## cr18332-mexicobundlefcl

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### Executive summary — context, risks, and FCL request
- Very strong policies and policy frameworks have helped Mexico navigate a complex external environment.
- Fiscal policy has been successful in stemming the rise in the public debt ratio in the past two years.
- Monetary policy maintains a cautious stance; financial supervision and regulation are strong; the flexible exchange rate helps adjustment to external shocks.
- Structural reforms initiated in 2012 have yielded important transformations in the Mexican economy.
- The FCL arrangement provides a reassuring signal and valuable insurance against external tail risks.
- Access history and request:
  - On November 29, 2017, Executive Board approved a 24-month precautionary FCL arrangement of SDR 62.3889 billion (700 percent of quota).
  - Current administration requests reduction in access to SDR 53.4762 billion (600 percent of quota).
  - Both administrations intend to treat the arrangement as precautionary.
  - Staff recommends completing the review, allowing purchases until expiration on November 28, 2019.

### Risks and vulnerabilities
- Key exposures:
  - Strong trade and financial links to the global economy, particularly the United States.
  - Susceptibility to changes in investor sentiment and abrupt shifts toward emerging markets.
  - High share of non-resident holdings of government paper increases exposure to capital flow reversals and increased risk premia.
- Specific risk factors:
  - Renewed volatility in global financial markets, increased risk premia, and sharp pull-back of capital from emerging markets.
  - A fall in global growth or an exacerbation of trade tensions among major economies would hamper growth.
  - Trade-regime uncertainty with the United States has receded following USMCA, but global trade tensions and country-specific uncertainty remain.

### Qualification for FCL and staff assessment
- Staff assessment: Mexico continues to meet the qualification criteria under Decision No. 14283-(09/29), adopted on March 24, 2009, as amended.
- Incoming administration provided assurances to maintain very strong policies and institutional policy frameworks.
- Staff supports the current administration’s request for reduced access to SDR 53.4762 billion (600 percent of quota).

### Recent economic and financial developments — key statistics
- Growth and inflation:
  - Output growth: 2.2 percent (first three quarters of 2018).
  - Core inflation: 3.7 percent (y-o-y) in September 2018.
  - Headline inflation: 4.65 percent in June, 5.0 percent in September; 4.9 percent in October.
  - Bank of Mexico policy rate: increased by 75 basis points in three steps between December 2017 and June 2018 to 7.75 percent; raised to 8 percent on November 15, 2018.
- External sector:
  - Current account deficit: US$12.6 billion (first half of 2018); full-year 2017: US$19.5 billion (1.7 percent of GDP).
  - Peso: 2.7 percent stronger in real effective terms relative to 2017 average (end-September 2018); recent episodes of weakening and sharp depreciation following airport cancellation announcement.
  - Net international investment liability position: about minus 48 percent of GDP (improved modestly).
  - Residents’ foreign assets: 60 percent of GDP (June 2018).
- Financial markets and sovereign ratings:
  - Moody’s upgraded outlook to stable in April 2018; Fitch kept rating at BBB+ but cut outlook to negative in October 2018 after airport announcement.
  - Sovereign CDS and bond spreads have risen somewhat but less than in other EMs.
  - Market moves (recent weeks): peso depreciated by some 5 percent since October 26; stock market fell by 9.5 percent; EMBIG spread widened by 50 basis points; 5-year CDS spread widened by 16 basis points.
- Financial sector soundness:
  - Banking sector Tier-1 capital ratio: 14.0 percent (as of July 2018).
  - Return on equity: 20.7 percent.
  - NPL ratio: 2.1 percent.
  - Commercial bank credit to non-financial corporate sector: strengthened by 9.4 percent (y-o-y) in real terms in September.
  - Consumer credit growth: 1.5 percent.
  - Household credit-to-GDP ratio: 16.1 percent (compare to 39.8 percent average for other emerging economies).
  - Provisioning: 150.7 percent of non-performing loans.
  - Gross international reserves: US$177.1 billion (end-September 2018); US$176.4 billion (end-October 2017).

### Outlook and policy stance
- Growth outlook:
  - Growth expected to accelerate modestly near term; supported by private consumption and small net exports contribution.
  - Investment expected to remain weak in export-oriented manufacturing.
  - Growth would gradually converge to just under 3 percent over the medium term as structural reforms continue.
  - Baseline medium-term projections (selected): GDP real growth 2.1 (2018), 2.3 (2019), 2.6 (2020), 2.9 (2021–2023).
- Monetary policy:
  - Bank of Mexico tightened policy by 450 basis points since December 2015.
  - Inflation target: 3 percent; headline inflation expected to converge toward the target in the second half of 2019.
- Fiscal policy:
  - 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.
  - Incoming administration preparing 2019 budget with unchanged PSBR target and assured staff fiscal plans consistent with reducing public-debt-to-GDP ratio.
  - Transition team committed to limiting PSBR to no more than 2.5 percent of GDP for 2019 and targeting a primary surplus close to 0.8 percent of GDP as main anchor.

### Incoming administration priorities and commitments
- Commitments:
  - Preserve independence of central bank; maintain floating exchange regime.
  - Fiscal policy aimed at gradually reducing public debt in relation to GDP.
  - Strengthen fiscal framework; fight tax evasion; improve efficiency and quality of public spending to create space for infrastructure spending.
  - No envisaged changes to tax system in the next couple years except for VAT and CIT reduction in northern border region.
  - Centralize public procurements and consolidate social programs and agencies to generate savings.
  - Transition team supports reducing FCL access to 600 percent of quota (SDR 53.4762 billion; around USD 74.1 billion as cited).

