On November 25, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Mexico. Over the last year, Mexico has maintained macroeconomic policy continuity, while pursuing an ambitious agenda of growth-enhancing reforms. Reforms have already been approved to upgrade education, make labor markets more flexible, and foster competition in telecommunications. Congress is currently debating a fundamental reform of the energy sector and is in the final stages of approving a financial sector reform. In October 2013, Congress modified the fiscal framework, reformed the main taxes and introduced a universal pension scheme and unemployment insurance.
In 2013, the economy has begun to operate well below capacity, with real GDP growth expected to slow to 1.2 percent (down from 3.6 percent in 2012). In the first semester, activity declined sharply, opening a sizable output gap estimated at -1.5 percent of potential GDP in the second quarter. Projected growth for 2013 assumes a strong rebound in the second semester, with manufacturing recovering in response to a pick-up in U.S. manufacturing, and public spending regaining its lost momentum. However, this projection assumes a gradual recovery in construction. The storms that hit both coasts in September are expected to have only a modest effect on growth.
The slack in the economy is helping to contain price pressures, with headline inflation now projected at 3½ percent by the end of the year—close to the 3 percent inflation target. Supply shocks had driven up food prices and pushed headline inflation above 4 percent earlier this year.
However, since mid-year these pressures on food prices have subsided, and core inflation has stayed at historical lows of 2½ percent y/y since July. Medium-term inflation expectations have remained firmly anchored at 3½ percent— albeit still above the 3 percent target.
Demand policies are supporting a recovery in growth. The public sector borrowing requirement (PSBR) is expected to reach 4.1 percent of GDP this year, compared with 3.7 percent of GDP in 2012. This stance would imply a considerable fiscal stimulus in the second semester, as the PSBR amounted to only 1.0 percent of GDP in the first semester. The central bank has reduced its policy rate so far this year by a total of 100 basis points to 3.50 percent in response to the widening of the negative output gap and in the absence of significant inflationary pressures.
The external current account deficit is projected to widen to 1.7 percent of GDP in 2013. The non-oil trade deficit would remain at 1 percent of GDP, while the oil trade surplus would fall to 0.6 percent of GDP, reflecting weaker production and exports of oil. The Fund’s current account model and a range of exchange rate metrics in the External Balance Assessment (EBA) suggest that the current account balance and real exchange rate are broadly in line with fundamentals and desirable policy settings.
Mexico’s financial asset markets showed more resilience than many other emerging markets after the Fed initiated its discussion of tapering on May 22. In this context, net capital inflows are projected to remain steady at about 4 percent of GDP in 2013. Through April, investor appetite for Mexican assets was underpinned by heightened prospects for further structural reforms, as well as the ample global supply of liquidity, generating a strong appreciation of the peso and a compression in sovereign debt yields. After the Fed initiated the discussion on the tapering of quantitative easing, asset markets reversed course for several months. In the second quarter, gross capital inflows, especially portfolio investment from non-residents fell sharply from a peak in the first quarter. Residents helped cushion the effects of this shift by keeping more of their funds within Mexico, leading to a smaller decline in overall net capital inflows. The recent delay in tapering announced by the Fed in mid-September has led to signs of a recovery in capital inflows in recent months.
The banking system—which accounts for about 60 percent of financial system assets—has remained resilient. The annual expansion in bank credit to the private sector has slowed from about 15 percent in nominal terms in mid-2012 to 10 percent as of August 2013. As of July 2013, the system’s capital adequacy ratio stood at 15.6 percent, largely unchanged from a year ago. However, NPLs have increased to 4 percent of total loans in July 2013, from 3.1 percent at end-2012, although provisions still amounted to 174 percent of NPLs.
Executive Board Assessment
IMF Executive Directors noted that Mexico’s very strong fundamentals, sound policy framework, and skillful macroeconomic management have allowed Mexico to deal with global volatility exceptionally well in recent months. At the same time, they noted that growth this year will be below potential, and downside risks remain from unsettled external conditions. Directors welcomed the authorities’ commitment to maintain prudent macroeconomic policies and continue to implement far-reaching structural reforms.
Directors supported the moderately expansionary fiscal stance. They emphasized nonetheless that medium-term consolidation will be important as growth recovers. In this regard, Directors welcomed legislation that would facilitate achieving the medium-term fiscal targets and a sustainable path for the public debt. More broadly, Directors welcomed the more comprehensive medium-term fiscal framework recently put in place, which will provide a more effective anchor for policy and reduce procyclicality. They encouraged the authorities to consider further efforts to simplify the operations of the oil stabilization funds, bolster collection of nonoil tax revenues, and preserve the gains from the elimination of the subsidy on domestic gasoline prices.
Directors agreed that the current stance of monetary policy is appropriate, and that monetary and exchange rate policies are well positioned to manage tail risks from the global economy. Directors noted that the Flexible Credit Line continues to serve as a complement to foreign reserves if global tail risks materialize.
Directors noted the resilience of Mexico’s financial system. They mentioned that recent reforms should promote competition and access in the financial sector while strengthening regulation and consumer protection. Directors also encouraged the authorities to monitor private sector indebtedness and the rise in nonperforming construction loans.
Directors welcomed the progress in structural reforms aimed at upgrading public education, increasing labor market flexibility, and fostering competition in telecommunications. Together with other reforms currently under discussion, these reforms will provide an important, if gradual, impetus to medium-term growth. Implementation will be key, and Directors underscored the benefits of a prompt approval of the secondary legislation and regulations.