## 1mexea2022001

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### The 2023 Budget Proposal — context, developments, and staff assessment
- Context
  - Global inflation surge, tighter financial conditions, and weaker U.S. growth prospects pose risks to Mexico.
  - Structural constraints: low growth, weak productivity, high inequality, investment weakness, policy uncertainty in some sectors, rule of law and corruption issues, crime, regional disparities, and weak outcomes in education and health.
  - Mexico assessed as well placed to navigate risks given prudent macroeconomic policy conduct, strong monetary and fiscal frameworks, and no major macroeconomic imbalances.

- Recent developments
  - Real GDP: expanded at an above-trend rate of 1.8 percent in the first half of 2022 after stagnation in the second half of 2021.
  - Output gap: estimated about -2½ percent in early 2021 and nearly closed in mid-2022.
  - External current account: recorded a small deficit of 0.4 percent of GDP.
  - Sectoral recovery uneven: many goods-producing and some services sectors above pre-pandemic levels; construction and some other sectors remained below.
  - Labor market: employment increased; un- and under-employment decreased; labor market conditions improved ahead of output.

- Inflation and policy response
  - Headline inflation: about 3 percent at end-2020; 7.4 percent by end-2021; 8.7 percent by August (y/y).
  - Food inflation: 14.1 percent in August; has consistently exceeded the 3-percent target over the past decade and accounted for over 50 percent of the increase in headline inflation above target.
  - Core inflation: 8.1 percent.
  - Inflation expectations: near-term above upper limit of target range; medium-term rising notably; longer-term broadly stable.
  - Banxico tightening: initial 25 bp hikes, then 50 bp and 75 bp hikes; policy rate: 9.25 percent (current).
  - Policy rate differential: about 6 percentage points above the U.S. Fed.
  - Markets priced a terminal policy rate of about 10.5 percent to be reached in Q1 2023.
  - Staff baseline assumption: policy rate raised to around 10 percent by early 2023, maintained, then gradually reduced starting late 2023.

- Financial conditions and external sector
  - Financial Conditions Index (FCI): moderate increase by end-June 2022 but well below past peaks.
  - Yields: one-year government bond yield up by over 250 bps so far this year; 20-year bond up by about 100 bps; real yield on an inflation-linked Udibono maturing in 2031 risen by 80 bps.
  - Sovereign USD 10-year spreads widened less than most peers with similar credit ratings.
  - Portfolio flows: moderate portfolio outflows (nonresidents selling peso bonds) offset by domestic institutional buyers (pension funds).
  - Peso: broadly stable vs USD; GIR and ARA coverage at 125 percent.
  - Banking: bank credit recovering to pre-pandemic nominal levels; total capital adequacy ratio increased to over 19 percent from 16 percent before the pandemic.

- Fiscal policy, fuel and food measures, and PEMEX
  - Authorities smoothed retail fuel prices and stabilized prices of some essential food items; fiscal cost of fuel pricing regime rose after the Russian invasion of Ukraine, yielding higher-than-budgeted subsidies in 2022H1.
  - PEMEX: EBITDA more than doubled to over USD 23 billion in the first six months of 2022 vs same period last year; improved cash generation used mostly for debt amortization; total debt outstanding declined somewhat but remains high; Pemex external spreads above Mexican government and most oil peers.

- 2023 draft budget — key elements and staff assessment
  - Draft budget targets a small increase in the overall deficit due to higher interest payments: 3.8 to 4.1 percent of GDP.
  - Staff estimate: fiscal stance (change in structural primary balance) about neutral in 2023.
  - Expenditure: increased by 8.5 percent in nominal terms in 2023 vs authorities’ estimated 2022 outturn (or by 0.1 percentage points of authorities’ projected GDP).
  - Increased spending accommodates higher interest payments, some social programs (notably non-contributory social pensions for the elderly), priority infrastructure, and modest social program funding related to fertilizers, national milk procurement, and rural supplies.
  - Revenues/taxes: no change in tax code; continued efforts to reduce tax evasion and avoidance; authorities project oil price below 2022 levels; excise collections expected to improve.
  - Staff GFS shares of GDP (presented as in source):
    - GFS Revenue: 23.2 24.3 24.1
      - Oil revenue 3.6 5.0 4.5
      - Excises (including fuel) 1/ 1.8 0.8 1.4
    - GFS Expenditure: 26.8 28.0 28.2
      - Interest payments 3.8 4.7 4.6
      - Fuel subsidy 1/ 0.0 0.5 0.0
    - Overall balance -3.5 -3.8 -4.1
    - Primary balance -0.1 0.7 0.3
    - Note: Fuel excises within excises include revenue effects of using the excise rate to smooth market prices. Fuel subsidy includes mostly direct fuel subsidy.

- Outlook for 2022–23 (staff baseline)
  - Growth: 2.1 percent in 2022 and 1.2 percent in 2023.
  - Current account: expected to slightly widen to about 1 percent of GDP in 2022–23 as import prices increase faster than export prices.
  - Inflation: projected to plateau at around 8½ percent in H2 2022 then decline gradually; core and headline inflation expected to return to midpoint of target band in mid-2024 under baseline policy-path (policy rate ~10 percent by early 2023, maintained, then gradually reduced starting late 2023).
  - Risks to inflation outlook tilted to the upside; downside growth risks include a sharper U.S. slowdown, tighter global financial conditions, capital flow reversals, and domestic impediments to investment and productivity.

### Outlook — Economic activity projected to pick up in 2024 and scenario analysis
- Key projections and dynamics
  - Economic activity projected to pick up in 2024 in tandem with the U.S.; output gap to narrow after widening in 2023.
  - Without significant structural reforms, rebound expected modest, to about 2 percent.
  - Potential output growth per capita would recover to a rate only slightly above one percent.
  - Average annual population growth projected at 0.7 percent per year in 2022-27. Potential GDP growth after 2024 thus about 1.8 percent.
  - Current account deficit projected to stabilize at around 1 percent of GDP in medium term.

- Balance of risks to near-term outlook
  - Overall balance of risks to near-term growth tilted to the downside.
  - Main external downside risks: higher global inflation and sharper global tightening; sharper U.S. deceleration (IMF illustrative scenario could result in peak output loss of 2 percent or more and stalling Mexico real GDP — Box 2).
  - Main domestic downside risks: slower reversal of inflation, emergence of new COVID-19 variants, supply shocks from China, rising inflation and declining incomes leading to social unrest.
  - Medium-term risks: pandemic scarring, climate-change induced risks.
  - Upside risks: continuation of nearshoring dynamics, smaller spillovers from U.S. slowdown, trade diversion boosting exports.

- Box 2 — Global Tightening and Inflation Scenario (G20MOD layers)
  - Layer 1: Temporary shock to global oil and food prices rising by 10 and 50 percent, respectively — raises Mexico headline inflation by nearly 1 percent above baseline for a few quarters; limited direct output effects absent monetary response.
  - Layer 2: Dislocation of inflation expectations → sharper domestic/global policy rate increase → output levels fall >1 percent below baseline in H1 2023; elevated systemic liquidity risk.
  - Layer 3: Adds 1 percent decline in domestic demand → output >2 percent below baseline at trough while somewhat attenuating price pressures.
  - Cumulative result: substantial pressure on corporate interest rates; capital flow shock not directly modeled.

### Policy discussions — Tackling high inflation and fiscal readiness for downside risks
- Monetary policy
  - Banxico: ex ante real policy rate reached about 4 percent by September 2022 (nominal rate adjusted for one-year ahead inflation expectations).
  - Banxico’s neutral real policy rate range (April–June 2019 Quarterly Report): 1.8 to 3.4 percent.
  - Staff assessment: policy rate of at least 10 percent required for inflation to reverse close to 3-percent target within usual two years.
  - Inflation risks: further commodity shocks, imported inflation, supply-chain constraints, minimum wage increases feeding into costs, and backward-looking price dynamics.
  - Policy recommendation: further increases in policy rate and maintaining it at a restrictive level; real ex ante policy rate to peak at over 5 percent in 2023 consistent with markets and staff forecast.
  - Communication: publish more on policy rate path underpinning macro forecast; review inflation-targeting framework for further improvements.

- Fiscal measures and readiness
  - Authorities used largely untargeted subsidies; expected fiscal cost around 2 percent of GDP (Annex VI).
    - Retail fuel price stabilization: estimated to have lowered inflation by 2 percentage points this year; fiscal cost ~1.5 percent of GDP; disproportionately benefited higher-income households.
    - Food measures relied on preexisting programs; direct impact on inflation minimal, smaller budgetary cost.
  - Overall effects: higher food and energy prices increased deficit by about ¼ percent of GDP with fuel subsidies offset by higher oil revenues and food measures funded by reducing other expenditures.
  - Proposed 2023 stance: neutral fiscal stance to support disinflation while avoiding material fiscal drag; priority to restore low and stable inflation.
  - Readiness recommendations:
    - Shift untargeted subsidies to targeted support for vulnerable households (one-off cash, temporary energy bill discounts, public transport subsidies).
    - Change retail fuel price regime to more market-based pricing to reduce subsidy leakage and reallocate savings to targeted support; 2020 data: top 20 percent accounted for about 45 percent of fuel excise tax collection vs bottom 20 percent 6 percent.
    - Build FEIP reserves (authorities estimate minimum 0.3 percent of GDP sufficient); recent amendments to FRBL proposed as part of 2023 budget would bring FEIP closer to desired level.
    - Medium-term reforms: debt anchor, broader coverage of structural spending rule, medium-term fiscal strategy, tighter escape-clause triggers, stronger fiscal council.

### Fiscal framework short-term reform trade-offs (FEIP and escape clauses)
- Short-term reforms expected to free up MEX$20–30 billion for FEIP if ratified before end-2022; funding amount uncertain and contingent on year-end headroom against debt ceiling.
- Advantages: quick implementation, preserves many parameters of existing framework, could provide contingent financing for near-term risks.
- Disadvantages: increased complexity, transparency knock-on effects, does not address pro-cyclicality from PSBR and BBR.
- Longer-run comprehensive reforms proposed: establish a debt anchor, clarify/tighten definitions and procedures, expand expenditure rule coverage, and adopt a medium-term sustainability framework with sequencing anchored by a medium-term fiscal strategy.

### Staff appraisal and macro policy guidance (summarized recommendations)
- Mexico well placed to navigate challenging global environment but should prepare contingency plans.
- Monetary: further increases and a clearly restrictive stance until inflation expectations re-anchor.
- Fiscal: neutral stance in 2022 and 2023 appropriate; shift untargeted measures toward targeted support; restore fiscal reserves and rebuild FEIP to around 0.3 to 0.5 percent of GDP.
- Exchange rate: maintain floating exchange rate as shock absorber; use monetary policy to counter imported inflation; consider FX intervention to mitigate market illiquidity.

### Key numeric projections (selected)
- Growth: 2022 = 2.1 percent; 2023 = 1.2 percent; 2024 = 1.8 percent (baseline medium-term projections).
- Inflation: end-of-period consumer prices: 2022 (Proj.) = 7.4; 2023 (Proj.) = 8.5; 2024 (Proj.) = 4.8; 2025 (Proj.) = 3.5; 2026 (Proj.) = 3.2; 2027 (Proj.) = 3.0.
- Gross international reserves (US$ billion): 2019 = 183.0; 2020 = 199.1; 2021 = 207.7; 2022 (Proj./various) ~205.7–207.7; later projections up to 213.9.
- Public debt (percent of GDP): 2019 = 53.6; 2020 = 53.3; 2021 = 60.1; 2022 = 57.6; baseline projections: 2023 = 57.7; 2024 = 58.2; 2025 = 58.6; 2026 = 58.9; 2027 = 59.3.

### Annex I — External Sector Assessment (selected findings)
- Overall assessment: external position in 2021 broadly in line with medium-term fundamentals; current account expected to stabilize around 1 percent of GDP in medium term.
- NIIP: projected to improve from –41 percent of GDP in 2021 to around –35 percent of GDP over medium term.
- Gross public external debt: estimated at 23 percent of GDP end-2021, about one-quarter comprised of holdings of local currency government bonds.
- Key 2021 figures (% GDP): NIIP –41; Gross Assets 58; Debt Assets 19; Gross Liab. 99; Debt Liab. 38.
- CA 2021: –0.4 percent of GDP; EBA cyclically adjusted CA norm: –1.2 percent; staff gap: –0.2 percent of GDP.
- REER: 2021 average appreciated about 6 percent vs 2020; IMF staff REER gap midpoint 0.5 percent (range –2.6 to 3.5 percent).
- Reserves adequacy: reserves at end-2021 = USD 208 billion (16 percent of GDP); 131 percent of ARA metric; 254 percent of short-term debt.

### Annex III — Debt sustainability baseline (selected series)
- Public debt (percent of GDP) baseline path: 57.6 (2021), 56.2 (2022), 57.7 (2023), 58.2 (2024), 58.6 (2025), 58.9 (2026), 59.3 (2027), 58.9 (2028), 58.4 (2029), 57.6 (2030), 56.8 (2031).
- Primary deficit (percent of GDP): 0.0 (2021), -0.7 (2022), -0.3 (2023), -1.8 (2024–2026), -1.6 (2027–2031).
- Macro assumptions (selected): Real GDP growth: 4.8 (2021), 2.1 (2022), 1.2 (2023), 1.8 (2024), 2.1 (2025–2031); Inflation (GDP deflator): 7.1 (2021), 8.9 (2022), 5.7 (2023), 3.4 (2024), 3.0 (2025–2031).
- Gross financing needs (percent of GDP): 12.4 (2021), 12.6 (2022), 12.3 (2023), 11.5 (2024), 10.9 (2025).