### External Economic Stress Index (ESI) and adverse scenario
- ESI construction and weights:
  - Exports, remittances, inward FDI proxied by U.S. growth (weight 0.50).
  - Debt flows proxied by change in U.S. Treasury 10-year yield (weight 0.35).
  - Equity flows proxied by VXEEM (weight 0.14).
  - Oil industry proxied by change in world oil prices (weight 0.02).
- Global downside scenario assumptions:
  - Inflation surprise in the United States leading to a 100 basis points increase in the U.S. term premium.
  - Reduction of U.S. growth by 0.67 percentage point and lower oil prices by 5 percent relative to baseline.
  - Surge in global financial market volatility with the VXEEM rising by 3 standard deviations.
- Scenario-specific shocks and assumptions:
  - Current account shock: 0.23 percent of GDP (smaller than 0.45 percent assumed at approval).
  - Foreign direct investment shock: 50 percent drop in net FDI inflows (smaller than assumed at approval).
  - Gross equity portfolio inflows shock: same shock (1.6 standard deviations) as at approval; Equity Portfolio Inflows shock 1.6 std dev = USD 10.7bn in table context.
  - Resident portfolio outflows shock: same shock (1.6 standard deviations) as at approval; Residents' foreign portfolio & other investment shocks 1.6 std dev = USD 23.9bn, USD 25.1bn in table context.
  - Foreign currency-denominated debt rollover assumption: 80 percent.
  - Peso-denominated debt rollover assumption: 71 percent.
- Reserve use and adequacy in scenario:
  - Assumed reserve drawdown of $14 billion in the downside scenario (table also labels alternatives USD 10-14 bn and USD 5bn).
  - Reserve adequacy (ARA metric) would be 108.2 percent in 2019 under the scenario.
- Selected scenario figures (External Financing Requirements and Sources, in billions of U.S. dollars, table context preserved):
  - Gross external financing requirements (Proj. Adverse 2019): 123.3 (2017), 95.2 (2016), 93.4 (2014), 99.1 (2012), 88.1 (2016), contribution to gap -11.0.
  - Change in international reserves: 0.4 (2017), -2.6 (2016), 2.5 (2014), 1.5 (2012), -12.5 (2016), -14.0 (Adverse 2019).
  - Financing Gap (USD billions) reported as 73.0; SDR (1.38370575773803 USD/SDR, Oct. 26, 2018) shown as 52.7; Percent of quota shown as 592 in table context.
- ESI conclusion: global downside scenario shows clear deterioration compared to November 2017; country-specific uncertainty (likelihood of abrupt change in trade relations with U.S.) has abated.

### FCL performance, access considerations, and illustrative adverse scenario results
- The FCL has complemented Mexico’s policies, policy frameworks, and international reserves, and bolstered market confidence.
- Access amount justified at SDR 53.4762 billion (600 percent of quota) as part of gradual phasing out while external risks remain elevated.
- Use of reserves in illustrative adverse scenario: assumed drawdown USD 14 bn; ARA metric 108.2 percent (2019 under scenario).
- Financing and capacity-to-repay metrics:
  - GRA credit to Mexico (SDR millions) assumed: 53,476.2.
  - Under full disbursement in 2018 scenario:
    - Total external debt would initially climb to 44.6 percent of GDP, then decline.
    - Fund credit would initially correspond to around 6.1 percent of GDP.
    - Projected debt service to the Fund would reach peak SDR 28.5 billion (about 2.7 percent of GDP) in 2022.
  - Sovereign bond (EMBIG) spread and five-year CDS spreads: 261 and 126 basis points, respectively (as of October 18, 2018).

### Institutional quality, governance, and safeguards
- Institutional anchors:
  - Inflation-targeting framework; fiscal responsibility law; prudential and regulatory framework for financial supervision.
  - 2017 World Bank Governance Indicators: government effectiveness at the 52nd percentile.
  - Control of corruption remains a weaker area.
  - Constitutional reform (May 2015) and secondary legislation (July 2016) created a National Anticorruption System and increased transparency; implementation under way.
- Safeguards and audits:
  - Safeguards procedures for 2017 FCL were completed.
  - EY México issued an unqualified audit opinion on Banco de México’s 2016 financial statements; FY 2016 financial statements published timely; FY 2017 financial statements recently published.
  - Banco de México’s Law amended to strengthen Audit Committee composition; committee meets regularly with external auditors; no significant issues emerged from safeguards procedures.
- Data quality:
  - Mexico remains in observance of the Special Data Dissemination Standards (SDDS); overall data quality high and adequate for surveillance.
- Track record:
  - Sustained track record of implementing very strong policies; staff’s assessment that all relevant core indicators were met in each of the five most recent years.

### Public debt, DSA, stress tests, and projections (selected numeric series)
- Gross public sector debt (percent of GDP): 48.9 (2014), 52.8 (2015), 56.8 (2016), 54.3 (2017), 53.1 (2018), projections 53.2 (2019), 53.4 (2020), 53.4 (2021), 53.4 (2022), 53.4 (2023).
- Public DSA baseline assumptions (selected):
  - Real GDP growth (percent): 2.1 (2018), 2.3 (2019), 2.6 (2020), 2.9 (2021–2023).
  - Inflation: 5.2 (2018), 3.5 (2019), 3.1 (2020), 3.2 (2021–2022), 3.1 (2023).
  - Primary balance (percent of GDP): 1.3 (2018), 1.1 (2019), 1.0 (2020–2023) under baseline.
  - Effective interest rate (percent): 7.5 (2018), 7.2 (2019), 7.0 (2020), 6.9 (2021–2023).
- Balance of payments (selected, billions of US$):
  - Current account: -24.6 (2014), -30.3 (2015), -23.9 (2016), -19.5 (2017), -20.7 (2018), projected -23.2 (2019), -25.2 (2020), -26.6 (2021), -28.6 (2022), -30.0 (2023).
  - Exports, f.o.b.: 396.9 (2014), 380.5 (2015), 373.9 (2016), 409.4 (2017), 448.7 (2018), projected 474.5 (2019), 502.7 (2020), 529.9 (2021), 567.1 (2022), 600.4 (2023).
  - Gross international reserves (billions of US$): 195.7 (2014), 177.6 (2015), 178.0 (2016), 175.4 (2017), 178.0 (2018), projections up to 205.7 (2023).

