## 1. Mexico—Adequacy of International Reserves—An Update

## Source details

**Canonical URL:** [1. Mexico—Adequacy of International Reserves—An Update](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04254.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04254.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04254.pdf.json)

---

### Overview
- Political transition to a full-fledged democracy has been smooth; progress made in building a sound institutional framework for policymaking.
- Prudent macroeconomic policies since the 1994–95 crisis, NAFTA, and structural reforms have boosted productivity and export shares; inflation has fallen to low single-digit levels.
- Market sentiment remains positive; domestic financial intermediation has deepened and diversified.
- Growth recent performance: real GDP grew at only 1.4 percent in the four quarters ended in the second quarter of 2003.

### Recent economic developments and macro context
- Growth dynamics and labor:
  - Real GDP growth: 1.4 percent (four quarters ended Q2 2003).
  - After strong performance during 1997–2000, output fell in 2001; growth rebounded in the first half of 2002 but slowed thereafter.
  - Output gap widened to 2¼ percent of GDP.
  - Open unemployment rate: 3½ percent.
- Inflation and wages:
  - Contractual wage increases: 9 percent in 2001; 5¾ percent in 2002; 5¼ percent in the first half of 2003.
  - Headline inflation: 5¾ percent at end-2002; dropped to 4 percent in August 2003.
  - Core inflation: 3¾ percent at end-2002; stabilized at about 3½ percent in mid-2003.
  - Inflation expectations peaked at 4½ percent in early 2003.
- Monetary policy and conditions:
  - The BOM tightened monetary stance starting September 2002; the “corto” increased to a record Mex$700 million by March 2003.
  - Reserve accumulation period shortened from 28 days to one day in April 2003.
  - Short-term market rates: rose to about 10½ percent in early March 2003, then fell below 5 percent in July 2003.
  - Staff’s real monetary conditions index (MCI) shows significant easing from early 2002 through mid-2003.

### External sector and reserves
- Current account and external flows:
  - Current account deficit: narrowed to 2¼ percent of GDP in 2002; declined to 1¼ percent in the first half of 2003.
  - Narrowing driven by higher oil exports and contraction in imports; non-oil export volumes stagnated since 2001.
  - Deficit largely financed by FDI inflows; private external borrowing moderated since mid-2002.
- Exchange rate and competitiveness:
  - About half of the real effective appreciation of nearly 30 percent during 1999–2001 was unwound by early 2003.
  - Peso recovered between March and June 2003 but weakened again in summer as domestic rates fell and competitiveness concerns arose.
- Reserves:
  - Net international reserves (NIR) fell by about US$2 billion from May through end-August 2003 to US$51.5 billion due to mechanism sales and federal government foreign currency needs.
  - Gross international reserves amounted to 137 percent of estimated short-term external debt by residual maturity at end-March 2003.
  - Gross international reserves in percent of short-term debt (by residual maturity): 2002: 126.4; 2003: 143.6; 2004: 162.2 (selected table series).

### Reserve accumulation mechanism (Box 1)
- Rules announced March 20, 2003:
  - In each quarter the Bank of Mexico (BOM) sells an amount equal to 50 percent of the gross foreign reserves accumulated in the previous quarter.
  - The amount announced at the beginning of each quarter; daily sales equal the total divided by the number of working days.
  - Asymmetric: no stipulation that the BOM will purchase dollars if reserves fall.
  - Suspension thresholds: if auction amount < US$125 million, mechanism temporarily suspended; reactivation only after accumulation > US$250 million.
- Operational observations:
  - First auction started May 2: US$32 million sold daily during May 2 to July 31.
  - For August–October quarter, BOM sold US$14 million per day with cumulative sales of US$878 million, compared with US$2.1 billion during May–July.
- Projections and sensitivities:
  - Initial estimates: total sales in 2003 would be US$3–4 billion.
  - To maintain recent ratios of reserves to short-term debt and gross financing requirements, BOM must accumulate about US$2½ billion per year on average (based on current projections).
  - Oil price sensitivity: each US$1 per barrel decline in world oil price reduces annual export receipts by US$750 million.
  - Historical “beta” between reserve changes and oil export receipts: about 0.3.
- Policy implication:
  - The asymmetric, rules-based sales mechanism aims to reduce carry costs while maintaining a transparent schedule of sterilized sales.
  - Reserve accumulation will depend principally on oil export receipts and government financing operations (including PEMEX); careful calibration and monitoring recommended.

### Fiscal sector developments and risks
- Fiscal consolidation:
  - Augmented public sector borrowing requirement excluding nonrecurring revenues: 3.4 percent of GDP in 2002 (below budgeted level but above PRONAFIDE targets).
  - Ratio of gross augmented public debt to GDP: rose to 49½ percent in 2002 from 48 percent in 2001.
  - 2003 budget: augmented deficit planned at 3.4 percent of GDP versus PRONAFIDE objective of just below 3.0 percent.
  - First half 2003: revenues boosted by high oil prices and nonrecurring revenues; income tax revenues shortfall over 0.2 percent of GDP; estimated ISCAS reimbursement cost 0.1–0.3 percent of annual GDP; stronger VAT receipts due to payment modality changes.
- Staff projections and targets:
  - Staff suggested aiming at lowering the augmented deficit to 2½ percent of GDP in 2004.
  - Associated staff estimate: improvement in the cyclically adjusted non-oil primary balance of about 1 percent of GDP.
  - The suggested adjustment would only partially reverse the estimated deterioration in 2002–03 of 1½ percent of GDP.
  - Fiscal impulse conventionally measured would amount to -¾ percent of GDP.
- Tax reform and expenditure pressures:
  - Original 2001 proposal (harmonize VAT at 15 percent) estimated to raise about 1½–2 percent of GDP; new proposals likely less ambitious.
  - Preliminary tax reform elements: modest VAT base extension; state-level VAT coordination; reduce income tax rate while broadening base; administrative improvements.
  - Example expenditure pressure: legislated increase in education outlays from 5½ percent of GDP in 2002 to 8 percent by 2006.
- Fiscal framework and transparency:
  - Authorities use broader augmented measures of deficit and public debt; staff recommended focusing public debate on augmented measures and setting medium-term objectives for augmented deficits and debt.
  - Staff stressed reducing financing vulnerabilities related to gross public debt rather than solely “net worth” approaches.
  - Mission urged addressing 2002 fiscal ROSC recommendations: align institutional coverage with international standards, present budgets in a rolling medium-term framework, and incorporate sub-national government information.

### Financial sector resilience and reforms
- Banking sector:
  - Nonperforming loans fell: commercial banks' nonperforming loans (percent of total loans): 2000: 5.8; 2001: 5.1; 2002: 4.6; 2003: 4.6.
  - Loan-loss provisions increased; steps taken to align framework with Basle Core Principles.
- Private firms and markets:
  - Shift from foreign to domestic capital markets for financing since mid-2002.
  - Direct financing of commercial banks to non-banking private sector: 6.4 percent real annual increase in June 2003.
  - Financial savings increased at a real annual rate of 5.5 percent in H1 2003; private-sector securities issuance real annual increase of 32 percent.
- Financial sector policy priorities:
  - Strengthen oversight of rapidly growing nonbank institutions.
  - Continue steps to deepen financial intermediation without excessive risk-taking; encourage issuance of fixed-rate domestic instruments and extend yield curve.

### Corporate sector vulnerabilities and stress tests (ANNEX IV)
- Market structure and exposure:
  - Share using suppliers’ credit: 63 percent of firms (second quarter of 2003).
  - Average debt-to-equity ratio: around one for sample firms; over 2 for smaller companies.
  - Ratio of foreign currency debt to total debt: 64 percent.
  - Short-term debt ratio: 48 percent of total debt at end-2003Q1 (down from 51 percent a year earlier).
  - Net open foreign exchange position at end-2003Q1: negative US$11 billion (assets US$28.8 billion; liabilities US$39.8 billion).
  - Listed firms' FX debt maturing: US$15.7 billion in 2003; US$9.2 billion in 2004.
- Stress-test findings (sample: 25 listed firms with largest FX exposure):
  - Solvency tests (2 STD shocks to exchange rate and interest rates): no firms insolvent; aggregate TD measures: 0.
  - Solvency tests (8 STD shocks): Number of companies insolvent or illiquid: 10; Aggregate size of TD: -2,042; Gross debt of companies in TD: 9,551; Gross debt of firms in TD (percent of GDP): 1.5.
  - Liquidity tests with rollover constraints:
    - 80 percent rollover: 15.0 companies in TD; Aggregate size of TD: 3,108; Gross debt of firms in TD (percent of GDP): 3.1.
    - 50 percent rollover: 24.0 companies in TD; Aggregate size of TD: 9,072; Gross debt of firms in TD (percent of GDP): 4.8.
  - Interpretation: Combined 2-standard-deviation shocks would not by themselves threaten liquidity and solvency; market access limitations (reduced rollover) could create widespread liquidity problems and raise gross debt of firms in distress to around 3 percent of GDP (80% rollover) or 4.8 percent of GDP (50% rollover).

