## 1. Response of Foreign Exchange and Local Currency Bond Markets Post-May 22 ## Source details **Canonical URL:** [1. Response of Foreign Exchange and Local Currency Bond Markets Post-May 22](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13334.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13334.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13334.pdf.json) --- ### Context - Mexico maintained macroeconomic policy continuity while pursuing growth-enhancing reforms (education, labor, telecommunications). - Fiscal policy governed by a Fiscal Responsibility Law (FRL) since 2006. - Monetary policy under an inflation targeting framework with exchange rate flexibility. - 2011 FSAP Update: financial regulatory and supervisory framework found sound. - Authorities refrained from capital flow measures; macro-prudential framework aims to limit maturity and currency mismatches in the banking system. - External linkages and market integration: - China accounts for 23 percent of U.S. imports and Mexico accounts for 12 percent. - Foreign-owned banks account for about 70 percent of banking system assets. - The U.S. accounts for over half of Mexico’s foreign portfolio liabilities and foreign direct investment. - Mexican peso daily global trading volume: US$135 billion (BIS survey, April 2013). - Inclusion in the World Global Bond Index (WGBI) in 2010 sharply increased internationalization of the domestic sovereign bond market. ### Recent Macroeconomic Developments (2013) - Real GDP growth expected: 1.2 percent (2013), down from 3.6 percent (2012). - Output gap: -1.5 percent of potential GDP in Q2 2013. - Sector shares and developments: - Manufacturing: 16 percent of real GDP; non-automotive manufacturing exports showed virtually no growth. - Public spending: 16 percent of real GDP; fell by about 2 percent in real terms. - Construction: about 7 percent of real GDP; declined sharply. - Growth projection assumptions: - Strong rebound in second semester; manufacturing recovery with U.S. pickup; public spending regaining momentum; gradual construction recovery. - Inflation: - Headline inflation projected at 3½ percent by end-2013. - Core inflation at 2½ percent y/y since July 2013. - Inflation in services running at 2¼ to 2½ percent y/y since early 2013. - Medium-term inflation expectations anchored at 3½ percent. - Demand policies: - PSBR expected to reach 4.1 percent of GDP in 2013 (3.7 percent in 2012). - PSBR in first semester amounted to 1.0 percent of GDP. - Central bank reduced policy rate by 100 basis points to 3.50 percent in 2013. - External sector: - Current account deficit projected to widen to 1.7 percent of GDP in 2013. - Non-oil trade deficit expected to remain at 1 percent of GDP. - Oil trade surplus expected to fall to 0.6 percent of GDP. - Capital flows and markets: - Net capital inflows projected at about 4 percent of GDP in 2013. - Through April 2013, strong appreciation of the peso and compression in sovereign yields; after May 22 (Fed taper discussion) asset markets reversed; tapering delay in mid-September led to signs of recovery. - Late September government placed a record 10-year bond of US$3.9 billion at a spread of 135 basis points. - Central bank refrained from FX intervention in 2013; government shortened local debt duration. - Peso cumulative depreciation vis-à-vis USD: 6.6 percent through October 2013. ### Box 1 — Foreign Exchange Market Response Post-May 22 - Trigger: Bernanke’s May 22 remarks that asset purchases could be scaled back. - U.S. Treasury market reaction: - 10-year U.S. Treasury yield rose by about 60 basis points by mid-June 2013. - 10-year U.S. Treasury reached 2.7 percent by end-June after the June 18–19 meeting. - Fed expected to begin scaling back LSAP in Q1 2014 and start raising the Federal funds rate in early 2015. - FX market behavior: - Between May 22 and June 21, peso depreciation and volatility among the highest in emerging markets, but markets functioned in an orderly manner (normal bid-ask spreads, no unusual trading volume). - Central Bank did not intervene in FX markets or impose capital outflow restrictions. - Level and implied volatility of exchange rate fell since June; cumulative depreciation through October was 6.6 percent. - Peso liquidity explanation: - Deep and liquid FX markets, full convertibility, and 24-hour trading made the peso used as a hedge or proxy for other emerging markets. ### Box 1 — Local Currency Bond Market Response Post-May 22 - Sovereign bond yields: - Between May 22 and June 21, Mbono 10-year yield rose by about 130 basis points. - By end-October 2013, Mbono yield declined to 6.05 percent—an increase of about 100 basis points with respect to May 21. - Short-term government securities (CETES) rates fell in line with policy rate cuts of 50 basis points, steepening the yield curve. - Market microstructure: - Volatility of Mbono yields increased; signs of illiquidity as primary dealers scaled back market-making, intraday volatility rose, bid-ask spreads widened. - Contributing factors: broad-based scaling back of risk-taking, regulatory changes imposing higher capital charges on government securities, and possible implementation of the Volcker rule. - Hedging activity: - Investors hedged interest rate risk by shortening duration via interest rate swaps and offset currency risk in derivatives markets; hedging helped keep foreign holdings of government securities relatively stable. - Stability also reflects investor base broadening after inclusion in Citigroup’s World Government Bond Index in 2010. - Observed indicators referenced: changes in 10-year yields (bps), average maturity of local sovereign bonds (years), foreign M-Bono holdings (USD billions), 10-year bond volatility (percent, 30-day rolling). ### Banking System and Financial Sector Resilience - Banking system: about 60 percent of financial system assets. - Credit and capitalization: - Bank credit growth to private sector slowed from about 15 percent (nominal) in mid-2012 to 10 percent as of August 2013. - System capital adequacy ratio: 15.6 percent as of July 2013. - Even smallest banks well above new regulatory minimums adopted after Basel III implementation. - NPLs and provisions: - NPLs increased to 4 percent of total loans in July 2013 (3.1 percent at end-2012). - Provisions: 174 percent of NPLs. - Construction NPL ratio doubled to about 6 percent; most non-performing loans concentrated in three large home-builders and are fully provisioned. - Staff estimate: 2013 slowdown could raise NPL ratio by another 0.3 percentage points by end-year. - Non-bank financial institutions: - Hold about 40 percent of system assets; pension funds and mutual funds account for nearly two-thirds. - Pension and mutual fund assets grew faster than banks and are within regulatory perimeter. - Insurance sector profitable; life insurance ~40 percent of premiums. - Pension funds and insurance companies diversified away from government securities. ### Box 2 — Corporate Fund-Raising in Capital Markets - Issuance and syndicated loans: - Mexican firms issued bonds totaling US$9.0 billion between January 2013 and May 22, and US$13.6 billion between May 22 and end-September 2013. - Syndicated loans rose from US$3.4 billion (pre-May 22) to US$14 billion (post-May 22 to end-September). - Yields and maturities: - Average yield to maturity on domestic currency issuances increased from 5.7 percent to 7.3 percent across the two periods. - Foreign currency issuances average yield increased from 4.9 percent to 6.2 percent. - Average maturity shortened from 11.9 years to 9.6 years. - Equity market and FIBRAs: - Firms raised $11.4 billion through IPOs and follow-ons in first nine months of 2013 (compared with $8.4 billion for all 2012). - FIBRAs accounted for one-third of equity value raised; seven FIBRAs raised nearly $5.7 billion since 2011. ### Structural Reforms and Medium-Term Outlook - Staff growth projections: - Real GDP: 3.0 percent (2014). - 2015–2018: 3½ to 4 percent a year (staff); faster than previous potential growth estimate of 3–3¼ percent. - Output gap not expected to close until 2016. - Authorities’ view: reforms could boost growth to 4–5 percent a year (upside risk). - Projected macro time series (2012–2018) — Real GDP Growth: 3.6, 1.2, 3.0, 3.5, 3.7, 3.8, 3.8; Inflation (annual average): 4.1, 3.6, 3.0, 3.0, 3.0, 3.0, 3.0; Current Account Balance (percent of GDP): -1.2, -1.7, -1.9, -2.0, -1.9, -1.9, -1.8; Output Gap (percent of potential GDP): 0.8, -1.0, -0.9, -0.5, 0.0, 0.0, 0.0. - Key structural reforms (summarized): - Pacto por México to promote cooperation on reforms. - Energy reform (pending): private participation in hydrocarbons and electricity; modify Article 27 and 28; secondary laws needed. - Fiscal reform (approved Oct 2013): amendments to FRL, tax reform to boost tax revenues by 2.0 percent of GDP by 2018, universal pension and unemployment insurance. - Financial sector reform (Chamber approval Sept 2013; Senate pending): competition, consolidated supervision, formalize Basel III, strengthen bank resolution. - Education reform (approved Sept 2013): professional system for teachers. - Telecommunications reform (approved mid-2013): more foreign ownership in segments, new regulator, powers to force break-ups or asset sales. - Labor reform (approved late 2012): flexible contracts, streamlined labor dispute resolution. - Governance and transparency reforms (pending): National Anti-Corruption Commission, data protection autonomy, national gendarmerie. ### Fiscal Framework and PSBR Path - Government intends PSBR at 4.1 percent of GDP in 2014 to avoid fiscal contraction while below capacity. - Medium-term anchor: reduce PSBR to 2.5 percent of GDP by 2017 (fiscal plan sent to congress Sept 2013). - Oil assumptions: - Energy reform expected to increase oil production from 2.5 mbpd to 3.0 mbpd by 2018. - Budget based on export price of US$85 per barrel; staff projection US$98 per barrel. - Revenue and expenditure projections: - Non-oil tax revenues: from 10.0 percent of GDP (2013) to 10.6 percent by 2017–18. - Total expenditures: rise from 25.2 percent of GDP (2013) to 26.4 percent (2014), then decline to 25.0 percent by 2018. - Public debt trajectory: - Increase from 44 percent of GDP at end-2012 to 47 percent by 2016; decline to 46 percent by 2018. - FRL amendments: - PSBR explicit fiscal target; annual budget documents to include 5-year PSBR projections and numerical targets. - Cap on real expenditure growth applied to Structural Current Spending (SCS). - Transitory articles lock key elements through 2017; SCS cannot grow faster than 2 percent in real terms relative to prior-year budget. ### PRONAFIDE and Spending Caps (2014–2018) - PRONAFIDE to set annual goals and limits consistent with 2 percent annual SCS real growth limit. - Real growth in wage bill limited to 2.4 percent a year. - Real growth in subsidies not to exceed 2.6 percent a year. - Transfers for capital expenditure by state and local governments held constant in real terms after 2014. - Purchases of goods and services to rise by 0.5 percent a year in real terms. - Federal government to centralize procurement of health supplies. - Pacing investment: detailed capital expenditure schedule consistent with PSBR path; significant decline in non-PEMEX investment in relation to GDP with possible greater non-PEMEX investment by 2017–18. ### Monetary and Exchange Rate Policy - Central bank committed to adjust policy rate as necessary to keep annual inflation close to 3 percent target and to rely on exchange rate flexibility as shock absorber. - Staff simulations: current monetary stance broadly consistent with keeping inflation close to target given slow output gap closure. - Limited room for further monetary easing noted; policy interest rate only slightly positive in real terms. - Reserves and reserve accumulation mechanism: - No plans to modify PEMEX reserve acquisition mechanism. - Net