boost replacement rates to around 50 percent, noting the need to manage increases carefully to avoid discouraging formal employment. - To reduce inequities, consider closing the DB for future accumulation of rights, honoring entitlements already earned and leaving affected individuals with a mixture of DB and DC pension to allow gradual decline in pension levels with years worked after the reform. - Healthcare spending: - Public healthcare spending projected to rise from 3.3 percent of GDP in 2015 to 8.7 percent by 2065 due to aging and rising expectations about healthcare quality. *International Monetary Fund — excerpt from chapter content.* ### 21. Enhancements of the fiscal framework would further strengthen the credibility of ### 21. Enhancements of the fiscal framework would further strengthen the credibility of fiscal policy. ### Fiscal framework: findings and concerns - The current framework leaves excessive discretion to the government once “exceptional circumstances” are invoked, in terms of: - when and how much the fiscal stance can deteriorate; and - how it should be brought back to equilibrium. - Desirable reforms identified: - A tighter link between the desired level of public debt and PSBR targets. - Limiting the exceptional circumstances clauses to cases of large output or oil price shocks. - Explicit guidance on the return path after such clause is invoked. - One-off transfers from the Bank of Mexico to the budget should be entirely used to reduce the PSBR and public debt. ### Fiscal institutions: fiscal council and congressional capacity - Recommendation: Establish a non-partisan, adequately-resourced, fiscal council with a formal mandate to provide an independent evaluation of fiscal policy to: - review macroeconomic forecasts; - monitor public finances; - assess compliance with fiscal rules; and - inform the public on the sustainability of public finances, including those of sub-national governments. - Expected benefits: Strengthen the fiscal policy debate and increase accountability. - Authorities’ response: - The government argued it had demonstrated credibility by consistently delivering on fiscal commitments and questioned the need for additional external scrutiny given existing banks, credit rating agencies, and other institutions analyzing Mexico’s public finances. - The authorities considered it more important to strengthen the capacity of the Centre for Public Finance Studies of Congress while ensuring it is non-partisan in its assessments. ### Debt management - Prudent debt management remains important to promote market liquidity and reduce financial vulnerabilities. - Actions noted: - Continued liability management transactions have helped to improve the debt maturity profile and minimize borrowing costs. - The inclusion of new Collective Action Clauses in international sovereign debt issuances has gradually contributed to strengthening debt contracts. ### Monetary and exchange rate policies: supporting the economy while ensuring stability - Monetary policy stance and recent actions: - The Bank of Mexico (Banxico) has kept its policy rate at 7.0 percent since July. - Banxico noted in its latest quarterly report that the balance of risks to inflation had turned neutral. - The 400-basis point tightening was viewed as successful in keeping medium- and long-term inflation expectations well anchored. - Staff assessment and recommendation on policy rate: - Staff estimates the current monetary stance is tight given that the ex-ante real policy rate exceeds 3 percent, close to the upper bound of Banxico’s estimated fluctuation range for the neutral rate. - In 2016, staff estimated the real neutral rate at 1-1.5 percent. - With inflation projected to decline rapidly in early-2018, fiscal policy set to remain contractionary, and a negative, albeit small, output gap, staff recommended a reduction in the policy rate as soon as inflation is firmly on a downward path and inflation expectations remain well anchored. - The authorities highlighted the need for continued tight monetary policy in the presence of significant external risks and considered the current stance adequate to bring inflation back to the 3-percent target by end-2018, while noting recent earthquakes could lift inflation slightly at end-2017. - Communication: - Continued clear communication by Banxico would further enhance the effectiveness of monetary policy. - Banxico’s communication has centered on anchoring inflation expectations but has included lengthy discussions with repeated focus on exchange rate movements and U.S. policies. - Staff encouraged Banxico to continue enhancing communication of future monetary policy decisions, linking them to U.S. monetary policy and the exchange rate only insofar as they affect the central bank’s ability to achieve the inflation target. - Authorities agreed their written communication was long but felt more detailed elaboration about the board’s thinking was warranted; they noted communications and actions had preserved Banxico’s credibility. - Exchange rate flexibility and intervention: - Agreement that exchange rate flexibility should remain the key shock absorber. - FX interventions in the spot