## 1. External Sector Assessment (_cr14319)

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### Recent macroeconomic developments
- Real GDP grew 1.1 percent in 2013; growth projected to recover to 2.4 percent in 2014 and accelerate to 3.5 percent in 2015.
- Structural reforms in energy, telecommunications, anti-trust, labor markets, education, and the financial sector have been enacted; secondary laws for energy and telecommunications recently approved.
- Energy reform ends a 75-year state monopoly in oil and gas production and distribution; first round of bidding for oil and gas fields to be launched in early 2015, with contracts expected to be awarded starting in the second half of that year.
- Labor market: total employment grew about 1 percent year-on-year in the first half of 2014; unemployment rate has inched up since early 2013; real wage growth subdued; shift from informal to formal employment noted.
- Headline inflation rose to 4½ percent year-on-year in January 2014 (one-off tax effects estimated at about 40 basis points); core inflation remains close to 3 percent.
- Bank of Mexico reduced policy rate by 50 basis points to 3 percent in June 2014.
- Fiscal stance: fiscal policy projected to be neutral in 2014; Public Sector Borrowing Requirement (PSBR) budget target slightly over 4 percent of GDP; structural fiscal balance broadly unchanged from 2013.
- Current account deficit widened to 2.1 percent of GDP in 2013; projected to remain unchanged in 2014.
- Nominal and real effective exchange rates depreciated modestly since end-2013.
- Foreign reserves around US$190 billion.
- Gross portfolio inflows have rebounded after Q2 2013 slowdown; foreigners hold 37 percent of all local-currency public debt and about 55 percent of Mbonos and Cetes.
- Commercial bank credit growth slowed to about 8 percent year-on-year in nominal terms in H1 2014; consumer credit growth moderated to 8 percent (from 16 percent last year); Infonavit mortgage credit growth decelerated to 2 percent in 2014.
- Development banks credit and guarantees have grown rapidly from a low base; development banks account for 15 percent of total bank lending or 3¼ percent of GDP.

### Outlook and staff assessment
- Staff baseline:
  - Structural reforms expected to boost medium-term potential growth to 3½–4 percent (potential growth estimated at around 2¾–3 percent in 2014; actual growth has averaged 2½ percent over the last fifteen years).
  - Output gap estimated by staff at around 1 percent negative as of mid-2014; expected to close gradually over the next year.
- Authorities’ view: reforms could boost annual growth to 4–5 percent.
- External sector: current account and real effective exchange rate broadly in line with fundamentals per staff assessment; temporary deterioration in current account projected as FDI and machinery imports rise, then narrowing in medium term as exports strengthen.
- Energy and telecommunications reforms expected to attract significant foreign direct investment and boost both oil and non-oil exports.
- Inflation: headline inflation expected to decline toward the 3-percent target in 2015; combined effect of tax and gasoline adjustments expected to reduce annual inflation by about ¾ percentage point in 2015.

### Risks and vulnerabilities
- External risks:
  - A surge in global financial market volatility (e.g., earlier or sharper-than-expected U.S. interest rate increases) could prompt capital flow reversals, reduced market access, and increased asset price volatility.
  - Protracted market instability could reduce long-term investor confidence, lower-than-expected FDI inflows, and slow reform implementation.
- Domestic risks:
  - Upside near-term: faster-than-expected recovery in business and consumer confidence could boost domestic demand.
  - Medium-term: delays or weak implementation of structural reforms could limit growth benefits.
- Investor behavior:
  - Foreign mutual funds active in Mexico have been somewhat more prone to herding during past market stress episodes than domestic investors, potentially amplifying volatility.
- Policy buffers and resilience:
  - Credible policy frameworks: flexible exchange rate, open capital account, inflation targeting, and fiscal discipline under the Fiscal Responsibility Law.
  - Policy tools: exchange rate flexibility; foreign exchange intervention, liquidity provision, and debt duration management for significant overshooting or dysfunctional markets.
  - Buffer levels: reserves about US$190 billion; FCL arrangement complements buffers.

### Policy discussions and recommendations
- Structural reforms:
  - Continue timely and effective implementation of energy, telecommunications, financial sector, and other reforms to raise investment, introduce new technologies, reduce business costs, and increase productivity.
  - Monitor and facilitate foreign direct investment inflows to support the expected boost to potential growth.
- Monetary policy:
  - Stance deemed appropriate given contained core inflation and labor market slack.
  - Central bank committed to adjust policy rate as needed to keep inflation aligned with the 3 percent target.
  - Watch for upside risks to inflation from faster-than-expected closing of the output gap and potential broad wage pressures from any minimum wage increase.
- Fiscal policy:
  - 2015 budget proposal projects fiscal deficit narrowing from 4.2 to 4.0 percent of GDP; authorities accommodated a decline in oil revenues of ½ percentage point of GDP.
  - Staff supports accommodating temporary oil revenue decline but cautions against delays in consolidation plans; improvements in structural and non-oil balances imply mild fiscal tightening in 2015 with spending projected to decline as a share of GDP.
- Financial sector:
  - Promote development of financial instruments to help investors hedge exchange and interest rate risks.
  - Support ongoing financial sector reforms, including development banks’ mandate to expand micro-financing and lending to underserved sectors, while monitoring concentration and sectoral risks.
- Contingency preparedness:
  - Maintain and, where appropriate, use foreign exchange intervention, liquidity provision, and debt management to handle significant currency overshooting or dysfunctional market conditions.

### Fiscal consolidation plan and projections (staff support)
- 2015 budget projects reduction of the public sector borrowing requirement from 4 to 2½ percent of GDP over 2015–18.
- Expected outcome: stabilize gross public debt at about 49 percent of GDP and put it on a downward path thereafter.
- Consolidation relies on a gradual increase in tax revenues related to the 2014 tax reform.
- Non-oil tax revenues are expected to rise by additional 1¾ percentage points of GDP by 2018 due to newly formalized enterprises and income from an implicit excise tax on gasoline.
- Expenditure is projected to remain broadly stable in percent of GDP in the medium term, implying a compression of the wage bill to compensate for rising pension expenditure.
- Plan broadens the tax base and prevents cuts in capital expenditure.

### Oil production assumptions and fiscal risks
- Fiscal projections assume PEMEX oil production will stabilize at 2.4 million barrels per day starting in 2015.
- Production by private companies is assumed to commence in 2016 and increase steadily thereafter.
- Total oil output is expected to reach 3 million barrels per day by 2019.
- Staff noted significant downside risks to these oil production assumptions.
- Illustrative downside scenario: production 4½ percent below the baseline on average between 2016 and 2019 would result in a fiscal deficit gap of about ½ percent of GDP by 2019 relative to the current baseline.
- If production continues to surprise on the downside, it will be necessary to adjust expenditure or raise non-oil revenues to prevent a trend increase in public debt.

### Fiscal Responsibility Law amendments and the Oil Stabilization and Savings Fund
- 2014 amendments:
  - PSBR made an official target for fiscal policy.
  - Current structural expenditure in real terms capped at 2 percent per year in 2015–16, and at the rate of potential output growth thereafter.
  - Sovereign Oil Stabilization and Savings Fund created to manage oil revenues.
- Fund mechanics:
  - PEMEX and private oil companies will transfer to the fund all government dues including profit sharing, royalties, and license fees (except corporate income tax).
  - The fund will transfer up to 4.7 percent of GDP to the central government every year (equivalent to the amount of oil revenues in percent of GDP in 2013).
  - Revenues in excess of that will be saved in the fund until the balance grows to 3 percent of GDP.
  - After 3 percent of GDP balance reached: 40 percent of additional surplus saved; the rest earmarked as: 10 percent for the universal pension system, 10 percent for research and development and renewable energy projects, 30 percent for infrastructure and oil-related investment, and 10 percent for scholarships and regional development.
  - Once the sovereign wealth fund reaches 10 percent of GDP, the return on investments will be transferred to the federal government, in addition to the 4.7 percent of GDP.
- Staff welcomed the fund for greater stability in oil revenues and saving a large share of future oil income windfalls.

### Recommendations to strengthen fiscal discipline and transparency
- Strengthen budget approval and execution to enforce expenditure appropriation limits; historically, actual expenditure has exceeded budget plans in each of the past 5 years.
- More realistic budgeting combined with stricter controls on execution to ensure PSBR targets are met; higher-than-expected oil revenues should be saved in the sovereign wealth fund.
- Invoke the escape clause in the Fiscal Responsibility Law only in case of a growth slowdown, with deficit levels aligned with the estimated output gap.
- Consider stronger independent assessment of fiscal policy; outsource calculation of potential output growth and the output gap to an independent group of experts as an initial step.
- Authorities published methodology for potential output growth as the average of actual growth for the last ten years and growth projections for the next five years.
- Improve public communication to promote better understanding of the fiscal framework; emphasize PSBR and current expenditure targets.
- Staff welcomed compilation and reporting of historical fiscal data in accordance with GFSM 2001 in the 2015 budget and encouraged fiscal projections to be reported in line with these standards.

### PEMEX and CFE reforms and pension liabilities
- PEMEX and CFE to have greater operational independence starting in 2015, with governance by Boards including government representatives and independent experts.
- Their tax regime will be aligned with the tax regime of private oil companies.
- Federal government agreed to assume a share of pension liabilities of PEMEX and CFE if they reform their pension systems to reduce the net present value of future liabilities.
- Staff supported gradual move to a defined-contribution pension for PEMEX and CFE.

### Subnational government finances
- Total subnational government debt about 3 percent of GDP, but deficits and debt have increased notably since 2008; reported debt understates overall liabilities because it excludes credit from private sector providers of goods and services.
- A uniform accounting methodology (General Government Accounting Law) for states’ and municipalities’ finances introduced; several states adopted it, others expected by end-2015.
- Staff suggested reported data should be audited, consolidated, and made publicly available; recommended adopting a formal fiscal framework for local governments similar to the Fiscal Responsibility Law.
- A law on local government finances (Ley Nacional de Responsabilidad Hacendaria y Deuda Pública) was sent to Congress the previous year.
- Pension system for state employees should be reformed to reduce unfunded liabilities.