### IMF financing, FCL metrics, and effect on Fund liquidity
- Proposed FCL access (Table 11):
  - Proposed access: 53,476 (in millions of SDRs).
  - Total access in percent of actual quota: 600.
  - Total access in percent of gross international reserves: 42.
- Forward Commitment Capacity (FCC) impact:
  - FCC before approval: 183,529.6 (millions of SDR).
  - FCC on approval: 192,442.3 (millions of SDR).
  - Change in percent: 4.9.
- Effect of 14.3 percent (100 percent of quota) reduction in access would increase the Fund’s FCC by about SDR 8.9 billion, or by 4.9 percent, compared to unchanged access.

### Authorities’ formal communications (Appendices I & II)
- Current administration letter (Mexico City, November 9, 2018):
  - Requests reduction to 600 percent of quota for remaining 12 months; SDR 53.4762 billion.
  - States: "As before, we intend to treat the arrangement as precautionary. We do not intend to make permanent use of the FCL."
  - Lists external risks including decline in global growth, global trade tensions, renewed volatility, increased risk premia, and vulnerabilities related to U.S. monetary policy normalization.
  - Cites recent trade agreement among Mexico, Canada, and the U.S. as dissipating risk of abrupt change in trade relations.
  - Signed by José Antonio González Anaya and Alejandro Díaz de León Carrillo.
- Transition team letter (Mexico City, November 9, 2018):
  - Commits to maintaining strong policies and institutional frameworks; 2019 budget limit PSBR to no more than 2.5 percent of GDP; medium-term fiscal plan targeting a primary surplus close to 0.8 percent of GDP.
  - Fully supports reducing FCL access to 600 percent of quota (SDR 53.4762 billion, around USD 74.1 billion as cited).
  - Signed by Carlos Urzua.

### Statement by the Staff Representative (November 26, 2018) — updates
- Central bank policy rate hike on November 15: from 7.75 to 8 percent (majority decision; one Board member voted for 50 basis points).
- Public consultation announced by President-elect for November 24–25 on proposed infrastructure projects and social programs.
- Proposed banking legislation to eliminate bank fees was publicly discouraged by the President-elect; transition team will coordinate with Ministry of Finance on future initiatives.
- Recent market moves and inflation:
  - Peso depreciated by some 5 percent since October 26; stock market fell by 9.5 percent; EMBIG spread widened by 50 basis points; 5-year CDS spread widened by 16 basis points.
  - Headline inflation eased to 4.9 percent (y-o-y) in October, down from 5.0 percent in September.
  - Core inflation edged up to 3.73 percent from 3.67 percent in September.
- Staff: "does not alter the thrust of the staff appraisal."

*Source: IMF staff assessment as presented in the content unit.*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Context and Policy Framework
- Very strong policies and policy frameworks have helped Mexico navigate a complex external environment.
- Fiscal policy has been successful in stemming the rise in the public debt ratio in the past two years.
- Monetary policy maintains a cautious stance.
- Financial supervision and regulation are strong.
- The flexible exchange rate is playing a key role in helping the economy adjust to external shocks.
- Structural reforms initiated in 2012 have yielded important transformations in the Mexican economy.
- The FCL arrangement provides a reassuring signal on the strength of Mexico’s policies and a valuable insurance against external tail risks.
- Executive Directors noted Mexico’s very strong policies and policy frameworks in the 2018 Article IV consultation.
- The incoming administration (taking office on December 1) committed to maintain very strong economic policies and policy frameworks, including fiscal consolidation and a reduction in public debt in relation to GDP.

### Risks and Vulnerabilities
- Mexico remains exposed to substantial external downside risks.
- Key exposures:
  - Strong trade and financial links to the global economy, particularly the United States.
  - Susceptibility to changes in investor sentiment and abrupt shifts toward emerging markets.
  - High share of non-resident holdings of government paper increases exposure to capital flow reversals and increased risk premia.
- Specific risk factors:
  - Renewed volatility in global financial markets, increased risk premia, and sharp pull-back of capital from emerging markets.
  - A fall in global growth or an exacerbation of trade tensions among major economies would hamper Mexico’s growth prospects.
- Trade-regime uncertainty with the United States has receded following the conclusion of USMCA, but global trade tensions and country-specific uncertainty remain.

### Flexible Credit Line (FCL) Arrangement and Access Request
- On November 29, 2017, the Executive Board approved a 24-month precautionary arrangement with Mexico under the FCL in the amount of SDR 62.3889 billion (700 percent of quota).
- The current administration is requesting a reduction in access to SDR 53.4762 billion (600 percent of quota).
- Rationale for reduction in access:
  - The risk of an abrupt change in Mexico’s trade relations with key trading partners has abated.
  - Other external risks facing Mexico remain elevated.
  - The reduction is consistent with the current and incoming administrations’ exit strategies envisioning a gradual phasing out of Mexico’s use of the facility subject to dissipation of external risks.
- Both administrations intend to continue to treat the arrangement as precautionary.
- Staff recommends that the Board completes the review under the FCL arrangement, which would allow Mexico to make purchases until the expiration of the arrangement on November 28, 2019.

### Qualification for FCL
- Staff’s assessment: Mexico continues to meet the qualification criteria for access to FCL resources specified under the Executive Board decision on FCL arrangements (Decision No. 14283-(09/29), adopted on March 24, 2009, as amended).
- The incoming administration provided assurances that it intends to maintain very strong policies and institutional policy frameworks.
- Staff supports the current administration’s request for reduced access.

