## 1mexea2019001

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### Political and policy context
- President Lopez Obrador took office in December 2018 and pledged commitment to fiscal prudence and an independent central bank.
- Monetary policy has returned inflation to target; financial sector supervision and regulation remain robust.
- Flexible exchange rate assists adjustment to external shocks; Mexico’s external position is broadly consistent with medium-term fundamentals and desirable policy settings.
- Policy uncertainty has weakened investment through decisions such as cancelation of energy auctions, renegotiation of pipeline contracts, and a public consultation canceling the Mexico City airport project.
- Concerns about sustainability of drastic budget cuts and impacts on human capital, regulatory agencies, and autonomous institutions.
- New fiscal priorities and a commitment not to raise taxes until after 2021 create challenges reconciling large-scale investment projects and social transfers with announced fiscal targets and stabilizing public debt.
- State-centered energy policy constrains private sector role and places responsibility for stabilizing Pemex on the government.
- Structural reform agenda has mostly stalled.

### Recent developments (economic performance and markets)
- Growth and labor:
  - Mexican economy slowed sharply; growth came to a stand-still in 2019:H1 amid weak domestic demand, tight monetary conditions, budget under-execution, and slowing global manufacturing activity.
  - Net exports supported activity largely through compression in imports.
  - Investment recovery held back by elevated uncertainty; consumption showed signs of weakness.
  - Unemployment rate edged up to 3.7 percent as real wage growth turned positive.
- External sector and flows:
  - Current account improved in 2019:H1 as import growth, notably of capital goods, declined while exports held up relatively well (partly due to trade diversion amid U.S.–China tensions).
  - Strong remittances supported the current account.
  - Following solid performance in 2019:Q1, portfolio and FDI inflows slowed in Q2.
- Inflation and monetary policy:
  - Headline inflation fell from around 5 percent a year ago to Banxico’s 3 percent target; non-core inflation, particularly energy prices, drove much of the decline.
  - Core inflation remained at 3.8 percent.
  - Banxico reduced the policy rate in two 25-basis-point steps in August and September to 7.75 percent.
  - Banxico refrained from FX intervention and allowed the peso to adjust freely.
- Markets and ratings:
  - Peso relatively resilient and strengthened relative to regional peers, aided by high carry.
  - Sovereign spreads widened; equities dropped amid policy uncertainty and weakening growth.
  - Fitch downgraded Mexico from BBB+ to BBB with a stable outlook in June and reduced Pemex’s rating from BBB+ to BB+ in two steps.
  - S&P and Moody’s revised outlook to negative in March and June, respectively.
- Financial sector soundness (as of June):
  - Tier-1 capital ratio: 14.2 percent.
  - Return on equity: 20.9 percent.
  - NPL ratio: 2.1 percent (near record low).
  - Commercial bank credit growth to non-financial corporate sector slowed from over 11 percent y-o-y to 9 percent in August.
  - Consumer credit growth: 7.2 percent y-o-y.

### Outlook and staff projections
- Baseline assumptions:
  - Uncertainty assumed to subside gradually amid an improving investment climate and anticipated ratification of the USMCA by all signatories by next year.
  - Banxico assumed to continue easing monetary policy as risks dissipate and core inflation converges to the 3 percent headline target, reaching a neutral policy stance by 2021.
- Fiscal and monetary dynamics:
  - Budget execution expected to accelerate; fiscal stance to turn expansionary driven by measures announced in July to accelerate spending within budgetary limits and boost SME and consumer lending by development banks and public institutions.
  - Staff projects Public Sector Borrowing Requirement (PSBR) to reach 2.8 percent of GDP in 2019—compared to the 2.5 percent target—and notes a PSBR of 2.2 percent of GDP in 2018.
  - Authorities project a PSBR of 2.7 percent of GDP; deviation from target explained by lower-than-budgeted revenues due to slowing growth and lower-than-expected oil production.
  - Ex-ante real rate in staff’s October projection was just below 5 percent; staff and Banxico estimates of the neutral rate are 2.0–2.5 and 1.8–3.4 percent respectively.
  - Monetary and financial conditions expected to ease but remain tight; credit growth to edge down slightly.
- Growth and inflation projections (selected exact figures):
  - Real GDP growth (percent): 2016: 2.9; 2017: 2.1; 2018: 2.1; 2019: 0.4; 2020: 1.3; 2021: 1.9; 2022: 2.1; 2023: 2.3; 2024: 2.4.
  - Inflation (period average, percent): 2016: 2.8; 2017: 6.0; 2018: 4.9; 2019: 3.7; 2020: 3.1; 2021–2024: 3.0 each year.
  - General government overall balance (Net lending/borrowing, percent of GDP): 2016: -2.8; 2017: -1.1; 2018: -2.2; 2019: -2.8; 2020: -2.6; 2021: -2.2; 2022: -2.3; 2023: -2.3; 2024: -2.4.
  - General government gross debt (percent of GDP): 2016: 56.8; 2017: 54.0; 2018: 53.7; 2019: 54.0; 2020: 54.8; 2021: 54.9; 2022: 55.0; 2023: 55.1; 2024: 55.1.
  - Current account (percent of GDP): 2016: -2.2; 2017: -1.7; 2018: -1.8; 2019: -1.2; 2020: -1.6; 2021: -1.7; 2022: -1.8; 2023: -1.9; 2024: -2.0.
  - Net international reserves (in billions of U.S. dollars): 2016: 176.5; 2017: 172.8; 2018: 174.8; 2019: 176.4; 2020: 178.1; 2021: 181.0; 2022: 184.5; 2023: 189.1; 2024: 194.1.
- Staff central outlook:
  - Growth projected to reach 0.4 percent in 2019, with a modest pick-up in 2019:H2 supported by public spending acceleration.
  - Growth projected to reach 1.3 percent in 2020 as monetary conditions ease, uncertainty subsides, and private consumption recovers.
  - Medium-term growth revised down to 2.4 percent reflecting several years of sub-par investment and stalled structural reforms, particularly in the energy sector.
  - Headline inflation expected to remain around Banxico’s 3-percent target; core inflation should reach the headline target by mid-2020.
  - Authorities projected a somewhat more upbeat 2020 growth of around 2 percent.

### Risks (Annex I and text)
- Overall balance of risks tilted to the downside.
- External risks:
  - Fall in global growth (e.g., from a U.S. slowdown).
  - Uncertainty about Mexico’s trade relationship with the U.S. since USMCA ratification remains pending.
  - U.S. tariff threat related to migration issues.
  - Exposure to financial market volatility, increased risk premia, and sharp pull-back of capital from EMs.
- Domestic risks:
  - Weaker medium-term growth and investor reassessment if administration weakens commitment to fiscal prudence and strong institutions.
  - Pemex downgrade to non-investment grade by a second major rating agency could trigger selling pressure.
  - Lower oil revenues could make fiscal targets harder to achieve.
- Upside risks:
  - Concrete steps to enhance governance, rule of law, and productivity-enhancing structural reforms.
  - USMCA ratification expected to reduce uncertainty, boost FDI and strengthen the investment climate.
- RAM — selected exact entries:
  - Sharp rise in risk premia: Relative Likelihood: H; Impact: H; Time Horizon: ST; Policy Response: Exchange rate flexibility and provision of liquidity.
  - Rising protectionism and retreat from multilateralism: Relative Likelihood: H; Impact: H; Time Horizon: ST, MT.
  - Weaker-than-expected growth in the U.S.: Relative Likelihood: M; Impact: H; Time Horizon: ST, MT.
  - Pemex downgrade to junk by second major agency: Relative Likelihood: H; Impact: L; Time Horizon: ST.
  - Lower oil revenues: Relative Likelihood: M; Impact: H; Time Horizon: ST, MT.
  - Failure to achieve fiscal targets: Relative Likelihood: M; Impact: H; Time Horizon: ST, MT.

### Fiscal policy: staff recommendations and fiscal assessment
- Staff welcome commitment to fiscal prudence but recommend more ambitious medium-term targets to put public debt on a downward path.
- Authorities’ deficit target of 2.6 percent of GDP for 2020 considered appropriate to balance prudence with avoiding contractionary policy amid a large negative output gap.
- Staff view:
  - Monetary policy expected to ease only gradually from a very tight stance; preserving prudent fiscal stance important as anchor.
  - Authorities’ medium-term projections target a PSBR of 2.2–2.4 percent of GDP, which would keep debt broadly stable at around 55 percent of GDP.
  - Staff recommended lower deficits over the medium term to rebuild buffers and accommodate higher social, investment and aging-related spending.
- Fiscal gaps and measures:
  - Staff projects a fiscal gap of about 0.5 percent of GDP in 2020, and up to 1.5 percent of GDP thereafter.
  - Gaps arise from less optimistic assumptions for nominal growth, oil production and revenue administration gains, and doubts about feasibility of cuts to goods and services spending.
  - Staff concerned about low level of non-Pemex capital spending, which could be crowded out by large priority projects (e.g., the Maya train and the Trans-Isthmus railway).
  - In an adverse scenario where the fiscal gap persists, staff projects debt could rise to 63 percent of GDP by 2024.
  - Authorities stated readiness to cut spending—or take revenue measures—if shortfalls materialize and to prioritize a non-increasing net debt-to-GDP ratio.

### Pemex business plan: staff assessment and authorities’ view
- Staff recommended reformulating Pemex’s business plan to strengthen the company and reduce risks to the budget.
- Staff concerns about the plan:
  - Limits cooperation with private firms in Pemex’s upstream business to service contracts.
  - Envisages heavy investment in loss-making downstream business.
  - Does not focus on selling non-core assets.
  - Lacks credible measures to reduce operating costs.
  - Places onus of stabilizing Pemex on the government.
- Authorities’ position: confident the business plan will deliver projected increases in oil production, reserves and refining capacity; did not see reason to reconsider the plan at this stage.
- Key market and plan-related points:
  - Additional support in September included $5 billion for debt buybacks; Pemex issued $7.5 billion bonds.
  - A downgrade by Moody’s to below investment grade could lead to additional selling pressure of $6–10 billion as Pemex bonds become ineligible for some global investment grade bond indices.
  - Plan projects a 60 percent increase in production by 2024—to 2.7mbpd—which staff view as optimistic.
  - Plan assumes adding reserves of around 140 percent of annual production every year and commercial discoveries rising from 4 fields per year to 34 per year; rating agencies assume a 50 percent replacement rate ratio (RRR).
  - Conservative scenario with production stabilizing at 2019 levels but RRR at 50 percent: reserve life would decline to around 5 years in 2024.
  - Scenario where production targets are met but RRR is 50 percent: reserve life would decline to only 3 years.
  - Dos Bocas refinery expected by most analysts to cost around $12–15 billion—compared to authorities’ $8 billion estimate—and completion likely to last longer than the current target of mid-2022. Project earmarked at around 13 percent of the 2019–22 capex plan.
  - Plan assumes improvements in EBITDA margins from 33 percent in 2018 to over 60 percent.
  - Pemex’s financial situation projected to remain weak with likely negative free cash flow (FCF) for the foreseeable future.

### Tax revenues and revenue administration (recommendations)
- Mexico’s tax revenue: 13 percent of GDP.
- Authorities envisage reform delivering at least 2 percent of GDP in additional tax revenues effective in 2022; staff recommended earlier implementation to underpin 2021 targets.
- VAT:
  - Collecting VAT from digital service providers welcomed.
  - Taxing (non-export related) zero-rated goods at the standard 16 percent rate could boost revenues by around 1 percent of GDP; targeted benefits needed to offset impact on the poor.
- CIT and PIT:
  - Tax expenditures for CIT and PIT accounted for 1.5 percent of GDP in 2018.
  - Authorities consider at least 0.7 percent of GDP of these are inefficient or regressive; agreement they could be rationalized and threshold for top PIT bracket lowered.
- Gasoline excise tax:
  - Current formula guarantees cumulative retail fuel price growth below CPI inflation since November 30, 2018.
  - Staff noted policy disproportionately benefits the rich and should be revoked, providing some 0.2 percent of GDP in additional revenues relative to 2019 projection; authorities did not agree.
- Subnational taxes:
  - Staff recommended raising property taxes (current collection is 1.5 percent of GDP less than Latin American average) and redesigning vehicle registration tax; proposed federal agency to update cadaster and policy coordination.
  - Authorities agreed justification exists but saw implementation challenges for property taxation.
- Border tax regime:
  - Staff advised cancelling VAT and CIT reductions at the border (foregone revenues about 0.2 percent of GDP); authorities view regime as temporary for 2019-20 and instrumental for border region employment.
- Revenue administration:
  - Welcomed abolition of right to offset excess tax credits against other taxes to reduce fraud once backlog clears.
  - Recommended comprehensive strategy to tackle non-compliance, move toward high-coverage VAT audit process; authorities agreed to seek Fund advice on tax and customs administration.

