## 1mexea2020002 - EXECUTIVE SUMMARY

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### Context
- Mexico has pursued very strong macroeconomic policies and institutional policy frameworks, including an independent, inflation-targeting central bank and a flexible exchange rate.
- Flexible Credit Line (FCL) details:
  - Eighth FCL arrangement approved on November 22, 2019, in the amount of SDR 44.5635 billion (500 percent of quota, around US$61 billion).
  - Authorities signaled intention to request reduction in access to SDR 35.6508 billion (400 percent of quota) at mid-term review; given elevated global risks around the Covid-19 shock, authorities are not requesting a reduction and expect to treat the FCL as precautionary.
- Staff assessment and recommendation:
  - Mexico continues to meet the qualification criteria for FCL resources under Decision No. 14283-(09/29).
  - Staff recommends completing the review to allow purchases until the expiration of the FCL arrangement on November 21, 2021.

### Recent developments and impact of Covid-19
- Human and economic impact:
  - Official death toll currently exceeds 90,000; unofficial estimates are significantly higher based on excess mortality statistics.
  - The share of the working poor jumped from 36 percent pre-pandemic to 48 percent in mid-2020.
  - Real GDP shrank by 0.1 percent in 2019.
  - Historic contraction in GDP by 19 percent (y/y) in 2020Q2.
- Labor market:
  - Over 20 percent of workers lost their jobs in April; about one third (about four million) remain economically inactive.
  - An additional 11 percent of workers became underemployed, with more than 6 percent still underemployed in August.
  - Unemployment rate has risen above 5 percent.
- Inflation and monetary stance:
  - Annual headline inflation slightly under 4 percent through September; central bank target is 3 percent.
  - Core inflation near 4 percent; services inflation remains below 2.5 percent.
  - Policy rate: hiked to 8.25 percent by mid-2019; lowered to 7 percent before the pandemic; cut by a total of 400 basis points since last summer (275 basis points since March 2020); policy rate is 4.25 percent.
- External and financial developments:
  - Exports and imports initially slumped by more than 30 percent y/y in Q2; manufacturing exports recovered faster.
  - Remittances increased by 26 percent in pesos in the first seven months of 2020.
  - Gross international reserves rose to $200 billion in October from $183 billion at end-2019; reserves now 130 percent of the Assessing Reserve Adequacy (ARA) metric.
  - Swap line with the U.S. Federal Reserve for $60 billion established; about $6 billion tapped initially and use has declined below $2 billion.
  - Sovereign dollar borrowing costs declined to historic lows of around 3-3.5 percent; Pemex re-accessed international markets in October 2020, raising US$1.5 billion at a yield of 6.95 percent on a 5-year bond.
- Banking sector:
  - Broadly resilient, highly concentrated, mostly international, with sizable capital buffers and low NPLs.
  - Profitability problems emerging in smaller banks; liquidity conditions remain well above regulatory requirements.
- Policy environment:
  - Pandemic-era fiscal response described as very muted.
  - Fiscal gaps increased to 1¼-2 percent of GDP over 2021-25.
  - Reversals in structural reforms, notably in the energy sector, and cancellation of large private projects have weakened investment sentiment.

### Outlook, risks, and staff projections
- Baseline projections and medium-term outlook:
  - Output projected to contract by 9 percent this year and grow by 3½ percent next year under current policies.
  - Over the medium term, growth expected near the potential rate of around 2 percent.
  - Potential output by 2025 projected at 9 percent below pre-pandemic projections.
  - External current account projected to increase to a modest surplus in 2020 and decline gradually over the medium term.
- Key downside risks:
  - Uncertain path of the global pandemic, possible resurgence in infections and delays in vaccine development.
  - Renewed financial market volatility, declines in oil prices, adverse growth outcomes in key trading partners, premature withdrawal of stimulus in advanced economies.
  - Policy risks from reform reversals and actions that undermine the investment climate.
- Policy guidance:
  - Monetary policy: with 1-year ahead inflation expectations well anchored, staff believes consideration could be given to further easing rates while maintaining external financial stability.
  - Fiscal policy: implement a medium-term tax reform once recovery is firmly established to finance public investment and social spending, close fiscal gaps, and lower public debt.
  - Maintain the FCL as a precautionary buffer given elevated global risks and uncertainty.

### Fiscal response, projections, and public debt outlook
- Fiscal response:
  - Covid-19 related discretionary budget support in 2020 amounted to 0.7 percent of GDP—the lowest among G20 economies.
  - Draft 2021 budget: real spending increasing by just 0.1 percent.
  - Staff view: temporary near-term fiscal support of 2½–3½ percent of GDP could help better combat the pandemic and its effects.
  - No new medium-term tax reforms or base-broadening efforts were announced.
  - Stabilization and trust funds expected to be drawn down substantially.
  - Authorities proposed a pension reform financed by gradually lifting the contribution rates of private employers.
  - Staff recommends considering complementary measures to offset any impact of pension contribution increases on labor market informality.
- Fiscal projections and gaps:
  - Authorities' budget forecasts: overall deficit (PSBR) of 4.7 percent of GDP in 2020; target PSBR of 3.4 percent of GDP in 2021; medium term guidelines indicate deficits of around 2½ percent of GDP.
  - Staff projections: overall deficit to widen to 5.8 percent of GDP in 2020.
  - Fiscal gaps of 1¼–2 percent of GDP in 2021 and beyond to meet authorities’ deficit targets (based on more prudent assumptions).
- Public debt outcomes under scenarios:
  - If measures identified to close fiscal gaps, gross public debt would stabilize around 65 percent of GDP.
  - Otherwise, debt would rise to 73 percent of GDP over the medium term.
  - Staff note: gross public debt expected to rise by about 12 percent of GDP in 2020 due to GDP contraction and peso depreciation; if authorities meet fiscal targets over the medium-term, public debt should stabilize around 65 percent of GDP.
  - Staff assesses Mexico’s public debt to be sustainable with high probability.