market or through non-deliverable forwards (NDFs) settled in local currency are better suited to respond to disorderly market conditions associated with excessive volatility. - Staff and authorities agreed a mix of exchange rate adjustment and intervention, along with the buffer provided by the FCL, could be used to address materialized risks, taking into account the nature of the shock. - Authorities indicated intervention this year was limited to two instances perceived as disorderly market conditions. - Authorities view intervention via NDFs as a good substitute for spot intervention, useful when liquidity in forward markets dries up. - Efforts to diversify trading partners and steadfast implementation of structural reforms to enhance competitiveness would reduce vulnerability to shocks, though benefits would materialize only in the medium- and long-term. - Noted operational detail: - In March, the Foreign Exchange Commission introduced a framework for auctions of up to US$20 billion of non-deliverable forwards (NDF), to be settled in pesos, but only US$1 billion have been auctioned so far. *MEXICO INTERNATIONAL MONETARY FUND 19* ### Box 5. Monetary Policy Communication ### Box 5. Monetary Policy Communication ### Communication channels - The Bank of Mexico communicates its decisions and rationale through three main channels: - a press release the day of its board meeting, - the publication of the minutes of its policy meetings, - quarterly inflation reports. - The box focuses on the minutes of the Bank’s monetary policy meetings. ### Minutes: availability and length - Banxico is one of the few central banks that publish minutes from policy meetings. - Minutes provide a more complete and nuanced explanation of the board's decisions and view of the risks to the outlook. - Minutes’ length is a quantifiable characteristic reflecting the level of detail and effort to increase transparency. - Findings: - Banxico’s minutes have become longer over time. - Minutes are longer after meetings when the policy rate was changed. ### Topics, evolution, and external influences - Topics covered in the minutes have evolved: - Since early 2016, terms related to “inflation”, “policy”, and “interest rates” have become more prevalent. - Terms related to currency and U.S. developments have become important in board discussions. - After the 2016 U.S. elections, mentions of U.S. developments reached levels only seen during the U.S. taper tantrum and broadly stayed at those levels throughout 2017. ### Tone, information content, and predictability - The tone of the discussion in the minutes appears to provide some indication of future policy changes. - Recent staff work (Barbosa and others (forthcoming)) analyzes the effects of the information content of central bank minutes in the region on future policy decisions. - Results summarized: - Information in minutes is useful for predicting future policy in the region. - Surprisingly, minutes are less useful for predicting future policy in the case of Mexico. - Methodological note: - The “tone” index is constructed by applying computational linguistics models to central bank minutes: words in the minutes are scored into “hawkish” (+1) and “dovish” (-1) words and aggregated for each minute. ### Policy implication and recommendation - A stronger communication and transparency framework could better anchor expectations and further increase the effectiveness of monetary policy. *Prepared by Juan Yepez (WHD).* ### Box 6. The National Anti-Corruption System (NACS) (concluded) ### Box 6. The National Anti-Corruption System (NACS) (concluded) ### Incidence of Corruption (INEGI, Encuesta Nacional de Calidad e Impacto Gubernamental, 2015) - Share of the population of a given state considering that corruption in that state is frequent — incidence measures computed as ratios of victims of corruption to total population aged 18 and above in urban areas and having been in touch with the administration. - Prevalence of corruption by region (percent): - Mexico (all states): Prevalence of corruption in administrative procedures: 12.6; Prevalence of corruption in relations with the federal government: 2.7; Prevalence of corruption in relations with state governments: 17.3; Prevalence of corruption in relations with municipal governments: 12.6. - Central states: 13.9; 3.7; 19.3; 11.9. - North-Eastern states: 9.5; 1.9; 13.1; 10.8. - North-Western states: 15.7; 2.3; 21.1; 18.4. - Western states: 11.6; 1.9; 15.6; 12.5. - South-Eastern states: 10.2; 2.5; 14.1; 9.6. - Definitions of administrative relations by level: - Federal government: electricity payment, tax reports and payments, medical treatments (planned or emergencies), payment of housing or social benefits, passport delivery. - State governments: vehicle registration and tax payment, civil registrar, building permits, judicial procedures, relations with the police and public security authorities, business registration, and public... - Municipal governments: drinking water provision, property tax payment, municipal services, building permits, local administrative procedures, relations with the municipal police and public security authorities. ### IMF Staff