### Financial sector stability and related observations
- Commercial banks remain well capitalized and profitable; capital levels well in excess of minimum Basel III requirements.
- Non-performing loans (NPLs) stabilized at 3¼ percent as of June, up from 2½ percent in 2012; increase mostly in construction sector; NPLs fully provisioned.
- Average liquidity coverage ratio (LCR) of the banking system exceeded 200 percent in 2013; LCR to be introduced in 2015 per Basel Committee’s schedule.
- Pension funds hold assets of about 13 percent of GDP; insurance companies hold about 6 percent of GDP.
- Capital in insurance sector exceeds minimum capital guarantee by 75 percent, and technical reserve requirement by 10 percent.
- Real estate investment trusts (FIBRAs) have assets equivalent to about 1½ percent of GDP and are mostly funded by equity; leverage limits and liquidity requirements recently introduced.
- Corporate leverage and share of debt denominated in foreign currency have increased since 2008, especially in 2013; bond issuance by lower-rated firms has also increased.
- Staff recommended improved data collection and analysis of firms’ foreign exchange exposures, including through derivatives.
- Development banks should avoid crowding out commercial banks or relaxing credit standards; limit lending to subnational governments to projects with clear developmental goals.
- Financial sector reform actions: strengthened bank resolution framework, expanded credit reporting, eased legal hurdles for repossessing collateral via specialized federal courts, amended Financial Group Act in January 2014 to set guidelines for consolidated supervision of financial conglomerates.

### Staff appraisal and growth outlook
- Mexico’s macroeconomic policies and policy frameworks remain very strong: inflation targeting with flexible exchange regime for monetary policy, and fiscal policy anchored by the Fiscal Responsibility Law.
- Authorities committed to an open capital account and continuous development of financial markets.
- Mexico has made impressive progress on structural reforms; strong implementation is critical for reforms to boost productivity and output growth.
- Real GDP projected to grow at 2½ percent in 2014, and to reach 3½ percent in 2015, supported by the U.S. recovery, stronger manufacturing and related services, and increasing construction activity aided by government infrastructure spending.

### External vulnerability and buffers (Annex I highlights)
- Mexico is susceptible to global financial stress but offsetting strengths include strong fundamentals, deep and liquid financial markets, substantial reserve buffers, and a flexible exchange rate.
- Key indicators:
  - Current account deficit: 2.1 percent of GDP in 2013.
  - Cyclically-adjusted current account deficit: 0.2 percentage points of GDP narrower than the norm.
  - Real effective exchange rate: assessed slightly undervalued (range of 0 to 10 percent undervaluation).
  - Net international investment liability position: about 40 percent of GDP.
  - Residents’ foreign assets: 45 percent of GDP in June 2014.
  - Foreign exchange reserves: amounted to 116 percent on the ARA metric in 2013.
- Assessment: Mexico’s external sector position broadly consistent with medium-term fundamentals and desirable policy settings; FCL provides insurance against tail risks.

### Spillovers from United States (Box 5 summary)
- Linkages:
  - 80 percent of good exports go to the United States.
  - U.S. accounts for over half of Mexico’s foreign portfolio liabilities and foreign direct investment.
  - Foreign-owned banks account for about 70 percent of banking system assets.
  - Mexican peso daily global trading volume of US$135 billion (BIS data).
  - International investors hold 37 percent of local-currency sovereign bonds, and 52 percent of total public debt.
- Growth spillovers:
  - Staff analysis suggests 1 percentage point increase in US growth would raise Mexico’s growth by 0.8 percentage points.
  - Model simulations: even with a mild increase in EM risk premia (up to 100 basis points) accompanying U.S. normalization, overall growth effect for Mexico likely positive.
- Risks from abrupt U.S. interest rate increases:
  - A 100 basis points shock to 10-year U.S. Treasury rates translates into a 140 basis points increase in Mexico’s 10-year sovereign yield (vector error correction model).
  - Variance decomposition: 50 percent of fluctuations in Mexico’s 10-year sovereign yield explained by innovations in the U.S. 10-year treasury yield.
  - Historical: Mexico among most affected in aftermath of taper tantrum in June 2013.

### Investor behavior and capital flow volatility (Box 6 summary)
- Empirical findings:
  - Foreign participation tended to amplify volatility of Mexican sovereign bond yields during global shocks.
  - Domestic investors played some mitigating role; evidence mixed by investor type and shock.
  - Strong evidence of herding and positive-feedback trading by global bond funds active in Mexico, especially during market stress; similar behavior among domestic bond funds but to a lesser degree.
- Policy implications:
  - Policy credibility and effective communication are key.
  - Deep and diverse domestic investor base can mitigate effects of global shocks.
  - In pension sector reforms, avoid regulations that could induce herding among fund managers.
  - FCL insurance remains important to maintain market confidence at times of stress.

### Structural reforms and projected growth effects (Box 4 highlights)
- Aggregate impact: reforms could increase potential growth by about 0.75 to 0.9 percentage points to reach 3½–4 percent over 2016–19 (compared to estimated 2¾–3 percent in 2014).
- Energy reform channels and impacts by 2019:
  - Higher oil and gas production: cumulative growth by 2019 of about 1.4 percent.
  - Boost to manufacturing via lower electricity prices: cumulative growth by 2019 of about 0.6 percent.
  - Additional value added from higher investment in related services: cumulative growth by 2019 of about 0.5 percent.
  - Implied average: about 0.6 percentage point increase in growth per year over 2016–19.
- Financial reform: assumed acceleration of financial deepening to 1.5 percentage points of GDP starting in 2016; estimated additional growth from deepening: 0.07 and 0.16 percentage points per year over 2016–19.
- Telecommunication reform: closing ¼ of gap with OECD broadband access could raise real GDP by 0.41 to 0.79 percentage point; evenly over 5 years implies annual increase of 0.08–0.16 percentage points.
- Other reforms (labor, education, antitrust): effects harder to quantify, may materialize over longer horizons and interact with other reforms.

### External Sustainability and Public Debt Sustainability (Annex I and DSA highlights)
- NIIP and external position:
  - NIIP about -39 percent of GDP; gross foreign assets and liabilities roughly 45 percent and 84 percent of GDP, respectively.
  - Foreign-held portfolio liabilities about 40 percent of GDP; around one third are holdings of local-currency government bonds.
  - Projected current account deficits averaging less than 2.5 percent of GDP imply NIIP to GDP ratio projected to remain broadly stable over the medium term.
- DSA key projections and indicators:
  - Nominal gross public debt trajectory (percent of GDP): 41.3 (2012); 43.2 (2013); 46.4 (2014); 47.8 (2015); 48.9 (2016); 49.6 (2017); 49.5 (2018); 48.9 (2019); 48.2 (table entries).
  - Gross public debt projected to reach 47.8 percent of GDP by end-2014 (table shows projections and peak gross debt of 49.6 percent in 2016).
  - Gross financing needs about 11 percent of GDP in 2014; staff projects 10.9 percent of GDP in 2014 and decrease to 8.3 percent of GDP by 2019.
  - Projected effective nominal interest rate on sovereign debt forecasted to rise from 6.1 percent in 2014 to 7.4 percent by 2019.
  - Debt structure: average maturity just under 8 years; 82 percent of government securities at fixed interest; 24 percent of debt denominated in foreign currency; about 52 percent of marketable debt held by non-residents.
- Stress tests (selected outcomes):
  - Primary balance shock: 0.8pp of GDP deterioration in primary balance in 2015–16 shifts up public debt reaching 49.7 percent of GDP by end of projection period.
  - Growth shock: real output growth lowered by 2.9 percent for 2 years starting in 2015 leads debt-to-GDP ratio to increase to about 56 percent and stabilize around 54 percent by end of projection period; gross financing needs climb to 12.3 percent of GDP in 2017 then stabilize around 10 percent.
  - Interest rate shock: spreads increase by 200 bps starting in 2015; government implicit average interest rate climbs to almost 8.4 percent by 2019.
  - Combined macro-fiscal shock: under combined shock debt would stabilize at around 59 percent of GDP without explosive trajectory.
- External debt:
  - External-debt-to-GDP ratio: 35 percent projected for end-2014 and expected to remain stable over the medium-term.
  - Under a 30 percent real exchange rate depreciation shock the debt-to-GDP ratio would increase to 48 percent.
- Public DSA risk highlights:
  - Main risk arises from large share of debt held by non-residents—about 52 percent of total debt—and foreign holdings of peso-denominated government bonds expose Mexico to sudden shifts in investor sentiment.

### Selected macro-financial indicators and staff/Board perspectives
- Real GDP (annual percent change): 2013: 1.1; 2014: 2.4 (staff projection); 2015: 3.5 (staff projection).
- Headline inflation: 4½ percent year-on-year in early 2014; expected to stay around 4 percent in remainder of 2014 and decline gradually in 2015 toward 3 percent target.
- Current account deficit: -2.1 percent of GDP in 2013; -2.1 percent projected in 2014.
- Gross domestic investment (percent of GDP): 21.6 (2014).
- Gross domestic savings (percent of GDP): 20.6 (2014).
- Bank credit to the non-financial private sector (nominal): 9.7 (2014).
- Non-performing loans share: 3¼ percent in June (up from 2½ percent in 2012).
- Directors and staff views:
  - Directors welcomed rebound in activity and completion of legislative process for structural reforms.
  - Directors noted global financial market volatility risks and confidence in Mexico's strong policy fundamentals and FCL insurance.
  - Directors considered monetary policy stance appropriate and supported plans to reduce PSBR to 2.5 percent of GDP by 2018, emphasizing strict adherence to the announced fiscal path and boosting non-oil revenues if oil revenues fall short.