### External financing, debt management, and vulnerabilities
- Public external debt fell from 15 percent of total debt in 2000 to 13½ percent in 2002.
- Gross financing needs of the public sector estimated at US$78 billion in 2003.
- Three quarters of domestic debt still short-term or linked to short-term interest rates.
- Directors and staff agreed a projected medium-term current account deficit close to 3 percent of GDP was manageable if confidence in policies maintained; about 70 percent of the deficit expected to be financed by FDI.
- Stress scenarios (ANNEX IV):
  - Baseline external debt (percent of GDP) rises modestly through 2003 and then stabilizes (e.g., 2003: 30.2; 2004: 30.2).
  - Scenario of one-time 30 percent nominal depreciation in 2003: external debt jumps to 38.7 in 2003.

### Policy priorities and staff recommendations (Staff appraisal and Executive Board)
- Fiscal policy:
  - Restart fiscal consolidation in 2004; staff recommended aiming for augmented deficit of 2½ percent of GDP in 2004 and set and regularly update medium-term objectives for augmented deficits and debt.
  - Consider a fiscal responsibility law; link annual budgets formally to a medium-term framework; present budgets in rolling medium-term frameworks.
  - Reduce financing vulnerabilities by increasing issuance of fixed-rate, domestic-currency instruments and extending the yield curve.
- Structural reforms to boost growth and reduce poverty:
  - Deep reforms needed in the energy sector; tax system; labor market; and judicial system.
  - Rapid approval and implementation of structural reforms encouraged to boost private investment, employment, and competitiveness.
- Monetary and exchange rate policy:
  - Continue efforts to reduce inflation toward BOM’s longer-term target of 3 percent.
  - Consider shifting from the corto to an interest-rate operating instrument as inflation and interest rates stabilize; maintain transparent inflation-targeting framework.
  - Flexible exchange rate regime deemed effective in cushioning external shocks; reserves considered adequate in that context.
- Financial sector:
  - Continue reforms to modernize and strengthen financial sector, deepen intermediation, and strengthen oversight of nonbank institutions.
  - Address outstanding 2002 fiscal ROSC recommendations and improve transparency and public-sector definitions consistent with GFS.

### Data quality, surveillance, and Article IV timing
- Mexico’s data generally of high quality and adequate for surveillance; authorities encouraged to implement the 2003 statistical ROSC recommendations.
- Proposed next Article IV consultation on standard 12-month cycle.
- Selected historical indicators (Table excerpts):
  - Real GDP (annual % change): 2000: 6.6; 2001: -0.3; 2002: 0.9; 2003: 1.5; 2004: 3.5.
  - Consumer prices (end of year): 2000: 9.0; 2001: 4.4; 2002: 5.7; 2003: 3.8; 2004: 3.0.
  - Augmented balance (percent of GDP): 2000: -3.7; 2001: -3.7; 2002: -3.4; 2003: -3.3; 2004: -2.5.
  - Gross external debt (percent of GDP, end of period): 2000: 28.3; 2001: 26.0; 2002: 26.7; 2003: 29.1; 2004: 29.0.
  - Net international reserves (increase -) (billions of U.S. dollars): 2000: -8.2; 2001: -5.3; 2002: -7.1; 2003: -5.9; 2004: -3.8.
  - Oil export price (US$/bbl): 2000: 24.8; 2001: 18.6; 2002: 21.3; 2003: 23.8; 2004: 20.5.
- Balance of payments projections (selected):
  - Current account (billions of U.S. dollars): 2003: -11.0; 2004: -15.5; 2005 (proj): -18.8; 2006 (proj): -19.6.
  - Exports (billions of U.S. dollars): 2003: 105.8; 2004: 111.6; 2005 (proj): 120.9.
  - Imports (billions of U.S. dollars): 2003: -112.3; 2004: -121.1; 2005 (proj): -133.3.
- Medium-term staff projections (selected):
  - Real GDP (annual % change): 2004: 3.5; 2005: 3.8; 2006: 4.0; 2007: 4.3; 2008: 4.5.
  - Consumer prices (end of year): 2004–2008 (proj): 3.0, 3.0, 3.0, 3.0, 3.0.
  - Augmented balance (percent of GDP) projections: 2003: -3.3; 2004: -2.5; 2005: -2.0; 2006: -1.7; 2007: -1.5; 2008: -1.5.
  - External current account balance (percent of GDP) projections: 2003: -1.8; 2004: -2.4; 2005: -2.8; 2006: -2.8; 2007: -2.7; 2008: -2.8.

### Recent updates (IMF Staff Statement, October 15, 2003 and subsequent notes)
- Government reduced official growth forecast for 2003 from 3 percent to 1.5 percent.
- Labor market: unemployment reached 4 percent in August; formal sector employment fell to lowest since December 1998.
- Exchange rate: peso depreciated by almost 12 percent since peak in May; exchange rate reached about MEX$11.3/US$ following Moody’s PEMEX rating review; real effective exchange rate depreciated by about 8 percent.
- Net international reserves: US$52.1 billion on October 3, compared with peak of US$54.0 billion in early May.
- On October 7, the government issued US$1 billion of 10-year bonds with yield 6.063 percent (spread of 179 basis points over U.S. treasuries).
- CPI for September: 12-month headline inflation stable at 4 percent; core inflation around 3½ percent; inflation expectations for end-2003 declined to 3.7 percent.
- Short-term market interest rates: after being close to 5 percent since spring, rose by almost 100 basis points in recent days due to peso weakness.

*Source: IMF staff report excerpt (Mexico—Adequacy of International Reserves—An Update, including Box 1 and annexes).*

### 1. Mexico—Adequacy of International Reserves—An Update.................................12

### 1. Mexico—Adequacy of International Reserves—An Update

### Overview
- Political transition to a full-fledged democracy has been smooth; progress made in building a sound institutional framework for policymaking.
- Prudent macroeconomic policies since the 1994–95 crisis, NAFTA, and structural reforms have boosted productivity and export shares; inflation has fallen to low single-digit levels.
- Market sentiment remains positive; domestic financial intermediation has deepened and diversified.
- Growth has been disappointing recently: real GDP grew at only 1.4 percent in the four quarters ended in the second quarter of 2003.

### Recent economic developments and macro context
- Growth dynamics:
  - After strong performance during 1997–2000, output fell in 2001; growth rebounded in the first half of 2002 but slowed thereafter.
  - Real GDP growth: 1.4 percent (four quarters ended Q2 2003).
  - Output gap widened to 2¼ percent of GDP.
  - Open unemployment rate: 3½ percent.
- Inflation and labor:
  - Contractual wage increases: 9 percent in 2001; 5¾ percent in 2002; 5¼ percent in the first half of 2003.
  - Headline inflation: 5¾ percent at end-2002; dropped to 4 percent in August 2003.
  - Core inflation: 3¾ percent at end-2002; stabilized at about 3½ percent in mid-2003.
  - Inflation expectations peaked at 4½ percent in early 2003.
- Monetary policy and monetary conditions:
  - The BOM tightened monetary stance starting September 2002; the “corto” (borrowed reserves objective) increased to a record Mex$700 million by March 2003.
  - Reserve accumulation period shortened from 28 days to one day in April 2003.
  - Short-term market rates: rose to about 10½ percent in early March 2003, then fell below 5 percent in July 2003.
  - Staff’s real monetary conditions index (MCI) shows significant easing from early 2002 through mid-2003.

### External sector and reserves
- Current account and external flows:
  - Current account deficit: narrowed to 2¼ percent of GDP in 2002; declined to 1¼ percent in the first half of 2003.
  - Narrowing driven by higher oil exports and contraction in imports; stagnating non-oil export volumes since 2001.
  - Deficit largely financed by FDI inflows; private external borrowing moderated since mid-2002.
- Exchange rate and competitiveness:
  - About half of the real effective appreciation of nearly 30 percent during 1999–2001 was unwound by early 2003.
  - Peso recovered between March and June 2003 but weakened again in summer as domestic rates fell and competitiveness concerns arose.
- Reserve management mechanism (May 2003):
  - Prior approach: buying all net foreign exchange receipts of the federal government and PEMEX and raising NIR by an equivalent amount.
  - New mechanism: selling half of the BOM’s accumulation of reserves in the previous quarter to the market (Box 1 referenced).
  - Impact: From implementation in May through end-August 2003, NIR fell by about US$2 billion to US$51.5 billion due to mechanism sales and federal government foreign currency needs.
  - Gross international reserves amounted to 137 percent of estimated short-term external debt by residual maturity at end-March 2003.

### Fiscal sector developments
- Fiscal consolidation:
  - Progress limited in 2002. Public sector borrowing requirement excluding nonrecurring revenues (“augmented” deficit): 3.4 percent of GDP in 2002—below budgeted level but above PRONAFIDE targets.
  - Ratio of gross augmented public debt to GDP: rose to 49½ percent in 2002 from 48 percent in 2001.
  - 2003 budget: augmented deficit planned at 3.4 percent of GDP versus PRONAFIDE objective of just below 3.0 percent.
  - First half 2003: revenues boosted by high oil prices and nonrecurring revenues; income tax revenues shortfall over 0.2 percent of GDP; estimated ISCAS reimbursement cost 0.1–0.3 percent of annual GDP; stronger VAT receipts due to payment modality changes.
- Structural reform progress:
  - Financial sector reforms advanced; less progress in electricity generation, labor market regulation, and tax reform.
  - Limited congressional support for administration’s 2002 medium-term plan (PRONAFIDE) reforms has dampened private investment.