### Recent Economic and Financial Developments
- Growth and inflation:
  - Output growth was flat at 2.2 percent in the first three quarters of 2018 amid election-related uncertainty.
  - Core inflation declined to 3.7 percent (y-o-y) in September 2018.
  - Headline inflation accelerated from 4.65 percent in June to 5.0 percent in September (amid rising energy prices).
- External sector:
  - Current account deficit reached US$12.6 billion in the first half of 2018.
  - Full-year 2017 current account deficit was US$19.5 billion (1.7 percent of GDP).
  - At end-September 2018, the peso was 2.7 percent stronger in real effective terms relative to its 2017 average.
  - Mexico’s net international investment liability position improved modestly to about minus 48 percent of GDP.
  - Residents’ foreign assets stood at 60 percent of GDP in June 2018.
- Financial markets and sovereign ratings:
  - The peso weakened pre-elections and strengthened thereafter; volatility remained high.
  - Recent sharp peso depreciation followed the announcement by President-elect Lopez Obrador of canceling the partially-completed new Mexico City airport.
  - Sovereign CDS and bond spreads have risen somewhat over the past year, but less than in other EMs.
  - Moody’s upgraded the outlook on Mexico’s A3 credit rating to stable in April 2018.
  - Fitch kept Mexico’s rating at BBB+ in October 2018 but cut the outlook to negative from stable following the airport announcement.
  - Moody’s and S&P have not changed Mexico’s rating or outlook following the airport announcement.
- Financial sector soundness:
  - As of July 2018, banking sector Tier-1 capital ratio: 14.0 percent.
  - Return on equity: 20.7 percent.
  - NPL ratio: 2.1 percent (near record low).
  - Commercial bank credit to the non-financial corporate sector strengthened by 9.4 percent (y-o-y) in real terms in September.
  - Consumer credit growth slowed to 1.5 percent.
  - Household credit-to-GDP ratio: 16.1 percent (compare to 39.8 percent average for other emerging economies).
  - Very limited FX lending.

### Outlook and Policy Stance
- Growth projections and drivers:
  - Growth is expected to accelerate modestly in the near term.
  - Growth will be supported by private consumption and a small contribution from net exports.
  - Investment is expected to remain weak, particularly in the export-oriented manufacturing sector.
  - Growth would gradually converge to just under 3 percent over the medium term as structural reforms continue to be implemented.
- Monetary policy:
  - Bank of Mexico increased its policy rate by 75 basis points in three steps between December 2017 and June 2018 to 7.75 percent.
  - Monetary conditions are projected to progressively tighten as inflation declines.
  - A negative output gap is expected to help keep inflation on track to converge toward the 3-percent target in the second half of 2019.
- Fiscal policy:
  - The 2018 public sector borrowing requirement (PSBR) target of 2.5 percent of GDP is expected to be met.
  - Public debt is projected to decline to around 53 percent of GDP from 54.3 percent in 2017, thanks to a primary surplus of 1.3 percent.
  - For 2019, the incoming administration is preparing a budget with an unchanged PSBR target and has assured staff that fiscal plans would be consistent with reducing the public-debt-to-GDP ratio from the current level.
- Incoming administration priorities:
  - Focus on fighting tax evasion and improving the efficiency and quality of public spending to create space for infrastructure spending.
  - No envisaged changes to the tax system in the next couple of years, except for a reduction in the VAT and CIT in the northern border region.
  - Plans to centralize public procurements and consolidate social programs and various government agencies to generate savings.
  - Strengthening the fiscal framework is a priority.

### External Economic Stress Index (ESI) and Scenarios
- The ESI was updated using the same model, proxy variables, and weights as for the 2017 FCL request.
- Risks captured and proxies:
  - Exports, remittances, inward FDI proxied by U.S. growth (weight 0.50).
  - Debt flows proxied by change in U.S. Treasury 10-year yield (weight 0.35).
  - Equity flows proxied by VXEEM (weight 0.14).
  - Oil industry proxied by change in world oil prices (weight 0.02).
- Baseline scenario corresponds to WEO projections for U.S. growth, oil prices, and the U.S. 10-year bond yield; VXEEM projections align with VIX futures as of October 9, 2018.
- Global downside scenario assumptions:
  - Inflation surprise in the United States leading to a 100 basis points increase in the U.S. term premium.
  - Reduction of U.S. growth by 0.67 percentage point and lower oil prices by 5 percent relative to the baseline WEO projection.
  - Surge in global financial market volatility with the VXEEM rising by 3 standard deviations.
- The ESI global downside scenario shows a clear deterioration compared to November 2017; country-specific uncertainty has abated somewhat, particularly the likelihood of an abrupt change in Mexico’s trade relations with the United States.
- The current ESI is not designed to fully capture certain country-specific uncertainties such as the impact of tariffs, non-tariff barriers, an abrupt drop in FDI, or reorganization of global supply chains.

### Staff Recommendation and Review Outcome
- Staff supports the current administration’s request to reduce access to SDR 53.4762 billion (600 percent of quota).
- Staff recommends that the Board completes the review under the FCL arrangement, allowing purchases until the arrangement’s expiration on November 28, 2019.
- Staff assessment: Mexico continues to meet FCL qualification criteria.

*International Monetary Fund, November 7, 2018.*

### 13.      The FCL has served the Mexican economy well, providing insurance against tail risks.

### 13. The FCL has served the Mexican economy well, providing insurance against tail risks.

### FCL performance and policy intent
- The FCL arrangements have complemented Mexico’s policies, policy frameworks, and international reserves, and have been effective in bolstering market confidence.
- The current and incoming administrations reaffirm that Mexico does not intend to make permanent use of the FCL and will continue to treat the arrangement as precautionary.
- The current administration requested a reduction in access to Fund resources to 600 percent of quota as part of a gradual phasing out of Mexico’s use of the facility.