### Expenditure efficiency and composition (selected recommendations)
- Enhance expenditure efficiency to shift spending toward growth-friendly and inclusive mix; increase public investment from current low levels.
- Social protection: about 8,000 federal, state and municipal programs—improve targeting, reduce overlaps, and address inclusion/exclusion errors.
- Wage bill: implement stricter standards and more transparency in temporary personnel use; consistent merit-based recruitment; establish centralized payroll while maintaining pay competitiveness.
- Education: payroll audits to identify ghost workers and curb absenteeism; rebalance spending toward investment in equipment and facilities; improve early-childhood education and access in low-coverage regions.
- Pension system:
  - Current contribution rate of 6.5 percent may at best yield a replacement rate of 26 percent for a full career average earner—the second lowest rate among OECD countries.
  - Recommended increase in contribution rate for defined-contribution system; consider increasing effective retirement age and consolidating non-contributory pension pillars.
- Health: target investment to rural and impoverished areas, reduce administrative and insurance costs, improve portability of insurance, build compatible information infrastructure to reduce duplication.
- Public procurement: further centralize procurement and adopt digital platform to yield savings and reduce corruption/bid rigging risks.
- Authorities agreed scope exists for efficiency gains and emphasized raising public investment, better targeting social benefits, and pension reform.

### Fiscal framework: strengthening rules and institutions (Annex IV summary)
- Staff and authorities broadly agreed framework could benefit from a well-calibrated debt anchor and broader coverage of the structural spending rule.
- Framework lacks a well-defined adjustment path to return to target after a shock; triggers for escape clauses should be tightened.
- Staff recommended a modern medium-term budget framework and reiterated 2018 Fiscal Transparency Evaluation recommendations.
- Staff suggested elements:
  - Explicit public debt ceiling paired with correction mechanism and intermediate thresholds.
  - Structural spending rule covering broader expenditure envelope (potentially all budgetary spending).
  - Reduce discretion in invoking escape clauses; time limits and return-to-target requirements.
  - Create a countercyclical fund to save in good times and spend during downturns.
  - Establish a non-partisan, adequately-sourced fiscal council with formal mandate to provide independent fiscal evaluation.
- Authorities’ proposed five elements in draft 2020 budget:
  1. explicit public debt ceiling as nominal anchor;
  2. structural spending rule;
  3. less discretionary use of escape clauses;
  4. a countercyclical fund;
  5. a fiscal council.

### Monetary and exchange rate policies
- Monetary policy:
  - Staff noted scope to continue easing; policy still very tight despite large negative output gap.
  - Recommendation: continue lowering policy rate so long as inflation remains close to target and inflation expectations anchored.
  - Authorities agreed there could be scope for further easing but favored caution given elevated risks and sticky core inflation above target.
- Communication:
  - Commended Banxico for recent communication improvements; encouraged concise communication and limited focus on exchange rate and U.S. monetary policy only when relevant to inflation.
- Exchange rate:
  - Agreement that exchange rate flexibility should remain key shock absorber; intervention limited to disorderly market conditions.
  - Flexible exchange rate induced gradual strengthening of the non-oil balance as Mexico shifted from net oil exporter to net oil importer.
  - Authorities agreed foreign currency reserves were adequate and the FCL provides an important buffer.

### Macro-financial policies: resilience, supervision, and inclusion
- Financial resilience:
  - Authorities’ stress tests showed most banks (except a few very small ones) remain above regulatory minimum capital ratios under adverse scenarios.
  - Staff stress tests of largest corporates suggest debt-at-risk would remain manageable even under severe exchange rate and earnings shocks.
  - Banking system faces concentration risk due to exposure to a handful of large corporates; authorities monitor concentration risks, especially regarding Pemex and CFE.
- Regulatory and supervisory recommendations (in line with 2016 FSAP):
  - Increase operational independence, budget autonomy, and legal protection of banking and securities supervisor.
  - Integrate prudential supervision under one authority for all financial institutions.
  - Enhance definition of “common risk” and “related party” for bank exposures.
  - Expand resolution regime to cover financial holding companies and strengthen resolution powers.
- Financial deepening and inclusion (multi-pronged):
  - Prioritize financially vulnerable groups, particularly women and the rural population.
  - Improve credit reporting, movable collateral registry, and install specialized bankruptcy courts.
  - Upcoming fintech regulation for Open Banking to promote information sharing; initiatives to improve banking infrastructure in remote areas via Banco del Bienestar.
  - Boost competition and transparency: expand Banxico initiatives enhancing client mobility in payroll loans to other products; complementary initiatives by CONDUSEF and Banco de Mexico to improve transparency and cost comparisons.
  - Reduce cash use: promote CoDi mobile payment platform; migrate all government programs to electronic payments recommended.
  - Development banks: focus lending on underserved sectors, avoid lending to sectors well served by commercial banks, avoid quantitative targets, align governance with best practices.

### Macro-structural policies: productivity, inclusion, and rule of law
- Growth challenge:
  - Need to reinvigorate productivity-enhancing reforms to foster strong, sustainable and inclusive growth; medium-term outlook weakened and growth insufficient to narrow income gap with the U.S.
  - Poverty and inequality improved only modestly and failed to do so in Mexico’s South.
- Priority structural challenges: corruption, labor informality, and crime.
- Anti-corruption and AML/CFT:
  - Most elements of National Anticorruption System now in place.
  - Recommendations: focus on implementation, prevention and enforcement; support interagency cooperation; strengthen accountability via performance agreements and public sharing of results; ensure funding for training, retention and protection of staff; enact pending AML/CFT legislation; introduce comprehensive criminal liability for legal persons; reconsider statutes of limitations.
  - Federal prosecutor (FGR) should implement measures to rectify shortcomings and consider specialized courts or judges for complex financial crime cases.
  - Inter-agency task force should design legal framework to ensure accurate, verified and up-to-date beneficial ownership information is available to company registers, banks, notaries and companies.
- Reducing informality:
  - Share of informal workers: 56 percent.
  - Recommendations: reduce hiring and firing restrictions (consider unemployment insurance financed at least partly by non-labor taxes); reduce entry costs for formal firms by lowering procedural costs/time to start/formalize a business; effectively implement recent labor reforms to improve dispute resolution and enforcement.
- Improving security:
  - Administration’s approach includes long-term prevention focused on youth education/training and creation of a National Guard.
  - To prevent oil theft, government guarded and shut-off pipelines in early-2019.
  - Staff highlighted need to enhance efficiency and quality of law enforcement and judicial institutions.

### Gender gaps and labor force participation
- Gender parity in education contrasts with low female labor force participation and pay gaps.
- Gender gaps increase during child-bearing years; women with more children participate less.
- Child care and maternity/paternity benefits remain well below OECD peers and should be expanded.
- Staff raised concern over cancelation of subsidies for child care facilities and replacement with direct transfers to families.
- Promoting financial inclusion of women should be pillar of government’s upcoming financial inclusion initiatives.

### Financial inclusion (Box 4) — progress and constraints
- Progress slow due to limited financial infrastructure and education, lack of competition in banking sector and widespread informal activity.
- Proportion of adults with more than one financial product unchanged at 45 percent since 2015.
- Gender gaps:
  - Account ownership gap: -8 percentage points (2017 Findex).
  - Retirement accounts and asset ownership gaps: -18 percentage points each.
- Geographic disparities: South lags rest of country; regional gaps in ATMs (22 percentage points) and branches (10 percentage points).
- Mobile money usage: 6 percent of Mexican adults (aged 15+).
- Cash predominates:
  - More than 90 percent of rent, utility, and house service payments are made in cash (ENIF).
  - 38 percent of private sector wages are still paid in cash (Findex).
  - In 2017, government provided close to one third of transfers and payments in cash.
- MSMEs:
  - Account for 95 percent of companies and provide over 70 percent of employment.
  - Only 11 percent of MSMEs have access to bank finance (INEGI).
  - Over 60 percent of MSMEs reject bank loans due to high costs.
  - Close to 50 percent of SMEs unaware of any government programs.

- Reasons for not using mobile banking among account holders (percent, ENIF 2018):
  - 21% Prefer other options
  - 18% Lack of trust
  - 15% Its too complicated
  - 6% Don’t know how to contract it
  - 5% Cellular does not allow
  - 20% Don’t know the service
  - 2% No internet
  - 5% Bank does not allow
  - 8% Other

### Minimum wage policy (Box 8) — changes and implications
- January 2019: national minimum wage raised by 16 percent; doubled in 43 municipalities in border region (Northern Border Free Zone).
- Administration objective to significantly raise minimum wage by 2024; doubling in border region part of package including lower VAT and CIT rates.
- Historical context: real minimum wage remained low since 1990s, well below regional and OECD peers.
- Distributional and regional impact:
  - Share of workers earning up to a minimum wage in northern region doubled from 8 to 17 percent.
- Labor market effects:
  - Minimum wages make formal employment relatively more expensive; past moderate increases associated with lower formalization rates and decreases in overall inequality.
  - Rapid and large increases can have adverse effects on formal employment, particularly in regions/industries with high shares of minimum-wage workers and limited contractual adjustment margins.
- Early 2019 outcomes (2019:H1):
  - Increase in wages of formal employees accompanied by slower formal employment growth in border states; potential switching from formal to informal contracts may moderate total employment effects.
- Policy implication: further adjustments should be gradual and accompanied by complementary measures.

### Debt, external debt and DSA highlights
- External debt fell from 37.7 percent of GDP in 2017 to 36.6 percent of GDP in 2018 (reflecting mostly price and exchange rate changes of -1.3 percentage points).
- Under baseline, external debt projected to increase slightly to around 40 percent of GDP.
- Around two thirds of Mexico’s external debt (25 percent of GDP) owed by public sector; federal government accounts for 16 percent of GDP.
- Key external debt vulnerability: a 30 percent depreciation estimated to increase external debt up to 55 percent of GDP.
- Public DSA — selected exact figures:
  - Nominal gross public debt: 46.4 (2017), 54.0 (2018), 53.7 (2019), 54.0 (2020), 54.8 (2021), 54.9 (2022), 55.0 (2023), 55.1 (2024), 55.1 (2024).
  - Public gross financing needs: 11.6 (2017), 7.5 (2018), 7.8 (2019), 10.6 (2020), 9.9 (2021), 9.9 (2022), 10.3 (2023), 10.5 (2024), 10.1 (2024).
  - Real GDP growth (in percent table entries): 2.1 (2017), 2.1 (2018), 2.1 (2019), 0.4 (2020), 1.3 (2021), 1.9 (2022), 2.1 (2023), 2.3 (2024), 2.4 (2024).
  - Effective interest rate (in percent): 7.7 (2017), 7.8 (2018), 8.2 (2019), 7.7 (2020), 7.4 (2021), 7.2 (2022), 7.1 (2023), 7.0 (2024), 7.0 (2024).
  - Primary (noninterest) revenue and grants: 24.0 (2017), 24.3 (2018), 23.2 (2019), 22.5 (2020), 22.0 (2021), 22.1 (2022), 22.2 (2023), 22.2 (2024), 22.4 (cumulative 133.3).
- External debt sustainability tests (selected exact figures):
  - Baseline external debt: 40 (percent of GDP) in projection tables.
  - Historical scenario projection: 49 (percent of GDP).
  - Real depreciation shock (one-time real depreciation of 30 percent in 2020) leads to external debt rising to 55 (percent of GDP).
  - Table 1 baseline series for external debt: 32.4 (2014), 35.6 (2015), 38.3 (2016), 37.7 (2017), 36.6 (2018), 37.4 (2019), 38.9 (2020), 39.1 (2021), 39.7 (2022), 40.1 (2023), 40.4 (2024).
- Public debt dynamics:
  - Since 2015, deficits averaged 2.5 percent; debt increased by 4.7 percentage points of GDP since 2014, largely driven by peso depreciation and asset accumulation.
  - Out of 13 years fiscal rules framework in place, full compliance observed in 5 years.
  - FEIP had accumulated assets of about 1.3 percent of GDP as of end-2018; FEIP used in 2019 to compensate for revenue shortfalls with 0.5 percent of GDP expected to be transferred by year-end.

