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Mexico: Arrangement Under the Flexible Credit Line and Cancellation of the Current Arrangement

Author(s):
International Monetary Fund. Western Hemisphere Dept.
Published Date:
December 2014
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Context

1. Mexico’s macroeconomic policies and policy frameworks remain very strong. Monetary policy is guided by an inflation targeting framework in the context of a flexible exchange rate regime and fiscal policy is anchored by the fiscal responsibility law. The external current account deficit is low and stable, and the real effective exchange rate is in line with economic fundamentals. The 2011 FSAP found that the financial regulatory and supervisory framework was sound. The authorities remain committed to maintaining an open capital account and further development and deepening of Mexico’s financial markets. Over the last two years, the government has made impressive progress in advancing an ambitious agenda of structural reforms in a broad range of areas. At the conclusion of the 2014 Article IV Consultation, Executive Directors expressed confidence in Mexico’s very strong policy fundamentals and policies.

2. Despite Mexico’s sound fundamentals, it remains exposed to external risks. Mexico has close ties with the global economy, and particularly with the U.S., through both trade and financial channels. Foreign-owned banks account for about 70 percent of banking system assets, with a large presence of Spanish banks. There has been a sizeable increase in portfolio inflows into the domestic sovereign bond market since the inclusion of Mexico in the World Global Bond Index (WGBI) in 2010. International investors now hold 52 percent of total public debt, and 37 percent of local currency-denominated sovereign bonds, reflecting the strength of the Mexican economic policy framework and yielding many economic benefits, including a lower cost of finance and a more diversified investor base. At the same time, they can make Mexico more exposed to abrupt shifts in investor sentiment toward emerging markets. 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.

Recent Developments

3. Mexico has completed the legislative process underpinning its comprehensive structural reforms agenda. Over the last two years, important reforms have been approved in the areas of energy, telecommunications, anti-trust, labor markets, education, and the financial sector. Secondary laws for the energy and telecommunication reforms were recently approved by Congress, clearing the way for implementation. The energy reform opened the door to private investment in the sector, ending a 75-year state monopoly in oil and gas production and distribution. By enhancing competition, reducing labor market frictions, and encouraging investment, the reforms are expected to boost productivity and output over the medium term.

4. After a sharp slowdown in 2013, growth is projected to recover to 2.4 percent this year (Figure 1). Real GDP grew 1.1 percent in 2013, reflecting weak external demand and a decline in construction activity. Economic activity has accelerated in recent months. The strong recovery in the U.S. in the second quarter of 2014 has triggered a rebound in Mexico’s manufacturing production and exports (especially in the automotive sector). In addition, construction activity is firming up, supported by a rebound of residential investment and an increase of government spending on infrastructure. The recovery is increasingly broad-based, with activity in the service sector picking up as well. Inflationary pressures remain contained, and the degree of slack in the labor market suggests that the economy continues to operate below potential.

Figure 1.Recent Economic Developments

Sources: National authorities; Haver Analytics; Bloomberg; and IMF staff calculations.

1/ IMF staff projections.

5. Bond issuance has been robust, while bank credit growth has moderated (Figure 2). Over the last year, gross portfolio inflows have rebounded and bond spreads have narrowed. Private corporations and the government have taken advantage of the renewed investors’ risk appetite to issue foreign-currency bonds at favorable rates. The nominal exchange rate has remained relatively stable, and the implied exchange rate volatility from option prices has fallen to historical lows. In February, Moody’s raised Mexico’s foreign currency sovereign rating to A3, citing the expected positive impact of structural reforms on potential growth. At the same time, commercial bank credit growth slowed down to about 8 percent year-on-year in nominal terms in the first half of 2014. The deceleration has been concentrated in construction and consumer credit growth.

Figure 2.Recent Financial Developments

Sources: National authorities; Haver Analytics; Dealogic; EPFR; Bloomberg; and IMF staff calculations.

1/ As of July 2014.

6. Mexico’s external sector position remains strong. The current account deficit widened to 2.1 percent of GDP in 2013, reflecting higher net factor payments, while the trade balance remained stable. In 2014, the current account deficit is projected to remain broadly unchanged. The nominal and real effective exchange rates have depreciated modestly since end-2013. The current account deficit and the real effective exchange rate are broadly in line with fundamentals and desirable policy settings according to staff’s assessment. External competitiveness remains strong. Mexico’s share in U.S. manufacturing imports has increased from 10 to 13 percent over the last five years, and unit labor costs in manufacturing have declined.