### Access considerations and illustrative adverse scenario
- Access amount justified: SDR 53.4762 billion (600 percent of quota).
- Scenario assumptions:
  - Renewed volatility in global financial markets, increased risk premia, sharp pull-back of capital from emerging markets, intensified global trade tensions, and a significant decline in global growth.
  - Decline in inward FDI, reduction in portfolio inflows, residents increasing foreign asset holdings, and an initial offset of current-account improvement from depreciation by a decline in net exports within the one-year projection horizon.
- Use of reserves:
  - Assumed reserve drawdown of $14 billion in the downside scenario.
  - Reserve adequacy (ARA metric) would be 108.2 percent in 2019 under the scenario.
- Current account shock assumed in the scenario: 0.23 percent of GDP (smaller than the 0.45 percent assumed at approval).
- Foreign direct investment shock: a 50 percent drop in net FDI inflows (smaller than assumed at approval).
- Gross equity portfolio inflows shock: same shock (1.6 standard deviations) as at approval of the current arrangement.
- Foreign currency-denominated debt rollover assumption: 80 percent.
- Resident portfolio outflows shock: same shock (1.6 standard deviations) as at approval.
- Peso-denominated debt rollover assumption: 71 percent.
- Selected scenario summary figures (External Financing Requirements and Sources, in billions of U.S. dollars):
  - Gross external financing requirements (Proj. Adverse 2019): 123.3 (2017), 95.2 (2016), 93.4 (2014), 99.1 (2012), 88.1 (2016), contribution to gap -11.0 (table context preserved from source).
  - Change in international reserves: 0.4 (2017), -2.6 (2016), 2.5 (2014), 1.5 (2012), -12.5 (2016), -14.0 (Adverse 2019).
  - Assumed reserve drawdown labeled USD 14 bn (and alternative labels USD 10-14 bn, USD 5bn in source table).
  - Financing Gap (USD billions) reported as 73.0; SDR (1.38370575773803 USD/SDR, Oct. 26, 2018) shown as 52.7; Percent of quota shown as 592 in table context.
  - Selected flow shocks shown in the table: Equity Portfolio Inflows shock 1.6 std dev = USD 10.7bn; Residents' foreign portfolio & other investment shocks 1.6 std dev = USD23.9bn, USD25.1bn, etc., as presented in the source table.

### Qualification review — fundamentals and policy framework
- Staff assessment: Mexico continues to meet the qualification criteria for an FCL arrangement.
- Monetary policy:
  - Guided by a credible inflation-targeting framework in the context of a flexible exchange rate regime.
  - Bank of Mexico tightened monetary policy by 450 basis points since December 2015.
  - Inflation target: 3 percent; headline inflation expected to converge toward the target in the second half of 2019.
- Fiscal policy and public debt:
  - Fiscal policy guided by the fiscal responsibility law.
  - Fiscal consolidation plan aiming to reduce the PSBR from 4.5 percent of GDP in 2014 to 2.5 percent in 2018; targets for 2015, 2016 and 2017 were met and the 2018 target is projected to be met.
  - Transition team committed to a PSBR target of 2.5 percent of GDP for 2019 (draft 2019 budget to be presented to congress by December 15, per source).
  - Staff assesses Mexico’s public debt to be sustainable with high probability; updated debt sustainability analysis shows the debt trajectory is overall robust to standard shocks.
- External position and reserves:
  - External current account deficit is low and envisaged to remain moderate over the medium term.
  - External debt: 37 percent of GDP at end-March 2018.
  - Net foreign assets projected to remain around minus 45 percent of GDP through 2023.
  - Gross international reserves: US$177.1 billion at end-September 2018, compared to US$176.4 billion at end-October 2017.
  - Reserves have exceeded 100 percent of the ARA metric in each of the last three years.
  - Exchange stabilization and swap lines: potential size of the U.S. Treasury’s swap line with Mexico increased from US$3 billion to US$9 billion (October 2018); complemented by a swap line of US$3 billion with the Federal Reserve.
- Capital flows and market access:
  - Capital account dominated by private flows; public flows accounted for only around a fifth of direct, portfolio and other asset and liability flows on average over the last three years.
  - Mexico among the highest-rated emerging markets.
  - Sovereign bond (EMBIG) spread and five-year CDS spreads: 261 and 126 basis points, respectively (as of October 18th, 2018).
  - Government fully covered its external financing needs for 2018 and a substantial part of 2019 external currency amortizations; cumulative issuance in international markets over the last five years equivalent to more than 1,400 percent of Mexico’s Fund quota.
- Financial sector soundness and supervision:
  - Banking system Tier-1 capital ratio: 14.0 percent (as of July 2018).
  - Provisioning at 150.7 percent of non-performing loans.
  - Corporate balance sheets resilient to exchange rate shocks aided by hedges.
  - Private pension funds hold assets of about 15.5 percent of GDP.
  - Insurance sector capital exceeds minimum requirements; Solvency II regime adopted in April 2015.
  - Real estate investment trusts remain small and financed mostly by equity, with new statutory limits on leverage.
  - 2016 FSAP and 2018 Article IV consultation did not highlight significant solvency risks or recapitalization needs.
  - Mexico adopted Basel III capital rules in 2013; Basel Committee assessed it as compliant in 2015; Liquidity coverage ratio minimum requirements in place since January 2015.
- Data and transparency:
  - Overall quality of Mexican data continues to be high and adequate for effective surveillance; Mexico remains in observance of the Special Data Dissemination Standards (SDDS).
- Track record:
  - Sustained track record of implementing very strong policies; staff’s assessment that all relevant core indicators were met in each of the five most recent years.