### Annex V — Domestic market development, foreign investors and peso stability
- Foreign holdings of peso-denominated government securities have declined since early 2015; portfolio outflows accelerated during risk aversion episodes.
- Peso stability supported by high interest rate differential (Banxico spread vs U.S. >6 percent), strong policy framework, remittances, tourism, and nearshoring-related inflows.
- Domestic investors, notably pension funds, have been filling foreign investor absences; pension funds projected to grow from 20 percent of GDP in 2020 to 35–56 percent of GDP by 2040 with potential annual purchases of USD 7–10 billion of domestic government securities.

### Annex VIII — Trade diversion evidence (2014 U.S. sanctions on Russia)
- Key finding: Mexico’s exports to the U.S. increased after 2014 U.S. sanctions on Russia by about USD 0.85 billion or 0.07 percentage points of 2012 GDP (comparing imports of 2015–16 to 2012–14).
- Empirical approaches: dynamic regressions and local projections using monthly HS 6-digit data 2012–16; local projections imply nominal exports from Mexico increased by about 10 percent four months after the sanction (impulse response).

### Supply-side policy agenda to unlock growth potential — priorities and recommendations
- Current administration focus: redistribution, trade promotion, infrastructure (notably Isthmus corridor), minimum wage increases, subcontracting law, and social pension increases.
- Supply-side constraints to address: corruption, crime, rule of law, human capital and infrastructure shortfalls, labor and product market rigidities.
- Staff recommendation: gradual permanent increase in productive government spending of around 2 to 3 percent of GDP financed by revenue-increasing tax reforms to lift growth potential and reduce socioeconomic gaps.
  - Address spending shortfalls: education, health, public investment, social safety nets.
  - Efficiency improvements: reduce leakage, single beneficiary registry, better coordination, national/sector strategies, multi-year budgeting.
- Medium-term tax reform proposals (selected):
  - VAT: eliminate zero-ratings except for a few essential foodstuffs; rationalize exemptions; implement high-coverage VAT audit processes.
  - Personal income tax: eliminate exclusions, reduce tax expenditures, widen top bracket — estimated yield around ¾ percent of GDP.
  - Subnational taxes: gradually increase property taxes to raise over ¾ percent of GDP; update cadaster; simplify local vehicle tax.
  - Carbon pricing: current carbon tax USD 3 per ton CO2 with de facto natural gas exemption; recommend raise to USD 75 by 2030 and expand coverage — projected revenue close to 1.8 percent of GDP by 2030 (with compensation measures for affected households).
- PEMEX: continue restructuring and business-plan changes—focus on profitable fields, sell non-core assets, reform pension scheme, increase partnerships with private firms.

### Governance, labor, trade, energy, and climate recommendations
- Governance: implement anti-corruption law effectively, strengthen investigation/prosecution, participate in voluntary transnational corruption assessments.
- Labor and informality: align real minimum wage increases with productivity of low-wage workers; improve labor dispute resolution; lower layoffs restrictions; reduce formalization costs; improve childcare access.
- Trade and USMCA: implement USMCA provisions, increase domestic value-added content in exports, reduce trade barriers with China/EU/Latin America, strengthen customs cooperation.
- Energy and climate: restore market-oriented regulatory frameworks to encourage private participation and renewables; expand and operationalize ETS beyond pilot phase; raise carbon tax and implement feebates and clean-energy public investment.

### Financial system resilience, supervision, and macroprudential toolkit
- Financial system: emerged from pandemic in good health; NPLs rose modestly then declined; capital adequacy high and rising; liquidity comfortable.
- FSAP recommendations (selected):
  - Strengthen autonomy and resources of regulatory agencies; improve CNBV supervisory techniques and consolidated supervision of financial conglomerates.
  - Enhance systemic liquidity monitoring; enhance Banxico’s Emergency Liquidity Assistance framework.
  - Strengthen bank resolution and recovery (remove impediments to resolvability, expand resolution remit, fill IPAB board vacancies).
  - Enhance cybersecurity strategy and oversight.
  - Introduce mortgage LTV and DTI limits proactively; publish macroprudential strategy and counter-cyclical buffer guidelines.
  - Strengthen AML/CFT effectiveness, beneficial ownership transparency, and supervision of fintech/virtual assets risks.

- Authorities’ stance: consider the financial system robust and resilient; committed to monitoring systemic risks, strengthening supervision, boosting cyber resilience, and developing CBDC for financial inclusion while safeguarding stability and integrity.

### Annex highlights — social, external, and macro-financial indicators (selected figures)
- Table 1 selected statistics:
  - GDP per capita (U.S. dollars, 2021): 10,048.8
  - Population (millions, 2021): 129.0
  - Life expectancy at birth (years, 2020): 75.1
  - Infant mortality rate (per thousand, 2020): 11.8
  - Poverty headcount ratio (% of population, 2020): 43.9
  - Income share highest 20 / lowest 20 (2020): 9.1
  - Adult literacy rate (2019): 95.4
  - Gross primary education enrollment rate (2020): 104.7

- Balance of payments summary (US$ billions, selected)
  - Current account: 2019 = -3.4; 2020 = 27.1; 2021 = -4.8; 2022 = -17.3; 2023 (Proj.) = -18.2; 2024 (Proj.) = -17.2; 2027 (Proj.) = -15.1
  - Exports, f.o.b.: 2019 = 460.6; 2020 = 417.2; 2021 = 494.8; 2022 = 564.1; 2027 = 685.9
  - Imports, f.o.b.: 2019 = 455.2; 2020 = 383.0; 2021 = 505.7; 2022 = 591.5; 2027 = 701.2
  - Secondary income (remittances), net: 2019 = 36.2; 2020 = 40.9; 2021 = 51.3; 2022 = 55.1; 2027 = 68.3
  - Gross international reserves (US$ billion): 2019 = 183.0; 2020 = 199.1; 2021 = 207.7; 2022 = 205.7; 2027 (Proj.) = 213.9

- Baseline medium-term GDP growth contributions (real)
  - GDP growth: 2019 = -0.2; 2020 = -8.1; 2021 = 4.8; 2022 = 2.1; 2023 = 1.2; 2024 = 1.8; 2025–2027 = 2.1 each year.

- Banking system indicators (selected)
  - Regulatory capital to risk-weighted assets: 14.9 (2016), 15.6 (2018), 15.9 (2019), 16.0 (2021), 17.7 (2022Q2), 19.5 (2021 table).
  - Non-performing loans to total gross loans: around 2.1–2.4 percent across reported years.

- Market indicators (selected)
  - EMBIG Mexico spread (period average): 318.2 (2019), 474.4 (2020), 354.2 (2021), 380.9 (YTD Jun-22).
  - Sovereign 10-year local currency bond yield (period average): 7.6 (2019), 6.3 (2020), 6.9 (2021), 8.4 (Jun-22).

- Risk Assessment Matrix (selected risks and policy responses)
  - Commodity price shocks: Likelihood: High; Impact: Medium; Policy response: Monetary policy to respond if shocks feed into core inflation.
  - Systemic social unrest: Likelihood: High; Impact: Medium; Policy response: Tighten monetary policy, better-target social transfers, accelerate investment in low-income regions.
  - De-anchoring of inflation expectations and stagflation: Likelihood: Medium; Impact: High; Policy response: Decisive monetary tightening.
  - Abrupt global slowdown or U.S. recession: Likelihood: Medium; Impact: High; Policy response: Tighten monetary policy if inflation affected; frontload fiscal expenditure and delay revenue measures to support activity without adding price pressures.

*Source: IMF staff report excerpts and annexes from content unit 1mexea2022001.*

### 1. The 2023 Budget Proposal _______________________________________________________________________9

### 1. The 2023 Budget Proposal

### Context
- Mexico faces a challenging environment as global inflation has surged, with tighter financial conditions and weaker growth prospects for the U.S., Mexico’s main trading partner.
- Structural constraints persist: low growth, weak productivity, high inequality, investment weakness, increased policy uncertainty in some sectors, and obstacles in rule of law, corruption, crime, regional disparities, and weak outcomes in education and health.
- Mexico is assessed as well placed to navigate risks given prudent macroeconomic policy conduct, strong monetary and fiscal frameworks, and no major macroeconomic imbalances, but difficult policy trade-offs lie ahead.

### Recent developments
- Real GDP: expanded at an above-trend rate of 1.8 percent in the first half of 2022 after stagnation in the second half of 2021.
- Output gap: staff estimates that the output gap, which was about -2½ percent in early 2021, was nearly closed in mid-2022.
- External current account: recorded a small deficit of 0.4 percent of GDP in the period referenced.
- Sectoral recovery uneven: many goods producing and some services sectors produced above pre-pandemic levels; construction and some other sectors remained below.
- Labor market: employment increased and un- and under-employment decreased; labor market conditions improved ahead of output.

### Inflation and policy response
- Headline inflation:
  - about 3 percent at end-2020
  - 7.4 percent by end-2021
  - 8.7 percent by August (year-on-year)
- Food inflation: 14.1 percent in August; has consistently exceeded the 3-percent target over the past decade and accounted for over 50 percent of the increase in headline inflation above target.
- Core inflation: 8.1 percent (recent measure).
- Inflation expectations: near-term expectations above the upper limit of the target range; medium-term expectations rising notably; longer-term expectations broadly stable.
- Banxico monetary tightening:
  - initial 25 basis-point (bp) hikes, followed by 50 bp and 75 bp hikes as inflation broadened.
  - policy rate: 9.25 percent (current).
  - policy rate is about 6 percentage points above that of the U.S. Fed.
  - markets priced a terminal policy rate of about 10.5 percent in this tightening cycle, to be reached in the first quarter of 2023.
- Staff baseline assumption for inflation path: policy rate raised to around 10 percent by early 2023, maintained, and then gradually reduced starting in late 2023.

### Financial conditions and external sector
- Financial Conditions Index (FCI) for Mexico: moderate increase by end-June 2022 but well below past peaks.
- Interest rates and bond yields on peso-denominated debt: risen to highest levels since the Global Financial Crisis; one-year government bond yield up by over 250 bps so far this year; 20-year bond up by about 100 bps.
- Real yield on an inflation-linked Udibono maturing in 2031: risen by 80 bps.
- Yields on foreign-currency Mexican securities: risen; sovereign USD 10-year spreads widened less than most peers with similar credit ratings.
- Portfolio flows: moderate portfolio outflows continued, primarily sales of peso-denominated government bonds by nonresidents; offset by strong buying by domestic institutional investors, notably pension funds.
- Peso: broadly stable against the U.S. dollar, supported by rising interest rate differential, strong fiscal fundamentals, monetary policy commitment, and remittances.
- Gross international reserves and ARA metric: coverage at 125 percent.
- Credit and banking:
  - Bank credit to private sector recovering (peso- and FX-denominated loans recovering to pre-pandemic levels in nominal terms).
  - Mexican banking system: total capital adequacy ratio increased to over 19 percent from 16 percent before the pandemic.
  - System profitability recovering; large institutions maintain ample liquidity buffers.

### Fiscal policy, fuel and food measures, and PEMEX
- Authorities smoothed retail fuel prices and stabilized prices of some essential food items:
  - fiscal cost of fuel pricing regime rose following the Russian invasion of Ukraine, yielding higher-than-budgeted subsidies in 2022H1.
  - nonbinding agreement to stabilize prices of 24 food items initially for six months; temporary tariff reductions on certain foods; measures to reduce distribution costs and promote food production by small farmers.
- PEMEX:
  - reported earnings more than doubled to over USD 23 billion in the first six months of 2022 (EBITDA basis) compared to the same period last year.
  - improved cash generation has allowed a rise in capital expenditures but mostly to be used for debt amortization.
  - total debt outstanding has declined somewhat but remains high; spreads on Pemex’s external debt remain above those on Mexican government bonds and most oil sector peers.

### The 2023 draft budget (Box 1) — key elements and staff assessment
- Draft budget targets a small increase in the overall deficit due to higher interest payments: 3.8 to 4.1 percent of GDP.
- Staff estimate: fiscal stance (change in structural primary balance) will be about neutral in 2023.
- Expenditure: increased by 8.5 percent in nominal terms in 2023 compared to the authorities’ estimated 2022 outturn (or by 0.1 percentage points of authorities’ projected GDP).
- Increased spending accommodates:
  - higher interest payments,
  - some social programs—particularly (non-contributory) social pensions for the elderly,
  - priority infrastructure projects,
  - increased funding for social programs related to fertilizers, procurement of national milk, and rural supplies (though program sizes remain modest).
- Revenues and taxes:
  - budget entails no change in the tax code;
  - continued efforts highlighted to reduce tax evasion and avoidance.
  - authorities project oil price to be well below 2022 levels, excise collections expected to improve (including from fuels).
- Staff table (GFS shares of GDP; presented as in source):
  - Staff Report 2021 Current
  - GFS Revenue                      23.2 24.3 24.1
    - Oil revenue 3.6 5.0 4.5
    - Excises (including fuel) 1/ 1.8 0.8 1.4
  - GFS Expenditure                 26.8 28.0 28.2
    - Interest payments        3.8 4.7 4.6
    - Fuel subsidy 1/ 0.0 0.5 0.0
  - Overall balance -3.5 -3.8 -4.1
  - Primary balance -0.1 0.7 0.3
  - Note: Fuel excises within excises include the revenue effects of using the excise rate to smooth market prices. Fuel subsidy includes mostly direct fuel subsidy.

### Outlook and risks
- Growth outlook:
  - Staff projects economic growth of 2.1 percent in 2022 and 1.2 percent in 2023.
  - After pickup in first half of 2022, activity expected to slow in second half of 2022 and in 2023 due to tighter global financial conditions and cooling U.S. growth.
  - Baseline assumes moderate further tightening in financial conditions and a neutral fiscal stance based on 2022 developments and the proposed 2023 budget.
  - Current account: expected to slightly widen to about 1 percent of GDP in 2022–23 as import prices increase faster than export prices.
- Inflation outlook:
  - Inflation projected to plateau at around 8½ percent in the second half of 2022 and then decline gradually.
  - Core and headline inflation expected to return to the midpoint of the target band in mid-2024 under the baseline policy-path assumption (policy rate raised to around 10 percent by early 2023, maintained, then gradually reduced starting late 2023).
  - Risks to the inflation outlook are judged to be tilted to the upside.
- Downside risks to growth include more material weakening in U.S. demand; tighter-than-expected global financial conditions; capital flow reversals; and domestic impediments to investment and productivity.

