## cr18307-mexicobundle ## Source details **Canonical URL:** [cr18307-mexicobundle](https://www.imf.org/-/media/files/publications/cr/2018/cr18307-mexicobundle.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18307-mexicobundle.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18307-mexicobundle.pdf.json) --- ### Recent developments and macro outcomes - Real GDP growth: 2.8 (2014), 3.3 (2015), 2.9 (2016), 2.0 (2017), 2.1 (2018 staff projection). - Output growth projected: 2.1 percent in 2018 and 2.3 percent in 2019; then to gradually converge to just under 3 percent over the medium term. - Private consumption remains the main driver of activity, supported by manufacturing exports. - Private investment: strengthened somewhat in recent quarters but continues to be held back by uncertainty. - Headline inflation: declined over the past year but accelerated to 5.0 percent in September amid rising energy prices. - Core inflation: returned to within the confidence band. - Unemployment: described as low (qualitative). ### Fiscal stance, public debt, and fiscal recommendations - 2018 public sector borrowing requirement (PSBR) target: 2.5 percent of GDP (projected to be met). - Better-than-projected revenue performance from improved tax compliance expected to be broadly offset by higher-than-budgeted non-programmable expenditures. - Public debt: 54.3 percent of GDP in 2017; projected to decline to around 53 percent of GDP. - Primary surplus: 1.3 percent of GDP projected to support the decline in public debt ratio. - Government revenue (percent of GDP): 23.4 (2014), 23.5 (2015), 24.6 (2016), 24.8 (2017), 23.5 (2018). - Government expenditure (percent of GDP): 28.0 (2014), 27.5 (2015), 27.4 (2016), 25.9 (2017), 26.0 (2018). - Augmented overall balance (percent of GDP): -4.5 (2014), -4.0 (2015), -2.8 (2016), -1.1 (2017), -2.5 (2018). - Staff fiscal recommendations: - Continue fiscal consolidation to keep public finances on a sound footing and public debt on a downward trajectory. - Strengthen fiscal framework by setting up a non partisan, adequately financed fiscal council with a formal mandate to independently evaluate policy. - Boost non-oil tax revenue; avoid introductions of tax exemptions or reduced rates that could erode the tax base. - See scope for boosting VAT and fuel excise revenues and strengthening tax administration. - Exercise restraint in current spending and improve spending efficiency to create room for infrastructure investment and other priorities. - Strengthen Pemex’s financial situation before contemplating new investments in refining. ### Monetary policy, inflation, and external sector - Banco de México policy rate: raised in three steps from 7 percent to 7.75 percent between December 2017 and June 2018. - Recommendation: monetary policy could be gradually reduced once inflation is firmly on a downward path, expectations remain well anchored, and uncertainty recedes. - Current account (percent of GDP): -1.9 (2014), -2.6 (2015), -2.2 (2016), -1.7 (2017), -1.7 (2018). - Exports, f.o.b. (annual percentage changes): 4.4 (2014), -4.1 (2015), -1.7 (2016), 9.5 (2017), 9.6 (2018). - Imports, f.o.b. (annual percentage changes): 4.9 (2014), -1.2 (2015), -2.1 (2016), 8.6 (2017), 9.6 (2018). - Gross international reserves (in billions of U.S. dollars): 195.7 (2014), 177.6 (2015), 178.0 (2016), 175.4 (2017), 178.0 (2018). - Outstanding external debt (percent of GDP): 32.5 (2014), 35.7 (2015), 38.5 (2016), 38.1 (2017), 38.5 (2018). - Staff projects a broadly unchanged current account deficit from last year and a slight widening over the medium term. - Foreign exchange reserves: assessed as adequate; the FCL provides an effective complement in reducing risks. - Risk: strong presence of foreign investors increases exposure to capital flow reversals and rising risk premia. ### Financial sector, inclusion, and regulatory priorities - Bank credit to the non-financial private sector (annual percentage changes): 6.1 (2014), 15.6 (2015), 17.7 (2016), 13.0 (2017), 14.0 (2018). - Broad money (annual percentage changes): 12.2 (2014), 12.3 (2015), 12.5 (2016), 11.1 (2017), 9.6 (2018). - Directors: financial sector remains resilient; encouraged continued close monitoring. - Policy calls: - Increase financial deepening and inclusion. - Regulate Fintech; close regulatory gaps. - Strengthen resolution and crisis management frameworks. - Further enhance the AML/CFT framework. - Development bank lending: noted positive role in promoting financial inclusion; staff advised limiting role to underserved markets and against quantitative lending targets. ### Executive Board assessment and broader policy package - Overall view: Mexico’s very strong policies and policy frameworks, and important structural reforms, underpin resilience to a complex external environment. - Trade: welcomed conclusion of the new trade agreement with Canada and the United States. - Monetary policy recommendations: - Current stance considered appropriate; Banco de México should remain prudent, vigilant and guided by data developments. - Policy rate could be gradually reduced once inflation is firmly on a downward path, expectations remain anchored, and uncertainty recedes. - Flexible exchange rate should remain the key shock absorber. - Structural and governance recommendations: - Rekindle the structural reform agenda to boost growth and reduce poverty and inequality. - Fully implement the National Anti Corruption System. - Continue energy sector reform and private participation in the oil and gas sector to attract investment and boost production and growth. - Improve enforcement of labor market regulations; introduce unemployment insurance; improve the defined contribution pension system; strengthen the social safety net. ### Incoming administration platform, policy uncertainty, and outlook - Incoming team commitments: central bank independence, fiscal prudence, respect of private property rights, endorsement of the new trilateral trade agreement, ambitious infrastructure projects (e.g., constructing a new refinery), social programs (e.g., doubling of old-age pensions and programs to support youth), and commitment not to increase taxes. - Uncertainties: future of the energy reform, future direction of Pemex, fate of the construction of a new airport; uncertainty likely to persist until approval of the 2019 budget and announcement of medium-term priorities. - Near-term macro indicators: - Output growth: "flat at 2.0 percent y-o-y in 2018:H1." - Unemployment rate: "around 3.3 percent." - Core inflation: "3.7 percent (y-o-y) in September 2018." - Headline inflation: accelerated from "4.5 percent in June to 5.0 percent in September." - Growth and inflation projections: - Near-term: growth expected to accelerate modestly; inflation projected to start falling. - Medium term: growth projected to gradually converge to "just under 3 percent". - Headline inflation projected to converge toward the central bank’s 3-percent target in the second half of 2019. - Credit and financial conditions: - Credit growth: projected to remain healthy at "above 10 percent over the medium term." - Credit quality: projected to remain strong but could decline with riskier lending practices or global tightening. ### Fiscal policy detailed recommendations and arithmetic - Staff shared objective: continue fiscal policy geared toward putting the public debt ratio on a firm downward trajectory. - 2019 draft budget: current administration preparing a draft targeting a "2½ percent of GDP PSBR." - Debt dynamics: - Keeping PSBR at "2½ percent of GDP" over the medium term would stabilize gross debt below "54 percent of GDP." - Staff recommended aiming for a primary surplus of "very close to 1 percent of GDP" to reduce fiscal sustainability risks and expand fiscal space. - Transition team stance: - Committed to meeting the deficit target with a primary surplus as main anchor. - View: reducing public debt-to-GDP ratio would entail a primary surplus of "0.5-1.0 percent of GDP." - For 2019, would not deviate from target of "2½ percent of GDP." - Tax policy options (staff): - Tax all goods at the standard "16 percent VAT" rate to increase VAT revenue by "at least 1 percent of GDP". - Eliminate the right of taxpayers to offset their excess VAT credits against other taxes. - Abolish the current practice of fuel price smoothing by reducing the fuel excise to stabilize excise revenues. - Limit exemptions for personal income taxation to increase revenues and progressivity. - Reform capital income taxation and introduce inheritance taxation. - Reform property tax to increase tax collection at sub-national level. - Improve tax administration per FAD TA recommendations and adopt a comprehensive strategy to address VAT non-compliance. ### VAT, tax mobilization, and administration - Tax-to-GDP ratio increased by almost three percentage points since 2013 but still lags peers. - Mexico collects 0.23 percent of GDP per percentage point of VAT rate; OECD and regional peers collect 0.4 and 0.3 percent of GDP per percentage point of VAT rate, respectively. - Taxing all food items at a zero rate creates revenue losses in excess of 1 percent of GDP. - Offsetting unpaid VAT refunds against other tax obligations: offsets amounted to 1.1 percent of GDP; under GFS guidelines these offsets should be deducted from official VAT revenue figures. - SAT weaknesses: lacks a comprehensive VAT compliance improvement plan; fragmented organizational structure; audit probabilities for VAT payers extremely low. ### Pension system (defined-contribution) — coverage, adequacy, and reform options - Coverage and contribution densities: - About 64 percent of workers in the private sector and 27 percent of workers in the public sector will not contribute long enough to receive a pension. - Less than half the individuals affiliated with IMSS contribute in a given year. - 82 percent of ISSSTE-affiliates contribute in a given year. - Private sector workers contribute about 19 weeks per year on average (contribution density of 37 percent). - Public sector contribution density about 76 percent (39.5 weeks per year). - About 60 percent of IMSS affiliates in the bottom income quintile have contribution densities below 50 percent. - Replacement rates: - Conditional replacement rates vary between 40.0 and 47.8 percent for private and public-sector workers. - Average conditional replacement rate reaches 66 percent for public sector workers in the first wage quintile and falls to 35.3 percent for workers in the top wage quintile. - Main DC system parameters: - Private sector: Creation date 1997; Institute in charge Mexican Institute of Social Security (IMSS); Retirement age 65; Minimum contribution period 1250 weeks (about 24 years); Contribution rate 6.5 percent (Employer: 5.150 percent; Worker: 1.125 percent; Government: 0.225 percent; Social quota: variable); Minimum guaranteed pension (June 2018) 3,051 pesos per month. - Public sector: Creation date 2007; Institute in charge Institute for Security and Social Services for State Workers (ISSSTE); Retirement age 65; Minimum contribution period 25 years (1300 weeks); Contribution rate 11.3 percent (Employer: 5.175 percent; Worker: 6.125 percent; Social quota: fixed); Minimum guaranteed pension (June 2018) 4,756 pesos per month. - Policy options: - Gradually increase contribution rates, particularly for private sector workers. - Shorten required contributory period to encourage contributions and formal employment. - Consolidate federal and local non-contributory pension pillars. - Reduce management fees of pension funds which exceed one percent of assets under management. ### Pemex, energy sector, and investment priorities - Pemex: operations and credit quality improved mainly due to a drastic reduction in capital spending, but debt remains elevated and output has continued to drop. - Oil theft: costing Pemex $1.6 billion per year (0.15 percent of GDP) per Pemex reporting. - Staff recommendations: - Persevere with the energy sector reform and Pemex’s multi-year business plan. - Joint ventures with the private sector recommended to increase production and ensure long-term financial soundness. - Plans to build a new refinery should be put on hold until a