*Source: IMF staff assessment as presented in the content unit.*

### 18.      International indicators of institutional quality show that Mexico has around average

### 18.      International indicators of institutional quality show that Mexico has around average

### Institutional quality and governance
- Mexico's institutional quality of economic policy is underpinned by the inflation-targeting framework, the fiscal responsibility law, and an effective prudential and regulatory framework for financial supervision.
- According to the 2017 World Bank's Governance Indicators, Mexico's government effectiveness ranks at the 52nd percentile among all countries.
- A weaker area continues to be the control of corruption.
- Constitutional reform adopted in May 2015 and secondary legislation promulgated in July 2016:
  - Further empowers the federal government to investigate, prosecute, and sanction corrupt activity.
  - Creates a National Anticorruption System.
  - Increases transparency requirements in the use of public funds.
  - Requires an appointment of an independent anti-corruption prosecutor.
  - Implementation has begun with the institutional setting at the federal level nearing completion.
- Mexico underwent a full assessment of its anti-money laundering framework; the report provided further recommendations for strengthening effectiveness of anti-money laundering measures.

### Response to shocks and policy frameworks
- Mexico has a strong track record responding to significant shocks due to very strong fiscal and monetary institutional frameworks.
- Flexible exchange rate has helped adjustment to external shocks; there were no incidences of interventions in the foreign exchange market in 2018.
- Fiscal consolidation is on track; monetary policy has kept inflation expectations anchored close to the inflation target.
- Fiscal framework:
  - Anchored in the 2006 fiscal responsibility law, strengthened in 2014.
  - 2014 reform defined the Public Sector Borrowing Requirements as a fiscal target and set a cap on the real rate of growth of structural current spending.
  - Targets for PEMEX and CFE were introduced.
- Central bank:
  - Independent from the government since 1994, with a constitutional mandate to maintain the currency’s purchasing power.
  - Formally adopted an inflation-targeting framework in 2001; inflation targets have been set since 1996.
  - Increased the policy rate by 450 bps since end-2015, succeeding in bringing inflation down from recent peaks and anchoring inflation expectations close to the target.
- Policy cyclicality:
  - Fiscal policy was strongly expansionary after the global financial crisis with a large negative output gap.
  - Following fiscal reform in 2013/14, and with a closed or positive output gap, fiscal policy was generally contractionary, raising non-oil revenues to offset a continued decline in oil revenues.

### Impact on Fund finances, risks, and safeguards
- Safeguards procedures for Mexico’s 2017 FCL arrangement were completed.
  - EY México issued an unqualified audit opinion on Banco de México’s 2016 financial statements.
  - Staff reviewed the 2016 audit results and noted timely publication of the FY2016 financial statements.
  - Banco de México’s Law was amended to strengthen the Audit Committee’s composition by including a majority of independent members; the committee now meets regularly with external auditors.
  - No significant issues emerged from the safeguards procedures.
  - The FY 2017 financial statements have also recently been published.
- Reduction in access and effect on Fund liquidity:
  - Proposed 14.3 percent (100 percent of quota) reduction in access would increase the Fund’s Forward Commitment Capacity by about SDR 8.9 billion, or by 4.9 percent, compared to a scenario of unchanged access.
- Mexico’s capacity to repay the Fund:
  - Current and incoming administrations intend to treat the FCL arrangement as precautionary.
  - In a scenario of full disbursement in 2018:
    - Total external debt would initially climb to 44.6 percent of GDP, but gradually decline thereafter.
    - Fund credit would initially correspond to around 6.1 percent of GDP.
    - Projected debt service to the Fund would reach a peak level of about SDR 28.5 billion (about 2.7 percent of GDP) in 2022.

### Staff appraisal, risks, and FCL access
- The FCL arrangement has supported market confidence, provided insurance against tail risks, and helped Mexico weather bouts of volatility.
- Staff considers access at 600 percent of quota appropriate given the current risk environment.
- Elevated uncertainties include:
  - Renewed volatility and increased risk premia in global financial markets leading to a sharp pull-back of capital from emerging market economies.
  - Risks of intensified global trade tensions and a significant decline in global growth.
  - The risk of an abrupt change in Mexico’s trade relations has dissipated.
- The current and incoming administrations intend to treat the FCL as precautionary and as a supplement to reserves.
- Staff’s assessment: Mexico continues to meet the qualification criteria for access to FCL resources; staff recommends completion of the review under the FCL arrangement for Mexico and supports Mexico’s requested lower level of access.

*Source: IMF staff report.*

### 26.      The incoming administration’s commitment to maintaining very strong policies and

### cr18332-mexicobundlefcl - 26.      The incoming administration’s commitment to maintaining very strong policies and

### Institutional commitments and policy stance
- The incoming administration commits to preserving the strength and independence of economic-policy institutions, in particular:
  - an independent central bank;
  - a floating exchange regime to help the economy adapt to shifting global conditions.
- Fiscal policy will continue to aim at gradually reducing public debt in relation to GDP.
- Financial oversight will remain based on the sound regulatory and supervisory framework.

### Recent macroeconomic developments and near-term outlook
- Inflation:
  - Headline inflation came down after increasing largely on account of higher food and domestic fuel prices.
- Labor market:
  - Unemployment remains at its lowest level in a decade.
- Credit:
  - Household credit growth is slowing while corporate credit growth remains solid.
- External sector:
  - The current account deficit has declined.
  - Current account balance (in percent of GDP): -1.9 (2014), -2.6 (2015), -2.2 (2016), -1.7 (2017), -1.7 (2018), projections around -1.8 to -1.9 (2019–2023).
- Fiscal outlook:
  - The fiscal deficit is projected to stabilize at 2.5 percent in the medium term.
  - General government revenue and expenditure (in percent of GDP): revenue 23.4 (2014), 23.5 (2015), 24.6 (2016), 24.8 (2017), 23.5 (2018), projections 21.7 (2019) onward; expenditure 28.0 (2014), 27.5 (2015), 27.4 (2016), 25.9 (2017), 23.5 (2018), projections 22.4 (2019) onward.
  - Overall fiscal balance (in percent of GDP): -4.5 (2014), -4.0 (2015), -2.8 (2016), -1.1 (2017), -2.5 (2018), projected -2.5 (2019–2023).