*Italic: Source — _cr14319 - External Sector Assessment (IMF staff report excerpts and annexes).*

### 1. External Sector Assessment ____________________________________________________________________ 17

### 1. External Sector Assessment

### Recent macroeconomic developments
- Real GDP grew 1.1 percent in 2013; growth projected to recover to 2.4 percent in 2014 and accelerate to 3.5 percent in 2015.
- Structural reforms in energy, telecommunications, anti-trust, labor markets, education, and the financial sector have been enacted; secondary laws for energy and telecommunications recently approved.
- Energy reform ends a 75-year state monopoly in oil and gas production and distribution; first round of bidding for oil and gas fields to be launched in early 2015, with contracts expected to be awarded starting in the second half of that year.
- Labor market: total employment grew about 1 percent year-on-year in the first half of 2014; unemployment rate has inched up since early 2013; real wage growth subdued; shift from informal to formal employment noted.
- Headline inflation rose to 4½ percent year-on-year in January 2014 (one-off tax effects estimated at about 40 basis points); core inflation remains close to 3 percent.
- Bank of Mexico reduced policy rate by 50 basis points to 3 percent in June 2014.
- Fiscal stance: fiscal policy projected to be neutral in 2014; Public Sector Borrowing Requirement (PSBR) budget target slightly over 4 percent of GDP; structural fiscal balance broadly unchanged from 2013.
- Current account deficit widened to 2.1 percent of GDP in 2013; projected to remain unchanged in 2014.
- Nominal and real effective exchange rates depreciated modestly since end-2013.
- Foreign reserves around US$190 billion.
- Gross portfolio inflows have rebounded after Q2 2013 slowdown; foreigners hold 37 percent of all local-currency public debt and about 55 percent of Mbonos and Cetes (most liquid local-currency sovereign bonds and short-term paper).
- Commercial bank credit growth slowed to about 8 percent year-on-year in nominal terms in H1 2014; consumer credit growth moderated to 8 percent (from 16 percent last year); Infonavit mortgage credit growth decelerated to 2 percent in 2014.
- Development banks credit and guarantees have grown rapidly from a low base; development banks account for 15 percent of total bank lending or 3¼ percent of GDP.

### Outlook and staff assessment
- Staff baseline: structural reforms expected to boost medium-term potential growth to 3½–4 percent (potential growth estimated at around 2¾–3 percent in 2014; actual growth has averaged 2½ percent over the last fifteen years).
- Authorities’ view: reforms could boost annual growth to 4–5 percent.
- External sector: current account and real effective exchange rate broadly in line with fundamentals per staff assessment; temporary deterioration in current account projected as FDI and machinery imports rise, then narrowing in medium term as exports strengthen.
- Energy and telecommunications reforms expected to attract significant foreign direct investment and boost both oil and non-oil exports.
- Inflation: headline inflation expected to decline toward the 3-percent target in 2015 as tax-related base effects dissipate, food prices normalize, and fuel price adjustments moderate; combined effect of tax and gasoline adjustments expected to reduce annual inflation by about ¾ percentage point in 2015.
- Output gap estimated by staff at around 1 percent negative as of mid-2014; expected to close gradually over the next year.

### Risks and vulnerabilities
- External risks:
  - A surge in global financial market volatility, triggered by earlier or sharper-than-expected U.S. interest rate increases, geopolitical risks, or investors’ reassessment of sovereign risks, could prompt capital flow reversals, reduced market access, and increased asset price volatility.
  - Protracted market instability could reduce long-term investor confidence, lower-than-expected FDI inflows, and slow reform implementation.
- Domestic risks:
  - Upside near-term: faster-than-expected recovery in business and consumer confidence could boost domestic demand.
  - Medium-term: delays or weak implementation of structural reforms could limit growth benefits.
- Investor behavior:
  - Foreign mutual funds active in Mexico have been somewhat more prone to herding during past market stress episodes than domestic investors, potentially amplifying volatility.
- Policy buffers and resilience:
  - Credible policy frameworks: flexible exchange rate, open capital account, inflation targeting, and fiscal discipline under the Fiscal Responsibility Law.
  - Policy tools: exchange rate flexibility as shock absorber; foreign exchange intervention, liquidity provision, and debt duration management for significant overshooting or dysfunctional markets.
  - Buffer levels: reserves about US$190 billion; FCL arrangement complements buffers.

### Policy discussions and recommendations
- Structural reforms:
  - Continue timely and effective implementation of energy, telecommunications, financial sector, and other reforms to raise investment, introduce new technologies, reduce business costs, and increase productivity.
  - Monitor and facilitate foreign direct investment inflows to support the expected boost to potential growth.
- Monetary policy:
  - Stance deemed appropriate given contained core inflation and labor market slack.
  - Central bank committed to adjust policy rate as needed to keep inflation aligned with the 3 percent target.
  - Watch for upside risks to inflation from faster-than-expected closing of the output gap and potential broad wage pressures from any minimum wage increase.
- Fiscal policy:
  - 2015 budget proposal projects fiscal deficit narrowing from 4.2 to 4.0 percent of GDP; authorities accommodated a decline in oil revenues of ½ percentage point of GDP.
  - Staff supports accommodating temporary oil revenue decline but cautions against delays in consolidation plans; improvements in structural and non-oil balances imply mild fiscal tightening in 2015 with spending projected to decline as a share of GDP.
- Financial sector:
  - Promote development of financial instruments to help investors hedge exchange and interest rate risks, reducing incentives for abrupt disinvestment.
  - Support ongoing financial sector reforms, including development banks’ mandate to expand micro-financing and lending to underserved sectors, while monitoring concentration and sectoral risks (noted deceleration in lending to construction after difficulties with three large builders).
- Contingency preparedness:
  - Maintain and, where appropriate, use foreign exchange intervention, liquidity provision, and debt management to handle significant currency overshooting or dysfunctional market conditions.

*Italic: Source — _cr14319 - 1. External Sector Assessment (IMF staff report excerpt).*

### 17.      Staff strongly supported the authorities’ intention to reduce the fiscal deficit gradually

### _cr14319 - 17.      Staff strongly supported the authorities’ intention to reduce the fiscal deficit gradually

### Fiscal consolidation plan and projections
- The 2015 budget projects a reduction of the public sector borrowing requirement from 4 to 2½ percent of GDP over 2015–18.
- This path is expected to stabilize gross public debt at about 49 percent of GDP and put it on a downward path thereafter.
- Consolidation relies on a gradual increase in tax revenues related to the 2014 tax reform.
- Non-oil tax revenues are expected to rise by additional 1¾ percentage points of GDP by 2018 due to newly formalized enterprises and income from an implicit excise tax on gasoline.
- Expenditure is projected to remain broadly stable in percent of GDP in the medium term, implying a compression of the wage bill to compensate for rising pension expenditure.
- The consolidation plan broadens the tax base and prevents cuts in capital expenditure.

### Oil production assumptions and fiscal risks
- Fiscal projections assume PEMEX oil production will stabilize at 2.4 million barrels per day starting in 2015.
- Production by private companies is assumed to commence in 2016 and increase steadily thereafter.
- Total oil output is expected to reach 3 million barrels per day by 2019.
- Staff noted significant downside risks to these oil production assumptions.
- An illustrative downside scenario with production 4½ percent below the baseline on average between 2016 and 2019 would result in a fiscal deficit gap of about ½ percent of GDP by 2019 relative to the current baseline.
- Staff and authorities agreed that if production continues to surprise on the downside, it will be necessary to adjust expenditure or raise non-oil revenues to prevent a trend increase in public debt; measures would also be needed in case of persistent shortfalls in tax revenues relative to current projections.
- The implicit tax on gasoline is defined as the difference between the government-administered gasoline prices and international prices.

### Fiscal Responsibility Law amendments and the new Oil Stabilization and Savings Fund
- Amendments approved by Congress in 2014 strengthen the fiscal framework:
  - The public sector borrowing requirement (PSBR) was made an official target for fiscal policy.
  - Current structural expenditure in real terms would be capped at 2 percent per year in 2015–16, and at the rate of potential output growth thereafter.
  - A sovereign Oil Stabilization and Savings Fund was created to manage oil revenues.
- PEMEX and private oil companies will transfer to the fund all government dues including profit sharing, royalties, and license fees (except for the corporate income tax which is paid directly to the central government).
- The fund will transfer up to 4.7 percent of GDP to the central government every year (equivalent to the amount of oil revenues in percent of GDP in 2013).
- Revenues in excess of that will be saved in the fund until the balance grows to 3 percent of GDP.
- After this balance is reached, 40 percent of any additional surplus income will continue to be saved and the rest will be earmarked: 10 percent for the universal pension system, 10 percent for research and development and renewable energy projects, 30 percent for infrastructure and oil-related investment, and 10 percent for scholarships and regional development.
- Once the sovereign wealth fund reaches 10 percent of GDP, the return on investments will be transferred to the federal government, in addition to the 4.7 percent of GDP.
- Staff welcomed the fund as providing greater stability in oil revenues for budget purposes and ensuring a large share of any future oil income windfall would be saved.

### Recommendations to strengthen fiscal discipline and transparency
- Strengthen the budget approval and execution process to enforce expenditure appropriation limits; historically, actual expenditure has exceeded budget plans in each of the past 5 years.
- More realistic budgeting of expenditure combined with stricter controls on execution is needed to ensure PSBR deficit targets are met; higher-than-expected oil revenues should be saved in the new sovereign wealth fund.
- The escape clause to both deficit targets envisaged in the Fiscal Responsibility Law should be invoked only in the case of a growth slowdown, with deficit levels aligned with the estimated output gap; monetary policy is better-suited to respond to mild cyclical fluctuations.
- Consider stronger independent assessment of fiscal policy; one initial step could be outsourcing the calculation of potential output growth and the output gap to an independent group of experts.
- The authorities published the methodology for calculating potential output growth as the average of actual growth for the last ten years and growth projections for the next five years.
- Improve public communication to promote better understanding of the fiscal framework; fiscal analysis and reporting should emphasize the PSBR and current expenditure targets.
- Staff welcomed compilation and reporting of historical fiscal data in accordance with international standards (GFSM 2001) in the 2015 budget and encouraged fiscal projections to be reported in line with these standards.

### PEMEX and CFE reforms and pension liabilities
- PEMEX and the Federal Electricity Company (CFE) will have greater operational independence starting in 2015, including more freedom in investment and operational decisions, and governance by Boards including government representatives and independent experts.
- Their tax regime will be aligned with the tax regime of private oil companies.
- The federal government has agreed to assume a share of the pension liabilities of PEMEX and CFE if they reform their pension systems to reduce the net present value of future liabilities.
- Staff supported a gradual move to a defined-contribution pension for the two public companies to align their pension system with that of federal government employees.