### Recommendations summary (selected policy actions)
- Fiscal:
  - Adopt more ambitious medium-term fiscal targets to put public debt on a declining path.
  - Specify additional measures to underpin fiscal targets and close projected fiscal gap of 0.5–1.5 percent of GDP during 2020–24 starting in 2020.
  - Reform tax system to raise at least 2 percent of GDP in additional revenues (earlier implementation than 2022 preferred).
  - Rationalize regressive tax expenditures (CIT and PIT), lower threshold for top PIT bracket, tax digital services, consider revoking gasoline price support formula, raise subnational property and vehicle taxes, cancel border tax incentives.
  - Strengthen revenue administration—high-coverage VAT audits and tackle VAT non-compliance.
- Pemex:
  - Reformulate Pemex business plan to focus on upstream cooperation with private firms, sell non-core assets, credibly reduce operating costs, and avoid heavy investment in loss-making downstream activities.
- Fiscal framework and institutions:
  - Introduce explicit public debt ceiling with correction mechanisms and intermediate thresholds.
  - Broaden structural spending rule coverage and pair with a return-to-target correction mechanism.
  - Tighten escape clause triggers and consider dropping deficit targets in favor of debt ceiling plus enhanced spending rule.
  - Create non-partisan, adequately-resourced fiscal council; modernize medium-term budget framework.
  - Consider simplifying FEIP rules and orienting fund toward over-the-cycle stabilization; consider unification of funds and elimination of accumulation ceilings.
- Monetary and exchange rate policy:
  - Continue lowering policy rate while inflation remains close to target and inflation expectations anchored.
  - Maintain exchange rate flexibility as main shock absorber; limit FX intervention to disorderly conditions.
  - Keep concise central bank communication and strengthen forward guidance when feasible.
- Financial sector and inclusion:
  - Close regulatory and supervisory gaps (increase independence, integrate supervision, enhance definitions and resolution regime).
  - Advance fintech/Open Banking, improve credit reporting, movable collateral registry, specialized bankruptcy courts.
  - Promote CoDi and electronic payments; migrate government program payments to electronic channels.
  - Focus development bank lending on underserved sectors and align governance with best practices.
- Structural reforms:
  - Restart energy auctions and risk-sharing with private firms; remove trade-in-services barriers (transportation and logistics); address corruption, labor informality and crime to raise productivity and inclusion.
  - Reduce informality by lowering entry costs, reforming hiring/firing rules and considering unemployment insurance financed partly by non-labor taxes.
  - Continue addressing gender gaps via expanded childcare and maternity/paternity benefits and financial inclusion of women.

_International Monetary Fund — staff report excerpts from "1. Synchronization of Mexican Economic Activity with the U.S." (1mexea2019001)._

### 1. Synchronization of Mexican Economic Activity with the U.S. __________________________________ 21

### 1. Synchronization of Mexican Economic Activity with the U.S.

### Political and policy context
- President Lopez Obrador took office in December 2018 and pledged commitment to fiscal prudence and an independent central bank.
- Monetary policy has returned inflation to target; financial sector supervision and regulation remain robust.
- The flexible exchange rate is helping adjustment to external shocks; Mexico’s external position is broadly consistent with medium-term fundamentals and desirable policy settings.
- Policy uncertainty has weakened the investment climate, driven by decisions that appeared to weaken policy predictability, including:
  - cancelation of energy auctions;
  - renegotiation of pipeline contracts;
  - a public consultation that led to cancelation of the Mexico City airport project.
- Concerns about sustainability of drastic budget cuts and impacts on human capital, regulatory agencies, and autonomous institutions.
- Resignation of the former Finance Minister and his reported criticisms reinforced uncertainty.
- New policy priorities have created fiscal challenges: reconciling large-scale investment projects and social transfers, and a commitment not to raise taxes until after 2021, with announced fiscal targets and stabilizing public debt.
- A state-centered energy policy constrains private sector role and places responsibility for stabilizing Pemex on the government.
- Structural reform agenda has mostly stalled.

### Recent developments (economic performance and markets)
- Economic growth:
  - The Mexican economy slowed sharply; growth came to a stand-still in 2019:H1 amid weak domestic demand, tight monetary conditions and budget under-execution, and slowing global manufacturing activity.
  - Net exports supported activity largely through compression in imports.
  - Investment recovery has been held back by elevated uncertainty; consumption has shown signs of weakness.
  - Unemployment rate edged up to 3.7 percent as real wage growth turned positive.
- External sector:
  - Current account improved in 2019:H1 as import growth, notably of capital goods, declined while exports held up relatively well, partly due to trade diversion amid U.S.–China tensions.
  - Strong remittances supported the current account.
  - Following solid performance in 2019:Q1, portfolio and FDI inflows slowed in Q2.
- Inflation and monetary policy:
  - Headline inflation fell from around 5 percent a year ago to Banxico’s 3 percent target; non-core inflation, particularly energy prices, drove much of the decline.
  - Core inflation remained at 3.8 percent.
  - Banxico reduced the policy rate in two 25-basis-point steps in August and September to 7.75 percent.
  - Banxico refrained from FX intervention and allowed the peso to adjust freely.
- Financial markets and ratings:
  - The peso was relatively resilient in 2019 and strengthened relative to regional peers, aided by high carry.
  - Sovereign spreads widened; equities dropped amid policy uncertainty and weakening growth.
  - Fitch downgraded Mexico from BBB+ to BBB with a stable outlook in June and reduced Pemex’s rating in two steps from BBB+ to BB+.
  - S&P and Moody’s revised outlook to negative in March and June, respectively.
- Financial sector soundness:
  - As of June, Tier-1 capital ratio stood at 14.2 percent and return on equity at 20.9 percent.
  - NPL ratio remained at a near record low of 2.1 percent.
  - Commercial bank credit growth to non-financial corporate sector slowed from over 11 percent y-o-y to 9 percent in August.
  - Consumer credit growth remained stable at 7.2 percent y-o-y.

### Outlook and staff projections
- Baseline assumptions:
  - Assumes uncertainty will subside gradually amid an improving investment climate and anticipated ratification of the USMCA by all signatories by next year.
  - Assumes Banxico will continue easing monetary policy as risks dissipate and core inflation converges to the 3 percent headline target, reaching a neutral policy stance by 2021.
- Fiscal and monetary dynamics:
  - Budget execution expected to accelerate; fiscal stance to turn expansionary driven by measures announced in July to accelerate spending within budgetary limits and boost SME and consumer lending by development banks and public institutions.
  - Staff projects Public Sector Borrowing Requirement (PSBR) to reach 2.8 percent of GDP in 2019—compared to the 2.5 percent target—and notes a PSBR of 2.2 percent of GDP in 2018.
  - Authorities project a PSBR of 2.7 percent of GDP; deviation from target explained by lower-than-budgeted revenues due to slowing growth and lower-than-expected oil production.
  - Ex-ante real rate in staff’s October projection was just below 5 percent; staff and Banxico estimates of the neutral rate are 2.0–2.5 and 1.8–3.4 percent respectively.
  - Monetary and financial conditions expected to ease but remain tight; credit growth to edge down slightly.
- Growth and inflation projections (table of key indicators):
  - Real GDP growth (percent): 2016: 2.9; 2017: 2.1; 2018: 2.1; 2019: 0.4; 2020: 1.3; 2021: 1.9; 2022: 2.1; 2023: 2.3; 2024: 2.4.
  - Inflation (period average, percent): 2016: 2.8; 2017: 6.0; 2018: 4.9; 2019: 3.7; 2020: 3.1; 2021–2024: 3.0 each year.
  - General government overall balance (Net lending/borrowing, percent of GDP): 2016: -2.8; 2017: -1.1; 2018: -2.2; 2019: -2.8; 2020: -2.6; 2021: -2.2; 2022: -2.3; 2023: -2.3; 2024: -2.4.
  - General government gross debt (percent of GDP): 2016: 56.8; 2017: 54.0; 2018: 53.7; 2019: 54.0; 2020: 54.8; 2021: 54.9; 2022: 55.0; 2023: 55.1; 2024: 55.1.
  - Current account (percent of GDP): 2016: -2.2; 2017: -1.7; 2018: -1.8; 2019: -1.2; 2020: -1.6; 2021: -1.7; 2022: -1.8; 2023: -1.9; 2024: -2.0.
  - Net international reserves (in billions of U.S. dollars): 2016: 176.5; 2017: 172.8; 2018: 174.8; 2019: 176.4; 2020: 178.1; 2021: 181.0; 2022: 184.5; 2023: 189.1; 2024: 194.1.
- Staff’s central outlook:
  - Growth projected to reach 0.4 percent in 2019, with a modest pick-up in 2019:H2 supported by public spending acceleration.
  - Growth projected to reach 1.3 percent in 2020 as monetary conditions ease, uncertainty subsides, and private consumption recovers.
  - Staff revised medium-term growth down to 2.4 percent, reflecting several years of sub-par investment and stalled structural reforms, particularly in the energy sector.
  - Headline inflation expected to remain around Banxico’s 3-percent target; core inflation should reach the headline target by mid-2020.
  - Authorities projected a somewhat more upbeat 2020 growth of around 2 percent, driven by strengthening private consumption, increasing oil production and development bank lending.
- External position and reserves:
  - Staff and authorities agreed external position remains broadly in line with medium-term fundamentals and desirable policy settings (Annex II).
  - Following a temporary narrowing in 2019, current account deficit projected to widen slightly over the medium term but remain broadly in line with fundamentals.
  - At end-September, the peso was 2 percent stronger in real effective terms relative to its 2018 average.
  - Staff assesses the peso as broadly in line with fundamentals; net international investment position projected to improve modestly to below 46 percent of GDP over the medium term.
  - Foreign exchange reserves are adequate; the FCL provides an effective complement.

### Risks
- Balance of risks is tilted to the downside (Annex I).
- External risks:
  - A fall in global growth, e.g., from a U.S. slowdown.
  - Uncertainty about Mexico’s trade relationship with the U.S. since USMCA ratification by all signatories remains pending.
  - The U.S. tariff threat related to migration issues remains a source of volatility.
  - Exposure to financial market volatility, increased risk premia, and a sharp pull-back of capital from emerging markets.
- Domestic risks:
  - Weaker medium-term growth and potential investor reassessment of Mexico’s credit quality if administration weakens commitment to fiscal prudence, strong institutions, and a favorable business environment.
  - A Pemex downgrade to non-investment grade by a second major rating agency could trigger selling pressure.
  - Lower oil revenues could make it harder to achieve fiscal targets.
- Upside risks:
  - Concrete steps to enhance good governance, rule of law, and advance productivity-enhancing structural reforms could improve outcomes.
  - USMCA ratification expected to reduce uncertainty, boost FDI and strengthen the domestic investment climate.
- Authorities highlighted continued uncertainty about trade relations with the U.S. and global financial market volatility as key risks; staff agreed rising global trade tensions remain a significant risk though trade diversion may mitigate part of the adverse impact.

### Fiscal policy: staff recommendations and fiscal assessment
- Staff welcome commitment to fiscal prudence but recommend more ambitious medium-term targets to put public debt on a downward path.
- Authorities’ deficit target of 2.6 percent of GDP for 2020 considered appropriate to balance prudence with avoiding contractionary policy amid a large negative output gap.
- Staff view:
  - Monetary policy will likely not be accommodative because it is expected to ease only gradually from a very tight stance.
  - Preserving a prudent fiscal stance remains important as an anchor of stability.
  - Authorities’ medium-term projections target a PSBR of 2.2–2.4 percent of GDP, which would keep debt broadly stable at around 55 percent of GDP.
  - Staff recommended lower deficits over the medium term—sufficient to rebuild buffers and put debt on a declining path while accommodating higher social, investment and aging-related spending.
  - Authorities noted their projections—assuming higher nominal growth—see the debt ratio decline over the medium-term.
- Staff urged authorities to specify additional measures to underpin fiscal targets:
  - Staff projects a fiscal gap of about 0.5 percent of GDP in 2020, and up to 1.5 percent of GDP thereafter.
  - Gaps arise from less optimistic assumptions for nominal growth, oil production and revenue administration gains, and doubts about feasibility of sharp cuts to goods and services spending.
  - Staff expressed concern about low level of non-Pemex capital spending, which would be further crowded out by large priority projects (e.g., the Maya train and the Trans-Isthmus railway).
  - In an adverse scenario where the fiscal gap persists, staff projects debt could rise to 63 percent of GDP by 2024 (Annex III).
  - Authorities stated readiness to cut spending—including capital expenditure—or take revenue-enhancing measures if shortfalls materialize and to prioritize a non-increasing net debt-to-GDP ratio in line with the existing fiscal framework.