### Financial sector resilience
- Banking sector:
  - Nonperforming loans have fallen; loan-loss provisions have increased.
  - Steps taken to align framework with Basle Core Principles; system resilience to shocks improved.
- Private firms:
  - Shift from foreign to domestic capital markets for financing since mid-2002.

### Main issues and policy priorities discussed with Fund staff
- Structural reforms:
  - Need for tax reform to reduce reliance on oil revenues and aid fiscal consolidation.
  - Need for energy sector reform to increase capacity in line with growing demand.
  - Measures to raise labor market flexibility.
- Fiscal consolidation:
  - Agreement on need for further consolidation; authorities intended to pursue consolidation in 2004 via a tax reform plan.
  - Staff concern: spending pressures could hinder deficit reduction even if tax reform raises revenues.
  - Staff suggestion: set and regularly update medium-term objectives for broad definitions of deficits and debt to discipline annual budget formation.
- Other policy priorities implicit in text:
  - Continue efforts to reduce inflation toward BOM’s longer-term objective of 3 percent.
  - Crisis-proof the economy through financial modernization and prudent debt management (noted achievements: issuance of bonds with CACs; participation in FSAP).

*Source: IMF staff report excerpt (Mexico—Adequacy of International Reserves—An Update).*

### Box 1. Mexico: Adequacy of International Reserves—An Update

### Box 1. Mexico: Adequacy of International Reserves—An Update

### Reserve adequacy indicators
- At end-2002, Mexico’s reserves were equivalent to 126 percent of short-term debt with a remaining maturity of less than a year, and 100 percent of gross external financing requirements, up from 105 percent and 86 percent respectively at end-2001.
- In terms of foreign currency deposits at banks, reserves reached about 740 percent at end-2002.

### Reserve accumulation mechanism announced by authorities
- On March 20, a new “rules-based” mechanism was announced to reduce reserve accumulation and the “carry costs” of rising reserves.
- Under the mechanism:
  - In each quarter the Bank of Mexico (BOM) sells an amount equal to 50 percent of the gross foreign reserves accumulated in the previous quarter.
  - The amount will be announced at the beginning of each quarter, and daily sales will equal the total divided by the number of working days.
  - The mechanism is asymmetric: there is no stipulation that the BOM will purchase dollars in the foreign exchange market if reserves were to fall.
  - If the amount to be auctioned in any quarter is less than US$125 million, the mechanism would be temporarily suspended. Reactivation will not take place until there is an accumulation of reserves greater than US$250 million.
- Operational detail and observed auctions:
  - The first auction started on May 2, with US$32 million being sold on a daily basis during May 2 to July 31.
  - For the quarter between August and October, the BOM will sell US$14 million per day with cumulative sales of US$878 million, compared with US$2.1 billion during May to July.

### Projected sales, accumulation needs, and sensitivities
- Initial estimates (by market analysts and the BOM) suggested that total sales in 2003 would be US$3–4 billion.
- Given the volatility in oil prices, it is difficult to anticipate the outcome for the remainder of the year.
- Based on current projections for the balance of payments, it is estimated that, to maintain recent ratios of reserves to short-term debt and gross financing requirements, the BOM must accumulate reserves of about US$2½ billion per year on average.
- Projections of actual reserve accumulation are sensitive to assumptions for oil prices and external financing. Assuming these determinants do not deviate markedly from recent levels, reserves would accumulate at a rate that would maintain or raise reserve adequacy ratios.
- Oil price sensitivity and transmission:
  - Given the current level of oil exports, each US$1 per barrel decline in the world oil price reduces annual export receipts by US$750 million.
  - The historical “beta” between reserve changes and oil export receipts is about 0.3.
- The precise impact of oil price movements on reserve accumulation is difficult to judge, as the oil price assumptions underlying initial estimates were not specified.

### Operational and policy implications
- The asymmetric, rules-based sales mechanism aims to reduce the opportunity or “carry cost” of holding international reserves while maintaining a transparent schedule of sterilized sales.
- Reserve accumulation going forward will depend principally on oil export receipts and government financing operations (including PEMEX) in international markets.
- Given sensitivity to oil prices and external financing, maintaining reserve adequacy ratios requires continued monitoring of receipts and careful calibration of the sales mechanism.

*Source: _cr04254 - Box 1. Mexico: Adequacy of International Reserves—An Update*

### 26.      While the authorities remain committed to further fiscal consolidation, they have

### _cr04254 - 26.      While the authorities remain committed to further fiscal consolidation, they have

### Fiscal consolidation: status and risks
- Authorities committed to further fiscal consolidation but had not formulated specific objectives for the 2004 budget.
- Political difficulty expected in building support given the already low level of the traditional definition of the deficit (½ percent of GDP) on which budget discussions focused.
- Uncertainty about how much revenue tax reform could generate in the absence of political consensus on scope and content.
- Staff and authorities concurred on the risk that revenue gains from tax reform could be used to meet expenditure pressures rather than deficit reduction.
- Existing broad debt-to-GDP ratio of about 50 percent noted as a level associated with financing problems in some other emerging-market countries.
- Recent edging up in the broad debt-to-GDP ratio raised the risk of an upward drift that could trigger market concerns.
- Authorities viewed recent upward movement in the ratio as largely temporary (low growth and real exchange rate depreciation) and expected it to fade, anticipating a most likely scenario of a steady decline in the debt-to-GDP ratio with continued strengthening in the debt structure.

### Staff projections and recommended fiscal targets
- Staff advocated adhering to the PRONAFIDE path for the augmented deficit to place the debt-to-GDP ratio on a downward trajectory, but noted this would require more ambitious consolidation measures than recent developments implied.
- Staff suggested aiming at lowering the augmented deficit to 2½ percent of GDP in 2004.
- Associated staff estimate: improvement in the cyclically adjusted non-oil primary balance of about 1 percent of GDP.
- The suggested adjustment would only partially reverse the estimated deterioration in 2002–03 of 1½ percent of GDP.
- As conventionally measured, the fiscal impulse would amount to -¾ percent of GDP, with actual contractionary effect depending on the quality of measures and impact on confidence.
- Within this substantial cyclically adjusted adjustment, some scope could exist to allow automatic stabilizers to operate symmetrically in response to adverse and favorable output developments.

### Tax reform and expenditure pressures
- Original tax reform proposal submitted in 2001 (harmonize VAT at 15 percent) estimated to raise about 1½–2 percent of GDP in additional revenues; new proposals likely less ambitious.
- Preliminary tax reform discussions included: modest extension of VAT eliminating some zero ratings but stopping short of harmonized rate; coordinating introduction of a state-level VAT; reducing income tax rate while broadening the base; administrative improvements to reduce tax avoidance and evasion.
- Example of expenditure pressure: legislation mandating increase in education outlays from 5½ percent of GDP in 2002 to 8 percent by 2006 (implementation may depend partly on availability of revenues).

### Fiscal framework, debt measures, and transparency
- Authorities indicated Mexico’s definition of the augmented balance and public debt was broader than that used by many other countries.
- PIDIREGAS borrowing used to finance public infrastructure investment and thus argued not to reduce public sector net worth; staff noted practical difficulties in implementing a “net worth” approach, including judging productivity of PIDIREGAS spending and accounting for unmeasured liabilities (e.g., unfunded pension liabilities).
- Staff observation: public investment in Mexico did not appear high by international standards; PIDIREGAS borrowing for public investment represented less than half of the difference between traditional and broad deficit measures, remainder largely attributable to servicing costs of debt issued for bank restructuring.
- Staff emphasized importance of reducing financing vulnerabilities related to gross public debt rather than net worth.
- Authorities believed fiscal responsibility principles (proposed earlier) should accompany tax reform to ensure deficits fell; proposed principles required that the traditional definition of the budget be balanced over a four-year period.
- Staff suggested designing any medium-term framework around augmented definitions of the deficit and debt with proper adjustment for oil revenue volatility; allow scope for counter-cyclical policies as credibility became established; set clear objectives for declining ratios of public debt-to-GDP over time.
- Staff emphasized transparency as key and recommended focusing public debate on augmented measures of deficits and debt to inform public opinion.
- Mission stressed addressing recommendations from the 2002 fiscal ROSC: align institutional coverage of government with international standards by excluding commercial public enterprises; present budgets in a rolling medium-term framework with clearly specified fiscal objectives; incorporate timely information on sub-national governments in fiscal accounts.
- Authorities intended to publish a revised public sector definition more in line with the new Government Finance Statistics (GFS) in the near future.