### Subnational government finances
- Total subnational government debt is relatively modest at about 3 percent of GDP, but deficits and debt have increased notably since 2008; reported debt understates overall liabilities because it excludes credit from private sector providers of goods and services.
- A uniform accounting methodology (set in the General Government Accounting Law) for states’ and municipalities’ finances was introduced; several states have already adopted it, and the rest are expected to do so by the end of 2015.
- Staff suggested reported data should be audited, consolidated, and made publicly available; recommended adopting a more formal fiscal framework to constrain local government deficits, along the lines of the Fiscal Responsibility Law for the federal government.
- A law on local government finances (Ley Nacional de Responsabilidad Hacendaria y Deuda Pública) was sent to Congress the previous year.
- Staff noted that the pension system for state employees should also be reformed to reduce unfunded liabilities.

### Financial sector stability and related observations
- Commercial banks remain well capitalized and profitable; capital levels are well in excess of minimum Basel III requirements.
- The share of non-performing loans (NPLs) in total loans stabilized at 3¼ percent as of June, up from 2½ percent in 2012; the increase reflected mostly a rise in impaired loans in the construction sector.
- Non-performing loans remain fully provisioned.
- The average liquidity coverage ratio (LCR) of the banking system exceeded 200 percent in 2013; the LCR will be introduced in 2015 according to the Basel Committee’s gradual implementation schedule.
- Pension funds hold assets of about 13 percent of GDP; insurance companies hold assets of about 6 percent of GDP.
- Capital in the insurance sector exceeds the minimum capital guarantee requirement by 75 percent, and the technical reserve requirement by 10 percent.
- Real estate investment trusts (FIBRAs) have assets equivalent to about 1½ percent of GDP and are mostly funded by equity; leverage limits and liquidity requirements were recently introduced for FIBRAs.
- Corporate leverage and the share of debt denominated in foreign currency have increased since 2008, especially in 2013; bond issuance by lower-rated firms has also increased.
- Staff recommended continued improvement in data collection and analysis of firms’ foreign exchange exposures, including through derivatives.
- Development banks have a more active role in financial inclusion and competition but should avoid crowding out commercial banks or relaxing credit standards; lending to subnational governments should be limited to projects with a clear developmental goal.
- Financial sector reform strengthened bank resolution framework, expanded credit reporting, eased legal hurdles for repossessing collateral via specialized federal courts (which require sufficient funding), and gave supervisors new powers to evaluate bank credit expansion.
- The Financial Group Act was amended in January 2014 to set regulatory guidelines for consolidated supervision of financial conglomerates; a committee including all relevant supervisors will oversee conglomerates, with a designated lead supervisor.
- The effects of international financial regulatory reforms on Mexico have been manageable; commercial banks will phase in the Basel III minimum LCR over the next five years.
- Upgraded reporting requirements for foreign exchange operators, wire services, and unregulated SOFOMES should strengthen AML/CFT efforts; authorities expressed concern about potential de-risking by foreign banks affecting cross-border transactions including remittances.

### Staff appraisal and growth outlook
- Mexico’s macroeconomic policies and policy frameworks remain very strong: inflation targeting with a flexible exchange regime for monetary policy, and fiscal policy anchored by the fiscal responsibility law.
- Authorities remain committed to an open capital account and continuous development and deepening of financial markets.
- Mexico has made impressive progress on structural reforms (energy, education, telecommunications, labor); secondary legislation for the energy reform will open the hydrocarbons sector to private investment and liberalize the electricity sector.
- Strong implementation is critical for reforms to boost productivity and output growth over the medium term.
- Real GDP is projected to grow at 2½ percent in 2014, and to reach 3½ percent in 2015, supported by the U.S. recovery, stronger manufacturing and related services, and increasing construction activity aided by government infrastructure spending.

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

### 33.      As a highly open economy, Mexico remains susceptible to stress in global financial

### _cr14319 - 33.      As a highly open economy, Mexico remains susceptible to stress in global financial

### External vulnerability and buffers
- As a highly open economy, Mexico is susceptible to stress in global financial markets; a surge in volatility (for example, from a disorderly normalization of U.S. monetary policy) could cause a reversal of capital flows and higher risk premia.
- Offsetting strengths:
  - Strong fundamentals, deep and liquid financial markets, and substantial reserve buffers.
  - Flexible exchange rate to facilitate adjustment to shocks.
  - Rules-based foreign exchange intervention and liquidity support useful in case of market dysfunction.
  - The FCL arrangement provides insurance against tail risks.
- Key external sector indicators (Box 1):
  - Current account deficit: widened to 2.1 percent of GDP in 2013.
  - Cyclically-adjusted current account deficit: 0.2 percentage points of GDP narrower than the norm.
  - Real effective exchange rate: assessed to be slightly undervalued (range of 0 to 10 percent undervaluation).
  - Mexico’s share in U.S. manufacturing imports: increased from 10 to 13 percent over the last five years.
  - Net international investment liability position: about 40 percent of GDP.
  - Residents’ foreign assets: 45 percent of GDP in June 2014.
  - Foreign exchange reserves: amounted to 116 percent on the ARA metric in 2013.
  - Reserves as a share of foreign portfolio liabilities and of short-term external debt have declined as foreign holdings of domestic debt rose rapidly.

### Monetary policy and inflation outlook
- Monetary policy stance:
  - Will remain geared toward reaching the inflation target.
  - Current accommodative stance considered appropriate as the economy is operating below potential and inflation pressures are contained.
- Inflation projection and risks:
  - Headline inflation projected to decline toward the target in 2015 as tax-related base effects dissipate and administered price increases moderate.
  - Spare capacity is expected to diminish gradually in coming quarters; pressures on wages and prices should be monitored carefully.

### Fiscal policy, PSBR, and public finances
- Fiscal framework improvements:
  - The new Fiscal Responsibility Law strengthens the fiscal framework and provides clear fiscal targets consistent with a sustainable public debt path.
  - Progress on reporting public sector fiscal data in line with international accounting standards is welcome.
- Staff support and targets:
  - Staff strongly supports authorities’ plan to reduce the PSBR to 2.5 percent of GDP by 2018.
  - Planned consolidation will help stabilize public debt and put it on a downward path.
- Recommendations and contingencies:
  - More realistic budgeting of expenditure and stricter control on spending execution to ensure PSBR and expenditure targets are met.
  - If medium-term oil production projections are optimistic and revenue shortfalls persist, measures should be taken to ensure PSBR targets are achieved.
  - Discretionary fiscal stimulus should be considered only in case of a sharp decline in economic activity (in the spirit of escape clauses in the Fiscal Responsibility Law).
  - Plans to reform the pension system for PEMEX and CFE are welcome; potential to reduce the net present value of future liabilities for the public sector.

### Subnational (state and municipal) finances
- Need to strengthen monitoring and control of state and municipal financing.
- Recommended steps:
  - Full adoption of the uniform accounting methodology for reporting local government finances.
  - Reported data should be audited, consolidated, and made publicly available.
  - Introduce a formal legal framework to anchor local fiscal policy-making, similar to the FRL for the federal government.
  - Reform pension system for state employees to align it with that for federal employees.

### Financial sector soundness and supervision
- Overall balance sheet strength:
  - Banks and non-bank financial intermediaries maintain strong balance sheets, high liquidity and capital buffers, and conservative lending practices.
  - Corporate and household balance sheets appear sound.
  - Insurance companies are well capitalized and profitable.
- Risks and monitoring:
  - Rise in foreign exchange borrowing among some large companies needs careful monitoring.
  - Increased role of development banks in financial inclusion and credit to underserved sectors is welcome, but caution is needed to avoid displacement of private bank lending or relaxation of credit standards.
- Supervision and regulation:
  - Progress in strengthening regulation and consolidated supervision of large financial conglomerates is commendable.

### Construction sector, housing policies, and recent developments (Box 2)
- Construction sector importance and recent performance:
  - Construction accounts for 7 percent of GDP and entered a downturn in mid-2012, contracting by 6½ percent over the last two years.
  - Decline was most pronounced in low-income housing construction; construction employment fell sharply.
- Causes:
  - Poor financial choices by the largest private homebuilders (GEO, HOMEX, URBI): heavy debt, out-of-town low-rise developments, lack of infrastructure and amenities, leading to abandonment and bankruptcies.
  - Changes in government housing subsidy policies (from 2011 and February 2013) redirecting subsidies away from single-family outskirts toward high-rise developments closer to urban centers, and Infonavit’s policy shift toward purchase of existing houses.
- Policy response and outcomes:
  - March 2013: government guarantees for construction loans by commercial banks to homebuilders.
  - July 2014: Infonavit increased the maximum amount it can lend to prospective home buyers by 76 percent and extended mortgage maturities.
  - Result: residential construction activity started to recover in recent months, with a strong pickup in formal employment in the sector.

### Business sentiment, market concentration, and corporate investment (Box 3)
- Sentiment and investment behavior:
  - Business sentiment deteriorated between May 2013 and February 2014: share of firms perceiving it “was the right time to invest” fell from 50 percent to 40 percent.
  - Deterioration coincided with a weakening economy and the initial discussion/adoption of structural reforms; domestic policy and regulatory uncertainty likely contributed.
  - Dominant firms in oligopolistic sectors may have reduced investment more as their market power was contested by antitrust and telecom reforms.
- Empirical findings (panel regression results):
  - Regression results suggest: (i) firms in more concentrated sectors may tend to invest less on average; and (ii) deterioration in sentiment is associated with larger decreases in investment rates for firms in less competitive industries.
  - Key coefficient (interaction): Concentration*Domestic uncertainty = -2.812 (standard error 1.317), significant at **p<0.05** in specification (1).
  - Sample period: 2005Q2-2014Q2; N = 3,207 (or 3,119 in some specifications); R2 = 0.01; firm-fixed effects included.
- Outlook:
  - Uncertainty associated with reforms dissipated after approval of important secondary legislation; investment intentions turned positive in recent months.
  - Antitrust and telecom reforms aim to enhance competition in concentrated industries, which should spur investment.