*Source: IMF staff summary of "1. The 2023 Budget Proposal" (chapter content).*

### 16.      Economic activity is projected to pick up in 2024

### 16.      Economic activity is projected to pick up in 2024

### Outlook and key projections
- Economic activity is projected to pick up in 2024 and the following years, in tandem with the U.S.
- The output gap will narrow after widening somewhat in 2023.
- Without significant structural reforms, the growth rebound is expected to be modest, to about 2 percent.
- Potential output growth per capita would recover to a rate only slightly above one percent.
  - Average annual population growth is projected at 0.7 percent per year in 2022-27. Potential GDP growth after 2024 would thus be about 1.8 percent.
- The current account deficit is projected to stabilize at around 1 percent of GDP in the medium term.

### Balance of risks to the near-term outlook
- Overall balance of risks to near-term economic growth is tilted to the downside.
- Main downside external risks:
  - Higher global inflation and a sharper tightening of global financial conditions.
  - A sharper deceleration in global or U.S. growth. An illustrative global inflation scenario presented in the July 2022 World Economic Outlook Update could result in a peak output loss of 2 percent or more and stalling real GDP in Mexico (Box 2).
  - Additional external price shocks (including from the Russian invasion of Ukraine) could push up inflation, especially food, and inflation expectations.
  - Tighter-than-expected monetary policy globally could lead to an upswing in capital outflows, potential system-wide liquidity stress, downward pressure on the peso, and higher imported inflation.
  - A fall in remittances as the U.S. economy slows or worsening competitiveness relative to competitors that have seen a real depreciation.
  - A sharper U.S. slowdown would be particularly consequential—in the short-term Mexican GDP has an elasticity of more than one with that of the U.S. (Annex VII).
- Main downside domestic risks:
  - The inflation surge might reverse more slowly than expected if it has led to more backward-looking price dynamics or further increases in inflation expectations, requiring a tighter monetary policy stance.
  - Emergence of new COVID-19 variants with greater immune evasion or higher hospitalization and mortality could lower mobility and raise precautionary saving.
  - Additional large negative supply shocks from China if continued zero COVID-19 policies motivate lockdowns.
  - Rising inflation, declining incomes, and worsening crime and inequality could lead to social unrest and political instability.
- Medium-term risks:
  - Scarring from the pandemic or policy uncertainty could lower potential output.
  - Climate-change induced risks (more frequent severe hurricanes and floods, or earlier emergence—or larger amounts of—stranded assets in the carbon-intensive energy sector).
- Upside risks:
  - Continuation of nearshoring dynamics in Mexico building productive and distribution capacity to serve North American markets.
  - Smaller spillovers from a U.S. slowdown than historically seen (e.g., robust domestic service sector performance or delayed effects on manufacturing).
  - Mexico’s exports could get some boost from trade diversion effects due to geopolitical tensions.

### Authorities’ views on outlook and risks
- Authorities see the conjuncture of high and rising global and domestic interest rates, high inflation, and downside risks to growth as presenting elevated uncertainty with risks tilted to the downside.
- The budget contemplates growth for 2023 in the range of 1.2 to 3.0 percent in 2023, with a central estimate of 2.1.
- The latest Banxico forecast puts growth between 0.8 and 2.4 percent with a central estimate of 1.6 percent.
- Authorities expect inflation to fall in 2023 from a high level under normalization of supply shocks, fiscal measures to contain fuel prices pass-through, and decisive monetary policy.
- They view disappointing growth in the U.S. as the headline risk but note the manufacturing sector might this time be less affected than services in a U.S. slowdown.
- They expect Mexico could benefit from the nearshoring trend.
- Faster-than-expected global monetary tightening could spark a steepening credit curve and pressures on capital flows, though experience through the tightening cycle so far attenuates these concerns.

### Box 2 — Global Tightening and Inflation Scenario (model simulation)
- A global tightening and inflation scenario was simulated with the IMF’s G20MOD multi-country DSGE model; results are presented in cumulative layers.
- Layer 1: Temporary shock to global oil and food prices rising by 10 and 50 percent, respectively, relative to the baseline.
  - Raises headline inflation in Mexico by nearly 1 percent above an already elevated baseline in year-on-year terms for a few quarters.
  - Limited direct effects on output absent a significant monetary policy response.
- Layer 2: Commodity shock causes a temporary dislocation of inflation expectations globally, including Mexico.
  - Results in a sharper increase in the domestic (and global) policy interest rate to bring expectations back in line with the inflation target.
  - Output levels fall substantially below baseline, peaking at more than 1 percent below in the first half of 2023.
  - Higher policy rates present elevated systemic liquidity risk.
- Layer 3: Adds a 1 percent decline in domestic demand (inspired by diminished real earnings expectations or an un-modeled credit contraction).
  - Brings output to more than 2 percent below baseline at the trough while somewhat attenuating price pressures.
- The three layers put substantial cumulative pressure on the corporate interest rate; a capital flow shock is not modeled directly.
- The simulation is consistent with the global downside scenario presented in the July 2022 World Economic Outlook Update.

### Policy discussions — Tackling high inflation
Monetary policy
- Banxico has taken a proactive approach. Since June 2021, successive and gradually larger increases in the reference rate brought the ex ante real policy rate (i.e., the nominal rate adjusted for one-year ahead inflation expectations) to a moderately restrictive level by September 2022 at about 4 percent.
  - In its April–June 2019 Quarterly Report, Banxico used a range of models to establish a range between 1.8 and 3.4 percent for the neutral real policy rate.
- Staff assessment: a policy rate of at least 10 percent would be required for inflation to reverse close to the central bank’s 3-percent target within the usual two years or so.
- Inflation risks are expected to remain heightened due to:
  - Further shocks to global commodity prices and domestic food prices (e.g., severe drought conditions in some Mexican states).
  - More persistent inflation imported from advanced economies.
  - Longer-lasting price pressures from supply chain constraints.
  - Further expected increases in the minimum wage feeding into costs and prices.
  - Inertia from more frequent domestic price adjustments and upticks in near-term inflation expectations feeding into wages and prices.
- Policy recommendation: Further increases in the policy rate and maintaining it at that higher level are warranted given asymmetric upside risks to inflation.
  - A risk management approach would argue for policy rates to rise further and stay firmly restrictive for some time to keep wage and price formation anchored.
  - Such an approach would entail a real ex ante policy rate that would peak at over 5 percent in 2023, broadly consistent with market expectations for nominal rates and staff’s inflation forecast.
- Communication measures:
  - Banxico has published updated inflation forecasts with every rate decision since August 2021 and more recently provided guidance on the direction of the next policy rate change.
  - Further steps could include publishing more information on the policy rate path that underpins its macro forecast (expected rate, expected length at the peak, and possible triggers for changes), clearly presented as expectations and not a policy commitment.
  - A broader review of Banxico’s inflation targeting framework over the past two decades could suggest further improvements to the policy framework and communications toolkit.

Fiscal measures
- Authorities have used largely untargeted subsidies to mitigate the rise in the cost of living; expected fiscal cost around 2 percent of GDP (see Annex VI).
  - Retail fuel price stabilization: estimated to have lowered inflation by an estimated 2 percentage points this year; fiscal cost estimated at around 1.5 percent of GDP; disproportionately benefited higher income households and diluted price signals for fuel demand.
  - Measures to mitigate higher food prices relied on preexisting programs (e.g., increased emphasis on direct fertilizer provision to small farmers or support for subsistence farming); direct impact on inflation minimal and smaller budgetary cost.
- Overall fiscal and redistributive measures helped support real incomes:
  - Higher food and energy prices increased the deficit by around ¼ percent of GDP with fuel subsidies offset by higher oil revenues and food-related measures funded from reducing other expenditures.
  - Administration increased universal social (noncontributory) pensions and projected to raise the minimum wage from 42 percent of the median formal sector wage in 2018 to 59 percent in 2022.
  - In the context of a stronger recovery and record-high remittance inflow, these fiscal efforts, higher minimum wage, and other labor market measures may have contributed to an increase in real per capita labor income of about 5 percent (y/y) by mid-2022.
- Proposed 2023 stance:
  - The proposed neutral fiscal stance in 2023 aims to support monetary policy’s disinflation efforts while avoiding a material fiscal drag on activity.
  - With the economy operating close to potential, priority is to restore low and stable inflation. A restrictive monetary stance and a broadly neutral fiscal stance are seen as appropriate.
  - Continuing large minimum wage increases could add to inflation pressures, work at cross-purposes to monetary and fiscal policies, and potentially reduce formal employment for lower income workers.

Authorities’ views on policies
- Authorities agree on the need for robust monetary policy to keep inflation expectations well-anchored and consider the early and decisive monetary response successful.
- They highlight strengthened communication efforts and will continue to evaluate other tools to improve communication.
- They view anti-inflationary fiscal measures as having helped mitigate effects of inflation on those most exposed and have sustained momentum on flagship reforms. Fuel price stabilization has been central to supporting households and restraining inflation.

### Policy discussions — Managing potential downside risks (fiscal policy readiness)
- Fiscal policy could better prepare for downside risks; the neutral stance could be maintained if growth slows modestly, but more can be done to be ready to provide targeted support for poorer households. Additional discretionary fiscal support should be considered in the event of significant weakening.
- Under Mexico’s fiscal framework (balanced budget rule and constraints on debt issuance), scope for countercyclical fiscal policy is limited. Modest steps to increase ability for targeted support include:
  - Changing the retail fuel price regime to create room for more targeted support in case of prolonged global oil price increases:
    - More market-based fuel pricing would allow passthrough of global fuel prices to domestic retail prices, encourage transition to greener energy sources, reduce budgetary cost of subsidies, and strengthen price signals for fuel demand.
    - Fiscal savings could be reinvested in targeted support for vulnerable households by leveraging existing social safety nets or other tools (one-off cash payments, temporary energy bill discounts, temporary public transport subsidies).
    - Note: fuel tax expenditure under the current regime entails large leakage of support to higher income households. Using 2020 data, authorities estimate the top 20 percent of the income distribution accounted for about 45 percent of the fuel excise tax collection whereas the bottom 20 percent accounted for 6 percent.
  - Implementing and building upon proposed reforms to the fiscal framework:
    - Fiscal reserves in the Fondo de Estabilización de los Ingresos Presupuestarios (FEIP) have fallen to less than 0.1 percent of GDP given extensive usage during the pandemic and a restrictive replenishment mechanism under the Federal Budget and Fiscal Responsibility Law (FRBL).
    - Authorities estimate a minimum of 0.3 percent of GDP would provide sufficient resources for a fiscal policy response.
    - Recent amendments to the FRBL proposed as part of the 2023 budget would bring FEIP reserves closer to this desired level by enabling utilization of headroom against the government’s debt ceiling, enhancing short-term preparedness.
    - Medium-term reforms required to enhance flexibility while ensuring sustainability and credibility could include: (i) a well-calibrated debt anchor; (ii) broader coverage of expenditure in the structural spending rule; (iii) a medium-term fiscal strategy specifying the post-shock adjustment path to return to the debt target; (iv) tighter triggers for the use of escape clauses; and (v) a strengthened role for the fiscal council.

*Source: IMF staff report chapter "16.      Economic activity is projected to pick up in 2024" (1mexea2022001).*

### 30.      A medium-term fiscal strategy could help to anchor expectations about future fiscal

### 1mexea2022001 - 30.      A medium-term fiscal strategy could help to anchor expectations about future fiscal

### Fiscal position, medium-term strategy, and debt sustainability
- Public debt ratio is expected to remain broadly unchanged in the next decade.
- Weaker-than-expected growth or adjustment slippages would result in a rising debt path.
- Sovereign Risk and Debt Sustainability Analysis (SRDSA) (Annex III) indicates that public debt remains sustainable.
- With the proposed fiscal framework reform, a credible debt anchor and a medium-term fiscal strategy could:
  - increase the scope to let fiscal policy act as a shock absorber, and
  - reduce the volatility in activity as a result.
- Staff’s baseline projections for the SRDSA include increasing fiscal gaps in the outer years, which reflect the estimated adjustment needed to achieve the deficits projected in the authorities’ latest Budget Update.
- The growth-adjusted interest factor (r-g) captures interest costs of the debt ratio, adjusted for growth effects, which on their own lower the latter.

### Authorities’ views on fuel pricing, FEIP, and contingent financing
- The authorities prefer to maintain the current retail fuel price stabilization mechanism, given:
  - the current administration’s pledge that fuel prices will not rise in real terms above their November 2018 level, and
  - the legal basis of the pricing mechanism.
- Under Mexico’s fiscal framework, FEIP has served as the de facto source of contingent financing for the budget alongside smaller trust funds when revenue shortfalls materialized during the 2020 downturn.
- Mexico’s fiscal framework does not permit the issuance of debt for non-capital spending.
- The FBFRL places restrictions on how FEIP can be replenished; balance sheet transfers to FEIP are likely viewed as expenditures that must be balanced by a pre-identified revenue source or spending cuts elsewhere in the budget.
- With oil prices expected to decline next year, the formula underpinning the fuel pricing mechanism is expected to result in lower subsidies in 2023.
- Authorities have a track record of tapering subsidies when market price pressures abated.
- Other policies addressing food prices include:
  - removal of tariffs on key food imports, and
  - regulatory agreements with retailers on food price passthrough.
- In anticipation of downside risks, authorities are interested in reforms to the fiscal framework that would enable the allocation of fiscal savings and funding from debt issuance to the stabilization fund, while respecting key tenets of the current framework.
- In case of a shock affecting vulnerable populations, authorities consider they can create space to provide support by reallocating spending away from public investment.

