## _cr04419

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### Overview and key issues
- Broad-based recovery after three years of weak activity; private and official growth estimates for 2004 rose to around 4 percent by mid-year.
- Recovery driven by U.S. recovery and upturn in U.S. manufacturing beginning H2 2003; Mexican manufactured exports grew by 10½ percent in the first seven months of 2004 over the same period in 2003.
- Final domestic demand accelerated to 4 percent in the first half of 2004 over the same period in 2003.
- Public debt rose to around 51 percent of GDP in 2003 compared with 47¾ percent in 2001.
- Headline inflation rose above the Bank of Mexico’s (BOM) 2–4 percent variability interval; core inflation stabilized around 3½ percent.
- Main Fund advice emphasized: consolidate fiscal position and save a significant portion of future oil windfalls; lower inflation to the medium-term target; advance structural and financial reforms; crisis-proof the economy.
- Political fragmentation since July 2003 congressional elections constrained major legislative initiatives before 2006.

### Recent economic developments and key indicators
- Output and demand:
  - Real GDP growth: 1.3 percent in 2003; growth accelerated to 3.8 percent in the first half of 2004 over the previous year.
  - Staff estimate: output gap narrowed to slightly below 2 percent of GDP.
  - Formal private sector employment increased by 185,000 in the first half of 2004; seasonally adjusted unemployment rate 3.7 percent in July after peaking at 3.9 percent in February.
- GDP component highlights (selected table entries preserved):
  - Final domestic demand growth in Q1–Q2 2004: 4.5.
  - Private consumption entries include 5.4 and 4.2 in specified quarterly entries.
  - Private fixed investment table entries include -5.9, -4.0, -5.7, 5.0, -2.1, -8.1, -4.4, -8.6, 4.0, 6.8.
- External sector:
  - Mexican manufactured exports growth: 10½ percent in first seven months of 2004 over same period in 2003.
  - Current account deficit: 1½ percent of GDP in 2003.
- Monetary and financial markets:
  - Headline CPI: just under 4 percent at end-2003 (12-month); rose to 4.8 percent in August (12-month); 5.1 percent in September (12-month).
  - Core inflation: 3.7 percent (August); 3.8 percent (September).
  - Inflation expectations (next 12 months): 4.1 percent (August); 4.6 percent (September).
  - Contractual wage settlements: averaged 4.5 percent in first eight months of 2004; 4.8 percent in September.
  - Bank of Mexico tightened policy five (and later six/seven) times since beginning of 2004 via increases in the corto; overnight inter-bank (fondeo) rose from just over 5 percent in second half of 2003 to slightly over 7 percent by mid-September 2004 and to slightly over 8 percent in some summaries.
  - 10-year government bond yield rose from about 8½ percent in January to just over 10½ percent in September 2004.
  - Peso movements: depreciated by 7½ percent against the U.S. dollar through 2003, and a further 3 percent through mid-September 2004; other entries show depreciation by 2 percent through end-September and period appreciations of about 2½ percent since early September in later updates.
  - Real effective exchange rate depreciated by 13 percent through 2003, and a further 1 percent in first seven months of 2004; elsewhere cited as about 25 percent from peak in 2001 to date.

### Fiscal performance, oil revenues, and public debt
- 2003 fiscal outcomes:
  - Augmented deficit fell slightly to 3 percent of GDP from 3¼ percent in 2002.
  - Traditional deficit at ½ percent of GDP, broadly in line with the 2003 budget target.
  - Non-oil augmented deficit: 9½ percent of GDP in 2003 vs. 8 percent in 2002.
  - A small contribution of 0.1 percent of GDP made to the Oil Stabilization Fund (OSF) in 2003.
- 2004 year-to-date (first seven months):
  - Total revenue growth: 9 percent over same period in 2003.
  - Overall spending growth: 7 percent.
  - Programmable current spending rose by 7 percent (budget assumed no nominal increase for year).
- Public debt and debt management:
  - Ratio of gross augmented public debt to GDP rose by 1¼ percentage point in 2003 to reach 51 percent, largely due to peso depreciation.
  - Net international reserves: US$58.2 billion at end-July 2004 from US$48 billion at end-2002; gross reserves at end-August estimated at 170 percent of short-term external debt by residual maturity.
  - Liability management: exchange of global bonds in early 2004; domestic debt strategy focused on extending maturities and improving liquidity.

### Saving oil windfalls — staff recommendations and authorities’ stance
- Staff recommended:
  - Incorporate an objective oil price assumption in the budget (for instance, based on futures markets).
  - Earmark at least one half of the difference between revenues from this price and an assumed long-term price for saving (preferably via a lower traditional deficit), with deviations subject to same savings rule (transfers to/from OSF).
- Table (Text Table 3) entries — Mexico: Saving of Windfall Oil Revenues (as presented):
  - Oil price versus budget (US$/barrel): 0.6, 3.6, 6.4, 11.4, n/a, 9.2.
  - Windfall oil revenues (in percent of GDP) 1/: -0.4, 0.2, 1.0, 1.9, 2.7, 1.6.
  - Savings (in percent of GDP): 0.0, -0.1, 0.1, 0.1, 0.1, 0.7.
    - OSF: 0.0, -0.1, 0.1, 0.1, 0.1, 0.1.
    - Traditional balance: 0.0, 0.0, 0.0, 0.0, 0.0, 0.1.
    - Trust funds (PEMEX and infrastructure): ........., 0.0, 0.0, 0.5.
  - Footnote 1/: On a gross basis. The net revenue impact would be partially offset by higher fuel prices for public enterprises and higher prices for imported gasoline.
- Authorities’ view:
  - Agreed on need to save windfalls but noted political difficulty resisting spending pressures; optimistic tax/pension reforms and fiscal responsibility legislation could be feasible.

### Medium-term growth projections and scenarios (2005–09)
- Staff baseline projection revised down to an annual average slightly over 3 percent absent significant reforms.
- Three scenarios for 2005–09:
  - Low scenario: Real GDP growth 2.1 percent; Potential output growth 1.8 percent; Trend TFP growth -0.5.
  - Baseline scenario: Real GDP growth 3.2 percent; Potential output growth 2.9 percent; Trend TFP growth 0.3.
  - High scenario: Real GDP growth 4.5 percent; Potential output growth 4.2 percent; Trend TFP growth 1.2.
- Text Table 2 (Baseline Medium-Term Projection, selected rows):
  - Real GDP (annual percentage change): 2004 4.0; 2005 3.2; 2006 3.3; 2007 3.2; 2008 3.1; 2009 3.1.
  - Consumer prices (end-year): 2004 4.3; 2005 3.8; 2006 3.0; 2007 3.0; 2008 3.0; 2009 3.0.
  - Gross domestic investment (percent of GDP): 2004 21.8; 2005 21.2; 2006 20.9; 2007 21.0; 2008 20.8; 2009 20.7.
  - Gross national saving (percent of GDP): 2004 20.7; 2005 19.9; 2006 19.4; 2007 19.4; 2008 19.0; 2009 18.8.
  - Augmented balance (PSBR excl. nonrecurring revenues, percent of GDP): 2004 -3.1; 2005 -2.6; 2006 -2.3; 2007 -2.1; 2008 -2.0; 2009 -2.0.
  - Augmented primary balance (percent of GDP): 2004 0.3; 2005 1.0; 2006 1.2; 2007 1.1; 2008 1.1; 2009 1.1.
  - Current account balance (percent of GDP): 2004 -1.1; 2005 -1.3; 2006 -1.5; 2007 -1.6; 2008 -1.8; 2009 -1.9.

### Debt sustainability, scenarios, and vulnerabilities
- Public sector gross debt key indicators (selected):
  - Gross public sector debt (percent of GDP): average 51.4; 2001 49.7; 2002 51.0; 2003 49.3; 2004p 48.7; 2005p 47.5; 2006p 46.7; 2007p 45.6; 2008p 44.7; 2004–09 average 47.1.
  - Of which foreign currency denominated (percent of GDP): series include 22.8, 24.8, 21.5, 17.5, 15.3, 16.9, 17.9, 17.2, 17.1, 17.0, 16.9, 16.8, 16.5, 16.9.
- Bound tests and scenarios:
  - No policy change: public debt projected to stay around current level.
  - Oil price shock to US$20 per barrel: public debt projected to stay around current level.
  - Combined shock (lower oil price + higher interest rates + no fiscal adjustment): debt ratio could rise close to 60 percent of GDP by 2009 in pessimistic scenario.
  - Staff view: one-off shocks alone would not put debt ratio on an unsustainable path, but slower growth and exchange rate depreciation could increase public debt by about 4 percentage points of GDP within two years.
- External financing and vulnerability indicators:
  - Gross external financing requirements for 2004 estimated at US$48 billion (~7 percent of GDP) in one summary and US$48.1 billion in tables.
  - Net international reserves: 2002 US$48.0 billion; 2003 US$57.4 billion; 2004 projected US$62.4 billion.
  - Gross official reserves in percent of short-term debt (by residual maturity): 2003 163.9; 2004 156.8; 2005 proj. 155.5.
  - EMBI+ spread spiked to 250 basis points in mid-May 2004, then fell below 200 basis points by end-August; later series show EMBI+ Mexico end-period: 237 (Mar 2004), 212 (Jun 2004), 199 (Sep 2004).
  - Public sector gross financing needs close to 12 percent of GDP in 2004; gross total external debt (percent of GDP) around mid-20s.

### Financial sector, supervision, and market developments
- Financial system resilience increased; systemic problems unlikely.
- Banking indicators: sound profitability, loan provisions, and capital adequacy.
- Shift in intermediation: bank intermediation share falling; consumer credit up while business lending stagnated.
- Sofoles: accounted for 4 percent of total financial assets (about 2½ percent of GDP) in March 2004; mortgage lending 65 percent of sofole total assets; automobile credit 26 percent.
- Supervisory reforms: prompt corrective action system implemented; resolution mechanism for failed banks not yet concluded.
- Staff recommendations:
  - Strengthen supervision, including a framework for bank resolution.
  - Strengthen oversight of nonbank institutions and review development banks’ roles.
  - Continue deepening domestic bond market: increase issuance of fixed-rate domestic-currency instruments and extend the domestic yield curve.

### Structural reform agenda — objectives, status, and priorities
- Energy sector:
  - Objective: increase efficiency of public producers and allow broader private participation; constitutional barriers remain.
  - Status: PEMEX introduced multiple service contracts in 2002; limited private investment allowed in electricity generation; no oil sector constitutional change expected.
- Labor market:
  - Objective: increase productivity and employment in formal sector by reducing rigidities.
  - Status: Reform submitted in 2002 but did not address major rigidities (high nonwage and dismissal costs); authorities still envisage further reforms.
- Telecommunications:
  - Objective: increase coverage and quality, lower costs, promote competition.
  - Market structure: Telmex controls 96 percent of fixed-line network; Telcel controls 80 percent of mobile market.
  - Status: Regulatory-strengthening bills in congress; WTO March 2004 ruling found Telmex’s sole authority to set domestic connection charges breached WTO obligations.
- Financial market reform:
  - Status: Congress passed measures on credit guarantees, bank supervision, and payments system; closure and sale of government banks reduced participation; foreign ownership increased; oversight strengthened.
- Judicial and governance reforms:
  - Law enabling public access to government information approved April 2002; corporate governance and minority shareholder protection legislation enacted; 2003 legislation protecting creditor rights approved.
- Policy priority: advance feasible reforms (tax, pension, fiscal responsibility, telecommunications) to boost medium-term growth and competitiveness.

### Policy recommendations and priorities going forward
- Fiscal:
  - Consolidate fiscal gains; lower augmented deficit and public debt vulnerabilities.
  - Save a significant portion of future oil windfalls (staff recommends earmarking at least one half of excess).
  - Raise non-oil revenues via tax reform; implement pension reform to avoid rising pension costs post-2008.
  - Strengthen fiscal responsibility mechanisms focusing on augmented measures.
- Monetary and exchange rate:
  - Maintain BOM credibility in reducing inflation to 3 percent while supporting recovery.
  - Appropriate tightening bias until inflation expectations clearly decline; consider moving to an interest rate instrument when warranted.
  - Improve monetary policy communication; consider publication of an official inflation forecast over time.
  - Maintain market-determined exchange rate and transparent rules-based reserve accumulation mechanism (reserve sales spread increased to 12 months in March 2004 from 3 months).
- Financial sector and crisis-proofing:
  - Strengthen supervision and bank-resolution framework.
  - Deepen domestic markets and lengthen yield curve; increase fixed-rate domestic-currency instruments.
  - Strengthen oversight of nonbank intermediaries and review development banks.
- Structural reforms:
  - Seek politically feasible executive and regulatory actions to advance telecommunications and other reforms; entrench legal certainty for existing energy contracts.

