Mexico: Staff Concluding Statement of the 2021 Article IV Mission

IMF News, October 8, 2021

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Mexico: Staff Concluding Statement of the 2021 Article IV Mission

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• Published: October 8, 2021

Economic outlook and pandemic impact

• The Mexican economy is rebounding from its deepest downturn in decades.
• Growth projections: 6.2 percent in 2021 and 4 percent in 2022.
• Manufacturing and exports are above pre-pandemic levels; services are re-opening, and employment is recovering.
• Humanitarian and social costs:
  • There have been over half a million excess deaths likely linked to COVID-19.
  • Under-employment remains above the peak reached during the global financial crisis; over 4½ million more people are unemployed, under-employed, or available to work (the broad U6 unemployment category) than before the pandemic.
  • Already-high levels of poverty have increased further.
  • The young face sizable learning losses with potentially harmful longer-term effects.
• Long-run concerns:
  • Real income per capita has continued its long-run divergence from the U.S., with projections signaling further divergence ahead.
  • Low productivity growth and high poverty remain Mexico’s key problems.
  • The economy will face new challenges from technological shifts and the effects of climate change.
• Policy priorities: safeguard the recovery, preserve economic stability, and promote inclusive and sustainable growth. First priority: vaccinating the eligible population as swiftly as possible.

Fiscal policy — stance, recommended supportive measures, and medium-term adjustment

Findings

• Authorities pursued a conservative fiscal policy through the pandemic, focusing on containing public debt.
• COVID-19 fiscal support was notably less than that of emerging market (EM) and regional peers.
• The authorities increased resources for health, social (non-contributory) pensions for the elderly, Pemex, and public investment projects, while restraining spending elsewhere.
• Efforts to tackle tax evasion have boosted revenues; plans to deepen these efforts are underway.
• Multiplicity of tax regimes for SMEs and the self-employed is being simplified; careful attention to design is warranted.
• The scope for further cuts to non-pension, non-Pemex spending is limited due to previous sizeable cuts.

Recommended near-term fiscal support (numeric specifics)

• Mexico has some fiscal space and comfortable market access that could be deployed to limit human costs.
• A permanent increase in spending of about 1½ percent of GDP in 2022 could alleviate pressures on the vulnerable, mitigate scarring, and secure the recovery:
  • Around ¾ percent of GDP toward increasing education and health spending.
  • About ½ percent of GDP toward strengthening poverty reduction efforts (including for childcare benefits).
  • ¼ percent of GDP for incremental public investment in green infrastructure.
• These measures could be followed by a further, permanent increase in spending of 1½ percent of GDP in 2023-24.
• Total permanent increase envisaged: about 3 percent of GDP, of roughly equal amounts for poverty alleviation, education and health, and quality public investment.

Design and efficiency measures

• Social assistance: strengthen targeting, reduce overlaps and coverage gaps across multiple programs, and enhance administrative capacity.
• Education and health: pair increased spending with efficiency-enhancing measures (invest in equipment and facilities, improve early-childhood education and childcare facilities, curb absenteeism, target health investments to impoverished areas, decrease administrative and insurance costs).
• Public investment: conduct rigorous and transparent cost-benefit analyses, including external review, to ensure sound project selection.
• Contain rising pension costs and reform Pemex’s business plan.

Pensions

• Consider reforms to the minimum pension design to mitigate early retirement risks (strengthen link between retirement age and pensions).
• Align special pension regimes with the broader system.
• Swiftly complete transition from the expensive pre-1997 pension scheme.
• Increase the age at which public sector workers become eligible for a full pension.
• Consider maintaining current level of social (noncontributory) pensions, adjusted for inflation, in coming years.

Pemex

• Pemex’s losses are placing a burden on taxpayers and crowding out more productive fiscal uses.
• Strengthen governance and procurement processes given past corruption scandals.
• Any further support should be accompanied by a new strategy prioritizing financial objectives: focus on profitable fields, sell non-core assets, postpone new refinery plans, reform costly pension scheme, and increase transparency.
• Partnering with private firms recommended to leverage expertise and manage costs.

Revenue mobilization and reform (medium-term)

• Pre-pandemic non-oil revenue collections were nearly 6 percent of GDP below Latin American peers and about half those of the OECD.
• A medium-term revenue goal: raise 3-4 percent of GDP through a progressive tax reform phased in as the economy strengthens.
• Continue strengthening tax administration in parallel.
• Menu of reform options includes:
  • personal income taxes: broaden the base by eliminating a range of exclusions and tax expenditures and broaden the top bracket;
  • subnational property taxes: update the cadaster, improve coordination across levels of government, and simplify and better enforce the vehicle tax;
  • mining taxation: reform regime to collect more revenues when profits increase while minimizing impact on competitiveness;
  • VAT: eliminate zero-rating except for a few key food items, rationalize exemptions, implement a comprehensive compliance risk management strategy, and eliminate reduced rates at the border;
  • gasoline excise: adopt a more market-based system for gasoline prices (current excise formula disproportionately benefits the rich).