*Source: IMF staff report chapter "1. Synchronization of Mexican Economic Activity with the U.S."*

### 19.      Staff recommended reformulating Pemex’s business plan, with a view to

### 19.      Staff recommended reformulating Pemex’s business plan, with a view to 

### Pemex business plan: staff assessment and authorities’ view
- Staff recommended reformulating Pemex’s business plan to strengthen the company and reduce risks to the budget.
- Staff concerns about the plan:
  - Limits cooperation with private firms in Pemex’s upstream business to service contracts.
  - Envisages investing heavily in its loss-making downstream business.
  - Does not lay a focus on selling non-core assets.
  - Lacks credible measures to reduce operating costs.
  - These decisions place the onus of stabilizing Pemex squarely on the government (Box 2).
- Authorities’ position:
  - Confident the business plan will deliver projected increases in oil production, reserves and refining capacity.
  - Did not see reason to reconsider the plan at this stage.

### Fiscal revenues: need to boost tax revenues and increase progressivity
- Mexico’s tax revenue level and authorities’ reform objective:
  - Mexico stands out compared to peers with only 13 percent of GDP in tax revenues.
  - Authorities envisage a reform that would deliver at least 2 percent of GDP in additional tax revenues.
  - The reform would be effective in 2022; staff recommended an earlier implementation date to help underpin the 2021 fiscal target.
- VAT:
  - Staff welcomed proposals to collect VAT from digital service providers that was previously forgone.
  - Taxing (non-export related) zero-rated goods at the standard 16 percent rate could boost revenues by around 1 percent of GDP, while targeted benefits would need to offset the impact on the poor.
- CIT and PIT:
  - Tax expenditures for CIT and PIT accounted for 1.5 percent of GDP in 2018.
  - Authorities consider that at least 0.7 percent of GDP of these are inefficient or regressive.
  - Agreement that these could be rationalized and the threshold for the top PIT bracket should be lowered.
- Gasoline excise tax:
  - The current formula guarantees cumulative retail fuel price growth below CPI inflation since November 30, 2018.
  - Staff noted the policy disproportionately benefits the rich and should be revoked, which could provide some 0.2 percent of GDP in additional revenues relative to the projection for 2019.
  - The authorities did not agree the formula should be revoked and consider it provides stability to energy prices and does not constitute a risk to public finances.
- Subnational taxes:
  - Staff recommended raising additional revenues from property taxes, which currently collect 1.5 percent of GDP less than the average Latin American country.
  - A federal agency to update the cadaster and policy coordination at the subnational level could facilitate reform; along with a redesigned vehicle registration tax, this would allow for a reduction in transfers to states and municipalities.
  - Authorities agreed there is justification for subnational taxes but saw implementation challenges for property taxation.
- Border tax regime:
  - Staff advised cancelling the VAT and CIT tax reductions at the border (foregone revenues of about 0.2 percent of GDP).
  - Authorities highlighted the border tax regime is a temporary special tax regime for 2019-20 and view it as instrumental in providing employment and economic opportunities in the border region.
- Revenue administration:
  - Staff welcomed abolition of the right to offset excess tax credits against other taxes, which should reduce fraud once the backlog of grandfathered claims clears.
  - Staff recommended adopting a comprehensive strategy to tackle non-compliance in line with IMF technical assistance, moving towards a high-coverage audit process for VAT returns.
  - Authorities agreed such measures could strengthen tax collections and will seek Fund advice on tax and customs administration.

### Expenditure efficiency and composition
- Staff view: enhancing expenditure efficiency can shift spending toward a more growth-friendly and inclusive mix; public services functioning and redistributive role are priorities; public investment should be increased from current low levels.
- Social protection spending:
  - Federal, state and municipal levels have about 8,000 social protection programs.
  - Efficiency gains could come from improving targeting, reducing errors of inclusion and exclusion, and addressing beneficiary and program overlaps (Selected Issues Paper 2).
- Wage bill:
  - Containment measures: stricter standards and more transparency in temporary personnel use, consistent application of merit-based recruitment, and establishment of a centralized payroll system—while maintaining pay competitiveness.
- Education spending:
  - Measures: payroll audits to identify ghost workers and curb absenteeism; rebalance spending toward investment in equipment and facilities; improve quality of early-childhood education and access in low-coverage regions (Selected Issues Paper 2).
- Pension system:
  - Staff welcomed reduction in management fees for pension funds and recommended improving pension adequacy by increasing the contribution rate for the defined-contribution system.
  - The current contribution rate of 6.5 percent may at best yield a replacement rate of 26 percent for a full career average earner—the second lowest rate among OECD countries (OECD Economic Survey 2019).
  - Additional options: increase the effective retirement age and consolidate federal and local non-contributory pension pillars.
- Health sector:
  - Investment should target rural and impoverished areas with deficient access; reduce administrative and insurance costs; improve portability of insurance and build compatible information infrastructure to reduce beneficiary duplication.
- Public procurement:
  - Further centralizing procurement and adopting a digital platform could yield savings and reduce corruption and bid rigging risks.
- Authorities’ stance:
  - Agreed there was scope for efficiency gains, emphasized administration’s spending-efficiency improvements to date, and underscored importance of raising public investment, better targeting social benefits, and reforming the pension system.

### Fiscal framework: strengthening rules and institutions
- Authorities plan to propose a revamp of the fiscal framework as part of the 2021 budget following broad consultation.
- Staff and authorities broadly agreed:
  - The framework could benefit from a well-calibrated debt anchor.
  - The structural spending rule should cover a broader expenditure envelope.
  - The framework lacks a well-defined adjustment path to return to target after a shock.
  - Triggers for the use of escape clauses should be tightened.
  - A non-partisan, adequately-sourced fiscal council should be created with a formal mandate to provide an independent evaluation of fiscal policy (Annex IV).
- Staff recommended putting in place a modern medium-term budget framework and reiterated recommendations of the 2018 Fiscal Transparency Evaluation.

### Monetary and exchange rate policies
- Monetary policy:
  - Staff noted scope to continue easing monetary policy; policy still very tight despite a large negative output gap.
  - Staff advocated continuing to lower the policy rate so long as inflation remains close to the target and inflation expectations are anchored.
  - Authorities agreed there could be scope for further easing but favored caution given elevated domestic and external risks and sticky core inflation above target.
- Communication:
  - Staff commended Banxico for recent communication improvements and encouraged concise communication and limited focus on exchange rate movements and U.S. monetary policy only when relevant to inflation.
  - Strong forward guidance can strengthen monetary policy transmission; authorities noted Mexico’s complex risk environment limits forward guidance.
- Exchange rate:
  - Agreement that exchange rate flexibility should remain the key shock absorber; intervention limited to disorderly market conditions.
  - Staff highlighted the flexible exchange rate’s role in inducing a gradual strengthening of the non-oil balance as Mexico shifted from net oil exporter to net oil importer (Box 3).
  - Authorities agreed flexible exchange rate has served Mexico well and that foreign currency reserves were adequate, with the FCL providing an important buffer.

### Macro-financial policies: resilience, supervision, and inclusion
- Financial sector resilience:
  - Authorities’ stress tests showed most banks (except a few very small ones) remain above regulatory minimum capital ratios under adverse scenarios.
  - Staff stress tests of largest corporates suggest debt-at-risk would remain manageable even under severe exchange rate and earnings shocks (Annex VI).
  - Banking system faces concentration risk due to exposure to a handful of large corporates; authorities monitor concentration risks, especially regarding Pemex and CFE.
- Regulatory and supervisory gaps (staff recommendations, in line with 2016 FSAP):
  - Increase operational independence, budget autonomy, and legal protection of the banking and securities supervisor.
  - Integrate prudential supervision under one authority for all financial institutions.
  - Enhance the definition of “common risk” and “related party” for bank exposures.
  - Expand the resolution regime to cover financial holding companies and strengthen authorities’ powers in banking resolution.
  - Authorities noted current governance has worked well, are evaluating revision for financial holding companies, and are discussing draft regulation to implement Basel standards on large exposures.
- Financial deepening and inclusion (multi-pronged strategy; authorities have announced measures):
  - Prioritize financially vulnerable groups, particularly women and the rural population.
  - Improving financial infrastructure:
    - Improve credit reporting systems, movable collateral registry, and install specialized bankruptcy courts.
    - Upcoming fintech regulation for Open Banking to promote information sharing; initiatives to improve banking infrastructure in remote areas via Banco del Bienestar.
  - Boost competition and transparency in financial products:
    - Commendation for Banxico’s initiatives to enhance client mobility in payroll loans; recommendation to expand to other products.
    - Complementary initiatives by CONDUSEF and Banco de Mexico to improve transparency and cost comparisons for clients.
  - Reduce use of cash:
    - Promote CoDi mobile payment platform to boost bank accounts and competition; migrate all government programs to electronic payments recommended.
    - Authorities prioritized reduced reliance on cash and were optimistic about CoDi.
  - Fintech regulation:
    - Secondary regulation should balance promoting competition and inclusion with financial stability and consumer protection.
    - Authorities agreed these are main principles in the Fintech law and will monitor Fintech-related risks.
  - Development banks:
    - Staff advised focusing development bank lending on underserved sectors, avoid lending to sectors well served by commercial banks, avoid quantitative targets, and align board composition and CEO selection with international best practices.
    - Authorities noted financial inclusion metrics are considered and highlighted consolidation measures for development banks.

### Macro-structural policies: productivity, inclusion, and rule of law
- Growth and inclusion challenge:
  - Staff stressed need to reinvigorate productivity-enhancing reforms to foster strong, sustainable and inclusive growth.
  - Growth has disappointed and medium-term outlook weakened; insufficient to narrow income gap with the U.S. and other advanced economies.
  - Poverty and inequality have improved only modestly and failed to do so in Mexico’s South.
- Priority structural challenges identified: corruption, labor informality, and crime.
- Combating corruption and money laundering:
  - With most elements of the National Anticorruption System (NACS) now in place and the 2018 Fund-led AML/CFT assessment available (Box 6), authorities should focus on effective implementation, prevention and enforcement.
  - Recommended actions: support interagency cooperation; strengthen accountability through mutual performance agreements and public sharing of performance results; ensure sufficient funding for training, retention and protection of staff in relevant agencies; enact pending AML/CFT legislation in a timely manner; introduce comprehensive criminal liability for legal persons; reconsider statutes of limitations.
  - Federal prosecutor (FGR) should implement measures to rectify fundamental shortcomings and consider specialized courts or judges for complex financial crime cases.
  - An inter-agency task force should design and implement a legal framework to ensure accurate, verified and up-to-date basic and beneficial ownership information is available with company registers, Mexican banks and notaries as well as the companies.
  - Authorities agreed on the need to focus on implementation and enact pending AML legislation; noted steps taken to improve availability of beneficial ownership information and customer due diligence measures for all financial institutions.
- Reducing labor informality:
  - The share of informal workers remains high at 56 percent.
  - Recommendations: reinvigorate efforts to reduce hiring and firing restrictions and consider replacing them with an unemployment insurance scheme financed at least in part by non-labor taxes; reduce entry costs for formal firms by lowering procedural costs and time burdens to start and formalize a business.
  - Recent labor reforms need effective implementation to establish a more efficient labor dispute resolution mechanism, improve enforcement of worker rights, and strengthen even-handed application of labor union regulations.
- Improving security:
  - Administration’s approach: long-term prevention focused on halting criminal recruitment of youth through education and training and creation of a National Guard.
  - To prevent oil theft, the government guarded and shut-off pipelines in early-2019.
  - Staff highlighted the critical need to enhance efficiency and quality of law enforcement and judicial institutions to strengthen the rule of law.