### External sector policies and exchange rate flexibility
- The peso has faced less downward pressure over the past year than other emerging market currencies.
- Relatively high interest rate differential between Mexico and the U.S. has made holding peso assets more attractive, helping contain upside risks to inflation.
- The peso has also been supported by strong remittances, a track record of fiscal discipline, and some inflows linked to the “nearshoring” of productive capacity.
- If the balance of payments weakens, peso depreciation should be allowed to act as a shock absorber.
- Standard financial frictions underpinning concerns about depreciation generally are not relevant in Mexico’s case:
  - peso FX markets are deep and liquid; during 2020 turbulence they saw below-average rises in the UIP premium and in bid-ask spreads.
  - FX mismatches in balance sheets are contained.
- If a large shock causes sizeable depreciation, policy rate hikes might be needed to counter inflation passthrough.
- If such a shock triggered market illiquidity and sharply higher bid-ask spreads, temporary FX intervention could be considered.
- The IMF’s Flexible Credit Line (FCL) provides an additional external buffer against such external risks and will help contribute to market confidence.

### Financial system resilience and supervisory recommendations
- The financial system emerged from the pandemic in good health:
  - Non-performing loans (NPLs) rose modestly from low levels during the pandemic and began declining last year.
  - Capital adequacy ratios are high and rising.
  - Liquidity ratios are comfortable.
- Banking system demonstrated strong resilience to severe macrofinancial shocks in solvency and liquidity stress tests under the 2022 FSAP (although some smaller banks may require additional buffers).
- Systemic vulnerabilities and liquidity risks appear broadly contained, given high capital buffers, low private sector leverage, and no sign of stretched asset prices.
- Risks from the recent rapid rise of interest rates warrant monitoring:
  - Increase in rates should, all else equal, increase banks’ net interest margin, especially for larger institutions.
  - Mexican banks’ increased holdings of domestic government bonds could lead to mark-to-market losses (impact not expected to be large since holdings are of short duration).
  - A large fraction of non-financial corporate credit is floating rate; higher interest payments could strain liquidity for some corporates and possibly increase default rates.
  - Offsetting pressures: Mexican corporates retain relatively strong buffers and FSAP stress tests imply heightened default risks under the adverse scenario from currently low levels would be manageable for the banking sector.

- FSAP recommendations and priority policy actions:
  - Capacity of regulatory agencies: strengthen autonomy and resources of regulatory government agencies and legal protection of supervisors.
  - Banking supervision and regulation:
    - CNBV should continue to improve supervisory techniques by simplifying its risk-based rating system and using principles- rather than rules-based methodologies.
    - CNBV should be enabled to supervise effectively all financial conglomerates on a consolidated basis; amend the 2014 Financial Groups law to make application mandatory for all such conglomerates.
  - Systemic liquidity management:
    - Continue monitoring conditions; consider further attention to high levels of short-term wholesale funding of development banks (risks attenuated by liabilities guaranteed by the sovereign).
    - Banxico’s Emergency Liquidity Assistance framework could be further enhanced.
  - Safety nets:
    - CNBV should closely monitor risks from loan concentration and contingent credit lines to non-financial corporates and apply Pillar 2 requirements as needed.
    - Strengthen bank resolution and recovery by removing impediments to banks’ resolvability, eliminating barriers to effective use of purchase and assumption and bridge bank tools, and expanding the resolution regime’s remit to financial holding companies.
    - Fill board vacancies at the Deposit Insurance and Resolution Authority (IPAB).
  - Cybersecurity: Banxico and CNBV could enhance cybersecurity by further developing strategy and enhancing oversight, inspection, and investigative powers and instruments.
  - Climate risks: exposure to physical and transition risks from climate change is manageable but financial tail risks will worsen if investments in resilience are not made and global climate policy action is delayed.

### Macroprudential toolkit, mortgages, and financial deepening
- The macrofinancial toolkit could benefit from additional instruments.
- Mortgage market: mortgages are still small as a share of bank capital and GDP, but they are growing rapidly.
  - Introducing loan-to-value and debt-to-income requirements at this early stage would be prudent.
  - Publishing a macroprudential strategy and counter-cyclical buffer guidelines would further advance macroprudential policy.
- Financial deepening should remain a policy priority:
  - Authorities have increased access to bank branches and financial products, improved transparency, and broadened access with more digital connectivity.
  - Mexico’s relatively poor financial depth is a headwind to inclusive growth.
  - Difficulties in collateral recovery and perceptions of judicial quality are additional headwinds.

### Fintech, CBDC, and AML/CFT
- Authorities should continue to foster Fintech to increase competition and broaden financial inclusion.
  - Mexico’s 2018 Fintech law promoted rapid creation of new firms, primarily in e-payments.
  - Banxico has recently undertaken a plan to launch a central bank digital currency (CBDC) with a primary objective to promote greater financial inclusion.
  - CBDC implementation raises complex legal, regulatory, and operational issues; Banxico should continue stakeholder engagement and ensure sufficient resources, and safeguards to financial stability and integrity remain robust.
- AML/CFT and beneficial ownership:
  - Authorities have made good progress aligning legal and regulatory framework with the FATF standard, but should enhance effectiveness.
  - Ensure adequate, accurate and timely information on beneficial ownership is available; plan to establish a beneficial ownership register and strengthen legal framework for designated non-financial business and professions.
  - Strengthen AML/CFT consolidated supervision, allocate adequate resources, and reinforce enforcement to ensure effective, proportionate, consistent, and dissuasive sanctions.
  - Monitor emerging financial integrity risks related to fintech and virtual assets (registration, customer due diligence, and supervision).

### Authorities’ stance on financial sector recommendations
- Authorities underscore commitment to monitoring and containing emerging systemic risks via risk-based prudential oversight.
- They consider the Mexican financial system robust and resilient to possible future adverse shocks and view the policy framework as having performed well during the pandemic.
- Authorities are considering further analysis of potential system-wide liquidity risks and intend to continue strengthening the risk-based supervisory framework and expanding consolidated supervision.
- They do not fully share concerns on risks associated with contingent credit lines (vast majority revocable) or liquidity risks from development banks (institutions fully backed by the sovereign government), but will monitor and assess these issues.
- Authorities emphasize that institutional arrangements governing autonomy of regulatory agencies are defined legislatively and note a track record of supervisors and regulators operating with a high level of independence.
- Authorities are committed to boosting cyber resilience and to developing new areas such as climate risk and fintech, including in the context of their CBDC project focused on promoting financial inclusion.

### Growth, productivity, poverty, and regional inequality
- Productivity growth has been weak despite trade opening and a stable macroeconomic environment.
  - The 1994 North American Free Trade Agreement (NAFTA) eliminated almost all tariffs among Canada, Mexico, and the U.S., reshaping the Mexican economy with exports as a share of GDP rising threefold and increased FDI.
  - Cautious fiscal and monetary policies achieved moderate inflation, exchange rate stability, and stable public debt.
  - Other supply-side impediments appear to have held back productivity gains.
  - Total factor productivity which account for financial deepening has even been negative over 1990–2020 including in the manufacturing sector according to estimates from INEGI.
- Poverty and labor income:
  - Poverty rates have consistently hovered around 40 percent but rose in 2020 due to the pandemic.
  - With the economic recovery, real income has rebounded, and poverty rates have fallen back to pre-pandemic levels.
  - Real per capita labor income and the percent of population in labor income poverty are tracked in CONEVAL data (note: data on per capita labor income is missing for 2020Q2 due to the impact of the COVID-19 pandemic on data collection).
- Regional disparities:
  - Northern and Central regions have benefited from proximity to the U.S.; the South has suffered from little integration and limited economic opportunity.
  - This has resulted in low levels of investment in health, education, and infrastructure in the South, reinforcing significantly poorer economic performance and lower real incomes.

*Source: IMF staff report excerpts from 1mexea2022001.*

### 46.      The supply side policy agenda should be broadened to unlock Mexico’s growth

### The supply side policy agenda should be broadened to unlock Mexico’s growth potential

### Supply-side agenda and priorities
- Current administration focus: redistribution, trade promotion, infrastructure investment, and trade integration, especially in Southern states.
- Flagship reforms include:
  - Implementation of the U.S.-Mexico-Canada Agreement (USMCA).
  - Increases in the minimum wage and the subcontracting law to reduce wage inequality.
  - Increases in the general social pension to reduce old age poverty.
  - Development of trade infrastructure in the Isthmus of Tehuantepec (“Isthmus corridor”).
- Additional priority constraints to address: corruption, crime and rule of law issues; human capital and infrastructure shortfalls; labor and product market rigidities.

### A budget for higher, more equitable growth
- Recommendation: gradual increase in productive government spending, financed by revenue-increasing tax reforms, to lift growth potential and reduce socioeconomic gaps.
- Areas with spending shortfalls to address: education, health, public investment, and social safety nets.
- Structural indicators noted as well below peers: spending per student, teacher-to-student ratio, and public health spending per capita (relative to OECD and emerging market averages).
- Pandemic effect: increased spending needs, particularly in education after 18 months of school closures.
- Fiscal gap (staff forecast): 0.2 percent of GDP in 2023, gradually increasing to around 1.3 percent of GDP by 2027.
- Efficiency improvements recommended: reduce leakage of social assistance benefits, eliminate overlaps with a single beneficiary registry, better coordination across government levels, national and sector strategies, and better multi-year budgeting.

### Recommended scale and effects of higher spending
- Suggested permanent increase in spending: around 2 to 3 percent of GDP.
- Expected outcomes: foster inclusive growth, reduce poverty, address pandemic legacies, and make progress toward the Social Development Goals (SDG).
- Complementary reforms to enhance gains: program efficiency, targeted transfers, and public investment efficiency.

### Pemex: fiscal and operational priorities
- Higher oil prices lowered immediate debt service pressures on Pemex, but restructuring efforts should continue.
- Recommended business-plan changes: focus on production in profitable fields, sell non-core assets, reform pension scheme, and increase partnerships with private firms in upstream projects to reduce costs and fiscal risks.

### Medium-term tax reform (revenue mobilization)
- Objective: generate additional revenues to finance permanent increases in spending on health, education, and social assistance.
- Context: non-oil revenue was nearly 6 percent of GDP below Latin American peers and about half the OECD average before the pandemic.
- Tax policy measures proposed:
  - Value Added Tax (VAT):
    - Eliminate zero-ratings except for a few essential foodstuffs, and rationalize exemptions and differences in rates to increase collection.
    - Implement comprehensive risk management and high-coverage audit process for VAT returns to reduce the compliance gap.
  - Personal income tax:
    - Eliminate exclusions (e.g., income on personal business activities and independent services), reduce tax expenditure, and widen the top personal income tax bracket.
    - Estimated yield: around ¾ percent of GDP.
  - Subnational taxes:
    - Gradually increase property taxes to raise over ¾ percent of GDP.
    - Actions needed: update the cadaster and enhance federal–subnational policy coordination.
    - Simplify and better enforce the local vehicle tax to increase revenues for states and municipalities.
  - Carbon tax and emissions pricing:
    - Current carbon tax rate: USD 3 per ton of CO2; de facto exemption of natural gas noted.
    - Recommendation: raise the carbon tax to USD 75 by 2030 (aligned with the global carbon tax floor proposed for G20 economies by the IMF) and expand emissions pricing coverage.
    - Projected revenue from such carbon pricing and expanded coverage: close to 1.8 percent of GDP by 2030.
    - Note: compensation schemes needed for those most negatively affected by higher energy prices.
- Overall assessment: comprehensive package of higher spending financed by higher revenues should have positive complementarities between growth and equity; VAT reforms and base-broadening personal income tax measures expected to have small adverse effects on long-run growth if coupled with compensation for poor households.

### Governance, corruption, and crime
- Weak civil justice contract enforcement discourages business expansion and formal employment; complicates collateral seizure and impedes financial development.
- Corruption undermines public service provision; organized crime increases transport and insurance costs and discourages entrepreneurship.
- Legal and institutional steps:
  - New law treating corruption and fraud as felony offenses expected to enable more comprehensive investigations.
  - Implementation challenges: assessing effectiveness, coordinating across state levels, prevention measures, facilitation of reporting (including whistleblowing protections), and empowering investigative and prosecutorial institutions.
  - Recommendation: Mexico should participate in the next round of voluntary assessments of transnational aspects of corruption by the Fund.

### Labor market, informality, and pensions
- Recent labor reforms need complementary measures to reduce informality.
- 2021 pension reform risks reducing formal labor supply incentives by reducing qualifying weeks for pension eligibility and raising contribution rates.
- Informality remains elevated and associated with low productivity.
- Risk: minimum wage increases and subcontracting reforms may incentivize informality if not aligned with productivity.
- Recommended measures to reduce informality:
  - Align real minimum wage increases more closely with average productivity growth of low-wage workers.
  - Continue improving labor dispute resolution mechanisms (build on experience of 21 states that implemented the mechanism).
  - Lower restrictions to layoffs.
  - Reduce regulatory costs of formalizing a business.
  - Improve access to and quality of childcare to increase female labor force participation.

### Trade policy and USMCA implementation
- USMCA and its implementation are catalysts for higher growth and reform:
  - Reduces regulatory divergence and complements tariff eliminations.
  - Implementation includes new independent labor adjudication courts at state level.
- Challenge: increase domestic value-added content of exports to meet tighter rules of origin (notably in automotive and textile sectors).
  - Complementary reforms needed: structural fiscal reforms to support education and training.
- Additional trade steps: reduce trade barriers with China, the EU, and Latin America; strengthen customs cooperation with Central America.
- Domestic regulatory reforms to foster competition:
  - Remove FDI restrictions in surface, maritime, and air transport.
  - Streamline licensing and permit procedures to reduce corruption vulnerabilities and improve competitiveness.
  - Strengthen the autonomous competition authority by reversing budget cuts and preserving statutory independence.