comprehensive technical and financial feasibility analysis is completed and weighed against other priorities. ### Crime, security, and economic costs - Violent crime: 15,973 homicides recorded in the first half of 2018 — highest level since comparable records began in 1997. - 2017: 25,339 homicides — a 50 percent jump from 2015; murder rate of 21 per 100,000 persons in 2017. - Direct costs associated with offenses against firms and protection estimated at 0.7 percent of GDP. - Firms report that expenditures for security measures and direct losses from acts of crime alone accounted for 0.7 percent of GDP. ### Financial stability, stress tests, and resolution frameworks - Banking sector indicators (selected): Tier-1 capital ratio "14.0 percent" (July 2018 for one reporting); return on equity "20.7 percent"; NPL ratio "2.1 percent." - Banking sector resilience: recent stress tests confirm sector resilience; provisioning levels adequate. - Corporate stress tests (sample of 50 largest corporations): - Average share of foreign currency debt to total debt is 54 percent. - Debt-at-risk could increase from 0.6 percent of GDP to 0.6-0.9 percent of GDP depending on hedges. - Full default of debt-at-risk could increase gross NPL ratio by 0.33-0.36 percentage points. - Resolution and crisis management recommendations: - Extend bank resolution regime to cover financial holding companies. - Develop formal contingency plan for systemic crises. - Conduct systemic crisis simulation exercises involving foreign shareholders. ### Structural reforms, governance, and anti-corruption priorities - Need to re-kindle structural reform agenda: governance, security, rule of law, and informality identified as priorities to boost potential growth and reduce poverty and inequality. - Governance and anti-corruption actions recommended: - Fully implement National Anti-Corruption System and appoint an operationally independent anti-corruption prosecutor. - Adopt a three-prong strategy to ensure up-to-date basic and beneficial ownership information across company registers, banks, notaries, and companies. - Proceed with constitutional reforms and create the National Digital Platform (NDP) for procurement and other data. - Swift implementation of AML/CFT assessment recommendations. - AML/CFT key findings: - Mexico substantially meets 4 of 11 immediate outcomes; technical compliance: compliant or largely compliant with 24 of the FATF Recommendations; 16 Recommendations partially or non-compliant. - Main predicate crimes: drugs and human trafficking, corruption and tax evasion. - Typical ML methods: shell and front companies, purchase of real estate and other high value goods, cash smuggling. - Recommendations include reorienting financial intelligence use, increasing investigative resources, introducing specialized teams, and reforming preventive measures and supervision for financial sector and DNFBPs. ### Fintech legal and regulatory framework - Law approved in March 2018 aims to provide regulatory certainty for crowdfunding, payment methods and cryptocurrencies. - Regulation on e-payment and crowdfunding published in September 2018 covering license requirements, investor protection, data sharing and AML/CFT. - Key clauses: - P2P lenders should not guarantee a fixed return; Fintech firms should have "skin the game". - Open data framework to allow data sharing with consumer permission; regulated fee to access data via open data APIs. - Regulatory sandbox recognized; CNBV has set up a sandbox for testing innovative ideas. - Fintech statistics and risks: - 238 fintech firms operating in Mexico as of June 2017 (Finnovista). - 69 percent began operations within the last 3 years; 39 percent have less than 10 employees. - Potential benefits: competition, financial inclusion, lower transaction costs. - Risks: ML/TF risks, cyber risk, data privacy concerns, financial fraud, maturity mismatches, cryptocurrency risks. ### Outlook, risks, and Risk Assessment Matrix (RAM) - Outlook: - Output growth: projected to accelerate to 2.1 percent in 2018 and 2.3 percent in 2019; converge to just under 3 percent over the medium term. - Inflation: expected to converge toward the Bank of Mexico’s 3-percent target in the second half of 2019. - Main risks (tilted to the downside): - External: weaker-than-projected global growth; renewed volatility in global financial markets; global trade-related uncertainty; rising protectionism. - Domestic: uncertainty about incoming administration’s fiscal plans; continuation of energy reforms; possible further declines in oil production; perceived corruption and deterioration in the rule of law. - RAM selected entries (likelihood and impact): - Sharp tightening of global financial conditions — Relative likelihood: H; Impact: H; Policy response: Exchange rate flexibility and provision of liquidity. - Rising protectionism and retreat from multilateralism — Relative likelihood: H; Impact: H; Policy response: Exchange rate flexibility; temporary FX interventions and liquidity provision; structural reforms. - Weaker than expected oil production at PEMEX — Relative likelihood: M; Impact: M; Policy response: Implement joint ventures to benefit from technology transfer. - Slower-than-anticipated fiscal consolidation — Relative likelihood: M/L; Impact: H; Policy response: Maintain consolidation; use positive revenue surprises to reduce deficit faster. - A further deterioration in corruption and the weak rule of law — Relative likelihood: L; Impact: M; Policy response: Strengthen rule of law and anti-corruption reforms. ### Key numeric indicators and medium-term projections (selected) - GDP real growth: 2014 = 2.8; 2015 = 3.3; 2016 = 2.9; 2017 = 2.0; 2018 (proj.) = 2.1; 2019 (proj.) = 2.3; 2023 (proj.) = 2.9. - Consumer prices (end-of-period): 2017 = 6.8; 2018 (proj.) = 4.4; 2019 (proj.) = 3.1; 2023 (proj.) = 3.0. - Current account balance (percent of GDP): 2017 = -1.7; 2018 (proj.) = -1.7; 2019 (proj.) = -1.8; 2023 (proj.) = -1.9. - Gross international reserves (in billions of U.S. dollars): 2014 = 195.7; 2015 = 177.6; 2016 = 178.0; 2017 = 175.4; 2018 (proj.) = 178.0; 2023 (proj.) = 205.7. - Gross public sector debt (percent of GDP): 2014 = 48.9; 2015 = 52.8; 2016 = 56.8; 2017 = 54.3; 2018 (proj.) = 53.1; 2023 (proj.) = 53.4. _International Monetary Fund — Staff Report for the 2018 Article IV Consultation (cr18307-mexicobundle)._ ### 2.3 percent in 2019. Private consumption remains the main driver of activity, supported by ### cr18307-mexicobundle - 2.3 percent in 2019. Private consumption remains the main driver of activity, supported by ### Recent developments and macro outcomes - Real GDP growth: 2.8 (2014), 3.3 (2015), 2.9 (2016), 2.0 (2017), 2.1 (2018 staff projection). - Output growth projected: 2.1 percent in 2018 and 2.3 percent in 2019; then to gradually converge to just under 3 percent over the medium term. - Private consumption remains the main driver of activity, supported by manufacturing exports. - Private investment: strengthened somewhat in recent quarters but continues to be held back by uncertainty. - Headline inflation: declined over the past year but accelerated to 5.0 percent in September amid rising energy prices. - Core inflation: returned to within the confidence band. - Unemployment: described as low (qualitative). ### Fiscal stance and public debt - 2018 public sector borrowing requirement target: 2.5 percent of GDP (projected to be met). - Better-than-projected revenue performance reflecting improvements in tax compliance is expected to be broadly offset by higher-than-budgeted non-programmable expenditures. - Public debt: 54.3 percent of GDP in 2017; projected to decline to around 53 percent of GDP. - Primary surplus: 1.3 percent of GDP projected to support the decline in public debt ratio. - Government revenue (percent of GDP): 23.4 (2014), 23.5 (2015), 24.6 (2016), 24.8 (2017), 23.5 (2018). - Government expenditure (percent of GDP): 28.0 (2014), 27.5 (2015), 27.4 (2016), 25.9 (2017), 26.0 (2018). - Augmented overall balance (percent of GDP): -4.5 (2014), -4.0 (2015), -2.8 (2016), -1.1 (2017), -2.5 (2018). ### Monetary policy and external sector - Banco de México policy rate: raised in three steps from 7 percent to 7.75 percent between December 2017 and June 2018. - Recommendation: monetary policy could be gradually reduced once inflation is firmly on a downward path, expectations remain well anchored, and uncertainty recedes. - Current account: external current account balance (percent of GDP): -1.9 (2014), -2.6 (2015), -2.2 (2016), -1.7 (2017), -1.7 (2018). - Exports, f.o.b. (annual percentage changes): 4.4 (2014), -4.1 (2015), -1.7 (2016), 9.5 (2017), 9.6 (2018). - Imports, f.o.b. (annual percentage changes): 4.9 (2014), -1.2 (2015), -2.1 (2016), 8.6 (2017), 9.6 (2018). - Gross international reserves (in billions of U.S. dollars): 195.7 (2014), 177.6 (2015), 178.0 (2016), 175.4 (2017), 178.0 (2018). - Outstanding external debt (percent of GDP): 32.5 (2014), 35.7 (2015), 38.5 (2016), 38.1 (2017), 38.5 (2018). - Staff projects a broadly unchanged current account deficit from last year and a slight widening over the medium term. - Foreign exchange reserves: assessed as adequate according to a range of indicators; the FCL provides an effective complement in reducing risks. - Risk: strong presence of foreign investors increases exposure to capital flow reversals and rising risk premia. ### Financial sector and structural issues - Bank credit to the non-financial private sector (annual percentage changes): 6.1 (2014), 15.6 (2015), 17.7 (2016), 13.0 (2017), 14.0 (2018). - Broad money (annual percentage changes): 12.2 (2014), 12.3 (2015), 12.5 (2016), 11.1 (2017), 9.6 (2018). - Directors: financial sector remains resilient; encouraged continued close monitoring. - Calls to: increase financial deepening and inclusion; regulate Fintech; close regulatory gaps; strengthen resolution and crisis management frameworks; further enhance the AML/CFT framework. - Development bank lending: noted positive role in promoting financial inclusion. ### Executive Board assessment and policy recommendations - Overall view: Mexico’s very strong policies and policy frameworks, and important structural reforms, underpin resilience to a complex external environment. - Trade: welcomed conclusion of the new trade agreement with Canada and the United States. - Fiscal policy recommendations: - Continue fiscal consolidation to keep public finances on a sound footing and public debt on a downward trajectory. - Strengthen fiscal framework by setting up a non partisan, adequately financed fiscal council with a formal mandate to independently evaluate policy. - Boost non-oil tax revenue; avoid introductions of tax exemptions or reduced rates that could erode the tax base. - See scope for boosting VAT and fuel excise revenues and strengthening tax administration. - Exercise restraint in current spending and improve spending efficiency to create room for infrastructure investment and other priorities. - Strengthening Pemex’s financial situation is a prerequisite before contemplating new investments in refining. - Monetary policy recommendations: - Current stance considered appropriate; Banco de México should remain prudent, vigilant and guided by data developments. - Policy rate could be gradually reduced once inflation is firmly on a downward path, expectations remain anchored, and uncertainty recedes. - Flexible exchange rate should remain the key shock absorber. - Commended central bank for improving communication strategy. - Structural and governance recommendations: - Rekindle the structural reform agenda to boost growth and reduce poverty and inequality. - Fully implement the National Anti Corruption System. - Continue energy sector reform and private participation in the oil and gas sector to attract investment and boost production and growth. - Improve enforcement of labor market regulations; introduce unemployment insurance; improve the defined contribution pension system; strengthen the social safety net to encourage formal employment and reduce poverty and inequality. ### Outlook, risks, and policy priorities - Outlook: - Output growth: projected to accelerate to 2.1 percent in 2018 and 2.3 