### Monetary policy and exchange rate management
- BOM officials and staff agreed recent easing of monetary conditions appropriate given decline in headline inflation and inflation expectations, lower wage growth, and indicators of economic slack.
- Prospects favorable for bringing end-year inflation within the upper limit of the “variability interval” (with a target centered on 3 percent, and a margin of ±1 percent).
- BOM would not resist further market-induced easing if global economy failed to recover in second half of the year, provided inflation continued to converge to target.
- The corto was left unchanged as inflation expectations continued to decline.
- BOM officials considered the corto very useful as an operating instrument, allowing clear signaling for reducing inflation and permitting relatively large and rapid declines in interest rates in response to observed declines in inflation.
- Staff cautioned that the loose relationship between the levels of the corto and monetary conditions could be problematic for keeping inflation within a narrow target range and could lead to confusing market signals if the corto were moved to offset market-induced changes in monetary conditions.
- Staff argued shifting to an interest rate as an operating instrument would be increasingly desirable as inflation converged to the long-term target, enhancing controllability of inflation and communication; authorities noted potential for large and frequent movements in an interest-rate instrument given exposure to external shocks and market volatility.
- BOM officials agreed further refinements to the inflation-targeting framework should be considered; establishment of a fixed schedule for policy announcements beginning in 2003 improved transparency and market dynamics.
- On the measure of inflation to target, BOM officials acknowledged core inflation could be more appropriate from some perspectives but preferred a broader indicator like the CPI as reference.
- BOM officials noted considerable information already provided in monthly Monetary Policy Implementation Report and Quarterly Inflation Report; technical difficulties exist in producing inflation forecasts.

### Corto, monetary conditions, and volatility (Box 3 key points)
- Since 1995 monetary policy implemented via changes in the “corto” — aggregate quantity of funds banks borrow from the BOM to satisfy zero reserve balance requirement; BOM adjusts peso liquidity through open market operations; borrowing from BOM at penalty interest rate equal to twice the market rate.
- Sustained decline in inflation achieved since 1999 using the corto.
- Staff view: relationship between corto and market interest rates has been inconsistent, raising questions about tightness of control over monetary conditions measured by variables more directly linked to the economy (interest rates and exchange rate).
- Staff calculations suggested interest rates in Mexico have typically been considerably more volatile than in other countries with floating exchange rates, while peso volatility was similar to peers.
- Authorities argued corto allows market interest rates to adjust flexibly to shocks and is a signaling device; objective has been to minimize the cost of disinflation rather than reduce interest rate volatility.
- Real monetary conditions index defined in Box 3 notes: calculated as 75 percent of the change in the real 28-day cetes rate since 1997 plus 25 percent of the change in the log REER index (1994=100), also since 1997.

### Exchange rate and reserves
- Authorities committed to letting the exchange rate be determined by market forces; Mexico’s low level of dollarization in the banking system reduces macroeconomic risk of currency movements.
- Authorities viewed market sentiment toward the peso as increasingly symmetric, allowing the exchange rate to act as a buffer against external shocks without jeopardizing policy credibility.
- Staff endorsed the transparent approach to exchange rate management, noting exchange rate volatility did not appear to unduly complicate policy formation or undermine macroeconomic performance.
- New mechanism for slowing reserve accumulation did not change transparent approach to exchange rate and reserve management.
- Staff and authorities agreed present level of reserves was adequate in terms of coverage of short-term external debt and Mexico’s gross financing needs.
- In near term, assuming world oil prices remained high, further reserve accumulation was likely under the new mechanism.
- Staff noted longer-term path for reserves would depend importantly on level of world oil prices and public-sector external financing, including prospect that some PIDIREGAS projects would be financed domestically; recommended reviewing reserve accumulation mechanism over time to ensure reserves remain adequate relative to external risks.
- Authorities affirmed intention to ensure reserves remained at an appropriate level.

### Financial sector reforms
- Mexican authorities pursued reforms to modernize and strengthen the financial sector.
- 2001 FSSA concluded resilience of the financial system to shocks had increased and systemic problems were not likely.
- Additional measures introduced to reduce BOM’s credit risk and increase liquidity of instruments used for repo operations, in line with international best practice and FSSA recommendations.
- Beneficial effects of financial reforms beginning to be felt in higher credit growth and diversification of financial instruments.

*Source: _cr04254 - 26.      While the authorities remain committed to further fiscal consolidation, they have*

### 39.      The authorities noted that legislation is in progress on a comprehensive

### _cr04254 - 39.      The authorities noted that legislation is in progress on a comprehensive

### Financial sector reform and supervision
- Legislation is in progress on a comprehensive framework for prompt corrective action to resolve problem banks.
  - Key elements would include a clear timeline for early intervention and resolution, improved coordination among supervisory agencies, and strengthened rules to dissolve and liquidate banks.
- Authorities attach high priority to strengthening supervisory oversight of nonbank institutions due to rapid growth in recent years.
  - Authorities noted there are no signs of instability in the nonbank sector but rapid growth warrants closer supervision to avoid inappropriate risk-taking.
- Competition among banks may be insufficiently strong, as indicated by recent increases in fees and charges; authorities plan to address this by increasing transparency of costs rather than direct controls.

### External sector policies and competitiveness
- Concerns about the leveling off of Mexico’s share of U.S. imports since 2001, contrasted with the continuing rise in China’s share.
  - Private sector complaints that the renminbi is undervalued were noted; staff view that with the peso freely floating against the U.S. dollar, overall Mexican competitiveness issues cannot be ascribed to nominal exchange rate rigidities in other countries.
  - It was noted that it is unrealistic to expect the Mexican share of U.S. imports to continue rising at the pace observed since the mid-1990s, as the share of exports in Mexican output was reaching levels similar to other open economies.
  - Restoring robust medium-term growth in real incomes, while maintaining competitiveness, requires advancing the structural reform agenda.
- Authorities are continuing efforts to liberalize trade outside North America, including negotiation of a bilateral agreement with Japan.
  - The U.S.–Central America free trade agreement could affect Mexico’s maquiladora sector somewhat, but authorities believed the impact would be minimal due to Mexico’s more established trade links with North America and prior sectoral contraction.
  - Government is conducting studies on competitiveness issues, including the impact from the phasing out of textile quotas at end-2004.

### Vulnerabilities in public and external financing
- Public external debt developments:
  - Public external debt fell from 15 percent of total debt in 2000 to 13½ percent in 2002.
  - Efforts made to lengthen maturities and switch to fixed-rate instruments.
  - Mexico issued international bonds with CACs under New York law earlier this year, reflecting market confidence in debt-management policies.
- Domestic public debt structure and financing needs:
  - Three quarters of domestic debt is still either short-term or linked to short-term interest rates.
  - Gross financing needs of the public sector are estimated at US$78 billion in 2003.
  - Authorities intend to increase the share of fixed-rate domestic instruments and lengthen average maturity.
- Current account and external financing:
  - Staff and authorities agreed a projected medium-term current account deficit of close to 3 percent of GDP was manageable if confidence in policies is maintained.
  - About 70 percent of the deficit would be financed by FDI, with the remainder financed by public and private sector borrowing (including PIDIREGAS) and portfolio inflows.
  - Mexico’s net external liabilities projected to remain stable at about 40 percent of GDP.
- Gross external financing requirements and risks:
  - Gross external financing requirements for this year are estimated at US$57 billion, equivalent to around 8 percent of GDP.
  - Immediate risks are low: government has met its external financing requirement for the year and market conditions produced strong private sector capital inflows during the first half of the year.
  - However, adverse shifts in market sentiment or weakened assessments of Mexico’s creditworthiness could constrain market access and raise vulnerabilities.
- Corporate sector liquidity risks under stress:
  - Stress tests indicate overall liquidity and solvency would not be significantly affected by a combined adverse shock of two standard deviations to the exchange rate, interest rates, and economic growth.
  - If such shocks were accompanied by market access limitations (only 80 percent rollover of one year’s amortizations), most firms would face liquidity problems.
  - In that scenario, gross debt of firms in liquidity distress would amount to around 3 percent of GDP.

### Other structural and governance issues
- Governance and corruption:
  - Authorities give high priority to improving governance and reducing corruption, which are serious problems in Mexico.
  - Staff noted widespread concerns about governance of public enterprises and suggested improvements such as vertical disintegration of PEMEX to foster competition, establishment of corporate structures that promote greater autonomy, commercial reorientation of operations, and strengthened regulatory oversight.
  - Authorities’ strategy includes: improvements in the regulatory framework; judicial reform; better audits and controls of public sector operations; stricter sanctions on corrupt practices; more transparency in the public sector; better administration of public property.
  - Actions include legislation enabling access to public sector information, mandating financial disclosure by federal civil servants, and more transparent bidding practices in public enterprises. Legislation improving private corporate governance and protecting minority shareholders’ rights has also been enacted.
  - Mexico ranked 63 out of 113 countries in the latest ranking of corruption by Transparency International.
- Poverty and social programs:
  - Based on the 2002 income and expenditure survey and official poverty measures, authorities estimate absolute poverty fell from about 24 percent of the population in 2000 to 20 percent in 2002.
  - The decline was more pronounced in rural than urban areas; in absolute terms, 3.4 million individuals moved out of poverty.
  - Authorities attribute these developments to strengthening social programs, increased remittances, and lower prices of basic staples.
  - Coverage of social programs such as Oportunidades and Procampo was extended significantly (by 70 percent in the case of Oportunidades), while remittances rose from US$6.6 billion in 2000 to US$9.9 billion in 2002.
- Anti-money laundering and transparency:
  - Mexico is party to major international anti-terrorism conventions and has endorsed the IMF/World Bank/FATF methodology for assessing systems to prevent money laundering and terrorist financing.
  - Mexico is party to the OECD convention; a final report on actions is expected to be submitted by June 2004.
  - Recent passage of the Information Act aims to increase transparency.