7. Mexico’s net international investment liability position has remained stable at about 40 percent of GDP. The country has seen a surge in capital inflows since 2010, when Mexico was included in Citigroup’s World Government Bond Index. However, these inflows have not translated into external or domestic imbalances as the accumulation of gross external liabilities has been matched by a rise in external asset holdings (residents’ foreign assets stood at 45 percent of GDP in June 2014). Steady reserve accumulation has helped Mexico maintain broadly stable measures of reserve adequacy over time (Table 7). Reserves amounted to 116 percent on the ARA metric in 2013.

Table 1.Indicators of Fund Credit
Projections
2014201520162017201820192020
Stocks from prospective drawings 1/
Fund credit in millions SDR47,29247,29247,29247,29223,64600
In percent of quota1,3041,3041,3041,30465200
In percent of GDP6555200
In percent of exports of goods and services17161514600
In percent of gross reserves373533311500
Flows from prospective drawings 2/
Charges in millions of SDR2361,1951,2161,2151,2273191
Debt service due on GRA credit in millions of SDR2361,1951,2161,21524,87323,9651
In percent of quota6.533.033.533.5686.0661.00.0
In percent of GDP0.00.10.10.12.42.20.0
In percent of exports of goods and services0.10.40.40.46.65.80.0
In percent of gross reserves0.20.90.80.815.313.80.0
Memo Item:
Total external debt (percent of GDP)40.440.741.041.038.836.636.6
Sources: IMF Finance Department; Mexican authorities, and Fund staff estimates

End of period. Assumes full drawings under the FCL upon approval of the review. The Mexican authorities have expressed their intention to treat the arrangement as precautionary.

Based on the rate of charge as of October 16, 2014. Includes GRA charges, surcharges under the system currently in force and service charges.

Sources: IMF Finance Department; Mexican authorities, and Fund staff estimates

End of period. Assumes full drawings under the FCL upon approval of the review. The Mexican authorities have expressed their intention to treat the arrangement as precautionary.

Based on the rate of charge as of October 16, 2014. Includes GRA charges, surcharges under the system currently in force and service charges.

Table 2.Proposed Access
High-Access Cases 1/
Proposed Arrangement FCLProposed Arrangement (Percentile)20th65th Percentile80thMedian
(Ratio)
Access
In millions of SDRs47,292991,38610,98115,4186,662
Average annual access (percent of quota)65283171394647271
Average annual access (percent of total) 2/652823007781,009575
Total access in percent of: 3/
Actual quota1,304873418001,053600
Gross domestic product6443.07.39.66.2
Gross international reserves373626558548
Exports of goods and nonfactor services 4/173811.227.939.020
Imports of goods and nonfactor services17489.722.932.918
Total debt stock 5/
Of which: Public12448162912
External17737152212
Short-term 6/5164215111236
M27236152412
Source: Executive Board documents, MONA database, and Fund staff estimates.

High access cases include available data at approval and on augmentation for all the requests to the Board since 1997 which involved the use of the exceptional circumstances clause or SRF resources. Exceptional access augmentations are counted as separate observations. For the purpose of measuring access as a ratio of different metrics, access includes augmentations and previously approved and drawn amounts.

Correspond to quotas prior to 2008 Reform.

The data used to calculate ratios is the actual value for the year prior to approval for public, external, and short-term debt, and the projection at the time of program approval for the year in which the program was approved for all other variables (projections for 2012 were used).

Includes net private transfers.

Refers to net debt.

Refers to residual maturity.

Source: Executive Board documents, MONA database, and Fund staff estimates.

High access cases include available data at approval and on augmentation for all the requests to the Board since 1997 which involved the use of the exceptional circumstances clause or SRF resources. Exceptional access augmentations are counted as separate observations. For the purpose of measuring access as a ratio of different metrics, access includes augmentations and previously approved and drawn amounts.

Correspond to quotas prior to 2008 Reform.

The data used to calculate ratios is the actual value for the year prior to approval for public, external, and short-term debt, and the projection at the time of program approval for the year in which the program was approved for all other variables (projections for 2012 were used).