### Energy policy, renewables, and climate mitigation
- Recent energy policy changes created policy uncertainty; new electricity law replaced auctions with nonmarket-based policies and granted regulatory power to Comisión Federal de Electricidad (CFE), creating conflicts of interest and disrupting contracts signed under the 2013 reform.
- Recommendation: restore market-oriented regulatory frameworks to encourage private sector participation and leverage Mexico’s renewable energy resources for cheaper, more reliable, sustainable, and competitive energy supply.
- Climate mitigation agenda:
  - Mexico established mitigation and adaptation agenda early, but reducing greenhouse gas emissions requires determined steps and ambitious carbon pricing.
  - ETS expansion in 2023 is important but currently in pilot phase with limited coverage; pilot covers entities responsible for around 40 percent of emissions.
  - Key reforms to make ETS functional: ensure enforceable monitoring, introduce legally binding emissions caps, implement planned auction system for allowances, and scale up coverage.
  - Complementary sectoral measures: feebates, public investment in clean energy infrastructure networks, and regulatory reforms in the energy sector.

### Authorities’ views
- Authorities supportive of pro-growth productive spending increase supported by tax reforms, noting implementation will take time.
- Confidence in administrative measures to combat tax evasion and tax fraud as sources of robust revenues.
- Emphasis on increased public investment in underdeveloped areas, industrial policy, and strengthening human capital.
- Efforts to improve governance include greater reliance on the army to curb crime and removal of conditionality in transfer programs to lower vulnerability to corruption.
- Positive note: 2019 labor law implementation accelerated resolution of labor disputes.
- Authorities seek to increase labor market formality via outsourcing law and tax administration reforms and support a regulatory framework strengthening state-owned energy enterprises.

### Staff appraisal and macro policy guidance
- Mexico is well placed to navigate a more challenging global environment due to strong macroeconomic policies and frameworks, but should prepare contingency plans for downside scenarios.
- Near-term growth expected to slow; balance of risks tilted to the downside (risks include persistent inflation, spikes in oil/food prices, tighter global financial conditions, sharper U.S. slowdown).
- Policy recommendations:
  - Monetary: further increases in the policy rate and maintaining a clearly restrictive stance for some time to re-anchor inflation expectations.
  - Fiscal: envisaged neutral fiscal stance in 2022 and 2023 is appropriate given near-term priorities.
  - Targeting: shift untargeted fiscal measures toward targeted support to safeguard priority spending and insulate the budget from oil price swings.
  - Fiscal buffers: restore fiscal reserves and strengthen the fiscal institutional framework; rebuild the FEIP stabilization fund to around 0.3 to 0.5 percent of GDP.
  - Exchange rate: maintain floating exchange rate as a shock absorber; use monetary policy to counter inflationary impact of a weaker peso, and consider FX intervention to mitigate market illiquidity.

*Source: IMF staff report chapter — “The supply side policy agenda should be broadened to unlock Mexico’s growth potential.”*

### 66.      Additional measures would help the financial system remain resilient in a changing

### 66.      Additional measures would help the financial system remain resilient in a changing

### Financial sector resilience and AML/CFT
- Systemic vulnerabilities are found to be contained, but the 2022 FSAP flags the need for upgrading the financial sector oversight and crisis management frameworks to close some gaps and address emerging challenges.
- After aligning the legal and regulatory AML/CFT framework with Financial Action Task Force standards, the focus should now be on strengthening the AML/CFT regime, including through:
  - adequate resourcing,
  - ensuring the availability of high-quality beneficial ownership information,
  - monitoring emerging financial integrity risks related to fintech.

### Unlocking growth potential and reducing inequality
- Despite increased trade openness and macroeconomic stability, productivity growth has been weak and the growth in output per worker has averaged close to zero over the past 15 years.
- The authorities’ agenda addresses some obstacles to higher productivity and growth, but additional efforts are needed to:
  - address corruption, crime, and the weak rule of law;
  - increase human capital investments and address infrastructure bottlenecks;
  - reduce labor and product market rigidities.

### Financial inclusion and digital finance
- Financial inclusion should be deepened to support inclusive growth.
- The potential of digital finance to increase financial access and depth should be fostered through increased competition in the financial sector, while maintaining safeguards to ensure financial stability and integrity.
- Efforts to broaden digital connectivity and to improve the transparency of financial services should continue.

### Anticorruption framework
- Determined implementation of the anticorruption framework will be key to enhancing its effectiveness.
- Steps should include:
  - strengthening prevention,
  - facilitating reporting including whistleblower protection,
  - further empowering institutions in charge of investigation, prosecution, and oversight.

### Fiscal policy: productive spending and tax reform
- A gradual increase in productive government spending, financed by reforms to raise tax revenues, would promote growth and equity.
- Higher spending on education, health, public investment, and social protection is critical to improve human and physical capital and to narrow the significant variation in social outcomes across states.
- To be effective, this higher spending would need to be accompanied by more efficient public spending, building on recent steps taken to improve spending control and program design.
- Recent tax administration reforms have buoyed revenue, but a well-designed tax policy reform is needed to:
  - reduce differences in VAT rates,
  - reduce tax expenditures,
  - widen the top personal income tax bracket.
- These reforms should be combined with adequate compensation to offset the impact on poorer households.

### Labor market reforms
- Recent labor market reforms should be adapted to lessen their negative effects on formal sector employment.
- The current strategy could be complemented by:
  - continued implementation of the labor dispute resolution mechanisms;
  - lowering firing restrictions;
  - reducing the regulatory costs of formalizing a business;
  - aligning increases in the real minimum wage to increases in the productivity of lower wage workers.

### Energy policy and climate measures
- A more predictable energy policy that is more open to private sector participation would boost competitiveness and investment.
- Reestablishing more market-oriented regulatory frameworks would leverage Mexico’s large and diverse renewable energy resource base and incentivize investments to create a cheaper, more reliable, sustainable, and competitive energy supply.
- Further steps toward carbon pricing would reduce greenhouse emissions. Specific recommendations include:
  - the expansion in 2023 of the emission trading system (ETS) will be an important step towards comprehensively pricing emissions;
  - ensuring adequate coverage, enforcement, and monitoring of polluting activity;
  - introducing legally binding emissions caps;
  - introducing the planned auction system for allowances to make the ETS fully functional.
- Other measures to help Mexico achieve its NDCs include:
  - increasing the carbon tax,
  - introducing feebates,
  - expanding public investment in clean energy infrastructure,
  - regulatory reforms.

*Source: 1mexea2022001 — excerpt from IMF chapter.*

### 74.      It is recommended that the next Article IV consultation take place on the standard 12-

### 1mexea2022001 - 74.      It is recommended that the next Article IV consultation take place on the standard 12- month cycle.

### Article IV scheduling
- It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

### High-frequency indicators and activity
- Private sector forecasts had declined steadily during the first half of 2022, including because of the slowdown in the U.S.
- Labor market is in a recovery phase with rising employment job posting.
- Card transactions’ growth is slowing (Card Transactions: 14-day MA, Index, Jan-Feb Avg. = 100).
- As a rising share of the population is vaccinated, Covid-19 waves’ economic effects are less sharp; mobility is not much affected by recent waves.
- 2022 GDP Growth Forecasts panel notes: New Forecast, Average Forecast, 80-20 Range shown.

### Labor market indicators
- Participation has largely recovered while unemployment has fallen below average.
- Nominal wages are rising, especially in the formal sector (Formal IMSS Wages (monthly) and Overall wages (quarterly, RHS) series shown).
- Manufacturing jobs were relatively insulated and recovered early while construction has lagged.
- Irregular employment acted as a shock absorber through the crisis but conditions have normalized, with similar behavior in informal employment.
- Unit labor costs (ULCs) appear flat amid high seasonal variation.

### Real sector: output, investment, and exports
- Business confidence is now declining.
- Gross fixed capital formation fell sharply and has seen a relatively slow rebound; private confidence is losing momentum but consumption is resisting so far.
- Exports recovered quickly and were on a steady growth path in late 2021 and early 2022; manufacturing is leading the recovery along with services most affected during the pandemic.
- Employment dropped steeply during the pandemic but has largely recovered.
- Notes on measurement:
  - Employment is employment as a share of the economically active population.
  - Formal employment is IMSS-reporting employees (does not capture self-employed formal workers).

### Prices and inflation
- Headline inflation is at 20-year highs led by food prices.
- Core inflation has risen with a lag, driven by processed foods; merchandise inflation is rising with services inflation now following.
- Policy rate has been raised to above 2019 peaks while rising inflation expectations present a more moderate path for the real rate.
- Real wages struggle to keep pace with inflation as productivity declined through the pandemic.
- Survey-based inflation expectations:
  - Short-term expectations substantially exceed the central bank's range of variability but long-run expectations remain anchored.
- Consumer prices:
  - End of period: 2019 = 4.8; 2020 = 2.8; 2021 = 3.2; 2022 = 7.4; 2023 (Proj.) = 8.5; 2024 (Proj.) = 4.8; 2025 (Proj.) = 3.5; 2026 (Proj.) = 3.2; 2027 (Proj.) = 3.0
  - Average: 2019 = 3.6; 2020 = 3.4; 2021 = 5.7; 2022 = 8.0; 2023 (Proj.) = 6.3; 2024 (Proj.) = 3.9; 2025 (Proj.) = 3.3; 2026 (Proj.) = 3.1; 2027 (Proj.) = 3.0

### External sector and reserve adequacy
- Gross international reserves:
  - 2019 = 183.0 (US$ billion)
  - 2020 = 199.1
  - 2021 = 207.7
  - 2022 (Proj. / various tables) show values around 205.7–207.7 and later projections up to 213.9.
- GIR to GDP, GIR to Broad Money, GIR to Short-term External Debt + Current Account Deficit, and GIR to ARA Metric presented in comparative charts across EMEs.
- ARA Metric and reserve adequacy notes:
  - ARA Metric formulae for fixed and floating exchange rates provided.
  - Upper and lower lines denote the 100-150 percent range of the ARA metric considered broadly adequate for precautionary purposes.

### Fiscal sector: revenues, expenditures, debt, and trust funds
- Public debt projections and fiscal balances:
  - Public debt is projected to remain almost flat below 60 percent of GDP over the medium-term.
  - Overall deficit is likely to stay high in 2022 due to fuel subsidies.
  - The deficit in Mexico was lower than peer groups in 2021.
- Public sector revenues and expenditures (selected series, in percent of GDP):
  - Total revenues and expenditures and oil revenue / non-oil tax revenue trends shown across 2008–2021 and projections to 2027.
- Gross public sector debt:
  - 2019 = 53.6 percent of GDP
  - 2020 = 53.3
  - 2021 = 60.1
  - 2022 = 57.6 (table values)
  - Projections through 2027 included.
- Trust Funds managed by Secretaría de Hacienda have reduced considerably since the pandemic (As of March 2022, shown in billions of pesos).

### Financial markets
- Exchange rate:
  - Nominal (MXN/USD) and Real effective exchange rate series shown; peso stable since recovering from the pandemic shock.
- Yields and spreads:
  - Yields have risen in response to policy hikes, mostly at the short end, leading to an inversion of the yield curve (1-Year, 5-Year, 10-Year, 20-Year yields shown as of Sep 2022).
  - Credit spreads have risen in recent months, but less so than for some other emerging markets.
  - Sovereign 5Y CDS spread and CEMBI corporate spreads as of September 23, 2022 presented.
- Sovereign debt holdings in local currency and foreign inflows in local currency debt:
  - Foreigners continue to reduce their holdings of peso-denominated bonds.
  - Capital flows stabilized; surge in demand for inflation-linked bonds (Udibonos) in early 2022.
- Financial market indicators (latest, mixed-period):
  - EMBIG Mexico spread (period average): 318.2 (2019), 474.4 (2020), 354.2 (2021), 380.9 (year-to-date Jun-22).
  - Sovereign 10-year local currency bond yield (period average): 7.6 (2019), 6.3 (2020), 6.9 (2021), 8.4 (Jun-22).

### Banking system and financial soundness
- Capitalization and profitability:
  - Regulatory capital to risk-weighted assets: 14.9 (2016), 15.6 (2018), 15.9 (2019), 16.0 (2021), 17.7 (2022Q2), 19.5 (2021, table shows series).
  - Return on equity and return on assets series shown; banking profitability proved resilient.
- Asset quality and NPLs:
  - Nonperforming loans to total gross loans around 2.1–2.4 percent across reported years.
  - Non-performing loans at commercial banks and development banks rose earlier in the year due to a few entities’ difficulties and a change to IFRS 9; development bank NPLs showed larger increases.
- Credit growth:
  - Commercial bank credit has resumed growth, outpacing inflation; development bank credit growth continues to decline.
- Financial Soundness Indicators highlights (selected):
  - Liquid assets to short-term liabilities: 31.4–38.5 (percent across years).
  - Customer deposits to total (noninterbank) loans: 88.9–105.2 (percent across years).

### Nonfinancial corporate sector
- Leverage and issuance:
  - Nonfinancial corporate leverage has seen a reprieve since 2020.
  - Hard currency issuance has fallen sharply amidst higher yields.
- Debt servicing and profitability:
  - Interest coverage ratio and EBITDA growth indicate debt servicing capacity reversed recent declines and profitability improved.
- Maturity profile and liquidity:
  - Maturity structure weighted toward longer maturities; current ratios deteriorated somewhat.
  - Maturity profile shows distributions across 2023, 2024, 2025-2027, 2028-2032, >2032 with proportions in Peso and FX; example percentages shown in chart: 6%, 9%, 23%, 27%, 34% (label context in figure).