*International Monetary Fund — 1mexea2019001 (excerpt).*

### 32.      There is also a need to continue addressing gender gaps. Gender parity in education

### 1mexea2019001 - 32. There is also a need to continue addressing gender gaps. Gender parity in education

### Gender gaps and labor force participation
- Gender parity in education contrasts with low female labor force participation and pay gaps.
- Gender gaps increase during child-bearing years; women with more children participate less.
- Child care and maternity/paternity benefits remain well below OECD peers and should be expanded.
- Staff raised concern over the cancelation of subsidies for child care facilities and their replacement with direct transfers to families.
- Promoting the financial inclusion of women should be a pillar of the government’s upcoming financial inclusion initiatives.

### Productivity, competition, and product market regulation
- Strengthening competition and easing product market regulations would benefit productivity growth.
- Staff analysis: lack of competition reduces firm investment (2018 SIP) and weakens productivity growth (2017 SIP).
- Recommendations:
  - Remove barriers to trade in services, especially in the transportation and logistics sector.
  - Restart energy auctions and risk-sharing arrangements between Pemex and private firms.
  - Promote efforts to strengthen the multilateral trading system, including supporting the modernization of WTO rules, overcoming the WTO Appellate Body blockage, and advancing WTO plurilateral and multilateral initiatives.

### Minimum wage policy
- The minimum wage fell sharply in real terms during the early 1990s.
- It was raised by 16 percent this year (41 percent over the past three years) across the country and was doubled in the U.S. border region.
- While acknowledging potential distributional benefits, staff recommended further adjustments in the minimum wage be gradual, in line with the evolution of labor productivity, to avoid short- and medium-term disruptions to formal employment growth.

### Macroeconomic assessment and growth projections
- Very strong policies and policy frameworks have contributed to Mexico’s resilience: fiscal prudence, prudent monetary policy, robust financial sector supervision and regulation, flexible exchange rate.
- Growth has declined sharply, and fiscal pressures are mounting amid new spending priorities and a commitment to not raise taxes until after 2021.
- Drastic budget cuts for some institutions have raised concern about potential impacts on human capital; productivity-enhancing reforms have largely stalled.
- Growth is projected to reach 0.4 percent in 2019 and 1.3 percent in 2020 on the back of a modest recovery in domestic demand as uncertainty subsides and monetary conditions ease further.

### Fiscal targets, gaps, and recommended adjustments
- The authorities’ announced PSBR targets of 2.2–2.4 percent of GDP over the medium term would keep debt broadly stable at around 55 percent of GDP.
- While this level is sustainable, more ambitious medium-term fiscal targets would help rebuild buffers and insure against downside risks and demographics-related spending pressures.
- Additional measures are needed to meet announced fiscal targets. Budget projections are based on optimistic assumptions for nominal GDP growth, oil production, tax revenue buoyancy, and projected compression of spending on goods and services.
- In the absence of additional measures, a fiscal gap of 0.5–1.5 percent of GDP would emerge during 2020–24.
- Closing this gap with credible measures starting in 2020 is imperative to safeguard fiscal credibility.

### Tax and revenue recommendations
- Non-oil tax revenues should be boosted while making the tax system more progressive to reduce income inequality.
- Specific recommendations:
  - Rationalize regressive tax expenditures.
  - Broaden the tax base.
  - Lower the threshold for the top PIT bracket.
  - Abolish border incentives and fuel price support.
  - Raise subnational property and vehicle registration taxes.
- Enhance public expenditure efficiency to shift spending toward a more growth-friendly and inclusive mix.
- Strengthen revenue administration with a comprehensive strategy to tackle VAT non-compliance and move toward a high-coverage audit process for VAT returns.

### Pemex: business plan and fiscal risks
- Pemex’s business plan should be reformulated to strengthen the company and reduce risks to the budget.
- To support production and reserves, more cooperation with private firms and stronger focus on upstream business are important.
- Recommendations: sell non-core assets and provide convincing plans to reduce operating costs.
- Key points from staff assessment of Pemex’s plan and market reaction:
  - Business plan relied on optimistic production and reserve projections, limited private cooperation, and heavy investing in a loss-making refining business.
  - Additional support in September included $5 billion for debt buybacks; Pemex issued $7.5 billion bonds.
  - A downgrade by Moody’s to below investment grade could lead to additional selling pressure of $6–10 billion as Pemex bonds become ineligible for some global investment grade bond indices.
  - The plan projects a 60 percent increase in production by 2024—to 2.7mbpd—which staff view as optimistic.
  - The plan assumes adding reserves of around 140 percent of annual production every year and commercial discoveries increasing from 4 fields per year to 34 per year; rating agencies assume a 50 percent replacement rate ratio (RRR).
  - In a conservative scenario where production stabilizes at 2019 levels but RRR stays at 50 percent, reserve life would decline to around 5 years in 2024.
  - In a scenario where production targets are met but RRR is 50 percent, reserve life would decline to only 3 years.
  - The Dos Bocas refinery is expected by most analysts to cost around $12–15 billion—compared to the authorities’ $8 billion estimate—and completion likely to last longer than the current target of mid-2022. The project is earmarked at around 13 percent of the 2019–22 capex plan.
  - The plan assumes large improvements in EBITDA margins from 33 percent in 2018 to over 60 percent.
  - Pemex’s financial situation is projected to remain weak with likely negative free cash flow (FCF) for the foreseeable future, potentially putting further pressure on government finances.

### Fiscal framework strengthening
- Strengthen the fiscal framework to support fiscal responsibility:
  - Introduce a permanent debt ceiling and a structural spending rule.
  - Pair rules with effective correction mechanisms and a non-partisan, adequately-sourced fiscal council.
  - Adopt a modern medium-term budget framework as a complement.

### Monetary policy stance
- There is scope for further monetary easing given a very tight policy stance amid a large negative output gap.
- Recommendation: Banxico should continue to lower the policy rate so long as inflation stays close to the target and inflation expectations remain anchored.
- Central bank communication should be concise; exchange rate flexibility should remain the key shock absorber.
- Foreign exchange intervention should be limited to incidences of disorderly market conditions, while the FCL provides an additional buffer.

### Financial sector regulation, supervision, and inclusion
- Financial sector resilience remains strong but could be enhanced by closing regulatory and supervisory gaps identified in the 2016 FSAP.
- Recommendations:
  - Increase operational independence, budget autonomy and legal protection of the banking and securities supervisor.
  - Extend supervisor authority to financial holding companies.
  - Integrate prudential supervision functions under one authority for all financial institutions.
  - Enhance definitions of “common risk” and “related party”.
  - Strengthen the resolution and crisis management framework.
- Continue efforts to boost financial sector competition and inclusion through a multi-pronged strategic approach to boost lending and strengthen competition and inclusion.

### Structural reforms and informality
- Reinvigorating the structural reform agenda is imperative to foster strong, sustainable and inclusive growth.
- Structural reforms are central to raising growth, reducing poverty and inequality, and narrowing regional income disparities and the income gap with advanced economies.
- Key structural reform recommendations:
  - Restart energy auctions and risk-sharing arrangements between Pemex and private firms to attract private investment.
  - Lower participation barriers for women and remove constraints to trade in services, especially in transportation and logistics, to narrow gender gaps and boost activity.
  - Address high levels of informality by reducing entry costs for formal firms, strengthening enforcement, and replacing hiring and firing restrictions with an unemployment insurance scheme.
  - Further adjustments in the minimum wage should be gradual.

### Corruption, rule of law, and AML/CFT
- Concrete policy action is needed to fight corruption and strengthen the rule of law.
- Priorities:
  - Effective implementation of the National Anti-Corruption System.
  - Enhance effectiveness and quality of law enforcement and prosecution.
  - Address shortcomings identified in the AML/CFT assessment.

### Boxed empirical findings and external linkages
- Synchronization with the U.S.:
  - The U.S. accounts for 80 percent of Mexico’s exports and 46 percent of its imports.
  - In 2018, the U.S. was the origin of 38 percent of FDI in Mexico and the source of 94 percent of remittances.
  - More than two-thirds of Mexico’s exports are manufacturing products sold to the U.S., about a third of which are automotive exports.
  - Since 1996, the correlation coefficient in GDP growth between Mexico and the U.S. was close to 0.8.
  - The slowdown in U.S. manufacturing activity likely contributed to the weakening of Mexican growth in 2019:H1.
- Adjustment in external accounts:
  - Since 2013, the oil trade balance shifted from a surplus of 0.7 percent of GDP to a deficit of around 2 percent, rendering Mexico a net oil importer.
  - Manufacturing exports increased by 8 percent of GDP between 2013 and 2018, supporting a near 2 percentage point improvement in the non-oil trade balance.
  - Mexico likely benefited from trade diversion in the short term, as indicated by the 11.8 percent growth rate of U.S. imports from Mexico in 2018:H2.
  - The U.S. has remained Mexico’s main export market throughout this period (about 80 percent of non-oil exports).

*International Monetary Fund — 1mexea2019001 (selected excerpts)*

### Box 4. Financial Inclusion

### Box 4. Financial Inclusion

### Progress and disparities
- Financial inclusion has strengthened but progress has been slow due in part to limited financial infrastructure and education, lack of competition in the banking sector and widespread informal activity.
- The proportion of adults with more than one financial product has remained largely unchanged at 45 percent since 2015; due mainly to high costs and informal employment.
- Gender gaps:
  - Account ownership gap: -8 percentage points (2017 Findex survey).
  - Gaps in holdings of retirement accounts and asset ownership: both at -18 percentage points.
- Geographic disparities:
  - The South lags the rest of the country according to most measures of financial inclusion.

### Cash and payment practices
- Cash remains the predominant means of payment.
- More than 90 percent of rent, utility, and house service payments are made in cash (ENIF).
- 38 percent of private sector wages are still paid in cash (Findex).
- By contrast, in the G-7 economies, private sector wages are paid almost exclusively into bank accounts.
- In 2017, the government provided close to one third of transfers and payments in cash, which is unchanged from 2014.

### Financial infrastructure and mobile services
- Large geographic gaps in financial infrastructure, and lack of financial education hampers growth in electronic payments.
- Regional disparities (South vs Northwest): 22 percentage points difference in use of ATMs and 10 percentage points difference in use of branches (ENIF).
- Mobile money usage: 6 percent of Mexican adults (aged 15+) are mobile money users (Findex), which is close to the average of the LAC region.
- Main reasons for account holders not using mobile money are lack of trust or knowledge of the service and complexity of use.

### Banking competition, MSMEs, and access to finance
- Low banking sector competition hampers financial inclusion: intermediation margins have increased, and overhead and administrative costs have not declined.
- Banks mostly serve known clients with credit based on strong balance sheets and penalize Micro and SMEs (MSMEs) with significant margins.
- MSME statistics:
  - MSMEs account for 95 percent of companies.
  - MSMEs provide over 70 percent of employment.
  - Only 11 percent of MSMEs have access to bank finance (INEGI).
- Over 60 percent of MSMEs reject bank loans due to high costs.
- Close to 50 percent of SMEs state not to be aware of any government programs, indicating an education/information gap.

### Reasons for not using mobile banking among account holders (percent)
- 21% Prefer other options
- 18% Lack of trust
- 15% Its too complicated
- 6% Don’t know how to contract it
- 5% Cellular does not allow
- 20% Don’t know the service
- 2% No internet
- 5% Bank does not allow
- 8% Other

*Source: ENIF 2018.*

### Box 8. Minimum Wage Policy

### Box 8. Minimum Wage Policy

### Policy change and scope
- In January 2019, the national minimum wage was raised by 16 percent.
- In January 2019, the minimum wage was doubled in 43 municipalities in the border region (the newly created Northern Border Free Zone).
- The national minimum wage increase is the first step in the administration’s objective to significantly raise the minimum wage by 2024.
- The immediate doubling in 43 municipalities forms part of a wider package of incentives that include lower VAT and CIT rates.

### Historical context and international comparison
- Mexico’s real minimum wage has remained low since the 1990s at levels that are well below regional and OECD peers.
- The 2019 increase constitutes the biggest policy shift in over two decades by historical and international standards.
- While the minimum-to-median wage ratio remains below the OECD average at the national level, the ratio in the northern region has already risen well above the average.

### Distributional and regional impact
- The share of workers earning up to or less than a minimum wage in the northern region has doubled from 8 to 17 percent.

### Labor market effects: evidence and channels
- Minimum wages make formal employment relatively more expensive, influencing contractual decisions.
- Past minimum wage increases, which were significantly more moderate, were associated with lower formalization rates and decreases in overall inequality. 1
- Negative effects are likely to be concentrated in selected northern industries relying on formal contracts with limited scope for contractual adjustments. 2
- Staff analysis suggests that labor market duality—between informal and formal firms as well as salaried and non-salaried forms of contractual employment—introduces flexibility in hiring decisions and limits adverse aggregate productivity effects. See “Informality and Aggregate Productivity: The Case of Mexico”, 2019, IMF Working Paper.