### Staff appraisal: policy priorities and recommendations
- Macroeconomic and structural assessment:
  - Substantial progress since the 1994–95 crisis has allowed Mexico to weather difficult external conditions since 2001 relatively well.
  - Progress noted in modernizing the financial sector, strengthening the structure of public debt, and bringing inflation down to low levels.
  - The recent economic downturn reflects largely an unfavorable external environment rather than a domestic financial crisis.
- Fiscal policy concerns and recommendations:
  - Progress in structural reforms and fiscal consolidation has slowed due to political difficulties; the process of lowering the public debt-to-GDP ratio has stalled.
  - Staff are concerned fiscal consolidation has faltered: the augmented deficit has remained at around 3½ percent of GDP in recent years, the overall debt-to-GDP ratio has edged up, and revenues have become increasingly reliant on high oil prices.
  - Early actions to restart consolidation in 2004 are critical given medium-term spending pressures in social services, agriculture, infrastructure, and pension reform.
  - Achieve fiscal adjustment through reforms that increase efficiency and boost confidence in medium-term sustainability to minimize negative short-term growth impacts.
  - Annual budget discussions should be formally linked to a medium-term framework and framed in terms of augmented fiscal definitions.
  - A fiscal responsibility law could provide an appropriate framework for observing medium-term targets, including for the overall debt path; design deserves careful consideration.
  - Staff encourage authorities to set and regularly update specific objectives for the augmented deficit and debt to discipline annual budget discussions.
- Structural reforms to boost growth and reduce poverty:
  - Deep and significant structural reforms are needed in the energy sector; tax system; labor market; and the judicial system.
  - Implementing reforms will be politically difficult, but there is increasing recognition of the need for action and the costs of inertia (weak growth, external vulnerabilities, adverse debt dynamics).
- Monetary and exchange rate policy:
  - BOM’s monetary policy stance geared to achieving a decline in inflation to 3 percent in 2003 and beyond; staff share view that headline inflation will converge toward the target by end-2003.
  - Authorities encouraged to shift to interest rate targeting within a more formalized inflation-targeting framework as inflation and interest rates stabilize at low levels.
  - The recent shift to daily reserve accumulation periods could facilitate using a short-term interest rate as an operating instrument.
  - Mexico’s flexible exchange rate regime has been effective in cushioning external shocks; international reserves remain adequate in the context of a flexible exchange rate.
  - Staff agree the new rules-based mechanism for accumulating foreign reserves does not change transparent reserves management or commitment to a market-determined exchange rate; flexible implementation over time is needed to ensure reserves remain adequate.
- Financial sector recommendations:
  - Mexico’s banking system remains sound and well-regulated; steps taken in 2002 toward full compliance with the Basle Core Principles are welcome.
  - Challenge is to deepen financial intermediation without excessive risk-taking and to streamline financial rules to encourage innovation and competition.
  - Staff support authorities’ priority to strengthen oversight of rapidly growing nonbank institutions.
  - Address outstanding issues from the 2002 fiscal ROSC, including publishing a revised public sector definition excluding commercial enterprises from general government coverage, and incorporating medium-term macroeconomic and fiscal projections in economic guidelines underlying annual budgets.
  - Continue reducing public debt vulnerabilities by increasing issuance of fixed-rate, domestic-currency instruments and extending the yield curve.
  - Deepening the domestic bond market via growth of institutional investors should diversify financing sources, lower liquidity and contagion risk, and reduce foreign currency mismatches in firms’ balance sheets.

*Source: _cr04254 - 39. The authorities noted that legislation is in progress on a comprehensive (IMF staff report content provided).*

### 62.      Mexico’s data are generally of high quality, and are adequate to conduct

### _cr04254 - 62.      Mexico’s data are generally of high quality, and are adequate to conduct

### Data quality and surveillance
- Mexico’s data are generally of high quality, and are adequate to conduct surveillance effectively.
- The authorities are encourage[d] to implement the recommendations of the 2003 statistical ROSC.

### Article IV consultation timing
- It is proposed that the next Article IV consultation with Mexico take place on the standard 12-month cycle.

### Key historical macroeconomic indicators (selected from Table 1)
- Real GDP (annual percentage change):
  - 2000: 6.6
  - 2001: -0.3
  - 2002: 0.9
  - 2003: 1.5
  - 2004: 3.5
- Net exports (contribution to growth):
  - 2000: -1.8
  - 2001: -0.7
  - 2002: -0.1
  - 2003: -0.4
  - 2004: 0.3
- Total domestic demand (annual percentage change):
  - 2000: 8.3
  - 2001: 0.4
  - 2002: 1.0
  - 2003: 1.9
  - 2004: 3.1
- Consumer prices (end of year):
  - 2000: 9.0
  - 2001: 4.4
  - 2002: 5.7
  - 2003: 3.8
  - 2004: 3.0
- Augmented balance (PSBR excluding nonrecurring revenues, percent of GDP):
  - 2000: -3.7
  - 2001: -3.7
  - 2002: -3.4
  - 2003: -3.3
  - 2004: -2.5
- Augmented primary balance (percent of GDP):
  - 2000: 1.2
  - 2001: 0.8
  - 2002: 0.5
  - 2003: 0.0
  - 2004: 0.6
- External current account balance (percent of GDP):
  - 2000: -3.1
  - 2001: -2.9
  - 2002: -2.2
  - 2003: -1.8
  - 2004: -2.4
- Gross external debt (percent of GDP, end of period):
  - 2000: 28.3
  - 2001: 26.0
  - 2002: 26.7
  - 2003: 29.1
  - 2004: 29.0
- Change in net international reserves (increase -) (billions of U.S. dollars):
  - 2000: -8.2
  - 2001: -5.3
  - 2002: -7.1
  - 2003: -5.9
  - 2004: -3.8
- Gross official reserves in percent of short-term debt (by residual maturity):
  - 2000: 89.5
  - 2001: 104.8
  - 2002: 126.4
  - 2003: 143.6
  - 2004: 162.2
- Oil export price (US$/bbl):
  - 2000: 24.8
  - 2001: 18.6
  - 2002: 21.3
  - 2003: 23.8
  - 2004: 20.5

### Balance of payments and external sector (selected items, Table 2)
- Current account (billions of U.S. dollars):
  - 2001: -18.1
  - 2002: -13.9
  - 2003: -11.0
  - 2004: -15.5
  - 2005 (proj): -18.8
  - 2006 (proj): -19.6
  - 2007 (proj): -20.2
  - 2008 (proj): -22.1
- Merchandise trade balance, f.o.b. (billions of U.S. dollars):
  - 2001: -10.0
  - 2002: -7.9
  - 2003: -6.5
  - 2004: -9.5
  - 2005 (proj): -12.4
- Exports (billions of U.S. dollars):
  - 2001: 100.8
  - 2002: 101.5
  - 2003: 105.8
  - 2004: 111.6
  - 2005 (proj): 120.9
- Imports (billions of U.S. dollars):
  - 2001: -110.8
  - 2002: -109.4
  - 2003: -112.3
  - 2004: -121.1
  - 2005 (proj): -133.3
- Net international reserves (increase -) (billions of U.S. dollars), projections:
  - 2001: -5.3
  - 2002: -7.1
  - 2003: -5.9
  - 2004: -3.8
  - 2005–2008 (annual projections): -3.8, -3.9, -3.9, -3.9
- Crude oil export volume (millions of bbl/day):
  - 2001: 1.7
  - 2002: 1.7
  - 2003: 1.9
  - 2004: 1.8
  - 2005 (proj): 2.0
  - 2006 (proj): 2.2
  - 2007 (proj): 2.3
  - 2008 (proj): 2.3
- Crude oil price (US$/bbl), historical and projections:
  - 2001: 18.6
  - 2002: 21.3
  - 2003: 23.8
  - 2004: 20.5
  - 2005–2008 (proj): 17.6, 17.2, 17.2, 16.8

### Public finances and fiscal indicators (selected from Table 3)
- Budgetary revenue (percent of GDP):
  - 2001: 21.8
  - 2002: 22.6
  - 2003: 22.4
  - 2003 Prel./2004 Staff Projections: 23.4 (2003 prel.), 22.4 (2004 proj.)
- Budgetary expenditure (percent of GDP):
  - 2001: 22.5
  - 2002: 23.7
  - 2003: 22.9
  - 2004: 23.9
- Traditional balance (percent of GDP):
  - 2001: -0.7
  - 2002: -1.2
  - 2003: -0.5
  - 2004: -0.5
- Augmented balance (PSBR excl. nonrecurring revenue) (percent of GDP) 2001–2004:
  - 2001: -3.7
  - 2002: -3.4
  - 2003: -3.3
  - 2004: -2.5
- Gross public sector debt (percent of GDP):
  - 2001: 48.0
  - 2002: 49.5
  - 2003: 50.0
  - 2004: 51.1
  - 2005 (proj): 50.9