Includes net private transfers.

Refers to net debt.

Refers to residual maturity.

Table 3.Selected Economic, Financial, and Social Indicators
I. Social and Demographic Indicators
GDP per capita (U.S. dollars, 2013)10,650Poverty headcount ratio (% of population, 2012) 1/45.5
Population (millions, 2013)118.4Income share of highest 20 percent / lowest 20 percent (2010)11.4
Life expectancy at birth (years, 2012)74.5Adult illiteracy rate (2012)5.8
Infant mortality rate (per thousand, 2013)12.8Gross primary education enrollment rate (2012) 2/105.0
Sources: World Bank Development Indicators; CONEVAL; National Institute of Statistics and Geography; National Council of Population; Bank of Mexico; Secretariat of Finance and Public Credit; and IMF staff estimates.

CONEVAL uses a multi-dimensional approach to measuring poverty based on a “social deprivation index,” which goes beyond the level of income and also factors in the level of education, access to health services, access to social security, quality and the size of one’s home, access to basic services in the dwelling, and access to food.

Percent of population enrolled in primary school regardless of age as a share of the population of official primary education age.

Contribution to growth. Excludes statistical discrepancy.

2014 based on data available until September 2014.

2014 based on data available until June 2014.

2014 based on data available until July 2014.

Includes commercial banks and direct credit by development banks.

Includes money held by the public sector.

Federal Government plus Social Security and State-owned Companies, excl. nonrecurring revenue and transfers to stabilization funds.

II. Economic Indicators
Proj.
20112012201320142015
(Annual percentage change, unless otherwise indicated)
National accounts (in real terms)
GDP4.04.01.12.43.5
Consumption4.54.62.31.53.3
Private4.84.92.51.62.8
Public2.43.41.20.72.0
Investment5.45.5−2.41.85.0
Fixed7.84.5−1.80.45.2
Private12.18.8−1.33.45.4
Public−4.1−9.5−3.6−2.64.2
Inventories 3/−0.50.2−0.20.30.0
Exports of goods and services8.25.91.26.84.4
Imports of goods and services8.05.51.55.65.1
Exchange rates
Nominal exchange rate (US$/Mex$)
(average, appreciation +) 4/1.7−5.73.11.4
Employment and inflation
Consumer prices (average)3.44.13.83.93.5
Formal sector employment, IMSS-insured workers (average) 5/4.34.63.52.7
National unemployment rate (annual average)5.25.04.94.84.5
Unit labor costs: manufacturing (real terms, average) 6/−1.8−2.80.8−0.2
Money and credit
Nominal bank credit to non-financial private sector 7/17.111.012.010.711.7
Broad money (M4a) 8/15.714.58.89.59.9
Public sector finances (in percent of GDP)
General government revenue22.923.423.321.921.3
General government expenditure26.227.127.126.125.3
Overall fiscal balance (public sector borrowing requirements) 9/−3.3−3.7−3.8−4.2−4.0
Gross public sector debt43.243.246.447.848.9
External sector
External current account balance (in percent of GDP)−1.1−1.3−2.1−2.1−2.0
Exports of goods, f.o.b.17.16.12.53.96.9
Export volume2.29.02.86.54.0
Imports of goods, f.o.b.16.45.72.83.66.8
Import volume8.54.63.05.95.3
Net capital inflows (in percent of GDP)4.34.34.83.23.0
Real effective exchange rate (CPI based)
(average, appreciation +)0.4−2.96.1−0.7
Terms of trade (improvement +)6.8−3.6−0.1−0.31.3
Memorandum items
Output gap−0.60.8−0.7−1.1−0.4
Sources: World Bank Development Indicators; CONEVAL; National Institute of Statistics and Geography; National Council of Population; Bank of Mexico; Secretariat of Finance and Public Credit; and IMF staff estimates.

CONEVAL uses a multi-dimensional approach to measuring poverty based on a “social deprivation index,” which goes beyond the level of income and also factors in the level of education, access to health services, access to social security, quality and the size of one’s home, access to basic services in the dwelling, and access to food.

Percent of population enrolled in primary school regardless of age as a share of the population of official primary education age.

Contribution to growth. Excludes statistical discrepancy.

2014 based on data available until September 2014.

2014 based on data available until June 2014.