### Growth, investment, and reform priorities
- Authorities announced in October a series of investment projects that could amount to 1¼ percent of GDP in the coming years.
- Structural priorities to boost investment and productivity:
  - Reinforce the rule of law.
  - Improve the business climate.
  - Tackle labor market informality.
- Staff view: modifying Pemex’s business strategy to focus on profitability and sustainability remains key to reduce budget strains and protect the value of Mexico’s oil assets.

### Flexible Credit Line, external position, and qualification
- FCL stance and access:
  - Authorities not requesting change in access amid elevated pandemic-related external risks and heightened uncertainty.
  - Prior strategy: reduced access from 700 percent to 600 percent of quota in 2018, then to 500 percent of quota last year; intended further reduction to 400 percent of quota during current review conditional on reduced external risks.
  - Authorities expect to treat the FCL as precautionary and prefer drawing down internal fiscal buffers; recourse to the FCL may be needed to address actual balance of payments pressures.
- Staff view on external position and indicators:
  - 2019 external position assessed broadly in line with medium-term fundamentals and desirable policies.
  - External debt/GDP ratio expected to increase by 9 percentage points of GDP this year reflecting denominator effects, but expected to stabilize next year.
  - Net foreign assets projected to be around –55 percent of GDP through 2025.
  - Capital account dominated by private flows; public flows about one sixth of direct, portfolio, and other flows on average over the last three years.
  - Sovereign bond (UMS) spread and 5-year CDS close to pre-crisis levels at 245 and 128 basis points respectively (as of October 30th, 2020).
  - Gross international reserves: US$200 billion as of early-October 2020, compared to US$182.9 last September; reserves exceeded 100 percent of the ARA metric in each of the last four years.
  - Central bank temporary US$60 billion swap line with U.S. Federal Reserve; separate US$3 billion swap line with the Federal Reserve associated with the North American Framework Agreement; US$9 billion swap line with the U.S. Treasury.
  - Public sector issued or guaranteed external bonds/disbursements in international markets during each of the last five years cumulative equivalent to nearly 1,600 percent of Mexico’s IMF quota.

### Institutional quality, governance, and vulnerabilities
- Strengths:
  - Inflation-targeting framework anchored by a strong, independent central bank.
  - Fiscal responsibility law.
  - Effective prudential and regulatory framework for financial supervision.
- Weaknesses:
  - Control of corruption remains a weaker area.
  - National Anti-Corruption System (NACS) created in 2016; implementation, prevention, and enforcement progress remains low.
  - Recent concerns about reform reversals have raised policy uncertainty and deterioration in investment, alongside perceptions of eroding independence and quality of regulation.

### Policy trade-offs and staff recommendations (sequencing and priorities)
- Near-term:
  - Provide temporary near-term support of 2½–3½ percent of GDP to better combat the pandemic and its effects.
- Medium-term:
  - Prepare and implement a quality medium-term tax reform once recovery is firmly underway to close gaps, lower public debt, and create space for public investment and enhanced safety nets.
  - Modify Pemex’s business strategy to prioritize profitability and sustainability.
  - Implement reforms to reinforce the rule of law, improve the business climate, and tackle labor market informality.
  - Consider complementary measures to offset potential increases in labor market informality from higher employer pension contributions.
- Overall staff appraisal: some space exists for further temporary and targeted fiscal support, but overall fiscal policy has been very conservative; early announcements of medium-term reforms could improve risk sentiment and investment.

### Box 1 — External Economic Stress Index (ESI): methodology, weights, and scenarios
- Overview and methodology:
  - ESI initially presented in November 2014; methodology explained in Flexible Credit Line—Operational Guidance Note, IMF Policy Paper, August 2018.
  - Calculation choices: (i) selection of relevant external risks, (ii) selection of proxy variables capturing these risks, (iii) choice of weights.
  - Updated index uses same model and proxy variables as 2017, 2018, and 2019; weights updated.
- Risks and proxy variables:
  - Exports, remittances, and inward FDI proxied by U.S. growth.
  - Debt portfolio flows proxied by change in the U.S. Treasury 10-year yield.
  - Equity portfolio flows proxied by VXEEM.
  - Oil industry proxied by change in world oil prices.
  - All variables expressed in shares of GDP.
- Exact weights (from 2019 balance of payment and IIP data):
  - U.S. growth: 0.51.
  - Change in the U.S. long-term yield: 0.34.
  - VXEEM: 0.13.
  - Change in the oil price: 0.02.
- Scenarios and quantitative assumptions:
  - Baseline: uses WEO projections; VXEEM assumed at average of first half of 2020.
  - Global downside scenario (October 2020 WEO-based) quantitative assumptions relative to baseline:
    - Global growth in 2020 is roughly ¾ percentage points weaker.
    - Global growth in 2021 is almost 3 percentage points weaker.
    - Cumulative reduction of U.S. growth of 2.4 percentage point.
    - Lower oil prices by 6 percent over the next two years.
    - VXEEM rises by 3 standard deviations (comparison: VXEEM increased by 4 standard deviations in 2008:Q4 and 2011:Q3).
  - Country-specific external downside scenario: not directly captured by ESI but staff notes elevated country-specific uncertainties given Mexico’s close trade relations with the United States.
- Index behavior notes:
  - Proxy variables calculated using mean and standard deviation between 1995 and 2019.
  - Sharp increase in second half of 2020 reflects a technical rebound in U.S. growth after its sharp contraction in the first half.