### Financial system indicators (selected from Table 4 and Table 5)
- Bank of Mexico net international reserves (end-period, in billions of U.S. dollars):
  - Dec 1999: 44.9
  - Dec 2000: 46.3
  - Dec 2001: 55.6
  - Dec 2002: 46.6
  - Dec 2003: 50.4 (Table 5 monthly series shows end-period movement through 2003)
- Commercial banks' nonperforming loans (percent of total loans):
  - 2000: 5.8
  - 2001: 5.1
  - 2002: 4.6
  - 2003: 4.6 (Table 5 monthly measures)
- EMBI+ Mexico (basis points; end of period) (selected end-period values from Table 5):
  - 2001 Dec: 308
  - 2002 Dec: 251
  - 2003 Dec: 230

### Medium-term projections (Table 6, staff projections)
- Real GDP (annual percentage change):
  - 2002: 0.9
  - 2003: 1.5
  - 2004: 3.5
  - 2005: 3.8
  - 2006: 4.0
  - 2007: 4.3
  - 2008: 4.5
- Consumer prices (end of year):
  - 2002: 5.7
  - 2003: 3.8
  - 2004: 3.0
  - 2005–2008 (proj): 3.0, 3.0, 3.0, 3.0
- Exports, f.o.b. (annual percentage change):
  - 2002: 0.6
  - 2003: 4.3
  - 2004: 5.5
  - 2005: 8.3
  - 2006: 9.9
  - 2007: 9.4
  - 2008: 8.8
- Imports, f.o.b. (annual percentage change):
  - 2002: -1.3
  - 2003: 2.7
  - 2004: 7.9
  - 2005: 10.0
  - 2006: 9.2
  - 2007: 8.7
  - 2008: 8.8
- Augmented balance (PSBR excl. nonrecurring revenues, percent of GDP) projections:
  - 2003: -3.3
  - 2004: -2.5
  - 2005: -2.0
  - 2006: -1.7
  - 2007: -1.5
  - 2008: -1.5
- Augmented primary balance (percent of GDP) projections:
  - 2003: 0.0
  - 2004: 0.6
  - 2005: 1.3
  - 2006: 1.8
  - 2007: 1.9
  - 2008: 1.7
- External current account balance (percent of GDP) projections:
  - 2003: -1.8
  - 2004: -2.4
  - 2005: -2.8
  - 2006: -2.8
  - 2007: -2.7
  - 2008: -2.8

*Source: IMF staff report excerpt (tables and text as provided).*

### ANNEX                                                                        I

### ANNEX I — MEXICO—FUND RELATIONS (As of May 31, 2003)

### Membership and Quota
- Membership status: Joined December 31, 1945; Article VIII.
- Quota: 2,585.80 SDR Million (100.00 percent).
- Fund holdings of currency: 2,279.35 SDR Million (88.15 percent).
- Reserve position in Fund / Financial transaction plan transfers (net): 306.53 SDR Million (87.00 percent).
- Other (implied): 11.85 SDR Million.

### SDR Department
- Net cumulative allocation: 290.02 SDR Million (100.00 percent).
- Holdings: 289.18 SDR Million (99.71 percent).

### Purchases, Loans, and Arrangements
- Outstanding Purchases and Loans: None.
- Financial Arrangements: None.
- Projected Obligations to the Fund: ≤ SDR 50,000 (annually 2004-2007).

### Exchange Rate and Consultation
- Exchange rate arrangement: Mexico has a floating exchange rate regime since December 22, 1994.
- Mexico maintains an exchange system free of restrictions on payments and transfers for current international transactions.
- Article IV Consultation: Last consultation concluded by the Executive Board on September 23, 2002 (staff report IMF Country Report No.02/237).
- Participation in Financial Sector Assessment Program in 2001; related FSSA discussed in August 2001 and published (IMF Country Report No. 02/192, October 2001).

### Resident Representation
- A resident representative has been stationed in Mexico City since May 1995.

---

### ANNEX II — MEXICO—RELATIONS WITH THE WORLD BANK

### World Bank Strategy and Lending Envelope
- CAS strategic objectives: 1) consolidating the macroeconomic framework; 2) accelerating growth through competitiveness; 3) human capital development; 4) balancing growth and poverty reduction with environmental protection; 5) building an efficient, transparent, and accountable government.
- Three-year (FY2003–05) lending envelope: US$5 billion (half in fast-disbursing operations).
- Lending depends on legal/regulatory conduciveness and political consensus; lacking consensus, lending will be correspondingly lower.

### Recent Lending and Programs (FY1999–2002 and beyond)
- New lending committed during FY1999–2002: US$4.8 billion.
- Education: US$300 million loan supporting the second phase of compensatory education program.
- Taxation: Two loans totaling US$355 million to support corporate and personal income tax reforms and improve tax compliance.
- Financial sector/rural access: US$64.6 million loan to increase access of rural low-income population to financial services.
- Municipal infrastructure/administrative capacity: US$400 million loan to increase efficiency of small-scale social and productive municipal infrastructure investments.

### Portfolio and Exposure (as of July 2002)
- Active projects: 24 with total undisbursed balance of US$3.6 billion.
- Average annual disbursements over past four years: US$1.2 billion.
- Bank exposure to Mexico: US$11 billion, within the single-borrower exposure ceiling of US$13.5 billion.

---

### ANNEX III — STATISTICAL ISSUES

### General Assessment
- Core data: Published on a timely basis and of good quality.
- Timeliness, periodicity, and coverage: Improved considerably since 1995.
- Mexico observes the Special Data Dissemination Standards (SDDS); metadata posted on the DSBB.
- Fiscal data: Preliminary data available with a 45-day lag following each quarter; final data available mid-year of the subsequent year; both published and submitted to congress.

### Balance of Payments and External Debt Statistics
- Some balance of payments statistics conform to the fifth edition of the Balance of Payments Manual, but full transition not yet completed.
- Improvements made in external debt statistics, including compilation of external liabilities of publicly traded companies registered with the Mexican stock exchange (external debt outstanding, annual amortization schedule for the next four years broken down by maturity and type of instrument).
- Projection of total external debt service of commercial banks: still not available.
- International reserves data compiled according to the Operational Guidelines for the Data Template on International Reserves and Foreign Currency Liquidity of the IMF (October 1999).

### Fiscal Reporting
- Since 2001 authorities report a comprehensive fiscal balance measure—the Public Sector Borrowing Requirement—which includes PIDIREGAS and interest cost on previously unrecorded government liabilities.

### Data ROSC
- Data ROSC for Mexico completed on May 23, 2003 and published as IMF Country Report No. 03/150.
- Overall quality: Good; in some cases periodicity and timeliness exceed SDDS requirements.
- Authorities are continuing work on areas needing improvement.

### Core Statistical Indicators (as of August 20, 2003)
- Date of Latest Observation examples: Exchange Rates — August 22; International Reserves — May 30; Central Bank Balance Sheet — March 31; Reserve/Base Money — July 31; Broad Money — June 31; Interest Rates — July 31; Consumer Price Index — July; Exports/Imports — May; Current Account Balance — Fourth quarter 2002; Overall Government Balance — First quarter 2003; GDP/GNP — First quarter 2003; External Debt/Debt Service — March.
- Frequency codes: D-daily, W-weekly, M-monthly, Q-quarterly, Bi-W-bi-weekly.
- Sources and modes: A-direct reporting by central bank/ministry, N-official publication/press release; E-electronic data transfer, C-facsimile.
- Confidentiality: B-for use by staff and Executive Board, C-for unrestricted use.

---

### ANNEX IV — MEXICO—AN UPDATE OF CORPORATE SECTOR VULNERABILITIES

### Market Structure and Financing
- Corporate sector remains highly segmented: bank and bond financing mainly for top-tier companies; small- and medium-sized firms rely mostly on suppliers’ credit.
- Share using suppliers’ credit: 63 percent of firms (second quarter of 2003).
- Main reasons for not using bank credit: high interest rates and economic uncertainty.

### Leverage and Currency Exposure
- Average debt-to-equity ratio: around one for sample firms; over 2 for smaller companies.
- Ratio of foreign currency debt to total debt: 64 percent.
- Hedging through derivatives: Not believed to be significant.
- Short-term debt ratio: 48 percent of total debt at end-2003Q1 (down from 51 percent a year earlier).

### Refinancing, Maturity, and FX Position
- Listed firms in the stock exchange (BMV) foreign exchange debt maturing: US$15.7 billion in 2003; US$9.2 billion in 2004.
- Net open foreign exchange position of corporate sector at end-2003Q1: negative US$11 billion (assets US$28.8 billion; liabilities US$39.8 billion).
- Maturity profile of FX liabilities: 65 percent long-term.
- Concentration: About 10 percent of firms hold 67 percent of total FX liabilities; these firms have more than half their sales abroad and 75 percent of their assets are FX denominated.
- Construction sector: 76 percent of FX liabilities due in the short term.

### Defaults and Sectoral Difficulties
- Companies in default and with financial difficulties over the last year limited to mining, telecommunications, and construction—due mainly to weak global demand, high leverage, and weak commodity prices; difficulties appear not systemic.