international reserves: US$167 billion at end-2012; staff illustrative scenario projects rise to US$223 billion by end-2018. - Reserve coverage metrics (end-2012): Coverage of imports 4.5 months; Coverage of imports plus interest payments 4.9 months; Coverage of short-term debt at residual maturities 209 percent; Coverage of broad money 19 percent; Coverage of foreign portfolio liabilities 39 percent. ### Risks, Contagion Scenarios, and Policy Responses - Main external risk: less accommodative U.S. monetary policy and tail risks from faster-than-expected tightening. - Other external risks: slowdown in emerging markets, renewed European distress, weaker China. - Transmission channels: portfolio flows, limited banking-system direct transmission due to subsidiary structure and local deposits funding. - Authorities’ emphasized responses: - Maintain open capital account and exchange rate flexibility. - Preserve central bank credibility and anchored inflation expectations. - Contingency plans tested (used in Lehman crisis); FCL as an important safeguard. - Staff model findings (Box 4): - VECM: one-standard deviation impulse to U.S. rates (~10 basis points) → 6.2 basis points response in Mexican yields after two weeks; peaks at 12.8 basis points after two months (conditional pass-through ~1.3). - GPM scenarios: - Baseline: no change in U.S. Federal Funds rate; U.S. 10-year to 3.25 percent by end-2014; U.S. real GDP growth 2.6 percent (2014). - Faster U.S. recovery (1 percent higher for one year): Mexico growth higher by ~¾ percentage point; may require moderate policy rate increase. - Disorderly unwinding (yields rise without faster U.S. growth): tighter financial conditions in Mexico, slower growth; central bank could reduce policy rate if inflation expectations anchored but must monitor FX conditions. - Staff credit-risk model: 100 basis point rise in borrowing costs → NPL ratio up 70 basis points, concentrated in consumer credit. ### Public Debt, DSA Findings, and Stress Tests - Gross debt projected ~45 percent of GDP by end-2013. - Gross financing needs slightly above 11 percent of GDP in 2013 and 2014; average below 10 percent over forecasting period. - Debt profile: - Average maturity ~8 years by end-2012. - >80 percent of total debt at fixed rates. - ~76 percent of total debt denominated in local currency. - ~46 percent of gross debt held by non-residents on average during projection period. - DSA scenarios: public and total external gross debt sustainable over medium term even under extreme shocks. - Stress-test outcomes (selected): - Primary balance shock: primary balance -2.5 percent of GDP by 2015; debt-to-GDP peaks at 53.4 percent in 2015; gross financing needs increase to 8.6 percent of GDP by 2018. - Interest rate shock: permanent nominal rate increase 200 bps from 2014; average interest rate rises to 8.2 percent by 2018; debt-to-GDP reaches 48 percent. - Combined shock: debt stabilizes at about 57 percent of GDP by 2018; no signal of unsustainable trajectory over forecasting horizon. - Stochastic simulations: - 75 percent probability debt <50 percent over medium term. - With restrictions on positive primary-balance shocks, debt path <58 percent of GDP with 90 percent probability. - Alternative quarterly VAR: median debt begins downward trajectory from 2017; median public debt 45½ percent of GDP by 2022. ### Staff Appraisal and Policy Recommendations - Resilience reflects confidence in sound and predictable policy management, exchange rate flexibility, and open accounts. - Staff supports current monetary stance given slack; endorses new fiscal framework but would have preferred a somewhat tighter fiscal stance in 2014. - Key recommendations: - Maintain careful management of spending and revenues to meet medium-term PSBR target. - Preserve gains from elimination of domestic gasoline subsidy. - Simplify oil stabilization funds (staff recommended). - Strengthen monitoring of private-sector indebtedness and balance-sheet exposures; develop comprehensive balance-sheet data on corporates and households. - Exercise CNBV’s new powers judiciously; remain vigilant that development banks’ role does not hinder commercial intermediation. - Complete adoption of expected loan loss provisioning for commercial loans by end-2013. - Strengthen supervision of mixed conglomerates and oversight of Sofomes (reporting to credit bureaus, registration, AML compliance). ### Key Statistics (selected exact figures from source) - Real GDP growth: 3.6 (2012); 1.2 (2013); 3.0 (2014, proj. staff). - PSBR: 3.7 percent of GDP (2012); 4.1 percent of GDP (2013). - Policy interest rate: 3.50 percent (end-2013 after 100 bps cut). - Headline inflation: projected 3½ percent by end-2013. - Core inflation: 2½ percent y/y since July 2013. - Cumulative peso depreciation vis-à-vis USD through October 2013: 6.6 percent. - Net capital inflows (projected): about 4 percent of GDP in 2013. - Foreign bond issuance by Mexican firms: US$9.0 billion (Jan–May 22, 2013); US$13.6 billion (May 22–end-Sept 2013). - Average yields: domestic currency issuances 5.7 percent → 7.3 percent (pre → post); foreign currency issuances 4.9 percent → 6.2 percent (pre → post). - Average maturity (weighted): 11.9 years (pre); 9.6 years (post). - Banking system capital adequacy ratio: 15.6 percent (July 2013). - NPL ratio: 4.0 percent (July/Sept 2013); 3.1 percent (end-2012). - Provisions: 174 percent of NPLs (July 2013). - Gross international reserves: US$167 billion (end-2012). - Reserve coverage metrics (end-2012): Coverage of imports 4.5 months; Coverage of imports plus interest payments 4.9 months; Coverage of short-term debt at residual maturities 209 percent; Coverage of broad money 19 percent; Coverage of foreign portfolio liabilities 39 percent. - Public debt trajectory: 44 percent of GDP (end-2012) → 47 percent by 2016 → 46 percent by 2018. - Tax reform revenue target: boost tax revenues by 2.0 percent of GDP by 2018. - Budget oil price assumption: US$85 per barrel (authorities) vs. staff projection US$98 per barrel. - Projected net international reserves under illustrative scenario: US$167 billion (end-2012) → US$223 billion (end-2018). *Source: IMF staff report excerpt (Mexico).* ### 1. Response of Foreign Exchange and Local Currency Bond Markets Post-May 22 ________________7 ### 1. Response of Foreign Exchange and Local Currency Bond Markets Post-May 22 ### Context - Mexico has maintained macroeconomic policy continuity while pursuing growth-enhancing reforms, including laws to upgrade education, make labor markets more flexible, and foster competition in telecommunications. - Fiscal policy has been governed by a Fiscal Responsibility Law (FRL) since 2006. - Monetary policy operates under an inflation targeting framework with a firm commitment to exchange rate flexibility. - The 2011 FSAP Update found the financial regulatory and supervisory framework was sound. - Authorities have refrained from adopting any capital flow measures. - The macro-prudential framework aims at limiting maturity and currency mismatches in the banking system. - Congress debated a fundamental reform of the energy sector and was finalizing approval of a reform to broaden access to financial markets; in October 2013 Congress modified the fiscal framework, reformed the main taxes, and introduced a universal pension scheme and unemployment insurance. - Mexico’s external linkages: - China accounts for 23 percent of U.S. imports and Mexico accounts for 12 percent. - Foreign-owned banks account for about 70 percent of banking system assets and operate as subsidiaries regulated by the CNBV. - The U.S. accounts for over half of Mexico’s foreign portfolio liabilities and foreign direct investment. - Based on a BIS survey, the Mexican peso has a daily global trading volume of US$135 billion and is the most actively traded emerging market currency in the world. - Inclusion of Mexico in the World Global Bond Index (WGBI) in 2010 sharply increased internationalization of the domestic sovereign bond market. ### Recent Macroeconomic Developments (2013) - Real GDP growth expected to slow to 1.2 percent (down from 3.6 percent in 2012). - Output gap estimated at -1.5 percent of potential GDP in Q2 2013. - Sectoral notes: - Manufacturing accounts for 16 percent of real GDP; non-automotive manufacturing exports showed virtually no growth. - Public spending accounts for 16 percent of real GDP and fell by about 2 percent in real terms. - Construction accounts for about 7 percent of real GDP and declined sharply. - Growth projection for 2013 assumes: - A strong rebound in the second semester. - Manufacturing recovering with a pick-up in U.S. manufacturing. - Public spending regaining momentum. - Gradual recovery in construction, with risks from financial difficulties of large homebuilders. - Inflation dynamics: - Headline inflation projected at 3½ percent by end-2013—somewhat above the target of 3 percent. - Core inflation at 2½ percent y/y since July 2013. - Inflation in services running at 2¼ to 2½ percent y/y since early 2013. - Medium-term inflation expectations anchored at 3½ percent. - Demand policies: - Public sector borrowing requirement (PSBR) expected to reach 4.1 percent of GDP in 2013 (compared with 3.7 percent of GDP in 2012). - PSBR in the first semester amounted to 1.0 percent of GDP. - Central bank reduced policy rate by a total of 100 basis points to 3.50 percent in 2013. - External sector: - Current account deficit projected to widen to 1.7 percent of GDP in 2013. - Non-oil trade deficit expected to remain at 1 percent of GDP. - Oil trade surplus expected to fall to 0.6 percent of GDP. - Fund’s current account model and EBA metrics suggest the current account balance and real exchange rate are broadly in line with fundamentals and desirable policy settings. - Capital flows and markets: - Net capital inflows projected to remain steady at about 4 percent of GDP in 2013. - Through April 2013, investor appetite underpinned by prospects for structural reforms and ample global liquidity, generating strong appreciation of the peso and compression in sovereign debt yields. - After May 22 (Fed tapering discussion) asset markets reversed for several months. - In Q2 2013, gross capital inflows from non-residents, especially portfolio investment, fell sharply; residents partly cushioned the shift by increasing outflows accumulation abroad (i.e., keeping more funds within Mexico). - Delay in tapering announced by the Fed in mid-September led to signs of recovery in capital inflows. - In late September, government placed a record 10-year bond of US$3.9 billion at a spread of 135 basis points. - Central bank refrained from any foreign exchange market intervention in 2013; government shortened duration of local debt issuance. - Cumulative depreciation of the peso vis-à-vis the U.S. dollar was 6.6 percent through October 2013. ### Box 1 — Foreign Exchange Market Response Post-May 22 - Trigger: Federal Reserve Chairman Bernanke’s May 22 remarks that asset purchases could be scaled back. - U.S. Treasury market reaction: - Yield on 10-year U.S. Treasury rose by about 60 basis points by mid-June 2013. - After the June 18–19 meeting, the 10-year U.S. Treasury reached 2.7 percent by end-June. - Fed expected to begin scaling back LSAP in Q1 2014 and start raising the Federal funds rate in early 2015. - FX market behavior: - Between May 22 and June 21, peso depreciation and volatility were among the highest in emerging markets, but markets functioned in an orderly manner (normal bid-ask spreads and no unusual trading volume movements). - Central Bank did not intervene in FX markets or impose capital outflow restrictions. - The level and implied volatility of the exchange rate fell since June; cumulative depreciation through October was 6.6 percent. - Peso liquidity explanation: - Mexico’s deep and liquid FX markets, full convertibility, and 24-hour trading may have