Appraisal: Macroeconomic Outlook and Risks (paragraphs 42–50) - Growth and inflation projections and drivers: - Growth projected to slow to 2.1 and 1.9 percent in 2017 and 2018, respectively, if heightened and prolonged uncertainty about the future economic relationship with the United States, and tighter monetary conditions weigh on the economy. - With uncertainty resolved and continued implementation of structural reforms, growth would gradually converge to 2.7 percent over the medium term. - Headline and core inflation projected to start declining and converge toward the central bank’s target by end-2018. - The flexible exchange rate and Mexico’s strong fundamentals and policy buffers provide resilience against adverse shocks. - The Flexible Credit Line remains an important complement to reserve buffers, providing insurance against tail risks. - External risks: - Mexico is particularly vulnerable to changes in its trade regime with the United States; substantial impediments to bilateral trade could significantly impact financial markets, investment, and growth. - Risk of renewed global financial market volatility, increased risk premia, and a pull-back of capital from emerging markets remains; exposure heightened by the high share of non-resident holdings of government paper. - Fiscal outlook and public debt: - This year’s expected fiscal outcome would result in a reduction in public debt to about 53 percent of GDP. - Keeping the PSBR at 2½ percent of GDP over the medium term would stabilize debt around that level. - Recommendation to consider a slightly more ambitious medium-term target to put the public debt-to-GDP ratio on a downward trajectory to strengthen ability to respond to adverse shocks and demographic-related spending pressures. - Efficiency and revenue recommendations: - Improve efficiency of public expenditure and tax revenue collection to create space for infrastructure spending. - Priority: improve effectiveness of public administration; enhance education and health efficiency; consolidate and better target social assistance programs. - Strengthen non-oil tax collections with emphasis on reducing the large VAT compliance gap. - Continue improvements in PEMEX’s profitability and efficiency. - Fiscal framework enhancements: - Desirable to have a tighter link between desired public debt level and medium-term PSBR targets. - Limit exceptional circumstance clauses to large output or oil price shocks. - One-off profit transfers from the Bank of Mexico to the budget should be entirely used to reduce the PSBR and public debt. - Establish a non-partisan, adequately-resourced fiscal council to improve accountability and fiscal policy debate. - Monetary policy stance: - Conditional on inflation expectations remaining well-anchored, the Bank of Mexico should ease monetary policy as soon as inflation is firmly on a downward path. - The pause in the monetary tightening cycle is appropriate; the current monetary stance is tight and inflation is projected to decline rapidly in early-2018. - A reduction in the policy rate is appropriate as soon as inflation trends downward and expectations remain anchored, given contractionary fiscal policy and a small negative output gap. - Financial sector resilience: - The banking sector is well capitalized and resilient to market, liquidity, and credit risks thanks to high capital buffers. - Non-financial corporates would be able to weather further large shocks to the exchange rate or interest rates. - Implementation of the new national strategy for financial inclusion would improve access to financial services for low-income households and small enterprises; further efforts needed to increase financial deepening. - Further reforms of the regulatory framework would help enhance financial sector resilience. - Structural reform implementation priorities: - Perseverance needed in implementation of the structural reform agenda. - Priority reforms: governance, security, the rule of law, and informality, as weaknesses in these areas may impede the reforms' full impact. - Implementation of the National Anti-Corruption System is critical to end the corruption trap, improve economic efficiency, and increase productivity by reducing misallocation of resources and rent-seeking behavior. - Enhancing the efficiency and quality of law enforcement and judicial institutions is critical to improve security and strengthen the rule of law. - Better enforcement of anti-discrimination laws can help reduce gender imbalances and raise female labor force participation. *Source: IMF staff appraisal text and INEGI survey data as presented in the supplied content.