### Early 2019 outcomes (2019:H1)
- In 2019:H1, the policy has already produced an increase in wages of formal employees accompanied by slower formal employment growth in the border states.
- The effects on total employment could be less prominent because of the possibility of switching from formal to informal contracts in many industries located at municipalities at the north border.

### Key implications for policy
- Rapid and large minimum wage increases can have potentially significant adverse effects on formal employment, particularly in regions and industries with high shares of minimum-wage workers and limited contractual adjustment margins.
- Policy packages that combine wage increases with complementary measures (for example, incentives in the Northern Border Free Zone such as lower VAT and CIT rates) may alter the net employment and regional outcomes, but notable disemployment risks remain for formal jobs in affected sectors.

*Italic: Source: Box 8. Minimum Wage Policy, 1mexea2019001 - Box 8. Minimum Wage Policy*

### Annex I. Risk Assessment Matrix

### Annex I. Risk Assessment Matrix

### Key Risks and Potential Deviations from Baseline
- Sharp rise in risk premia
  - Source: An abrupt deterioration in market sentiment (e.g., prompted by policy surprises, renewed stresses in emerging markets, or a disorderly Brexit) could trigger risk-off events such as recognition of underpriced risk.
  - Implications: Higher risk premia cause higher debt service and refinancing risks; stress on leveraged firms, households, and vulnerable sovereigns; disruptive corrections to stretched asset valuations; and capital account pressures—all depressing growth.
  - Relative Likelihood: H
  - Impact: H
  - Time Horizon: ST
  - Policy Response: Exchange rate flexibility and provision of liquidity to mitigate disorderly market conditions.

- Rising protectionism and retreat from multilateralism
  - Source: Escalating and unpredictable trade actions and a WTO dispute settlement system under threat; additional barriers including investment and trade restrictions in technology sectors; threat of new actions.
  - Implications: Near term—imperils the global trade system and international cooperation; reduces growth directly and through adverse confidence effects and financial market volatility. Medium term—geopolitical competition, protracted tensions, and fraying consensus about the benefits of globalization lead to economic fragmentation and undermine the global rules-based order, with adverse effects on investment, growth, and stability.
  - Relative Likelihood: H
  - Impact: H
  - Time Horizon: ST, MT
  - 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. The authorities should continue to promote efforts to strengthen the multilateral trading system.

- Weaker-than-expected growth in the U.S.
  - Relative Likelihood: M
  - Impact: H
  - Time Horizon: ST, MT
  - Policy Response: Steadfast implementation of structural reforms to boost growth potential.

- Pemex downgrade to junk by second major agency
  - Relative Likelihood: H
  - Impact: L
  - Time Horizon: ST
  - Policy Response: Exchange rate flexibility and fiscal adjustment; consider changes to Pemex’ business plan.

- Lower oil revenues due to a further drop in Pemex production or declines in prices
  - Implications: A fall in proceeds would make it harder to meet fiscal targets.
  - Relative Likelihood: M
  - Impact: H
  - Time Horizon: ST, MT
  - Policy Response: Exchange rate flexibility and fiscal adjustment.

- Failure to achieve the current fiscal targets, leading to further steady increase in public debt and an increase in country risk premia
  - Relative Likelihood: M
  - Impact: H
  - Time Horizon: ST, MT
  - Policy Response: Maintain the consolidation effort. Use positive revenue surprises to reduce the deficit faster.

- A meaningful erosion in institutional quality or a more prolonged period of elevated policy uncertainty
  - Implications: Would deteriorate the investment climate and weaken investment.
  - Relative Likelihood: M
  - Impact: H
  - Time Horizon: ST, MT
  - Policy Response: Strengthen policy predictability and institutions.

### Definitions and Risk Assessment Notes
- The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff).
- The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent).
- The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.
- “Short term (ST)” and “medium term (MT)” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.
- Likelihood and impact notation: Low (L), Medium (M), High (H).

*Source: Annex I. Risk Assessment Matrix*

### 37.7 percent of GDP in 2017 to 36.6 percent of GDP in 2018, reflecting mostly price and

### 1mexea2019001 - 37.7 percent of GDP in 2017 to 36.6 percent of GDP in 2018, reflecting mostly price and

### External debt level and near-term projection
- External debt fell from 37.7 percent of GDP in 2017 to 36.6 percent of GDP in 2018, reflecting mostly price and exchange rate changes (-1.3 percentage points).
- Under the baseline scenario, external debt is projected to increase slightly to around 40 percent of GDP.
- Around two thirds of Mexico’s external debt (25 percent of GDP) is owed by the public sector, predominantly by the federal government (16 percent of GDP).

### Risk mitigation factors for external debt
- Federal government rollover risks are mitigated by:
  - a very favorable maturity structure (debt is predominantly at maturities exceeding one year);
  - currency composition (with around 1/3 of debt denominated in peso);
  - continuous prudent debt management by the government.
- Private sector external debt:
  - concentrated in the non-financial corporate sector;
  - is mostly medium and long term;
  - foreign exchange risks are well-covered by natural and financial hedges.
- The banking sector is well-capitalized and liquid and assessed to be resilient to large shocks.

### Key external debt vulnerability
- Despite favorable currency composition, a depreciation of the exchange rate is identified as the most significant risk to external debt sustainability:
  - a 30 percent depreciation is estimated to lead to an increase in the external debt to up to 55 percent of GDP.

*As the coverage of debt statistics in Mexico is limited to two of the required six debt instruments, namely debt securities and loans.*

### Public DSA — baseline metrics and projections (selected exact figures)
- Nominal gross public debt: 46.4 (2017), 54.0 (2018), 53.7 (2019), 54.0 (2020), 54.8 (2021), 54.9 (2022), 55.0 (2023), 55.1 (2024), 55.1 (2024) [presented as in source table].
- Public gross financing needs: 11.6 (2017), 7.5 (2018), 7.8 (2019), 10.6 (2020), 9.9 (2021), 9.9 (2022), 10.3 (2023), 10.5 (2024), 10.1 (2024) [presented as in source table].
- Real GDP growth (in percent): 2.1 (2017), 2.1 (2018), 2.1 (2019), 0.4 (2020), 1.3 (2021), 1.9 (2022), 2.1 (2023), 2.3 (2024), 2.4 (2024).
- Inflation (GDP deflator, in percent): 4.3 (2017), 6.7 (2018), 5.0 (2019), 3.8 (2020), 3.1 (2021), 3.0 (2022), 3.0 (2023), 3.0 (2024), 3.0 (2024).
- Effective interest rate (in percent): 7.7 (2017), 7.8 (2018), 8.2 (2019), 7.7 (2020), 7.4 (2021), 7.2 (2022), 7.1 (2023), 7.0 (2024), 7.0 (2024).
- Change in gross public sector debt (cumulative): 2.2 (2017), -2.7 (2018), -0.3 (2019), 0.3 (2020), 0.7 (2021), 0.1 (2022), 0.1 (2023), 0.1 (2024), 1.5 (cumulative shown).
- Primary deficit: 0.6 (2017), -2.6 (2018), -1.6 (2019), -0.8 (2020), -0.9 (2021), -1.2 (2022), -1.1 (2023), -1.1 (2024), -1.0 (2024), -6.2 (cumulative shown).
- Primary (noninterest) revenue and grants: 24.0 (2017), 24.3 (2018), 23.2 (2019), 22.5 (2020), 22.0 (2021), 22.1 (2022), 22.2 (2023), 22.2 (2024), 22.4 (cumulative 133.3).
- Primary (noninterest) expenditure: 24.6 (2017), 21.7 (2018), 21.6 (2019), 21.7 (2020), 21.1 (2021), 20.8 (2022), 21.1 (2023), 21.1 (2024), 21.4 (cumulative 127.1).
- Automatic debt dynamics (contribution): 1.5 (2017), -1.4 (2018), 0.4 (2019), 1.8 (2020), 1.5 (2021), 1.1 (2022), 1.0 (2023), 0.9 (2024), 0.8 (2024), 7.2 (cumulative).
- Of which: real interest rate: 1.4 (2017), 0.5 (2018), 1.6 (2019), 2.0 (2020), 2.2 (2021), 2.1 (2022), 2.1 (2023), 2.1 (2024), 2.1 (2024), 12.6 (cumulative).
- Of which: real GDP growth: -0.9 (2017), -1.1 (2018), -1.1 (2019), -0.2 (2020), -0.7 (2021), -1.0 (2022), -1.1 (2023), -1.2 (2024), -1.3 (2024), -5.4 (cumulative).
- Exchange rate depreciation contribution: 0.9 (2017), -0.8 (2018), -0.1 (2019) [projections thereafter shown as dots].
- Change in assets: 0.3 (2017), 0.8 (2018), 1.1 (2019), -0.2 (2020), 0.4 (2021), 0.4 (2022), 0.4 (2023), 0.4 (2024), 0.4 (2024), 1.8 (cumulative).
- Residual: 0.1 (2017), 0.8 (2018), 0.1 (2019), -0.1 (2020), 0.1 (2021), 0.1 (2022), 0.1 (2023), 0.1 (2024), 0.1 (2024), 0.5 (cumulative).

### Composition of public debt and alternative scenarios (selected exact figures)
- Baseline underlying assumptions (in percent):
  - Real GDP growth: 0.4 (2019), 1.3 (2020), 1.9 (2021), 2.1 (2022), 2.3 (2023), 2.4 (2024).
  - Inflation: 3.8 (2019), 3.1 (2020), 3.0 (2021), 3.0 (2022), 3.0 (2023), 3.0 (2024).
  - Primary Balance: 0.8 (2019), 0.9 (2020), 1.2 (2021), 1.1 (2022), 1.1 (2023), 1.0 (2024).
  - Effective interest rate: 7.7 (2019), 7.4 (2020), 7.2 (2021), 7.1 (2022), 7.0 (2023), 7.0 (2024).
- Alternative scenarios presented include Historical Scenario and Constant Primary Balance Scenario with their respective underlying assumptions (figures reproduced as in source).

### Stress tests — selected outcomes
- Stress test scenarios reported include Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Shock, and Combined Macro-Fiscal Shock.
- Example values under scenarios (2019–2024) presented exactly as in source:
  - Baseline Real GDP growth: 0.4 (2019), 1.3 (2020), 1.9 (2021), 2.1 (2022), 2.3 (2023), 2.4 (2024).
  - Real GDP Growth Shock Real GDP growth: 0.4 (2019), -1.5 (2020), -0.9 (2021), 2.1 (2022), 2.3 (2023), 2.4 (2024).
  - Under a Real Exchange Rate Shock, inflation rises to 4.7 (2020) from 3.8 (2019) and then returns to 3.0 thereafter.
  - Combined Shock and other scenario tables show movements in effective interest rates, primary balances, and public gross financing needs as presented.