### Selected exact numerical points (preserved from source)
- Real GDP growth: 2003 1.3 percent; Q1–Q2 2004 3.8 percent (first half).
- Manufactured exports growth: 10½ percent (first seven months of 2004 vs. same period in 2003).
- Public debt: around 51 percent of GDP in 2003; 47¾ percent in 2001.
- Augmented deficit: 2003 3 percent of GDP (fell slightly from 3¼ percent in 2002).
- Traditional deficit: ½ percent of GDP in 2003; budget target 0.3 percent of GDP for 2004; draft 2005 traditional deficit 0.1 percent of GDP.
- Non-oil augmented deficit: 2003 9½ percent of GDP; 2002 8 percent.
- OSF contribution: 0.1 percent of GDP in 2003.
- Net international reserves: US$58.2 billion at end-July 2004 (US$48 billion at end-2002).
- Reserve auctioning: pre-announced sales equal to 50 percent of net reserve accumulation in previous 3-month period; sales spread over following 12 months (changed March 2004).
- Headline CPI: just under 4 percent end-2003; 4.8 percent in August 2004; 5.1 percent in September 2004.
- Core inflation: 3.7 percent (August); 3.8 percent (September).
- Inflation expectations (12-month): 4.1 percent (August); 4.6 percent (September).
- Contractual wage settlements: averaged 4.5 percent (first eight months of 2004); 4.8 percent (September).
- Overnight inter-bank (fondeo) rate: rose from just over 5 percent in second half 2003 to slightly over 7 percent by mid-September 2004; other entries note increases up to slightly over 8 percent.
- 10-year government bond yield: about 8½ percent in January 2004 to just over 10½ percent in September 2004.
- Peso depreciation: 7½ percent through 2003 and a further 3 percent through mid-September 2004; alternative entries show depreciation by 2 percent through end-September and subsequent partial appreciation.
- Staff 2004 growth revision: 4 percent (from 3½ percent in April WEO).
- Staff inflation end-2004 projection: 4.3 percent (12-month basis).
- Baseline medium-term Real GDP projections (selected): 2004 4.0; 2005 3.2; 2006 3.3; 2007 3.2; 2008 3.1; 2009 3.1.
- Baseline medium-term Consumer prices (end-year): 2004 4.3; 2005 3.8; 2006–2009 3.0 each year.
- Public sector gross debt (selected): 2003 49.3 percent of GDP; 2004p 48.7; 2005p 47.5; 2006p 46.7; 2007p 45.6; 2008p 44.7.
- Gross external financing requirements (2004): US$48.1 billion (one table) / US$48 billion (text summary).
- Bond issuance (Sept 22): government issued US$1 billion 30-year bonds (increased to US$1.5 billion due to demand); yield 6.9 percent; implied spread 210 basis points.

*Source: IMF staff report: “Mexico—The Administration’s Structural Reform Agenda, 2002–06,” IMF consultation chapter (excerpts provided).*

### 1. Mexico—The Administration’s Structural Reform Agenda, 2002–06 ........................ 6

### Mexico—The Administration’s Structural Reform Agenda, 2002–06

### Overview and key issues
- Broad-based economic recovery after three years of weak activity; private and official growth estimates for 2004 rose to around 4 percent by mid-year.
- Recovery driven by U.S. economic recovery and a strong upturn in U.S. manufacturing beginning in the second half of 2003; Mexican manufactured exports grew by 10½ percent in the first seven months of 2004 over the same period in 2003.
- Final domestic demand accelerated to 4 percent in the first half of 2004 over the same period in 2003; private consumption and residential construction expanded; business fixed investment recovered after a 15 percent decline from the peak in 2000 through 2003.
- Fiscal position:
  - Government met objectives for the traditional deficit despite spending pressures.
  - Spending of recent “windfall” oil revenues has increased fiscal vulnerability to a decline in oil prices.
  - Public debt rose in 2003 to around 51 percent of GDP compared with 47¾ percent in 2001.
- Inflation and monetary policy:
  - Headline inflation rose above the Bank of Mexico’s (BOM) 2–4 percent variability interval.
  - Core inflation stabilized around 3½ percent; 12-month expectations of headline inflation edged up to over 4 percent.
  - Main policy challenge: maintain BOM credibility in reducing inflation to 3 percent without choking off the recovery.
- Fund policy advice emphasized:
  - Consolidating the fiscal position and saving a significant portion of future oil windfalls.
  - Lowering inflation to the medium-term target.
  - Advancing structural and financial reforms.
  - Crisis-proofing the economy.
- Political constraints: political fragmentation since July 2003 congressional elections has blocked legislative initiatives and made major actions unlikely before the 2006 elections; smaller-scale reforms and executive actions were discussed as more feasible near term.

### Recent economic developments and key indicators
- Output and demand:
  - Real GDP growth: 1.3 percent in 2003; growth accelerated to 3.8 percent in the first half of 2004 over the previous year.
  - Staff estimate: output gap narrowed to slightly below 2 percent of GDP.
  - Formal private sector employment increased by 185,000 in the first half of 2004; seasonally adjusted unemployment rate 3.7 percent in July after peaking at 3.9 percent in February.
- GDP component highlights (selected):
  - Final domestic demand growth in Q1–Q2 2004: 4.5 percent (Table indicates Final domestic demand 4.5 for Q1Q2 2004 in Text Table 1).
  - Private consumption shows increases: Private consumption 5.4 percent and 4.2 percent in specified quarterly entries in Text Table 1 (preserved as in source table layout).
  - Private fixed investment entries in Text Table 1 include values such as -5.9, -4.0, -5.7, 5.0, -2.1, -8.1, -4.4, -8.6, 4.0, 6.8 (preserved from source table).
- External sector and competitiveness:
  - Mexican manufactured exports growth: 10½ percent in first seven months of 2004 over same period in 2003.
  - Concerns about stagnation of Mexico’s market share in U.S. markets; maquiladora recovery seen as positive sign.
- Financial markets and monetary conditions:
  - Headline CPI: record low just under 4 percent at end-2003 (12-month basis); rose to 4.8 percent in August (12-month basis).
  - Core inflation: 3.7 percent (August).
  - Inflation expectations (next 12 months): 4.1 percent (August).
  - Contractual wage settlements averaged 4.5 percent in the first eight months of 2004.
  - Bank of Mexico policy actions: tightened policy five times since beginning of 2004 via increases in the corto.
  - Overnight inter-bank (fondeo) rate rose from an average of just over 5 percent in second half of 2003 to slightly over 7 percent by mid-September 2004.
  - 10-year government bond yield rose from about 8½ percent in January to just over 10½ percent in September 2004.
  - Peso and real exchange rate movements:
    - Peso depreciated by 7½ percent against the U.S. dollar through 2003, and a further 3 percent through mid-September 2004.
    - Real effective exchange rate depreciated by 13 percent through 2003, and a further 1 percent in the first seven months of 2004.
  - Result: monetary conditions remain relatively easy despite policy tightening, partly due to peso weakness.

### Fiscal policy discussions and staff recommendations
- Staff emphasis:
  - Save a significant portion of future oil windfalls to avoid greater budget dependence on oil revenues.
  - If oil prices do not fall sharply, meeting medium-term fiscal targets will be difficult without measures to boost non-oil revenues; absent such measures, significant spending restraint would be required.
- Authorities’ position:
  - Agreed on the need to save windfalls but noted political difficulty in resisting spending pressures when revenues are strong; also highlighted Mexico’s ability to cut spending when needed to meet deficit targets.
  - Optimistic that tax and pension reforms proposed by the National Fiscal Convention and passage of fiscal responsibility legislation could be feasible in forthcoming congressional sessions.

### Monetary policy discussions and staff recommendations
- Staff observations:
  - Monetary conditions remained relatively easy partly due to peso weakness; with headline inflation above the BOM’s target, tightening was appropriate.
  - Magnitude and timing of tightening dependent on assessment of supply shocks’ impact on underlying inflation and external monetary conditions.
  - Communication problem when inflation above target; publication of an official inflation forecast could help.
- Authorities/BOM response:
  - Considered further refinements to the inflation-targeting framework in due course.
  - Declared it premature to publish an inflation forecast, citing indirect links between monetary instruments and market conditions and uncertainties about the inflation outlook.

### Structural reform agenda (Box 1): objectives and status summaries
- Energy sector reform:
  - Objective: increase efficiency of public producers and allow broader private participation to gain expertise and expand capital investment; constitutional barriers remain.
  - Status: Incremental steps—PEMEX introduced multiple service contracts in 2002 allowing private firms operational responsibilities in gas fields; limited private investment allowed in electricity generation, but only state companies can distribute power; no changes in the oil sector; constitutional changes appear highly unlikely; focus on establishing legal certainty for existing agreements.
- Labor market reform:
  - Objective: increase productivity and employment in the formal sector by reducing rigidities (lower nonwage and dismissal costs, flexibility in work hours and probation, improve union governance).
  - Status: Reform submitted to congress in 2002 based on consensus but did not address major rigidities (notably high nonwage and dismissal costs); authorities still envisage reforms to allow more flexible arrangements and facilitate transfer from informal to formal sector; observers believe current proposal may be too watered down.
- Telecommunications reform:
  - Objective: increase coverage and quality, lower costs, promote competition, encourage new technologies and services.
  - Market structure: Telmex controls 96 percent of the fixed-line network; Telcel controls 80 percent of the mobile market; internet penetration limited by lack of fixed-line capacity.
  - Status: Bill work began in 2002 to strengthen regulatory authority and related areas; no significant progress; late 2003 plans to give COFETEL greater regulatory powers; March 2004 WTO ruling found Telmex’s sole authority to set domestic connection charges breached WTO services obligations.
- Financial market reform:
  - Objective: promote savings, modernize the financial system to reactivate bank lending, deepen capital markets, and modernize development banks.
  - Status: Congress passed measures on credit guarantees, bank supervision, and payments system; closure of government banks and sale of government shares reduced government participation; foreign ownership of banks and nonbank financial intermediation increased; oversight of banks strengthened.
- Judicial reform:
  - Objective: strengthen governance, improve legal and regulatory framework, reduce corruption, increase accountability.
  - Status: Several initiatives sent to congress; law enabling public access to government information approved in April 2002; legislation improving corporate governance and minority shareholder protection enacted; 2003 legislation protecting creditor rights approved.

### Key challenges and policy priorities going forward
- Consolidate fiscal gains while reducing vulnerability to oil price swings by saving windfalls and broadening the revenue base.
- Reduce inflation toward the 3 percent target while maintaining support for the nascent recovery; improve monetary policy communication.
- Advance structural reforms where politically feasible (tax, pension, fiscal responsibility, telecommunications via regulatory and executive actions) to boost medium-term growth and competitiveness.
- Strengthen crisis-resilience through continued financial-sector modernization and regulatory enhancements.

*Source: IMF staff report: “Mexico—The Administration’s Structural Reform Agenda, 2002–06,” IMF consultation chapter (excerpts provided).*

### 11.      Fiscal consolidation was modest in 2003, despite higher-than-budgeted oil prices

### 11.      Fiscal consolidation was modest in 2003, despite higher-than-budgeted oil prices

### Fiscal performance in 2003 and early 2004
- The augmented deficit fell slightly to 3 percent of GDP from 3¼ percent in 2002, primarily because of lower off-budget financing requirements arising from falling interest rates.
- The traditional deficit was at ½ percent of GDP, broadly in line with the 2003 budget target and the 2002 outturn.
- Windfall gains from higher oil revenues and public enterprise profits were used to:
  - offset shortfalls in non-oil tax revenues;
  - finance higher-than-budgeted capital outlays, wages, severance payments, and interest charges.
- The non-oil augmented deficit deteriorated further, reaching 9½ percent of GDP in 2003 compared with 8 percent in 2002.
- A small contribution of 0.1 percent of GDP was made to the Oil Stabilization Fund (OSF).
- In the first seven months of 2004:
  - total revenue growth was 9 percent over the same period in 2003;
  - overall spending grew by 7 percent;
  - programmable current spending also rose by 7 percent, compared with the budget assumption of no nominal increase for the year as a whole.

### Public debt and debt management
- The ratio of gross augmented public debt to GDP rose by 1¼ percentage point in 2003 to reach 51 percent, largely due to peso depreciation.
- The authorities completed their external financing program for 2004 on favorable terms.
- Liability management operations, including an exchange of global bonds in early 2004, helped improve yield curve efficiency.
- Domestic public debt management focused on:
  - extending maturities;
  - improving the liquidity of benchmark issues;
  - deepening domestic financial markets.

### Resolution of FOBAPROA debt
- In July, banks and the government agreed on the exchange of FOBAPROA debt for new bonds, resolving long-standing uncertainty.
- Of the original gross amount of about 3¼ percent of GDP, it is tentatively estimated that banks will receive about 1½ percent of GDP in new bonds issued by the deposit insurance agency (IPAB), with the difference reflecting recovered loans, loss sharing covered by banks, and related credits banks will pay.

### External sector and vulnerability indicators
- The current account deficit narrowed to 1½ percent of GDP in 2003, and was more than matched by FDI inflows.
- Net international reserves rose to US$58.2 billion at end-July 2004 from US$48 billion at end-2002, reflecting strong PEMEX receipts.
- Gross reserves at end-August are estimated at 170 percent of short-term external debt by residual maturity.
- Mexico’s EMBI+ spread spiked to 250 basis points in mid-May as U.S. interest rates rose, then fell back below 200 basis points by end-August.

### Corporate financing conditions
- Larger corporates issued peso-denominated fixed-rate debt in local capital markets to improve debt structure.
- Small- and medium-sized firms continued to face difficulties obtaining bank credit and market financing.
- Large companies in good financial health (mainly exporters) enjoyed relatively easy financing conditions.
- Bond defaults and financial difficulties observed were attributed to individual firms rather than systemic factors.

### Reserve auctioning mechanism
- In March 2004, the BOM modified the mechanism for auctioning international reserves:
  - The BOM continues to pre-announce the amount of dollars to be sold equal to 50 percent of net reserve accumulation in the previous 3-month period.
  - Sales are now spread over the following 12 months (previously 3 months) to reduce volatility in the foreign exchange market.

### Short-term economic outlook and risks
- Staff revised the 2004 growth projection to 4 percent from 3½ percent in the April WEO.
- Recent domestic indicators point to continued expansion; recovery expected to continue in H2 2004 at a more moderate pace than H1.
- Most U.S. forecasts still call for growth of around 4¼ percent in 2004.
- The impact of higher interest rates on spending is expected to be modest given improved corporate balance sheets and increasing credit availability.
- Risks to near-term growth are judged roughly balanced:
  - Upside: a sustained increase in private-sector confidence could lead to a stronger rebound than the 5 percent private fixed investment growth currently projected.
  - Downside: a continuing political stalemate could damp confidence; Mexico is vulnerable to a renewed downturn in U.S. manufacturing activity.
- Near-term inflation risks could be slightly on the upside.

### Inflation outlook
- CPI inflation is expected to remain above the 4 percent upper bound of the BOM’s variability interval in the near term due to:
  - persistent shocks to agricultural prices feeding into processed food prices;
  - quickly rising administered prices;
  - pass-through of peso depreciation and higher oil prices.
- Staff projects an inflation rate of 4.3 percent (12-month basis) by end-2004.