percent in 2019; converge to just under 3 percent over the medium term. - Inflation: expected to converge toward the Bank of Mexico’s 3-percent target in the second half of 2019. - Main risks: - External: weaker-than-projected global growth, renewed volatility in global financial markets, and global trade-related uncertainty. - Domestic: uncertainty about prioritization of the incoming administration’s fiscal plans given constrained fiscal space; continuation of energy and other reforms; possible further declines in oil production; perceived corruption and deterioration in the rule of law. - Key policy priorities: - Ensure continued strong policies and policy frameworks. - Maintain fiscal consolidation while accommodating planned increases in public investment and social spending by creating fiscal space through increased non-oil tax revenue, closing tax compliance gaps, strengthening fiscal framework, and improving spending efficiency. - Remain ready to gradually ease monetary policy if inflation declines and inflation expectations remain well anchored. - Fully implement recent reforms and re-invigorate the reform agenda with emphasis on strengthening the rule of law, fighting corruption, and reducing informality. *International Monetary Fund — Staff Report for the 2018 Article IV Consultation* ### 6. The incoming administration’s platform promises to address these challenges, but ### 6. The incoming administration’s platform promises to address these challenges, but ### Incoming administration platform and policy uncertainty - Mr. López Obrador highlighted commitments to central bank independence, fiscal prudence, and respect of private property rights. - The incoming team endorsed the new trilateral trade agreement with the United States and Canada. - Announced intentions include ambitious infrastructure projects (e.g., constructing a new refinery) and social programs (e.g., doubling of old-age pensions and programs to support youth), while committing to not increase taxes. - Committed to fiscal discipline and to reduce the public debt ratio. - Uncertainty surrounds: - the future of the energy reform, - the future direction of Pemex, - the fate of the construction of a new airport. - Policy uncertainty likely to persist until approval of the 2019 budget and announcement of medium-term priorities. ### Recent macroeconomic developments - Growth and demand - Output growth: "flat at 2.0 percent y-o-y in 2018:H1." - Private consumption supported activity; net exports more recently contributed. - Private investment remained anemic but strengthened somewhat compared to 2017. - Supply side: services and manufacturing performed solidly; mining contracted. - Construction activity rebounded after several quarters of negative contributions. - Unemployment rate: "around 3.3 percent" with real wage growth rebounding. - Inflation - Core inflation: "3.7 percent (y-o-y) in September 2018." - Headline inflation reversed downward trend, accelerating from "4.5 percent in June to 5.0 percent in September" amid rising energy prices. - External sector - Current account deficit: "1.1 percent of GDP in the first half of 2018", broadly unchanged relative to H1 2017 and compared to "1.7 percent in 2017 (full year)." - Non-oil trade balance: in surplus since second half of 2016. - FDI inflows: broadly stable. - Financial markets and sovereign risk - Peso weakened before elections and strengthened subsequently; volatility remained high. - Sovereign CDS and bond spreads have risen somewhat over the past year, but much less than in other EMs. - Credit ratings and outlooks: Moody’s upgraded the sovereign credit outlook to stable in April 2018; Fitch and S&P kept Mexico’s rating at "BBB+" with a stable outlook. - Banking sector - As of July 2018: Tier-1 capital ratio "14.0 percent"; return on equity "20.7 percent"; NPL ratio "2.1 percent." - Commercial bank credit to non-financial corporates strengthened by "10 percent (y-o-y) in real terms in August." - Consumer credit growth slowed to "just above 1 percent." - Household credit-to-GDP ratio: "16.1 percent" (compare "39.8 percent on average for other emerging economies"). - Fiscal position and public debt - 2018 PSBR target: "2.5 percent of GDP" expected to be met. - Public debt projected to decline to "around 53 percent of GDP from 54.3 percent in 2017," thanks to a primary surplus of "1.3 percent." - Monetary policy - Banxico increased its policy rate by "25 bps" in December 2017, and in February and June 2018, to "7.75 percent." - Medium-run inflation expectations: "about 3.5 percent." - Structural reforms and governance - Progress: oil exploration auctions progressed (first private company to begin oil production in 2019), gas network expansion, auctions for electricity generation investments successful, liberalization of gasoline prices completed in November 2017 (with excise tax adjustments), COFECE active, progress diversifying trading partners (agreement in principle with EU; first to ratify CPTPP). - Little progress: National Anti-Corruption System (NACS) implementation, appointment of an operationally independent anti-corruption prosecutor, perception of corruption continues to worsen. - Pending reforms: strengthening collateral registry, setting up specialized bankruptcy courts. ### Outlook and risks - Baseline assumptions - Reduced uncertainty related to U.S. trade relations but ongoing global trade tensions. - Incorporates incoming administration’s broad policy intentions as communicated by the transition team, including adherence to current administration’s fiscal path. - Assumes Banxico will maintain a tight stance until at least mid-2019 and that global financial conditions will continue tightening. - Growth and inflation projections - Near-term: growth expected to accelerate modestly; inflation projected to start falling. - Medium term: growth projected to gradually converge to "just under 3 percent" as structural reforms take effect. - Headline inflation projected to converge toward the central bank’s target in the second half of 2019. - Credit and financial conditions - Credit growth: projected to remain healthy at "above 10 percent over the medium term." - Credit quality: projected to remain strong but could decline with riskier lending practices, global financial tightening, or a decline in global growth/cross-border trade. - External position - Current account: staff projects an unchanged current account deficit from last year and a slight widening over the medium term. - Real effective peso: "2.7 percent stronger in real effective terms relative to its 2017 average" at end-September 2018. - Net international investment position: would improve modestly to about "minus 45 percent of GDP" over the medium term. - Net international reserves: adequate; FCL provides effective complement to reduce risks. - External financing needs: broadly unchanged in 2018-19. - Vulnerabilities: exposure to capital flow reversals and increased risk premia due to strong presence of foreign investors. - Risk balance - Tilted to the downside. - Key downside risks: a fall in global growth, exacerbation of trade tensions, renewed volatility in global financial markets, sharp pull-back of capital from EMs, faster-than-expected U.S. Federal Reserve tightening, faltering energy and other reforms, continued fall in PEMEX oil production or deviation from its business plan, deterioration in corruption and rule of law. - Upside: perseverance with structural reforms. ### Fiscal policy: staff recommendations to create fiscal space and enhance progressivity - Shared objective: continue fiscal policy geared toward putting the public debt ratio on a firm downward trajectory. - 2019 budget: current administration preparing a draft targeting a "2½ percent of GDP PSBR." - Debt dynamics: - Keeping PSBR at "2½ percent of GDP" over the medium term would stabilize gross debt below "54 percent of GDP." - This trajectory contingent on growth converging toward potential of "around 3 percent" and a steady path for interest rates. - Staff recommendation: a slightly more ambitious medium-term fiscal target to reduce fiscal sustainability risks and expand fiscal space for infrastructure and demographics-related spending. - Transition team fiscal stance - Committed to meeting the deficit target with a primary surplus as main anchor. - Views achieving reduced public debt-to-GDP ratio would entail a primary surplus of "0.5-1.0 percent of GDP." - For 2019, they would not deviate from the current administration’s target of "2½ percent of GDP." - Expect revenues in line with projections published last March; do not foresee changes to tax policy except for reduction in VAT and CIT rates in the border region with the United States. - Plan to finance new initiatives via consolidation of existing programs, efficiency gains in payroll management and public procurement, and savings in other current spending. - Staff fiscal arithmetic and advice - Staff noted that putting public debt on a downward trajectory would require aiming for a primary surplus of "very close to 1 percent of GDP." - The 0.8-percent of GDP debt-stabilizing primary balance assumes key variables remain at their 2023 level; lower growth projections in earlier years imply a higher debt-stabilizing primary surplus. - Need to boost non-oil tax revenues and strengthen progressivity; specific staff considerations: - Tax all goods at the standard "16 percent VAT" rate to increase VAT revenue by "at least 1 percent of GDP"; improvements in compliance would further boost collections. - Eliminate the right of taxpayers to offset their excess VAT credits against other taxes. - Abolish the current practice of fuel price smoothing by reducing the fuel excise to stabilize excise revenues and promote efficient fuel usage. - Limit exemptions for personal income taxation to increase revenues and progressivity. - Reform capital income taxation and introduce inheritance taxation to enhance progressivity and help reduce income inequality. - Reform the property tax to increase tax collection at the sub-national level, allowing reduction in central government transfers to states and municipalities, encouraging fiscal responsibility and efficiency. - Improve tax administration in line with FAD TA recommendations, including adopting a comprehensive strategy to address VAT non-compliance and addressing the lack of a high-coverage audit process for VAT returns. - Incoming administration stance on taxes - Current administration argued the 2013 tax reform increased tax revenues by "five percentage points of GDP" and thus considered additional measures not strictly necessary. - Incoming administration re-iterated no changes to the tax system during the first couple of years except the cut in VAT and CIT at the border region; focus instead on increasing tax collection and closing channels of tax evasion. - They argued that unification of VAT rates would increase inequality even if accompanied by targeted transfers to the poor. *Source: IMF staff.