### Structural reforms and projected growth effects (Box 4)
- Aggregate impact on potential growth:
  - Staff estimates reforms could increase potential growth by about 0.75 to 0.9 percentage points to reach 3½–4 percent over 2016–19 (compared to an estimated potential growth of 2¾–3 percent in 2014).
- Energy reform:
  - Ends a 75-year state monopoly in oil and gas; permits a wide range of risk-sharing contracts; increases autonomy of PEMEX and CFE; encourages private participation in electricity generation and natural gas distribution; improves regulation and management of transmission and distribution.
  - Impact on growth (three channels):
    - Higher oil and gas production: cumulative growth by 2019 of about 1.4 percent.
    - Boost to manufacturing via lower electricity prices: cumulative growth by 2019 of about 0.6 percent.
    - Additional value added from higher investment in related services: cumulative growth by 2019 of about 0.5 percent.
    - Implied average: about 0.6 percentage point increase in growth per year over 2016–19.
- Financial reform:
  - Aims to increase financial deepening by promoting competition and streamlining bankruptcy procedures; introduces credit and checking account portability; strengthens consumer protection and creditors’ rights; expands development banks’ role.
  - Historical and projected financial deepening:
    - Since 2007 financial deepening (domestic credit to non-financial private sector to GDP) increased at about 0.7 percentage points annually.
    - Staff baseline assumes pace accelerates to 1.5 percentage points of GDP starting in 2016.
    - Estimated additional growth from this deepening: 0.07 and 0.16 percentage points per year over 2016–19 (based on literature coefficients).
- Telecommunication reform:
  - Creates Instituto Federal de Telecomunicaciones (IFETEL); empowers asymmetric regulation against dominant players; opens sector to foreign investment; creates specialized courts; launches program to achieve internet coverage nationwide by 2018.
  - Impact on growth:
    - If reform closes ¼ of the gap with OECD average in broadband access, real GDP would rise by 0.41 to 0.79 percentage point.
    - Assuming even distribution over 5 years, annual output growth would increase by 0.08–0.16 percentage points.
- Other reforms:
  - Labor, education, and antitrust reforms: effects harder to quantify and may materialize over longer horizons; potential synergies with other reforms (e.g., labor flexibility encouraging investment in telecom and energy; education reform improving human capital and productivity).

### Institutional and procedural note
- It is proposed that the next Article IV Consultation with Mexico take place on the standard 12-month cycle.

*Source: IMF staff report (content unit _cr14319).*

### Box 5. Spillovers from United States

### Box 5. Spillovers from United States

### Mexico’s external linkages and financial integration
- Mexico’s manufacturing sector: "80 percent of good exports going to the United States."
- U.S. share in external financing: "The U.S. also accounts for over half of Mexico’s foreign portfolio liabilities and foreign direct investment."
- Banking system: "Foreign-owned banks account for about 70 percent of banking system assets, with a large presence of Spanish banks."
- World Global Bond Index: "There has been a sizable increase in portfolio inflows into the domestic sovereign bond market since the inclusion of Mexico in the World Global Bond Index (WGBI) in 2010."
- Peso trading volume: "Based on BIS data, the Mexican peso is the most actively traded emerging market currency in the world, with a daily global trading volume of US$135 billion."
- Sovereign bond holdings by international investors: "International investors now hold 37 percent of local currency denominated sovereign bonds, and 52 percent of total public debt, exposing Mexico to abrupt changes in investor sentiment."

### Growth spillovers from the United States
- Correlation and elasticity:
  - "The correlation between U.S. and Mexico’s growth is very strong."
  - "Staff analysis suggests that 1 percentage point increase in US growth would raise Mexico’s growth by 0.8 percentage points (April 2013, WHD Regional Economic Outlook, Chapter 3)."
- Model simulation result:
  - "Model simulations suggest that even if the normalization of U.S. monetary policy is accompanied by a mild increase in the risk premia for emerging market debt (up to 100 basis points), the overall growth effect for Mexico is still likely to be positive."

### Risks from abrupt U.S. interest rate increases
- Adverse scenario description:
  - "A sharp increase in interest rates in the absence of higher U.S. growth could have significant adverse effects."
  - "An unexpected rise in U.S. interest rates (for example due to inflation pressures or renewed worries about the debt ceiling), accompanied by an increase in emerging market risk premia would hit Mexico through both trade and financial channels."
- Transmission to Mexican yields:
  - "Staff analysis, using a vector error correction model suggests that changes in long-term U.S. interest rates transmit more than one-for-one to Mexican local sovereign bond yields."
  - "Specifically, 100 basis points shock to the 10-year U.S. Treasury rates translates into a 140 basis points increase in Mexico’s 10-year sovereign yield."
  - "Variance decomposition analysis shows that 50 percent of fluctuations in Mexico’s 10-year sovereign yield is explained by innovations in the U.S. 10-year treasury yield."
- Market dynamics:
  - "Non-linearities in the response of financial markets to shocks could exacerbate volatility further."
  - Historical episode: "Mexico was one of the most affected countries in the immediate aftermath of the taper tantrum in June 2013, despite its strong fundamentals. As investors started to differentiate among countries based on fundamentals, spreads on Mexico’s securities declined."

### Empirical correlation and cross-industry linkages (as presented)
- Correlation Between U.S. and Mexico Growth (year-on-year real growth rates):  
  - "Pre-NAFTAPost-NAFTA U.S./Mexico real GDP0.020.87"
  - "U.S./Mexico industrial production0.230.65"
  - "U.S./Mexico manufacturing0.110.75"
  - "U.S. imports/Mexico exports-0.040.92"
  - "U.S./Mexico consumption-0.260.76"
  - "U.S. consumption/Mexico exports-0.240.68"
  - "U.S./Mexico investment0.160.75"

### Key external shares and concentration (figures as presented)
- Total Exports by Destination, 2013 (In percent of total): "79 United States; 3 Canada; 2 Spain; 2 China, P.R.: Mainland; 1 Brazil; 13 Other"
- Mexico's Share in U.S. Manufacturing Imports (In percent): series shown for years 1996–2012 (chart present in source).
- Foreign Portfolio Liabilities by Source Country, 2013 (In percent of total): "48 United States; 12 Luxembourg; 11 United Kingdom; 5 Japan; 4 Germany; 20 Other"
- Total Imports by Origin, 2013 (In percent of total): "49 United States; 16 China, P.R.: Mainland; 4 Japan; 4 Korea, Republic of; 4 Germany; 23 Other"
- Largest Banks and Primary Country Affiliation, 2013 (In percent of total commercial banking system assets): "21 Spain -BBVA Bancomer; 18 United States -Banamex; 12 Mexico -Banorte; 12 Spain -Santander; 8 UK -HSBC; 29 Other"
- Stock of Inward FDI by Source Country, 2012 (In percent of total): "55 United States; 12 Spain; 10 Netherlands; 4 Canada; 4 United Kingdom; 15 Other"
- Net Capital Flows (USD, billions; adjusted for errors and omissions): series shown for 2007Q1–2014Q1 (chart present in source).
- Fund flows (Bond Funds (Foreign); Equity Funds (Foreign); Net Sellers) (In percent of total funds): series shown for 2012–2014 (chart present in source).

*Box 5. Spillovers from United States, _cr14319 - Box 5. Spillovers from United States.*

### Box 6. Does Investor Behavior Amplify Volatile Capital Flows in Mexico?

### Box 6. Does Investor Behavior Amplify Volatile Capital Flows in Mexico?

### Methodology
- Identifies extreme capital flow episodes in Mexico following the methodology developed by Forbes and Warnock (2012).
- Uses available aggregate and fund-level data to:
  - Examine the role of foreign and domestic investors (banks, pension and insurance funds, mutual funds) in amplifying or mitigating global shocks to 10-year Mbonos market during these episodes.
  - Assess whether local and global mutual funds active in Mexico behaved differently during periods of market stress.
- Empirical approaches include OLS regressions and multivariate GARCH models.

### Main findings
- Foreign participation tended to amplify the impact of global financial shocks—measured by changes in the Vix or U.S. sovereign bond yields—on the volatility of Mexican sovereign bond yields, more so during periods of market stress.
- Domestic investors played some mitigating role, but the empirical evidence was mixed, depending on the type of investors and whether the global shock was an increase in the Vix or in U.S. sovereign bond yields.
- Strong evidence of herding and positive-feedback trading behavior was found among global bond funds active in Mexico, especially during market stress; this behavior has contributed to the volatility of capital flows and can exacerbate tail events.
- Herding and positive trading behavior was also observed among domestic bond funds, though to a lesser degree than their foreign counterparts.

### Policy implications and recommendations
- Policy credibility will continue to be key, anchored by effective policy communication.
- A deep and diverse domestic investor base can help mitigate the effects of global shocks by absorbing excess supply of domestic assets in the face of a drop in demand by non-resident investors.
- In the context of ongoing regulatory reforms in the pension sector, the authorities should avoid regulations that could induce herding behavior among fund managers.
- The insurance provided by the FCL remains important to maintain market confidence at times of stress.

*Source: IMF staff analysis, Box 6. Does Investor Behavior Amplify Volatile Capital Flows in Mexico?*

### Annex I. External Sustainability Assessment

### Annex I. External Sustainability Assessment

### Mexico Overall Assessment
- Foreign asset and liability position and trajectory
  - Background: Mexico’s NIIP is about -39 percent of GDP (gross foreign assets and liabilities are roughly 45 percent and 84 percent of GDP, respectively).
  - Foreign-held portfolio liabilities are about 40 percent of GDP, of which around one third are holdings of local-currency government bonds.
  - With projected current account deficits averaging less than 2.5 percent of GDP, the NIIP to GDP ratio is projected to remain broadly stable over the medium term.
  - Assessment: While the NIIP is sustainable, gross foreign portfolio liabilities could be a channel of vulnerability to global financial volatility, especially through the domestic sovereign bond market.
- Overall Assessment statement: Mexico’s external sector position is broadly consistent with medium-term fundamentals and desirable policy settings.
  - The staff assesses the current account as having been only slightly on the strong side, and correspondingly the REER to have been slightly on the weak side.
  - The FCL provides an added buffer against global tail risks.
- Potential policy responses:
  - As the external sector position is broadly consistent with medium-term fundamentals, there is no reason to alter the current and planned policy settings.
  - Authorities have committed to reducing the public sector borrowing requirement from 4.2 percent of GDP in 2014 to 2.5 percent of GDP in 2018.
  - The consolidation relies on a gradual increase in tax revenues related to the 2014 tax reform.
  - The central bank will set monetary policy to ensure that the inflation converges towards the 3 percent permanent target within the horizon at which monetary policy operates, while maintaining a flexible exchange rate policy.