### Medium-term growth prospects and scenarios (Box 2 and Text Table 2)
- Staff revised down its baseline projection for GDP growth over 2005–09 to an annual average of slightly over 3 percent, assuming absence of significant reforms.
- Staff constructed three scenarios for 2005–09:
  - Low scenario (extrapolating declining TFP): Real GDP growth 2.1 percent; Potential output growth 1.8 percent; Trend TFP growth -0.5.
  - Baseline scenario: Real GDP growth 3.2 percent; Potential output growth 2.9 percent; Trend TFP growth 0.3.
  - High scenario (optimistic reforms): Real GDP growth 4.5 percent; Potential output growth 4.2 percent; Trend TFP growth 1.2.
- Growth accounting (Box Table 1) for selected periods:
  - 1965–79: Real GDP growth 6.5; Capital contribution 2.0; Labor contribution 2.4; TFP 2.1; Potential output growth 6.4; Trend TFP growth 2.0.
  - 1980–2003: Real GDP growth 2.6; Capital contribution 1.1; Labor contribution 2.0; TFP -0.5; Potential output growth 2.7; Trend TFP growth -0.4.
  - 1996–2003: Real GDP growth 3.5; Capital contribution 1.1; Labor contribution 1.6; TFP 0.7; Potential output growth 3.5; Trend TFP growth 0.7.
- Text Table 2 (Baseline Medium-Term Projection, selected rows):
  - Real GDP: 2004 4.0; 2005 3.2; 2006 3.3; 2007 3.2; 2008 3.1; 2009 3.1 (Annual percentage change).
  - Consumer prices (end-year): 2004 4.3; 2005 3.8; 2006 3.0; 2007 3.0; 2008 3.0; 2009 3.0 (In percent).
  - Gross domestic investment (percent of GDP): 2004 21.8; 2005 21.2; 2006 20.9; 2007 21.0; 2008 20.8; 2009 20.7.
  - Gross national saving (percent of GDP): 2004 20.7; 2005 19.9; 2006 19.4; 2007 19.4; 2008 19.0; 2009 18.8.
  - Augmented balance (PSBR excl. nonrecurring revenues, percent of GDP): 2004 -3.1; 2005 -2.6; 2006 -2.3; 2007 -2.1; 2008 -2.0; 2009 -2.0.
  - Augmented primary balance (percent of GDP): 2004 0.3; 2005 1.0; 2006 1.2; 2007 1.1; 2008 1.1; 2009 1.1.
  - Current account balance (percent of GDP): 2004 -1.1; 2005 -1.3; 2006 -1.5; 2007 -1.6; 2008 -1.8; 2009 -1.9.

### Policy discussion: fiscal policy
- Authorities reiterated commitment to achieving deficit targets and noted that success had underpinned policy credibility.
- Traditional-definition deficits had been kept close to the 2002 PRONAFIDE targets despite political pressures for greater spending.
- For 2004, the budget figure of 0.3 percent of GDP for the traditional deficit was considered realistic, with high oil revenues expected to more than offset possible non-oil revenue shortfalls and spending overruns; some of the windfall could be saved via transfers to the OSF.
- Authorities indicated spending beyond budget estimates in 2003 (and probably again in 2004) largely resulted from adjusters that allocated windfall oil revenues to public capital spending or covered increased public sector costs associated with higher energy prices; such spending would automatically compress if oil prices were to fall.

*Source: IMF staff report excerpt, chapter titled "Fiscal consolidation was modest in 2003, despite higher-than-budgeted oil prices."*

### 22.      Staff agreed that the authorities had established a strong reputation for fiscal

### _cr04419 - 22.      Staff agreed that the authorities had established a strong reputation for fiscal

### Fiscal performance, oil revenues, and short-term outcomes
- Staff assessment:
  - Authorities had established a strong reputation for fiscal prudence due to sustained achievement of deficit targets.
  - Concern: high oil revenues played a large role in meeting targets amid non-oil revenue shortfalls and spending overruns.
  - Little of the excess oil revenues would be saved in the medium term, appearing to contradict the spirit of the budget adjusters as originally envisaged.
  - Updated authority information: expect substantially higher savings of excess oil revenues in 2004 than staff estimates; part will finance later investment spending.
  - Overruns in current spending exceeded amounts attributable to adjusters and higher energy costs.
  - Budget figures exhibited a pattern of overestimating non-oil revenues and underestimating nondiscretionary expenditures, providing room for Congress to include more programmable spending even with a low oil price assumption.
  - Due to spending of excess oil revenues, the fiscal impulse in 2004 was expected to be slightly stimulative—implying a pro-cyclical stance given the recovery underway.

- Staff recommendation (short-term):
  - Need for a framework to promote greater medium-term savings of excess oil revenues to:
    - avoid inefficient spending at times of high world oil prices;
    - reduce fiscal dislocations from a drop in oil prices;
    - take advantage of favorable conditions to reduce public debt.

### Proposed saving rule and authorities' view
- Staff recommended:
  - Incorporate an objective assumption for oil prices in the budget (for instance, based on futures markets).
  - Explicitly earmark a significant portion (at least one half) of the difference between the oil revenues associated with this price and an assumed long-term price for saving—preferably in the form of a lower traditional deficit.
  - Deviations through the year between actual and assumed prices would be subject to the same savings rule (possibly via transfers to/from the OSF).
  - Advantages: (1) increases political commitment to saving; (2) gives savings precedence over other fiscal developments through the year.

- Authorities’ position:
  - Tending toward a conservative oil price assumption helps contain spending pressures and is more likely to deliver fiscal restraint.
  - Skeptical that a different adjuster mechanism would offset political pressures to spend excess revenues.
  - Agreed that operation of the adjusters had left only modest scope for saving oil revenues.
  - Hopeful that the OSF would accumulate a meaningful surplus if oil prices remain high.

### Text Table 3 — Mexico: Saving of Windfall Oil Revenues (as presented)
- Table headers/context: Staff Projection | Authorities' Estimate; columns: 2001, 2002, 2003, 2004, Total: 2001–04, 2004
- Oil price versus budget (US$/barrel): 0.6, 3.6, 6.4, 11.4, n/a, 9.2
- Windfall oil revenues (in percent of GDP) 1/: -0.4, 0.2, 1.0, 1.9, 2.7, 1.6
- Savings (in percent of GDP): 0.0, -0.1, 0.1, 0.1, 0.1, 0.7
  - OSF: 0.0, -0.1, 0.1, 0.1, 0.1, 0.1
  - Traditional balance: 0.0, 0.0, 0.0, 0.0, 0.0, 0.1
  - Trust funds (PEMEX and infrastructure): ........., 0.0, 0.0, 0.5
- Footnote 1/: On a gross basis. The net revenue impact would be partially offset by higher fuel prices for public enterprises and higher prices for imported gasoline.
- Sources: Authorities and IMF staff estimates.

### Medium-term fiscal framework and scenarios (Box 3)
- 2002 PRONAFIDE original framework:
  - Linked fiscal adjustment pace during 2002–06 to progress in structural reforms.
  - With only modest reforms: augmented deficit to fall from 4 percent of GDP in 2002 to 1.6 percent in 2006.
  - Net public debt projected to fall by 2 percentage points to 41½ percent of GDP.

- Actuals and revisions:
  - Program off-track: augmented deficit expected to reach 3.1 percent of GDP in 2004 vs. 2½ percent of GDP in PRONAFIDE.
  - Public debt edged up through 2003 due to higher deficit, low growth, and peso depreciation.

- Authorities’ latest framework (2004 budget, revised in 2005 draft):
  - Maintains original deficit targets for 2006 but concentrates adjustment in 2005–06.
  - Traditional balance improves by ½ percent of GDP over these years.
  - Off-budget financing projected to fall by 1 percent of GDP.
  - Based on strong growth outlook: average GDP growth of 4.1 percent in 2005–08 and a low oil price assumption of US$20.8 per barrel for the Mexico mix.
  - Tax reform seen as necessary; scope for spending reductions is limited.
  - New pressures for social spending estimated by staff at 1½–2 percent of GDP.
  - Government expected to service debt of rising PIDIREGAS projects upon completion.
  - Emphasis on need for pension reform to prevent pension bill spiraling after 2008.
  - Staff view: reliance on reducing off-budget financing to lower augmented deficit is problematic.

- Staff baseline scenario:
  - Based on authorities’ commitment to meeting traditional balance targets.
  - Assumes higher oil prices (averaging $29.7 per barrel in 2005–08) and lower growth.
  - Augmented deficit remains above authorities’ target as off-budget financing is compressed less; decline in augmented public debt is slower than authorities’ plan.
  - Underlying adjustment during 2005–07 of 1½ percent of GDP would still be substantial given rising spending pressures in health, education, and pensions.

- Specific fiscal projections and assumptions:
  - Staff: meeting objective for the augmented deficit of about 1½ percent of GDP in 2007 would require an estimated 1¾ percent of GDP in net consolidation measures, assuming a mild easing in world oil prices.
  - Authorities estimate pension system has a deficit in net present value terms of 116 percent of 2003 GDP.
  - A recent bill (August 2004) reduces pension and other benefits for new employees at IMSS, but applies only to new workers.

### 2005 draft budget, market reaction, and staff view
- Market reaction: generally favorable.
- Key budget figures and assumptions:
  - Traditional deficit would fall slightly to 0.1 percent of GDP in 2005 from 0.3 percent in 2004 (excluding payments for the voluntary retirement plan).
  - Augmented deficit would drop by about 1 percentage point to 2.2 percent of GDP.
  - Budget predicated on decline in oil prices for the Mexican mix to $23 per barrel next year, and real GDP growth of 3.8 percent.
  - Staff assumptions: futures market oil prices (early September) and GDP growth of 3.2 percent.
  - With oil revenues falling, the budget assumes a sharp drop in programmable current spending to achieve the deficit target.
  - Staff projection for 2005 (based on oil prices remaining near current levels) assumes across-the-board spending restraint that reduces programmable spending by ½ percent of GDP to achieve an outturn for the augmented balance of 2.6 percent of GDP.
  - Congress scheduled to pass final budget law by November 15.

### Fiscal governance, subnational finances, and public enterprises
- Fiscal responsibility and rules:
  - Authorities anticipate advancing fiscal responsibility legislation in the next session of congress, potentially including matching spending initiatives with revenue measures and balancing the traditional budget over the business cycle.
  - Mission encouraged emphasizing augmented measures of the budget position in fiscal responsibility principles to better reflect financial stability and debt sustainability and to avoid incentives to transfer activity off-balance-sheet.

- Public enterprises:
  - Staff view: limited government control over some public enterprises, including PEMEX, undermined efficiency and added fiscal uncertainty.
  - PEMEX costs exceeded those of other major international oil companies due to rigid labor contracts, generous pay scales, and inefficiencies.
  - Authorities agreed on need to strengthen corporate governance, align labor compensation with market conditions, and implement pension reform to ensure solvency of public enterprises.
  - Mission welcomed establishment of an independent audit committee for PEMEX to improve transparency.

- Subnational government debt:
  - Increased since the early 1990s but still represents less than 2 percent of GDP.
  - Own revenues of most states are less than 10 percent of total revenues; the rest mostly federal transfers.
  - Staff stressed maintaining tight controls on subnational borrowing and avoiding perceptions of federal bailouts; authorities noted bailouts are proscribed under the framework and market-based evaluations of state creditworthiness have strengthened.

### Debt sustainability and risks
- Staff reiterated that a gross public debt ratio of about 50 percent of GDP was uncomfortably high for a country still establishing full policy credibility.
- Staff debt sustainability analysis indicates augmented debt to GDP would fall under the baseline scenario of further fiscal consolidation, but remain near current levels if the augmented deficit is not reduced over time; adverse shocks could result in a rising debt ratio under a pessimistic scenario.
- Authorities argued recent increases in public debt ratios resulted from temporary shocks and that ratios were still expected to decline; they emphasized strengthened debt structure and market credibility.

### Monetary and exchange rate policy (summary of mission discussion)
- Policy goal: complete process of bringing inflation down to the 3 percent target.
- Observations:
  - Authorities attributed rise in headline inflation in first half of 2004 primarily to price shocks (commodity, meat, and administered prices); demand pressures did not appear to be a contributing factor.
  - Core services inflation (domestic costs) had continued to fall.
  - Staff noted price shocks could be persistent given global commodity market pressures and warned about rising inflation expectations.
  - Monetary conditions remained relatively easy through the first half of the year despite increases in the corto.
  - Staff and authorities agreed some further tightening in monetary conditions was likely needed; source, pace, and timing were key issues.
  - BOM officials indicated domestic market conditions should reflect “at least” the degree of tightening expected in U.S. policy.
  - Subsequent policy: domestic overnight rate rose in line with two increases in the U.S. fed funds target rate and when the BOM increased the corto in late July and late August.
- Communication and operating framework:
  - BOM streamlined and shortened press statements starting in May to signal views more clearly; money market conditions became more stable and overnight rate moved more systematically.
  - On shifting from the corto to an interest rate operating instrument, authorities cited difficulty identifying the size of the interest rate channel given data volatility and changing financial structure; until greater confidence established, hard to communicate precise intent via an interest rate tool.
  - Staff suggested publishing an inflation forecast could help motivate policy stance and influence expectations; BOM officials acknowledged merits but cautioned that an inaccurate forecast could jeopardize credibility or unduly delay disinflation.

*Source: IMF staff report extract (text provided in content unit).*

### 34.      The authorities remain firmly committed to allowing the exchange rate to be

### The authorities remain firmly committed to allowing the exchange rate to be

### Exchange rate policy and reserves
- Authorities committed to a market-determined exchange rate; viewed the peso depreciation since February as not based on fundamentals but on market uncertainty about U.S. policy tightening.
- No evidence of “Dutch disease” from high oil prices: both nominal and real exchange rates depreciated over the past two years, and oil exports were small in relation to GDP.
- Staff endorsed a transparent approach to exchange rate management; exchange rate volatility did not appear to unduly complicate policy formation or undermine macroeconomic performance.
- Rules-based mechanism for accumulating international reserves deemed consistent with a noninterventionist reserves approach.
- Present level of reserves assessed as adequate in terms of coverage of short-term external debt and Mexico’s gross financing needs.
- Authorities willing to refine the mechanism; reserve sales period lengthened starting in March 2004.