led investors to use the peso as a hedge or proxy for other emerging markets. - BIS rank in global FX turnover (April 2013) and depreciation vis-à-vis USD May 22–June 21 are noted in figures. ### Box 1 — Local Currency Bond Market Response Post-May 22 (Concluded) - Sovereign bond yields: - Between May 22 and June 21, Mbono 10-year yield rose by about 130 basis points. - By end-October 2013, Mbono yield had declined to 6.05 percent—an increase of about 100 basis points with respect to May 21. - Short-term government securities (CETES) rates fell in line with policy rate cuts of 50 basis points, steepening the yield curve. - Market microstructure: - Volatility of Mbono yields increased and some illiquidity signs surfaced (primary dealers scaled back market-making, higher intraday volatility, wider bid-ask spreads). - Contributing factors cited: broad-based scaling back of risk-taking, regulatory changes imposing higher capital charges on government securities, and possible implementation of the Volcker rule. - Hedging activity: - Investors hedged interest rate risk by shortening duration via interest rate swaps and offset currency risk in derivatives markets. - Ability to hedge helped keep foreign holdings of government securities relatively stable. - Stability also reflects broadening of investor base after inclusion in Citigroup’s World Government Bond Index in 2010. - Market indicators presented: - Change in local currency sovereign bond yields (10yr, bps) since May 22. - Average maturity of local sovereign bonds (years) and Mexico 10-year bond yield. - Foreign M-Bono holdings (USD billions). - Mexico & U.S. 10-Year Bond Volatility (In percent, 30-day rolling standard deviation). ### Banking System and Financial Sector Resilience - Banking system accounts for about 60 percent of financial system assets. - Credit and capitalization: - Expansion in bank credit to private sector slowed from about 15 percent in nominal terms in mid-2012 to 10 percent as of August 2013. - System capital adequacy ratio stood at 15.6 percent as of July 2013, largely unchanged from a year earlier. - Larger banks have more comfortable ratios; even smallest banks are well above new regulatory minimums adopted after Basel III implementation. - Non-performing loans (NPLs) and provisions: - NPLs increased to 4 percent of total loans in July 2013, from 3.1 percent at end-2012. - Provisions amounted to 174 percent of NPLs. - Pockets of vulnerability in construction (NPL ratio doubled to about 6 percent) and segments of consumer lending (especially payroll lending). - Banking sector credit to construction represents only around 9 percent of total credit. - Most non-performing loans concentrated in the largest three home-builders and these are fully provisioned. - Staff estimates: the 2013 growth slowdown could raise the NPL ratio by another 0.3 percentage points by end-year. - Non-bank financial institutions: - Hold about 40 percent of financial system assets; pension funds and mutual funds account for nearly two-thirds of that total. - Growth rate of assets of pension and mutual funds has been higher than banks in recent years and both are within the authorities’ regulatory perimeter. - Unregulated entities (Sofomes and Sofoles) are numerous but account for a small share of system assets. - Insurance sector is profitable with moderate growth; life insurance accounts for about 40 percent of premiums. - Pension funds and insurance companies remain important institutional investors in domestic markets and have diversified away from government securities. ### Box 2 — Corporate Fund-Raising in Capital Markets - Access to capital markets in 2013 remained firm despite U.S. monetary policy signals. - Issuance and syndicated loans: - Mexican firms issued bonds totaling US$9.0 billion between January 2013 and May 22, and US$13.6 billion between May 22 and end-September 2013. - Syndicated loans rose from US$3.4 billion in the first period to US$14 billion in the second period. - Yield and maturity changes: - Average yield to maturity on domestic currency issuances increased from 5.7 percent to 7.3 percent across the two periods. - For foreign currency issuances, average yield increased from 4.9 percent to 6.2 percent. - Firms faced a shortening of maturities from an average of 11.9 years to [text truncated in source]. *Source: IMF staff report excerpt titled "Response of Foreign Exchange and Local Currency Bond Markets Post-May 22" (Mexico).* ### 9.6 years. ### _cr13334 - 9.6 years. ### Capital markets and corporate financing - Compared to other countries in the region, Mexican capital markets have been relatively unscathed by market uncertainty. - Corporate Financing in LAC (Bond Issuances + Syndicated Loans denominated in local and foreign currencies; USD, billions): - Pre: 9.0 - Post: 13.6 - Share in Foreign Currency (in percent, weighted by value): - Pre: 34.3 - Post: 72.9 - Yield to Maturity, Foreign Currency (in percent, weighted by value): - Pre: 4.9 - Post: 6.2 - Average Maturity (in years, weighted by value): - Pre: 11.9 - Post: 9.6 - The total value of bond issuances and syndicated loans in the four comparator Latin American countries has dropped significantly in the post-May 22 period; firms in Brazil, Colombia, Peru, as well as Mexico, also face higher interest rates. ### Equity market activity and FIBRAs - In the first nine months of 2013, firms raised $11.4 billion through IPOs and follow-on offerings, compared to $8.4 billion for all 2012. - Several additional IPOs are planned in the rest of 2013. - Issuances this year have been buoyed by an increasing interest in FIBRAs: - FIBRAs accounted for one-third of the total value raised in the equity market. - Since the first FIBRA entered the market in 2011, the now seven FIBRAs listed on the stock exchange have raised nearly $5.7 billion. ### Bond market: terms and yields post-May 22 - Mexico Bond Issuances: Hardening of Terms Post May 22 (Jan. 2013 - May 22; May 22 - Sept. 30) — issuance terms hardened and yields increased in the post-May 22 window. - Average Yield-to-Maturity on Domestic Currency Corporate Bond Issuances (in percent, weighted by dollar amount of issuance) increased across several countries (chart referenced). ### Structural reforms and medium-term outlook - Staff view: - Real GDP is projected to rise by 3.0 percent in 2014. - For 2015–2018, staff projects real GDP would grow by 3½ to 4 percent a year (faster than the previous estimate of potential growth of 3–3¼ percent). - Staff estimates that the output gap would not close until 2016. - Authorities view: - Authorities believed that the reforms would boost growth to the range of 4 to 5 percent a year and saw the reforms as a source of upside risk to the outlook. - Projected macro time series (2012–2018): - Real GDP Growth: 3.6, 1.2, 3.0, 3.5, 3.7, 3.8, 3.8 - Inflation (annual average): 4.1, 3.6, 3.0, 3.0, 3.0, 3.0, 3.0 - Current Account Balance (percent of GDP): -1.2, -1.7, -1.9, -2.0, -1.9, -1.9, -1.8 - Output Gap (percent of potential GDP): 0.8, -1.0, -0.9, -0.5, 0.0, 0.0, 0.0 - Structural reforms can increase potential output via higher hydrocarbon production, increased competition (especially in telecommunications), financial deepening, and enhanced labor market flexibility. ### Key structural reforms (Box 3) - Pacto por México: agreement to promote political cooperation on structural reforms; by end-2013, expected congressional approval of over a half dozen major reforms. - Energy reform (approval pending): - Opens door for more private sector participation in hydrocarbons and electricity; would modify Article 27 and Article 28; retains that hydrocarbon resources belong to the Mexican people; secondary laws needed for implementation. - Fiscal reform (tax reform approved in October 2013; amendments to the Fiscal Responsibility Law (FRL) in reconciliation): - Amendments to FRL: require government to commit to a target for the Public Sector Borrowing Requirement (PSBR) consistent with a desired debt path; limit current spending growth (net of pensions, interest payments, fuel costs of the state electricity company and revenue sharing). - Tax reform to boost tax revenues by 2.0 percent of GDP by 2018. - Expands social safety net through universal pension and unemployment insurance. - Financial sector reform (approved by Chamber of Deputies in September 2013; Senate approval pending): - Foster greater competition, grant more flexibility to development banks, improve loan guarantees and collateral, streamline dispute resolution via specialized business courts, strengthen regulatory powers, enhance consumer protection, establish consolidated supervision of financial conglomerates, formalize Basel III rules (including countercyclical capital buffer and liquidity standards), strengthen bank resolution procedures. - Education reform (approved in September 2013): - Create a professional system for evaluating, hiring, assigning and promoting teachers; reduce labor unions’ interference in access to teaching positions. - Telecommunications reform (approved in mid-2013): - Allows more foreign ownership in segments including satellite communications; creates a new regulatory body with powers to grant/revoke concessions and force break-ups or asset sales; removes barriers to enforcement and resolution of disputes. - Labor reform (approved in late 2012): - Introduces new contractual modalities including flexible labor contracts; streamlines settlement of labor lawsuits and caps compensation for unjustified dismissals; prioritizes productivity and labor skills over seniority for promotion and vacancies. - Governance and Transparency reforms (pending): - Create a National Anti-Corruption Commission; expand autonomy and powers of the Federal Institute for Access to Public Information and Data Protection; creation of a national gendarmerie as part of security reform. ### Balance of payments illustrative scenario and reserves - Staff illustrative scenario: - Rise in external current account deficit to about 2 percent of GDP in 2015–16. - Assumes foreign direct investment rises to 1½–2 percent of GDP a year over the medium term, compared with less than 1 percent of GDP in recent years. - Investments would lead to an oil trade surplus of 0.8 percent of GDP by 2018 (compared with balance in a no-reform scenario). - Net international reserves would rise from US$167 billion at end-2012 to US$223 billion by end-2018, allowing the central bank to broadly keep the reserve coverage ratio constant in terms of portfolio investment. ### Risks, contagion scenarios, and policy responses - Main external risk: shift toward less accommodative monetary policy in the U.S.; tail risks from faster-than-expected tightening of U.S. financial conditions. - Other external risks: slowdown in emerging markets, reemergence of financial distress in Europe, disappointing activity in EMs or deeper slowdown in China. - Transmission channels: portfolio capital flows (reassessment of risk premia in EMs), some effect on exports; limited direct transmission through the banking system (funded largely through local retail deposits, subsidiary structure for foreign-owned banks). - Authorities’ emphasized policy response to contagion scenarios: - Maintain strong policy framework including an open capital account and reliance on exchange rate flexibility as a key policy buffer. - Maintain credibility in the central bank’s inflation targeting regime by keeping inflation expectations strongly anchored. - Mexico: Risk Assessment Matrix (selection): - Slippages in achieving medium-term fiscal targets — Likelihood: L; Impact: H; Policy response: Maintain expenditure control. - Protracted economic and financial volatility, especially in emerging markets (triggered by prospective exit from UMP in advanced countries) — Likelihood: H; Impact: H; Policy response: Exchange rate flexibility, together with provision of FX liquidity. Monetary policy