### Current account
- Background:
  - The current account (CA) deficit widened to 2.1 percent of GDP in 2013 (-1.7 percent cyclically adjusted), amid larger net factor payments.
  - In 2014, the current account deficit is projected to remain unchanged with an improving trade balance offset by a continued increase in factor payments.
  - The deficit is projected to rise to about 2.2 percent of GDP, on the back of imports associated with increased FDI in the energy and telecom sectors.
  - Investment is projected to rise by about 3 percentage points of GDP over the medium term, supported by an increase in public and private saving.
- Assessment:
  - Mexico’s CA appears to be slightly stronger than the level consistent with medium term fundamentals and desirable policy settings.
  - The EBA model estimates a cyclically-adjusted current account norm of -1.9 percent, implying a positive CA gap of +0.2 percent of GDP (including the upward influence on the CA of fiscal policies of other countries).
  - The staff assessment is similar, within a gap range centered on that estimate plus or minus 1 percent of GDP.
  - The small projected increase in Mexico’s CA deficit is consistent with fundamentals, desirable policy settings, and the expected effects of the growth-enhancing structural reforms on FDI.

### Real exchange rate
- Background:
  - The floating exchange rate has been a key shock absorber in an unsettled global environment.
  - In 2013, the peso became the most widely-traded emerging market currency.
  - As such, it often serves as a port-of-call for investors taking positions in other EM currencies with less liquid markets or capital account restrictions.
- Assessment:
  - The EBA REER regression estimates a small undervaluation of about 6 percent in 2013; this is also consistent with the EBA estimate that the current account is slightly on the strong side.
  - The staff assesses Mexico’s real effective exchange rate to be broadly consistent with fundamentals and desirable policy settings (slightly undervalued with a gap centered on -5 percent, in a range of 0 to -10 percent).

### Capital and financial accounts: flows and policy measures
- Background:
  - Gross capital inflows by non-residents in the period following the global crisis were broadly offset by purchases of assets abroad, particularly by the resident private sector.
  - Net capital inflows are expected to continue to be in excess of the external current account deficit; since 2010, a large share of these flows have been purchases of locally-issued government paper and other portfolio investments by non-residents.
  - Going forward, the structural reforms could raise overall inflows and FDI.
- Assessment:
  - While the local currency denomination and long duration of sovereign debt reduces the exposure of government finances to depreciation of the domestic currency, the presence of foreign investors leaves Mexico exposed to a reversal of capital flows and an increase in risk premia.
  - The authorities have refrained from capital flow management measures, in line with their view that an open capital account reduces policy uncertainty and supports long-term growth.

### FX intervention and reserves level
- Background:
  - The central bank remains committed to a floating exchange rate, using rules-based intervention only to prevent disorderly market conditions.
  - The central bank did not conduct any discretionary foreign exchange intervention in 2013 and 2014; it will continue to build its reserve buffer mostly through purchases of the net foreign currency proceeds of the state oil company.
- Assessment:
  - The current level of foreign reserves is adequate for normal times according to a range of standard reserve coverage indicators, and falls in the lower end of the 100-150 percent range of the IMF’s composite reserve adequacy metric.
  - The current policy of reserve accumulation is broadly consistent with the expected gradual rise in foreign-held portfolio liabilities.
  - The Fund FCL arrangement has been an effective complement to international reserves against global tail risks.

### Technical Background Notes (selected)
- Note 1: Following the tapering announcement by Ben Bernanke in May 21, 2013, Mexico’s currency experienced one of the sharpest depreciations across emerging markets, falling by nearly 8.4 percent by end-June 2013. By the end of April 2014 it had depreciated 6 percent with respect to May 21st 2013—significantly less than for other emerging market countries. The nominal and real effective exchange rates have depreciated modestly since end-2013.
- Note 2: Capital inflows by non-residents in the period after the global crisis did not lead to a significant widening of the current account deficit. Rather, they translated (in a BOP accounting sense) into a strong accumulation of hard-currency assets abroad, particularly by the private sector. Outward FDI, foreign bond and equity purchases, deposits abroad and domestic banks’ loans to non-residents represented two-thirds of the economy’s foreign asset accumulation over this period.
- Note 3: In the second quarter of 2013, gross capital inflows from non-residents, especially portfolio investment, fell sharply from a peak in the first quarter. Residents helped cushion the effects of this shift by repatriating part of their assets invested abroad, thus leading to a smaller decline in overall net capital inflows. Portfolio inflows bounced back strongly in the second half of 2013 and first half of 2014.

*Source: Annex I. External Sustainability Assessment, IMF staff report (2014).*

### 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
- The last Article IV consultation was concluded by the Executive Board on November 25, 2013.
- The relevant staff report was IMF Country Report No. 13/334.

### Technical Assistance (selected entries from source list)
- Years and departments listed include: 2014 FAD, 2014 STA, 2014 STA, 2014 STA, 2013 MCM, 2012 FAD, 2012 FAD, 2012 FAD, 2011 FAD.
- Purposes noted include: Tax Policy and Compliance; Sectoral Balance Sheets; National Accounts; Balance of Payments; Post-FSAP Follow Up; Pension and Health Systems; Treasury; Tax Regimes for PEMEX; 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.
- Resident Representative: None.

### Relations with the World Bank
- New Country Partnership Strategy (CPS) covering FY14–19 was discussed by the Board in December 2013; CPS is aligned with Mexico's National Development Plan (NDP) for 2013–18.
- IBRD lending surged to US$10.6 billion in FY10–12.
- As of July 31, 2014, the World Bank’s exposure to Mexico was US$15.15 billion, positioning Mexico as the largest borrower in the world in terms of IBRD debt outstanding.
- Active portfolio: 10 IBRD projects and 7 GEF operations for a net commitment of US$1.4 billion.
- FY14: first sub-national results-based loan to Oaxaca of US$55 million.
- Pipeline for FY15 includes five operations supporting social protection, education, and energy efficiency.
- Single Borrower Limit increased up to US$19.0 billion.

### Bank-Fund Collaboration under the JMAP — Priorities discussed
- A well-funded and effective government
  - Falling oil revenues and rising public spending needs require increased tax revenue and more efficient and targeted public spending.
  - Policies recommended include broadening the tax base, narrowing special regimes or preferential rates, generating information flows to facilitate tax compliance, increasing transparency, operational efficiency and progressivity of public expenditures, improving public sector performance through better budget and financial management, and developing a systemic coverage and mitigation strategy of fiscal risks.
- Comprehensive reforms to boost productivity and potential output growth
  - Focus on sound financial sector development, competitive business environment, fostering innovation, and upgrading infrastructure.
  - Continued financial sector surveillance; latest joint Bank-Fund FSAP took place in the second half of 2011.
- Social protection
  - Reforms needed to address fragmentation, weak design and coverage gaps in social security, social assistance and labor market programs.
  - Build a more inclusive, effective and integrated social protection system; attention to labor market impacts, measures to increase labor productivity and wages, skills development and employment services.
- Climate change and environmental protection
  - Reduce environmental and carbon footprint of growth; areas include energy efficiency and renewable energy, water management, urban planning, solid waste and natural resource use.

### Statistical Issues — Key findings and needs
- Data provision is adequate for surveillance; Mexico observes the Special Data Dissemination Standards (SDDS) and metadata are posted on the DSBB.
- A data ROSC update was completed on October 8, 2010 and published as IMF Country Report No. 10/330.
- National accounts
  - Generally follow the System of National Accounts, 1993 (1993 SNA); source data and statistical techniques are sound.
  - Most surveys exclude a random sample of small enterprises.
  - Some techniques need enhancement — example: taxes and subsidies on products at constant prices are estimated by applying the GDP growth rate (deviation from best practice).
  - 2014 STA reassessment based on May 2012 vintage of the Data Quality Assessment Framework (DQAF) found national accounts statistics generally of high quality and adequate for surveillance.
  - Areas for further improvement: resources for collecting state and local government source data and seasonally-adjusted data, explaining data revisions, compiling data on changes in inventories and on the volume of taxes on products.
- Sectoral accounts and balance sheets
  - INEGI published annual sectoral accounts and balance sheets following the System of National Accounts 2008 (2008 SNA) classifications for 2003–2012 in November 2013; revised and published on June 30, 2014.
  - STA mission in 2014 agreed with authorities on a work plan for developing quarterly sectoral accounts and balance sheets; INEGI and Banxico to collaborate on quarterly stocks and flows of financial assets and liabilities by institutional sectors.
- Prices
  - CPI and PPI concepts and definitions meet international standards; PPI compiled by product only.
  - ROSC mission on prices was conducted in November 2012.
- Balance of payments and external sector statistics
  - Some items conform to the Fifth edition of the Balance of Payments Manual, but a full transition has not been completed.
  - Improvements made on external debt statistics: compilation of external liabilities of the private sector and publicly traded companies (external debt outstanding, annual amortization schedule for the next four years broken down by maturity, and type of instrument).
  - 2014 STA technical assistance focused on strengthening data collection and compilation for external sector statistics, with emphasis on foreign direct investment, financial derivatives, bank accounts used in foreign exchange operations, capital account, and financial intermediation services indirectly measured; assistance for BPM6 adoption issues.
- Fiscal statistics
  - Authorities compile fiscal statistics following national concepts, making international comparison difficult.
  - Statistics 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 generally sound.
  - Recording of financial derivatives and repurchase agreements transactions overstates the aggregated other depository corporations (ODC) balance sheet and survey.
  - Data availability on other financial intermediaries enables construction of a financial corporations survey with full coverage, published monthly in International Financial Statistics.
- Financial Soundness Indicators
  - Mexico is reporting Financial Soundness Indicators (FSIs) for Deposit Takers on a monthly basis.