### Debt sustainability analyses, stress tests, and selected exact figures
- Public sector DSA (selected projections and indicators, exact figures preserved):
  - Nominal gross public debt: 2018 47.7, 2019 53.6, 2020 53.7, 2021 65.5, 2022 65.6, 2023 54.6, 2024 52.6, 2025 52.0, 2026 51.0.
  - Public gross financing needs (percent of GDP): 11.7, 7.8, 10.7, 14.7, 11.9, 11.5, 11.5, 11.9, 11.5.
  - Real GDP growth (in percent): 2018 2.2, 2019 2.2, 2020 -0.1, 2021 -9.0, 2022 3.5, 2023 2.3, 2024 2.2, 2025 2.1, 2026 2.1.
  - Inflation (GDP deflator, in percent): 4.4, 4.9, 4.0, 2.2, 2.9, 3.2, 3.2, 3.1, 3.0.
  - Effective interest rate (in percent): 7.5, 8.2, 7.8, 7.5, 6.6, 6.1, 5.9, 5.9, 6.0.
- Contribution to change in gross public sector debt (cumulative, 2018–2025) and identified debt-creating flows presented with exact numeric sequences as in source (e.g., "1.3-0.40.111.80.1-0.2-0.2-0.1-0.111.2").
- Public DSA scenario assumptions (selected):
  - Baseline: Real GDP growth 2019 -0.1, 2020 -9.0, 2021 3.5; Inflation 2020 2.2; Primary Balance 2020 -2.0; Effective interest rate 2020 7.5.
  - Constant Primary Balance scenario: Primary Balance set at -2.0 for projection years 2021–2025.
- Stress tests illustrating vulnerabilities:
  - External debt stress tests include interest rate shock, current account shock, growth shock, real depreciation shocks (one-time real depreciation of 30 percent occurs in 2021), and combined shocks (combined 1 standard deviation reduction in GDP growth for two years, permanent 200bp shock to real interest rate, 25 percent real depreciation and 1/2 standard deviation shock to primary balance for two years).
  - Example representative baseline: Gross external debt 42 (percent of GDP).
- Selected macroeconomic projections (exact figures):
  - Real GDP growth: 2019 -0.1, 2020 -9.0, 2021 3.5, 2022 2.3, 2023 2.2, 2024 2.1, 2025 2.1.
  - Consumer prices (end of period): 2019 2.8, 2020 3.7, 2021 2.9, 2022 3.0, 2023 3.0, 2024 3.0, 2025 3.0.
  - Current account balance (percent of GDP): 2019 -0.3, 2020 1.2, 2021 -0.1, 2022 -0.9, 2023 -1.5, 2024 -1.8, 2025 -2.0.
  - Gross public sector debt (percent of GDP): 2019 53.6, 2020 53.7, 2021 65.5, 2022 65.6, 2023 54.6, 2024 52.6, 2025 52.0.
  - Public sector overall balance (percent of GDP): 2020 -5.8, 2021 -3.4, 2022 -2.6, 2023 -2.5, 2024 -2.5, 2025 -2.5.
- Selected balance of payments and financial indicators (exact figures):
  - GDP per capita (U.S. dollars, 2019): 10,024.
  - Poverty headcount ratio (% of population, 2018): 41.9.
  - Population (millions, 2019): 127.
  - Life expectancy at birth (years, 2019): 75.1.
  - Summary Balance of Payments (billions of U.S. dollars): Current account 2019 -4.4; 2020 13.0; 2021 -1.0; 2022 -10.5; 2023 -18.0; 2024 -22.4; 2025 -25.8.
  - Exports, f.o.b. (billions): 2019 460.7; 2020 401.3; 2021 479.0; 2022 500.1.
  - Gross international reserves (billions of U.S. dollars): 2019 176.4; 2020 183.0; 2021 190.4; 2022 192.1; 2025 202.4.
  - Exchange rate (period average): 2019 19.3; 2020 21.8 (Aug-20).
  - EMBIG Mexico spread (basis points; period average): 2019 318; 2020 487 (Sep-20).
  - Gross total external debt (percent of GDP): 2019 36.6; 2020 45.5 (Proj.).
  - External debt service (percent of GDP): 2019 9.4; 2020 10.0 (Proj.).

### Safeguards, supervision, and staff appraisal
- Safeguards: EY Mexico issued an unmodified audit opinion on Banco de Mexico's 2018 financial statements; no significant issues emerged from safeguards procedures.
- Staff appraisal:
  - Mexico’s successive FCL arrangements have provided valuable insurance and buffers.
  - Heightened external risks have paused Mexico’s planned exit from the FCL; authorities expect to continue treating the FCL as precautionary.
  - Staff recommends completion of the mid-term review under the FCL arrangement for Mexico.

*IMF staff report: EXECUTIVE SUMMARY (1mexea2020002) — November 3, 2020*

### EXECUTIVE SUMMARY

### 1mexea2020002 - EXECUTIVE SUMMARY

### Context
- Mexico has pursued very strong macroeconomic policies and institutional policy frameworks, including an independent, inflation-targeting central bank and a flexible exchange rate.
- The Flexible Credit Line (FCL) has been an important buffer and credibility signal:
  - Mexico’s eighth FCL arrangement approved on November 22, 2019, in the amount of SDR 44.5635 billion (500 percent of quota, around US$61 billion).
  - At approval, authorities signaled an intention to request a reduction in access to SDR 35.6508 billion (400 percent of quota) at the mid-term review; given elevated global risks around the Covid-19 shock, authorities are not requesting a reduction and expect to treat the FCL as precautionary.
- Staff assessment: Mexico continues to meet the qualification criteria for FCL resources under Decision No. 14283-(09/29) (adopted March 24, 2009, as amended). Staff recommends completing the review to allow purchases until the expiration of the FCL arrangement on November 21, 2021.