### Reserves, external financing, and vulnerabilities
- Gross international reserves (billions of US$): 195.7 (2014), 177.6 (2015), 178.0 (2016), 175.4 (2017), 178.0 (2018), projections rising to 205.7 (2023) in dollar terms.
- Reserve coverage indicators (2017/2018):
  - Reserves in percent of ARA Metric: shown relative to adequacy range 100–150 percent.
  - Months of imports of goods and services: 5.0 (2014), 5.1 (2015), 4.7 (2016), 4.8 (2017), projected 4.8 (2018).
- Gross external debt and financing needs:
  - Gross total external debt (percent of GDP): 35.7 (2015), 38.5 (2016), 38.1 (2017), projected 38.5 (2018).
  - Gross external financing needs (billions of US$): 121.0 (2015), 123.3 (2016), 95.2 (2017), projected 95.2 (2018).
  - External debt service (in percent of GDP): 10.7 (2015), 10.8 (2016), 8.5 (2017), projected 7.2 (2018).

### Public debt, DSA results, and stress tests
- Gross public sector debt (percent of GDP), historical and projections (Table 3 / Table 6 / Figure 6):
  - 48.9 (2014), 52.8 (2015), 56.8 (2016), 54.3 (2017), 53.1 (2018), projections: 53.2 (2019), 53.4 (2020), 53.4 (2021), 53.4 (2022), 53.4 (2023).
- Public gross financing needs (in percent of GDP), projection path visible in figures (public gross financing needs series shown across 2018–2023).
- Public DSA baseline assumptions (Figure 7 underlying assumptions):
  - Real GDP growth (in percent): 2.1 (2018), 2.3 (2019), 2.6 (2020), 2.9 (2021–2023).
  - Inflation: 5.2 (2018), 3.5 (2019), 3.1 (2020), 3.2 (2021–2022), 3.1 (2023).
  - Primary balance (in percent of GDP): 1.3 (2018), 1.1 (2019), 1.0 (2020–2023) under baseline.
  - Effective interest rate (in percent): 7.5 (2018), 7.2 (2019), 7.0 (2020), 6.9 (2021–2023).
- Stress-test scenarios (Figure 8 highlights):
  - Primary balance shock, real GDP growth shock, real interest rate shock, real exchange rate shock, and combined shocks—each scenario shows impacts on gross nominal public debt (in percent of GDP) across 2018–2023.
  - Example scenario results (selected values from stress tests):
    - Real GDP growth shock path: real GDP growth 2.1 (2018), -0.5 (2019), -0.2 (2020), 2.9 (2021–2023).
    - Real interest rate shock path: effective interest rate rises to 7.5 (2018), 7.2 (2019), 7.4 (2020), 7.6 (2021), 7.8 (2022), 8.0 (2023).
    - Combined macro-fiscal shock path: shows an increase in gross nominal public debt (in percent of GDP) under combined scenario relative to baseline.

### Balance of payments and medium-term projections
- Summary Balance of Payments (Table 4a, 4b):
  - Current account (billions of US$): -24.6 (2014), -30.3 (2015), -23.9 (2016), -19.5 (2017), -20.7 (2018), projected -23.2 (2019), -25.2 (2020), -26.6 (2021), -28.6 (2022), -30.0 (2023).
  - Exports, f.o.b. (billions of US$): 396.9 (2014), 380.5 (2015), 373.9 (2016), 409.4 (2017), 448.7 (2018), projected 474.5 (2019), 502.7 (2020), 529.9 (2021), 567.1 (2022), 600.4 (2023).
  - Gross international reserves (billions of US$): 195.7 (2014), 177.6 (2015), 178.0 (2016), 175.4 (2017), 178.0 (2018), projections up to 205.7 (2023).
- Baseline medium-term projections (Table 7, selected):
  - GDP (real growth): 2.8 (2014), 3.3 (2015), 2.9 (2016), 2.0 (2017), 2.1 (2018), projections 2.3 (2019), 2.6 (2020), 2.9 (2021–2023).
  - Consumer prices (end of period): 4.1 (2014), 2.1 (2015), 3.4 (2016), 6.8 (2017), 4.4 (2018), projections 3.1 (2019), 3.0 (2020–2022), 3.0 (2023).

### IMF financing, FCL proposal, and GRA capacity
- Proposed FCL access (Table 11):
  - Proposed access: 53,476 (in millions of SDRs).
  - Total access in percent of actual quota: 600 (percentile/ratio context shown).
  - Total access in percent of gross international reserves: 42 (percentile metric).
- Capacity-to-repay indicators (Table 10):
  - GRA credit to Mexico (SDR millions) assumed: 53,476.2 (selected entries in the series).
  - Debt and debt-service ratios (in percent of GDP) under the assumed FCL drawing: Total external debt 38.1 (2017), 44.6 (2018), 44.4 (2019), 44.3 (2020), 44.3 (2021), 41.5 (2022), 39.0 (2023).
  - Total external debt service (in percent of GDP): 8.5 (2017), 7.2 (2018), 7.5 (2019), 7.6 (2020), 7.4 (2021), 9.9 (2022), 9.6 (2023).
- Impact on GRA finances (Table 12):
  - Forward Commitment Capacity (FCC) before approval: 183,529.6 (millions of SDR).
  - FCC on approval: 192,442.3 (millions of SDR).
  - Change in percent: 4.9.