### Common Indicators Required for Surveillance — Selected dates and frequencies (as of Nov. 6, 2014)
- Exchange Rates: Date of latest observation Oct. 2014; Date received Oct. 2014; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation Sept. 2014; Date received Sept. 2014; Frequency M; Frequency of Reporting M; Frequency of Publication M.
- Reserve/Base Money: Sept. 2014; Date received Sept. 2014; Frequency M; Frequency of Reporting D, M, W.
- Broad Money: Sept. 2014; Date received Sept. 2014; Frequency M.
- Central Bank Balance Sheet: Oct. 2014; Date received Oct. 2014; Frequency W.
- Consolidated Balance Sheet of the Banking System: Sept. 2014; Date received Sept. 2014; Frequency M.
- Interest Rates: Oct. 2014; Date received Oct. 2014; Frequency D.
- Consumer Price Index: Oct. 2014; Date received Oct. 2014; Frequency Bi-W.
- Revenue, Expenditure, Balance and Composition of Financing – General Government: Sept. 2014; Date received Sept. 2014.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Sept. 2014; Date received Sept. 2014; Frequency M.
- Stocks of Central Government and Central Government-Guaranteed Debt: Sept. 2014; Date received Sept. 2014; Frequency M.
- External Current Account Balance: Q2 2014; Date received Q2 2014; Frequency Q.
- GDP/GNP: Q2 2014; Date received Q2 2014; Frequency Q.
- Gross External Debt: Sept. 2014; Date received Sept. 2014; Frequency M.
- International Investment Position: Q2 2014; Date received Q2 2014; Frequency Q.

### Public Debt Sustainability Analysis (DSA) — Key findings and projections
- Current and projected debt levels
  - Mexico’s gross public debt is projected to reach 47.8 percent of GDP by end-2014.
  - Gross public debt projected to remain below the 50 percent of GDP threshold.
  - Projected peak gross debt of 49.6 percent of GDP in 2016.
  - Projected gross debt decline to 48.2 of GDP by 2019.
- Gross financing needs
  - Gross financing needs are about 11 percent of GDP in 2014.
  - Staff projects gross financing needs will be 10.9 percent of GDP in 2014 (down from 12.2 percent in the previous year) and will decrease to 8.3 percent of GDP by 2019.
- Sustainability assessment
  - DSA suggests Mexico’s government debt is sustainable even under severe shocks.
  - Direct interest and exchange rate pass-through to the budget is relatively low given debt structure.
  - Main risk arises from large share of debt held by non-residents—about 52 percent of total debt.
- Baseline and realism of projections
  - A higher primary deficit explains the increase in gross debt levels in 2014 relative to 2013; partially compensated by higher growth and lower sovereign yields.
  - Growth projections: current growth projection at 2.4 percent for 2014 (staff projection); SHCP projects growth for 2014 at 2.7 percent.
  - Sovereign yields
    - 10-year local currency bond yield at around 572 basis points as of August 29.
    - This is only 130 basis points higher than the historical low.
    - Spread between this bond and US government bonds of same maturity averaged 328 basis points for the last three months (as of the date in report).
    - Effective nominal interest rate on sovereign debt forecasted to rise from 6.1 percent in 2014 to 7.4 percent by 2019.
  - Fiscal adjustment
    - Structural primary balance improves between 2014 and 2019 under the baseline, driven by higher oil and non-oil revenues following 2014 tax and energy reform.
    - 2014 amendments to fiscal responsibility law introduced a cap on growth of almost 50 percent of total spending ("structural current spending") applicable from 2015 onwards.
    - Maximum projected 3-year adjustment of the structural primary balance of 1.5 percent of GDP considered feasible.
  - Maturity and rollover
    - Average maturity just under 8 years.
    - 82 percent share of government securities at fixed interest.
    - 24 percent of debt denominated in foreign currency.
    - A 100 basis points shock to the yield curve across maturities estimated to raise the interest bill by 0.1 percentage points of GDP.
    - Around 52 percent of marketable debt is held by non-residents.
- Stress tests and shocks
  - Primary balance shock
    - A deterioration of 0.8pp of GDP in the primary balance in 2015–16 shifts up public debt reaching 49.7 percent of GDP by the end of the projection period.
  - Growth shock
    - Real output growth rates lowered by 1 standard deviation, or 2.9 percent, for 2 years starting in 2015.
    - Nominal primary balance deteriorates reaching -2.4 percent of GDP by 2016.
    - Debt-to-GDP ratio increases to about 56 percent and then stabilizes around 54 percent at the end of the projection period.
    - Gross financing needs climb to 12.3 percent of GDP in 2017 and then stabilize around 10 percent by the end of the period.
  - Interest rate shock
    - Spreads increase by 200 bps starting in 2015.
    - Government implicit average interest rate climbs to almost 8.4 percent by 2019, about 1 percent higher than in the baseline.
    - Debt-to-GDP ratio and gross financing needs increase, reaching 49.4 (debt) and (gross financing needs figure in source truncated).

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

### 8.9 percent of GDP by 2019.

### _cr14319 - 8.9 percent of GDP by 2019.

### Public debt projections and baseline scenario
- Nominal gross public debt trajectory (in percent of GDP): 41.3 (2012); 43.2 (2013); 46.4 (2014); 47.8 (2015); 48.9 (2016); 49.6 (2017); 49.5 (2018); 48.9 (2019); 48.2 (label repeated in table).
- Change in gross public sector debt (cumulative): 0.0 (2012); 0.0 (2013); 3.19 (2014); 1.4 (2015); 1.1 (2016); 0.7 (2017); -0.1 (2018); -0.6 (2019); -0.6 (cumulative shown).
- Identified debt-creating flows (annual): -0.5 (2012); -0.0 (2013); 62.57 (2014) [table shows "62.57"—preserve as in source]; 1.4 (2015); 1.1 (2016); 0.7 (2017); -0.1 (2018); -0.6 (2019); -0.6 (cumulative).
- Primary deficit (in percent of GDP): -0.4 (2012); 1.1 (2013); 1.3 (2014); 1.5 (2015); 1.4 (2016); 0.7 (2017); 0.0 (2018); -0.8 (2019); -0.9 (cumulative).
- Primary (noninterest) revenue and grants (percent of GDP): 21.7 (2012); 23.4 (2013); 23.3 (2014); 22.1 (2015); 21.6 (2016); 22.5 (2017); 23.0 (2018); 23.4 (2019); 23.8 (cumulative 136.4).
- Primary (noninterest) expenditure (percent of GDP): 21.3 (2012); 24.6 (2013); 24.6 (2014); 23.6 (2015); 23.0 (2016); 23.2 (2017); 23.0 (2018); 22.6 (2019); 22.9 (cumulative 138.3).

### Baseline macro assumptions (selected)
- Real GDP growth (in percent): 2.5 (2012); 4.0 (2013); 1.1 (2014); 2.4 (2015); 3.5 (2016); 3.8 (2017); 3.8 (2018); 3.8 (2019).
- Inflation (GDP deflator, in percent): 5.6 (2012); 3.2 (2013); 2.0 (2014); 4.0 (2015); 3.3 (2016); 2.5 (2017); 3.1 (2018); 3.0 (2019).
- Nominal GDP growth (in percent): 8.3 (2012); 7.3 (2013); 3.1 (2014); 6.5 (2015); 6.9 (2016); 6.3 (2017); 7.0 (2018); 7.0 (2019).
- Effective interest rate (in percent; interest payments divided by debt stock at end of previous year): 7.1 (2012); 6.3 (2013); 6.0 (2014); 6.1 (2015); 6.0 (2016); 6.1 (2017); 6.5 (2018); 7.0 (2019); 7.4 (alternate row).

### Debt dynamics decomposition (selected contributions)
- Automatic debt dynamics (percent of GDP contribution): 0.0 (2012); -1.2 (2013); 1.3 (2014); -0.1 (2015); -0.3 (2016); 0.0 (2017); -0.1 (2018); 0.2 (2019); 0.3 (cumulative).
- Interest rate/growth differential (percent of GDP contribution): -0.4 (2012); -0.4 (2013); 1.2 (2014); -0.2 (2015); -0.4 (2016); -0.1 (2017); -0.2 (2018); 0.0 (2019); 0.2 (cumulative); -0.7 shown as final cumulative row.
  - Of which: real interest rate contributions: 0.5 (2012); 1.2 (2013); 1.7 (2014); 0.9 (2015); 1.1 (2016); 1.6 (2017); 1.5 (2018); 1.8 (2019); 1.9 (cumulative); 8.9 appears in table.
  - Of which: real GDP growth contributions: -0.9 (2012); -1.6 (2013); -0.4 (2014); -1.0 (2015); -1.6 (2016); -1.7 (2017); -1.7 (2018); -1.8 (2019); -1.7 (cumulative); -9.6 shown.
- Exchange rate depreciation contribution (percent of GDP): 0.4 (2012); -0.8 (2013); 0.1 (2014); remaining years shown as dots.

### Alternative scenarios and combined shock
- Combined shock defined as: "incorporates the largest effect of individual shocks on all relevant variables (real GDP growth, inflation, primary balance, exchange rate and interest rate)."
- Under the combined shock, "debt would stabilize at around 59 percent of GDP without showing signals of an explosive trajectory."
- Alternative scenario outputs (selected baseline vs scenarios):
  - Baseline Real GDP growth (2014–2019): 2.4; 3.5; 3.8; 3.8; 3.8; 3.8.
  - Historical scenario Real GDP growth (2014–2019): 2.4; 2.6; 2.6; 2.6; 2.6; 2.6.
  - Constant Primary Balance scenario Primary Balance (2014–2019): -1.5 each year (2014–2019).