### Recent developments and impact of Covid-19
- Human and economic impact:
  - Official death toll currently exceeds 90,000; unofficial estimates are significantly higher based on excess mortality statistics.
  - The share of the working poor jumped from 36 percent pre-pandemic to 48 percent in mid-2020.
  - Real GDP shrank by 0.1 percent in 2019.
  - Historic contraction in GDP by 19 percent (y/y) in 2020Q2 driven by large declines in consumption and investment.
- Labor market:
  - Over 20 percent of workers lost their jobs in April, of which a third (about four million) remain economically inactive.
  - An additional 11 percent of workers became underemployed, with more than 6 percent still underemployed in August.
  - The unemployment rate has risen above 5 percent.
- Inflation and monetary stance:
  - Annual headline inflation was slightly under 4 percent through September, above the central bank’s target of 3 percent.
  - Core inflation near 4 percent; services inflation remains below 2.5 percent.
  - Policy rate developments: rates were hiked to 8.25 percent by mid-2019, lowered to 7 percent before the pandemic, then cut by a total of 400 basis points since last summer (275 basis points since March 2020). The policy rate is 4.25 percent.
- External and financial developments:
  - Exports and imports initially slumped by more than 30 percent y/y in Q2; manufacturing exports recovered faster.
  - Remittances increased by 26 percent in pesos in the first seven months of 2020.
  - Gross international reserves rose to $200 billion in October from $183 billion at end-2019, now 130 percent of the Assessing Reserve Adequacy (ARA) metric.
  - A swap line with the U.S. Federal Reserve for $60 billion was established; about $6 billion was tapped initially and use has declined below $2 billion.
  - Sovereign external borrowing: sovereign dollar borrowing costs declined to historic lows of around 3-3.5 percent; Pemex re-accessed international markets in October 2020, raising US$1.5 billion at a yield of 6.95 percent on a 5-year bond.
- Banking sector:
  - Banking sector broadly resilient, highly concentrated, mostly international, with sizable capital buffers and low NPLs.
  - Profitability problems emerging in smaller banks; liquidity conditions remain well above regulatory requirements.
- Policy environment:
  - Pandemic-era fiscal response described as very muted, minimizing near-term public debt accumulation but risking a deeper contraction and prolonged economic scarring.
  - Fiscal gaps increased to 1¼-2 percent of GDP over 2021-25, heightening the importance of a medium-term tax reform when recovery is firm to finance public investment and social spending and to lower public debt.
  - Reversals in structural reforms, notably in the energy sector, and cancellation of large private projects have weakened investment sentiment and risk reducing the recovery and potential GDP growth.

### Outlook, risks, and policy recommendations
- Staff baseline projections and medium-term outlook:
  - Output projected to contract by 9 percent this year and grow by 3½ percent next year under current policies.
  - Over the medium term, growth is expected near the potential rate of around 2 percent.
  - Potential output by 2025 is projected at 9 percent below pre-pandemic projections.
  - The external current account projected to increase to a modest surplus in 2020 and decline gradually over the medium term.
- Key risks (tilted to the downside):
  - Uncertain path of the global pandemic, including possible resurgence in infections and delays in vaccine development.
  - Renewed financial market volatility, declines in oil prices, adverse growth outcomes in key trading partners, premature withdrawal of stimulus in advanced economies.
  - Policy risks from reform reversals and actions that undermine the investment climate.
- Policy guidance and considerations:
  - Monetary policy: staff notes the central bank faces a difficult tradeoff given countervailing inflation and external pressures. With 1-year ahead inflation expectations well anchored, staff believes consideration could be given to further easing rates to support the economy while maintaining external financial stability.
  - Fiscal policy: importance of implementing a medium-term tax reform once recovery is firmly established to finance increased public investment and social spending, close fiscal gaps, and lower public debt.
  - Maintain the FCL as a precautionary buffer given elevated global risks and uncertainty.

### Flexible Credit Line and qualification
- FCL history and current stance:
  - Mexico has treated successive FCL arrangements as precautionary since the FCL’s introduction in 2009.
  - Despite drawdown of internal fiscal buffers in response to Covid-19, authorities expect to continue treating the FCL as precautionary.
- Staff recommendation:
  - Staff recommends that the Board complete the mid-term review, allowing Mexico to make purchases until the FCL arrangement’s expiration on November 21, 2021, as Mexico continues to meet qualification criteria.

*IMF staff report: EXECUTIVE SUMMARY (1mexea2020002) — November 3, 2020*

### 15.      The authorities’ fiscal policy response to Covid-19 and its economic fallout has been

### 15.      The authorities’ fiscal policy response to Covid-19 and its economic fallout has been

### Fiscal response and near-term assessment
- Covid-19 related discretionary budget support in 2020 amounted to 0.7 percent of GDP—the lowest among G20 economies.
- The draft 2021 budget continues a conservative approach with real spending increasing by just 0.1 percent.
- Staff view: temporary near-term fiscal support of 2½–3½ percent of GDP could help better combat the pandemic and its effects.
- No new medium-term tax reforms or base-broadening efforts were announced.
- Stabilization and trust funds are expected to be drawn down substantially.
- Tax administration measures have yielded better-than-expected revenues so far in 2020.
- Authorities proposed a pension reform that would raise replacement rates and improve pension adequacy and eligibility; it will be financed by gradually lifting the contribution rates of private employers.
- Staff recommendation: consider complementary measures to offset any impact of pension contribution increases on labor market informality.

### Fiscal projections, gaps, and public debt outlook
- Budget forecasts:
  - Overall deficit (public sector borrowing requirement or PSBR) of 4.7 percent of GDP in 2020.
  - Target PSBR of 3.4 percent of GDP in 2021.
  - Medium term guidelines indicate deficits of around 2½ percent of GDP.
- Staff projections:
  - Overall deficit to widen to 5.8 percent of GDP in 2020.
  - Fiscal gaps of 1¼–2 percent of GDP in 2021 and beyond to meet authorities’ deficit targets (based on more prudent assumptions for nominal GDP growth, oil production, and revenue efficiency).
- Debt outcomes under scenarios:
  - If measures are identified to close the fiscal gaps, gross public debt would stabilize around 65 percent of GDP.
  - Otherwise, debt would rise to 73 percent of GDP over the medium term.
- Historical adjustment channels: Mexico has closed past budget gaps using revenue stabilization funds, other trusts, and expenditure contractions; but staff sees little scope for further expenditure cuts without impairing public services and sustainability, and stabilization funds and other trusts have declined.
- Staff view: a quality medium-term tax reform—implemented when the recovery is firmly in train—is needed to close gaps, lower public debt, and generate room for public investment and enhanced safety nets.
- Staff view: modifying Pemex’s business strategy to focus on profitability and sustainability remains key to reduce budget strains and protect the value of Mexico’s oil assets.