* ### 51. It is proposed that the next Article IV Consultation with Mexico take place on the ### cr17346-mexicoartiv - 51. It is proposed that the next Article IV Consultation with Mexico take place on the ### Proposed Consultation Cycle - It is proposed that the next Article IV Consultation with Mexico take place on the standard 12-month cycle. ### Real Sector and Labor Market: Findings - Growth supported by strong services and some growth in manufacturing amid falling oil production. - Growth supported by strong job creation, particularly in the formal sector. - Non-oil exports have recovered, in part due to strengthening U.S. external demand. - Private consumption has held up as sentiment recently stabilized. - Gross fixed capital formation has remained weak. - Indicators and selected figures: - Real GDP growth: series depicted for 2010–2017 with supply contributions by sector (Services, Other, Commerce, Construction, Mining, Manufacturing). - Consumer confidence index (Jan. 2003=100 NSA) series for 2010–2017. - Gross Fixed Capital Formation (Y/Y growth, NSA) components: Machinery and equipment; Construction; Total. - Employment: Formal employment, Total employment (3QMA), Unemployment (percent, SA; RHS) with unemployment falling to the lowest level in a decade. - Employment trends: robust creation of full-time jobs; job creation has slowed but remains close to the historical average. ### Prices and Inflation: Findings and Policy Response - Headline inflation increasing largely on account of increases in domestic fuel prices. - Real wage growth has turned negative. - Services price inflation is still close to the target. - Policy rate hikes have helped contain second-round effects from the depreciation, keeping medium-term inflation expectations anchored close to the target. - Core inflation was lifted by falling telecoms price deflation, pass-through from currency depreciation, and modest second-round effects from the fuel price rise. - Indicators and selected figures: - Policy rate and Ex-ante real policy rate (In percent) series for 2010–2017. - Survey-based inflation expectations: 12-months ahead; 5-8 years ahead. - Inflation components (Y/Y percent growth) for Durable goods, Non-durable goods, Services. - Contributions to Headline Inflation and Core Inflation by category (Telecom; Food and beverage; Transportation; Personal and educational expenses; Other; Food merchandise; Non-food merchandise). ### External Sector and Reserves: Findings and Projections - Current account deficit has declined; helped by recovery in automotive exports. - Net portfolio flows recovered in late 2016, particularly due to debt instruments. - Corporate bond issuance has moderated. - Reserves have stabilized amid only one discretionary intervention in early 2017. - Reserve adequacy: Figures presenting Reserves to ARA Metric (Adequacy range: 100-150%), Reserves to Three-Month Imports (>100% adequacy range), Reserves to Short-Term Debt (>100% adequacy range), Reserves to Broad Money (adequacy range: 5-20%). - Selected external-sector numbers (Table 5 and Table 7): - Current account (in percent of GDP): -2.5 (2013), -1.8 (2014), -2.5 (2015), -2.2 (2016), -1.8 (2017), projections to -2.1 (2022). - Exports of goods, f.o.b. (percent of GDP): 2.5 (2013), 4.4 (2014), -4.2 (2015), -1.8 (2016), 8.7 (2017), 2.8 (2018). - Gross international reserves (billions of U.S. dollars): 180.2 (2013), 195.7 (2014), 177.6 (2015), 178.1 (2016), 177.8 (2017). - Months of imports of goods and services: 5.2 (2013), 5.4 (2014), 5.0 (2015), 5.1 (2016), 4.7 (2017, Proj.). ### Fiscal Sector: Findings, Risks, and Policy Implications - The 2013 tax reform and lower oil prices and production have reduced fiscal dependence on oil. - Public sector deficit narrowed together with declining expenditure. - Public debt continued to increase, though projected to fall in 2017 in part due to currency appreciation. - Further declines in oil production remain a relevant fiscal risk. - Stabilizing the PSBR at 2.5 percent of GDP would stabilize the debt-to-GDP ratio. - Fiscal statistics and projections (Tables 1–4): - Overall Public Sector Deficit (In percent of GDP): -3.7 (2013), -4.6 (2014), -4.1 (2015), -2.8 (2016), -1.4 (2017), projected -2.5 (2018–2022). - Gross public sector debt (In percent of GDP): 46.4 (2013), 49.5 (2014), 53.7 (2015), 58.4 (2016), 53.8 (2017). - Public Sector Borrowing Requirements (PSBR): 3.7 (2013), 4.6 (2014), 4.1 (2015), 2.8 (2016), 1.4 (2017), projected 2.5 (2018–2022). - Budgetary revenue (in percent of GDP, Authorities’ presentation): 23.6 (2013), 23.1 (2014), 23.4 (2015), 24.8 (2016), 22.6 (2017), projected 20.7 (2018). - Oil revenue (percent of GDP): 8.3 (2013), 7.1 (2014), 4.6 (2015), 4.0 (2016), 3.9 (2017). ### Financial Sector and Banking System: Findings - Foreign ownership of domestic debt is significant; share of foreign holdings in local-currency sovereign debt fell only modestly amid volatility. - After falling in late 2016/early 2017, the peso appreciated on improved sentiment regarding US-related risks. - ETF and mutual funds' inflows have recovered since the decline in late 2016. - Banking sector remains profitable and well capitalized. - Commercial bank credit growth picked up late but has moderated; development bank consumer credit growth remains strong. - Non-performing loans: - Total Commercial Bank NPLs (In percent of outstanding loans): low levels; NPL trends shown for sectoral components. - Development banks NPLs are low. - Financial soundness indicators (Table 6, Latest available data = Jul y): - Regulatory capital to risk-weighted assets: 15.6. - Regulatory Tier 1 capital to risk-weighted assets: 14.3. - Nonperforming loans to total gross loans: 2.1. - Provisions to Nonperforming