* ### 25. Stronger non-oil tax revenues along with restraint in current spending would provide ### Stronger non-oil tax revenues along with restraint in current spending would provide ### Fiscal policy and public spending: space for infrastructure and priorities - Incoming administration pledged new social benefits and ambitious investment plans; transition team asserted fiscal costs would be fully offset by savings from fighting corruption and rationalizing current spending. - Staff supported higher infrastructure investment only within: - an overall sustainable fiscal position, and - a comprehensive infrastructure plan that includes an assessment of the management process of public investment and identifies priority projects. - Recommendations to contain and reorient current spending: - Stricter standards and more transparency in use of temporary personnel; consistent application of merit-based recruitment; establishment of a centralized payroll system to help contain the wage bill. - Maintain pay competitiveness for civil servants in management positions to reduce corruption incentives and ensure staff quality. - More careful audits of payrolls to identify ghost workers and curb absenteeism. - Rebalance education spending towards investment in equipment and facilities to increase efficiency and improve teaching quality; persevere with education reform. - Consolidate and better target social programs, but first conduct rigorous evaluations of current programs’ effectiveness; put plans to introduce new programs on hold until evaluations are complete. - Implement a single database for beneficiaries to eliminate benefit overlaps. - Reform public procurement by considering centralization across the public sector and adopting a digital platform to yield savings and reduce risks of corruption and bid rigging. ### Pension system reform: defined-contribution (DC) system issues and options (Box 1) - Background: - Mexico switched from a defined-benefit (DB) to a defined-contribution (DC) pension system in 1997 for private sector workers and in 2007 for public sector workers. - The DC system is mostly self-funded, except for a minimum pension for individuals meeting the minimum contribution period requirement. - Transitional workers could choose DB or DC benefits, delaying fiscal savings and creating inequities. - Contribution and coverage statistics (based on observed contribution densities): - About 64 percent of workers in the private sector and 27 percent of workers in the public sector will not contribute long enough to receive a pension. - Less than half the individuals affiliated with IMSS contribute in a given year. - 82 percent of ISSSTE-affiliates contribute in a given year. - On average, private sector workers contribute about 19 weeks per year over their working life, corresponding to a contribution density of 37 percent. - For public sector workers, contribution density is about 76 percent, or 39.5 weeks per year. - About 60 percent of IMSS affiliates in the bottom income quintile have contribution densities below 50 percent and less than 5 percent have contributed every working day over the last 6 years. - Replacement rates and equity: - Conditional replacement rates vary between 40.0 and 47.8 percent for private and public-sector workers. - Conditional replacement rates are higher for men than for women and for public sector workers than for private sector workers. - Minimum pensions imply higher conditional replacement rates for lower wages: average conditional replacement rate reaches 66 percent for public sector workers in the first wage quintile and falls to 35.3 percent for workers in the top wage quintile. - Policy options and cautions: - Gradually increasing the contribution rate for the DC pension system, in particular for private sector workers, would improve pension adequacy. - Shortening the required contributory period to qualify for a pension would encourage pension contributions and formal employment. - Any reform should be carefully designed to balance the additional budgetary cost from more workers qualifying for a minimum contributory pension and the potentially reduced spending for old-age social assistance. - Federal and local non-contributory pension pillars should be consolidated. - There is scope for reducing management fees of pension funds which exceed one percent of assets under management. - Main parameters of Mexico’s DC system (as presented): - Private sector: Creation date 1997; Institute in charge Mexican Institute of Social Security (IMSS); Retirement age 65; Minimum contribution period 1250 weeks (about 24 years); Contribution rate 6.5 percent (Employer: 5.150 percent; Worker: 1.125 percent; Government: 0.225 percent; Social quota: variable, depending on the wage level below 15 minimum wages); Minimum guaranteed pension (June 2018) 3,051 pesos per month, indexed every year to the CPI; Retirement benefit options Life annuity / Programmed withdrawals. - Public sector: Creation date 2007; Institute in charge Institute for Security and Social Services for State Workers (ISSSTE); Retirement age 65; Minimum contribution period 25 years (1300 weeks); Contribution rate 11.3 percent (Employer: 5.175 percent; Worker: 6.125 percent; Social quota: fixed for all wages below 10 minimum wages); Minimum guaranteed pension (June 2018) 4,756 pesos per month, indexed every year to the CPI; Retirement benefit options Life annuity / Programmed withdrawals. ### Pemex and energy investment - Further improvements in Pemex’s financial situation are a prerequisite before new investments in refining can be contemplated. - Energy reform broke Pemex’s monopoly, increased autonomy, and strengthened its financial position to permit private sector investment in its assets and operations. - Operations and credit quality have improved mainly due to a drastic reduction in capital spending, but: - Pemex debt remains elevated and output has continued to drop, reflecting mounting investment needs. - Staff recommendations: - Persevere with the energy sector reform and Pemex’s multi-year business plan and continue improving the company’s financial health. - Joint ventures with the private sector remain the best way to increase production in both mature and new fields and ensure long-term financial soundness. - Plans to build a new refinery should be put on hold until a comprehensive technical and financial feasibility analysis is completed and should be carefully weighed against other priorities. ### Fiscal framework and transparency - Staff advocated creation of a non-partisan, adequately-resourced fiscal council with a formal mandate to provide an independent evaluation of fiscal policy. - Additional recommendations: - Tighter link between the desired level of public debt and PSBR targets. - Limit exceptional circumstances clauses to cases of large output and oil price shocks. - One-off profit transfers from Banxico to the budget should be used entirely to reduce the PSBR and public debt. - Follow up on recommendations of the Fiscal Transparency Evaluation (FTE) report. - Incoming administration position: - Reiterated view that government had demonstrated credibility by consistently delivering on fiscal commitments and disputed need for additional external scrutiny given existing banks, agencies, and institutions analyzing public finances. - Noted strengthening fiscal framework was among priorities; open to different ways to achieve this, including strengthening governance, capacity, and scope of the Centre for Public Finance Studies of Congress, while ensuring non-partisan assessment. ### Monetary and exchange rate policies - Monetary stance and outlook: - Current monetary policy stance is adequate but there is scope to gradually ease policy. - Monetary conditions are projected to progressively tighten as inflation declines (with an ex-ante real policy rate of over 4.6 percent by end-2018). - A negative output gap is expected to help inflation converge toward the 3-percent target in the second half of 2019. - Staff recommended a gradual reduction in the policy rate once inflation is firmly on a downward path, expectations remain well anchored, and uncertainty recedes; this could be the case as soon as in early 2019. - Communication and governance: - Banxico announced communication improvements including: (i) identification of the vote of each Board member in the minutes; (ii) simultaneous publication of the monetary policy communiqué in Spanish and English; (iii) release of complete transcripts of monetary policy meetings after three years; (iv) publication of all public speeches and presentations by Board members. - Staff suggested communication continue to focus on exchange rate movements and U.S. interest rate policies only to the extent they bear importantly on inflation, and to keep minutes concise. - Exchange rate flexibility and reserves: - Agreement that exchange rate flexibility should remain the key shock absorber. - Banxico allowed flexible adjustment and refrained from intervention since last pre-announced auctions of NDF contracts in December 2017; outstanding contracts (notional amount of $5.5 billion) have been rolled over. - Staff and authorities agreed intervention should be limited to instances of disorderly market conditions and not to lean against the wind; NDFs provide a useful additional instrument to spot intervention. - Foreign currency reserves judged adequate at the current juncture, with the FCL providing an important buffer; further reserve accumulation could be called for going forward. ### Macro-financial policies and financial deepening - Financial sector resilience: - Recent stress tests by regulators confirm sector resilience: except for a few very small banks, all banks could absorb a substantial deterioration in credit quality and higher funding cost. - Staff’s stress tests of the top 50 largest corporations suggest debt-at-risk would remain manageable even under GFC-like severe shocks, including shocks to the exchange rate and earnings. - Authorities noted strong levels of capital and loan-loss provisions and expected overall quality to remain strong. - Financial deepening and inclusion: - Total credit to the non-financial private sector was 39.1 percent of GDP in 2017, up by 7.1 percentage points since 2012, but still low by international standards. - Staff welcomed regulation under the new FinTech legislation and highlighted need to: - Improve the collateral registry and install specialized bankruptcy courts to expedite insolvency resolution and boost commercial bank lending. - Make progress with the National Strategy for Financial Inclusion (NSFI) to improve access to finance for underserved populations. - Authorities agreed on the need to boost financial deepening and inclusion and highlighted recent growth in credit volumes as well as pension and insurance assets; noted NSFI focuses on financial education and consumer protection. *IMF staff report (excerpt).* ### 34. In this context, staff noted that the role of development bank lending should be ### cr18307-mexicobundle - 34. In this context, staff noted that the role of development bank lending should be ### Development bank lending - Staff: role should be limited to underserved markets; lending to sectors adequately served by commercial banks would unnecessarily commit scarce public resources and risk crowding out the commercial banking sector. - Staff advised against setting quantitative lending targets. - Staff supported changes in development banks’ incentive structures to encourage lending to sectors lacking access to market financing. - Board composition and selection of CEOs of development banks should be aligned with international best practices. - Incoming administration: expected development banks to play an important role in infrastructure finance and would consider consolidating a few development banks to improve efficiency. ### Financial sector governance and supervision - Staff: enhance financial sector resilience by closing gaps in governance of the regulatory framework. - In line with 2016 FSAP recommendations, staff urged authorities to: - increase the operational independence, budget autonomy, and legal protection of the banking and securities supervisor; - subsequently integrate all prudential supervision functions under one prudential authority. - Supervisory power should be extended to cover financial holding companies. - Maintaining competitive compensation will help improve supervision quality. - Current and incoming administrations: believe current institutional setup and governance structure of regulators provides sufficient safeguards and do not see the need to merge different regulators into one prudential regulator. ### Corporate stress tests (Box 3) — sample and shocks - Sample: 50 largest corporations; collectively market capitalization and debt amount to 33 percent of GDP and 30 percent of total corporate debt, respectively. - Shocks analyzed: - increase in borrowing costs by 200 basis points or 30 percent from median borrowing cost in 2016; - peso depreciation of 30 percent against the U.S. dollar; - earnings shocks of one standard deviation for each firm, assuming a 30 percent decline in global trade. - Hedges: - natural hedges proxied by ratio of foreign currency revenues to total revenues (average of 34 percent in 2018:Q1); - financial hedges: assume 50 percent of FX debt interest expense is hedged through derivatives. - In the