2014 based on data available until July 2014.

Includes commercial banks and direct credit by development banks.

Includes money held by the public sector.

Federal Government plus Social Security and State-owned Companies, excl. nonrecurring revenue and transfers to stabilization funds.

Sources: World Bank Development Indicators; CONEVAL; National Institute of Statistics and Geography; National Council of Population; Bank of Mexico; Secretariat of Finance and Public Credit; and IMF staff estimates.

CONEVAL uses a multi-dimensional approach to measuring poverty based on a “social deprivation index,” which goes beyond the level of income and also factors in the level of education, access to health services, access to social security, quality and the size of one’s home, access to basic services in the dwelling, and access to food.

Percent of population enrolled in primary school regardless of age as a share of the population of official primary education age.

Contribution to growth. Excludes statistical discrepancy.

2014 based on data available until September 2014.

2014 based on data available until June 2014.

2014 based on data available until July 2014.

Includes commercial banks and direct credit by development banks.

Includes money held by the public sector.

Federal Government plus Social Security and State-owned Companies, excl. nonrecurring revenue and transfers to stabilization funds.

Table 4.Financial Operations of the Public Sector, Authorities’ Presentation(In percent of GDP)
Prel.Staff Projections
2010201120122013201420152016201720182019
Budgetary revenue, by type22.322.522.523.622.422.023.023.624.024.2
Oil revenue7.37.67.67.87.26.77.27.37.37.5
Non-oil tax revenue 1/9.99.99.710.210.310.811.311.812.212.2
Non-oil non-tax revenue5.15.05.25.65.04.64.54.54.54.5
Budgetary expenditure25.125.025.125.925.925.526.026.126.026.2
Primary23.223.123.224.023.823.323.623.623.423.5
Programmable19.719.719.920.620.520.020.120.019.819.9
Current14.714.815.115.215.615.415.615.415.114.9
Wages6.05.95.96.06.05.95.95.85.85.7
Pensions2.62.72.82.93.13.23.33.43.53.6
Subsidies and transfers2.83.03.13.33.53.53.53.53.23.0
Other3.33.23.33.03.02.92.92.72.52.5
Capital5.04.84.75.44.94.64.54.64.75.0
Physical capital4.74.54.44.64.74.44.34.44.54.8
Of which: Pemex2.01.82.02.02.02.02.02.02.02.0
Financial capital 2/0.30.40.40.90.20.20.20.20.20.2
Nonprogrammable3.53.43.33.43.33.33.43.63.63.7
Of which: revenue sharing3.33.33.23.33.23.23.43.53.53.6
Interest payments 3/1.91.92.02.02.12.22.42.52.62.6
Traditional balance−2.8−2.5−2.6−2.3−3.5−3.5−3.0−2.5−2.0−2.0
Adjustments to the traditional balance1.50.91.11.50.70.50.50.50.50.5
Public sector borrowing requirements 4/−4.3−3.3−3.7−3.8−4.2−4.0−3.5−3.0−2.5−2.5
Augmented interest expenditure 5/2.52.42.52.52.72.72.83.03.33.4
Augmented primary balance−1.7−1.0−1.1−1.3−1.5−1.4−0.70.00.80.9
Memorandum items
Total revenue 6/22.422.923.423.322.121.422.623.223.623.8
Total expenditure 7/26.726.227.127.126.325.526.126.226.126.3
Total primary expenditure 8/24.223.924.624.623.722.823.323.222.822.9
Structural current spending 9/12.912.913.013.113.012.712.612.512.412.4
Structural current spending real growth (y/y, in percent) 10/−0.35.74.6−0.11.71.02.13.23.73.7
Crude oil export price, Mexican mix (US$/bbl)7210110298979492908988
Non-oil augmented balance 11/−8.4−8.0−8.2−8.7−8.3−7.7−7.6−7.2−6.7−6.9
Structural Primary Fiscal Balance−2.1−1.8−1.9−1.6−1.5−1.4−0.70.10.91.0
Fiscal Impulse 12/−0.2−0.30.0−0.2−0.1−0.2−0.7−0.8−0.8−0.1
Gross public sector debt42.243.243.246.447.848.949.549.448.848.2
Net public sector debt36.237.537.740.442.043.143.743.643.042.4
Nominal GDP (billions of Mexican pesos)13,28214,55015,61516,10417,15618,34519,50620,86722,31823,879
Sources: Mexican authorities and IMF staff estimates. Data refer to non-financial public sector, including PEMEX and other public entities but excluding state and local governments.