### Financial sector: structure and risks
- Financial system resilience has increased; systemic problems are unlikely.
- Banks’ indicators described as sound, with adequate profitability, loan provisions, and capital adequacy.
- Shift in intermediation: share of bank intermediation falling; bank credit to consumers increased significantly while business lending stagnated.
- Nonbank intermediaries growing, particularly in the mortgage sector.
- Sofoles accounted for 4 percent of total financial assets (about 2½ percent of GDP) in March 2004.
- As of March 2004: most sofoles independent of financial groups (66 percent of total sofole assets); 14 percent affiliated with domestic financial groups; 20 percent within foreign groups.
- Mortgage lending accounted for 65 percent of sofole total assets; automobile credit accounted for 26 percent.
- Sofoles financing: 77 percent of total financing from loans from commercial banks and other institutions (mainly through SHF); outstanding bonds of MXN25 billion in 2004Q1 for some sofoles.
- Bank lending rose by 6 percent in June 2004 over the previous year.
- Weak creditor rights were addressed through 2003 reforms to facilitate recovery of loan collateral.
- Staff view: direct action to force changes in banks’ behavior or fee structures not appropriate; foundation in place for a sound and sustained recovery in financial intermediation.

### Financial supervision and nonbank oversight
- Prompt corrective action system implemented to address banks in financial difficulty; resolution mechanism for failed banks not yet concluded.
- Authorities prioritized strengthening oversight of nonbank institutions; no signs of instability but rapid growth warrants close attention to avoid inappropriate risk-taking.
- Staff concerns:
  - Nonbank mortgage institutions funded mostly by Sociedad Hipotecaria Federal (SHF), thus not subject to full market scrutiny; SHF also guaranteed mortgages.
  - Potential for hidden liabilities in development banks; suggested review of their role and operations.
- Authorities response: development banks subject to supervisory oversight; balance sheets sound; did not pose a drain on federal operating budget; rationalization could be considered given changing environment.

### External sector: exports, competitiveness, and trade agreements
- Concerns eased about slow export growth and Mexico’s edging down in U.S. market share as exports accelerated significantly in 2004.
- Authorities viewed past U.S. market share losses as linked to sector-specific factors and likely transitory; noted upsurge of FDI in export industries and revival signs in maquiladora sector.
- Real effective exchange rate depreciated by about 25 percent from its peak in 2001; consistent with decline in non-oil current account deficit from about 6 percent of GDP in 2000 to 4¼ percent in 2003.
- Non-oil exports grew by over 10 percent in the first seven months of 2004.
- Staff view: with a freely floating exchange rate and a modest current account deficit, competitiveness not an issue for macroeconomic imbalances; but reforms needed to raise underlying productivity.
- Identified reform areas: improving public infrastructure and lowering its cost (energy, transportation, communication), making labor market more flexible, improving the legal system.
- Authorities concluded a trade agreement with Japan; staff estimates suggest a modest increase in bilateral trade and Mexican welfare.
- CAFTA could affect maquiladora sector but authorities judged impact minimal; elimination of MFA quotas likely to have larger negative impact on Mexico than CAFTA.

### Vulnerabilities and external financing
- Economy generally well placed to absorb adverse shocks; investment-grade rating well-established with possibility of further upgrades.
- Corporate and financial sector balance sheets strengthened; development of peso-denominated fixed-rate corporate debt market notable.
- Introduction of a 20-year fixed-rate bond in October 2003 lengthened the peso yield curve.
- Agreement with banks to exchange FOBAPROA for IPAB debt allowed smoothing of amortization profile.
- Public financing vulnerabilities:
  - About 35 percent of augmented debt is external.
  - About 60 percent of domestic debt is still either short-term or linked to short-term interest rates.
  - Gross financing needs of the public sector estimated at close to 12 percent of GDP in 2004.
- External financing requirements and risks:
  - For 2004, gross external financing requirements estimated at US$48 billion, equivalent to around 7 percent of GDP.
  - High oil prices, record remittance inflows, and low interest rates lowered the current account deficit to only 1½ percent of GDP.
  - Immediate risks low: government already met its external financing requirement for the year and private sector saw strong capital inflows in H1 2004.
- Medium-term outlook:
  - Projected medium-term current account deficit close to 2 percent of GDP seen as manageable if confidence in policies maintained.
  - About 70 percent of the deficit expected to be financed by FDI; remainder by public and private borrowing (including PIDIREGAS) and portfolio inflows.
  - Net external liabilities projected to remain stable at about 40 percent of GDP.
- Staff assessment: Mexico well protected against a sudden financial crisis but remaining vulnerabilities could allow market pressures to affect financing costs and slow sovereign rating progress; continued crisis-proofing recommended.

### Structural reforms and other issues
- Structural reform agenda stalled by lack of political consensus.
- Energy reform seen as least feasible politically; emphasis on entrenching existing progress in electricity generation and natural gas exploration.
- Legal challenges for gas multiple-service contracts create political and legal risks; rising energy prices reduce attractiveness of such contracts for service providers.
- Scope for reform outside legislature, including regulatory reforms:
  - Telecommunications competition could be increased; tariffs high by international standards.
  - Government considering new initiatives, including broadening services provided by cable operators.
- Social and legal developments:
  - Despite declines in average per capita real incomes during 2001–03, Mexico made further progress in reducing poverty through the CONTIGO strategy and high remittance inflows.
  - Mexico broadly on track to achieve Millennium Development Goals except for a few indicators expected to improve slowly.
  - Mexico party to major anti-terrorism conventions and endorsed IMF/World Bank/FATF methodology for anti–money laundering and terrorist financing assessment.
  - Party to OECD convention; final report on actions expected to be submitted by June 2004.
  - Main source of illegal proceeds remains drug trafficking; progress made via strengthened prosecution and financial reporting despite corruption and traffickers’ financial resources.

### Staff appraisal: outlook and policy priorities
- Broad-based recovery in 2004 indicates temporary nature of factors holding back growth in 2001–03: business confidence, investment, FDI inflows, and exports strengthening; traditional fiscal balance objectives met aided by rising oil prices; public debt structure improved; inflation modestly above objective but far below historical levels.
- Sustaining robust growth requires:
  - Fully establishing market confidence through continued sound macroeconomic and financial policies.
  - Demonstrating capacity to use favorable conditions to reduce vulnerabilities.
  - Progress on structural reforms to promote competition, increase legal certainty and public security, reduce market rigidities, and better harness resources—particularly in the energy sector.
- Continued progress needed to place Mexico among fast-growing emerging market economies.

*Source: IMF staff report content provided in the supplied PDF excerpt.*

### 52.      In the area of fiscal policy, the government has met deficit targets, but the budget

### _cr04419 - 52.      In the area of fiscal policy, the government has met deficit targets, but the budget

### Fiscal policy: deficits, oil dependence, and public debt
- Findings:
  - The government has met deficit targets, but the budget has become increasingly reliant on oil revenues.
  - Public debt has edged up.
  - Meeting targets for the traditional deficit does not ensure a gradual decline in the ratio of augmented public debt to GDP, as indicated by the experience in 2002–03.
- Policy recommendations / requirements:
  - Lowering the augmented deficit is central to reducing fiscal vulnerabilities.
  - More binding medium-term targets are needed for the augmented deficit and public debt.
  - Stronger mechanisms are needed to ensure that a substantial portion of windfall oil revenues is saved, requiring either greater spending discipline or tax measures to achieve appreciable increases in non-oil revenues.
  - Postponing choices through the spending of excess oil revenues is likely to increase the size of the needed fiscal adjustment, and perhaps make its timing less favorable.
- Near-term fiscal guidance:
  - Staff welcome the commitment to fiscal discipline represented by the lower deficit targets in the draft budget for 2005.
  - Meeting the 2005 targets is likely to require more spending restraint than has been evident in recent years, even if oil prices remain high.
  - If oil prices remain high, authorities are encouraged to aim at saving significantly more of the excess oil revenues for the medium term than is expected in 2004.
  - A decline in oil prices to the level assumed in the budget would provide a challenging test of the government’s ability to cut spending in the face of adverse shocks.

### Fiscal reforms and structural measures
- Recommended reforms:
  - Formal fiscal responsibility principles could help reduce the spending of windfall oil revenues, but would be more effective if they focused on augmented fiscal measures and contained provisions to avoid slippages in meeting medium-term targets.
  - Tax reform to raise non-oil revenues is needed to avoid budget cuts that would jeopardize spending in social areas and on public infrastructure.
  - Pension reform is essential to put the fiscal accounts on a sound path.
  - Action to enhance the accountability and efficiency of some public enterprises, including PEMEX, is needed to strengthen the fiscal position and raise the quality of Mexico’s infrastructure.

### Monetary policy: inflation targeting and communications
- Findings:
  - After considerable success in bringing down inflation, monetary policymakers face a challenging environment for both formulating and communicating policies.
  - Although the long-term target is close to being met, taking the last step is proving problematic in an environment of repeated price shocks.
  - Temporary price shocks pose a risk of prolonging the disinflationary process and make it more costly.
- Policy stance and recommendations:
  - The BOM has appropriately tightened policy to ensure credibility of its commitment to lowering inflation to 3 percent.
  - Staff believe a tightening bias in policy, including allowing the full pass-through of U.S. policy actions to Mexican markets, is appropriate until there are clear signs that inflation expectations are declining toward the long-term objective.
  - Staff supports efforts to refine monetary policy announcements to more directly signal the BOM’s views to markets; such steps have led to more stable short-term interest rates and more predictable market responses.
  - Further transparency and predictability could be achieved over time by moving to an interest rate instrument.
  - In the inflation-targeting framework, progress toward publication of an official inflation forecast would be desirable to motivate policy actions and anchor private-sector expectations, though staff recognizes potential drawbacks in the immediate circumstances.

### Exchange rate, reserves, and external competitiveness
- Findings and assessment:
  - Mexico’s flexible exchange rate regime has been effective in cushioning the economy from external shocks in recent years.
  - The recent level of external competitiveness appears to be broadly consistent with a sustainable balance of payments position.
  - International reserves remain adequate in the context of a flexible exchange rate, both in their coverage of short-term external debt and Mexico’s gross annual financing needs.
- Policy view:
  - Staff agree that the rules-based mechanism for accumulating foreign reserves is consistent with the authorities’ transparent approach to reserves management and commitment to a market-determined exchange rate.
  - Recent actions demonstrate a desirable degree of flexibility in adjusting the mechanism to ensure it is functioning soundly.

### Financial system, debt structure, and market development
- Findings:
  - Mexico’s financial system is generally sound and well-regulated.
  - The banking system as a whole has a sound level of profitability and capital adequacy.
  - Nonbank institutions have grown rapidly in recent years.
- Recommendations:
  - Strengthen supervision, including a framework for bank resolution.
  - Deepen financial activity without excessive risk-taking, and streamline financial regulation to encourage innovation and competition.
  - Strengthen oversight of nonbank institutions.
  - Review operations of development banks to ensure their role is well motivated and that they do not present a source of hidden financial risks.
  - Continue reducing vulnerabilities relating to public debt; the debt structure would be strengthened by further increasing issuance of fixed-rate domestic-currency instruments, extending the domestic yield curve, and diversifying the investor base.
  - Deepening the domestic bond market associated with the rapid growth of institutional investors should diversify financing sources, lower liquidity and contagion risk, and reduce foreign currency mismatches in firms’ balance sheets.

### Statistics and data quality
- Finding:
  - Mexico’s data are generally of high quality and are adequate to conduct surveillance.
- Recommendation:
  - The authorities are encouraged to implement the recommendations of the 2003 statistical ROSC.

*Source: _cr04419 (PDF), https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04419.pdf*

### 61.      It is proposed that the next Article IV consultation with Mexico take place on the

### _cr04419 - 61.      It is proposed that the next Article IV consultation with Mexico take place on the

### National accounts (constant prices)
- Real GDP (annual percentage change): 5.2 (1996), 6.8 (1997), 5.0 (1998), 3.6 (1999), 6.6 (2000), 0.0 (2001), 0.6 (2002), 1.3 (2003), 4.0 (2004), 3.2 (2005, proj.).
- Net exports (contribution): 3.0 (1996), 1.7 (1997), 1.5 (1998), -0.5 (1999), -1.8 (2000), -0.7 (2001), 0.0 (2002), 0.7 (2003), 0.7 (2004), 0.5 (2005 proj.).
- Total domestic demand: 5.6 (1996), 9.6 (1997), 6.2 (1998), 4.1 (1999), 8.3 (2000), 0.7 (2001), 0.6 (2002), 0.5 (2003), 3.3 (2004), 2.7 (2005 proj.).
  - Private consumption: 2.2 (1996), 6.5 (1997), 5.4 (1998), 4.3 (1999), 8.2 (2000), 2.5 (2001), 1.3 (2002), 3.0 (2003), 4.2 (2004), 2.5 (2005 proj.).
  - Public consumption: -0.7 (1996), 2.9 (1997), 2.3 (1998), 4.7 (1999), 2.4 (2000), -2.0 (2001), 0.1 (2002), 2.5 (2003), 0.1 (2004), 1.0 (2005 proj.).
  - Gross fixed private investment: 26.7 (1996), 23.5 (1997), 13.8 (1998), 7.3 (1999), 9.0 (2000), -5.9 (2001), -4.0 (2002), -5.7 (2003), 5.0 (2004), 4.0 (2005 proj.).
  - Gross fixed public investment: -14.8 (1996), 10.1 (1997), -7.5 (1998), 10.7 (1999), 25.2 (2000), -4.2 (2001), 14.2 (2002), 22.4 (2003), 7.5 (2004), -10.1 (2005 proj.).