response would depend on domestic economic conditions. - Significant deceleration in the United States (for example from a fiscal shock) — Likelihood: L; Impact: H; Policy response: Exchange rate flexibility as a first line of defense, coupled with monetary easing and automatic stabilizers. - Lower than anticipated EM growth potential — Likelihood: M; Impact: L; Policy response: Exchange rate flexibility, together with provision of FX liquidity. - Bond market stress in the US due to fiscal sustainability concerns — Likelihood: L; Impact: H; Policy response: Exchange rate flexibility, together with provision of FX liquidity. Monetary policy response would depend on domestic economic conditions. ### Stronger fiscal framework and tax measures - Previous FRL: set a balanced budget target excluding investment by PEMEX (a ‘traditional deficit’ of about 2 percent of GDP a year) with escape clauses; complex network of four oil stabilization funds handled oil price windfalls; PSBR usually larger than traditional deficit; PSBR declined from 5.1 percent of GDP in 2009 to 3.7 percent of GDP in 2012. - New FRL amendments: - Make the PSBR an explicit fiscal target in addition to the traditional measure of the deficit. - Annual budget documents must include 5-year projections for the PSBR consistent with a sustainable debt path and specific annual numerical targets. - Require the government to set a cap on real expenditure growth, applied to Structural Current Spending (SCS) as defined in the report. - Retains the current structure of the four oil stabilization funds; staff recommended simplifying these funds. - Tax reform highlights: - Moderately raised non-oil tax revenue and phased out subsidies on domestic sales of gasoline. - Key measures: extension of the 16 percent value-added tax to firms in border regions; increase in income tax by broadening the tax base and applying higher tax rates to high income earners; an 8 percent ‘junk food’ tax; a mining tax. - Domestic gasoline subsidy to be phased out by end-2014; afterwards domestic gasoline price will rise with domestic inflation and further with increases in international gasoline prices. - Staff noted projected revenue yield of the tax reform is realistic but subject to risks; tax reform will lead only to a modest increase in non-oil tax revenues and further reform may be required in a few years. - Fiscal regime for PEMEX to be updated in the context of the energy reform. *International Monetary Fund: Mexico staff report (content unit: _cr13334 - 9.6 years.)* ### 20. In the context of this new framework, the government defined a path for the PSBR ### _cr13334 - 20. In the context of this new framework, the government defined a path for the PSBR ### Fiscal framework and PSBR path - Government intends to keep the PSBR at 4.1 percent of GDP in 2014 to avoid a fiscal contraction while the economy is operating well below capacity. - Medium-term anchor: reduce the PSBR to 2.5 percent of GDP by 2017, as stated in the fiscal plan sent to congress in September 2013. - Oil production and revenue assumptions: - Energy reform expected to increase oil production from 2.5 million barrels per day (mbpd) to 3.0 mbpd by 2018. - Budget based on an export price of US$85 per barrel for Mexico’s oil mix, which is below the staff projection of US$98 per barrel. - Tax and expenditure projections: - Non-oil tax revenues to rise from 10.0 percent of GDP in 2013 to 10.6 percent by 2017–18. - Total expenditures to rise from 25.2 percent of GDP in 2013 to 26.4 percent in 2014. - Expenditures projected to decline to 25.0 percent of GDP by 2018 as spending caps become effective and electricity costs are contained. - Spending increases in 2014 reflect adjustments to avoid under-budgeting, higher public investment, and costs associated with reforms such as the universal pension and unemployment insurance. ### Public debt, DSA findings, and fiscal institutional coverage - Public debt trajectory implied by the fiscal path: - Increase from 44 percent of GDP at end-2012 to 47 percent by 2016. - Decline to 46 percent by 2018. - DSA scenarios suggest Mexico’s public and total external gross debt levels are sustainable over the medium term, even under the most extreme shocks. - Assessment observations: - Adjustment of the cyclically-adjusted primary balance in line with the authorities’ medium-term plan does not provide warning signals of being unsustainable, considering pre-2009 Mexican data and cross-country evidence on recent fiscal adjustments. - Broad institutional coverage of Mexico’s public debt includes development banks and other key public entities such as PEMEX, supporting that gross public sector liabilities are well captured. - Mexico’s favorable currency and maturity debt structure implies relatively small pass-through of interest rate or exchange rate shocks, and low budget risks from these shocks over the projection period. - The new FRL includes steps to strengthen subnational government finances by limiting debt-taking and enhancing reporting requirements. ### Staff assessment and 2014 stance - Staff endorsed the new fiscal framework as allowing more effective control of fiscal policy. - Staff view: a somewhat tighter fiscal stance in 2014 would be preferable, but initiating fiscal tightening is not advisable when the economy is operating below capacity. - Spending in 2014 is based on a conservative world oil price projection, which could yield opportunities to achieve a somewhat lower PSBR. - Staff emphasized the importance of careful management of spending and revenues over the next three to four years to entrench confidence that the medium-term PSBR target can be reached. ### Transitory articles, spending caps, and PRONAFIDE - The new FRL will include transitory articles that lock in key fiscal policy elements through 2017 and set ambitious targets to control current spending. - Transitory provisions: - SCS (structural current spending) cannot grow faster than 2 percent in real terms relative to the budget approved in the previous year. - This 2 percent real growth limit is about half of the projected growth in 2014 and lower than the 5 percent real growth during 2006–2013. - The ceiling will apply to spending execution throughout the year. - Five-year fiscal projections indicate these spending caps are consistent with reducing the PSBR to 2.5 percent of GDP by 2017. - Legal provisions to secure compliance will focus on: - Curbing under-budgeting practices by establishing binding constraints on the real growth in expenditure ceilings during both the budget process and execution stage. - Setting medium-term spending goals via PRONAFIDE (The Medium Term Development Financing Program) for 2014–2018, including annual goals and limits for specific budget categories consistent with the 2 percent annual growth limit on SCS. - Real growth in the wage bill limited to 2.4 percent a year, implying a decline in wages in relation to GDP; supported by centralization of the education payroll at the federal level and opening of new teaching positions. - Real growth in subsidies not to exceed 2.6 percent a year. - Transfers for capital expenditure by state and local governments held constant in real terms after 2014. - Purchases of goods and services to rise by 0.5 percent a year in real terms. - Federal government to centralize procurement of health supplies to reduce costs and enhance inventory controls. - Pacing investment: PRONAFIDE will establish a detailed capital expenditure schedule consistent with the medium-term PSBR path, including a significant decline in non-PEMEX investment in relation to GDP, with possible greater scope for non-PEMEX investment by 2017–18 as energy reform allows more private investment. ### Monetary and exchange rate policy - Central bank commitment: - Adjust policy rate as necessary to keep annual inflation close to the 3 percent inflation target. - Rely on exchange rate flexibility to help the economy adapt to global shifts. - Staff simulations: - With the output gap projected to close very slowly, the current stance of monetary policy is broadly consistent with keeping inflation close to the target. - Authorities noted limited room for further monetary easing given fiscal stance and that the policy interest rate was only slightly positive in real terms. - Exchange rate flexibility continues to function as a shock absorber; despite recent spikes in exchange rate volatility, there have been no balance-sheet or pass-through effects from exchange rate adjustments. - Reserves and reserve accumulation mechanism: - No plans to modify the mechanism for acquisition of reserves from PEMEX’s net trade balance. - Increase in international reserves will broadly maintain most coverage ratios at similar levels, except for a notable increase in the coverage of short-term debt. - As of end-2012, reserves were at the lower end of the 100 to 150 percent desired coverage of the Assessing Reserve Adequacy (ARA) metric. - Reserve coverage metrics as of end-2012: - Coverage of imports: 4.5 months. - Coverage of imports plus interest payments: 4.9 months. - Coverage of short-term debt at residual maturities: 209 percent. - Coverage of broad money: 19 percent. - Coverage of foreign portfolio liabilities: 39 percent. ### Risks from U.S. monetary normalization and contingency planning - Main external risk: developments in the U.S. economy due to close links between the two countries. - Authorities anticipate a smooth U.S. Fed transition to less accommodative policy, but recognize tail risks from: - Normalization of U.S. monetary policy and unwinding a very large balance sheet. - Potential U.S. debt limit impasses. - Contingency plans: - Authorities have tested contingency plans (many used in the Lehman crisis) to manage tail risks. - Fund support through the FCL is an important safeguard and part of these plans. - Exchange rate flexibility retained as an important buffer. - Continued careful public debt management is necessary, especially if investors reduce duration risk in sovereign debt portfolios. - Policy interplay under scenarios: - In an orderly tapering with a more rapid rise in 10-year U.S. treasury yields associated with faster U.S. growth, Mexico could experience faster growth and might require a hike in the policy interest rate depending on domestic conditions. - Conversely, higher U.S. yields with slower U.S. growth could provide scope for a lower policy interest rate in Mexico, relying on strong credibility of monetary policy to keep inflation expectations anchored. ### Spillover effects of U.S. monetary policy normalization (Box 4 — model findings) - Impact on Mexican yields: - VECM estimates: a one-standard deviation impulse to U.S. rates (about 10 basis points) translates into a 6.2 basis point response after two weeks and peaks at 12.8 basis points (a conditional pass-through of nearly 1.3) after two months. - Mexican 10-year yields after May 22 moved in line with fundamentals; no evidence of overshooting. - Small open economy macroeconomic model (GPM-based) scenarios: - Baseline assumptions: - No change in the U.S. Federal Funds rate. - Rise in the yield on 10-year U.S. treasuries to 3.25 percent by end-2014. - Real GDP growth in the U.S. of 2.6 percent in 2014. - Under baseline, current monetary stance broadly consistent with keeping inflation close to target. - Faster U.S. recovery scenario: - A simulation assuming a 1 percent faster rate of growth in the U.S. for one year implies growth in Mexico higher by about ¾ of a percentage point and may require a moderate policy rate increase to keep inflation on target. - Disorderly unwinding scenario (yield rises without faster U.S. growth): - Financial conditions in Mexico tighten and lead to slower growth. - If inflation expectations remain well anchored, the central bank could have scope to reduce its policy rate somewhat but would need to monitor FX market and possibly use