From 2015 onwards, in line with the 2015 Income Law, excise on gasoline is classified as non-oil tax revenue.

Due to lack of disaggregated data this item includes both financing and capital transfers.

Includes transfers to IPAB and debtor support programs.

Public Sector Borrowing Requirements excl. adjustments for net inflows to stabilization funds.

Treats transfers to IPAB as interest payments.

Budgetary revenue, excluding nonrecurrent revenue and gasoline subsidy.

Budgetary expenditure, including adjustments to the traditional balance with the exception of adj. for nonrecurrent revenue and gasoline subsidy.

Total expenditure minus augmented interest payments.

The 2014 amendment to the FRL introduced a cap on structural current spending real growth. The latter is defined as total budgeary expenditure, excluding: (i) interest payments; (ii) non-programable spending; (iii) fuel costs of CFE; and (iv) direct physical and financial investment of the federal government.

The cap on structural current spending real growth was set at 2.0 percent for 2015 and 2016, and equal to potential GDP real growht from 2017 onwards.

Excludes oil revenue (oil extraction rights, PEMEX net income, oil excess return levies, excise tax on gasoline) and PEMEX operational and physical capital expenditure.

Negative of the change in the structural primary fiscal balance, measured adjusting tax revenue for the cycle and oil net exports using a long-term moving average of oil prices.

Sources: Mexican authorities and IMF staff estimates. Data refer to non-financial public sector, including PEMEX and other public entities but excluding state and local governments.

From 2015 onwards, in line with the 2015 Income Law, excise on gasoline is classified as non-oil tax revenue.

Due to lack of disaggregated data this item includes both financing and capital transfers.

Includes transfers to IPAB and debtor support programs.

Public Sector Borrowing Requirements excl. adjustments for net inflows to stabilization funds.

Treats transfers to IPAB as interest payments.

Budgetary revenue, excluding nonrecurrent revenue and gasoline subsidy.

Budgetary expenditure, including adjustments to the traditional balance with the exception of adj. for nonrecurrent revenue and gasoline subsidy.

Total expenditure minus augmented interest payments.

The 2014 amendment to the FRL introduced a cap on structural current spending real growth. The latter is defined as total budgeary expenditure, excluding: (i) interest payments; (ii) non-programable spending; (iii) fuel costs of CFE; and (iv) direct physical and financial investment of the federal government.

The cap on structural current spending real growth was set at 2.0 percent for 2015 and 2016, and equal to potential GDP real growht from 2017 onwards.

Excludes oil revenue (oil extraction rights, PEMEX net income, oil excess return levies, excise tax on gasoline) and PEMEX operational and physical capital expenditure.

Negative of the change in the structural primary fiscal balance, measured adjusting tax revenue for the cycle and oil net exports using a long-term moving average of oil prices.