sample, average share of foreign currency debt to total debt is 54 percent. ### Corporate stress tests — results and bank spillovers - Debt-at-risk (debts with interest coverage ratio (ICR) below 1) could increase from 0.6 percent of GDP to 0.6-0.9 percent of GDP, depending on hedges. - a. With natural and financial hedges: five companies could have ICR below 1; their debts account for 0.7 percent of GDP (1.6 percent of total corporate debt). - a. With natural hedge only: five companies could have ICR below 1; their debts account for 0.7 percent of GDP (1.6 percent of total corporate debt). - b. Worst-case (no exchange rate hedges): six companies with ICR below 1; their debts account for 0.9 percent of GDP (2.0 percent of total corporate debt). - Banking sector impact: - Full default of debt-at-risk could lead to an increase in gross NPL ratio by 0.33-0.36 percentage points. - Banking sector is well capitalized, and provisioning levels are adequate. - Definitions and computations: - Debt-at-risk defined as debts with ICR below 1. - Loss Absorbing Buffers computed as Tier 1 Capital + Loan Loss Reserves - Stock of NPL, all divided by Risk-weighted assets. - Gross NPL ratio presented in percent of total loans (assuming no recovery). ### Resolution and crisis management - Staff: resolution and crisis management framework needs strengthening. - Recommendations: - Bank resolution regime should cover financial holding companies to ensure supervisors can manage true group risks and require banks to improve resolvability. - Develop a formal contingency plan for dealing with a systemic crisis. - Put in place a process to carry out a systemic crisis simulation exercise involving foreign shareholders. - Current administration: considered resolution framework strengthened since legal reform in 2014; noted ex-ante simulation exercises could be contemplated but would require significant resources and careful planning. ### Macro-Structural Policies: raising potential growth, reducing poverty and inequality - Need to re-kindle structural reform agenda to raise potential growth. - Pacto por México achievements: broke state monopolies and promoted competition in network industries; aimed at labor market, education, and governance shortcomings. - Major growth acceleration not yet in sight; much remains to boost potential growth and reduce poverty and income inequality. - Projected medium-term potential growth predicated on continuation of structural reform effort. - Priority reforms: governance, security, rule of law, and informality — staff’s analysis points to these as key drivers of meager productivity growth via misallocation and limiting firm investment and growth. - Current and incoming administrations: agreed governance, security, rule of law and labor informality are core structural challenges; agreed with need to press ahead with structural reform agenda. ### Governance and anti-corruption - Staff welcomed incoming administration's emphasis on fighting corruption and urged focus on existing anti-corruption reforms pending implementation and IMF-led AML/CFT assessment recommendations. - Specific recommendations for the next fiscal year: - Increase effectiveness of Prosecution Authority (PGR): competent authorities (Financial Intelligence Unit (FIU), Banking and Securities Commission (CNBV), Secretariat of Public Administration (SFP)) should annually conclude interagency performance agreements regarding number and types of corruption and money laundering case files that PGR will receive and successfully process. - Adopt a three-prong strategy to ensure up-to-date domestic and foreign basic and beneficial ownership information is soon available with company registers in Mexico, with Mexican banks and notaries, and with the companies themselves; consider new technologies (e.g., distributed ledger technology) and publicly accessible registries for transparency of beneficial ownership. - Proceed with constitutional reforms awaiting implementation: appointment of an operationally independent anti-corruption prosecutor, appointments of judges to fill new anti-corruption chambers at administrative courts, and creation and implementation of the National Digital Platform (NDP) to provide access to important data such as on procurement. - Swift implementation of AML/CFT assessment recommendations. ### Security and the rule of law - Violent crime: 15,973 homicides recorded in the first half of 2018 — highest level since comparable records began in 1997 (Box 5). - Other crimes including oil theft are at record levels with significant economic costs. - Enhancing efficiency and quality of law enforcement and judicial institutions is critical to improve security and strengthen rule of law. ### Competition and product market regulation - Mexico has progressed in strengthening competition and lifting product market regulations, but considerable scope for improvement remains. - Benefits of further reforms: eliminate privileges benefiting few, reduce prices benefiting many (particularly low-income households). - Specific reforms: remove barriers to trade in services, especially transportation and logistics, to support manufacturing and integration into global value chains. - Staff urged current and incoming administrations to ensure continued autonomy and adequate funding of COFECE and the Federal Telecommunications Institute. - Consider consulting COFECE and Federal Telecommunications Institute expertise on anti-competitive practices in product market regulations and public procurement. ### Incidence of corruption (INEGI, Encuesta Nacional de Calidad e Impacto Gubernamental, 2017) - Mexico (all states): - Prevalence of corruption in administrative procedures: 14.6 - Prevalence of corruption in relations with the federal government: 1.4 - Prevalence of corruption in relations with state governments: 21.0 - Prevalence of corruption in relations with municipal governments: 14.9 - Central states: - Prevalence of corruption in administrative procedures: 16.6 - Prevalence of corruption in relations with the federal government: 2.2 - Prevalence of corruption in relations with state governments: 23.2 - Prevalence of corruption in relations with municipal governments: 13.9 - North-Eastern states: - Prevalence of corruption in administrative procedures: 13.2 - Prevalence of corruption in relations with the federal government: 0.7 - Prevalence of corruption in relations with state governments: 19.8 - Prevalence of corruption in relations with municipal governments: 15.3 - North-Western states: - Prevalence of corruption in administrative procedures: 14.6 - Prevalence of corruption in relations with the federal government: 0.6 - Prevalence of corruption in relations with state governments: 21.1 - Prevalence of corruption in relations with municipal governments: 18.5 - Western states: - Prevalence of corruption in administrative procedures: 12.6 - Prevalence of corruption in relations with the federal government: 0.7 - Prevalence of corruption in relations with state governments: 18.4 - Prevalence of corruption in relations with municipal governments: 15.5 - South-Eastern states: - Prevalence of corruption in administrative procedures: 13.1 - Prevalence of corruption in relations with the federal government: 1.8 - Prevalence of corruption in relations with state governments: 18.7 - Prevalence of corruption in relations with municipal governments: 12.1 ### AML/CFT Assessment (Box 4) — key findings and recommendations - Overall: - Mexico substantially meets 4 of the 11 immediate outcomes; remaining immediate outcomes are either of moderate or low effectiveness. - Technical compliance: Mexico is compliant or largely compliant with 24 of the FATF Recommendations; 16 Recommendations are either partially or non-compliant. - Key findings: - Amount of proceeds generated by predicate crimes is high; main predicates: drugs and human trafficking, corruption and tax evasion. - Typical ML methods: use of shell and front companies, purchase of real estate and other high value goods, and cash smuggling, facilitated by high use of cash and relatively large informal economy. - Most authorities have good risk understanding, but mitigation measures are insufficiently comprehensive, not prioritized, and have not resulted in corresponding resource allocation. - Financial sector and certain DNFBPs have uneven risk understanding, especially regarding corruption and misuse of legal persons; serious concerns on identification of beneficial owners across sectors. - FIU produces good financial intelligence but volume is insufficient; law enforcement and prosecution not prioritizing money laundering or parallel financial investigations, and law enforcement effectiveness is undermined by corruption. - Recommendations: - Fundamental changes to use of financial intelligence in investigations, prosecution and confiscation measures to prioritize money laundering investigations. - Additional investigative resources to focus on AML/CFT and predicate crimes; introduction of specialized teams for money laundering and corruption; use of parallel financial investigations; focus on confiscation. - Fundamental reforms to preventive measures for the financial sector and DNFBPs, and to supervision of these sectors (including penalties available to supervisors). ### Crime and economic activity (Box 5) - Incidence of violent crimes has risen substantially in recent years. - Direct costs associated with offenses against firms and protection against such offenses estimated at 0.7 percent of GDP. - Many firms, especially SMEs, have reduced operations and investments due to exposure to crime. - Mexico experienced 25,339 homicides in 2017 — a 50 percent jump from 2015 and the highest number since tracking began; murder rate of 21 per 100,000 persons in 2017. - Cases of vehicle theft increased by 18 percent since 2015. - Theft of cargo trucks rose from 5,400 cases in 2015 to 10,230 in 2017. - According to the 2016 Encuesta Nacional de Victimización de Empresas, more than a third of firms had fallen victim to at least one criminal offense in 2015. - Firms report that expenditures for security measures and direct losses from acts of crime alone accounted for 0.7 percent of GDP. *Source: cr18307-mexicobundle (PDF chapter/section).* ### 2015. In addition, firms, especially smaller ones, ### cr18307-mexicobundle - 2015. In addition, firms, especially smaller ones, ### Crime, Pemex, and business effects - Pemex is suffering from record levels of oil theft and violent crime. - Oil theft is costing the company $1.6 billion per year (0.15 percent of GDP), according to its own reporting. - Gangs and organized-crime groups are the main perpetrators of fuel theft; local residents have been known to tap pipelines for fuel to use or resell. - Pemex has been using satellite technology to monitor trucks involved in oil theft. - Violent crime has held back Pemex’s operations, deterred private firms, and will be a major challenge for future auctions. - Firm-level consequences reported (ENVE, 2016): canceled growth plans, reduced working schedules, canceled distribution routes — effects vary by firm size (Micro, Small, Medium, Large). ### Crime trends (1997–2017) - Time series reported for number of crimes by type: Homicide, Kidnapping, Extortion, Vehicle theft with violence (RHS), Vehicle theft without violence (RHS). - Murder Rates 2015 (per 100,000 people) chart referenced with comparative country codes; note: CHN*, IND*, CHL* use 2014 latest data available. ### Energy reform and Pemex policy - Continue with ongoing energy sector reform and foster private sector participation in generation, transmission, and distribution of oil, gas, and electricity. - Any review of already awarded contracts should be completed as soon as possible, and future auctions should continue. - Private participation in the oil sector is presented as necessary to bring sizeable investment and technological know-how, and would allow re-establishing Mexico as a net oil exporter. - Pemex’s autonomy should be preserved, and its financial strengthening continue. ### Labor market informality and policy options - Labor market informality remains stubbornly high despite a slight decline over the past decade.5 - Formal firms that employ salaried workers face social insurance contributions, minimum wage requirements, taxes, and sizable hiring/firing costs — these create an implicit subsidy to small unproductive firms with informal employees. - Increases in non-contributory benefits to informal workers along with higher income taxes on salaried workers have widened the incentive gap. - Recommendations: - Aim at a further reduction in informality, including through better enforcement. - Replace firing and hiring restrictions with an unemployment insurance scheme. - Following detailed impact analysis and comparison with other countries, consider an eventual transition towards a social insurance system covering both salaried and non-salaried workers, replacing funding from wage-based taxes paid solely by formal salaried workers with other revenue sources. - Footnote: See Chapter 1 of the accompanying SIP. ### Gender gaps and female labor force participation (Box 6) - FLFP increased from 41 to 43 percent since 2005 while the gender wage gap decreased by a third. - Remaining 34 percent gap in the FLFP rate relative to that of men. - Women remain heavily underrepresented in several sectors; gains have come from services, while agriculture and manufacturing exhibit stagnant or worsening gender gaps. - Most women work in the informal economy; female-to-male ratios are lowest in the formal private sector. - Child-bearing years see substantial increases in participation gaps; women with more children participate substantially less. - Policy recommendation: better policies for childcare, and improved maternity/paternity benefits (noted to remain well below OECD peers), to boost inclusion across sectors. ### Minimum wage - The minimum wage fell sharply in real terms in the early 1990s but has started to rise in the past three years. - Staff recommended any future adjustments be very gradual to avoid discouraging formal employment. - Ideally, changes to minimum wage policy should be accompanied by measures that reduce barriers to formalization. - Authorities highlighted weighing short-term gains for benefited workers against longer-term consequences on displacement toward informality and effects on the rest of the wage structure. ### Poverty, inequality, and social programs - Mexico's inequality has only slightly declined over the last decade and remains high compared to peers. - Conditional cash transfer programs (e.g., Prospera) are effective at reducing inequality; other programs disproportionately benefit individuals at the top. - The redistributive role of fiscal policy is weaker in Mexico than in other OECD countries.6 - Recommendations: - Consolidate and better target social programs. - Expand the old-age safety net to alleviate old-age poverty while considering effects on incentives to formal employment and affiliation with the defined-contribution pension system. ### Safeguards and audits - Staff completed safeguards procedures for Mexico’s 2017 FCL arrangement. - EY México (the external auditor) issued an unqualified audit opinion on Banco de México’s 2016 financial statements. - Staff reviewed 2016 audit results and noted timely publication of FY2016 financial statements; FY 2017 financial statements have also recently been published. - Banco de México’s Law was amended to strengthen the Audit Committee’s composition by including a majority of independent members; committee now meets regularly with external auditors. - No significant issues emerged from the conduct of the safeguards procedures. ### Macroeconomic appraisal: growth, fiscal, monetary, and external - Growth: GDP growth is projected to accelerate modestly in the near term and converge to just below 3 percent over the medium term; these rates are insufficient to fill the income gap with more advanced OECD countries. - Public debt: has risen since 2012 and exceeds 54 percent of GDP. - Fiscal stance: Incoming administration intends not to exceed the fiscal deficit target and to reduce public debt below the current level. - Required path: keep the deficit below 2½ percent of GDP over the medium term, corresponding to a primary surplus very close to 1 percent of GDP. - Recommendation: create a non-partisan, adequately-resourced fiscal council with a formal mandate to provide independent evaluation of fiscal policy. - Tax and spending reforms recommended: - Comprehensive tax reform to boost non-oil tax revenue. - Improve tax administration to address tax evasion. - Unify VAT rates with targeted transfers to the poor. - Reduce personal income tax exemptions and reform capital income taxation. - Increase property tax collection at the sub-national level. - End excise cuts used to smooth fuel prices. - Avoid exemptions or reduced tax rates that create distortions and erode the tax base. - Improve payroll management, public procurement systems, consolidate and better target social programs, and improve the defined-contribution pension system to free resources for education, health, and infrastructure. ### Monetary policy - Current monetary policy stance is adequate, with scope to gradually ease policy. - Inflation is on track to revert to the 3-percent target in the second half of 2019. - With a moderately negative output gap, the policy rate could be gradually reduced as long as inflation declines as projected, inflation expectations remain well-anchored, and uncertainty recedes. - Continued clear central bank communication is crucial. ### Financial stability and regulatory reforms - Continued vigilance needed: strong capital buffers and adequate loss-provisioning support banking sector resilience. - A healthy banking system will support financial deepening and inclusion via the national strategy for financial inclusion. - Development banks can play a role in lending to under-served markets, but quantitative lending targets should be avoided. - Regulatory reform recommendations: - Increase operational independence, budget autonomy, and legal protection of the banking and securities supervisor. - Extend supervisor authority to financial holding companies to close gaps identified by the 2016 FSAP. - Strengthen the resolution and crisis management framework. ### Structural reforms and governance - Perseverance with structural reforms is central to boost growth and reduce poverty and inequality. - Continue energy sector reform and private participation in gas and oil sectors to attract investment and increase oil production and growth. - Better enforcement of labor market regulations, introduction of unemployment insurance, improvements in the defined-contribution pension system, and stronger social safety nets would encourage formal employment and reduce poverty and inequality. - The prompt implementation of all requirements of the 2014 National Anticorruption System is crucial to address corruption and improve governance. - Enhancing effectiveness and quality of law enforcement and prosecution is critical to improve security and strengthen the rule of law. - Address shortcomings identified in the AML/CFT assessments is a priority. *International Monetary Fund* ### 56. It is proposed that the next Article IV Consultation with Mexico take place on the ### cr18307-mexicobundle - 56. It is proposed that the next Article IV Consultation with Mexico take place on the ### Real sector - Growth has been supported by strong services and some growth in manufacturing amid falling oil production. - Gross fixed capital formation has generally remained weak but improved somewhat in recent quarters. - Private consumption continues to grow as sentiment stabilized; consumer confidence index levels shown rising from 60 in 2011 to 62 in 2018 (Index, Jan. 2003 = 100; specific series displayed). - Non-oil exports slowed down in 2017 but are starting to rebound; real export growth series show non-oil exports and U.S. manufacturing (RHS) dynamics. - Employment and job creation supported private consumption with formal employment and total employment series rising (Formal employment and Total Employment 3QMA). ### Labor market - Unemployment rate has continued to decline, falling to the lowest level in a decade (series show unemployment around 3.6 percent in 2018; National unemployment rate (annual average) reported as 3.6). - Job creation now hovers around the historical average (historical avg. (2007-18 Q1) plotted). - Robust creation of full-time jobs; contributions to employment growth by sector include Manufacturing, Construction, Commerce, Other, and Total. - Average nominal wages and formal IMSS wages picking up (Formal IMSS Wages (monthly) series rising through 2017). - Unit labor cost (ULC) based real effective exchange rate has begun to recover from low levels. ### Prices and inflation - Headline inflation is coming down after increases largely on account of increases in food and domestic fuel prices. - Core components are already close to the target; while services and durables inflation are close to or even below target, non-durables inflation is still at around 6 percent. - Policy rate hikes have helped contain second-round effects from extended episodes of exchange rate depreciation and have kept medium-term inflation expectations anchored within the target band. - End-of-period consumer prices: 2014 = 4.1; 2015 = 2.1; 2016 = 3.4; 2017 = 6.8; 2018 = 4.4; 2019 (proj.) = 3.1 (Table 7). ### External sector - The current account deficit has declined; Current account balance (cumulative last 4 quarters, in percent of GDP) series: 2014 = -1.9, 2015 = -2.6, 2016 = -2.2, 2017 = -1.7, 2018 (proj.) = -1.7 (Table 4b). - Depreciation of the peso and a boom in automotive exports helped improve the external position; Value of exports index shows Automotive exports outperforming Non-Automotive Manufacturing and Crude Oil. - Both equity and debt portfolio flows have remained in positive territory; Portfolio investment, net (percent of GDP) shown: 2014 = -3.7, 2015 = -2.1, 2016 = -2.9, 2017 = -0.7, 2018 (proj.) = -1.5 (Table 4b). - Corporate bond issuance moderated (Corporate Bond Issuance series in USD billions, data through December 2017). - Reserves have stabilized amid only one discretionary spot intervention in early 2017; Gross international reserves (in billions of U.S. dollars) series: 2014 = 195.7; 2015 = 177.6; 2016 = 178.0; 2017 = 175.4; 2018 (proj.) = 178.0 (Table 4a). ### Reserve adequacy (international perspective, 2017) - Reserves to ARA Metric 1/ and Reserves to GDP plotted with suggested adequacy range 100-150% for ARA; Mexico appears within international comparisons (figures shown for multiple metrics). - Reserves to 3M imports, Reserves to Short-Term Debt, and Reserves to Broad Money metrics presented with adequacy ranges: > 100% for 3M imports and short-term debt; 5-20% for broad money. ### Fiscal sector - The 2013 tax reform and lower oil production have reduced fiscal dependence on oil; oil revenue (RHS) trends shown declining vs. non-oil tax revenues rising. - Further declines in oil production remain an important fiscal risk (Oil Production Forecast vintages and PEMEX series displayed). - General government revenue and expenditure (in percent of GDP): revenue 2014 = 23.4, 2015 = 23.5, 2016 = 24.6, 2017 = 24.8, 2018 (proj.) = 23.5; expenditure 2014 = 28.0, 2015 = 27.5, 2016 = 27.4, 2017 = 25.9, 2018 (proj.) = 26.0 (Table 3). - Overall public sector deficit narrowed then widened: Overall fiscal balance (percent of GDP) 2014 = -4.5; 2015 = -4.0; 2016 = -2.8; 2017 = -1.1; 2018 (authorities' presentation) = -2.0 (Table 2 shows Traditional balance and PSBR path). - Gross public sector debt: 2014 = 48.9 percent of GDP; 2015 = 52.8; 2016 = 56.8; 2017 = 54.3; 2018 (proj.) = 53.1 (Table 3). IMF/Staff notes that stabilizing the debt-to-GDP ratio would require PSBR at 2.5 percent of GDP (shown in chart annotation). ### Financial sector and markets - The peso appreciated somewhat after falling in late 2016/early 2017 but remained volatile; Nominal (MXN/USD) series and REER index displayed (Index 2010=100). - Long-term and government bond yields in local currency have edged up (1-Year, 5-Year, 10-Year, 20-Year yields plotted; yields as of September 2018 shown). - Sovereign and corporate risk spreads have remained stable (5Y CDS and