loans: 159.3. - Return on assets: 2.0. - Return on equity: 19.7. - Liquid assets to short-term liabilities: 41.8. ### Nonfinancial Corporate Sector: Findings - Corporate leverage is declining. - Profitability has improved; Return on Equity (median) increased across 2007–2016. - Cash levels sufficient to meet short-term debts; Cash and Cash Equivalent to Short Term Debt (percent, median) shown for 2017–. - Maturity structure of borrowing has largely been termed out as bond issuance has moderated. - Interest coverage ratio (Earnings in multiples of Interest Expense, median) series showing robust debt servicing capacity. ### Social Development Indicators: Findings - Extreme poverty has declined over the past 25 years, but poverty remains higher than the LAC6 average. - Poverty headcount ratio at $1.90 (2011 PPP, % of population): comparative series for 1992, 2000, 2010, 2014 across countries; Mexico’s poverty indicators and higher income inequality noted. - Share of youth not in education, employment or training (Total, % of youth population): Mexico higher relative to peer groups. - Intentional homicides and infant mortality rate: homicide rate remains high but close to the regional average; infant mortality higher than regional average. ### Key Projections and Macroeconomic Path (Selected) - Baseline medium-term projections (Table 8): - GDP (real): 1.4 (2013), 2.3 (2014), 2.6 (2015), 2.3 (2016), 2.1 (2017), projected 1.9 (2018), 2.3 (2019), 2.7 (2020–2022). - Consumer prices, end of period: 4.0 (2013), 4.1 (2014), 2.1 (2015), 3.4 (2016), 6.1 (2017), projected 3.0 (2018–2022). - Crude oil export price, Mexican mix (US$/bbl): 98.88 (2013), 87.74 (2014), 44.33 (2015), 35.84 (2016), 43.64 (2017), projected 44.04 (2018), 44.34 (2019), 44.84 (2020), 45.54 (2021), 45.5 (2022). - Current account balance (percent of GDP): -2.5 (2013), -1.8 (2014), -2.5 (2015), -2.2 (2016), -1.8 (2017), projected -2.4 (2018), -2.5 (2019–2020), -2.3 (2021), -2.1 (2022). - Gross public sector debt (percent of GDP): projected path shows stabilization and decline pressures if PSBR maintained at 2.5 percent of GDP. *International Monetary Fund — Mexico: Article IV Consultation material (selected figures, tables, and narrative excerpts).* ### Annex I. Risk Assessment Matrix ### Annex I. Risk Assessment Matrix ### Risks overview - The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). - The relative likelihood is staff’s subjective assessment: “low” indicates a probability below 10 percent, “medium” between 10 and 30 percent, and “high” between 30 and 50 percent. - “Short term” and “medium term” indicate risks that could materialize within 1 year and 3 years, respectively. - Low (L), Medium (M), High (H) are used to score likelihood and impact. ### Detailed risks, likelihood, impact, and policy responses - Significant further strengthening of the US dollar and/or higher rates. - Description: As investors reassess policy fundamentals, as term premia decompress, or if there is a more rapid Fed normalization, leveraged firms, lower-rated sovereigns and those with un-hedged dollar exposures could come under stress. Could also result in capital account pressures for some economies. - Relative Likelihood: H - Impact: H - Policy Response: Exchange rate flexibility and provision of liquidity to mitigate disorderly market conditions. - Policy uncertainty and divergence. - Description: Two-sided risks to U.S. growth with difficult-to-predict policies and global spillovers. In Europe, uncertainty associated with negotiating post-Brexit arrangements and with upcoming major elections. Policy divergence could lead to rising global imbalances and exacerbate exchange rate and capital flow volatility. - Relative Likelihood: H - Impact: H - Policy Response: Exchange rate flexibility would be critical to restore equilibrium. Temporary FX interventions and liquidity provision could help smooth extreme volatility. - Retreat from cross-border integration (protectionism / economic isolationism). - Description: A fraying consensus about the benefits of globalization could lead to protectionism and economic isolationism, reducing global and regional policy collaboration with negative consequences for trade, capital and labor flows, sentiment, and growth. - Relative Likelihood: H - Impact: H - Policy Response: Exchange rate flexibility would be critical to restore equilibrium. Temporary FX interventions and liquidity provision could help smooth extreme volatility. Steadfast implementation of structural reforms to boost growth and raise competitiveness. - Termination of NAFTA. - Description: An immediate return to most-favored nation (MFN) or even higher tariffs would be disruptive for Mexico’s trade with its most important trading partner and could weaken growth, dampen capital inflows and raise risk premia. - Relative Likelihood: H - Impact: H - Policy Response: Exchange rate flexibility would be critical to restore equilibrium. Temporary FX interventions and liquidity provision could help smooth extreme volatility. Steadfast implementation of structural reforms and efforts to diversify trading relationships would increase competitiveness and boost growth over the medium