Table 5.Summary Balance of Payments
Projections
2010201120122013201420152016201720182019
(In billions of U.S. dollars)
Current account−4.1−12.8−15.3−26.3−27.0−27.9−33.9−34.3−35.4−36.1
Merchandise trade balance−3.0−1.40.0−1.20.51.1−2.10.7−0.23.2
Exports298.5349.4370.8380.0395.7423.1463.0510.9558.2613.0
o/w Manufactures 1/246.1279.2302.7315.3330.6354.9381.4411.2441.5470.0
Imports−301.5−350.8−370.8−381.2−395.2−422.1−465.1−510.2−558.4−609.7
o/w Petroleum and derivatives30.242.741.140.938.838.939.339.538.939.8
Net other goods 2/0.10.20.30.30.00.00.00.00.00.0
Net services−10.6−14.8−14.6−12.0−11.9−12.3−12.7−13.2−13.6−14.1
Net factor income−12.1−19.7−23.6−35.5−38.4−40.7−44.0−47.9−48.5−53.1
o/w Gross Repatriation of Profits and Interest Payments Abroad−22.9−30.3−36.7−45.1−48.4−52.6−58.3−65.0−68.8−75.8
Net transfers (Remittances)21.523.022.622.122.924.125.026.027.027.9
Financial Account44.550.951.461.041.741.347.648.951.656.4
Foreign direct investment, net8.411.1−4.726.014.018.528.029.330.637.9
Direct investment into Mexico23.523.717.839.222.827.537.338.940.648.1
Direct investment abroad−15.0−12.6−22.5−13.2−8.7−9.0−9.3−9.6−9.9−10.3
Portfolio investment, net31.445.972.749.030.933.832.229.230.129.1
Liabilities37.340.681.251.130.933.832.229.230.129.1
Public Sector28.137.056.933.222.723.923.224.525.925.3
o/w Local currency domestic-issued bonds23.131.646.622.016.717.215.816.417.115.8
Private sector9.23.624.317.98.29.99.04.74.23.8
Assets−5.95.3−8.5−2.10.00.00.00.00.00.0
Other investments, net4.6−6.1−16.6−14.0−3.2−11.1−12.6−9.6−9.1−10.6
Liabilites31.6−2.5−10.313.35.42.51.05.07.56.0
Assets−27.0−3.7−6.3−27.3−8.6−13.6−13.6−14.6−16.6−16.6
Errors and Omissions−19.8−10.0−18.7−16.90.00.00.00.00.00.0
Change in net international reserves20.728.617.813.214.713.313.714.616.217.3
Valuation adjustments−0.1−0.4−0.34.60.00.00.00.00.00.0
(In percent of GDP)
Current account balance−0.4−1.1−1.3−2.1−2.1−2.0−2.3−2.2−2.2−2.1
o/w Hydrocarbons trade balance1.11.21.00.70.10.00.10.20.60.7
o/w Non-hydrocarbons trade balance 3/−1.4−1.3−1.0−0.8−0.10.0−0.2−0.2−0.6−0.5
Net capital inflows4.24.34.34.83.23.03.33.23.13.2
Net FDI inflows0.80.9−0.42.11.11.31.91.91.92.2
Net portfolio inflows3.03.96.13.92.42.42.21.91.81.7
Net other investment inflows0.4−0.5−1.4−1.1−0.2−0.8−0.9−0.6−0.6−0.6
Memorandum items
Hydrocarbons exports volume growth (in percent)11.2−1.7−6.1−2.80.0−4.80.00.00.00.0
Non-hydrocarbons exports volume growth (in percent)17.33.38.45.57.35.05.47.57.56.9
Hydrocarbons imports volume growth (in percent)15.47.4−4.6−8.15.03.63.12.6−0.23.4
Non-hydrocarbons imports volume growth (in percent)24.18.66.54.45.95.310.28.77.67.6
Crude oil export volume (millions of bbl/day)1.41.31.31.21.21.21.21.21.21.2
Gross domestic product (in billions of U.S. dollars)1,0521,1721,1861,2611,3101,3881,4611,5481,6401,737
Sources: Bank of Mexico; Secretariat of Finance and Public Credit; and Fund staff projections.

Total exports are defined net of imports by the maquila sector. Correspondingly, total imports do not include maquila sector imports.

Goods procured in ports by carriers.

Excluding oil exports, petroleum products and natural gas imports.

Sources: Bank of Mexico; Secretariat of Finance and Public Credit; and Fund staff projections.

Total exports are defined net of imports by the maquila sector. Correspondingly, total imports do not include maquila sector imports.

Goods procured in ports by carriers.

Excluding oil exports, petroleum products and natural gas imports.

Table 6.Financial Soundness Indicators(In percent)
200920102011201220132014 1/
Capital Adequacy
Regulatory capital to risk-weighted assets16.217.616.516.016.215.9
Regulatory Tier 1 capital to risk-weighted assets14.015.114.313.814.514.0
Capital to assets9.810.810.010.510.810.4
Gross asset position in financial derivatives to capital82.365.172.878.472.782.8
Gross liability position in financial derivatives to capital85.565.872.678.172.283.3
Asset Quality
Nonperforming loans to total gross loans3.12.32.42.53.33.2
Provisions to Nonperforming loans173.3200.0191.0185.4147.6142.3
Earnings and Profitability
Return on assets1.62.01.61.92.41.7
Return on equity17.218.115.918.322.116.6
Liquidity
Liquid assets to short-term liabilities56.756.856.950.947.047.7
Liquid assets to total assets41.541.842.537.735.235.7
Customer deposits to total (noninterbank) loans88.885.982.888.686.990.0
Sources: Financial Soundness Indicators

As of June 2014.