CEMBI spreads as of September 21, 2018 displayed). - ETFs and mutual fund flows weakened in recent months but outflows remained contained (USD billions as of September 2018). ### Banking sector - The banking sector remains profitable and well capitalized: Regulatory capital to risk-weighted assets 2015 = 15.0, 2016 = 14.9, 2017 = 15.6, 2018 (July) = 15.6 (Table 5). - Nonperforming loans low: Nonperforming loans to total gross loans 2015 = 2.5, 2016 = 2.1, 2017 = 2.1, 2018 (July) = 2.1 (Table 5). - Return on assets and return on equity: ROA 2015 = 1.6, 2016 = 1.7, 2017 = 2.0, 2018 (July) = 2.2; ROE 2015 = 15.4, 2016 = 16.3, 2017 = 19.6, 2018 (July) = 20.7 (Table 5). - Commercial bank credit growth moderated after picking up; development bank consumer credit growth remains strong (credit growth series by sector). ### Nonfinancial corporate sector - Corporate leverage edged up; median Total Debt to Total Equity series shown rising modestly through 2017. - Nonfinancial corporate bond issuance expanded (US$ billion series excluding PEMEX). - Debt servicing capacity remains strong despite a drop in 2017: Interest Coverage Ratio (earnings in multiples of interest expense, median) plotted. - Maturity profile of corporate bonds largely termed out; current ratio (cash and cash equivalent to short-term debt) indicates corporate liquidity remains good. ### Social indicators - Poverty headcount ratio at $1.90 (2011 PPP) and at $3.10 (2011 PPP) shown; CONEVAL measure indicates Poverty headcount ratio (% of population, 2016) = 43.6 (Table 1). - GDP per capita (U.S. dollars, 2017) = 9,318.8 (Table 1). - Infant mortality rate (per 1,000 live births, 2016) = 12.6; life expectancy at birth (years, 2016) = 77.1 (Table 1). - The homicide rate remains high (Intentional homicides per 100,000 people plotted), and a large share of youth is excluded from education or employment (Share of youth not in Education, Employment or Training plotted). ### Key numeric indicators and medium-term projections (selected) - GDP real growth: 2014 = 2.8; 2015 = 3.3; 2016 = 2.9; 2017 = 2.0; 2018 (proj.) = 2.1; 2019 (proj.) = 2.3; 2023 (proj.) = 2.9 (Table 7). - Consumer prices (end-of-period): 2017 = 6.8; 2018 (proj.) = 4.4; 2019 (proj.) = 3.1; 2023 (proj.) = 3.0 (Table 7). - Current account balance (percent of GDP): 2017 = -1.7; 2018 (proj.) = -1.7; 2019 (proj.) = -1.8; 2023 (proj.) = -1.9 (Table 7). - Gross international reserves (in billions of U.S. dollars): 2014 = 195.7; 2015 = 177.6; 2016 = 178.0; 2017 = 175.4; 2018 (proj.) = 178.0; 2023 (proj.) = 205.7 (Table 4a). - Gross public sector debt (percent of GDP): 2014 = 48.9; 2015 = 52.8; 2016 = 56.8; 2017 = 54.3; 2018 (proj.) = 53.1; 2023 (proj.) = 53.4 (Table 3). *Source: cr18307-mexicobundle — IMF staff estimates, national authorities, and data presented in the chapter.* ### Annex I. Risk Assessment Matrix ### Annex I. Risk Assessment Matrix ### Overview - The Risk Assessment Matrix (RAM) displays events that could materially alter the baseline path. The RAM reflects staff views on sources of risk 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 (ST)” and “medium term (MT)” indicate that the risk could materialize within 1 year and 3 years, respectively. - Relative likelihood coding: Low (L), Medium (M), High (H). - Staff’s subjective probability interpretation: “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. ### Identified Risks, Likelihood, Impact, and Policy Responses - Sharp tightening of global financial conditions - Source: External - Type: (not specified) - Up/Downside: (not specified) - Relative likelihood: H - Impact: H - Policy response: Exchange rate flexibility and provision of liquidity to mitigate disorderly market conditions. - Unsustainable macroeconomic policies in systemically important countries - Source: External - Type: (not specified) - Up/Downside: (not specified) - Relative likelihood: M - 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 potential. - Rising protectionism and retreat from multilateralism - Source: External - Type: (not specified) - Up/Downside: (not specified) - 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 potential. Support for multilateral efforts to promote global trade. - Weaker-than-expected global growth - Source: External - Type: (not specified) - Up/Downside: (not specified) - Relative likelihood: M - Impact: H - Policy response: Steadfast implementation of structural reforms to boost growth potential. - Lower energy prices - Source: External - Type: (not specified) - Up/Downside: (not specified) - Relative likelihood: M - Impact: L - Policy response: Exchange rate flexibility and fiscal adjustment. - Weaker than expected oil production at PEMEX - Source: Domestic - Type: (not specified) - Up/Downside: (not specified) - Relative likelihood: M - Impact: M - Policy response: Implement joint ventures to benefit from technology transfer. - Slower-than-anticipated fiscal consolidation in the context of the incoming administration’s fiscal policy agenda - Source: Domestic - Type: (not specified) - Up/Downside: (not specified) - Relative likelihood: M/L - Impact: H - Policy response: Maintain the consolidation effort. Use positive revenue surprises to reduce the deficit faster. - A further deterioration in corruption and the weak rule of law - Source: Domestic - Type: (not specified) - Up/Downside: (not specified) - Relative likelihood: L - Impact: M - Policy response: Push ahead with structural reforms including to strengthen the rule of law and fight crime and corruption. *Annex I. Risk Assessment Matrix (RAM) contents and explanatory notes as presented in the source document.* ### 13.3 percent of GDP in 2023. ### cr18307-mexicobundle - 13.3 percent of GDP in 2023. ### Net Public Debt - Authorities use Historical Balance of the Public Sector Borrowing Requirements (HBPSBR), analogous to a net debt concept. - Staff estimate: net public debt (defined as gross debt minus public assets) would remain around 45 percent of GDP over the medium term. ### External Debt Sustainability - External debt dynamics: - Mexico’s external debt as share of GDP declined slightly by 0.4 percentage points in 2017, in part due to price and exchange rate changes (-1.8 percentage points), to 38.1 percent of GDP. - Under the current baseline projections, external debt is expected to increase slightly before stabilizing around 39 percent of GDP in the medium term. - Composition and vulnerabilities: - A relatively large share of Mexico’s external debt, 25.8 percent of GDP, is owed by the public sector, of which 16.8 percentage points by the federal government. - Mexican peso–denominated portion: 9.3 percent of GDP. - Exchange rate risk: a 30 percent depreciation is estimated to lead to an increase in external debt up to 54 percent of GDP. - Rollover risks for federal government debt are mitigated by a very favorable maturity structure and continuous prudent debt management. - Banking sector: well capitalized and liquid, assessed to be resilient to large shocks. - Non-financial corporate debt levels: low; foreign exchange risks well covered by natural and financial hedges. ### Public DSA Risk Assessment and Indicators - Visual/heat-map indicators summarized (as presented by IMF staff): - Debt level and gross financing needs compared to benchmarks (70% debt benchmark; 15% gross financing needs benchmark). - Market perception: EMBIG and sovereign spread indicators referenced (EMBIG average over last 3 months: 23-Jun-18 through 21-Sep-18). - Key market and macro indicators (selected exact figures): - Nominal gross public debt (percent of GDP): 44.3 (2016), 56.8 (2017), 54.3 (2018), with projections showing 53.1 (2019), 53.2 (2020), 53.4 (2021), 53.4 (2022), 53.4 (2023). - Public gross financing needs (percent of GDP): 11.1 (2016), 13.6 (2017), 7.5 (2018), 9.2 (2019), 10.1 (2020), 10.3 (2021), 10.0 (2022), 10.4 (2023). - Real GDP growth (in percent): 2.0 (2016), 2.9 (2017), 2.0 (2018), projections: 2.1 (2019), 2.3 (2020), 2.6 (2021), 2.9 (2022), 2.9 (2023). - Inflation (GDP deflator, in percent): 4.3 (2016), 5.4 (2017), 6.1 (2018), projections: 5.2 (2019), 3.5 (2020), 3.1 (2021), 3.2 (2022), 3.2 (2023), 3.1 (2023 noted earlier). - Nominal GDP growth (in percent): 6.4 (2016), 8.4 (2017), 8.3 (2018), projections: 7.4 (2019), 5.9 (2020), 5.8 (2021), 6.2 (2022), 6.2 (2023). - Effective interest rate (in percent): 7.8 (2016), 6.8 (2017), 7.8 (2018), projections: 7.5 (2019), 7.2 (2020), 7.0 (2021), 6.9 (2022), 6.9 (2023). - Sovereign spread indicators: EMBIG (bp) 263; 5Y CDS (bp) 116 (as of table date). - Cumulative change in gross public sector debt (selected values): - Change in gross public sector debt: 1.7 (2007-2015 actual cumulative), 3.9 (2016), -2.4 (2017), -1.3 (2018), with projections showing small changes through 2023 and a cumulative -0.9 noted. - Identified debt-creating flows (selected components, in percent of GDP): - Primary deficit: 0.2 (2007-2015), -0.6 (2016), -3.0 (2017), -1.3 (2018), projections: -1.1 (2019) through -1.0 (2023), cumulative -6.3. - Primary (noninterest) revenue and grants: 24.0 (2007-2015), 24.6 (2016), 24.8 (2017), 23.5 (2018), 21.7 through 21.8 in projections, cumulative 132.0. - Primary (noninterest) expenditure: 24.2 (2007-2015), 24.0 (2016), 21.8 (2017), 22.2 (2018), projections 20.6 through 20.8, cumulative 125.8. - Automatic debt dynamics contribution: 1.2 (2007-2015), 2.2 (2016), -1.1 (2017), 0.1 (2018), projections small positive contributions through 2023, cumulative 2.4. - Exchange rate depreciation contribution: 0.6 (2016), 3.1 (2017), -0.8 (2018). - Other identified debt-creating flows and change in assets: 0.2 (2007-2015), 2.2 (2016), 0.8 (2017), 0.6 (2018), projections 0.5 each year, cumulative 2.9. - Residual: 0.1 (2007-2015), 0.0 (2016), 0.8 (2017), -0.6 (2018), projections small positives thereafter, cumulative 0.1. ### Baseline and Alternative Scenarios—Underlying Assumptions - Baseline projections (selected exact figures): - Real GDP growth: 2.1 (2018), 2.3 (2019), 2.6 (2020), 2.9 (2021), 2.9 (2022), 2.9 (2023). - Inflation: 5.2 (2018), 3.5 (2019), 3.1 (2020), 3.2 (2021), 3.2 (2022), 3.1 (2023). - Primary Balance (percent of GDP): 1.3 (2018), 1.1 (2019), 1.0 (2020), 1.0 (2021), 1.0 (2022), 1.0 (2023). - Effective interest rate: 7.5 (2018), 7.2 (2019), 7.0 (2020), 6.9 (2021), 6.9 (2022), 6.9 (2023). - Historical scenario and Constant Primary Balance scenario parameters are provided and contrasted in the source tables. - Debt composition and projections include breakdowns by maturity (short-term vs medium and long-term) and by currency (local currency-denominated vs foreign currency-denominated) over 2016–2023. ### Stress Tests and Sensitivity Analyses - Stress tests conducted include: - Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Macro-Fiscal Shock. - Additional stress tests and alternative distributions/restrictions used for shock simulations. - Key stress-test outcomes (selected exact results): - External debt baseline: 39 (percent of GDP). - Historical scenario external debt: 50 (percent of GDP) in one depiction; baseline 39. - Combined shock results: e.g., combined shock showed external debt around 41 in one chart, and a 30 percent real depreciation shock in 2017 raised external debt to 54 percent of GDP. - Debt-stabilizing non-interest current account indicated as -2.4 (percent of GDP) in a projection line. - External debt DSA projections (selected rows, in percent of GDP unless noted): - Baseline external debt path: 31.1 (2013), 32.5 (2014), 35.7 (2015), 38.5 (2016), 38.1 (2017), 38.5 (2018), 38.6 (2019), 38.8 (2020), 39.0 (2021), 39.0 (2022), 39.0 (2023). - Change in external debt: 2.3 (2013), 1.4 (2014), 3.2 (2015), 2.7 (2016), -0.4 (2017), 0.4 (2018), 0.1 (2019), 0.2 (2020), 0.2 (2021), 0.0 (2022), 0.0 (2023). - Gross external financing needs (in billions of US dollars): 129.1 (2013), 136.9 (2014), 139.0 (2015), 122.9 (2016), 97.8 (2017), 90.9 (2018), 97.6 (2019), 109.0 (2020), 107.0 (2021), 115.9 (2022), 116.3 (2023). - Gross external financing needs as percent of GDP: 10.1 (2013), 10.4 (2014), 11.9 (2015), 11.4 (2016), 8.5 (2017), with 10-Year figures shown around 7.4–7.8 in ranges presented. ### Forecast Track Record and Annex IV Findings - Staff GDP and inflation forecast errors: - Staff’s forecast errors in projecting GDP growth are largely explained by the recent revision in National Accounts Statistics. - Mexico compared positively to the sample of EMDEs, but the RMSE for growth projections since 2012 exceeded that of trading partners and regional peers. - Largest same-year forecast errors occurred in 2014-16; errors largely explained by revisions of National Accounts statistics carried out in 2017. - In 2014 and 2015, growth revisions in the US represent an additional factor explaining the forecast errors. *Source: IMF staff (cr18307-mexicobundle).