### Social indicators and inclusiveness
- Poverty and inequality:
  - Poverty headcount ratio at $1.90 (2011 PPP) and $3.20 (2011 PPP) panels show trends; poverty in Mexico is slightly higher than the LAC6 average; extreme poverty has declined over the past 25 years.
  - Income share held by highest 10 percent and income inequality are slightly above the regional average.
- Other social measures:
  - Infant mortality rate, intentional homicides, and share of youth not in education, employment or training (NEET) presented; homicide rate remains high and a large but declining share of youth is excluded from education or employment.
- Table 1 selected statistics:
  - GDP per capita (U.S. dollars, 2021): 10,048.8
  - Population (millions, 2021): 129.0
  - Life expectancy at birth (years, 2020): 75.1
  - Infant mortality rate (per thousand, 2020): 11.8
  - Poverty headcount ratio (% of population, 2020) 1/: 43.9
  - Income share of highest 20 perc. / lowest 20 perc. (2020): 9.1
  - Adult literacy rate (2019): 95.4
  - Gross primary education enrollment rate (2020) 2/: 104.7

### Balance of payments (summary)
- Summary Balance of Payments (Table 4a, in US$ billions):
  - Current account: 2019 = -3.4; 2020 = 27.1; 2021 = -4.8; 2022 = -17.3; 2023 (Proj.) = -18.2; 2024 (Proj.) = -17.2; 2025 (Proj.) = -16.1; 2026 (Proj.) = -15.0; 2027 (Proj.) = -15.1
  - Exports, f.o.b.: 2019 = 460.6; 2020 = 417.2; 2021 = 494.8; 2022 = 564.1; 2023 = 577.4; 2024 = 597.1; 2025 = 622.8; 2026 = 654.0; 2027 = 685.9
  - Imports, f.o.b.: 2019 = 455.2; 2020 = 383.0; 2021 = 505.7; 2022 = 591.5; 2023 = 598.2; 2024 = 607.5; 2025 = 636.9; 2026 = 667.7; 2027 = 701.2
  - Secondary income (mostly remittances), net: 2019 = 36.2; 2020 = 40.9; 2021 = 51.3; 2022 = 55.1; 2023 = 56.2; 2024 = 58.6; 2025 = 61.8; 2026 = 65.2; 2027 = 68.3
  - Gross international reserves (US$ billions): 2019 = 183.0; 2020 = 199.1; 2021 = 207.7; 2022 = 205.7; 2023 (Proj.) = 207.4; 2024 (Proj.) = 209.0; 2025 (Proj.) = 210.7; 2026 (Proj.) = 212.3; 2027 (Proj.) = 213.9
- International Investment Position, net:
  - 2019 = -615.0; 2020 = -530.9; 2021 = -544.0; 2022 = -561.2; projections to -624.6 by 2027.

### Baseline medium-term projections (selected)
- GDP contributions (real terms, percent growth contributions):
  - GDP: 2019 = -0.2; 2020 = -8.1; 2021 = 4.8; 2022 = 2.1; 2023 = 1.2; 2024 = 1.8; 2025 = 2.1; 2026 = 2.1; 2027 = 2.1
  - Consumption contributions: 2019 = 0.0; 2020 = -7.0; 2021 = 5.1; 2022 = 4.5; 2023 = 0.9; 2024 = 1.3; 2025 = 1.7; 2026 = 1.7; 2027 = 1.7
- Current account balance (percent of GDP, Baseline Medium-Term Projections Table):
  - 2019 = -0.3; 2020 = 2.5; 2021 = -0.4; 2022 = -1.2; 2023 = -1.2; 2024 = -1.1; 2025 = -1.0; 2026 = -0.9; 2027 = -0.9
- Non-hydrocarbon current account balance (percent of GDP):
  - 2019 = 1.4; 2020 = 3.7; 2021 = 1.5; 2022 = 1.0; 2023 = 0.8; 2024 = 0.6; 2025 = 0.6; 2026 = 0.7; 2027 = 0.7
- Crude oil export price, Mexican mix (US$/bbl):
  - 2019 = 56.0; 2020 = 35.8; 2021 = 64.8; 2022 = 91.4; 2023 (Proj.) = 79.6; 2024 (Proj.) = 74.6; 2025 (Proj.) = 70.9; 2026 (Proj.) = 68.2; 2027 (Proj.) = 67.0
- Non-financial public sector overall balance (percent of GDP):
  - 2019 = -2.3; 2020 = -4.4; 2021 = -3.8; 2022 = -3.8; 2023 (Proj.) = -4.1; 2024 (Proj.) = -2.7; 2025 (Proj.) = -2.7; 2026 (Proj.) = -2.7; 2027 (Proj.) = -2.7

*International Monetary Fund staff summary of content unit 1mexea2022001 (selected figures, tables, and projections as presented in the source).*

### Annex I. External Sector Assessment

### Annex I. External Sector Assessment

### Overall assessment
- The external position in 2021 was broadly in line with the level implied by medium-term fundamentals and desirable policies.
- Rebalancing in 2021 was led by the economic reopening and recovery, domestically and elsewhere, and a smaller fiscal policy gap due to narrowing cross-country differences in pandemic-related fiscal support.
- The current account deficit is expected to stabilize around 1 percent of GDP in the medium term.
- Potential policy responses:
  - Implement further structural reforms to address investment obstacles to boost growth and exports in the medium and long terms. Reforms should include:
    - Tackling economic informality and governance gaps.
    - Increasing private sector participation in energy.
    - Reforming Pemex’s business strategy and governance.
  - Maintain the floating exchange rate as a shock absorber; use FX interventions only to prevent disorderly market conditions.
  - Continue to regard the IMF’s Flexible Credit Line as an added buffer against global tail risks.

### Foreign asset and liability position and trajectory
- Background:
  - Mexico’s NIIP is projected to improve from –41 percent of GDP in 2021 to around –35 percent of GDP over the medium term, driven mainly by the decline in foreign liabilities.
  - Foreign assets in 2021 were mostly direct investment (18 percent of GDP) and international reserves (16 percent of GDP).
  - Foreign liabilities were mostly direct investment (49 percent of GDP) and portfolio investment (39 percent of GDP).
  - Gross public external debt was estimated at 23 percent of GDP at the end of 2021, of which roughly one-quarter was comprised of holdings of local currency government bonds.
- Assessment:
  - The NIIP is sustainable and a relatively high share of local currency denomination of foreign public liabilities reduces FX risks.
  - The large gross foreign portfolio liabilities could be a source of vulnerability in case of global financial volatility.
  - Vulnerabilities from exchange rate volatility are moderate, as most Mexican firms with FX debt have natural hedges and actively manage their FX exposures.
- Key 2021 figures (% GDP):
  - NIIP: –41
  - Gross Assets: 58
  - Debt Assets: 19
  - Gross Liab.: 99
  - Debt Liab.: 38

### Current account
- Background:
  - In 2021, the CA balance moved to a deficit of 0.4 percent of GDP after posting a surplus of 2.5 percent of GDP in 2020, reflecting the recovery of import demand, including from restocking of intermediate goods.
  - An increase in investment and a decline in saving contributed roughly equally to the change in the CA balance in 2021.
  - The private sector saving-investment balance declined by 3.1 percentage points of GDP, more than offsetting the improvement in the public sector balance of 0.7 percentage point.
  - In 2022, the current account deficit is expected to widen with higher global commodity prices, given Mexico’s net commodity importer status.
  - Domestic fuel price ceiling and associated fuel subsidies will weaken substitution and income effects of higher oil prices and amplify their impact on the CA balance.
  - The 2022 CA deficit is projected to increase to around 1 percent of GDP, with considerable forecast uncertainty.
  - Over the medium term, the CA balance is projected to stabilize around a deficit of around 1 percent of GDP.
- Assessment and model results:
  - The EBA model estimates a cyclically adjusted CA norm of –1.2 percent of GDP in 2021.
  - This implies a CA gap of –0.2 percent of GDP, with a range from –1.2 to 0.8 percent of GDP.
  - Contribution from the overall policy gap is estimated at 1.3 percent of GDP, driven by the fiscal gap (1.2 percent).
  - IMF staff adjustments for COVID-19 transitory impacts:
    - Travel services: 0.1 percent of GDP
    - Transport balance: 0.6 percent of GDP
    - Household consumption composition shift: –0.3 percent of GDP
    - Trade in medical products: 0.1 percent of GDP
    - Remittances: –0.3 percent of GDP
  - Including adjustments, IMF staff midpoint CA gap: –0.2 percent of GDP, range: –1.2 to 0.8 percent of GDP.
- Key 2021 figures (% GDP):
  - CA: –0.4
  - Cycl. Adj. CA: –1.5
  - EBA Norm: –1.2
  - EBA Gap: -0.2
  - COVID-19 Adj.: 0.1
  - Other Adj.: 0
  - Staff Gap: -0.2

### Real exchange rate (REER)
- Background:
  - In 2021, the peso fluctuated in a narrow range of around 20 to 21 pesos per U.S. dollar.
  - The average REER in 2021 appreciated by about 6 percent compared to the 2020 average, mostly driven by a nominal appreciation.
  - As of July 2022, the REER had appreciated by 3 percent compared to its 2021 average.
- Assessment:
  - The IMF staff CA gap implies a REER gap of 0.5 percent (applying a semi-elasticity of 0.33).
  - The EBA REER level and index models estimate:
    - EBA REER level overvaluation: 7.7 percent in 2021.
    - EBA REER index undervaluation: 9.1 percent in 2021.
  - IMF staff’s overall assessment: REER gap in the range of –2.6 to 3.5 percent, with a midpoint of 0.5 percent.

### Capital and financial accounts: flows and policy measures
- Background:
  - In 2021, Mexico recorded a small amount of net financial account inflows.
  - Net portfolio outflows increased compared to the previous year due to higher purchases of foreign assets by residents and larger sales of Mexican assets by nonresidents.
  - These outflows were offset by a turnaround in other investment flows and continued strong net FDI inflows.
- Assessment:
  - Long maturity of sovereign debt and relatively high share of local-currency-denominated debt reduce exposure of government finances to FX depreciation and refinancing risks.
  - The banking sector is resilient; FX risks of nonfinancial corporate debt are generally covered by natural and financial hedges.
  - The strong presence of foreign investors leaves Mexico exposed to capital flow reversals and risk premium increases.

### FX intervention and reserves level
- Background:
  - The central bank remains committed to a free-floating exchange rate and uses discretionary FX intervention to prevent disorderly market conditions.
  - At the end of 2021, gross international reserves were USD 208 billion (16 percent of GDP), up from USD 199 billion at the end of 2020, largely owing to the IMF’s general SDR allocation.
  - In 2021, no FX intervention was conducted.
- Assessment:
  - Reserves at end-2021 were:
    - 131 percent of the ARA metric.
    - 254 percent of short-term debt (at remaining maturity).
  - The level of foreign reserves at the end of 2021 remains adequate.
  - IMF staff recommend that the authorities continue to maintain reserves at an adequate level over the medium term.
  - The Flexible Credit Line arrangement provides an additional buffer.

### Risk Assessment Matrix — selected risks, likelihood, impact, and policy responses
- Commodity price shocks
  - Likelihood: High
  - Impact: Medium. Oil price shocks weigh on fiscal expenditure because of retail fuel price smoothing. Oil and food price shocks feed through to headline and core inflation.
  - Policy response: Monetary policy should respond if shocks feed into core inflation and ensure that inflation expectations remain anchored.
- Systemic social unrest
  - Likelihood: High
  - Impact: Medium. A global wave of social unrest is likely to fall more lightly on Mexico in the current political alignment, but substantial pressure on basic goods prices could cause tension.
  - Policy response: Tighten monetary policy to address rising inflation; increase and better target social transfers; accelerate investment plans in low-income regions.
- De-anchoring of inflation expectations and stagflation
  - Likelihood: Medium
  - Impact: High. Supply shocks to food and energy prices could de-anchor expectations and trigger a wage-price spiral.
  - Policy response: Monetary policy should respond decisively to ensure the policy rate remains contractionary.
- Abrupt global slowdown or U.S. recession
  - Likelihood: Medium
  - Impact: High. A U.S. “hard landing” would transmit to Mexico through reduced external demand and remittances, tighter financial conditions, and capital outflows.
  - Policy response: Tighten monetary policy if domestic inflation is affected; decouple from Fed when appropriate; frontload fiscal expenditure plans and delay revenue measures to provide support without adding domestic price pressures.
- Local COVID-19 outbreaks
  - Likelihood: Medium
  - Impact: Medium. More contagious or vaccine-resistant variants could reverse declining hospitalizations and deaths and renew supply constraints.
  - Policy response: Renew vaccination campaigns and seek boosters if available; consider renewing pandemic-era support for key industries; expand targeted transfer programs.
- Deepening geo-economic fragmentation and geopolitical tensions
  - Likelihood: High
  - Impact: Low. Reduced global productivity and demand and higher input costs will weigh on Mexican growth, but nearshoring could have net positive impact.
  - Policy response: Implement structural reforms to allow flexible adjustment to rotations in export demand, including labor market reforms to reduce informality and facilitate sectoral reallocation.

### Debt sustainability and sovereign stress (Annex III highlights)
- Overall judgment:
  - The risk of Mexico experiencing sovereign stress is moderate overall.
  - Public debt is assessed to be sustainable with high probability over the extended time horizon.
- Staff commentary and projections:
  - Fan chart analysis suggests public debt ratios could increase materially in the medium term, possibly constraining policy options and leading to moderate risks of sovereign stress compared to low risks in the near term.
  - The projected debt path and GFN are expected to increase somewhat over the main projection period but decline over the extended 10-year period.
  - Debt is judged sustainable but notable risks from further shocks remain, particularly given the global macroeconomic context and the tight fiscal stance underpinning debt dynamics.
  - Persistence of medium-term factors and absence of structural reforms may pose a trade-off between long-run growth and budget balance.
  - Medium-term risks are assessed as moderate. Standardized stress tests suggest additional financing needs could reach close to 15 percent in a stress scenario but domestic banking and non-depository sectors could pick up slack.
  - The balanced budget rule assists in containing debt but may have implications for budget composition and restraint on investment and developmental expenditures.
- Final sustainability assessment:
  - Sustainable with high probability.