Sources: Financial Soundness Indicators

As of June 2014.

Table 7.Financial Indicators and Measures of External Vulnerabilities 1/
Proj.
2008200920102011201220132014
Financial market indicators 2/
Exchange rate (per U.S. dollar, average)11.113.512.612.413.212.813.2
(year-to-date percent change, + depreciation)1.821.4−6.5−1.76.0−3.02.6
28-day treasury auction rate (percent; period average)7.75.44.44.24.23.82.8
EMBIG Mexico (basis points; period average)254302187186188189180
Sovereign 10-year local currency bond yield (period average)8.38.07.06.85.75.66.0
Stock exchange index (period average, year on year percent change)−9.6−5.831.59.210.25.111.9
Financial system
Bank of Mexico net international reserves (US$ billion)85.490.8113.6142.5163.5176.5191.2
Nominal bank credit to the non-financial private sector (year on year percent change) 3/4/5.5−0.210.317.111.012.010.7
Nonperforming loans to total gross loans 3/2.73.12.32.42.53.33.2
External vulnerability indicators
Gross financing needs (billions of US$)86.870.877.4113.0109.4136.1170.5
Gross international reserves (end-year, billions of US$) 5/95.399.9120.6149.2167.1180.2194.9
Change (billions of US$)8.14.620.728.617.813.214.7
Months of imports of goods and services3.75.14.85.15.45.75.9
Months of imports plus interest payments3.95.45.05.45.76.06.3
Percent of broad money18.417.217.521.219.319.219.1
Percent of foreign portfolio liabilities34.941.639.648.239.038.038.6
Percent of short-term debt (by residual maturity)181.5207.8222.1156.7174.0145.8133.7
Percent of ARA Metric 6/105.4117.1109.4129.0118.1115.9117.2
Percent of GDP8.711.211.512.714.114.314.9
Gross total external debt (in percent of GDP)18.621.724.725.531.133.334.9
Of which: In local currency1.82.75.87.312.012.913.7
Gross total external debt (billions of US$)205.0194.5260.1298.9369.2420.5457.5
Of which: In local currency19.624.060.585.7142.1162.9179.6
External debt service (in percent of exports and net transfers)19.422.117.624.425.932.636.8
Sources: Bank of Mexico; National Banking and Securities Commission; National Institute of Statistics and Geography; Secretary of Finance and Public Credit; and IMF staff estimates

All data for 2014 are projections, unless otherwise specified.

As of September 2014.

As of June 2014.

Includes commercial banks and direct credit from development banks.

Excludes balances under bilateral payments accounts. For 2009, includes the allocation of SDR 2.337 billion in the general allocation implemented on August 28, 2009, and another SDR 0.224 billion in the special allocation on September 9.

The ARA metric was developed by the Strategy and Policy Review Department at the IMF to assess reserve adequacy.

Sources: Bank of Mexico; National Banking and Securities Commission; National Institute of Statistics and Geography; Secretary of Finance and Public Credit; and IMF staff estimates

All data for 2014 are projections, unless otherwise specified.

As of September 2014.

As of June 2014.

Includes commercial banks and direct credit from development banks.

Excludes balances under bilateral payments accounts. For 2009, includes the allocation of SDR 2.337 billion in the general allocation implemented on August 28, 2009, and another SDR 0.224 billion in the special allocation on September 9.

The ARA metric was developed by the Strategy and Policy Review Department at the IMF to assess reserve adequacy.

Outlook and Policies

8. Real GDP growth is projected to accelerate to 3.5 percent in 2015. Export demand from the US is expected to remain strong, underpinning the recovery of manufacturing production and related services. Construction activity has also firmed up, supported by the expansion of public investment in infrastructure. Business investment is expected to recover as spare capacity diminishes and business sentiment improves after the recent approval of secondary legislation for the energy and telecommunications reforms. The negative output gap—estimated by staff at around 1 percent as of mid-2014—is expected to close gradually over the next year.