policy rate to preserve orderly FX conditions. - Financial channel and credit risk: - Strength of bank balance sheets and sound regulation should mitigate banking sector risks. - Staff’s credit risk model: a 100 basis point rise in borrowing costs would raise the NPL ratio by 70 basis points, concentrated mainly in consumer credit. ### Financial sector resilience and reforms - Authorities’ assessment: - Banking system remained sound with sufficient cushions to handle recent increases in NPLs and market volatility. - Supervision is strong and risks closely monitored (2011 FSAP Update findings referenced). - Recent asset-quality deterioration in construction sector largely due to financial distress of three large homebuilding firms; banks’ capital can withstand loan losses, aided by provisioning. - Government will not bail out these firms to avoid moral hazard. - Recent steps to clarify low-income housing policy expected to encourage a recovery in construction in 2014. - NPLs in payroll and other personal loans still need further reduction. - New FRL provisions to constrain state and local government borrowing will help contain credit risk from that sector. - Adoption of expected loan loss provisioning for commercial loans to be completed by end-2013; authorities’ estimates suggest no increase in overall provisioning levels from the shift. - Recent increases in yields on local currency government securities have had very small effects on bank capital. - Financial sector reform objectives and measures: - Increase intermediation, promote competition, and enhance financial stability. - Streamline bankruptcy process and ease legal hurdles for repossession of collateral, including creation of specialized courts. - Establish a centralized bureau for credit information. - Promote portability of banking services, including housing loans, to foster competition. - Address 2011 FSAP recommendations: strengthen regulatory powers and bank resolution framework. - Strengthen supervision of financial conglomerates by enabling oversight of non-financial firms in mixed conglomerates. - Strengthen oversight of Sofomes by requiring reporting to credit bureaus, registration with consumer protection agency, and compliance with AML standards. - Staff recommendations and cautions: - Remain vigilant that the enhanced role of development banks does not interfere with commercial banks’ efforts to increase intermediation. - Ensure CNBV’s new powers to enforce investment guidelines for banks are exercised judiciously. - Supervisory authorities should enhance monitoring of indebtedness and balance sheet exposures in the economy, including developing comprehensive balance sheet data on corporates and households. *Source: IMF staff report excerpt (Mexico).* ### 31. The authorities noted that the effects of international financial regulatory reforms on ### _cr13334 - 31. The authorities noted that the effects of international financial regulatory reforms on ### Effects of international financial regulatory reforms on Mexico’s financial system - All foreign banks operating in Mexico were subsidiaries and were subject to macroprudential limits on transactions with their parent banks. - In the recent post-May 22 market turbulence episode, primary dealers were less willing to act as market makers for government securities under all conditions. - Authorities were uncertain whether changes in market making behavior reflected: - a preference for less risk taking by those banks; or - the effects of reforms, such as higher capital risk weights on holdings of Mexican government securities; or - the prospect of the implementation of the Volcker rule. - The new framework for regulation of derivatives traded over the counter might have a significant effect on the trading volume of this kind of activity in Mexico. ### Anti‑money laundering and combating the financing of terrorism (AML/CFT) - Mexico has adopted many legislative and institutional measures to strengthen its AML/CFT framework in line with recommendations and specific observations of the 2008 Mutual Evaluation Report. - Most issues have already been addressed; authorities remain committed to adopting all recommendations. - Recent actions: - Government submitted reforms to Congress to bring the legal framework for criminalization of money laundering and financing of terrorism fully in line with international standards. - Government has been more aggressive in prosecuting money laundering activities. - The Financial Intelligence Unit has been strengthened to obtain more and better information from financial institutions and designated non-financial businesses and professions (DNFBPs). - The Financial Intelligence Unit will be issuing guidelines to all reporting entities to freeze the funds of those persons suspected of money laundering or financing of terrorism. ### FSAP Recommendations and financial sector reform (Box 5 summary) - Main FSAP update recommendations (Executive Board discussion in December 2011): - Address high levels of concentration risk: - CNBV should have more legal powers to regulate financial groups. - Prudential and risk management standards should apply fully to holding companies and financial conglomerates. - Consider swift implementation of Pillar 2 of Basel II, including introduction of capital charges for concentration risk and buffers above the regulatory minimum capital levels. - Improve the financial safety network: - Strengthen deposit insurance, establish a program for credit cooperatives, transfer legacy debt of deposit insurance fund to the government, and set up emergency funding with government guarantee. - Enhance competition: - Review retail banking fees, enhance consumer financial protection, change regulatory framework for pension funds to increase focus on long-term returns, and promote more contestability and access to financial services. - Increase autonomy of supervisors: - More operational autonomy for CNBV and CNSF, including fixed-term management teams and reduced overlapping responsibilities. - Status of the government’s financial sector reform bill: - Approved in the Chamber of Deputies and under consideration by the Senate. - Aimed at addressing longstanding issues limiting financial inclusion. - Concentration risk remains largely unaddressed; CNBV would be given powers to establish benchmarks to increase bank lending to the private sector (potential for distortions if not applied judiciously). - Reform elements addressing FSAP recommendations: - Foster greater competition by strengthening development banks, improving loan guarantees and collateral, streamlining bankruptcy procedures, creating specialized courts for repossession of collateral, and allowing bank clients to switch banks with very low transactions costs. - Strengthen regulatory powers and enhance consumer protection; increased portability of banking services. - Formalize Basel III rules (recently adopted in early 2013) into the domestic regulatory and supervisory frameworks. - Strengthen supervision of mixed conglomerates. ### Staff appraisal — resilience and policy framework - Mexico’s resilience to recent global financial market volatility reflects confidence in sound and predictable management of economic policies. - Key strengths: - Strong institutional framework that supports macroeconomic stability across government changes. - Exchange rate flexibility helps adjustment to shifting global conditions. - Commitment to open current and capital accounts provides investor confidence in stable rules. - Outcomes: - External current account balance and the real effective exchange rate are in line with economic fundamentals and desired policy settings. ### Staff appraisal — external risks and economic linkages - Mexico is closely linked to the global economy, especially the U.S., increasing exposure to external risks. - Risks noted: - Higher interest rates in advanced economies could be associated with a reversal of capital flows and a sustained increase in risk premiums across EMs, potentially intensifying liquidity strains on sovereigns and leveraged corporations. - U.S. policy uncertainty could have both financial impacts and significant effects on Mexico’s economic activity if the U.S. economy decelerates. ### Staff appraisal — structural reforms and growth outlook - Progress in advancing far-reaching structural reforms is impressive and signals commitment to addressing deep-rooted impediments to growth. - Reforms already approved: - Upgrade public education, make labor markets more flexible, foster competition in telecommunications, and strengthen the fiscal policy framework. - Reforms under discussion: - Energy and financial sectors. - Outlook: - Reforms are a source of optimism and an upside risk to the growth outlook over the next 5 to 10 years. - Uncertainty remains about precise effects on growth; quick approval of secondary legislation and regulations is crucial to provide clarity for investors. ### Staff appraisal — fiscal framework and public debt - Fiscal reform establishes a more comprehensive medium-term fiscal framework with a target on the PSBR consistent with a sustainable public debt path. - Policy changes: - Cap on real growth of current structural spending to diminish procyclical spending bias. - The government intends to reduce the PSBR to 2.5 percent of GDP by 2017. - Congress has approved legal provisions establishing binding caps on the real growth in current structural spending in 2015–2016. - Observations and recommendations: - Preferable to have capped real growth of all primary spending, but political concerns about limiting investment explain current approach. - Fiscal reform missed an opportunity to simplify oil stabilization funds to better save oil revenue windfalls. - Tax reform includes steps to enhance efficiency and bolster non-oil revenues; increase in non-oil tax revenue is limited, pointing to need for another eventual round of reform. - Essential to preserve gains from elimination of the subsidy on domestic gasoline prices. - Staff supports government’s medium-term PSBR path but would have preferred a somewhat tighter fiscal stance in 2014; not advisable to tighten while the economy operates below capacity. - Urges authorities to avoid raising spending if world oil prices turn out higher than the conservative projection underlying 2014 spending. - Mexico’s public debt would remain on a sustainable path even under extreme shocks, but avoiding slippages in meeting PSBR targets is essential. ### Staff appraisal — monetary policy and financial safety nets - Central bank has credibility from keeping inflation on target and allowing exchange rate flexibility. - Staff supports current monetary stance given slack in the economy. - Monetary and exchange rate policy are well-positioned to manage tail risks from the global economy, especially those associated with a less accommodative U.S. monetary policy and U.S. fiscal developments. - The FCL arrangement continues to complement reserves if global tail risks materialize. ### Staff appraisal — financial sector soundness and reform impact - Financial sector remains sound. - Recent financial sector reform is expected to: - Promote competition and enhance access to the financial system. - Strengthen regulatory powers and enhance consumer protection. - Bolster supervision of financial conglomerates. - Remaining concerns: - Concentration risk remains largely unaddressed. - New CNBV powers to establish bank-specific benchmarks to increase lending to non-financial firms and households should be exercised judiciously. *Source: IMF staff report excerpt.