### Debt coverage, structure, and disclosures (selected points)
- Debt coverage and reporting:
  - Classification of fiscal accounts matches that used in the IMF’s Fiscal Monitor.
  - State and Local governments are excluded from debt coverage given limits on their debt carrying capacity and absence of a federal guarantee obligation.
  - Debt is not consolidated across the Federal government and Non-Financial Public Sector; aggregate debt data represent gross amounts of individual liabilities.
- Staff commentary on structure and projections:
  - Shares of foreign and domestic currency-denominated liabilities in total public debt are expected to be broadly stable in the projection period.
  - Rising share of domestic other creditors reflects increased holdings of public debt liabilities by domestic pension funds following recent pension reforms.
  - Share of liabilities with longer maturities is expected to rise until 2025 and then stabilize, in line with the government’s debt management strategy.
  - Data on structure of debt holders are taken from the Arslanalp-Tsuda database; these data exclude SOEs, development banks, and other entities included in Public Sector fiscal accounts, hence debt as share of GDP is lower than in other SRDSA outputs.
- Selected structural indicators (as presented in figures and commentary):
  - Residual maturity: 9.2 years
  - Projections indicate increasing share of >5 years maturities through 2025 then stabilization.

*Source: Annex I. External Sector Assessment and selected annexes in the provided IMF country documentation.*

### Annex III. Figure 4. Mexico: Baseline Scenario

### Annex III. Figure 4. Mexico: Baseline Scenario

### Public debt and financing: baseline projections (percent of GDP)
- Public debt: 57.6 (2021), 56.2 (2022), 57.7 (2023), 58.2 (2024), 58.6 (2025), 58.9 (2026), 59.3 (2027), 58.9 (2028), 58.4 (2029), 57.6 (2030), 56.8 (2031)
- Change in public debt: -2.5 (2021), -1.4 (2022), 1.5 (2023), 0.5 (2024), 0.4 (2025), 0.4 (2026), 0.3 (2027), -0.3 (2028), -0.6 (2029), -0.7 (2030), -0.8 (2031)
- Contribution of identified flows: -3.3 (2021), -0.7 (2022), 1.6 (2023), 0.6 (2024), 0.5 (2025), 0.5 (2026), 0.5 (2027), -0.2 (2028), -0.4 (2029), -0.6 (2030), -0.7 (2031)
- Contribution of residual: 0.8 (2021), -0.7 (2022), -0.1 (2023), 0.0 (2024), -0.1 (2025), -0.2 (2026), -0.2 (2027), -0.2 (2028), -0.2 (2029), -0.2 (2030), -0.2 (2031)

### Fiscal positions and flows (percent of GDP)
- Primary deficit: 0.0 (2021), -0.7 (2022), -0.3 (2023), -1.8 (2024), -1.8 (2025), -1.8 (2026), -1.6 (2027), -1.6 (2028), -1.6 (2029), -1.6 (2030), -1.6 (2031)
- Noninterest revenues: 23.0 (2021), 24.1 (2022), 23.9 (2023), 23.9 (2024), 23.7 (2025), 23.7 (2026), 23.8 (2027), 23.8 (2028), 23.8 (2029), 23.8 (2030), 23.8 (2031)
- Noninterest expenditures: 23.1 (2021), 23.3 (2022), 23.7 (2023), 22.0 (2024), 21.9 (2025), 21.9 (2026), 22.1 (2027), 22.1 (2028), 22.1 (2029), 22.1 (2030), 22.1 (2031)

### Automatic debt dynamics and macro determinants
- Automatic debt dynamics: -3.5 (2021), -0.7 (2022), 1.4 (2023), 2.0 (2024), 1.9 (2025), 1.9 (2026), 1.8 (2027), 1.5 (2028), 1.2 (2029), 1.1 (2030), 1.0 (2031)
- Int. rate-growth differential: -2.5 (2021), -1.1 (2022), 0.9 (2023), 1.8 (2024), 1.7 (2025), 1.7 (2026), 1.6 (2027), 1.3 (2028), 1.1 (2029), 0.9 (2030), 0.8 (2031)
- Real interest rate: 0.3 (2021), 0.1 (2022), 1.6 (2023), 2.8 (2024), 2.9 (2025), 2.9 (2026), 2.8 (2027), 2.5 (2028), 2.3 (2029), 2.1 (2030), 1.9 (2031)
- Real growth rate: -2.7 (2021), -1.2 (2022), -0.6 (2023), -1.0 (2024), -1.2 (2025), -1.2 (2026), -1.2 (2027), -1.2 (2028), -1.2 (2029), -1.2 (2030), -1.2 (2031)
- Real exchange rate: -1.5 (2021) and no further values reported in the table
- Relative inflation: 0.5 (2021), 0.4 (2022), 0.4 (2023), 0.2 (2024), 0.2 (2025), 0.2 (2026), 0.2 (2027), 0.2 (2028), 0.2 (2029), 0.2 (2030), 0.2 (2031)
- Other identified flows: 0.1 (2021), 0.8 (2022), 0.5 (2023), 0.4 (2024), 0.4 (2025), 0.4 (2026), 0.4 (2027), 0.0 (2028), 0.0 (2029), 0.0 (2030), 0.0 (2031)
- Contingent liabilities: 0.0 for all reported years
- Other transactions: 0.1 (2021), 0.8 (2022), 0.5 (2023), 0.4 (2024), 0.4 (2025), 0.4 (2026), 0.4 (2027), 0.0 (2028), 0.0 (2029), 0.0 (2030), 0.0 (2031)

### Financing needs and composition
- Gross financing needs: 12.4 (2021), 12.6 (2022), 12.3 (2023), 11.5 (2024), 10.9 (2025), 11.2 (2026), 11.4 (2027), 11.3 (2028), 11.3 (2029), 11.5 (2030), 11.3 (2031)
- Of which: debt service: 12.7 (2021), 13.6 (2022), 12.8 (2023), 13.5 (2024), 12.9 (2025), 13.1 (2026), 13.2 (2027), 13.1 (2028), 13.1 (2029), 13.3 (2030), 13.1 (2031)
- Local currency financing: 10.6 (2021), 11.6 (2022), 10.9 (2023), 11.3 (2024), 10.2 (2025), 10.5 (2026), 10.3 (2027), 10.2 (2028), 10.2 (2029), 10.5 (2030), 10.2 (2031)
- Foreign currency financing: 2.1 (2021), 1.9 (2022), 1.9 (2023), 2.1 (2024), 2.6 (2025), 2.6 (2026), 2.9 (2027), 2.9 (2028), 2.9 (2029), 2.9 (2030), 2.9 (2031)

### Memo: macro and interest assumptions (selected)
- Real GDP growth (percent): 4.8 (2021), 2.1 (2022), 1.2 (2023), 1.8 (2024), 2.1 (2025), 2.1 (2026), 2.1 (2027), 2.1 (2028), 2.1 (2029), 2.1 (2030), 2.1 (2031)
- Inflation (GDP deflator; percent): 7.1 (2021), 8.9 (2022), 5.7 (2023), 3.4 (2024), 3.1 (2025), 3.0 (2026), 3.0 (2027), 3.0 (2028), 3.0 (2029), 3.0 (2030), 3.0 (2031)
- Nominal GDP growth (percent): 12.2 (2021), 11.2 (2022), 6.9 (2023), 5.3 (2024), 5.3 (2025), 5.2 (2026), 5.1 (2027), 5.1 (2028), 5.1 (2029), 5.1 (2030), 5.1 (2031)
- Effective interest rate (percent): 7.6 (2021), 9.1 (2022), 8.7 (2023), 8.6 (2024), 8.4 (2025), 8.2 (2026), 8.0 (2027), 7.4 (2028), 7.0 (2029), 6.8 (2030), 6.5 (2031)

### Staff commentary (main points)
- The public debt to GDP ratio is expected to decline in 2022 with the economic recovery after the pandemic-related downturn in 2020 and exchange rate appreciation.
- With slowing GDP growth globally and in Mexico in 2023, the public debt ratio is expected to increase in 2023 despite the contribution from the primary budget deficit.
- Beyond 2023, Mexico’s relatively low trend growth, in real and nominal terms, and a relatively high average interest rate on public debt mean that r-g dynamics will not contribute to lowering the public debt ratio in the medium-term.
- The primary budget surplus is expected to offset the unfavorable automatic debt dynamics.
- Mexico has a strong track record in maintaining a prudent fiscal policy stance.

*International Monetary Fund — Annex III. Figure 4. Mexico: Baseline Scenario*

### Annex V. Domestic Market Development, Foreign Investors and

### Annex V. Domestic Market Development, Foreign Investors and Peso Stability

### Overview
- Foreigners (nonresident investors) have been reducing their holdings of domestic, peso-denominated government securities since early 2015.
- Part of the recent decline was driven by China’s entry to the global bond index and a consequent loss of Mexico’s weight.
- Reductions in foreign holdings have generally been gradual but temporarily accelerated during periods of increasing risk aversion, including in the COVID-19 pandemic.
- Despite implied capital outflows, the peso and local-currency government securities markets have remained relatively stable.

### A. Peso Stability
- Even as the trade-weighted dollar index has risen by 8 percent over the last year, the peso has followed the dollar’s appreciation and has been one of the better performing currencies.
- Carry trades likely explain part of this performance:
  - Banxico’s quick response to rising inflation pressures pushed the interest rate spread versus the U.S. to over 6 percent, close to previous highs in the past decade or so.
  - Compared to other emerging markets, Mexico now has a relatively high ratio of carry to implied volatility (3-Month Carry/Implied Volatility), a common metric used to assess the attractiveness of carry trades.
- However, there is little correlation between recent currency performance and this carry/volatility measure, as countries with even higher ratios performed worse than the peso, implying additional drivers of peso stability:
  - Mexico’s relatively strong policy framework.
  - A recovery in other flows, notably a post-pandemic recovery in the U.S. and easing of COVID-19 restrictions that helped drive a strong recovery in remittances and tourism.

### B. Calm Domestic Government Security Market
- Continued sales by foreigners have not produced the adverse impact on conditions and liquidity in domestic government securities markets seen in the past; markets have remained relatively calm.
- Domestic investors, particularly pension funds, have been filling the absence of foreigners:
  - Pension funds became the biggest holders of domestic government securities in mid-2020.
  - The holdings of other institutional investors have also increased.
- Pension funds are expected to play an increasingly important role owing to recent pension reforms:
  - Banxico estimated that pension funds could grow from 20 percent of GDP in 2020 to 35-56 percent of GDP by 2040.
  - With an unchanged investment strategy, annual purchases of additional domestic government securities by pension funds could amount to roughly USD 7–10 billion even if their assets remained at 20 percent of GDP.
  - Purchases of such amounts would match the highest value of annual sales of domestic government securities by foreigners recorded in the last ten years.
- Historical asset-allocation context:
  - The share of government securities in pension funds declined from nearly 100 percent in 1999 to around 50–60 percent in 2010 in response to the government’s liberalization of pension funds asset allocation restrictions; the share stayed around the same since then.
- Risks and limits:
  - Tenors mostly held by foreigners could still face selling pressure, notably the very long-term government securities.

*Source: IMF staff analysis in Annex V, "Domestic Market Development, Foreign Investors and Peso Stability."*

### Annex VIII. The Impact on Mexico’s Exports to U.S. from 2014

### Annex VIII. The Impact on Mexico’s Exports to U.S. from 2014

### Key finding
- Mexico’s exports to the U.S. increased after the 2014 U.S. sanctions on Russia by about USD 0.85 billion or 0.07 percentage points of 2012 GDP, comparing imports of 2015–16 to 2012–14.

### Empirical approaches
- Dynamic regressions
  - Sample: monthly data 2012–16 at HS 6-digit level.
  - Regressand: log of nominal U.S. imports from Mexico.
  - Controls: (i) time dummy for each month; (ii) U.S. tariffs to Mexico at product level; (iii) product fixed effects.
  - Result: the coefficient on the time dummy increases in months following the U.S. sanctions (March and December 2014), suggesting positive effects on Mexico’s exports after the sanctions.
- Local projections
  - Regressand: accumulated change in the log of U.S. imports from Mexico.
  - Controls: (i) three lags of the dependent variable; (ii) current and three lags of shocks (March and December 2014 coded as 1, other months as 0); (iii) current and three lags of Mexican GDP; (iv) current and three lags of U.S. tariffs; (v) product fixed effects.
  - Result: impulse responses imply a positive statistically significant effect with nominal exports from Mexico increasing by about 10 percent four months after the sanction.

### Data and institutional notes
- Monthly U.S. import value data at HS 6-digit level from UN Comtrade and DataWeb, USITC for 2012/01 to 2016/12.
- U.S. tariffs on Mexico calculated from DataWeb, USITC.
- In 2014, following Russia’s invasion of Crimea, the U.S. issued four executive orders: the first three in March and the last one in December.

### Comparative pre/post import figures (as presented)
- Mexico
  - Pre-sanction US imports: 23.89 billion $
  - Pre-sanction percent of 2012 GDP: 1.99%
  - Post-sanction US imports: 24.74 billion $
  - Post-sanction percentage points of 2012 GDP: 2.06%
  - Change in US imports: 0.85 billion $, 0.07%
- Russian Federation
  - Pre-sanction US imports: 2.29 billion $
  - Pre-sanction percent of 2012 GDP: 0.10%
  - Post-sanction US imports: 1.36 billion $
  - Post-sanction percent of 2012 GDP: 0.06%
  - Change in US imports: -0.93 billion $, 0.04%

### Interpretation and caveats
- The patterns are consistent with positive trade diversion effects for Mexico following U.S. sanctions on Russia in 2014.
- Important caveats:
  - The analysis does not attribute causality; the estimated effects could capture other time-varying factors besides sanctions.
  - Local projections using shocks for the months of executive orders are intended to mitigate, but cannot eliminate, concerns about confounding events.