### External debt sustainability bound tests and scenarios (selected exact figures)
- Baseline external debt: 40 (in percent of GDP) in projection tables.
- Historical scenario projection: 49 (percent of GDP).
- CA shock scenario: 42 (percent of GDP) baseline vs scenario values shown.
- Combined shock scenario: 43 (percent of GDP).
- Real depreciation shock (one-time real depreciation of 30 percent in 2020) leads to external debt rising to 55 (percent of GDP) in the scenario presented.
- Growth shock scenario baseline: 43 (percent of GDP).
- Table 1 (External Debt Sustainability Framework) — selected exact figures:
  - Baseline: External debt 32.4 (2014), 35.6 (2015), 38.3 (2016), 37.7 (2017), 36.6 (2018), 37.4 (2019), 38.9 (2020), 39.1 (2021), 39.7 (2022), 40.1 (2023), 40.4 (2024).
  - Change in external debt: 1.4 (2014), 3.2 (2015), 2.7 (2016), -0.6 (2017), -1.1 (2018), 0.8 (2019), 1.5 (2020), 0.2 (2021), 0.6 (2022), 0.4 (2023), 0.3 (2024).
  - Identified external debt-creating flows (4+8+9): -1.7 (2014), 2.0 (2015), 0.6 (2016), -4.0 (2017), -2.5 (2018), -1.1 (2019), -1.1 (2020), -1.2 (2021), -1.2 (2022), -1.2 (2023), -1.2 (2024).
  - Current account deficit, excluding interest payments: 0.3 (2014), 0.9 (2015), 0.4 (2016), -0.1 (2017), -0.1 (2018), -0.6 (2019), -0.2 (2020), -0.1 (2021), 0.1 (2022), 0.2 (2023), 0.3 (2024).
  - Net non-debt creating capital inflows (negative): -2.2 (2014), -2.5 (2015), -2.9 (2016), -2.9 (2017), -2.2 (2018), -2.2 (2019–2024 repeated).
  - Automatic debt dynamics: 0.2 (2014), 3.6 (2015), 3.1 (2016), -0.9 (2017), -0.2 (2018), 1.7 (2019), 1.3 (2020), 1.1 (2021), 1.0 (2022), 0.9 (2023), 0.8 (2024).
  - Contribution from nominal interest rate: 1.6 (2014), 1.7 (2015), 1.9 (2016), 1.9 (2017–2024 repeated as 1.9/1.9/1.8/1.8/1.8/1.7).
  - Contribution from real GDP growth: -0.8 (2014), -1.2 (2015), -1.1 (2016), -0.8 (2017), -0.8 (2018), -0.1 (2019), -0.5 (2020), -0.7 (2021), -0.8 (2022), -0.9 (2023), -0.9 (2024).
  - Contribution from price and exchange rate changes: -0.5 (2014), 3.1 (2015), 2.4 (2016), -2.0 (2017), -1.3 (2018).
  - Residual, incl. change in gross foreign assets (2-3): 3.0 (2014), 1.1 (2015), 2.1 (2016), 3.4 (2017), 1.4 (2018), 1.9 (2019), 2.5 (2020), 1.4 (2021), 1.8 (2022), 1.6 (2023), 1.4 (2024).
  - External debt-to-exports ratio (in percent): 101.7 (2014), 103.1 (2015), 103.5 (2016), 99.8 (2017), 93.1 (2018), 96.7 (2019), 101.4 (2020), 101.8 (2021), 101.9 (2022), 100.8 (2023), 99.2 (2024).
  - Gross external financing needs (in billions of US dollars): 136.7 (2014), 139.9 (2015), 123.5 (2016), 98.0 (2017), 95.7 (2018), 97.2 (2019), 107.1 (2020), 112.5 (2021), 117.8 (2022), 122.0 (2023), 122.6 (2024).
  - Gross external financing needs (in percent of GDP): 10.4 (2014), 12.0 (2015), 11.5 (2016), 8.5 (2017), 7.8 (2018), 10-Year: 7.7/8.2/8.3/8.3/8.2/7.9 (presented as table entries).

### Annex IV — Strengthening the Fiscal Framework (summary of recommendations and proposals)
- Staff view: the fiscal framework should have:
  - a strong nominal anchor;
  - a structural spending rule that should cover a broader expenditure envelope.
- Additional desirable features:
  - adequately designed correction mechanisms;
  - a modern medium-term budgeting framework;
  - an adequately-sourced fiscal council with a formal mandate to provide an independent evaluation of fiscal policy.
- Authorities’ proposed five elements in draft 2020 budget to guide a new framework:
  1. an explicit public debt ceiling as a nominal anchor;
  2. a structural spending rule that could help stabilize the economic cycle;
  3. less discretionary use of escape clauses;
  4. a countercyclical fund;
  5. a fiscal council.
- Note on structure of Annex IV:
  - The note summarizes the main features of the 2006 Fiscal Responsibility Law (FRL) and subsequent changes in 2014;
  - analyzes performance of the enhanced fiscal framework since 2014;
  - evaluates the authorities’ proposals and presents a set of detailed recommendations.

*International Monetary Fund staff compilation of Mexico Public and External Debt Sustainability Analysis and Annex IV (Strengthening the Fiscal Framework), as presented in the source document.*

### 3. The 2006 FRL aimed at locking in low fiscal deficits and better managing oil revenues

### 3. The 2006 FRL aimed at locking in low fiscal deficits and better managing oil revenues

### Overview of the 2006 Fiscal Responsibility Law (FRL)
- Over 2004–2006, Mexico maintained fiscal deficits—measured by the traditional balance—of close to zero.
- The FRL introduced:
  - A permanent zero-balance target as a nominal anchor.
  - A reference oil price for revenue projections to smooth short-term oil-price fluctuations.
  - Rules that excess oil revenues be used to compensate for certain budgetary overruns and—to be saved—through several stabilization funds as a buffer for revenue shortfalls.
- The law increased accountability and transparency by requiring:
  - Annual budgets presented in a long-term quantitative framework with projections for the next five years.
  - Mandated assessment of fiscal costs associated with new legal initiatives.
  - Greater transparency and controls over trust funds.
  - Greater accountability in selection of investment projects and social programs through cost-benefit analyses.
  - Steps toward performance-based budgeting, requiring establishment of indicators to measure outcomes.

### Mexico’s Fiscal Framework (Box 1) — Fiscal Rules
- The current fiscal framework includes three rules and two revenue stabilization funds (FEIP for the federal government and FEIEF for states and municipalities).

- Balanced Budget Rule (since 2006)
  - Federal budget must be balanced on a cash basis after discounting up to 2 percent of GDP in Federal government, CFE and Pemex investment (a loosening instituted in 2009).
  - Traditional balance usually excluded some expenditure items and included drawing of financial resources outside the budget as revenue (one-off financing through stabilization funds, asset revaluations, above par issuance of sovereign bonds).
  - An escape clause permits deviations under exceptional circumstances. Regulations (Article 11) list five specific triggers:
    - (i) an increase in interest rates which would raise the government’s debt servicing costs by more than 25 percent;
    - (ii) a natural disaster with a fiscal cost of more than 2 percent of programmable spending, after resources of the natural resources disaster fund have been exhausted;
    - (iii) fiscal liabilities carried over from the previous fiscal year of more than 2 percent of programmable spending;
    - (iv) a fall in non-oil tax revenues of more than 2.5 percent;
    - (v) a fall in oil prices of more than 10 percent compared to the assumed price in the budget.
  - Regulations allow deficit increases for new policies with short-term fiscal costs but net long-term fiscal benefits.
  - The escape clause was used in 2010, 2011, 2012, and "could be used again next year" as suggested by the 2020 draft budget proposal.

- Public Sector Borrowing Requirement Rule (added in 2014)
  - Introduced to strengthen link between fiscal balance and public debt dynamics.
  - Includes all public sector entities except subnational governments and the central bank.
  - Legislation does not specify a long-term ceiling for the PSBR but requires a target for the current year and indicative medium-term targets in budget documents.
  - PSBR target to be set to achieve a non-increasing path of net public debt as a percentage of GDP.

- Structural Current Spending Rule (added in 2014)
  - Cap on the real growth rate of structural current spending equal to potential growth (average of past and projected growth rates) to limit pro-cyclicality.
  - Structural current spending defined as programmable spending excluding interest payments, cost of fuels for electricity generation, physical and financial investment of the federal government, pensions, and expenditures of CFE and Pemex.
  - The target has so far never been binding.

### Mexico’s Fiscal Framework (Box 1) — Revenue Stabilization Funds
- Sources of inflows for the FEIP and FEIEF:
  - I. The FEIP and FEIEF receive 2.2 and 0.64) percent, respectively, of annual oil revenues through the oil fund (FMP).
  - II. Any over-performance in non-oil revenues is first allocated to possible unplanned expenditures and, if additional funds remain, allocated: FEIP (65 percent), FEIEF (25 percent) and the fund for subnational infrastructure development (FIES).
- Conditions for using funds:
  - I. Capitalization ceilings as function of sum of tax revenues and transfers from the FMP: 8 percent for the FEIP and 4 percent for the FEIEF. Resources exceeding ceilings can finance the budget, amortize federal debt or capitalize the National Infrastructure Fund (FEIP) and fund subnational governments’ pension system (FEIEP).
  - II. FEIP can compensate for reductions in Federal Government oil and non-oil revenues relative to budget only after shortfalls in some categories compensated by overperformance in others and after any proceeds from oil hedges used. Maximum use per fiscal year is up to 50 percent of the capitalization ceiling of the fund. FEIEF can be used to compensate for shortfalls in revenues earmarked to subnational entities.

### Creation of Mexican Oil Fund (FMP) and related rules
- The FMP manages all oil-related revenues and payments (except taxes) starting in 2015.
- FMP makes transfers to the Federal Government for up to 4.7 percent of GDP per year; revenues exceeding this level are saved.
- Once long-term savings reach 3 percent of GDP, part of additional inflows can be spent under certain circumstances.
- Total annual oil revenues currently fall far short of 4.7 percent, implying no build-up of long-term savings.

### Performance of the Amended Fiscal Framework (Since 2015)
- Overall deficit (PSBR) dynamics:
  - PSBR averaged 1.7 percent of GDP during 2001-08.
  - The deficit averaged 4.1 percent in 2009–10 due to counter-cyclical policy during the global financial crisis.
  - During the subsequent four years (high average GDP growth of 2.9 percent and buoyant oil revenues), the deficit remained elevated at an average of 3.8 percent.
  - Since 2015, deficits have come down to an average of 2.5 percent.
  - Extraordinary revenues from oil hedge program and Banxico’s surpluses totaled 0.7, 1.5 and 1.5 percent of GDP in 2015, 2016 and 2017, respectively.
  - Out of 13 years that the fiscal rules framework has been in place, full compliance observed in 5 years.

- Public debt evolution:
  - Public debt increased by 4.7 percentage points of GDP since 2014, largely driven by peso depreciation and asset accumulation.
  - At end-2018, gross debt as a percentage of GDP was 16.3 percent higher than in 2006 and 4.8 percent higher than in 2014.
  - Debt increased by 7.9 percentage points between end-2014 and end-2016, with 5.2 percentage points owing to exchange rate depreciation.
  - Of the remaining 2.7 percentage points, 1.9 percent were due to asset accumulation including valuation changes (the pension reform of PEMEX and CFE securitized 1.6 percent of implicit pension liabilities).
  - Between 2016 and 2018, the debt ratio declined by 3.1 percentage points—of which exchange rate depreciation explained about 0.9 percentage points.

- Cyclicality assessment:
  - No evidence fiscal policy was pro-cyclical in the aftermath of the 2014 reforms.
  - During 2014–18, staff assessed the output gap as non-negative.
  - Fiscal impulse (change in structural primary balance) was negative each year except 2018 when it was close to zero.
  - Fiscal policy has thus been notably counter-cyclical since the 2014 amendments.
  - Policy was somewhat procyclical in 2006–07 and to a lesser extent in 2012–13.

- Coverage and limits of structural current spending rule:
  - Structural current spending accounts for 53 percent of programmable, 39 percent of budgetary and 36 percent of total public sector expenditures.
  - Low coverage implies the rule’s success in preventing pro-cyclicality depends on evolution of other spending items, which have grown faster and do not closely track structural current spending.

- Stabilization funds’ effectiveness:
  - Mandate to stabilize revenues relative to projections hampered by systematic under-projection of revenues.
  - FEIP was not used to stabilize revenues and had accumulated assets of about 1.3 percent of GDP as of end-2018.
  - FEIP was used in 2019 to compensate for revenue shortfalls, with 0.5 percent of GDP expected to be transferred by year-end.

### Potential Avenues for Reform — Main Findings and Recommendations
- Need for careful review with broad public consultation:
  - Reviews should involve independent experts or bipartisan committees and be sufficiently comprehensive to avoid politicization and partial reforms.

- Strengthen medium-term budget framework alongside FRL reforms:
  - Congress does not have to approve in-year budget adjustments although such changes average around 7 percent of the approved budget.
  - Macroeconomic and fiscal forecasts focus mainly on one-year projections and have substantial deviations from outturns.
  - Published forecasts tend to overestimate GDP growth (since 2013) and inflation.
  - No mechanisms for validating compliance with fiscal targets and rules; no published reconciliation of current forecasts with previous vintages.

- Evaluation of five authorities’ proposals to revise the fiscal framework (summary of staff assessment):

  Suggestion 1: Introduce a long-term public debt ceiling as a nominal anchor
  - Staff agrees a nominal anchor in form of an explicit, well-calibrated permanent debt ceiling would be beneficial.
  - The debt ceiling should balance prudence (buffer to avoid debt distress) and space for development financing including investment.
  - Pair the debt ceiling with an adequate correction mechanism:
    - Use several intermediate thresholds above the ceiling triggering progressively tighter fiscal adjustments.
    - Highest threshold should be set below or at the debt limit.
    - Breaching thresholds would trigger adjustments aimed at reducing debt by a specified amount per year; pace increases at higher thresholds.
    - Step-wise adjustment mechanisms help avoid drifting from the anchor while not derailing recoveries.