*Source: IMF staff (cr18332-mexicobundlefcl).*

### Appendix I. Written Communication from the Current

### Appendix I. Written Communication from the Current Administration Requesting a Reduction in Access

### Purpose and formal request
- The letter, dated Mexico City, November 9, 2018, to Ms. Christine Lagarde, requests a reduction in access under Mexico’s two-year Flexible Credit Line (FCL) arrangement.
- Requested new access level: 600 percent of Mexico’s quota for the remaining period of twelve months of the FCL arrangement.
- Requested access expressed in SDRs: SDR 53.4762 billion.
- The authorities state: "As before, we intend to treat the arrangement as precautionary. We do not intend to make permanent use of the FCL."

### Rationale and assessment of external risks
- Mexico’s strong economic policies and macroeconomic stability noted as background for the request.
- Mexico remains exposed to external tail risks due to openness to foreign trade and financial flows and active participation of non-resident investors.
- Specific external risks listed:
  - Significant decline in global growth.
  - Global trade tensions among major economies.
  - Renewed volatility in global financial markets.
  - Increased risk premia and a sharp pull-back of capital from emerging markets.
  - Risk of further disruptions to financial flows in case of an economic crisis in a large emerging market.
  - Vulnerability to shocks related to the process of normalization of U.S. monetary policy.
- The protection provided by the FCL is described as having "supported the rebuilding of buffers and the high degree of confidence in our economy."

### Timing and conditionality noted by authorities
- The November 9, 2017 letter had expressed the intention to set access to 600 percent of quota at the time of the mid-term review, conditional on a reduction in external risks including dissipation of the risk of an abrupt change in Mexico’s trade relations and on a smooth continuation of U.S. monetary policy normalization.
- The current request cites "the recent trade agreement reached by the governments of Mexico, Canada, and the U.S., which dissipates to a great extent the risk of an abrupt change in Mexico’s trade relations."

### Policy stance and commitment
- Authorities emphasize continuation of very strong policies and institutional frameworks as crucial to address domestic and external challenges.
- The letter states appreciation for IMF support through the FCL and reiterates that the arrangement is intended to be precautionary, not permanent.

### Signatories
- José Antonio González Anaya — Secretary of Finance and Public Credit.
- Alejandro Díaz de León Carrillo — Governor of Banco de México.

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### Appendix II. Letter from the Transition Team

### Transition team's commitments and support
- Dated Mexico City, November 9, 2018; addressed to Ms. Christine Lagarde.
- On behalf of President-Elect Andrés Manuel López Obrador, the transition team commits to maintaining Mexico’s strong economic policies and policy frameworks, including:
  - An independent central bank with a clear mandate to price stability and a commitment to a floating exchange regime.
  - Fiscal policy aiming to gradually reduce public debt in relation to GDP.
  - The 2019 budget will limit the public sector borrowing requirement to no more than 2.5 percent of GDP.
  - The medium-term fiscal plan will target a primary surplus close to 0.8 percent of GDP as the main anchor.
  - Preservation of sound regulatory and supervisory frameworks for financial oversight.
  - A reform agenda to strengthen the rule of law and the efficiency of public expenditure, particularly on infrastructure, to spur private investment and raise potential growth.
  - Preserve the strength and independence of economic-policy institutions.
- The transition team fully supports the request to reduce FCL access to 600 percent of Mexico’s quota, or SDR 53.4762 billion (around USD 74.1 billion), for the remainder of the arrangement.
- The transition team reiterates: "As before, we intend to treat the arrangement as precautionary. We do not intend to make permanent use of the FCL."
- Signed by Carlos Urzua, Coordinator of the Economic Transition Team of the President-Elect.

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### Statement by the Staff Representative on Mexico (November 26, 2018) — Key updates since staff report

- The information "does not alter the thrust of the staff appraisal."

Key developments and data (numbered as in the statement):

1. Central bank policy rate decision:
   - On November 15 the central bank hiked its policy rate by 25 basis points.
   - Policy rate increased from 7.75 to 8 percent.
   - Decision was by majority; one Board member voted for a 50 basis point increase.
   - Central bank noted the balance of risks for inflation was biased upwards and had deteriorated significantly.
   - Press release highlighted that recent peso depreciation was partly affected by the announcement to cancel the new Mexico City airport project and markets’ concerns regarding the incoming administration’s policies and some legislative initiatives.
   - Press release also noted sizable increases in sovereign risk premia and medium- and long-term interest rates.

2. Public consultation announced by the President-elect:
   - On November 12 the President-elect announced a new public consultation for November 24–25.
   - The consultation will seek public approval for proposed infrastructure investments including the planned new refinery, the Maya Railway and the Trans-Isthmic Railroad, and new social programs.
   - The consultation will follow the same process as the one that led to abandoning Mexico City's new international airport project.

3. Proposed banking legislation and transition team response:
   - On November 8 the head of the Senate proposed to eliminate bank fees including on ATM withdrawals and balance requests.
   - The President-elect subsequently declared he did not support the proposal and was not planning to change banking laws.
   - The transition team stated they had contacted leaders of both parliamentary chambers to ensure future initiatives would be coordinated with the Ministry of Finance.

4. Financial market developments (recent weeks):
   - Peso depreciated by some 5 percent since October 26.
   - Stock market fell by 9.5 percent.
   - EMBIG spread widened by 50 basis points.
   - 5-year CDS spread widened by 16 basis points.

5. Inflation data (October):
   - Headline inflation eased slightly to 4.9 percent (year-on-year) in October, down from 5.0 percent in September.
   - Energy and housing prices rose less than in the previous month.
   - Core inflation edged up slightly to 3.73 percent from 3.67 percent in September.

*Source: Appendix I and II; Statement by the Staff Representative (November 26, 2018).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18332-mexicobundlefcl.pdf_