### Growth, investment, and reform priorities
- Authorities announced in October, in conjunction with private sector representatives, a series of investment projects that could amount to 1¼ percent of GDP in the coming years.
- Risks from limited policy support:
  - Deep contraction risks delaying a robust recovery and leaving lasting economic scars that could test fiscal resources over the medium term.
  - Risk of weighing further on productivity growth, which has been relatively low.
- Structural priorities to boost investment and productivity:
  - Reinforce the rule of law.
  - Improve the business climate.
  - Tackle labor market informality.
- These reforms would facilitate a stronger recovery and help Mexico reap gains from USMCA.

### Tax reform preparations and Covid-19 complications
- Authorities had committed, at the FCL request, to prepare the ground for a comprehensive medium-term tax reform to underpin sustainability and inclusive growth.
- Authorities informed staff that the Covid-19 context has complicated the take up of these issues before the pandemic abates, with current focus on enhancing collection efficiency.
- Note: For 2021, there might be substantial one-off transfers from the central bank, related to the peso revaluation of international reserves.

### FCL access, qualification, and external/financial position
- Authorities are not requesting a change in access for this review amid elevated pandemic-related external risks and heightened uncertainty.
- Prior authorities’ strategy: phase out prolonged use of the facility by reducing access from 700 percent to 600 percent of quota in 2018, then to 500 percent of quota last year, and intending to request a further reduction to 400 percent of quota during the current review conditional on reduced external risks.
- External risks have risen substantially; authorities consider unchanged access provides a timely and adequate buffer while remaining committed to the 2017 exit strategy when exceptional global risks recede.
- Authorities expect to treat the FCL as precautionary and prefer drawing down internal fiscal buffers, but recourse to the FCL may be needed to address actual balance of payments pressures.
- Staff view: Mexico continues to meet the FCL qualification criteria:
  - Sustainable external position: 2019 external position assessed broadly in line with medium-term fundamentals and desirable policies; external current account expected to be in surplus this year as exports recover faster than imports.
  - External debt/GDP ratio expected to increase by 9 percentage points of GDP this year reflecting denominator effects from the output contraction, but expected to stabilize next year and converge to a small deficit over the next few years in line with fundamentals and desirable policies.
  - Net foreign assets projected to be around –55 percent of GDP through 2025.
  - Capital account position dominated by private flows; public flows accounted for only around a sixth of Mexico’s direct, portfolio, and other asset and liability flows on average over the last three years.
  - Track record of steady sovereign access to international capital markets at favorable terms despite recent ratings downgrades; sovereign bond (UMS) spread and 5-year credit default swap stand close to pre-crisis levels at 245 and 128 basis points respectively (as of October 30th, 2020).
  - Gross international reserves rose throughout the crisis reaching US$200 billion as of early-October 2020, compared to US$182.9 last September.
  - Reserves have exceeded 100 percent of the ARA metric in each of the last four years.
  - Central bank temporary US$60 billion swap line with the U.S. Federal Reserve; complemented by a separate US$3 billion swap line with the Federal Reserve associated with the North American Framework Agreement, and a US$9 billion swap line with the U.S. Treasury.
  - Public sector issued or guaranteed external bonds or disbursements in international markets during each of the last five years in a cumulative amount over that period equivalent to nearly 1,600 percent of Mexico’s IMF quota.
  - Staff assesses Mexico’s public debt to be sustainable with high probability; fiscal policy underpinned by the fiscal responsibility law.
  - Staff note: gross public debt expected to rise by about 12 percent of GDP in 2020 due to GDP contraction and peso depreciation; if the authorities meet fiscal targets over the medium-term, public debt should stabilize around 65 percent of GDP.
  - Debt projection sensitivity: growth, exchange rate fluctuations, interest rates, and oil price shocks; larger effects under a renewed Covid-19 shock paired with a risk-off shift in financial markets.
  - Low and stable inflation: headline inflation converged back to the 3 percent target in 2019; headline inflation saw high volatility during the pandemic while core inflation has risen steadily to the top of the inflation band.
  - Inflation drivers: exchange rate pass-through, supply constraints, and idiosyncratic food inflation (processed food included in the core basket).
  - Inflation expectations: 1-year ahead and medium-to-long term expectations have scarcely moved during the turbulent period.
  - Financial sector: generally well-capitalized and profitable banking system, average capital adequacy ratios remain above regulatory thresholds; private pension funds hold assets of about 16 percent of GDP with a conservative investment profile.
  - Supervisory framework: Basel III capital rules adopted in 2013; Basel Committee assessed Mexico as compliant in 2015; minimum liquidity coverage ratio requirements in place since January 2015.
  - Data transparency: overall quality of Mexican data continues to be high; Mexico remains in observance of the Special Data Dissemination Standards (SDDS).
  - Track record: all relevant core indicators were met in each of the five most recent years.

### Institutional quality, governance, and vulnerabilities
- Strengths:
  - Inflation-targeting framework anchored by a strong, independent central bank.
  - Fiscal responsibility law.
  - Effective prudential and regulatory framework for financial supervision.
- Weaknesses:
  - Control of corruption remains a weaker area.
  - Constitutional reform created the National Anti-Corruption System (NACS) in 2016; focus shifting toward implementation, prevention, and enforcement.
  - Progress remains low in investigation, prosecution, and enforcement despite legislation now in congress and the Financial Intelligence Unit following up.
  - Recent concerns about reform reversals have raised policy uncertainty and deterioration in investment, alongside perceptions of eroding independence and quality of regulation.