### External sector (volumes, prices, exchange rates)
- Exports, f.o.b. (annual % change): 22.7 (1996), 13.1 (1997), 1.1 (1998), 14.8 (1999), 21.8 (2000), -3.7 (2001), 0.6 (2002), 4.3 (2003), 19.1 (2004), 7.8 (2005 proj.).
- Export volume: 20.1 (1996), 22.1 (1997), 10.2 (1998), 9.6 (1999), 19.7 (2000), 2.3 (2001), -3.3 (2002), -2.0 (2003), 8.7 (2004), 6.1 (2005 proj.).
- Imports, f.o.b.: 27.4 (1996), 24.6 (1997), 12.7 (1998), 10.6 (1999), 23.1 (2000), -1.7 (2001), -1.3 (2002), 1.9 (2003), 19.1 (2004), 7.3 (2005 proj.).
- Import volume: 24.7 (1996), 22.5 (1997), 12.4 (1998), 11.3 (1999), 19.1 (2000), -1.9 (2001), -0.9 (2002), -0.5 (2003), 8.3 (2004), 7.0 (2005 proj.).
- Terms of trade (deterioration -): 0.1 (1996), -8.9 (1997), -7.3 (1998), 4.1 (1999), -1.5 (2000), -6.9 (2001), 4.4 (2002), 4.0 (2003), -0.3 (2004), 1.4 (2005 proj.).
- Nominal exchange rate (US$/Mex$) (average, depreciation -): -14.6 (1996), -4.0 (1997), -13.3 (1998), -4.4 (1999), 1.1 (2000), 1.2 (2001), -3.4 (2002), -11.7 (2003), ...... (2004), ...... (2005 proj.).
- Real effective exchange rate (CPI based) (average, depreciation -): 12.9 (1996), 17.8 (1997), 1.9 (1998), 9.0 (1999), 10.0 (2000), 8.3 (2001), -0.2 (2002), -12.8 (2003), ...... (2004), ...... (2005 proj.).

### Employment and inflation
- Consumer prices (end of year): 27.7 (1996), 15.7 (1997), 18.6 (1998), 12.3 (1999), 9.0 (2000), 4.4 (2001), 5.7 (2002), 4.0 (2003), 4.3 (2004), 3.8 (2005 proj.).
- Formal sector employment (annual % change): 0.7 (1996), 7.4 (1997), 8.0 (1998), 6.8 (1999), 5.9 (2000), 1.0 (2001), 1.0 (2002), -0.7 (2003), ...... (2004), ...... (2005 proj.).
- Real manufacturing wages: 26.1 (1996), 6.4 (1997), 2.8 (1998), 1.5 (1999), 5.8 (2000), 6.4 (2001), 2.2 (2002), 1.2 (2003), ...... (2004), ...... (2005 proj.).

### Money, interest rates, and credit
- Broad money (M4a) (annual % change): 31.7 (1996), 28.3 (1997), 25.1 (1998), 19.6 (1999), 12.9 (2000), 16.0 (2001), 10.7 (2002), 13.3 (2003), ...... (2004), ...... (2005 proj.).
- Treasury bill rate (28-day cetes, percent, annual average): 31.4 (1996), 19.8 (1997), 24.8 (1998), 24.8 (1999), 21.4 (2000), 15.2 (2001), 11.3 (2002), 7.1 (2003), 6.8 (2004), 7.5 (2005 proj.).
- Real interest rate (percent, annual average): 7.2 (1996), 6.3 (1997), 7.7 (1998), 9.6 (1999), 6.6 (2000), 7.0 (2001), 1.5 (2002), 2.3 (2003), 2.3 (2004), 3.2 (2005 proj.).

### Public finances (percent of GDP)
- Nonfinancial public sector augmented balance: -5.6 (1996), -5.6 (1997), -6.3 (1998), -6.3 (1999), -3.7 (2000), -3.7 (2001), -3.3 (2002), -3.1 (2003), -3.1 (2004), -2.6 (2005 proj.).
- Non-oil augmented balance: -11.0 (1996), -11.0 (1997), -10.2 (1998), -10.5 (1999), -8.9 (2000), -8.6 (2001), -8.0 (2002), -9.4 (2003), -10.3 (2004), -9.7 (2005 proj.).
- Augmented primary balance: 3.7 (1996), 3.0 (1997), 0.5 (1998), 1.3 (1999), 1.2 (2000), 0.8 (2001), 0.6 (2002), 0.1 (2003), 0.3 (2004), 0.9 (2005 proj.).
- Traditional balance: 0.0 (1996), -0.7 (1997), -1.2 (1998), -1.1 (1999), -1.1 (2000), -0.7 (2001), -1.2 (2002), -0.6 (2003), -0.4 (2004), -0.1 (2005 proj.).

### Savings, investment, and current account (percent of GDP)
- Gross domestic investment: 23.1 (1996), 25.9 (1997), 24.3 (1998), 23.5 (1999), 23.7 (2000), 21.1 (2001), 20.8 (2002), 19.8 (2003), 21.8 (2004), 21.2 (2005 proj.).
- Public investment: 3.0 (1996), 3.1 (1997), 2.8 (1998), 3.0 (1999), 3.6 (2000), 3.6 (2001), 4.2 (2002), 5.0 (2003), 5.2 (2004), 4.5 (2005 proj.).
- Private investment: 14.9 (1996), 16.4 (1997), 18.1 (1998), 18.2 (1999), 17.8 (2000), 16.3 (2001), 15.2 (2002), 14.3 (2003), 14.5 (2004), 14.7 (2005 proj.).
- Gross national savings: 22.4 (1996), 24.0 (1997), 20.5 (1998), 20.5 (1999), 20.6 (2000), 18.2 (2001), 18.6 (2002), 18.4 (2003), 20.7 (2004), 19.9 (2005 proj.).
- External current account balance (percent of GDP): -0.8 (1996), -1.9 (1997), -3.8 (1998), -2.9 (1999), -3.1 (2000), -2.9 (2001), -2.1 (2002), -1.4 (2003), -1.1 (2004), -1.3 (2005 proj.).
- Non-oil external current account balance (percent of GDP): -4.3 (1996), -4.7 (1997), -5.5 (1998), -5.0 (1999), -6.0 (2000), -5.0 (2001), -4.4 (2002), -4.3 (2003), -4.7 (2004), -4.8 (2005 proj.).

### Reserves and external debt
- Net international reserves (US$ billions): 17.5 (1996), 28.0 (1997), 30.1 (1998), 30.7 (1999), 33.6 (2000), 40.9 (2001), 48.0 (2002), 57.4 (2003), 62.4 (2004), 67.4 (2005 proj.).
- Gross official reserves in percent of short-term debt (by residual maturity): 33.4 (1996), 59.0 (1997), 72.9 (1998), 68.3 (1999), 82.8 (2000), 96.8 (2001), 117.1 (2002), 163.9 (2003), 156.8 (2004), 155.5 (2005 proj.).
- Gross external debt (in percent of GDP, end of period): 47.1 (1996), 37.5 (1997), 39.1 (1998), 37.0 (1999), 28.3 (2000), 26.1 (2001), 25.2 (2002), 26.1 (2003), 24.8 (2004), 24.5 (2005 proj.).
- Public external debt service (in percent of exports of goods, nonfactor services, and transfers): 38.6 (1996), 36.3 (1997), 21.6 (1998), 22.4 (1999), 27.1 (2000), 20.0 (2001), 15.9 (2002), 16.9 (2003), 10.9 (2004), 13.2 (2005 proj.).
- Oil export price (US$/bbl): 18.9 (2002), 16.5 (2003), 10.1 (2004), 15.7 (2005), 24.6 (2006), 18.6 (2007), 21.5 (2008), 24.7 (2009 proj.); (also listed earlier: 31.4, 31.5 in other tables for projections).

### Financial operations of the public sector (Table highlights)
- Budgetary revenue (percent of GDP): 21.8 (2001), 22.2 (2002), 23.7 (2003), 22.7 (2004 budget), 23.9 (2004 staff proj.), 21.6 (2005 budget), 23.7 (2005 staff proj.), 23.4 (2006), 23.2 (2007), 23.0 (2008), 22.7 (2009).
- Budgetary expenditure (percent of GDP): 22.5 (2001), 23.3 (2002), 24.4 (2003), 23.0 (2004 budget), 24.2 (2004 staff proj.), 21.7 (2005 budget), 23.8 (2005 staff proj.), 23.2 (2006), 22.9 (2007), 22.7 (2008), 22.4 (2009).
- Traditional balance (percent of GDP): -0.7 (2001), -1.2 (2002), -0.6 (2003), -0.3 (2004 budget), -0.4 (2004 staff proj.), -0.1 (2005 budget), -0.1 (2005 staff proj.), 0.2 (2006), 0.3 (2007), 0.3 (2008), 0.3 (2009).
- Augmented balance (PSBR excl. nonrecurrent revenue) (percent of GDP): -3.7 (2001), -3.3 (2002), -3.1 (2003), -3.3 (2004 budget), -3.1 (2004 staff proj.), -2.2 (2005 budget), -2.6 (2005 staff proj.), -2.3 (2006), -2.1 (2007), -2.0 (2008), -2.0 (2009).
- Augmented primary balance (percent of GDP): 0.8 (2001), 0.6 (2002), 0.1 (2003), 0.1 (2004 budget), 0.3 (2004 staff proj.), ... (2005 budget), 0.9 (2005 staff proj.), 1.2 (2006), 1.1 (2007), 1.1 (2008), 1.1 (2009).
- Oil revenue (percent of GDP): 6.6 (2001), 6.5 (2002), 7.9 (2003), 7.1 (2004 budget), 8.7 (2004 staff proj.), 7.3 (2005 budget), 8.6 (2005 staff proj.), 8.3 (2006), 8.1 (2007), 7.8 (2008), 7.6 (2009).
- Non-oil tax revenue (percent of GDP): 9.7 (2001), 9.8 (2002), 10.1 (2003), 10.1 (2004 budget), 9.8 (2004 staff proj.), 9.6 (2005 budget), 9.8 (2005 staff proj.), 10.0 (2006), 10.0 (2007), 10.0 (2008), 10.0 (2009).
- Nominal GDP (billions of Mexican pesos): 5,829 (2001), 6,262 (2002), 6,755 (2003), 7,084 (2004), 7,359 (2005), 7,934 (2006), 7,875 (2007), 8,409 (2008), 8,939 (2009), 9,488 (2010), 10,080 (2011).

### Balance of payments and financing (2002–09 summary)
- Current account (US$ billions): -14 (2002), -8.9 (2003), -7.2 (2004), -9.1 (2005), -11.1 (2006), -12.1 (2007), -14.9 (2008), -16.6 (2009).
- Merchandise trade balance, f.o.b. (US$ billions): -7.9 (2002), -5.6 (2003), -6.7 (2004), -6.6 (2005), -8.1 (2006), -8.6 (2007), -11.4 (2008), -11.3 (2009).
- Exports (US$ billions): 101.5 (2002), 105.9 (2003), 126.1 (2004), 135.9 (2005), 143.3 (2006), 152.5 (2007), 160.2 (2008), 168.4 (2009).
  - Petroleum and derivatives: 14.5 (2002), 18.7 (2003), 24.0 (2004), 24.6 (2005), 23.6 (2006), 23.7 (2007), 23.1 (2008), 22.8 (2009).
  - Manufactures 1/: 82.7 (2002), 82.0 (2003), 95.7 (2004), 104.9 (2005), 113.3 (2006), 122.2 (2007), 130.1 (2008), 138.2 (2009).
- Imports (US$ billions): -109.4 (2002), -111.5 (2003), -132.8 (2004), -142.5 (2005), -151.4 (2006), -161.1 (2007), -171.6 (2008), -179.7 (2009).
- Financial account (US$ billions): 17.3 (2002), 13.1 (2003), 12.1 (2004), 14.2 (2005), 16.0 (2006), 17.0 (2007), 19.6 (2008), 21.2 (2009).
  - Private sector financing (US$ billions): 20.3 (2002), 16.4 (2003), 8.2 (2004), 9.8 (2005), 11.0 (2006), 11.9 (2007), 14.3 (2008), 16.2 (2009).
    - Direct investment: 14.8 (2002), 10.8 (2003), 14.4 (2004), 15.1 (2005), 15.7 (2006), 16.4 (2007), 17.2 (2008), 18.0 (2009).
- Net international reserves (increase -) (US$ billions): -7.1 (2002), -9.5 (2003), -4.9 (2004), -5.1 (2005), -4.9 (2006), -4.9 (2007), -4.8 (2008), -4.6 (2009).
- Memorandum: Current account balance (percent of GDP): -2.1 (2002), -1.4 (2003), -1.1 (2004), -1.3 (2005), -1.5 (2006), -1.6 (2007), -1.8 (2008), -1.9 (2009).
  - Nonoil current account balance (percent of GDP): -4.4 (2002), -4.3 (2003), -4.7 (2004), -4.8 (2005), -4.7 (2006), -4.6 (2007), -4.7 (2008), -4.6 (2009).
- Gross financing needs (billions of US$): 67.2 (2002), 61.6 (2003), 48.1 (2004), 51.8 (2005), 56.2 (2006), 61.5 (2007), 65.7 (2008), 68.9 (2009).
- Gross total external debt (percent of GDP): 25.2 (2002), 26.1 (2003), 24.8 (2004), 24.5 (2005), 24.4 (2006), 23.9 (2007), 23.6 (2008), 23.3 (2009).
- Gross total external debt (billions of US$): 163.6 (2002), 165.6 (2003), 164.9 (2004), 171.1 (2005), 177.9 (2006), 185.1 (2007), 192.5 (2008), 199.7 (2009).