term. - Structurally weak growth in key advanced and emerging economies. - Relative Likelihood: H/M - Impact: H - Policy Response: Steadfast implementation of structural reforms to increase competitiveness. - Lower energy prices. - Description: Would lead to lower fiscal revenues and prospects for energy sector investments. - Relative Likelihood: L - Impact: L - Policy Response: Exchange rate flexibility and fiscal adjustment. - Further declines in oil production at PEMEX. - Relative Likelihood: L - Impact: M - Policy Response: Implement joint ventures to benefit from technology transfer. - Slower-than-anticipated fiscal consolidation in the context of the forthcoming electoral cycle. - Description: Could lead to further steady increase in public debt and an increase in country risk premiums. - Relative Likelihood: M/L - Impact: M - Policy Response: Maintain the consolidation effort. Use positive revenue surprises to reduce the deficit faster. ### Technical notes (as provided) - 1/ The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively. - 2/ Low (L), Medium (M), High (H). *Source: Annex I. Risk Assessment Matrix, cr17346-mexicoartiv* ### Annex III. Debt Sustainability Analysis ### Annex III. Debt Sustainability Analysis ### Summary - Mexico’s public debt is expected to remain sustainable in the medium term with high probability. - Under the baseline scenario, public debt is expected to stabilize over the medium term: after peaking at 58.4 percent of GDP at end-2016, the public debt-to-GDP ratio is projected to decline to 53.3 percent by 2018 and remain around this level in the medium term. - Gross financing needs are projected at 9.1 percent of GDP in 2018 and are expected to remain contained around 10 percent over the medium term. - The long average maturity and favorable currency composition of the debt mitigate short-term financing risks despite high foreign ownership of the debt. ### Public Debt Sustainability — Baseline and Realism of Projections - Debt levels: - Gross debt projected to decline very slightly from 53.8 percent of GDP in 2017 to 53.2 percent of GDP by 2022. - Gross financing needs over the medium-term projected to average around 10 percent of GDP. - Fiscal adjustment: - Structural primary balance (adjusted by the business cycle and oil prices) projected to increase from 0.5 percent of GDP in 2017 to 1.1 percent in 2022. - Revenue side: decline in one-offs would lead to lower revenues in 2018, then stabilize at a similar level over the medium term. - Spending side: projections assume compliance with the consolidation plan in the 2018 budget, which envisages a public sector borrowing requirement (PSBR) of 2.5 percent of GDP in 2018 and over the medium term. - Maximum projected 3-year adjustment of the cyclically-adjusted primary balance of around 1.9 percent of GDP considered feasible compared to DSA template distributions. - Growth assumptions: - Medium-term growth expected to pick up gradually and stabilize at 2.7 percent of GDP in the second half of the projection horizon. - Past projections suggest moderate forecast errors; no evidence of systematic projection bias for growth. - Sovereign yields and interest rate projections: - 10-year local-currency bond yield remained stable around 6.9 percent in September. - EMBIG spread averaged 251 basis points over the last three months. - Effective nominal interest rate on Mexico’s sovereign debt projected to rise from 6.7 percent in 2016 to 7.1 percent by 2022. ### Debt Profile and Risks - Rollover and exchange rate risks: - Long maturity structure reduces rollover risks; federal government peso-denominated debt average maturity about 8 years; FX bonds average maturity 20.7 years. - More than 65 percent of public debt denominated in local currency. - Real interest rate and real exchange rate shocks have moderate impact on debt stock given low direct interest pass-through to the budget and large share of local-currency debt. - Public debt held by non-residents and foreign-currency exposure: - Public debt held by non-residents highlighted as relatively high but mitigated by maturity and currency composition. ### Stochastic Simulations (Fan Charts) and Stress Tests - Fan charts: - Under symmetric distribution of risk, there is more than a 75 percent probability that debt will be below 60 percent of GDP over the medium term. - Under asymmetric scenario (no positive shocks to the primary balance), there is at least a 70 percent chance that the debt path will remain below 60 percent of GDP. - Individual stress shocks: - Debt ratio would remain below 60 percent of GDP under all individual shock scenarios. - A permanent real exchange rate depreciation of 25 percent increases debt by around 3 percentage points of GDP and increases gross financing needs by 0.5 percentage point of GDP in the first year. (This shock uses a pass-through elasticity of 7 percent (staff estimate) rather than the default value of 25 percent.) - Combined shock: - A combined shock (largest effects of individual shocks on real GDP growth, inflation, primary balance, exchange rate and interest rate) would raise debt to 66.9 percent of GDP. - Gross financing needs would reach 14 percent