  Suggestion 2: Incorporate elements to stabilize the economic cycle, e.g., a structural spending rule
  - Staff supports structural spending rule as operational target but recommends expanding coverage of expenditure.
  - Current rule covers little more than a third of total public spending; excluded items have often grown faster.
  - Recommend including all budgetary spending in the spending rule (potentially except interest expenditures if authorities consider them too volatile).
  - Equip structural spending rule with a correction mechanism:
    - Correction mechanism needed to correct deviations even if debt remains below thresholds.
    - Specify whether deviation is corrected in growth rates or levels; keep mechanism simple (e.g., requirement to return to target in three years).

  Suggestion 3: Reduce discretion in invoking escape clauses
  - Staff recommends significantly tightening triggers for escape clauses:
    - Escape clauses should have (i) a limited and clearly defined set of events, (ii) time limits on how long fiscal policy can deviate, and (iii) a requirement to return to targets after escape clause ends.
    - Escape clauses should only be triggered for events outside government’s control; current framework allows invocation under relatively mild shocks and grants significant discretion afterwards.
    - Triggers should be tightened so clause is invoked only for natural disasters and major shocks that threaten economic stability.
  - With a debt ceiling and enhanced spending rule, deficit targets could be dropped:
    - A simple framework combining a debt rule as nominal anchor with a small set of controllable operational rules is desirable.
    - Staff suggests relying on the debt ceiling and an enhanced spending rule alone and dropping the two existing deficit rules.
    - Caution: expenditure rule alone does not cover revenues and cannot ensure fiscal sustainability without correction mechanisms.

  Suggestion 4: Create a countercyclical fund to save in good times and spend during downturns
  - (Text indicates suggestion exists; detailed appraisal and staff view follow in the chapter beyond this excerpt.)

*Source: 1mexea2019001 - 3. The 2006 FRL aimed at locking in low fiscal deficits and better managing oil revenues*

### 21. Staff believes that consideration could be given to simplifying the rules of the FEIP

### 21. Staff believes that consideration could be given to simplifying the rules of the FEIP

### FEIP function and proposed rule changes
- The current administration has discontinued the practice of systematically under-projecting revenues.
- The FEIP has already begun to fulfill its intended role of stabilizing revenues relative to projections this year.
- Options for reform:
  - Change the rules to gear the fund towards stabilizing revenues over the cycle instead of relative to budget projections.
  - Simplify the rules of the fund.
- Rationale for over-the-cycle orientation:
  - Provides a clearer justification for the stabilization fund by emphasizing buffers against potentially imperfect access to credit markets during economic downturns.
- Design complications and limitations of the current funds (as noted in the source):
  - (i) Resources in the funds are subject to accumulation caps.
  - (ii) Some items are deducted from the pool of resources before transfer to the funds—i.e., shortfalls in revenues with respect to the budget, changes in energy costs not reflected in domestic electricity tariffs, and costs of natural disasters and outlays resulting from changes in interest or exchange rates.
  - (iii) There are complicated rules to distribute resources in the funds. These adjustments and rules operate as de facto earmarking over oil revenue windfalls.
  - Suggested reforms: Unification of the different funds; elimination of accumulation ceilings; and simplification of the transfer rules of revenue to the funds would be welcome.

### Staff assessment of the case for the FEIP in its current form
- Staff considers the case for the existence of a revenue stabilization fund in its current form in Mexico as relatively weak because:
  - Mexico runs fiscal deficits, implying that it needs to borrow to save which is costly.
  - There is no evidence that revenues in Mexico are particularly volatile, including because the share of oil revenues has notably declined in recent years.
  - Mexico already has an oil hedge program that insures its revenues fully for oil price fluctuations.
  - Mexico has maintained adequate market access even during severe shock episodes such as the GFC.
  - Even if it had not, the size of the fund in its current form is too small to make a meaningful difference during a major shock episode.

### Suggestion 5: Creation of an independent fiscal council
- Staff recommends creating a non-partisan, adequately resourced fiscal council with a mandate to provide an independent evaluation of fiscal policy.
- Functions and expected benefits:
  - Provide independent medium-term fiscal projections to contrast with those presented by the Executive Branch at the time of the budget discussion.
  - Provide assessments of structural positions.
  - Strengthen the fiscal policy debate with analysis from reputable experts.
  - Raise awareness and increase the political cost of fiscal indiscipline, even without binding recommendations.
- International context:
  - A rapidly growing number of countries have introduced independent fiscal councils over the last decade.
  - Recent adopters include several European Union member states and emerging and developing economies such as Colombia, Uganda, South Africa, and Peru.
  - Fiscal councils have helped enhance budget transparency, strengthen the credibility of fiscal accounts and forecasts, and provide long-term sustainability assessments and policy analyses (examples cited: Netherlands, Chile, Sweden).

### Annex V — Main recommendations on Public Investment Management (PIMA)
- Main recommendations include:
  - Strengthen fiscal discipline by improving the Medium-Term Fiscal Framework (MTFF), the application of fiscal rules and establishing independent oversight of fiscal planning.
  - Improve the effectiveness of national and sector strategies to guide investment project planning.
  - Strengthen medium-term budget planning.
  - Improve the co-ordination between the federation and states.
  - Develop a standard methodology for determining maintenance funding requirements for all types of infrastructure assets, and budget for them.
  - Promote a more competitive tendering and pro-competition culture among public procurement officials.
  - Improve the comprehensiveness and quality of public investment planning.
  - Improve the predictability of funding for major capital projects.
  - Strengthen the monitoring of cost overruns and project delays.
  - Enhance capital projects management and control during the execution stage.
  - Improve accounting and valuation of assets.
- PIMA assessment summary (selected items with institutional strength, effectiveness, and reform priority):
  - Planning
    - 1. Fiscal targets and rules — Medium; Medium; High
    - 2. National and sectoral planning — Medium; Low; High
    - 3. Coordination between entities — Low; Low; High
    - 4. Project appraisal — High; High; Low
    - 5. Alternative infrastructure financing — Medium; Medium; Medium
  - Allocation
    - 1. Multi-year budgeting — Medium; Low; High
    - 2. Budget comprehensiveness and unity — Medium; Medium; Low
    - 3. Budgeting for investment — Medium; Medium; Low
    - 4. Maintenance funding — Low; Medium; High
    - 5. Project selection — High; Medium; Low
  - Implementation
    - 1. Procurement — High; Medium; High
    - 2. Availability of funding — Medium; Medium; Medium
    - 3. Portfolio management and oversight — Medium; Medium; Medium
    - 4. Management of project implementation — Medium; Medium; Medium
    - 5. Monitoring of public assets — Medium; Low; Medium

### Annex VI — Household and Corporate Sector Health (key findings)
A. Non-Financial Corporates
- Corporate debt:
  - At 26 percent of GDP, corporate debt is among the lowest in emerging economies.
  - Corporate debt has increased by around 6 percentage points over the last five years.
- Foreign currency exposures and hedging:
  - Debt in foreign currency remains high, but most large corporations have largely hedged these exposures.
  - Among the largest 50 private corporations the debt-weighted FX share is close to 68 percent.
  - Foreign currency revenue accounts for around 50 percent of total revenue, weighed by outstanding debt.
  - The 2016 FSAP found that most companies use derivatives to hedge their FX and project financing debts close to their maturity and actively use short term currency forwards to hedge FX cashflow mismatches.
- Market access and debt servicing:
  - Although fundamentals have deteriorated over the last few years, debt servicing capacity remains strong for large corporates.
  - Corporates with international bond issuance still enjoy comfortable market access.
- Sensitivity analysis for the 50 largest corporations by outstanding debt (excluding Pemex and CFE):
  - Collectively, the debt of the top 50 companies in the sample amounts to 12 percent of GDP.
  - PEMEX and CFE debt sums up to 11 percent of GDP.
  - Total NFC debt to GDP is 26 percent.
  - The exercise considers three scenarios: (i) with “natural” hedges; (ii) with “natural” and financial hedges; and (iii) without hedges.
  - Shocks considered:
    - An increase in borrowing costs similar to the increase during the GFC.
    - A peso exchange rate depreciation of 30 percent against the U.S. dollar.
    - Earnings shocks of one standard deviation for each firm.
  - Hedges:
    - “Natural” hedges proxied by the ratio of foreign currency revenues to total revenues for each firm.
    - Financial hedges assumed as 50 percent of FX debt interest expense hedged through derivatives.
  - Results:
    - Debt-at-risk, defined as debts with interest coverage ratio (ICR) below 1, would remain below 0.5 percent of GDP, assuming hedges.
    - Debt-at-risk would rise to around 1.5 percent assuming no hedges.
B. Households
- Household debt:
  - Mexico’s household debt at 16 percent of GDP is among the lowest in EMEs and has remained relatively stable at around 15 percent over the last decade.
  - Mortgage credit is close to 10 percent of GDP. The main mortgage issuer is Infonavit while banks have historically provided around one third of the total.
  - Consumer credit is close to 6 percent of GDP.
  - The share of non-bank financial intermediaries in consumer credit has almost tripled in the last five years and a large share is due to non-regulated entities.
- Non-performing loans (NPLs):
  - NPLs for both housing and consumer loans have generally been stable and low in both banks and non-banks.
  - Sectors with increasing NPLs for non-banks include car loans; despite a large rise since early 2018 they are at comparable levels with bank NPLs.
  - Payroll loans have very low NPLs due to automatic payroll deductions.
  - Some microfinance entities like Sofipos have relatively high NPLs but they remain a very small share of the overall consumer loan market.

*Source: 1mexea2019001 - 21. Staff believes that consideration could be given to simplifying the rules of the FEIP*

### 7.      The banking system is relatively robust to an increase in NPLs given high consumer

### 7. The banking system is relatively robust to an increase in NPLs given high consumer loan provisioning and low levels of the overall consumer loan portfolio

### Banking system resilience and stress-test findings
- The 2016 FSAP stress tests found that the banking system "remains generally resilient to adverse and severe macro-financial shocks".
- Smaller banks "could experience large declines in capital adequacy" under severe shocks.
- Non-bank entities are "susceptible to funding risks (e.g., rollover of bank loans and bond issuance)" because they "don’t rely on a stable deposit base".

### Household and consumer debt levels and composition
- "Consumer debt is just 6 percent of GDP".
- Household debt "remains low and has been relatively stable over the last decade".
- Most consumer loans are for "cars, credit cards, personal and payroll loans".
- Breakdown of consumer loans by non-bank entities (Percent):
  - Automotive: 57%
  - Credit cards: 11%
  - Payroll: 9%
  - Personal and other: 23%

### Non-performing loans and loan portfolio characteristics
- "NPLs have been stable".
- Nonrevolving Consumer Loans, Payroll Loans, Loans on Consumer Durables, Housing Loans, Consumer Credit Card Loans (RHS), and Personal Loans (RHS) are tracked as distinct series in the reported data (sources: SHCP).

### Related fiscal and data points from the informational annex
- Pension liabilities are reported as "47 percent of GDP" and are "partially reported" in the government finance statistics.
- Mexico has accepted the obligations of Article VIII, sections 2, 3, and 4.
- Membership Status: "Joined December 31, 1945".
- Quota: "8,912.70" (SDR Million) at "100.00" percent of Quota.
- Fund holdings of currency: "7,057.79" (SDR Million) at "79.19" percent of Quota.
- Reserve position in Fund: "1,854.95" (SDR Million) at "20.81" percent of Quota.
- Latest Financial Arrangements include multiple FCL entries (dates and amounts are listed in the annex); note: "Access was reduced to 53,476.20 SDR million on November 26, 2018."

### Policy implications and vulnerabilities
- Given the low share of consumer debt in GDP and high provisioning by consumer loan originators, the banking system is relatively robust to increases in consumer NPLs.
- Vigilance is warranted for smaller banks that could see "large declines in capital adequacy" under severe macro-financial stress.
- Non-bank financial intermediaries present funding vulnerabilities due to reliance on market funding and the need for rollover of bank loans and bond issuance.

*MEXICO — STAFF REPORT FOR THE 2019 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1mexea2019001.pdf_