Monetary policy

Findings

• With inflation above the target range, the central bank has raised the policy rate by 75 basis points since June 2021.
• From mid-2019 until earlier this year, the central bank had cut the policy rate to 4 percent.
• Since March, inflation has been above the inflation target range, driven mostly by external factors (elevated food, energy, and merchandise inflation) and local demand-supply imbalances as the economy re-opens.
• The rise in inflation above the target range has prompted rate increases to signal commitment to the inflation objective and anchor inflation expectations.
• The central bank has enhanced transparency by presenting an updated inflation forecast with each decision and publicizing the vote of each board member.

Recommendations and framework

• A gradual path of policy normalization would balance support for recovery and firm anchoring of medium-term inflation expectations.
• The central bank has room to move gradually given transitory expectations of price pressures, considerable economic slack, and the fact that Mexico did not cut its policy rate abruptly in 2020.
• Policy must remain highly attuned to the evolution of inflation expectations; a faster pace of tightening could be needed if medium-term inflation expectations rise.
• Maintain exchange rate flexibility; limit foreign exchange intervention to instances of disorderly market conditions.
• Enhance clarity on the central bank’s assessment of the outlook: provide more details about macroeconomic forecasts and eventually publish an internally consistent macroeconomic forecast that includes the policy rate path underpinning the forecasts.
• Emphasize that policy is not on a pre-set path but will respond to developments, including inflation expectations and potential second-round effects.
• Conduct a strategic review of the monetary policy framework to assess performance and possible changes to the toolkit or communications strategy; consider roles of financial stability, inclusion, employment, and greening of the financial system within the legal framework.

Supply-side reforms, competitiveness, and climate policy

Findings and priorities

• Government’s inclusive growth strategy elements: implementing USMCA, increasing public investment to improve regional integration, enhancing financial inclusion, and promoting governance.
• However, privileging state-owned energy producers, reversing previous reforms, and canceling certain investment projects have weighed on investment and risk offsetting growth benefits.
• Electricity prices for corporations remain notably above those in the U.S. and many other EMs; reliability of electricity supply is a rising concern.

Energy sector recommendations

• Leverage Mexico’s large and diverse renewable energy resource base.
• Encourage private sector participation in electricity generation and hydrocarbon distribution.
• Strengthen the electricity grid to foster a cheaper, more reliable, sustainable, and competitive energy sector.
• Reform Pemex’s business plan (see fiscal section).

Climate policy and carbon pricing

• Mexico was the first EM to implement carbon taxation in 2014 and has put in place a pilot emissions trading scheme.
• Current carbon price is below that in other countries and well below what is needed to achieve its Nationally Determined Contribution (NDC).
• Policy options:
  • Comprehensively price emissions and gradually increase the role of carbon pricing.
  • Implement reinforcing sectoral measures (e.g., feebates).
  • Use revenues from higher carbon taxes to protect the poor and enhance inclusive growth, including funding Sustainable Development Goals.
  • Consider a border carbon adjustment to help preserve competitiveness.
  • Balance price-based measures with alternative instruments to achieve mitigation goals.

Labor market, inclusion, and governance

• Informality is high given Mexico’s level of development.
• Sharp minimum wage increases have put it above the median informal income and much of the formal income distribution.
• Recommendations:
  • Calibrate minimum wage increases in line with labor productivity growth.
  • Take a comprehensive approach to formalization (reduce regulatory costs of formalizing a business, lower firing restrictions as the labor market strengthens).
  • Improve access to and quality of childcare to increase female labor force participation; potential long-term net benefits.
  • Invest in education and training (including digital connectivity) to adapt the labor force to technological change.
  • Enhance independence and resources of regulatory institutions to underpin investment sentiment.
  • Boost competition in financial services and tackle impediments such as timely legal enforcement of contracts to lower costs and enhance access to finance.
  • Ensure regulatory agility to harness fintech benefits while balancing operational, financial and market integrity, consumer and investor protection, and financial stability.

Anti-corruption and AML/CFT

• Steps to combat corruption and strengthen AML/CFT include:
  • Adequately resourcing relevant anti-corruption agencies.
  • Enhancing powers of institutions in charge of investigations, prosecution, and oversight of public spending.
  • Enhancing verification mechanism related to public asset declarations by high-level public officials.
  • Enhancing money laundering enforcement commensurate with Mexico’s risk profile.
  • Introducing comprehensive criminal liability for legal persons.

Concluding engagement

• The IMF staff team expressed gratitude to the Mexican authorities and other counterparts for their time and constructive discussions.

International Monetary Fund

Content in this bundle

• wpiea2021181-print-pdf
  • wpiea2021181-print-pdf (Markdown version)
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References

• Mexico and the IMF
• IMF Policy Advice -- A Factsheet
• The IMF and Good Governance -- A Factsheet
• Mission Concluding Statements
• PRESS CENTER
• IMF Fiscal Monitor, April 2021
• https://www.imf.org/en/home