### Policy trade-offs and staff recommendations
- Staff view: additional measures are needed to close fiscal gaps over the medium term and stabilize public debt.
- Recommended sequencing and priorities:
  - Provide temporary near-term support of 2½–3½ percent of GDP to better combat the pandemic and its effects.
  - Prepare and implement a quality medium-term tax reform once recovery is firmly underway to close gaps, lower public debt, and create space for public investment and enhanced safety nets.
  - Modify Pemex’s business strategy to prioritize profitability and sustainability to reduce budgetary strains.
  - Implement reforms to reinforce the rule of law, improve the business climate, and tackle labor market informality to boost investment and productivity.
  - Consider complementary measures to offset potential increases in labor market informality from higher employer pension contributions.
- Staff assessment: there is some space for further temporary and targeted fiscal support, but overall fiscal policy has been very conservative; early announcements of medium-term reforms in revenues and Pemex strategy could improve risk sentiment and investment while providing additional policy space.

### Safeguards, supervision, and staff appraisal
- Safeguards: EY Mexico issued an unmodified audit opinion on Banco de Mexico's 2018 financial statements; no significant issues emerged from safeguards procedures.
- Staff appraisal:
  - Mexico’s successive FCL arrangements have provided valuable insurance and buffers; arrangements, along with sizable international reserves, supported authorities’ policies during volatility.
  - The heightened external risks have paused Mexico’s planned exit from the FCL; the authorities expect to continue treating the FCL as precautionary.
  - Staff’s assessment: Mexico continues to meet the qualification criteria for access to FCL resources given very strong macroeconomic policies, institutional frameworks, and sound fundamentals.
  - Staff recommends completion of the review under the FCL arrangement for Mexico.

*Source: 1mexea2020002 - 15.      The authorities’ fiscal policy response to Covid-19 and its economic fallout has been*

### Box 1. The Calculation of the External Economic Stress Index

### Box 1. The Calculation of the External Economic Stress Index

### Overview
- The external economic stress index (ESI) for Mexico was initially presented in Mexico’s staff report on the arrangement under the Flexible Credit Line, November 2014. Its methodology is explained in Flexible Credit Line—Operational Guidance Note, IMF Policy Paper, August 2018.
- Calculation required three main choices: (i) selection of relevant external risks, (ii) selection of proxy variables capturing these risks, and (iii) choice of weights for these variables.
- The updated index uses the same model and proxy variables as for the 2017 FCL request, the 2018 review, and the 2019 request; the weights have been updated.

### Risks and proxy variables
- Identified external risk channels:
  - Exports, remittances, and inward FDI (closely related to U.S. economic developments).
  - Exposure to changes in global financial conditions via an open capital account and significant stock of debt and equity portfolio investment.
  - Oil trade and fiscal revenues dependent on world energy price developments.
- Proxy variables:
  - Risks to exports, remittances, and inward FDI: proxied by U.S. growth.
  - Risks to debt portfolio flows: proxied by the change in the U.S. Treasury 10-year yield.
  - Risks to equity portfolio flows: proxied by the emerging market volatility index (VXEEM).
  - Risks to the oil industry: proxied by the change in world oil prices.
- All variables are expressed in shares of GDP.

### Weights and measurement
- Weights estimated using balance of payment and international investment position data in 2019.
- Exact weights:
  - U.S. growth: 0.51 (corresponds to the sum of exports, FDI, and remittances).
  - Change in the U.S. long-term yield: 0.34 (corresponds to the stocks of foreign debt).
  - VXEEM: 0.13 (corresponds to the stocks of foreign equity).
  - Change in the oil price: 0.02 (corresponds to oil exports).

### Scenarios and assumptions
- Baseline scenario:
  - Uses the WEO projections for U.S. growth, oil prices, and the U.S. 10-year bond yield.
  - VXEEM is assumed to remain relatively high at the average of the first half of 2020 during the projection period, given the high uncertainty over Covid-19.
  - Compared to the time of the 2019 request, the ESI under the baseline scenario indicates higher risks.
- Global downside scenario:
  - Based on the scenario in the October 2020 WEO; points to a much larger shock than at the time of the 2019 request.
  - Assumes slower progress against Covid-19 than the baseline, causing significant deterioration in economic activity and tighter financial conditions.
  - Quantitative assumptions relative to the baseline WEO projection:
    - Global growth in 2020 is roughly ¾ percentage points weaker.
    - Global growth in 2021 is almost 3 percentage points weaker.
    - Cumulative reduction of U.S. growth of 2.4 percentage point.
    - Lower oil prices by 6 percent over the next two years.
    - VXEEM rises by 3 standard deviations (for comparison, the VXEEM increased by 4 standard deviations in both 2008:Q4 and 2011:Q3).
  - Scenario implies a surge in global financial market volatility, disruptions to financial flows, higher risk premia for Mexico, and possible declines in rollover rates.
- Country-specific external downside scenario:
  - The ESI global downside scenario shows elevated external risks compared to November 2019, reflecting uncertain global economic and financial environment amid Covid-19.
  - Country-specific uncertainties remain high given Mexico’s close trade relations with the United States and integration into global financial markets.
  - Potential country-specific shocks include disruptions in value chains and an abrupt drop in FDI.
  - The current ESI is not designed to reflect these country-specific uncertainties, but staff views the combination of global risks and country-specific uncertainties as remaining elevated.

### Key statistics and exact figures
- Weights: 0.51 (U.S. growth), 0.34 (change in the U.S. long-term yield), 0.13 (VXEEM), 0.02 (change in the oil price).
- VXEEM assumption in baseline: average of the first half of 2020.
- Global downside scenario shocks:
  - Global growth 2020: roughly ¾ percentage points weaker.
  - Global growth 2021: almost 3 percentage points weaker.
  - Cumulative U.S. growth reduction: 2.4 percentage point.
  - Oil prices: lower by 6 percent over the next two years.
  - VXEEM increase: 3 standard deviations (historical comparison: 4 standard deviations in 2008:Q4 and 2011:Q3).