### Indicators of external vulnerability
- Exchange rate (per U.S. dollar, end-period): 9.14 (Dec 2001), 10.31 (Dec 2002), 10.77 (Dec 2003), 10.48 (Mar 2004), 10.93 (Jun 2004), 11.24 (Sep 2004), 11.15 (Dec 2004), 11.41 (Mar 2005), 11.48 (Jun 2005), 11.37 (Jul 2005), 11.37 (Aug 2005).
- 28-day treasury auction rate (percent; end-period): 6.8 (Dec 2001), 7.0 (Dec 2002), 8.4 (Dec 2003), 5.1 (Mar 2004), 4.5 (Jun 2004), 6.0 (Sep 2004), 6.1 (Dec 2004), 6.8 (Mar 2005), 7.2 (Jun 2005), 7.3 (Jul 2005), 7.3 (Aug 2005).
- EMBI+ Mexico (basis points; end of period): 308 (Dec 2001), 331 (Dec 2002), 291 (Dec 2003), 237 (Mar 2004), 212 (Jun 2004), 199 (Sep 2004), 183 (Dec 2004), 215 (Mar 2005), 200 (Jun 2005), 183 (Jul 2005), 183 (Aug 2005).
- Bank of Mexico net international reserves (US$ billion): 40.9 (Dec 2001), 48.0 (Dec 2002), 52.0 (Dec 2003), 53.4 (Dec 2004), 52.1 (Mar 2004 entry), 57.4 (Jun 2004 entry), 59.0 (Sep 2004), 59.1 (Dec 2004), 57.8 (Mar 2005), 58.2 (Jun 2005).
- Commercial banks' nonperforming loans (percent of total loans): 5.1 (1999), 4.6 (2000), 4.6 (2001), 4.2 (2002), 3.7 (2003), 3.2 (2004), 3.2 (2005), 3.0 (2006), ...... (later).
- Commercial banks' loan loss provision (percent of nonperforming loans): 123.8 (1999), 138.1 (2000), 134.3 (2001), 142.5 (2002), 154.3 (2003), 167.1 (2004), 167.4 (2005), 174.5 (2006).

### Summary operations of the financial system (selected)
- Bank of Mexico net international reserves (in local currency, billions of Mexican pesos): 29 (1999), 23 (2000), 22 (2001), 37 (2002), 55 (2003), 0 (June 2004 entry) ... (table contains more detailed series).
- Monetary base (billions of Mexican pesos): 189 (1999), 209 (2000), 226 (2001), 264 (2002), 304 (2003), 279 (June 2004).
- Financial system liabilities to the private sector (billions of Mexican pesos): 2,272 (1999), 2,566 (2000), 2,977 (2001), 3,295 (2002), 3,732 (2003), 3,900 (June 2004).
- Growth of credit to the private sector (annual % change): 2.7 (1999), 7.4 (2000), -7.3 (2001), 26.3 (2002), 5.8 (2003), 4.3 (2004).
- Banks nonperforming loans to total loans (percent): 8.9 (1999), 5.8 (2000), 5.1 (2001), 4.6 (2002), 3.2 (2003), 3.0 (2004).
- Banks loan-loss provisions to nonperforming loans (percent): 107.8 (1999), 115.4 (2000), 123.8 (2001), 138.1 (2002), 167.1 (2003), 174.5 (2004).

### Baseline medium-term projection (staff)
- Real GDP (annual % change): 6.6 (2000), 0.0 (2001), 0.6 (2002), 1.3 (2003), 4.0 (2004), 3.2 (2005), 3.3 (2006), 3.2 (2007), 3.1 (2008), 3.1 (2009).
- Consumer prices (end of year): 9.0 (2000), 4.4 (2001), 5.7 (2002), 4.0 (2003), 4.3 (2004), 3.8 (2005), 3.0 (2006), 3.0 (2007), 3.0 (2008), 3.0 (2009).
- Exports, f.o.b. (annual % change): 21.8 (2000), -3.7 (2001), 0.6 (2002), 4.3 (2003), 19.1 (2004), 7.8 (2005), 5.5 (2006), 6.4 (2007), 5.1 (2008), 5.1 (2009).
- Imports, f.o.b. (annual % change): 23.1 (2000), -1.7 (2001), -1.3 (2002), 1.9 (2003), 19.1 (2004), 7.3 (2005), 6.2 (2006), 6.4 (2007), 6.6 (2008), 4.7 (2009).
- Augmented balance (percent of GDP): -3.7 (2000), -3.7 (2001), -3.3 (2002), -3.1 (2003), -3.1 (2004), -2.6 (2005), -2.3 (2006), -2.1 (2007), -2.0 (2008), -2.0 (2009).
- Current account balance (percent of GDP): -3.1 (2000), -2.9 (2001), -2.1 (2002), -1.4 (2003), -1.1 (2004), -1.3 (2005), -1.5 (2006), -1.6 (2007), -1.8 (2008), -1.9 (2009).

### Millennium Development Goals (selected indicators)
- Population below $1 a day (%): 9.9 (2001).
- Poverty gap at $1 a day (%): 3.7 (2001).
- Percentage share of income or consumption held by poorest 20%: 3.1 (2001).
- Prevalence of child malnutrition (% of children under 5): 16.6 (1990), 16.9 (1995), 7.5 (2001).
- Net primary enrollment ratio (% of relevant age group): 100 (1990), 100 (1995), 99.4 (2001).
- Percentage of cohort reaching grade 5 (%): 79.5 (1990), 85.6 (1995), 88.5 (2001).
- Youth literacy rate (% ages 15-24): 95.2 (1990), 96.2 (1995), 96.6 (2001).
- Ratio of girls to boys in primary and secondary education (%): 98.5 (1990), 98.2 (1995), 101.3 (2001).
- Ratio of young literate females to males (% ages 15-24): 98.4 (1990), 98.9 (1995), 99.7 (2001).
- Share of women employed in the nonagricultural sector (%): 35.3 (1990), 35.9 (1995), 37.2 (2001).
- Proportion of seats held by women in national parliament (%): 14 (1995).

*Source: IMF staff estimates and projections, Mexican authorities' data as presented in the provided Tables.*

### 4. Reduce child mortalit

### 4. Reduce child mortalit

### 4. Reduce child mortality
- Under 5 mortality rate (per 1,000): 46363029
- Infant mortality rate (per 1,000 live births): 37302524
- Immunization, measles (% of children under 12 months): 78909596

### 5. Improve maternal health
- Maternal mortality ratio (modeled estimate, per 100,000 live births): ..                                  ..                                  83..                                  
- Births attended by skilled health staff (% of total): ..                             85.7..                             ..

### 6. Combat HIV/AIDS, malaria and other diseases
- Prevalence of HIV, female (% ages 15-24): ..                                  ..                                  0.1..                                  
- Contraceptive prevalence rate (% of women ages 15-49): ..                                65..                                  ..                                
- Number of children orphaned by HIV/AIDS: ..                                  ..                                  27,000..                                  
- Incidence of tuberculosis (per 100,000 people): ..                                  ..                                  3433.1
- Tuberculosis cases detected under DOTS (%): ..                                159573

### 7. Ensure environmental sustainabilit
- Forest area (% of total land area): 32.2..                             28.9..                             
- Nationally protected areas (% of total land area): ..                               3.73.510.2
- GDP per unit of energy use (PPP $ per kg oil equivalent): 4.14.75.8.. 
- CO2 emissions (metric tons per capita): 3.744.3.. 
- Access to an improved water source (% of population): 80..                                88..                                
- Access to improved sanitation (% of population): 70..                                74..                                
- Access to secure tenure (% of population): ..                                  ..                                  ..                                  ..

*Source: _cr04419 - 4. Reduce child mortalit*

### 8. Develo

### _cr04419 - 8. Develo

### Millennium Development Goals (MDGs) and Targets
- Youth unemployment rate (% of total labor force ages 15-24): 5.4, 9.6, 4.1, 4.9 (as presented in source table).
- Fixed line and mobile telephones (per 1,000 people): 65.6, 101.2, 354, 401.2 (as presented in source table).
- Personal computers (per 1,000 people): 8.2, 25.6, 68.7, 82 (as presented in source table).
- Source of data: World Development Indicators database, April 2004.
- MDG targets (as stated):
  - Goal 1 targets: Halve, between 1990 and 2015, the proportion of people whose income is less than one dollar a day. Halve, between 1990 and 2015, the proportion of people who suffer from hunger.
    - 2015 target = halve 1990 $1 a day poverty and malnutrition rates
  - Goal 2 target: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling.
    - 2015 target = net enrollment to 100
  - Goal 3 target: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015.
    - 2005 target = education ratio to 100
  - Goal 4 target: Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate.
    - 2015 target = reduce 1990 under 5 mortality by two-thirds
  - Goal 5 target: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio.
    - 2015 target = reduce 1990 maternal mortality by three-fourths
  - Goal 6 targets: Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases.
    - 2015 target = halt, and begin to reverse, AIDS, etc.
  - Goal 7 targets: Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water. By 2020, to have achieved a significant improvement in the lives of at least 100 million slum dwellers.
  - Goal 8 targets: Develop further an open, rule-based, predictable, non-discriminatory trading and financial system. Address special needs of the Least Developed Countries, landlocked countries and small island developing states. Deal comprehensively with the debt problems of developing countries to make debt sustainable in the long term. In cooperation with developing countries, develop and implement strategies for decent and productive work for youth. In cooperation with pharmaceutical companies, provide access to affordable, essential drugs in developing countries. In cooperation with the private sector, make available the benefits of new technologies, especially information and communications.

### Mexico — Fund Relations (As of July 31, 2004)
- Membership status: Joined December 31, 1945; Article VIII.
- Quota: SDR 2,585.80 (100.00 percent of quota).
- Fund holdings of currency: 2,032.54 (78.60 percent).
- Reserve position in Fund / Financial transaction plan transfers (net): 553.31 (87.00 percent) and 21.40 (percent shown separately).
- SDR Department:
  - Net cumulative allocation: 290.02 (100.00 percent).
  - Holdings: 294.96 (101.70 percent).
- Outstanding Purchases and Loans: None.
- Financial Arrangements: None.
- Projected Obligations to the Fund: ≤ SDR 50,000 (annually 2004–07).
- Exchange rate arrangement: Mexico has a floating exchange rate regime since December 22, 1994. Mexico maintains an exchange system that is free of restrictions on the making of payments and transfers for current international transactions.
- Article IV Consultation: Last concluded by the Executive Board on September 23, 2002. Relevant staff report: IMF Country Report No. 02/237. Mexico participated in the Financial Sector Assessment Program in 2001. Related Financial System Stability Assessment (FSSA) discussed in August 2001 and published (Country Report 02/192, October 2001).
- Resident Representative: None.

### Mexico — Statistical Issues
- Core data: Published on a timely basis and of good quality.
- Mexico observes the Special Data Dissemination Standards (SDDS); metadata posted on the Dissemination Standards Bulletin Board (DSBB).
- Fiscal data: Preliminary published with a 45-day lag following quarter end; final available mid-year of subsequent year and submitted to congress; revisions transparent and subject to public scrutiny.
- Balance of payments: Some statistics conform to the fifth edition of the Balance of Payments Manual; full transition not yet completed.
- External debt statistics: Improvements made, including compilation of data on 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 not yet 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 measure: Since 2001 authorities report a comprehensive measure of the fiscal balance — the Public Sector Borrowing Requirement — that encompasses direct net cost of public investment projects with deferred recording in the fiscal accounts (PIDIREGAS) and interest cost on previously unrecorded government liabilities.
- Data ROSC: Completed May 23, 2003 and published as IMF Country Report No. 03/150.
- Overall quality: Good, with some periodicity and timeliness exceeding SDDS requirements; authorities continuing work on improvements.

### Mexico — Relations with the World Bank
- World Bank Country Assistance Strategy (CAS) for Mexico (discussed May 2002) focuses on five 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.
- World Bank three-year (FY2003–05) lending envelope: US$5 billion (half in fast-disbursing operations); support contingent on legal/regulatory conduciveness and political consensus.
- FY1999–2002 new lending: US$4.8 billion.
- Recent loans highlighted:
  - Education: US$300 million (second phase of compensatory education program).
  - Taxation reforms/compliance: two loans totaling US$355 million.
  - Financial sector rural access: US$64.6 million.
  - Municipal infrastructure and decentralization: US$400 million.
- Bank portfolio (as of July 2002): 24 active projects; total undisbursed balance US$3.6 billion.
- Average annual disbursements over past four years: US$1.2 billion.
- Bank exposure to Mexico: US$11 billion (within nominal indicative single-borrower exposure ceiling of US$13.5 billion).

### Mexico — Debt Sustainability (Annex IV)
Public sector debt — key findings and scenarios:
- Overall assessment: Sustainability remains vulnerable to worsening economic environment and fiscal consolidation delays.
- Baseline projection: Public sector gross debt gradually reduces to about 45 percent of GDP by 2009 under high oil prices and authorities’ fiscal consolidation plans.
- Alternative scenarios:
  - No policy change (assumes no net fiscal savings over the medium-term): public debt projected to stay around current level.
  - Oil price shock: If oil prices fall abruptly to $20 per barrel, public debt projected to stay around current level.
  - Combined shock (lower oil price + higher interest rates + no fiscal adjustment): Debt ratio could rise close to 60 percent of GDP by 2009.
- One-off shocks alone would not put debt ratio on an unsustainable path, but slower growth and exchange rate depreciation based on historical volatility could increase public debt by about 4 percentage points of GDP within two years.