of GDP in 2022. ### Net Public Debt - Authorities focus on Historical Balance of the Public Sector Borrowing Requirements (HBPSBR), analogous to a net debt concept. - Staff estimates net public debt (gross debt minus public assets) would decline from 50.1 percent in 2016 to around 45 percent in the medium term. ### Authorities’ Views - Authorities reiterated goal to stabilize public debt-to-GDP ratio at a relatively low level for an emerging market economy. - They considered current medium term budget prospects consistent with a downward trend for the debt-to-GDP ratio. - Authorities highlighted that non-residents did not reduce their holdings of public debt even amid heightened uncertainty. ### External Debt Sustainability - External debt dynamics: - External debt as share of GDP increased by 6.5 percentage points between 2014 and 2016 (mainly due to price and exchange rate changes of 5.8 percentage points) to 39.4 percent of GDP. - Under baseline projections, external debt expected to remain stable just below 40 percent of GDP in the medium term. - Sectoral composition: - 26.6 percent of GDP of external debt is owed by the public sector; 17.8 percentage points by the federal government. - 9.8 percent of GDP of external debt denominated in Mexican peso. - Risks and resilience: - Depreciation of the exchange rate is the most significant risk to external debt sustainability; a 30 percent depreciation estimated to increase external debt up to 55 percent of GDP. - Rollover risks for federal government debt mitigated by favorable maturity structure and prudent debt management. - Banking sector assessed as well capitalized and liquid and resilient to large shocks. - Non-financial corporate debt levels are low and foreign exchange risks well covered by natural and financial hedges. ### Key Statistics and Projection Highlights (selected exact values from tables) - Public gross nominal debt: - 2015: 42.9 - 2016: 53.7 - 2017: 58.4 - 2018: 53.8 - 2019–2022: 53.3, 53.3, 53.3, 53.2, 53.2 (percent of GDP) - Public gross financing needs (percent of GDP): - 2016: 12.7 - 2017: 14.0 - 2018: 8.8 - 2019: 9.1 - 2020–2022: 10.3, 10.0, 10.5, 10.3 - Real GDP growth (in percent): - 2015: 2.4 - 2016: 2.6 - 2017: 2.3 - 2018: 2.1 - 2019: 1.9 - 2020–2022: 2.3, 2.7, 2.7, 2.7 - Inflation (GDP deflator, in percent): - 2015: 4.5 - 2016: 3.1 - 2017: 4.6 - 2018: 7.1 - 2019: 5.4 - 2020–2022: 3.7, 3.3, 3.6, 3.5 - Effective interest rate (in percent): - 2015: 7.0 - 2016: 6.4 - 2017: 6.7 - 2018: 6.1 - 2019: 6.3 - 2020–2022: 6.4, 6.6, 6.9, 7.1 - Change in gross public sector debt (cumulative 2015–2022): -5.3 (percent of GDP) - Identified debt-creating flows (cumulative 2015–2022): -4.0 (percent of GDP) - Primary deficit (percent of GDP, yearly and cumulative): - 2016: 1.1 - 2017: -0.5 - 2018: -1.9 - 2019–2022: -0.6, -0.7, -0.8, -1.0, -1.1 - Cumulative primary deficit (2015–2022): -6.0 - Automatic debt dynamics contributions (percent of GDP): - 2016: 2.4 - 2017: 3.0 - 2018: -1.7 - 2019–2022: -0.6, 0.2, 0.2, 0.2, 0.4 - Exchange rate depreciation contribution (noted in text): a significant factor in earlier debt increase; specific table cells indicate contribution (e.g., 2016: 3.1 percent shown in some rows as part of automatic dynamics and price/exchange rate changes). - Net public debt (gross minus public assets): staff estimate declines from 50.1 percent in 2016 to around 45 percent in the medium term. - External debt (percent of GDP, selected): - 2012: 29.2 - 2014: 32.9 - 2016: 39.4 - 2017–2022 baseline: 38.3, 37.6, 38.0, 38.3, 38.2, 38.2 - Gross external financing needs (in percent of GDP): - 2012: 7.1 - 2016: 11.8 - 2017: 10.0 (approx. shown as 10-Year values in tables) - Projections 2018–2022 in absolute US$ on table: 90.1, 101.6, 110.6, 121.1, 117.0, 123.7 (billions of US dollars) *Source: IMF staff (Annex III. Debt Sustainability Analysis).* ### 2014. STA conducted a mission during 2014 to assess the possibility for developing quarterly ### cr17346-mexicoartiv - 2014. STA conducted a mission during 2014 to assess the possibility for developing quarterly ### Development of quarterly sectoral accounts and balance sheets - STA mission during 2014 assessed the possibility of developing quarterly sectoral accounts and balance sheets and agreed a work plan with Mexican authorities. - INEGI and Banxico agreed to collaborate in the compilation of quarterly stocks and flows of financial assets and liabilities by institutional sectors. ### Prices - Concepts and definitions for both the CPI and PPI meet international standards. - The PPI is only compiled by product and not by economic activity. - A ROSC mission on prices was conducted in November 2012. ### Government finance statistics - Authorities compile fiscal statistics following national concepts, definitions, and classifications that make international comparison difficult. - Statistics are comprehensive and timely, except for states and municipalities. - New government accounting law mandates accounting standards that follow international standards for all levels of government and consider information needs of international organizations and national accounts. - Full adoption of uniform accounting standards