### Stress Test Analysis (sample: 25 listed firms with largest FX exposure)
- Solvency tests (two-standard deviation shocks):
  - Exchange rate and interest rate shocks: Number of insolvent/illiquid firms: 0; Aggregate size of Technical Default (TD): 0; Total accounting capital of companies in TD: 0; Gross debt of companies in TD: 0; Gross debt of firms in TD (percent of GDP): 0.
  - Including growth shock: same results (all zeros).
  - Eight-STD shock to exchange rate, interest rates, and growth shocks: Number of companies technically insolvent or illiquid: 10; Aggregate size of TD: -2,042; Total accounting capital of companies in TD: 5,626; Gross debt of companies in TD: 9,551; Gross debt of firms in TD (in percent of GDP): 1.5.
- Liquidity tests:
  - Exchange rate shock (2 STD): 2.0 companies; Aggregate size of TD: 67; Total accounting capital in TD: 1,543; Gross debt in TD: 1,011; Gross debt of firms in TD (percent of GDP): 0.2.
  - Interest rate shock (2 STD): 4.0 companies; Aggregate size of TD: 388; Total accounting capital in TD: 4,249; Gross debt in TD: 2,878; Gross debt of firms in TD (percent of GDP): 0.5.
  - Exchange rate and interest rate shocks (2 STD): 4.0 companies; Aggregate size of TD: 495; Total accounting capital in TD: 4,249; Gross debt in TD: 2,878; Gross debt of firms in TD (percent of GDP): 0.5.
  - As above, including growth shock: 4.0 companies; Aggregate size of TD: 447; Total accounting capital in TD: 4,249; Gross debt in TD: 2,878; Gross debt of firms in TD (percent of GDP): 0.5.
  - As above but rollover of only 80 percent: 15.0 companies; Aggregate size of TD: 3,108; Total accounting capital in TD: 25,946; Gross debt in TD: 19,540; Gross debt of firms in TD (percent of GDP): 3.1.
  - As above but rollover of only 50 percent: 24.0 companies; Aggregate size of TD: 9,072; Total accounting capital in TD: 34,446; Gross debt in TD: 29,535; Gross debt of firms in TD (percent of GDP): 4.8.
- Interpretation: A combined 2-standard-deviation shock to exchange rate, interest rate, and growth would not by itself threaten liquidity and solvency. However, if market access constraints reduce rollover rates (e.g., to 80 percent or 50 percent), liquidity problems could become widespread and gross debt of firms in liquidity distress could reach around 3 percent of GDP (80 percent rollover) or 4.8 percent of GDP (50 percent rollover).

---

### ANNEX IV — EXTERNAL SUSTAINABILITY FRAMEWORK, 2000–08 (Selected Tables and Projections)

### Baseline Scenario: External Debt Metrics (In percent of GDP)
- External debt: 2000: 28.4; 2001: 27.3; 2002: 27.9; 2003: 30.2; 2004: 30.2; 2005: 30.0; 2006: 29.9; 2007: 29.6; 2008: 28.1.
- Change in external debt: 2000: -8.5; 2001: -1.1; 2002: 0.6; 2003: 2.3; 2004: -0.1; 2005: -0.2; 2006: -0.1; 2007: -0.3; 2008: -1.5.
- Identified external debt-creating flows (4+5+6): 2000: -5.1; 2001: -2.3; 2002: -0.3; 2003: 1.2; 2004: -0.4; 2005: -0.2; 2006: -0.3; 2007: -0.4; 2008: -0.4.
- Current account deficit, excluding interest payments: 2000: 0.7; 2001: 0.9; 2002: 0.5; 2003: 0.6; 2004: 0.9; 2005: 0.9; 2006: 0.7; 2007: 0.7; 2008: 0.8.
- Net non-debt creating capital inflows (negative): 2000: -1.8; 2001: -3.2; 2002: -1.8; 2003: -1.6; 2004: -1.7; 2005: -1.7; 2006: -1.7; 2007: -1.7; 2008: -1.7.
- Automatic debt dynamics: 2000: -4.0; 2001: 0.1; 2002: 1.0; 2003: 2.3; 2004: 0.4; 2005: 0.6; 2006: 0.7; 2007: 0.6; 2008: 0.5.
  - Contribution from nominal interest rate: 2000: 2.3; 2001: 2.0; 2002: 1.7; 2003: 1.7; 2004: 1.8; 2005: 2.1; 2006: 2.3; 2007: 2.3; 2008: 2.3.
  - Contribution from real GDP growth: 2000: -2.0; 2001: 0.1; 2002: -0.2; 2003: -0.4; 2004: -1.0; 2005: -1.1; 2006: -1.1; 2007: -1.2; 2008: -1.3.
  - Contribution from price and exchange rate changes: 2000: -4.3; 2001: -2.0; 2002: -0.4; 2003: 1.0; 2004: -0.3; 2005: -0.5; 2006: -0.5; 2007: -0.5; 2008: -0.5.
- Residual, incl. change in gross foreign assets (2-3): 2000: -3.5; 2001: 1.2; 2002: 0.9; 2003: 1.1; 2004: 0.3; 2005: 0.1; 2006: 0.2; 2007: 0.2; 2008: -1.1.

### Key Macroeconomic and External Assumptions
- Real GDP growth (in percent): 2000: 6.6; 2001: -0.5; 2002: 0.9; 2003: 1.5; 2004: 3.5; 2005: 3.8; 2006: 4.0; 2007: 4.3; 2008: 4.5.
- Exchange rate appreciation (US dollar value of local currency, change in percent): 2000: 1.1; 2001: 1.2; 2002: -3.3; 2003: -8.4; 2004: -1.8; 2005: -1.5; 2006: -1.5; 2007: -1.5; 2008: -1.5.
- GDP deflator in US dollars (change in percent): 2000: 13.2; 2001: 7.9; 2002: 1.2; 2003: -4.4; 2004: 0.9; 2005: 1.5; 2006: 1.5; 2007: 1.5; 2008: 1.5.
- Nominal external interest rate (in percent): 2000: 7.6; 2001: 7.7; 2002: 6.3; 2003: 5.8; 2004: 6.0; 2005: 7.4; 2006: 8.0; 2007: 8.0; 2008: 8.2.
- Growth of exports (US dollar terms, in percent): 2000: 21.3; 2001: -4.2; 2002: 0.6; 2003: 3.0; 2004: 5.5; 2005: 7.8; 2006: 9.3; 2007: 9.0; 2008: 8.4.
- Growth of imports (US dollar terms, in percent): 2000: 22.6; 2001: -198.6; 2002: -0.7; 2003: 3.1; 2004: 7.9; 2005: 9.7; 2006: 9.0; 2007: 8.5; 2008: 8.7.

### Stress Tests for External Debt Ratio (Selected Results)
- Scenario 1 (historical average assumptions): External debt (percent of GDP) in 2002–2008 ranges around 27.9–28.3.
- Scenario 2 (nominal interest rate at historical average plus two standard deviations in 2003 and 2004): External debt rises e.g., to 31.1–32.0 in near years.
- Scenario 3 (real GDP growth at historical average minus two standard deviations in 2003 and 2004): External debt rises further, e.g., to 31.5–33.5.
- Scenario 4 (US dollar GDP deflator at historical average minus two standard deviations in 2003 and 2004): external debt increases (e.g., 30.4–32.3).
- Scenario 5 (non-interest current account at historical average minus two standard deviations in 2003 and 2004): external debt increases (e.g., 30.8–31.1).
- Scenario 6 (combination of shocks using one standard deviation): external debt increases (e.g., 30.1–31.7).
- Scenario 7 (one-time 30 percent nominal depreciation in 2003): external debt jumps to 38.7 (2003) and remains around 38.7–38.8 in subsequent years shown.

---

### IMF STAFF UPDATE — Statement by the IMF Staff Representative (October 15, 2003)

### New Information Since Staff Report
- Government reduced its official growth forecast for 2003 from 3 percent to 1.5 percent (aligning with the latest WEO projection).
- Recent indicators: Global indicator of economic activity 12-month change fell to 0.9 percent in July from 1.2 percent in June.
- Consumer confidence: Continued to decline in August and September; business confidence improved somewhat.
- Labor market: Unemployment reached a new peak of 4 percent in August; formal sector employment fell to its lowest level since December 1998.

### Exchange Rate Developments
- The peso depreciated sharply since July, reflecting weak activity and concerns about structural reforms.
- Exchange rate reached about MEX$11.3/US$ in recent days following Moody’s announcement that PEMEX’s debt rating is being reviewed for possible downgrading.
- Since the peak in May, the peso depreciated by almost 12 percent against the U.S. dollar.
- Real effective exchange rate depreciated by about 8 percent.

*Source: _cr04254 - ANNEX*

### 3. CPI data for September indicate that the 12-month change in headline inflation

### _cr04254 - 3. CPI data for September indicate that the 12-month change in headline inflation

### Inflation and monetary conditions
- 12-month change in headline inflation was stable at 4 percent.
- Core inflation remained subdued at around 3½ percent.
- Inflation expectations for end-2003 declined to 3.7 percent in September, suggesting the recent fall in the peso has not jeopardized prospects for reducing inflation to below 4 percent by end-year (the upper limit of the central bank’s “variability interval”).
- With monetary conditions having eased further as a result of peso depreciation, the Bank of Mexico (BOM) left the corto unchanged at its meeting last week, citing favorable prospects for inflation to decline within the target range by end-year.
- Short-term market interest rates: after remaining close to 5 percent since the spring, they have risen by almost 100 basis points in recent days in response to the weakness in the peso.