* ### 40. It is proposed that the next Article IV consultation with Mexico will take place on the ### _cr13334 - 40. It is proposed that the next Article IV consultation with Mexico will take place on the ### External Linkages - Total Exports by Destination, 2012: United States 71%, Canada 7%, China 2%, Spain 2%, Brazil 2%, Other 16%. - Mexico's Share in U.S. Manufacturing Imports (rolling 12-month ratio): series plotted from 2003 to 2013 showing increase to around 13 percent in recent years. - Stock of Inward FDI by Source Country, 2011: United States 55%, Netherlands 13%, Spain 13%, Canada 4%, United Kingdom 4%, Other 11%. - Largest Banks by Primary Country Affiliation (share of total banking system assets): Spain - BBVA Bancomer 18%, United States - Banamex 15%, Mexico - Banorte 12%, Spain - Santander 10%, UK - HSBC 7%, Other 38%. - Foreign Portfolio Liabilities by Source Country, 2011: United States 51%, Luxembourg 11%, United Kingdom 10%, Japan 6%, Germany 3%, Other 19%. - Non-Residents' Holdings of Domestic Sovereign Debt (Billions of USD): short-term (CETES) and long-term series 2008–2013; foreign holdings as percent of GDP shown (data as of October 4, 2013). ### Real Sector: Growth, Output Gap, and Labor - A sharp and unexpected deceleration in economic activity in the first half of 2013 opened a negative output gap. - Drivers of slowdown: sluggish external demand from the US, weak residential construction, and lower public spending. - Real GDP (SA, Y/Y percent change) series: 2007Q1–2014Q1 with forecast to 2014Q1. - Output Gap (in percent of potential GDP) plotted showing negative gap in 2013. - Mexico Manufacturing and US Manufacturing: Manufacturing (Y/Y monthly growth, SA) series 2007–2013. - Construction activity (Y/Y monthly percent change, SA) series shows weak residential construction. - Budgetary Expenditure (Y/Y real growth; 6-months MA) and Labor Market: Employment, Formal Labor Market (Y/Y percent change), and Nominal Wages (3 month MA, rhs) plotted for 2007–2013. ### Prices and Monetary Policy - Headline inflation: low and within the target band; series 2007–2013 shows headline inflation around 3–4 percent. - Inflation components: Non-Core (including agriculture) subsiding; Core inflation historically low—components merchandise and services. - Low pass-through to inflation despite recent currency depreciation. - Policy rate: central bank cut the policy rate to 3.5 percent in response to slowing economic activity. - Policy Rate and Ex-Ante Real Rate series (2007–2013); Inflation Expectations: 12-Months Ahead and 5-8 Years series around 3–5 percent. ### Fiscal Sector - Fiscal stance: Weak total revenue in a context of stable total spending is preventing fiscal consolidation; gross debt levels remain relatively moderate. - Oil-related indicators: Mezcla Mexicana market price and budget price series; budget assumptions note oil windfalls likely lower in future and government reducing fuel subsidies. - Fiscal aggregates (selected): - Fiscal Revenue (In percent of GDP), Total Expenditure, Primary Expenditure, and Fiscal Deficit (Augmented Balance, Structural Balance) series for 2007–2013 (IMF staff projections noted). - General Government Gross Debt (In percent of GDP) series for 2007–2013. - Fuel Subsidy Expenditure (In percent of GDP) series for 2007–2013. ### External Sector - Current account: projected to remain moderate; series for Oil Current Account, Non-Oil Current Account, and Overall Current Account (In percent of GDP) for 2007–2013 (IMF staff projections noted). - Exports: vibrant automotive exports; Mexico's Share of U.S. Automotive Imports (12 month moving average) and Non-Automotive Manufacturing Exports (Y/Y monthly change) series. - Gross portfolio inflows by non-residents came to a sudden stop in Q2 2013, though corporate bond issuances held up after the Fed’s tapering announcement on May 22, 2013. - Bonds and Equity: Gross Portfolio Inflows (USD, billions) and Corporate Bond Issuance: Foreign Placements (USD, billions) series for 2007–2013. - Reserve accumulation slowing in part due to valuation effects from an increase in US 10 year yields; Sources of Reserve Accumulation series includes valuation, market operations, Federal Government, PEMEX, Total Accumulation (USD, billions). ### Banking System and Financial Soundness - Banking sector remains profitable and well capitalized; capital buffers adequate to withstand market risk. - Credit cycle has turned; pockets of vulnerability mainly in the construction sector. - Key indicators (2009–2013): - Return on Assets and Capital to Risk-Weighted Assets plotted (commercial and development banking sector). - Capital composition: Complementary Capital, Basic Capital, Net Capital Requirement, Capital to Risk Weighted Assets (In percent). - Credit Growth by Sector (Companies, Consumption, Housing) and NPL metrics: Total NPLs, Total Performing Loans, NPL Ratio (percent, rhs); Bank Credit and NPLs to Construction Sector (Portfolio Balances; Billions of Pesos, NSA). ### Selected Economic, Financial, and Social Indicators (snapshots) - Social and demographic (2012 unless noted): - GDP per capita (U.S. dollars, 2012): 10,063 - Population (millions, 2012): 117.1 - Life expectancy at birth (years, 2012): 74.3 - Poverty headcount ratio (% of population, 2010): 51.3 - Income share highest 20% / lowest 20%: 11.3 - Macro forecasts and historical series (selected from Table 1 and Tables 6–7): - Real GDP growth: 2009 -4.5, 2010 5.1, 2011 4.0, 2012 3.6, 2013 1.2, 2014 3.0 (Proj.). - Consumer prices (annual average) 2013 3.6, 2014 3.0 (Proj.). - Bank credit to non-financial private sector (nominal percent growth): 2009 -1.0, 2010 10.0, 2011 17.2, 2012 12.0, 2013 11.0, 2014 11.0 (Proj.). - Nonfinancial public sector: Government revenue 2013 22.8% of GDP, Government expenditure 2013 25.2% of GDP. - Augmented balance (percent of GDP): 2009 -5.1, 2010 -4.3, 2011 -3.4, 2012 -3.7, 2013 -4.1, 2014 -4.1 (Proj.). - Gross public sector debt (percent of GDP): 2009 43.9, 2010 42.4, 2011 43.6, 2012 43.5, 2013 45.3, 2014 46.8 (Proj.). - Current account balance (percent of GDP): 2009 -0.9, 2010 -0.3, 2011 -1.0, 2012 -1.2, 2013 -1.7, 2014 -1.9 (Proj.). ### Balance of Payments and External Metrics - Summary Balance of Payments (selected, in billions US$ and percent of GDP): - Current account (US$ billions): series 2009–2018 provided; memorandum: Current account balance as percent of GDP: 2009 -0.9, 2010 -0.3, 2011 -1.0, 2012 -1.2, 2013 -1.7, 2014 -1.9, 2015 -2.0, 2016 -1.9, 2017 -1.9, 2018 -1.8 (Staff projections). - Exports and imports (US$ billions) series: Exports 2009 229.7, 2010 298.5, 2011 349.4, 2012 370.7, 2013 380.2, 2014 399.4 (proj). - Gross international reserves (end-year, billions US$): 2009 99.9, 2010 120.6, 2011 149.2, 2012 167.1, 2013 184.6, 2014 199.5 (proj). - Gross total external debt (billions US$): 2009 195.0, 2010 247.9, 2011 282.2, 2012 346.9, 2013 372.6, 2014 389.1 (proj). ### Financial Soundness and External Vulnerability Indicators - Financial soundness (2009–2013): - Regulatory capital to risk-weighted assets: 2009 15.9, 2010 17.1, 2011 16.4, 2012 15.8, 2013 16.6. - Nonperforming loans to total outstanding loans: 2009 3.7, 2010 2.8, 2011 2.9, 2012 2.9, 2013 4.0 (data as of September 2013). - Return on assets: 2009 1.6, 2010 2.0, 2011 1.6, 2012 1.9, 2013 2.5. - External vulnerability (selected): - Exchange rate (per U.S. dollar, end-period): 2008 13.5, 2009 13.1, 2010 12.4, 2011 14.0, 2012 13.0, 2013 12.9. - Bank of Mexico net international reserves (US$ billion): 2009 90.8, 2010 113.6, 2011 142.5, 2012 163.5, 2013 172.1. - Commercial banks' nonperforming loans (percent of loans): 2009 3.7, 2010 2.8, 2011 2.9, 2012 2.9, 2013 4.0. ### Annex — External Sector Assessment (summary) - Mexico’s current account deficit and exchange rate level appear broadly in line with fundamentals and desirable policy settings. - Floating exchange rate has been an effective shock absorber amid volatile external conditions. - During May/June 2013 market tensions, authorities refrained from reactivating rule-based FX intervention. - Foreign investment in peso-denominated government debt remained at record high levels even as yields increased. - Reserve accumulation (from PEMEX’s foreign exchange balance) has helped maintain adequate reserve buffers. - Large stock of foreign portfolio investment poses risks in an unsettled external environment. - The Flexible Credit Line (FCL) arrangement is an important complement to reserve buffers against global tail risks. *Source: INTERNATIONAL MONETARY FUND.* ### 1. Mexico’s current account (CA) deficit has remained relatively stable at about 1 percent of ### _cr13334 - 1. Mexico’s current account (CA) deficit has remained relatively stable at about 1 percent of ### Current account and trade developments - CA deficit remained relatively stable at about 1 percent of GDP in 2012, similar to 2011. - Oil CA surplus narrowed as petroleum-related exports declined somewhat. - Narrower non-oil CA deficit offset the oil surplus narrowing, driven by robust merchandise exports, particularly vehicle and parts-related exports to the U.S. - Remittance inflows, particularly from the U.S., remained large and steady. - Net factor income deficit (driven primarily by interest payments to foreign holders of Mexican debt) and the non-factor services deficit more than offset remittance inflows. - External Balance Assessment (EBA) result: the cyclically-adjusted balance is about 1 percentage point of GDP narrower than the model’s CA norm. - Comparing the 2013 projection for the CA deficit (slightly wider than in 2012) indicates the gap between the model and the projection is narrower than 1 percent of GDP. ### Medium-term outlook for the current account - Over the medium term, the CA deficit is expected to widen modestly to between one and a half and two percent of GDP. - Widening mainly attributed to a larger factor income deficit as foreign holdings of Mexican portfolio and direct investments increase. - Projected deterioration in the oil trade balance will be somewhat offset by modest improvements in the non-oil trade balance (led by robust manufactured exports). - Macro policy continuity and growth-promoting structural reforms introduce upside potential for exports and direct investment in manufacturing, energy, and telecommunications. - Reforms and projects may be associated with wider CA deficits in the short-run as foreign services and equipment are employed. ### Exchange rate assessment and functioning - Mexico’s flexible exchange rate has served as an important buffer against heightened external risks and uncertainties. - Nominal exchange rate showed significant volatility during periods of global risk aversion, but did not pose major difficulties for balance sheets of households, corporates, and financial institutions. - Volatility attributed in part to significant hedging activity of foreign holders of Mexican assets; peso market is highly liquid and used by market participants as a proxy against broader emerging market risks. - Mexican authorities did not revive the rule-based intervention strategy despite heightened volatility. - Range of metrics indicate Mexico’s exchange rate is broadly in line with fundamentals: - 2013 Pilot External Sector Report and EBA using the equilibrium REER methodology indicated Mexico’s real effective exchange rate was 11 percent undervalued at the end of 2012; about 6 percentage points of the result represents an unexplained residual. - An analysis using October 2013 WEO data and a CGER-like REER model suggests Mexico’s REER is 11 percent overvalued. - Macrobalance and external sustainability methods suggest the REER broadly in line with fundamentals. - The modest gap between EBA model estimates and actual CA assessment is consistent with an exchange rate broadly in line with fundamentals. ### Capital flows, portfolio inflows, and risks - Mexico experienced historically large portfolio capital inflows in full-year 2012 ($48 billion) and Q1 2013. - Large inflows associated with lax global monetary conditions, strong domestic macro fundamentals, and expectations of significant structural reforms. - Foreign holdings and their share of local-currency government bonds reached record