* ### 2. Mexico stands out positively in terms of staff’s errors in projection inflation. Mexico’s ### 2. Mexico stands out positively in terms of staff’s errors in projection inflation. Mexico’s ### Forecast accuracy and recent vintage errors - Mexico’s RMSE for inflation projections is lower than that of the EMDE sample as a whole and lower than samples of regional peers and trading partners. - Mexico: Real GDP Growth (vintages 2012–2017) - Outturn: 3.6, 1.4, 2.8, 3.3, 2.9, 2.0 - Forecast in October: 3.8, 1.2, 2.4, 2.3, 2.1, 2.1 - Error: -0.1, 0.1, 0.4, 1.0, 0.8, -0.1 - US Real GDP Growth (vintages 2012–2017) - Outturn: 2.2, 1.8, 2.5, 2.9, 1.6, 2.2 - Forecast in October: 2.2, 1.6, 2.2, 2.6, 1.6, 2.2 - Error: 0.1, 0.3, 0.3, 0.3, 0.0, 0.0 - Mexico CPI Inflation (avg., vintages 2012–2017) - Outturn: 4.1, 3.8, 4.0, 2.7, 2.8, 6.0 - Forecast in October: 4.0, 3.6, 3.9, 2.8, 2.8, 5.9 - Error: 0.2, 0.2, 0.1, -0.1, 0.0, 0.2 - Source for these series: WEO and Fund Staff Calculations. ### Annex V — Overview: Tax Revenue Mobilization - Recent gains in tax revenue have been impressive, but Mexico’s tax-to-GDP ratio "significantly lags that of regional and international peers." - The tax-to-GDP ratio has increased by almost three percentage points since 2013 (the year before the last major tax reform). - Drivers of the increase: - Increases in direct taxes. - Fuel excises as fuel price subsidies have been reduced. - VAT revenue has stagnated and remains much below that of other countries. ### Corporate Income Tax (CIT) risks and productivity - Heavy reliance on CIT exposes Mexico to potential revenue losses from the U.S. tax reform through profit-shifting and potential relocation of production. - Beer et al. (2018) estimate that losses in CIT revenue from multinational enterprises (MNE) are larger in Mexico than in most other countries they consider. - Mexico’s CIT rate is relatively high (Figure 2 in source); lowering the CIT rate could exacerbate revenue losses. - CIT productivity is at the average of international peers and above several advanced economies, implying "little scope to increase CIT revenue through base broadening measures." - (Figure references and data sources: FAD Tax Policy Rates Database; OECD; Eurostat; WEO; IMF Staff calculations.) ### Value-Added Tax (VAT) — scope for revenue increases - There is "much scope to increase VAT revenue, with the potential to more than double its current revenue intake." - Mexico collects 0.23 percent of GDP per percentage point of VAT rate, while OECD and regional peers collect 0.4 and 0.3 percent of GDP per percentage point of VAT rate, respectively. - Mexico’s low VAT c-efficiency ratio reflects a combination of low tax compliance and a narrow base, implying large policy and compliance gaps. Key VAT-specific findings and recommendations: - Taxing all food items at a zero rate creates revenue losses in excess of 1 percent of GDP. - First-best: tax all goods and services at a single rate and provide targeted social benefits where needed. - Second-best: make goods currently zero-rated VAT exempt to decrease VAT complexity, reduce the number of VAT refunds, and likely increase revenue. - Optionally tax unhealthy food items subject to excises, and food items typically consumed by the rich (e.g., frozen or processed food) at the standard rate. - Offsetting unpaid VAT refunds against other tax obligations: - Offsets amounted to 1.1 percent of GDP. - Under GFS guidelines, these offsets should be deducted from official VAT revenue figures; doing so would lower VAT revenue by over 25 percent and worsen VAT efficiency/productivity measures. - Cross-crediting complicates verification and increases opportunities for tax fraud. - E-commerce and digital services VAT regime should be modified: - Tax services provided abroad but consumed in Mexico by requiring providers to register for VAT in Mexico. - Require platforms enabling P2P transactions in Mexico to register for VAT and to provide information on providers, users and payments. ### Small taxpayer regime - The small taxpayer regime is overly complex; tax obligations can vary by industry, type of clients and sales relative to two different thresholds. - The regime imposes a significant compliance burden and can cause distortions and productivity losses. - Despite an increase in the number of small taxpayers, "the level of additional revenue generated is very low." - Recommendation: a rigorous evaluation is necessary to determine whether the small taxpayer regime helps taxpayers graduate into the normal regime. ### VAT compliance and SAT institutional issues - SAT has sophisticated tools, systems, and legislation to address high VAT non-compliance but lacks a comprehensive compliance improvement plan. - SAT’s fragmented organizational structure limits effectiveness. - Audit probabilities for VAT payers are extremely low, reducing the perceived risk of detection of fraudulent behavior. - A comprehensive SAT strategy to address VAT non-compliance could help reduce the compliance gap. ### Fuel excises and price smoothing - There is scope to generate additional revenue from fuel price excises. - Current practice of fuel price smoothing, while preferable to outright fuel subsidies, is still costly in terms of foregone revenue and could be reduced or abolished. ### Personal Income Tax (PIT) - Limited scope to raise revenues from PIT via rate increases: - Average and top marginal PIT rates are above the regional average. - The top marginal rate was increased by five percentage points as part of the 2014 tax reform. - The labor wedge appears to be excessively high despite limited scope for rate increases. - (Figure 4 and data sources: FAD Tax Policy Rates Database; IBFD.) ### Property taxation (local level) - Revenue from property taxation is very low as a percent of GDP and well below regional and OECD averages (Figure 5). - Increasing property tax revenue is feasible mainly over the medium term. ### Social Security Contributions (SSC) and evasion - Revenue from SSC is relatively low, presumably in part due to evasion and avoidance. - SSC are levied on the base wage of salaried workers, but not on the wage of non-salaried workers, facilitating avoidance. - The vast majority of firms implicitly report effective SSC rates of less than the legally required norm (legal effective minimum rate is around 17 percent for taxpayers under the normal tax regime; before 2014 it was binding for all firms with salaried workers). - Significant variation exists across states: a difference of 7.3 percentage points between the state with the lowest and highest reported rate. - Regression analysis using Mexico’s 2013 Economic Census suggests SSC non-compliance is endemic and concentrated spatially and across industries and supply chains — compliance of individual firms depends on compliance of other nearby or connected firms. - Box 1 finding: large-scale efforts by authorities would likely be required to change compliance behavior. ### Annex VI — Fintech regulation: balancing risks and rewards - Fintech in Mexico has grown rapidly but penetration remains low: - 238 fintech firms operating in Mexico as of June 2017 (Finnovista). - 69 percent of fintech firms began operations within the last 3 years. - 39 percent have less than 10 employees. - Mexico accounts for 25 percent of Fintech activities in Latin America. - Example volumes: total electronic payments with Paypal Mexico amounted to MXN11billion in 2016; largest P2P lending platform Kubo Financiero had a loan balance of about USD10 million in 2017. - Potential benefits of Fintech: - Strengthen competition in the financial sector. - Promote financial inclusion and reduce intermediation costs. - Reduce costs for payment and remittance transactions (benefitting migrant workers). - Use of big data algorithms for credit risk (P2P lending) and potential inclusion of rural areas. - Faster and cheaper cross-border money transfers. - Risks similar to traditional financial intermediaries: - ML/TF risks, cyber risk, data privacy concerns, financial fraud. - Fund-raising activities could turn into Ponzi games without appropriate supervision and consumer protection. - Big data-based risk models have not been fully tested across economic cycles — risk of significant mispricing and investor losses. - Some fintech asset managers face maturity mismatches and liquidity risk or deposit runs. - Cryptocurrency assets may pose considerable ML/TF risks due to varying anonymity and absence of regulated intermediaries. _Italic: Source — cr18307-mexicobundle (PDF chapter/section) — IMF Staff calculations and source figures as cited in the document._ ### 4. The new legal and regulatory framework for Fintech should reduce the legal ### cr18307-mexicobundle - 4. The new legal and regulatory framework for Fintech should reduce the legal ### Overview - The law approved in March 2018 is intended to give Fintech companies greater regulatory certainty regarding crowdfunding, payment methods and rules surrounding cryptocurrencies such as bitcoin. - Regulation on e-payment and crowdfunding was published in September 2018, which covers license requirements, investor protection, data sharing and AML/CFT. - Fintech firms can formally apply to enter the new regulatory regime. ### Key clauses of the March 2018 law - P2P lenders should not guarantee a fixed return for investors while Fintech firms should have “skin the game” by linking their fee or own capital to the performance of the P2P loan. - An open data framework will be adopted to allow financial institutions and Fintech firms to share transactions data with the permission of the consumer. - The fee to access the data will be regulated to cover the cost of providing the data through open data APIs. ### Regulatory sandbox and implementation - The regulations recognize the sandbox approach to provide regulatory relief for Fintech firms who might be unable to meet the full requirements initially. - Sandboxes often include safeguards to contain restrictions on the scope of the experiment, such as the duration, and number and type of customers. - Example: an e-payment firm with demonstrated benefit for its users can operate under regulatory sandbox for up to one year, extendable for another year upon request under the discretion of the regulator. - CNBV has set up a sandbox for testing innovative ideas free of regulatory burden on a small scale and for targeted products. ### Principles for Fintech regulation - Regulations aim to strike a balance between promoting innovation and investor protection. - Fintech regulations should be proportional and adaptive to balance innovation and risks while ensuring a level playing field. - Ideally, Fintech regulations should be technology-neutral and designed to reduce regulatory arbitrage. - International best practices on Fintech regulations have yet to emerge, including on data access, the definition of security (e.g. P2P loan, initial coin offering) and the licensing regime. - Regulatory uncertainty and overreach can hurt the Fintech industry; the regulatory stance currently varies significantly across countries in terms of licensing requirements, transaction size and flexible bank charters. ### Implications for financial inclusion and competition - Given the low credit penetration and financial inclusion in Mexico, Fintech has good potential to improve competition, lower transaction costs, and ease credit access, especially for SMEs and households. *International Monetary Fund — Staff report excerpt (October 18, 2018).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18307-mexicobundle.pdf_