Public sector debt — selected numeric indicators (from Table 1, Mexico: Public Sector Debt Sustainability Framework, 1999-2009)
- A. Gross public sector debt (percent of GDP):
  - Average: 51.4
  - 1997: 56.6
  - 1998: 50.8
  - 1999: 49.3
  - 2000: 47.8
  - 2001: 49.7
  - 2002: 51.0
  - 2003: 49.3
  - 2004p: 48.7
  - 2005p: 47.5
  - 2006p: 46.7
  - 2007p: 45.6
  - 2008p: 44.7
  - 2004–09 average: 47.1
- Of which foreign currency denominated (percent of GDP): 22.8, 24.8, 21.5, 17.5, 15.3, 16.9, 17.9, 17.2, 17.1, 17.0, 16.9, 16.8, 16.5, 16.9.
- Of which domestic currency denominated (percent of GDP): 28.6, 31.8, 29.3, 31.8, 32.4, 32.9, 33.1, 32.2, 31.6, 30.5, 29.8, 28.8, 28.2, 30.2.
- Change in gross public sector debt from previous period: -4.0, 5.3, -5.9, -1.5, -1.5, 2.0, 1.3, -1.6, -0.6, -1.2, -0.8, -1.1, -0.9, -1.0.
- Net debt creating flows: -4.1, -3.0, -3.3, -5.0, 0.2, -0.8, -1.1, -1.4, -1.0, -1.2, -1.1, -1.1, -1.1, -1.2.
- Augmented primary deficit 1/: -3.0, -0.5, -1.3, -1.2, -0.8, -0.6, -0.1, -0.3, -0.9, -1.2, -1.1, -1.1, -1.1, -0.9.
- Total revenue 2/ (percent of GDP): 22.0, 20.0, 20.4, 21.1, 21.0, 21.4, 23.1, 23.4, 23.3, 23.0, 22.8, 22.6, 22.3, 22.9.
- Total expenditure 3/ (percent of GDP): 27.6, 26.3, 26.7, 24.7, 24.7, 24.7, 26.3, 26.5, 25.9, 25.3, 24.9, 24.6, 24.3, 25.3.
- Total primary expenditure (percent of GDP): 18.9, 19.5, 19.1, 19.8, 20.2, 20.8, 23.0, 23.2, 22.3, 21.9, 21.7, 21.5, 21.3, 22.0.
- Total Interest cost 4/ (percent of GDP): 8.7, 6.8, 7.6, 4.9, 4.5, 3.9, 3.2, 3.4, 3.6, 3.5, 3.2, 3.1, 3.0, 3.3.
- Nonrecurrent revenue (incl. Privatizations) (percent of GDP): 1.1, 0.4, 0.4, 0.4, 0.7, 0.7, 0.6, 0.5, 0.4, 0.4, 0.4, 0.4, 0.4, 0.4.
- Growth of real primary spending: 1.5%, 4.8%, -2.1%, 4.8%, 14.1%, 4.6%, 6.0%, 4.8%, -0.8%, 1.0%, 2.4%, 2.0%, 2.2%, 1.9%.
- Primary deficit (percent of GDP): -1.3, -1.2, -0.8, -0.6, -0.1, -0.8, 0.5, -0.2, -0.9, -1.2, -1.1, -1.1, -1.1, -0.9.
- Public sector debt-to-revenue ratio 5/: 248.4, 232.0, 226.2, 231.7, 220.7, 210.8, 209.2, 206.4, 204.8, 202.1, 200.4, 205.6 (table entries as presented).
- Gross financing need 6/: entries include values such as 12.0, 11.4, 12.8, 11.8, 11.9, 13.9, 14.9, 14.8, 15.4, 13.8 (in percent of GDP) and in billions of U.S. dollars values including 74.7, 74.1, 80.2, 78.5, 83.0, 101.9, 115.4, 120.8, 132.6, 105.3 (as presented).
- Debt-stabilizing augmented primary balance: -4.6, -0.3, -0.7, 2.5, 1.4, -1.4, 0.3, 0.0, 0.3, 0.0, 0.2, -0.1 (table entries).

Public sector debt — bound tests and alternative scenarios (selected):
- Bound tests 1–9: multiple stress cases showing gross public sector debt levels under shocks; examples include:
  - If effective real interest rate in 2005 and 2006 is on baseline plus 2 STD: debt entries show increases to 50.1, 50.4, 49.6, 48.5, etc.
  - If real growth in 2005 and 2006 is on average minus 2 STD: debt entries show increases to 51.9, 54.1, 53.4, 52.3, 51.5, 52.1.
  - Combined two standard deviation shock to real GDP growth, effective real interest rate and primary balance: debt entries rise to 54.5, 59.9, 59.2, 58.2, 57.4, 56.4 (2005–2009 entries).
  - One time 30 percent depreciation in 2005 (everything else baseline except primary deficit): debt entries rise to 53.9, 52.8, 52.0, 50.9, 50.1, 51.5.
- Alternative scenarios in D:
  - No policy change scenario: debt trajectory remains around 49.4–50.0 range (2004–09 entries).
  - Price of Mexican oil exports falls to 20 US$/bbl in 2005 and remains at that level: debt entries around 50.2–50.3 range.
  - No policy change scenario in pessimistic environment: debt increases to 51.3, 52.8, 54.9, 56.7, 58.9, 54.0 (2005–09 entries).

External debt — key findings and scenarios:
- Overall assessment: Sustainability of external debt appears resilient to a worsening economic environment under baseline and a scenario combining higher interest rates and lower oil prices.
- External debt-to-GDP ratio: Would remain in the 23–26 percent of GDP range throughout the projection period under baseline and country-specific (higher interest + lower oil) scenario.
- Under most extreme shocks (peso depreciation by about 24 percent in 2005 and 2006; or mix of higher nominal interest rates, lower GDP growth rates, and exchange rate depreciation by 1 standard deviation): External debt would approach 45 percent of GDP and 2006 gross external financing needs would double in US$ terms compared to 2004.
  - Note: Sample standard deviations are high because the historic series include Tequila crisis. Excluding 1994-96 lowers the 2006 projected debt-to-GDP ratio under the most extreme shock to below 38 percent of GDP.
- Figure 2 scenarios (summarized):
  - Baseline, collection of shocks (one standard deviation), depreciation (two standard deviations), alternative country-specific shock.
  - Gross external financing need (in billions of US$) and External debt-to-GDP ratio (in percent) shown for 2003–09 under these scenarios.

External debt — selected numeric indicators (from Table 2, Mexico: External Debt Sustainability Framework, 1999-2009)
- External debt (percent of GDP): 36.9 (1999), 28.4 (2000), 26.1 (2001), 25.2 (2002), 26.1 (2003), 24.5 (2004), 24.2 (2005), 23.9 (2006), 23.6 (2007), 23.4 (2008), 23.0 (2009).
- Change in external debt: -2.1, -8.5, -2.3, -0.8, 0.9, -1.7, -0.2, -0.3, -0.3, -0.3, -0.4 (1999–2009 entries).
- Identified external debt-creating flows (percent of GDP): -4.2, -5.1, -2.3, -0.8, 1.0, -1.5, -1.1, -0.8, -0.7, -0.4, -0.3.
- Current account deficit, excluding interest payments (percent of GDP): 0.2, 0.8, 0.9, 0.7, -0.1, -0.6, -0.5, -0.3, -0.3, 0.0, -0.1.
- Deficit in balance of goods and services (percent of GDP): 1.5, 1.8, 2.2, 1.8, 1.6, 1.6, 1.5, 1.7, 1.7, 1.9, 1.8.
- Exports (percent of GDP): 20.3, 20.4, 18.2, 17.6, 18.7, 20.8, 21.3, 21.3, 21.5, 21.5, 21.4.
- Imports (percent of GDP): 21.8, 22.2, 20.4, 19.4, 20.3, 22.4, 22.8, 23.0, 23.2, 23.4, 23.3.
- Net non-debt creating capital inflows (negative): -2.2, -1.8, -3.2, -2.0, -1.3, -1.6, -1.6, -1.6, -1.6, -1.5, -1.5.
- Automatic debt dynamics (percent of GDP): -2.1, -4.0, 0.1, 0.5, 2.4, 0.6, 1.0, 1.1, 1.1, 1.1, 1.3.
  - Contribution from nominal interest rate: 2.7, 2.4, 2.0, 1.4, 1.5, 1.6, 1.8, 1.8, 1.8, 1.8, 2.0.
  - Contribution from real GDP growth: -1.2, -2.0, 0.0, -0.1, -0.3, -1.0, -0.8, -0.7, -0.7, -0.7, -0.7.
  - Contribution from price and exchange rate changes: -3.6, -4.4, -2.0, -0.8, 1.2 (additional projected entries omitted in source excerpt).
- Residual, including change in gross foreign assets: 2.0, -3.5, 0.0, 0.0, -0.1, -0.1, 0.8, 0.5, 0.5, 0.2, -0.1.
- External debt-to-exports ratio (percent): 181.9, 139.3, 143.3, 143.3, 139.8, 117.6, 113.8, 112.2, 109.9, 108.8, 107.3.
- Gross external financing need (in billions of US$): 59.2, 72.4, 71.1, 60.1, 52.2, 43.2, 46.7, 51.3, 56.6, 61.0, 64.3.
- Gross external financing need (in percent of GDP): 12.3, 12.5, 11.4, 9.3, 8.2, 6.4, 6.6, 6.9, 7.2, 7.4, 7.4.

External debt — alternative scenarios and bound tests (selected)
- A1. Key variables at historical averages in 2005–09: external debt entries include 24.5, 23.6, 22.5, 21.3, 19.8, 18.1.
- A2. Country-specific shock of fall in oil prices: external debt entries include 24.5, 26.3, 26.4, 26.1, 25.8, 25.5.
- B1–B6 bound tests: demonstrate sensitivity to shocks such as higher nominal interest rates, lower real GDP growth, change in US dollar GDP deflator, non-interest current account shocks, combinations using one standard deviation shocks, and a one-time 30 percent nominal depreciation in 2005. Example outcomes:
  - B2 (Real GDP growth at historical average minus two standard deviations in 2005 and 2006): external debt entries increase to 24.5, 26.4, 28.4, 28.1, 27.8, 27.4.
  - B3 (Change in US dollar GDP deflator at historical average minus two standard deviations): external debt entries show large increases to 24.5, 31.6, 41.0, 40.7, 40.2, 39.7.
  - B6 (One time 30 percent nominal depreciation in 2005): external debt entries increase to 24.5, 34.1, 33.8, 33.5, 33.1, 32.7.

Projections and figures
- Figures present:
  - Figure 1: Mexico Gross Public Debt, 2001-2009 — baseline vs no policy change, lower oil price, no policy change with pessimistic environment (percent of GDP).
  - Figure 1.B: Debt Sustainability Shocks — baseline and shocks (real interest rate increase, GDP growth slowdown, primary balance decline, exchange rate shock).
  - Figure 2: Debt Ratio and Gross External Financing Need, 2003-09 — baseline, collection of shocks (one standard deviation), depreciation (two standard deviations), alternative country-specific shock (external debt-to-GDP ratio and gross external financing need in billions of US$).
- Statement by IMF Staff Representative: October 18, 2004 — additional information available since staff report; thrust of staff appraisal unchanged.

*Source: _cr04419 - 8. Develo (IMF staff report excerpts and annexes as provided in the source content).*

### 1.      Recent indicators are consistent with continuing economic recovery. The index

### _cr04419 - 1.      Recent indicators are consistent with continuing economic recovery. The index

### Recent activity and investment
- The index of overall economic activity rose by 3.5 percent in July over the previous year.
- Gross fixed investment increased by 8.6 percent over the same period.
- Retail sales grew by 4.8 percent (year-over-year for the period referenced).
- Industrial production rose by 4.7 percent in August over the previous year.

### Inflation, wages, and expectations
- Headline CPI inflation increased to 5.1 percent in September (12-month basis).
- Core inflation edged up to 3.8 percent.
- Contractual wage settlements rose to 4.8 percent in September after averaging 4½ percent in the first eight months of the year.
- In mid-October, Mexico's social security institute (IMSS) and its unions agreed on a 3 percent wage increase plus 1 percent in benefits for the next twelve months.
- Inflation expectations for end-2004 climbed further to 4.6 percent in the September survey.

### Monetary policy and exchange rate
- The Bank of Mexico (BOM) increased the corto for the sixth time this year on September 24.
- Domestic short-term interest rates rose in association with the tightening in U.S. monetary policy on September 21.
- Short-term rates have risen by close to 50 basis points since the beginning of September.
- The peso appreciated by about 2½ percent against the U.S. dollar since early September.

### Trade, oil exports, and reserves
- August trade: imports increased by 20.7 percent from the year-ago level, while exports increased by 27.3 percent reflecting higher oil exports and non-oil export volumes.
- Net international reserves stood at US$57.6 billion end-September, compared with US$57.2 billion at end-August.

### Mexican crude oil price outlook
- The price of the Mexican mix has averaged US$30.1 per barrel for the year through mid-October.
- Staff assumption for the year was U$31.4 per barrel for the year as a whole.
- The current spot price stands near US$40 per barrel, suggesting that the average price for the year could modestly exceed the staff’s assumption.

*Source: _cr04419 — IMF staff report content provided in the input.*

### 6.      On September 22, the government issued US$1 billion of 30-year bonds to pre-

### _cr04419 - 6.      On September 22, the government issued US$1 billion of 30-year bonds to pre-

### Bond issuances and external debt management
- On September 22, the government issued US$1 billion of 30-year bonds to pre-fund 2005 financing requirements.
- Issuance details:
  - Yield: 6.9 percent.
  - Implied spread: 210 basis points over U.S. treasuries.
  - High demand allowed increase of the amount issued from US$1 to US$1.5 billion.
- Pemex issuance:
  - Recently issued a US$1.75 billion perpetual bond with a coupon of 7.75 percent in Asian markets.
- Mexico continues to include collective action clauses (CACs) in bond issues.
- The US$1.5 billion fixed-rate 30-year placement helps pre-finance most of 2005 obligations and aligns with the external net debt-reduction target of US$500 million approved by Congress for the year.

### Macroeconomic outlook and recent performance
- GDP growth projections:
  - Expected growth in 2004: 4.0 percent.
  - Expected growth in 2005: 3.8 percent.
- Economic drivers and indicators:
  - Recovery linked to strength of global economy, particularly the US.
  - Manufacturing and maquila exports reflect world recovery; imports of intermediate goods anticipate industrial growth.
  - Consumption and investment have shown increased dynamism.
  - Recovery widespread across sectors with improved employment indicators.
- Current account:
  - Historically exceeded 7 percent of GDP in run-up to 1994-95 crisis; now down to a sustainable 1.5 -2.0 percent of GDP.
- International reserves:
  - Increased ten-fold over past ten years to close to US$60 billion.
  - Net international reserves increased to US$58 billion in August 2004, compared with US$48 billion at end-2002.
- Financial markets and domestic debt:
  - Maturity of yield curve extended up to 20 years.
  - Institutional investor interest in long-term fixed-rate domestic issuances increased.
  - Currently, almost 50 percent of domestic debt instruments with a maturity of one year or more are linked to fixed rates, compared to nearly 15 percent at the end of 2000.
  - Expected domestic debt share of public debt: 65 percent in 2005, compared to 53 percent in 2000.