at the sub-national level is crucial to obtain a precise measure of public fixed investment in national accounts. - Authorities started to report government finance statistics in GFSM 2014 format in 2017 and reported a time series that covers GFS from 2008 to 2016 inclusive; these will be published in the next GFS yearbook. ### Monetary and financial statistics; financial sector surveillance - Methodological foundations of monetary statistics are generally sound. - Availability of data on other financial intermediaries such as insurance companies and pension funds allow construction of a financial corporation’s survey with full coverage of the Mexican financial system, published monthly in International Financial Statistics. - Mexico reports Financial Soundness Indicators (FSIs) for Deposit Takers on a monthly basis. ### External sector statistics and BPM6 migration - In 2017, Banco de Mexico migrated balance of payments and international investment statistics to the sixth edition of the Balance of Payments and International Investment Position Manual (BPM6) and adopted a BPM6-consistent structure in national publications. - Measures to improve external debt statistics include compilation of data on external liabilities of the private sector and publicly traded companies registered with the Mexican stock exchange (external debt outstanding, annual amortization schedule for the next four years broken down by maturity, and type of instrument). - STA conducted two technical assistance missions on external sector statistics (ESS) in 2014 and 2015 focused on: foreign direct investment, financial derivatives, bank accounts used in foreign exchange operations, capital account, financial intermediation services indirectly measured, private sector debt, and the migration to BPM6. - Implementation of missions’ recommendations significantly improved ESS quality. - Ongoing efforts: compile manufacturing services on physical inputs owned by others; improve coverage of capital account transactions and nonfinancial private sector transactions and positions. ### Data standards, ROSC, and dissemination - Mexico observes the Special Data Dissemination Standards (SDDS); metadata are posted on the Dissemination Standards Bulletin Board (DSBB). - In a number of cases, periodicity and timeliness of disseminated data exceed SDDS requirements. - A data ROSC update was completed on June 24, 2015 and was published as IMF Country Report No. 15/176. - Consumer prices ROSC completed on 2012; other assessments referenced to a ROSC completed on July, 2014. ### Selected dissemination and periodicity notes (Table of Common Indicators Required for Surveillance, As of Oct. 10, 2017) - Exchange Rates: Date of latest observation Sep. 2017; Date received Oct. 2017; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D. - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Sep. 2017; Oct. 2017; W W W. - Reserve/Base Money: Jul.2017 (Date of latest observation); Sep. 2017 (Date received); D D D. - Broad Money: Jul.2017; Sep.2017; M M M. - Consumer Price Index: Aug.2017; Sep.2017; Bi-W Bi-W Bi-W. - Revenue, Expenditure, Balance and Composition of Financing – General Government: Aug. 2016; Oct. 2016; M M M. - External Current Account Balance: Q2 2017; Sep. 2017; Q Q Q. - GDP/GNP: Q1 2017; Sep. 2017; Q Q Q. - Gross External Debt: Q2 2016; Sep. 2016; Q Q Q. - International Investment Position: Q1 2017; Jul. 2017; Q Q Q. ### Statement by the Staff Representative on Mexico (November 8, 2017) - Foreign Exchange Commission NDF program: - On October 25 the Foreign Exchange Commission announced it would sell non-deliverable forwards (NDFs) settled in local currency for a total of US$4 billion in seven weekly auctions. - The first two operations entailed a total of US$1.5 billion in contracts and were met by strong demand. - These auctions follow the program’s first use in March 2017 with the auctioning of US$1 billion in NDF contracts. - Contracts will be rolled over at maturity for as long as the Foreign Exchange Commission deems necessary. - National accounts revision and flash estimate: - On October 31 authorities published revised National Accounts data series along with the 2017:Q3 flash estimate. - Output declined 0.2 percent s.a.a.r in 2017:Q3 following a 0.6 percent expansion in 2017:Q2. - In year-on-year terms, the economy grew by 1.6 percent in 2017:Q3, compared with 1.9 percent in 2017:Q2. - This is in line with staff’s annual growth projection of 2.1 percent for 2017. - Authorities published a revised National Accounts data series with a new base year of 2013; as a result, annual average real GDP growth in the years 2013–16 was revised from 2.1 percent to 2.6 percent. - FATF AML/CFT assessment: - The Financial Action Task Force (FATF) discussed Mexico’s AML/CFT assessment at its Plenary meeting; the draft report was approved pending a final quality and consistency review ahead of publication. - The overall findings of the FATF report are consistent with the staff assessment as reflected in the staff report. *International Monetary Fund — Mexico country report material (excerpts).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17346-mexicoartiv.pdf_