*Source: Box 1. The Calculation of the External Economic Stress Index, 1mexea2020002.*

### Box 1. The Calculation of the External Economic Stress Index (concluded)

### Box 1. The Calculation of the External Economic Stress Index (concluded)

### Index behavior and scenario presentation
- The global downside scenarios are illustrated in the chart by dots.
- The index would fall if the described shocks materialized in any given quarter.
- Note: Proxy variables are calculated by using the mean and standard deviation between 1995 and 2019.
- The sharp increase in the second half of 2020 reflects a technical rebound in U.S. growth after its sharp contraction in the first half.

### Recent economic developments (high-level findings from figures and notes)
- Output experienced a historical contraction led by manufacturing.
- Deep initial job losses have partially recovered, but gains have slowed.
- High frequency data suggests a slow recovery on many dimensions.
- The fiscal deficit is projected to widen in 2020 following the sharp growth decline owing to COVID-19.
- After falling decisively, inflation is now edging up on exchange rate passthrough and supply shocks, as in 2009.
- A stringent lockdown slowed the outbreak (Figure notes reference Oxford University Stringency index).
- Ultra high frequency indicators indexed to Jan-Feb average = 100 show declines in flights, Apple Mobility, card transactions, and job postings in 2020 (indexed series, Jan–Feb avg. = 100).

### Financial and external developments (selected findings)
- Initial turbulence in markets has receded; nominal yields are low at the short end, steepening the yield curve (Government bond yields shown for 1-year, 5-year, 10-year, 20-year).
- EMBIG and CEMBI spreads spiked in early 2020 and partially receded (EMBIG Mexico and CEMBI series shown).
- The Mexican peso has partially recovered relative to other EM currencies (index with Jun. 2014 = 100).
- Bank credit to corporates followed consumer credit after a spike in credit line draws.
- Local currency debt outflows have been stanched but have not recovered (Foreign Inflows in Local Currency Debt, 30 day Moving Sum, MXN bn).
- Current account: factor income and transfers contribute to an expected surplus for the year; CA Forecast Avg shown in percent of GDP.

### External position, reserve coverage, and FCL context
- Almost all external debt is to private creditors: Private 89 percent, Public 11 percent (Holders of gross foreign currency debt, 2020Q2).
- Gross international reserves coverage indicators (GIR to GDP, GIR to Broad Money, GIR to Short-term external debt) place Mexico among peers (Figures comparing GIR metrics across EMEs).
- The ARA Metric definition and the 100–150 percent range are noted as benchmarks for reserve adequacy.
- Figures show Mexico's GIR to GDP, GIR to Broad Money, GIR to Short-term External Debt, and GIR to ARA Metric (end-2019) relative to other countries and medians.

### External debt sustainability (stress tests and scenarios)
- Baseline gross external debt projections (in percent of GDP) are charted alongside scenarios with:
  - Combined 1/ (per footnote: combined permanent 1/4 standard deviation shocks applied to interest rate, growth, and current account balance).
  - 30% real depreciation scenario.
  - 25% real depreciation scenario.
- External debt scenarios and public debt scenarios are presented with baseline and alternative paths.
- Figure 5 stress tests (External debt in percent of GDP) include:
  - Interest rate shock.
  - Current account (CA) shock.
  - Growth shock.
  - Real depreciation shock (one-time real depreciation of 30 percent occurs in 2021).
  - Combined shock (Combined 3/ per footnote: combined 1 standard deviation reduction in GDP growth for two years, permanent 200bp shock applied to real interest rate, 25 percent real depreciation and 1/2 standard deviation shock to the primary balance for two years).
- Representative baseline and scenario average projections in boxes: e.g., Baseline: Gross external debt 42 (percent of GDP) in box listings; Historical and scenario numbers appear (e.g., Historical 52; Real depreciation shock 57).

### Public sector debt sustainability (baseline, composition, and stress tests)
- Public sector (defined as Central government, state-owned enterprises, public sector development banks, and social security funds; excludes local governments).
- Public DSA (Baseline scenario, as of October 01, 2020) key projections and indicators:
  - Nominal gross public debt: 2018 47.7, 2019 53.6, 2020 53.7, 2021 65.5, 2022 65.6, 2023 54.6, 2024 52.6, 2025 52.0, 2026 51.0 (table header lists years and series; "Nominal gross public debt47.753.653.765.565.665.465.265.064.9"—preserve formatting).
  - Public gross financing needs: 11.7, 7.8, 10.7, 14.7, 11.9, 11.5, 11.5, 11.9, 11.5 (percent of GDP; shown as "Public gross financing needs11.77.810.714.711.911.511.511.911.55").
  - Real GDP growth (in percent): 2018 2.2, 2019 2.2, 2020 -0.1, 2021 -9.0, 2022 3.5, 2023 2.3, 2024 2.2, 2025 2.1, 2026 2.1 (presented as "Real GDP growth (in percent)2.22.2-0.1-9.03.52.32.22.12.1").
  - Inflation (GDP deflator, in percent): 4.4, 4.9, 4.0, 2.2, 2.9, 3.2, 3.2, 3.1, 3.0 (presented as "Inflation (GDP deflator, in percent)4.44.94.02.22.93.23.23.13.0").
  - Effective interest rate (in percent): 7.5, 8.2, 7.8, 7.5, 6.6, 6.1, 5.9, 5.9, 6.0 (presented as "Effective interest rate (in percent)4/7.58.27.87.56.66.15.95.96.0").
- Contribution to change in gross public sector debt (cumulative, 2018–2025): change in gross public sector debt values include "1.3-0.40.111.80.1-0.2-0.2-0.1-0.111.2" with identified debt-creating flows "1.7-0.10.39.80.40.10.00.10.110.5".
- Identified debt-creating flows include primary deficit, automatic debt dynamics, other identified debt-creating flows, and change in assets (table rows with exact numeric sequences preserved, e.g., Primary deficit0.5-1.6-1.32.0-0.2-0.8-0.7-0.7-0.8-1.2).
- Public DSA alternative scenarios (Figure 7) present Baseline, Historical, and Constant Primary Balance scenarios with underlying assumptions:
  - Baseline underlying assumptions (selected): Real GDP growth (2020 -9.0; 2021 3.5; 2022 2.3; 2023 2.2; 2024 2.1; 2025 2.1); Inflation 2020 2.2; 2021 2.9; Primary Balance 2020 -2.0; 2021 0.2; Effective interest rate 2020 7.5; 2021 6.6.
  - Historical scenario: Real GDP growth 2021 2.7, 2022 2.7, etc.; Primary Balance in historical scenario remains near -0.1 in projection years.
  - Constant Primary Balance scenario sets Primary Balance at -2.0 for projection years 2021–2025.
- Stress tests (Figure 8) show impacts on Real GDP growth, Inflation, Primary balance, and Effective interest rate under:
  - Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, and Combined Shock.
  - Example numeric entries for Combined Shock: Real GDP growth (2020 -9.0; 2021 2.1; 2022 0.8; 2023 2.2; 2024 2.1; 2025 2.1); Effective interest rate (2020 7.5; 2021 6.9; 2022 6.5; 2023 6.6; 2024 6.9; 2025 7.2).