### Inflation and monetary policy
- Inflation history and recent developments:
  - Over the last eight years inflation declined significantly; single digit inflation became the norm.
  - Inflation reached a figure under 4 percent at the end of 2003.
  - Inflation accelerated from 4 percent at end-2003 to 5.1 percent in September 2004 (PIN section).
  - Core inflation: 3.8 percent (PIN section).
- Sources of recent inflationary pressure:
  - Supply shocks: temporary suspension of some meat imports from the US, climate effects on agricultural prices, higher international prices for oil and other commodities.
  - Increases in administered prices resulting from non-discretionary formulas linking domestic prices to international references.
  - Cyclical recovery increases pass-through of supply shocks to consumer prices.
- Bank of Mexico policy stance:
  - Operates within an inflation-targeting scheme; carries out cautious analysis of inflationary pressures and their impact on expectations.
  - Has tightened monetary policy on six occasions this year.
  - Focus on limiting effects on inflation expectations from higher commodity prices, remaining vigilant against cyclical pressures from aggregate demand, and promoting orderly transition to higher interest rates.
  - Monetary policy announcements now follow a predetermined calendar and emphasize underlying inflation and the nature of price shocks.
- Debate on publication of official inflation forecasts:
  - Staff suggests publishing an official inflation forecast to improve communications when inflation is above target.
  - Authorities argue that an official forecast could create confusion or validate higher inflation expectations if forecasts differ from the target, potentially delaying disinflation.
  - Authorities note market participants produce inflation forecasts that remain within the central bank's variability interval and that the Bank of Mexico’s approach has yielded good results.

### Fiscal policy, savings, and composition of spending
- Fiscal balances and targets:
  - Fiscal deficit expected for 2004: 0.3 percent of GDP.
  - Target deficit for 2005: 0.1 percent of GDP.
  - Public Sector Borrowing Requirements (PSBR):
    - Expected to amount to 2.6 percent of GDP at end-2004.
    - Expected to amount to 2.1 percent of GDP in 2005.
- Role of oil revenues:
  - Public finances have benefited from oil windfall and recovery; authorities expect to meet fiscal targets without problems.
  - Income Law for last two years and for 2005 incorporated conservative assumptions for the oil price to avoid generating permanent expenditure pressures.
  - Excess revenues allocated to savings and investment rather than current public-sector consumption.
  - Budget Decree allocation formula for excess revenues (after deducting expected increase in non-programmable expenditures and decrease in other revenue sources):
    - 74.2 percent to savings vehicles (PEMEX trust fund, Oil Stabilization Fund and improvement of the public balance).
    - 25.8 percent to infrastructure investment in the states.
  - PEMEX share expected to be eventually allocated to investment in oil sector development (exploration, production, etc.), viewed as preserving wealth rather than current expenditure.
  - Authorities argue investment in development of Mexican oil sector yields a rate of return substantially larger than yield on financial assets such as T-bills.
- Assessment of savings:
  - Authorities contend the assumption that in 2004 savings have been small is incorrect; excess revenues are mostly allocated to investment and savings and are non-recurrent.
- Debt-service and risk management:
  - External public debt management strategy has produced a comfortable debt-service schedule due to rollover on favorable terms.
  - Shift towards domestic financing has reduced risks associated with reductions in flows to emerging markets.
  - Reduction in domestic financing cost improved private sector balance sheets and domestic market development.
  - To reduce interest rate risk, government will continue substituting floating-rate debt for new fixed-rate instruments.

### Debt-to-GDP ratio and international comparisons
- Exchange rate effects:
  - Recent debt-to-GDP path has been influenced more by exchange rate movements (peso-dollar and dollar-other currency exchange rates) than by fiscal indiscipline; authorities expect the debt-to-GDP share to return to a decreasing path.
- International comparisons:
  - Selected Issues paper on “Structure and Cost of Public Debt in Mexico” shows current broad public debt level in Mexico is lower than the median value of emerging market economies as a percentage of GDP.
  - Analysis contradicts characterization of Mexican debt in Staff Report paragraph 25 as “uncomfortably high” and suggests size of Mexican public debt does not itself prevent future rating upgrades.

### Output gap, productivity, and structural reform
- Staff baseline for potential output:
  - Baseline potential output growth for 2005-2009: 2.9 percent (staff assumption).
  - Authorities argue this is low due to TFP growth assumption influenced by large negative swings in the 1980s and 1990s.
- Authorities' critique and upward revision recommendation:
  - Reasons to revise potential growth upward:
    - Trend TFP growth should be higher.
    - Output gap is larger than estimated in the paper.
    - Process of returning to potential output should take 3-4 years at most.
    - Mexican economy still to benefit from recent financial sector reforms and a sounder banking system.
  - Authorities suggest average growth rate for 2005-2009 should be revised upwards by at least 0.5 percent.
- Structural reform importance:
  - Medium-term growth contingent on progress in reform agenda.
  - Lack of further economic reforms cited as explaining failure to deliver growth and development.
  - Authorities engaged in dialogue to reach consensus on reforms to boost productivity; legislative approval seen as in national interest.

### Statistical coverage and surveillance concerns
- Data transparency and dissemination:
  - Mexico observes the SDDS and posts metadata on the DSBB.
  - Since 2001 Mexico publishes the comprehensive measure Public Sector Borrowing Requirement, which includes financing needs of public entities and of private and social entities acting on the government’s behalf.
- Concerns about evenhandedness of Fund surveillance:
  - FAD internal report cited:
    - More than 80 percent of Latin American countries provide information on non-financial public enterprise sector.
    - Operations of public enterprises in Middle-Eastern countries often not covered; only 12 percent of OECD countries provide this information.
    - Coverage of fiscal targets in Fund programs in Latin America includes non-financial public sector figures in over 70 percent of cases, compared with an average of nearly 20 percent in the universe of country programs.
  - Authorities call on management and staff to design a plan to ensure all members are subject to the same scrutiny and indicators.

### Public Information Notice (PIN) highlights (IMF Executive Board conclusion)
- IMF Executive Board concluded the 2004 Article IV consultation with Mexico on October 18, 2004.
- Key points from PIN:
  - Broad-based recovery in 2004 after three years of weak activity.
  - Business confidence, investment, and FDI inflows strengthening; exports picked up sharply.
  - Economic activity accelerated to 3.8 percent in the first half of 2004 over the previous year.
  - Mexican manufactured exports grew 10½ percent (seasonally adjusted) in first seven months of 2004 over same period in 2003.
  - Inflation accelerated to 5.1 percent in September 2004 from 4 percent at end-2003; core inflation 3.8 percent.
  - Change in Banco de Mexico reserve-auction mechanism in March 2004:
    - Banco de Mexico pre-announces amount of dollars to be sold equal to 50 percent of net reserve accumulation in previous three-month period.
    - Sale of dollars now spread over following 12 months instead of three months to reduce volatility in amount sold throughout year.

*Source: _cr04419 - 6.      On September 22, the government issued US$1 billion of 30-year bonds to pre-*

### 3.7 percent of GDP in 2000 to 3.1 percent in 2003, gross public debt rose by about 1.75

### 3.7 percent of GDP in 2000 to 3.1 percent in 2003, gross public debt rose by about 1.75

### Fiscal developments and projections
- Augmented overall balance:
  - 2000: 3.7 percent of GDP
  - 2003: 3.1 percent of GDP
  - For 2004: expected to remain broadly unchanged
  - Draft budget for 2005: decline in the augmented deficit to 2.2 percent of GDP
- Traditional overall balance:
  - For 2004: would fall slightly to 0.4 percent of GDP (in line with budget targets)
  - Draft budget for 2005: traditional deficit would fall to 0.1 percent of GDP
- Gross public debt:
  - Rose by about 1.75 percentage points to 51 percent of GDP during 2000–2003
  - Vulnerabilities: a large portion of domestic debt either short term or linked to short-term interest rates
  - Public sector has a significant gross financing need
- Fiscal policy recommendations and observations from Directors:
  - Aim at saving significantly more of the excess oil revenues for the medium term (most Directors)
  - Some Directors considered use of part of these revenues for productive investments to be a prudent strategy
  - Establish stronger mechanisms to ensure a substantial portion of windfall is saved
  - Combine medium-term expenditure reduction with measures to achieve significant increases in non-oil revenues
  - Fiscal reforms urged, including formal fiscal responsibility principles based on augmented fiscal measures
  - Tax reform to raise non-oil revenues will be needed to avoid budget cuts jeopardizing spending in social areas and public infrastructure
  - Pension reform required to ensure fiscal accounts remain on a sound path
  - Enhance accountability and efficiency of public enterprises, including PEMEX, to strengthen fiscal position and raise infrastructure quality

### Monetary policy and market developments
- Banco de Mexico actions:
  - Tightened policy seven times since the beginning of 2004 via increases in the corto (the borrowed reserves objective)
- Interest rates and yields:
  - Overnight inter-bank (fondeo) rose from about 5 percent in January to slightly over 8 percent in mid-September
  - 10-year government bond yield increased from about 8½ percent in January to 10½ percent in September
  - Treasury bill rate (28-day cetes, in percent, annual average): 21.4 (1999–2000), 15.2 (2000), 11.3 (2001), 7.1 (2002), 6.2 (2003) [table entries preserved]
- Exchange rate and reserves:
  - Peso depreciated by 2 percent through end-September after falling by 6½ percent against the U.S. dollar in 2003
  - Change in net international reserves (end of period, billions of U.S. dollars): 0.6 (1999–2000), 2.8 (2000), 7.3 (2001), 7.1 (2002), 9.5 (2003)
- Market sentiment:
  - Investment-grade status maintained
  - EMBI+ spread: spike to 250 basis points in mid-May, fallen back to about 180 basis points
- Directors’ view on monetary policy:
  - Recognized success of inflation targeting in bringing inflation to low single-digit levels
  - Recent tightening of monetary stance viewed as appropriate to ensure credibility of commitment to lowering inflation
  - Tightening bias should remain until there are clear signs inflation expectations decline toward the long-term objective
  - Support for refining monetary policy announcements to signal views more directly to markets
  - Scope to further increase transparency and predictability in policy implementation, including moving to an interest rate instrument when conditions warrant
  - Publication of an official inflation forecast not recommended immediately given evolving instruments and potential added uncertainty, but to be kept under review
- Exchange rate regime:
  - Flexible exchange rate regime viewed as effective in cushioning external shocks
  - External competitiveness broadly consistent with sustainable balance of payments position
  - Rules-based mechanism for accumulating foreign reserves viewed as appropriate and transparent

### Debt management and financial sector
- Liability management operations:
  - Several operations, including an exchange of global bonds in early 2004, improved efficiency of the yield curve
- Domestic public debt management priorities:
  - Extending maturities
  - Improving liquidity of benchmark issues
  - Deepening domestic financial markets
- Remaining vulnerabilities:
  - Large portion of domestic debt short term or linked to short-term interest rates
  - Significant gross financing need for the public sector
- Directors’ recommendations on debt structure:
  - Continue to increase fixed–rate domestic–currency instruments
  - Extend the domestic yield curve
  - Diversify the investor base
- Banking sector and financial system:
  - Continued improvement in broad indicators of banking sector soundness
  - Banking system has a sound level of profitability and capital adequacy
  - Challenge: deepen financial activity without excessive risk-taking
  - Streamline financial regulation to encourage innovation and competition
  - Review nonbank financial sector and development banks to ensure they do not pose hidden financial risks

### Executive Board assessment and reform priorities
- Commendations:
  - Continued pursuit of sound macroeconomic policies
  - Signs of strengthened and more broadly based economic recovery; business confidence and investment have risen
  - Strong FDI inflows; exports have picked up; favorable market perceptions
  - Progress in modernizing the financial sector; balance sheets appear healthy
- Key challenges highlighted:
  - Bring inflation down to the long-term objective
  - Reduce debt vulnerabilities
  - Reinvigorate the program of structural reforms
- Structural reform agenda emphasized by Directors:
  - Fiscal reforms, including tax reform and pension reform
  - Enhance governance
  - Enhance flexibility in the labor market
  - Build consensus for reforms to promote private investment
  - Enhance competition in the telecommunications sector

### Selected economic and financial indicators (selected table entries preserved exactly)
- National accounts and prices (Annual percentage changes, unless otherwise indicated):
  - Real GDP: 3.6 6.6, 0.0, 0.6 1.3
  - Real GDP per capita 2/: 2.6 4.8, -1.5, -0.9 -0.2
  - Gross domestic investment (in percent of GDP): 23.5 23.7, 21.1, 20.8 19.8
  - Gross national savings (in percent of GDP): 20.5 20.6, 18.2, 18.6 18.4
  - Consumer price index (end period): 12.3 9.0, 4.4, 5.7 4.0
- External sector:
  - Exports, f.o.b. 3/: 14.8 21.8, -3.7, 0.6 4.3
  - Imports, f.o.b. 4/: 10.6 23.1, -1.7, -1.3 1.9
  - External current account balance (in percent of GDP): -2.9 -3.1, -2.9, -2.1 -1.4
  - Outstanding external debt (in percent of GDP): 37.0 28.3, 26.1, 25.2 26.1
  - Total debt service ratio 5/ (in percent of exports of goods, services, and transfers): 43.2 44.6, 38.4, 31.1 31.0
- Nonfinancial public sector (in percent of GDP):
  - Augmented overall balance 6/: -6.3 -3.7, -3.7, -3.3 -3.1
  - Traditional overall balance: -1.1 -1.1, -0.7, -1.2 -0.6
  - Net augmented public sector debt: 46.5 42.2, 41.5, 43.8 45.4
- Money and credit:
  - Monetary base: 43.5 10.7, 8.0, 17.0 15.0
  - Broad money (M4) (including public sector): 19.6 12.9, 16.0, 10.7 13.3
  - Treasury bill rate (28-day cetes, in percent, annual average): 21.4 15.2, 11.3, 7.1 6.2

*Source: IMF staff report content as provided in the supplied document excerpt.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04419.pdf_