levels, especially after Mexico was included in the WGBI. - Market turbulence in May/June 2013 led to a sudden stop in portfolio inflows in Q2 2013; total net capital inflows declined but remained positive due to a large FDI transaction. - Pace of increases in foreign holdings leveled off; a large amortization led to a decline in their share during that period. Foreign demand gradually returned and holdings were at record levels again. - Large portfolio exposure of foreign market participants represents significant risks in the event of a surge in global risk aversion. - Particular risk: disorderly unwinding of risk positions associated with reduced U.S. monetary accommodation or a U.S. fiscal shock, given large participation of U.S. investors and correlation of Mexican external financing conditions to U.S. rates. ### International reserves, coverage metrics, and net foreign assets - Gross international reserves increased in 2012 to $167 billion (13.6 percent of GDP). - Reserve coverage metrics (changes since last assessment): - IMF metric coverage: 119 percent (declined from last year’s 125 percent). - Coverage of broad money: 19 percent (declined). - Coverage of foreign portfolio liabilities: 39 percent (declined). - Coverage of imports: 4.5 months (increased). - Coverage of imports plus interest payments: 4.9 months (increased). - Coverage of short-term debt at residual maturities: 209 percent (increased). - Annex reserve coverage highlights (2012): - Mexico: 19.3% reserves to broad money plus 8.3% of FCL. - Mexico: 185.2% reserves to STD at remaining maturity plus current account and 74.3% of FCL. - Mexico: 38.9% reserves to portfolio investment plus 23.5% of FCL. - Mexico: 5.0 months reserves to months of imports plus 2.2 months of FCL. - Mexico: 119% reserves to ARA metric plus 50% of FCL. - Mexico: 14.1% reserves to GDP plus 6.2% of FCL. - Net foreign liability position: - As of end-2012, Mexico’s net foreign liability position was about negative 42 percent of GDP (higher than the recent high of 40 percent at end-2010). - Gross portfolio liabilities, particularly debt, grew substantially to 22 percent of GDP. - Over the medium term, NFA expected to remain broadly stable as the current account deficit is projected to be in line with the NFA-stabilizing level of 1.6 percent. *Source: IMF staff report text provided in the content unit _cr13334 - 1. Mexico’s current account (CA) deficit has remained relatively stable at about 1 percent of* ### 2011. Mexico maintains an exchange system that is free of multiple currency practices and ### 2011. Mexico maintains an exchange system that is free of multiple currency practices and restrictions on the making of payments and transfers for current international transactions. ### Article IV Consultation and Technical Assistance - The last Article IV consultation was concluded by the Executive Board on November 19, 2012. The relevant staff report was IMF Country Report No. 12/316. - Technical assistance entries (year — Dept — Purpose) as listed: - 2013 — MCM — Post-FSAP Follow Up - 2012 — FAD — Pension and Health Systems - 2012 — FAD — Treasury - 2012 — FAD — Tax Regimes for PEMEX - 2011 — FAD — Custom Administration - 2011 — FAD — Tax Policy - 2010 — FAD — Fiscal Risks Management - 2010 — FAD — Treasury - 2010 — LEG — AML/CFT Risk Based Supervision - 2009 — STA — National Accounts - 2009 — FAD — Fiscal Framework - 2009 — LEG — AML/CFT Risk Based Supervision - 2008 — FAD — Customs Administration - 2007 — FAD — Intergovernmental Fiscal Relations - 2007 — FAD — Customs Administration - 2007 — FAD — Treasury - Resident Representative: None ### Relations with the World Bank and Bank-Fund Collaboration under the JMAP - Relations with the World Bank: - A new Country Partnership Strategy (CPS) covering FY14–19 was jointly prepared with the Government of Mexico and was ready for Board discussion in December 2013. - The new CPS is aligned with Mexico's National Development Plan (NDP) for 2013–18. - Mexico is approaching the single borrower limit (SBL) of US$16.5 billion. - After pre-paying some US$5 billion during FY07 to bring down exposure to US$4.1 billion by end FY07, exposure increased rapidly from FY08 with US$10.6 billion commitments in FY10–12. - As of September 30, 2013, Bank’s exposure was US$14.78 billion. - Active portfolio: 12 IBRD projects for a net commitment of US$4.08 billion. - For FY14 total lending is envisaged at a low range of US$350 million. - Bank-Fund collaboration priorities discussed: - Need for non-oil revenue mobilization to address diminishing oil revenues and rising age-related spending. - Structural reforms to boost potential growth and ensure productivity gains accrue to all sectors. - Addressing climate change: increase renewable energy sources and improve efficiency of lighting and appliances. - Financial sector surveillance: the FSAP update took place in the second half of 2011 as a joint Bank-Fund effort. ### Statistical Issues - Mexico observes the Special Data Dissemination Standards (SDDS); metadata posted on the Dissemination Standards Bulletin Board (DSBB). - A data ROSC update was completed on October 8, 2010 and published as IMF Country Report No. 10/330. - Balance of payments: - Some items conform to the Fifth edition of the Balance of Payments Manual, but a full transition has not been completed. - Since release of Q2 2010 (August 25, 2010), Banco de México has been publishing a new format following the Fifth edition guidelines. - Measures to improve external debt statistics include compilation of data on external liabilities of the private sector and 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). - National accounts: - Generally follow System of National Accounts, 1993 (1993 SNA). - Economic censuses every five years and a vast program of monthly and annual surveys; most surveys use scientific sampling techniques but most samples exclude a random sample of small enterprises. - Some techniques need enhancement; taxes and subsidies on products at constant prices are estimated by applying the GDP growth rate (a deviation from best practice). - Prices: - CPI and PPI concepts and definitions meet international standards. - PPI compiled by product and not by economic activity. - A ROSC mission on prices was conducted in November 2012. - Fiscal statistics: - Compiled following national concepts, definitions, and classifications that make international comparison difficult. - Comprehensive and timely except for states and municipalities. - New government accounting law mandates accounting standards that follow international standards for all levels of government. - Authorities committed to reporting government financial statistics in GFSM 2001 format and data for the GFS Yearbook. - Monetary and financial statistics: - Methodological foundations of monetary statistics are generally sound. - Recording of financial derivative and, to a lesser extent, repurchase agreement transactions are overstating the aggregated other depository corporations (ODC) balance sheet and survey. - Availability of data on other financial intermediaries allows construction of a financial corporations survey with full coverage, published monthly in International Financial Statistics. - Mexico reports Financial Soundness Indicators (FSIs) for Deposit Takers on a monthly basis. ### Public Debt Sustainability Analysis (DSA) — Key Findings and Baseline Projections - Gross debt: - Gross debt levels in Mexico projected at 45 percent of GDP by end-2013. - Gross financing needs slightly above 11 percent of GDP in 2013 and 2014; on average below 10 percent of GDP for the whole forecasting period. - Different DSA scenarios suggest public debt is sustainable even under extreme shocks. - Large share of debt held by non-residents—about 48 percent of total debt. - Realism of Baseline Scenario: - Debt level dynamics: - Increase in gross debt levels in 2013 relative to 2012 is due to a slight increase in the primary deficit and a much slower pace of growth. - Fiscal consolidation plans kick in from 2015 onwards; gross debt projected to decline from a peak of 47.7 percent of GDP in 2016 to 46.8 of GDP by 2018. - Projected improvement in the primary balance expected to reach the debt-stabilizing level—0.2 percent of GDP—in 2016. - Staff projects gross financing needs will decrease from 11.4 percent in 2013 to 7.3 percent of GDP by 2018. - Growth: - Staff’s current growth projection: 1.2 percent for 2013. - Debt dynamics are sensitive to sudden changes in GDP growth; growth shocks are relevant under DSA stress tests. - Sovereign yields: - 10-year local currency bond yield at around 575 basis points as of October 23. - Spread against the U.S. 10-year Treasury bill during September remained on average at 340 bps. - Effective nominal interest rate on Mexico’s sovereign debt forecast to increase from 6.3 percent in 2012 to 7.2 percent by 2018. - 7.2 percent is consistent with the average effective rate observed between 2002 and 2010. - Fiscal adjustment: - Important adjustment in the cyclically adjusted primary balance between 2013 and 2018. - Adjustment explained by better structural oil and non-oil revenues from 2013 tax and energy reforms and a spending growth ceiling applying from 2014 onwards. - Amendments to the Fiscal Responsibility Law approved in 2013 introduce a new fiscal target on the broader public sector borrowing requirement (PSBR). - Projected adjustment of the cyclically-adjusted primary balance over 3 years during the projection horizon is around 1.5 percent of GDP. - Debt profile: - Average maturity of almost 8 years by end-2012. - More than 80 percent of total debt at fixed interest rates. - A 100 basis points positive shock to the yield curve across maturities is estimated to raise the interest bill by about 0.1 percentage points (ppts) of GDP per year. - Large share of local-currency denominated debt—about 76 percent of total debt. - Around 46 percent of total gross debt is held by non-residents on average during the whole projection period. - Approximately ¾ of non-resident holdings are at maturities longer than one year. - Stress tests: - Primary balance shock: - A deterioration of 0.8 ppts of GDP in the primary balance in 2014–15 shifts up public debt by a similar amount, reaching 48 percent of GDP by the end of the projection period—1 ppt of GDP above the baseline. - Gross financing needs increase moderately; effective interest rates on public debt do not show significant differences relative to the baseline. - Growth shock: - A one standard deviation shock to GDP growth rates lowers the growth rate by [text truncated at source]. *Prepared by the Staff of the International Monetary Fund, November 8, 2013.