*Source: IMF staff analysis using UN Comtrade and USITC data.*

### 7.      The reforms represent a pragmatic step forward in enabling fiscal policy to respond to

### 7.      The reforms represent a pragmatic step forward in enabling fiscal policy to respond to immediate downside risks, but comprehensive reform is necessary to improve flexibility and reliability while ensuring transparency and fiscal responsibility.

### Short-term reforms and FEIP funding
- Ratification of the proposed reforms before the end of 2022 are expected to free up MEX$20–30 billion for FEIP.
- The additional funding for FEIP is predicated on whatever headroom against the debt ceiling is left at year-end, making the extent of financing:
  - subject to uncertainty, and
  - therefore unreliable for guaranteed contingency financing.
- Types of financial assets FEIP would be allowed to hold include government securities or other types of liquid asset that could be sold, securitized, or collateralized.
- A transfer from FMP’s reserves to FEIP is another possibility and would leave budgetary resources untouched, but:
  - requires that the Chamber of Deputies approve such a transfer;
  - existing legislation expedites this decision-making process where FMP reserves exceed 3 percent of GDP by the end of the previous year—a remote possibility with reserves standing at 0.07 percent of GDP in July 2022;
  - FMP reserves can be used directly for budgetary needs even when they are below 3 percent of GDP but FEIP resources must be completely exhausted first and a two-thirds majority vote by the Chamber of Deputies is required.

### Trade-offs and limitations of the short-term approach
- Advantages:
  - By leaving many parameters of the existing fiscal framework untouched, the reforms enable quick implementation at a time when risks are concentrated in the near-term.
  - Could provide large support to contingencies required should the downside risks facing the domestic and global economy in 2023 materialize.
- Disadvantages and risks:
  - Complexity increases and there are knock-on consequences for transparency.
  - Funding amount for FEIP depends on year-end headroom against the debt ceiling and is therefore uncertain and unreliable.
  - The reforms do not address the pro-cyclical bias in the current fiscal framework resulting from both the PSBR and the Balanced Budget Rule (BBR).

### Longer-run comprehensive reform options
- Proposed comprehensive reforms include:
  - Establishment of a debt anchor.
  - Clarification and tightening of definitions and procedures.
  - Expanded expenditure rule coverage.
  - Focus on medium-term sustainability strategies.
- Purpose and sequencing:
  - These reforms would enhance the flexibility of fiscal policy while maintaining and strengthening fiscal responsibility.
  - As these proposals represent a notable departure from the existing framework, a medium-term sustainability strategy (itself a recommendation) could be used to anchor the transition.

### Annex X — Fiscal Framework: Key design features and staff proposals (high-level highlights)
- Expenditure
  - Current: The Structural Current Spending Rule (SCR) requires that the real growth rate of structural current spending does not exceed potential output growth. Structural current spending excludes interest payments, fuel for electricity generation, CFE and PEMEX expenditures, and Federal government investment. It accounts for 36 percent of total public expenditures. Under Article 18 of the FBFRL any proposed increase of expenditures in the budget beyond the permitted growth must be accompanied by a revenue or spending cut initiative to neutralize its effect.
  - Staff proposals: A reformed expenditure rule with greater coverage of public expenditure, including of some capital expenditures; clearer and more transparent rules on the growth of structural expenditures linked to macroeconomic aggregates that are less prone to measurement volatility.
- Deficit
  - Current: The Balanced-Budget Rule (BBR) requires that the budget must be balanced on a cash basis, excluding investments by PEMEX and its subsidiaries. Coverage includes the Federal government, PEMEX and CFE, and IMSS and ISTE, and various trust funds. The rule is broadly procyclical.
  - Staff proposal: Removal of the Balanced-Budget Rule to reduce procyclicality of fiscal policy.
- Debt
  - Current: The Public Sector Borrowing Requirement Rule (PSBR) requires that the budget documentation sets a target for the public sector borrowing requirement for the current year and indicative targets for the medium-term, aiming to ensure borrowing requirements are non-increasing over time. Coverage includes all entities except subnational governments and the central bank. Restrictions on debt issuance by purpose: Article 73 of the Constitution and the FBFRL restrict issuance of debt to productive investment.
  - Staff proposals: Introduction of a debt anchor would enable removal of debt issuance requirements where there is a cap on overall debt at the safe level. Debt issuance could then be used for directly managing shocks, capital spending, and transformational current spending (to be balanced by revenue mobilization over medium-term as per Staff's fiscal policy advice). Specify medium-/longer-term debt targets and support by a 4- or 5-year Sustainability Framework.
- Escape clauses
  - Current: Escape clauses can be enacted based on triggers including:
    - (i) financial cost of debt exceeding more than 25 percent of its level approved in the previous year due to interest increases;
    - (ii) natural disaster costs exceeding more than 2 percent of programmable expenditure in the previous year;
    - (iii) floating debt higher than 2 percent of programmable expenditure in the previous year;
    - (iv) a greater than 2.5 percent reduction in tax revenues compared to the previous year;
    - (v) a reduction of more than 10 percent in the oil price or shocks to oil production; and
    - (vi) a cost higher than 2 percent of previous year programmable expenditure, when it implies implementation of legal changes or fiscal policy measures that will benefit public by increasing costs or reducing revenues in a permanent way.
  - Justification for activation must include reasons, precise size of financing, number of years, and measures expected to return budget equilibrium.
  - Historical use: Escape clauses were used in 2010-12 and 2014-16, meaning that the framework was only respected in 7 out of the 13 years to 2020. The inflexibility of the current framework is deemed to be a key factor.
  - Staff proposals: Reformed escape clauses would simplify and tighten trigger definitions, increase transparency, require a plan to return to fiscal rules, and clarify the role of Congress in activating clauses.

### Annex XI — FSAP Key Recommendations (selected themes and timing)
- Timeframe key: C: continuous, I: immediate (less than one year), NT: short term (1–2 years), MT: medium term (3–5 years).
- Cross-cutting themes (NT/C): Enhance autonomy of regulatory government agencies and legal protection of supervisors; assess and enhance organizational structure and resource needs of individual agencies; enhance oversight of SPEI relative to the PFMI and cybersecurity.
- Systemic risk analysis (NT/MT): Monitor dynamics of contingent credit lines and portfolio concentration; expand liquidity stress test framework and incorporate in Supervisory Review Process to inform Pillar 2 requirements for banks.
- Financial sector oversight (NT/MT): Develop and publish a macroprudential policy strategy (NT); consider expanding macroprudential toolkit with limits on loan-to-value and debt-service-to-income ratios (MT); ensure effective consolidated supervision of financial holding companies (MT); refine the risk-based supervisory methodology (CEFER) (NT); continue developing cybersecurity strategy and improve cyber regulatory and supervisory practices (NT); improve cyber response and recovery capabilities and conduct market-wide cyber crisis simulation exercises (MT); issue supervisory guidance on climate-related risk management and introduce disclosure requirements of climate and ESG information (NT).
- Financial integrity and crisis management (NT/C/MT): Implement remaining 2018 Mutual Evaluation Report recommendations (NT); review liquidity risk mitigation framework for development banks (NT); explore options to enhance the ELA framework (NT); further strengthen mechanisms to ensure credibility and feasibility of banks’ financial contingency arrangements while preserving resolvability (C); introduce statutory bail-in powers and eliminate barriers to effective use of P&A and bridge bank tools (MT); shorten resolution planning cycle for D-SIBs and midsize banks and eliminate impediments to banks’ resolvability (C).

### Annex XII — Recent reforms in tax administration (findings and limits)
- Measures implemented since 2019 include:
  - Abolition of the right to offset excess tax credits against other taxes.
  - Requirement that digital platforms withhold taxes due on transactions in which they acted as intermediary.
  - Implementation of General Anti-Abuse Rules (GAAR) and prohibition of company mergers for tax purposes.
  - Enaction of actions 2, 4 and 12 in the OECD’s BEPS agenda.
- Results and caveats:
  - Since 2019, income and corporate tax and VAT revenues have grown as a share of GDP, with expected increases of 1.0 and 0.6 percent of GDP between 2019 and 2022, respectively.
  - Analysis by authorities suggests a reduction in VAT evasion of around MEX$170 billion between 2018 and 2021.
  - Returns to further revenue gains from administration reforms are expected to moderate over the medium-term because:
    - non-compliant behaviors adapt;
    - the base of erosion and evasion narrows;
    - remaining issues require more complex solutions.
  - New focus on non-compliance at the border may be a tougher challenge due to overlap with security issues and the need for close coordination between the tax administration and the army, which has taken over physical customs inspection functions.

### Annex XIII — Mexico’s pension system: recent reforms and implications
- Main parameter changes from 2019–2022 and implications:
  - Contribution rates:
    - Increase in contribution rates from 6.5–10 percent to 15 percent by 2030.
    - Currently, employees pay 1.125 percent of earnings, the government 0.225 percent (plus a social quota depending on earnings), and the employer 5.15 percent, leading to a range of contribution rates from 6.5 percent for high earners to 10 percent for low earners.
    - Total contributions set to rise to 15 percent by increasing employer contributions to 13.875 percent for high earners, while lower earners will be subsidized by the government. Government contributions will change from 2023, while employer contribution rates rise gradually until reaching final values in 2030.
  - Minimum years of contributions:
    - Until 2020, the minimum years of contributions was close to 25 years.
    - 2021 reforms lowered this to 15 years in 2021 with yearly increases so that a minimum of 20 years is reached by 2031.
    - This affects eligibility timing for those covered by the post-1997 reform system.
  - Minimum pension levels:
    - Before 2021 there was only one minimum pension of almost MEX$40,000 per year.
    - From 2021 the minimum pension can be taken five years early and differs according to average career earnings (indexed to prices) and career length.
    - The lowest minimum pension increased to MEX$45,000 for someone with 20 years of contributions or more.
    - For an average wage earner, the minimum pension more than doubled to MEX$85,000 per year.
  - Caps on fees:
    - From 2022, fees cannot exceed average fees in Chile, Colombia, and the U.S.
- Fiscal and labor-market implications:
  - Near-term pension spending will increase while labor market incentives may be adversely affected.
  - Government spending on pensions increased from 1.4 percent of GDP in 2000 to 4.0 percent of GDP in 2021.
  - Enabling early retirement could reduce labor force participation among older workers.
  - Linking minimum pension to earnings history may reduce incentives to remain in formal employment except for those near earnings or career length thresholds.
  - Increased contribution rate for employers may raise the labor wedge, impacting employment and potentially pushing more workers into the informal sector despite subsidies for low earners.

### Annex XIV — Mexico’s trade with Central America (findings)
- Levels and shares:
  - Mexico’s exports to Central America constitute 1.7 percent of its total exports in 2021.
  - Mexico’s imports from Central America comprise 0.6 percent of total imports in 2021.
  - Central America’s exposure to Mexico in 2021: around 5.8 percent of the region’s total exports go to Mexico and 13.5 percent of imports come from Mexico.
  - Country-specific exposures:
    - Nicaragua, Guatemala and Belize have more than 8 percent of exports going to Mexico.
    - Guatemala, El Salvador and Honduras have import exposure of more than 15 percent of their imports coming from Mexico.
- Policy implications:
  - Important gains could be made by further trade integration through:
    - converging trade rules and regulatory standards;
    - strengthening infrastructure and human capital;
    - reducing non-tariff barriers; and
    - enhancing customs cooperation.
  - Given the match between top products exported by Mexico and those imported by Central America (e.g., machinery and equipment), there is scope for Mexico to increase exports to the region.

*International Monetary Fund — 1mexea2022001 (chapter/section content).*

### 3.      Regional trade integration could be supported through convergence of trade rules and

### 3.      Regional trade integration could be supported through convergence of trade rules and 

### Trade integration and complementary policies
- Regional trade integration could be supported through convergence of trade rules and regulatory standards and trade facilitation measures.
- Complementary policies like strengthening of infrastructure and human capital would—apart from increasing broader growth—help in enhancing trade linkages (IMF 2017).

### Mexico–Central America trade liberalization and nontariff barriers
- The Mexico-Central America free trade agreement resulted in liberalization of tariff lines by Mexico across a range of products from the region, with commitment to further tariff elimination (WTO 2015).
- Compared to Central American countries, Mexico’s overall nontariff trade restrictions is around the middle range.
- Some Central American countries have remained flat at high restriction levels for many years.
- Reducing nontariff trade barriers from both sides would facilitate further integration in the region.

- Annex XIV. Figure 2. Key Products Traded by Mexico and Central America (notes and data)
  - Axis: 0 2 4 6 8 10 12 14 16 18 (Nontariff Barriers)
  - Countries shown: Mexico Costa Rica Belize El Salvador Guatemala Honduras Nicaragua Panama
  - Source: Estefania-Flores et. al (2022): "A Measurement of Aggregate Trade Restrictions and their Economic Effects", IMF Working Paper WP/22/1.
  - Note: This is a measure of how restrictive official government policy is towards the international flow of goods and services, excluding import and exports tariffs. The underlying data is from the IMF Annual Report on Exchange Arrangements and Exchange Restrictions.
  - Interpretation: Lower number reflects fewer restrictions. Fewer restrictions (label in figure).

### Customs cooperation and border facilitation
- Strengthened customs cooperation could go a long way in facilitating Mexico’s trade with this region.
- Mexico could replicate in the Southern border the cooperation programs and mechanisms in place with the U.S. following the 1994 North American Free Trade Agreement ( IMF 2022).
- Potential benefits of replicating U.S. cooperation programs and mechanisms:
  - improve coordination,
  - improve infrastructure in the border areas,
  - capacity development and risk management,
  - reduce bottlenecks.

*Source: IMF staff report informational annex material (selected text from the provided content).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1mexea2022001.pdf_