### Key macroeconomic projections and baseline medium-term outlook (selected exact figures)
- Real GDP growth: 2019 -0.1, 2020 -9.0, 2021 3.5, 2022 2.3, 2023 2.2, 2024 2.1, 2025 2.1 (Table 7: "GDP2.62.12.2-0.1-9.03.5").
- Consumer prices (end of period): 2019 2.8, 2020 3.7, 2021 2.9, 2022 3.0, 2023 3.0, 2024 3.0, 2025 3.0 (Table 7 entries: "Consumer prices End of period 6.8 4.8 2.8 3.7 2.9 3.0 3.0 3.0 3.0").
- Current account balance (in percent of GDP): 2019 -0.3, 2020 1.2, 2021 -0.1, 2022 -0.9, 2023 -1.5, 2024 -1.8, 2025 -2.0 (Table 7: "Current account balance (in percent of GDP) -1.8 -2.1 -0.3 1.2 -0.1 -0.9 -1.5 -1.8 -2.0").
- Non-hydrocarbon current account balance (in percent of GDP): 2019 1.4, 2020 2.9, 2021 2.0, 2022 1.1, 2023 0.4, 2024 -0.1, 2025 -0.3.
- Gross public sector debt (percent of GDP): 2019 53.6, 2020 53.7, 2021 65.5, 2022 65.6, 2023 54.6, 2024 52.6, 2025 52.0 (Table 7 and DSA tables).
- Public sector overall balance (percent of GDP): 2020 -5.8, 2021 -3.4, 2022 -2.6, 2023 -2.5, 2024 -2.5, 2025 -2.5 (Table 7: "Overall balance -1.1 -2.2 -2.3 -5.8 -3.4 -2.6 -2.5 -2.5 -2.5").

### Selected fiscal and balance of payments statistics (exact figures as presented)
- Table 1 highlights (selected):
  - GDP per capita (U.S. dollars, 2019): 10,024.
  - Poverty headcount ratio (% of population, 2018) 1/: 41.9.
  - Population (millions, 2019): 127.
  - Life expectancy at birth (years, 2019): 75.1.
- Table 4a Summary Balance of Payments (in billions of U.S. dollars):
  - Current account: 2017 -20.5; 2018 -25.4; 2019 -4.4; 2020 13.0; 2021 -1.0; 2022 -10.5; 2023 -18.0; 2024 -22.4; 2025 -25.8.
  - Exports, f.o.b.: 2017 409.4; 2018 450.7; 2019 460.7; 2020 401.3; 2021 479.0; 2022 500.1; 2023 524.3; 2024 546.3; 2025 565.2.
  - Gross international reserves (billions of U.S. dollars): 2017 178.0; 2018 175.4; 2019 176.4; 2020 183.0; 2021 190.4; 2022 192.1; 2023 194.0; 2024 197.1; 2025 202.4.
- Table 6 Financial Indicators and External Vulnerabilities (selected):
  - Exchange rate (period average): 2017 18.9; 2018 19.2; 2019 19.3; 2020 21.8 (Aug-20).
  - EMBIG Mexico spread (basis points; period average): 2017 256; 2018 273; 2019 318; 2020 487 (Sep-20).
  - Gross financing needs (billions of US$): 2017 93.3; 2018 97.5; 2019 103.2; 2020 72.7 (Proj.).
  - Gross international reserves (end-year, billions of US$): 2017 175.4; 2018 176.4; 2019 183.0; 2020 197.1 (Jun-20).
  - Gross total external debt (percent of GDP): 2017 37.7; 2018 36.6; 2019 36.6; 2020 45.5 (Proj.).
  - External debt service (in percent of GDP): 2017 8.4; 2018 7.7; 2019 9.4; 2020 10.0 (Proj.).

### Fund credit indicators (Table 10, exact figures)
- Stocks from prospective drawings (end of period, in millions SDR):
  - 2020 44,563.50
  - 2021 44,563.50
  - 2022 44,563.50
  - 2023 44,563.50
  - 2024 22,281.75
  - 2025 0.00
- In percent of quota: 2020–2023 500; 2024 250; 2025 0.
- In percent of GDP: 2020 6; 2021 7; 2022 6; 2023 6; 2024 3; 2025 0.
- Flows from prospective drawings — Charges in millions of SDR: 2020 223; 2021 990; 2022 1,038; 2023 1,038; 2024 992; 2025 219.
- Memo item: Total external debt (percent of GDP) 2020 46.8; 2021 55.9; 2022 53.5; 2023 50.8; 2024 48.0; 2025 45.4.

*Source: IMF staff and figures/tables as presented in "Box 1. The Calculation of the External Economic Stress Index (concluded)".*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1mexea2020002.pdf_