### External sector and financing
- Trade data for August showed a smaller-than-expected deficit.
- Imports declined by 3.4 percent from the year-ago level.
- Exports declined marginally; higher oil exports partially compensated for a 5 percent decline in manufacturing exports.
- Net international reserves stood at US$52.1 billion on October 3, compared with the peak of US$54.0 billion in early May.
- On October 7, the government issued US$1 billion of 10-year bonds to pre-fund 2004 financing requirements.
  - The bond was issued with a yield of 6.063 percent, implying a spread of 179 basis points over U.S. treasuries.

### Fiscal performance and outlook
- Fiscal data through end-August suggest that the objectives for the traditional and augmented deficits for 2003 are likely to be met.
- Public finances continue to be boosted by higher-than-projected oil revenues.
  - Through end-September, the price of the Mexican mix has, on average, been about US$6 above the budget assumption of US$18.35 per bond.
  - The exchange rate has been significantly more depreciated than anticipated.
- Offsetting factors:
  - Spending has exceeded budget estimates.
  - Income tax receipts remain weak.

### Structural reforms and budget timetable
- Political negotiations on structural reforms continue without any major breakthroughs.
- A working group, chaired by Secretary of Finance Gil Díaz, has been deliberating on tax reform.
  - A proposal has been advanced to reduce the VAT rate from 15 percent to 10 percent, while broadening the base.
  - The states would also introduce a common 2 percent VAT.
- The administration has presented a draft bill to opposition legislators to increase the scope for private-sector involvement in electricity generation.
- The 2004 draft budget will be submitted to congress by mid-November.
- The Secretary of Finance has indicated an objective for the narrow definition of the deficit of

*Source: _cr04254 - 3. CPI data for September indicate that the 12-month change in headline inflation*

### 0.3 percent of GDP, broadly in line with the 2002 medium-term framework (PRONAFIDE).

### _cr04254 - 0.3 percent of GDP, broadly in line with the 2002 medium-term framework (PRONAFIDE).

### Background and recent performance
- Article IV consultation concluded October 15, 2003.
- After strong performance from 1997 to 2000, output fell in 2001; growth rebounded in H1 2002 but stalled thereafter.
- Real GDP growth in the four quarters ending in Q2 2003: 1.4 percent (seasonally adjusted).
- Headline inflation: 5.7 percent at end-2002; dropped to 4 percent in August and September 2003.
- Core inflation: 3.5 percent in April 2003, then stabilized around that level through September 2003.
- Private external borrowing declined in H1 2003 as firms switched from foreign to domestic capital markets.

### External sector and international reserves
- Current account deficit narrowed since 2001; almost entirely financed by FDI inflows.
- Net international reserves increased by US$9.3 billion during 2002 and Q1 2003, largely due to high oil prices on PEMEX receipts.
- New mechanism implemented in May 2003 to slow reserve accumulation and lower carrying costs.
- Gross international reserves amounted to 106 percent of short-term debt by residual maturity at end-September 2003.

### Fiscal stance, PRONAFIDE, and public debt
- Pace of fiscal consolidation (broad public sector deficit) slower than envisaged in 2002 medium-term plan.
- Budget target for 2003: augmented deficit of 3.4 percent of GDP is likely to be met, with higher oil revenues offsetting shortfalls in other revenues.
- Expenditures are expected to exceed budget estimates.
- For the 2004 budget, authorities announced a fiscal deficit objective of 0.3 percent of GDP, consistent with PRONAFIDE.
- Public external debt fell from 15 percent of total debt in 2000 to 13½ percent in 2002.
- Net public sector debt figures: 50.0, 46.6, 42.2, 42.0, 43.5 (years as in table sequence).
- Augmented overall balance (percent of GDP): -6.3, -6.3, -3.7, -3.7, -3.4 (years as in table sequence).
- Traditional overall balance (percent of GDP): -1.2, -1.1, -1.1, -0.7, -1.2 (years as in table sequence).
- Authorities shifted domestic securities issuance towards fixed-rate instruments; average maturity of domestic public debt increased from 816 days at end-2002 to 914 days at end-June 2003 (and was 542 days in December 2000).

### Debt management and market access
- Government issued five bonds with collective action clauses in 2003; latest issue US$1 billion of 10-year bonds to pre-fund part of 2004 financing.
- Mexico redeemed all Brady bonds.
- Directors endorsed increased issuance of fixed-rate, domestic-currency instruments and extension of the yield curve to reduce vulnerabilities.

### Monetary policy and exchange rate
- Bank of Mexico tightened monetary stance starting September 2002 in response to rising inflation expectations.
- Short-term interest rates: rose to about 10 percent in early March 2003, fell below 5 percent in July 2003, then increased in recent weeks due to peso weakness.
- Recent peso depreciation implies monetary conditions have eased further, supporting activity.
- Directors and authorities expect end-2003 headline inflation to be below 4 percent given declining inflation expectations and slack.
- Banco de Mexico operational instrument ("corto") allows large and rapid interest-rate adjustments and has contributed to inflation reduction; discussion on possible shift to short-term interest rate target as inflation stabilizes.
- Since January 2003 the Board of Governors announces monetary policy decisions on predetermined dates.
- CPI chosen as the reference index for the inflation target; core inflation remains an essential input for policy.

### Financial sector and structural reforms
- Progress in financial sector reforms: 25 reforms and amendments enacted (17 in 2001, 7 in 2002, 1 in 2003).
- Direct financing of commercial banks to non-banking private sector: 6.4 percent real annual increase in June 2003 (seventh straight month of positive gains).
- Financial savings increased at a real annual rate of 5.5 percent in H1 2003; private-sector securities issuance recorded a real annual increase of 32 percent in the same period.
- Legal reform (May) created Fideicomiso de Garantía to reduce transaction costs in collateral recovery.
- Authorities prioritized strengthening oversight of rapidly growing nonbank institutions and combating money laundering and terrorism financing.

### Vulnerabilities and risk assessment
- Directors and staff view Mexico’s vulnerabilities as moderate, mainly deriving from public finances and sensitivity to oil price swings.
- Projected medium-term current account deficit considered manageable and largely financed by FDI flows.
- Staff notes some public debt vulnerabilities due to a large portion of domestic debt being short-term or linked to short-term rates and significant gross financing needs.
- Authorities dispute cross-country comparisons of debt-to-GDP ratios, arguing differences in macro policy and debt maturity structures matter; staff finds Mexico’s debt robust to a variety of temporary shocks.

### Executive Board assessment and policy recommendations
- Directors commended strengthened policies, modernization of the financial sector, strengthened public debt structure, reduced inflation, and progress in poverty reduction.
- Key challenges: diversify sources of growth and strengthen medium-term growth sufficiently to reduce poverty further.
- Urged authorities to restart fiscal consolidation in 2004 and reinvigorate productivity-enhancing structural reforms (tax system, energy sector, labor market, judicial system).
- Recommended rapid approval and implementation of structural reforms to boost private investment, employment, and competitiveness.
- Suggested building public awareness of reform importance to achieve appropriate scope and speed.
- Supported efforts to improve governance, fight corruption, and enhance transparency.
- Recommended formal linkage of annual budget discussions to a medium-term plan and consideration of a fiscal responsibility law; suggested authorities set and regularly update medium-term objectives for the augmented deficit and debt.

### Selected economic and financial indicators (extracts from table)
- Real GDP: 5.0, 3.6, 6.6, -0.3, 0.9 (annual percentage changes; sequence corresponds to years shown).
- Real GDP per capita: 4.0, 2.6, 4.8, -1.8, -0.6.
- Gross domestic investment (percent of GDP): 24.3, 23.5, 23.8, 20.9, 20.3.
- Gross national savings (percent of GDP): 20.5, 20.5, 20.6, 18.0, 18.1.
- CPI (end of period): 18.6, 12.3, 9.0, 4.4, 5.7.
- Exports, f.o.b. (annual % change): 1.1, 14.8, 21.8, -3.7, 0.6.
- Imports, f.o.b. (annual % change): 12.7, 10.6, 23.1, -1.7, -1.3.
- External current account balance (percent of GDP): -3.8, -2.9, -3.1, -2.9, -2.2.
- Change in net international reserves (end of period, in billions of U.S. dollars): 2.1, 0.6, 2.8, 7.3, 7.1.
- Outstanding external debt (percent of GDP): 39.4, 36.9, 28.3, 26.0, 26.7.
- Total debt service ratio (percent of exports): 47.9, 43.8, 42.5, 39.1, 32.7.
- Monetary base (annual % change): 20.8, 43.5, 10.7, 8.0, 17.0.
- Broad money (M4) (annual % change): 26.8, 19.4, 15.8, 16.2, 10.8.
- Treasury bill rate (28-day cetes, percent, annual average): 24.8, 21.4, 15.2, 11.3, 7.1.

*Public Information Notice (PIN) No. 03/130 — October 30, 2003 (Corrected: November 6, 2003).*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04254.pdf_