### Stress tests (macro-fiscal shocks)
- Stress test scenarios and selected underlying assumptions (2014–2019):
  - Primary Balance Shock: Real GDP growth 2.4; 3.5; 3.8; 3.8; 3.8; 3.8. Inflation 4.0; 3.3; 2.5; 3.1; 3.0. Primary balance series includes -1.5 (2014), -2.2 (2015), -1.5 (2016), 0.0 (2017), 0.8 (2018), 0.9 (2019). Effective interest rate varies (6.1–7.4).
  - Real GDP Growth Shock: Real GDP growth 2.4; 0.6; 0.9; 3.8; 3.8; 3.8. Inflation 4.0; 2.6; 1.7; 3.1; 3.0; 3.0. Primary balance includes -1.5; -2.2; -2.4; 0.0; 0.8; 0.9.
  - Real Interest Rate Shock: Effective interest rate rises to 7.1; 7.9; 8.4 in stressed years; other variables per scenario table.
  - Real Exchange Rate Shock: Inflation spike in 2015 to 8.2 (from 3.3 baseline in 2015) in the shock scenario.
  - Combined Macro-Fiscal Shock underlying assumptions: Real GDP growth 2.4; 0.6; 0.9; 3.8; 3.8; 3.8. Inflation 4.0; 2.6; 1.7; 3.1; 3.0; 3.0. Primary balance -1.5; -2.2; -2.4; 0.0; 0.8; 0.9. Effective interest rate 6.1; 6.2; 6.5; 7.1; 7.9; 8.4.
- Stress test outcomes (selected indicators):
  - Gross nominal public debt (in percent of GDP) under stress rises relative to baseline across shock scenarios, with charts indicating higher tails up to the 75th–90th percentiles.
  - Public gross financing needs (in percent of GDP) increase under stress scenarios (charts show movement up to higher percentiles).

### Public DSA risk assessment (heat map highlights)
- Market perception indicators as of 17-Jun-14 through 15-Sep-14: EMBI shown as 166 bp (table cell).
- External financing requirement and other risk-assessment benchmarks noted: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in share of short-term debt; 15 and 45 percent for public debt held by non-residents; 20 and 60 percent for share of foreign-currency denominated debt.
- Percent of public debt held by non-residents shown as 52% in one chart area.

### External debt sustainability (selected findings)
- External-debt-to-GDP ratio: "35 percent projected for end-2014" and "expected to remain stable over the medium-term."
- Under an extreme shock scenario—a 30 percent real exchange rate depreciation—"the debt-to-GDP ratio would increase to 48 percent."
- Mitigating factors noted:
  - A larger share of Mexico’s (public) debt is now denominated in pesos.
  - Mexico has taken advantage of low interest rates.
  - Foreign investor recognition has allowed lengthening of maturity structure of external debt.
- Vulnerabilities noted:
  - "The large share of foreign holdings of the peso-denominated government bonds exposes Mexico to sudden shifts in investor sentiment."
- Bound-test results (selected): Baseline external debt 37 (historical and baseline lines in charts); combined shock raises external debt to 39 in some scenarios; 30% depreciation raises to 48 in the specific shock.

### External debt tables and macro assumptions (selected exact figures)
- Table 1 baseline external debt (percent of GDP): 21.7 (2009); 24.7 (2010); 25.5 (2011); 31.1 (2012); 33.3 (2013); 34.9 (2014); 35.6 (2015); 36.2 (2016); 36.4 (2017); 36.8 (2018); 36.9 (2019).
- Change in external debt (percent of GDP): 3.1 (2009); 3.0 (2010); 0.8 (2011); 5.6 (2012); 2.2 (2013); 1.6 (2014); 0.7 (2015); 0.6 (2016); 0.2 (2017); 0.3 (2018); 0.1 (2019).
- Identified external debt-creating flows (percent of GDP): 3.6 (2009); -3.5 (2010); -1.7 (2011); 0.1 (2012); -1.4 (2013); 0.2 (2014); -0.5 (2015); -0.9 (2016); -0.9 (2017); -1.0 (2018); -1.4 (2019).
- Exports (percent of GDP): 27.4 (2009); 29.9 (2010); 31.2 (2011); 32.7 (2012); 31.8 (2013); 31.8 (2014); 32.0 (2015); 33.3 (2016); 34.6 (2017); 35.6 (2018); 36.8 (2019).
- Gross external financing needs (in billions of US dollars): 65.4 (2009); 54.7 (2010); 84.1 (2011); 88.4 (2012); 123.1 (2013); 155.8 (2014); 147.7 (2015); 163.1 (2016); 167.7 (2017); 173.5 (2018); 188.9 (2019).
- Gross external financing needs (in percent of GDP): 7.3 (2009); 5.2 (2010); 7.2 (2011); 7.5 (2012); 9.8 (2013); 10-Year10-Year11.9 (table mixed notation preserved).

### Macro outlook, fiscal and financial sector context (selected excerpts)
- Growth: "After a sharp slowdown in 2013... growth is projected to recover to 2.4 percent this year."
- Labor and inflation: Headline inflation rose to "4½ percent year-on-year in early 2014"; expected to "stay around 4 percent in the remainder of 2014" and decline gradually in 2015. Core inflation "remains close to 3 percent."
- Monetary policy: "The Bank of Mexico cut the policy rate by 50 basis points to 3 percent in June."
- Fiscal: "The fiscal outturn for the first half of 2014 has been broadly in line with the Public Sector Borrowing Requirement (PSBR) budget target of slightly over 4 percent of GDP."
- Banking sector: NPL share "reaching 3¼ in June up from 2½ percent in 2012"; NPLs fully provisioned; profitability and capitalization remain strong.
- External: Current account deficit widened to "2.1 percent of GDP in 2013"; in 2014 projected to remain unchanged. Moody’s raised foreign currency sovereign rating to "Aa3" in February (2014).
- Structural reforms: "More than a dozen reforms have been approved over the last year and a half including on energy, telecommunications, anti-trust, labor markets, education, and the financial sector." Reforms expected to "boost productivity and output over the medium term."

### Executive Board assessment (selected policy perspectives)
- Directors welcomed the rebound in activity and completion of legislative process for structural reforms.
- Directors noted global financial market volatility risks and expressed confidence in Mexico's "strong policy fundamentals" and the insurance provided by the FCL arrangement.
- Directors considered the current stance of monetary policy "remains appropriate" and welcomed the Bank of Mexico’s commitment to adapt policy in case of upward pressure on prices.
- Directors supported authorities’ plans to reduce the public sector borrowing requirement (text truncated in source).

*Source: IMF staff; Press Release No. 14/511, November 12, 2014; _cr14319 - 8.9 percent of GDP by 2019._*

### 2.5 percent of GDP by 2018. They emphasized that strict adherence to the announced fiscal path

### 2.5 percent of GDP by 2018. They emphasized that strict adherence to the announced fiscal path

### Fiscal framework, revenues, and budget execution
- Strict adherence to the announced fiscal path will strengthen the credibility of the new fiscal framework.
- Some Directors stressed that boosting non oil revenues would be needed, especially if oil revenues are lower than anticipated.
- Directors encouraged the authorities to improve budget implementation further through more realistic expenditure budgeting and stricter control of budget execution.
- Directors welcomed the creation of an oil stabilization and saving fund.
- Directors welcomed the plan to reform the pension system of the two large state owned companies.

### State and municipal finances
- Monitoring and control of state and municipal finances need to be strengthened.
- Full adoption of the uniform accounting methodology for reporting local government finances would be important.
- Introduction of a formal legal framework to anchor fiscal policymaking at the local level would be important.

### Financial sector oversight and risks
- Directors commended Mexico’s sound financial sector and the progress in strengthening the regulation and consolidated supervision of large financial conglomerates.
- Advised careful monitoring of the rise in non performing loans in housing and foreign currency borrowing among some large companies.
- While welcoming the increased role of development banks in improving financial inclusion, Directors recommended caution to avoid displacing private bank lending or relaxing credit standards.

### Structural reform agenda
- Directors underscored the importance of strong and steady implementation of the structural reform agenda.
- Properly sequenced and executed, these reforms would boost productivity and output growth over the medium term.

### Mexico: Selected Economic and Financial Indicators (highlights)
- Real GDP: 2010: 5.1; 2011: 4.0; 2012: 4.0; 2013: 1.1; 2014: 2.4 (Annual percentage changes)
- Real GDP per capita 3/: 2010: 3.6; 2011: 2.8; 2012: 2.8; 2013: -0.1; 2014: 1.4
- Gross domestic investment (in percent of GDP): 2010: 22.1; 2011: 22.3; 2012: 23.1; 2013: 21.5; 2014: 21.6
- Gross domestic savings (in percent of GDP): 2010: 21.7; 2011: 21.2; 2012: 21.8; 2013: 19.5; 2014: 20.6
- Consumer price index (period average): 2010: 4.2; 2011: 3.4; 2012: 4.1; 2013: 3.8; 2014: 3.9

External sector
- Exports, f.o.b.: 2010: 29.9; 2011: 17.1; 2012: 6.1; 2013: 2.5; 2014: 3.9
- Imports, f.o.b.: 2010: 28.6; 2011: 16.4; 2012: 5.7; 2013: 2.8; 2014: 3.6
- External current account balance (in percent of GDP): 2010: -0.4; 2011: -1.1; 2012: -1.3; 2013: -2.1; 2014: -2.1
- Change in net international reserves (end of period, billions of U.S. dollars): 2010: 20.7; 2011: 28.6; 2012: 17.8; 2013: 13.2; 2014: 14.7
- Outstanding external debt (in percent of GDP): 2010: 24.7; 2011: 25.5; 2012: 31.1; 2013: 33.3; 2014: 34.9

Nonfinancial public sector (in percent of GDP)
- Government Revenue: 2010: 22.4; 2011: 22.9; 2012: 23.4; 2013: 23.3; 2014: 22.1
- Government Expenditure: 2010: 26.7; 2011: 26.2; 2012: 27.1; 2013: 27.1; 2014: 26.3
- Augmented overall balance: 2010: -4.3; 2011: -3.3; 2012: -3.7; 2013: -3.8; 2014: -4.2

Money and credit
- Bank credit to the non-financial private sector (nominal) 4/: 2010: 10.0; 2011: 17.2; 2012: 12.0; 2013: 10.4; 2014: 9.7
- Broad money (M4a, nominal): 2010: 12.0; 2011: 15.7; 2012: 14.5; 2013: 8.8; 2014: 9.5

*Sources: National Institute of Statistics and Geography; Bank of Mexico; Secretariat of Finance and Public Credit; and IMF staff estimates*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14319.pdf_