* ### 2.8 percent, for 2 years starting in 2014. The nominal primary balance deteriorates significantly ### _cr13334 - 2.8 percent, for 2 years starting in 2014. The nominal primary balance deteriorates significantly ### Stress-test shock scenarios and key outcomes - Primary Balance Shock: - Primary balance reaches -2.5 percent of GDP by 2015 (relative to -0.8 percent under the baseline). - Debt-to-GDP ratio peaks at 53.4 percent of GDP in 2015 and falls back to 52.5 percent of GDP by the end of the projection period. - Gross financing needs increase to 8.6 percent of GDP by 2018. - Interest Rate Shock: - Permanent increase in the nominal interest rate by 200 bps starting in 2014. - Average interest rate rises to 8.2 percent by 2018, about 1 percent higher than in the baseline. - Debt-to-GDP ratio reaches 48 percent; gross financing needs reach 8 percent of GDP. - Combined Shock: - Incorporates largest effects of individual shocks on real GDP growth, inflation, primary balance, exchange rate and interest rate. - Debt stabilizes at about 57 percent of GDP by 2018, without showing signals of an unsustainable trajectory when inspecting underlying debt dynamics over the forecasting horizon. ### Stochastic simulations and fan-chart results - Fan Chart (DSA template, annual data 2002–12): - Under random shocks for growth, effective interest rates, primary balances, and real exchange rates, the underlying probability distribution is roughly symmetric around the baseline. - There is a 75 percent probability that debt will be below 50 percent over the medium term. - With restrictions on maximum size of the primary balance (e.g., no positive primary-balance shocks in a given year), the debt path is projected to remain below 58 percent of GDP with 90 percent probability. - Alternative stochastic simulation (staff-prepared, quarterly data over more than 30 years): - Distribution of debt-path projections falls within the range of the DSA-template fan chart. - Using an unrestricted VAR with Mexican data (output gap, real exchange rate, domestic real interest rate, commodity gap, U.S. real interest rates), conditional forecasts generated around the baseline indicate: - Median debt path begins a downward trajectory starting in 2017. - Median public debt falls to 45½ percent of GDP by 2022. - Close to 50 percent probability that debt would be lower than in 2013. - Less than 5 percent probability that public debt will reach 50 percent of GDP in 2015–2016. ### Mexico baseline projections and debt dynamics (selected figures) - Nominal gross public debt (percent of GDP): 41.2 (2011); 43.6 (2012); 43.5 (2013); 45.3 (2014); 46.8 (2015); 47.6 (2016); 47.7 (2017); 47.2 (2018); 46.8 (2018 shown elsewhere). - Public gross financing needs (percent of GDP): 10.6 (2011); 10.9 (2012); 11.5 (2013); 11.4 (2014); 10.3 (2015); 8.9 (2016); 10.2 (2017); 9.1 (2018); 7.3 (2018 shown elsewhere). - Real GDP growth (percent): 2.1 (2011); 4.0 (2012); 3.6 (2013); 1.2 (2014); 3.0 (2015); 3.5 (2016); 3.7 (2017); 3.8 (2018). - Inflation (GDP deflator, percent): 5.4 (2011); 4.8 (2012); 3.8 (2013); 4.3 (2014); 3.4 (2015); 3.0 (2016); 3.0 (2017); 3.0 (2018). - Primary Balance (percent of GDP, baseline): -1.5 (2013); -1.4 (2014); -0.8 (2015); -0.2 (2016); 0.5 (2017); 0.7 (2018). - Effective interest rate (percent): 6.4 (2013); 6.3 (2014); 6.3 (2015); 6.4 (2016); 6.9 (2017); 7.2 (2018). - Cumulative change in gross public sector debt (2011–2018 projection): 0.2 (2011); 1.1 (2012); -0.08 (2013); 1.8 (2014); 1.5 (2015); 0.8 (2016); 0.1 (2017); -0.5 (2018); -0.5 (2018 cumulative); 3.2 (cumulative to 2018). ### Composition of public debt and scenario comparisons - Composition highlights (projection period): - By maturity: share of medium-and long-term vs. short-term shown in projection charts (numbers preserved in charts). - By currency: trend toward larger share denominated in local currency (projection charts). - Alternative scenarios presented: Baseline, Historical, Constant Primary Balance, Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Shock. - Example scenario outcomes (selected): - Real GDP Growth Shock primary balances: Primary balance -1.5 (2013); -2.3 (2014); -2.5 (2015); -0.2 (2016); 0.5 (2017); 0.7 (2018). - Real Interest Rate Shock effective interest rate: 6.4 (2013); 6.3 (2014); 6.4 (2015); 6.4 (2016); 6.8 (2017); 7.1 (2018). - Real Exchange Rate Shock inflation: 4.3 (2013); 8.3 (2014); 3.0 (2015–2018). ### External debt sustainability - External-debt-to-GDP ratio: - Projected 29 percent for end-2013 and expected to remain stable over the medium-term. - With a 30 percent real exchange rate depreciation (most extreme shock), debt-to-GDP increases to 40 percent. - Factors mitigating external-debt risks: - Larger share of (public) debt denominated in pesos. - Lengthening of maturity structure of external debt. - Low interest rates and strong macroeconomic fundamentals used to extend maturities. - Historical and scenario projections (selected figures from table): - External debt (percent of GDP): 18.5 (2008); 21.8 (2009); 23.7 (2010); 24.3 (2011); 29.4 (2012); 29.0 (2013); 29.1 (2014); 28.9 (2015); 28.5 (2016); 28.0 (2017); 27.4 (2018). - Change in external debt (percent of GDP): -0.4 (2008); 3.3 (2009); 1.9 (2010); 0.6 (2011); 5.2 (2012); -0.4 (2013); 0.1 (2014); -0.2 (2015); -0.4 (2016); -0.5 (2017); -0.6 (2018). - Gross external financing need (in billions of US dollars): 78.9 (2008); 69.3 (2009); 60.7 (2010); 78.7 (2011); 91.0 (2012); 102.9 (2013); 114.2 (2014); 120.2 (2015); 125.0 (2016); 129.9 (2017); 135.5 (2018). - External debt-to-exports ratio (percent): 66.5 (2008); 79.7 (2009); 79.0 (2010); 77.3 (2011); 89.7 (2012); 94.1 (2013); 93.5 (2014); 91.2 (2015); 88.1 (2016); 84.5 (2017); 80.3 (2018). - Sensitivity tests: - Individual shocks (interest rate, current account, growth) have only marginal impacts on Mexico’s external debt-to-GDP ratio except for large real depreciation scenarios. ### Assessment of baseline realism and forecast track record (selected diagnostics) - Forecast track record percentiles (2004–2012): - Real GDP growth: Mexico median forecast error -0.09; percentile rank 37%. - Primary balance: Mexico median forecast error -0.49; percentile rank 42%. - Inflation (GDP deflator): median forecast error 1.80; percentile rank 59%. - Boom-bust analysis: - Mexico does not match criteria for boom-bust crisis event analysis. - Cyclically-Adjusted Primary Balance (CAPB) metrics: - 3-year adjustment in CAPB: percentile rank 35%. - 3-year average level of CAPB: percentile rank 88%. ### Press-release summary (Article IV Consultation, November 25–26, 2013) - IMF Executive Board concluded 2013 Article IV consultation with Mexico on November 25, 2013. - Near-term economic conditions and policy context: - Real GDP growth expected to slow to 1.2 percent in 2013 (down from 3.6 percent in 2012). - Output gap estimated at -1.5 percent of potential GDP in Q2 2013. - Headline inflation projected at 3½ percent by end-2013; core inflation at 2½ percent y/y since July. - PSBR expected to reach 4.1 percent of GDP in 2013, compared with 3.7 percent of GDP in 2012. - Structural reforms underway or recently approved: education upgrades, labor-market flexibility, competition in telecommunications; Congress debating energy-sector reform and finalizing financial-sector reform; October 2013 fiscal framework modifications including tax reform, universal pension scheme and unemployment insurance. *Source: IMF staff (content unit: _cr13334 - 2.8 percent, for 2 years starting in 2014. The nominal primary balance deteriorates significantly).* ### 2012. This stance would imply a considerable fiscal stimulus in the second semester, as the PSBR ### _cr13334 - 2012. This stance would imply a considerable fiscal stimulus in the second semester, as the PSBR ### Fiscal and monetary stance - The public sector borrowing requirement (PSBR) amounted to only 1.0 percent of GDP in the first semester of 2012. - The central bank reduced its policy rate by a total of 100 basis points to 3.50 percent in 2013 in response to the widening negative output gap and absence of significant inflationary pressures. - Directors supported a moderately expansionary fiscal stance but emphasized that medium-term consolidation will be important as growth recovers. - Directors welcomed legislation facilitating achievement of medium-term fiscal targets and a sustainable path for public debt, and the more comprehensive medium-term fiscal framework to reduce procyclicality. - Policy recommendations included considering further efforts to: - simplify the operations of the oil stabilization funds; - bolster collection of nonoil tax revenues; - preserve the gains from the elimination of the subsidy on domestic gasoline prices. ### External sector and current account - The external current account deficit is projected to widen to 1.7 percent of GDP in 2013. - The non-oil trade deficit is projected to remain at 1 percent of GDP in 2013. - The oil trade surplus is projected to fall to 0.6 percent of GDP in 2013, reflecting weaker production and exports of oil. - The Fund’s current account model and exchange rate metrics in the External Balance Assessment (EBA) suggest the current account balance and real exchange rate are broadly in line with fundamentals and desirable policy settings. ### Capital flows, asset markets, and global spillovers - Mexico’s financial asset markets showed more resilience than many other emerging markets after the Fed initiated its discussion of tapering on May 22 (year implied by context). - Net capital inflows are projected to remain steady at about 4 percent of GDP in 2013. - Through April 2013, investor appetite was underpinned by prospects for structural reforms and ample global liquidity, generating a strong appreciation of the peso and compression in sovereign debt yields. - After the Fed’s tapering discussion, asset markets reversed for several months: in Q2 2013, gross capital inflows, especially portfolio investment from non-residents, fell sharply from a Q1 peak. - Residents cushioned the shift by keeping more funds within Mexico, leading to a smaller decline in overall net capital inflows. - The Fed’s mid-September delay in tapering led to signs of recovery in capital inflows in recent months (relative to the period described). ### Banking system and financial resilience - The banking system accounts for about 60 percent of financial system assets. - Annual expansion in bank credit to the private sector slowed from about 15 percent in nominal terms in mid-2012 to 10 percent as of August 2013. - As of July 2013, the system’s capital adequacy ratio stood at 15.6 percent, largely unchanged from a year ago. - Nonperforming loans (NPLs) increased to 4 percent of total loans in July 2013, from 3.1 percent at end-2012. - Provisions amounted to 174 percent of NPLs as of July 2013. - Directors encouraged authorities to monitor private sector indebtedness and the rise in nonperforming construction loans. - Recent reforms are expected to promote competition and access in the financial sector while strengthening regulation and consumer protection. ### Structural reforms and growth outlook - Directors noted growth in the referenced year will be below potential and downside risks remain from unsettled external conditions. - Directors welcomed progress in structural reforms aimed at: - upgrading public education; - increasing labor market flexibility; - fostering competition in telecommunications. - Directors emphasized that implementation and prompt approval of secondary legislation and regulations will be key to realizing medium-term growth benefits. ### Key statistics (selected from "Mexico: Selected Economic and Financial Indicators") - Real GDP: -4.5, 5.1, 4.0, 3.6, 1.2 (2009, 2010, 2011, 2012, 2013) - Real GDP per capita 3/: -6.1, 3.5, 2.7, 2.4, 0.2 (2009, 2010, 2011, 2012, 2013) - Gross domestic investment (percent of GDP): 22.9, 22.1, 22.4, 22.9, 21.3 (2009–2013) - Gross domestic savings (percent of GDP): 22.2, 21.9, 21.5, 21.7, 19.6 (2009–2013) - Consumer price index (period average): 5.3, 4.2, 3.4, 4.1, 3.6 (2009–2013) - Exports, f.o.b.: -21.2, 29.9, 17.1, 6.1, 2.6 (2009–2013) - Imports, f.o.b.: -24.1, 28.5, 16.4, 5.7, 3.8 (2009–2013) - External current account balance (percent of GDP): -0.9, -0.3, -1.0, -1.2, -1.7 (2009–2013) - Change in net international reserves (end of period, billions of U.S. dollars): 5.4, 22.8, 28.9, 21.0, 17.5 (2009–2013) - Outstanding external debt (percent of GDP): 21.8, 23.7, 24.3, 29.4, 29.0 (2009–2013) - Government Revenue (percent of GDP): 23.3, 22.4, 22.7, 22.7, 22.8 (2009–2013) - Government Expenditure (percent of GDP): 25.6, 25.2, 25.2, 25.3, 25.2 (2009–2013) - Augmented overall balance (percent of GDP): -5.1, -4.3, -3.4, -3.7, -4.1 (2009–2013) - Bank credit to the non-financial private sector (nominal percent growth) 4/: -1.0, 10.0, 17.2, 12.0, 11.0 (2009–2013) - Broad money (M4a): 6.1, 12.0, 15.7, 14.5, 9.6 (2009–2013) *Source: _cr13334 - 2012. This stance would imply a considerable fiscal stimulus in the second semester, as the PSBR* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13334.pdf_