9. The wave of structural reforms should increase potential output over the medium term. Overall, the broad package of reforms is expected to stimulate growth through increased investment, the introduction of new technologies, reduction of business costs, and a rise in productivity. Staff estimates suggest an increase in potential growth to 3½ to 4 percent in the medium term (potential growth is estimated at around 2¾–3 percent in 2014, while actual growth in Mexico has averaged 2½ percent over the last fifteen years).

10. With the economy still operating below potential, monetary policy remains consistent with achieving the inflation target. The authorities stressed that the recent increase in headline inflation has been driven by temporary factors. The annualized quarter-on-quarter growth of core prices has remained stable around 3 percent and long-term inflation expectations are well anchored. Continued weakness in the labor market suggests that demand pressures on prices remain contained. Headline inflation is expected to decline toward the target in 2015 as tax-related base effects dissipate and gasoline price increases moderate. The authorities are monitoring the price and wage developments closely and would adjust policy as needed to keep inflation in line with the target.

11. The 2015 budget proposal implies a mild withdrawal of fiscal stimulus next year with further deficit reductions planned thereafter. In the budget proposal sent to Congress in September, the overall fiscal deficit in 2015 is projected to narrow slightly relative to 2014 (from 4.2 to 4.0 percent of GDP). The budget envisages a reduction in expenditure of about ½ percent of GDP, offset by a decline in oil production and revenues, which is expected to be temporary.1 The authorities plan to reduce the fiscal deficit further over the next four years, with a goal of stabilizing public debt and setting it on a downward path. The consolidation relies mostly on a gradual increase in tax revenues related to the 2014 tax reform.

12. Amendments to the Fiscal Responsibility Law, approved by Congress in 2014, strengthen the fiscal framework in several ways. First, the public sector borrowing requirement (PSBR), which is a broader measure of the public sector balance than the “traditional balance”, was made an official target for fiscal policy. Second, real growth in current structural expenditure will be capped at 2 percent per year in 2015–16, and at the rate of potential output growth thereafter.2 Finally, a new sovereign Oil Stabilization and Savings Fund has been created to manage oil revenues. Overall, these measures would help maintain fiscal discipline and strengthen Mexico’s fiscal buffers over time.

13. The authorities remain committed to strengthening the regulatory and supervisory framework of the financial sector. A financial sector reform was approved in 2014. It enhanced the collection of credit information for individuals and businesses through extending reporting requirements to the credit bureaus to a wide set of entities. In addition, the legal framework for bank resolution has been strengthened in line with the 2011 FSAP recommendations. Another important aspect of the reform was the easing of legal hurdles for banks to repossess collateral through the creation of specialized federal courts. The supervision framework for large financial groups has also been improved.

The Role of the Flexible Credit Line

14. The FCL has served the Mexican economy well. The previous FCL arrangements provided useful insurance in the immediate aftermath of the 2008–09 global financial crisis and during the euro area crisis (Mexico has strong financial linkages with the euro area as host of subsidiaries of several European banks). Staff’s econometric analysis suggests that during the taper talk episode in mid-2013, exchange rate pressures eased more rapidly for emerging markets with an FCL arrangement, after accounting for the role of fundamentals (Box 1). An empirical analysis of sovereign spreads in a recent Fund review of precautionary credit instruments also found that the FCL has been effective in helping bolster confidence; and respondents to a survey agreed that the FCL had been an important addition to the IMF lending tool kit.3

Box 1.Currency Movements During the 2013 Taper Talk Episode: The Role of Fundamentals and the FCL

Analysis of daily nominal exchange rate data during the 2013 taper tantrum reveals that after an initial period of indiscriminate sell-off of emerging markets currencies, investors started to differentiate on the basis of fundamentals. In addition, the presence of an FCL arrangement reduced depreciation pressures (controlling for the role of fundamentals).

The Mexican peso was one of the hardest hit emerging market currencies in the immediate aftermath of the May 2013 taper tantrum, despite the country’s strong fundamentals (Figure A). Staff analysis suggests that countries with deeper and more liquid financial markets experienced larger depreciations at the beginning of the episode (the foreign exchange turnover is the main variable explaining initial currency movements). The Mexican peso is fully convertible and can be traded 24 hours a day. It is now the emerging market currency with the highest daily turnover, and anecdotal evidence suggests that it is sometimes traded as a proxy for other emerging market currencies at times of financial stress, which could account for its initial sharp depreciation.

Figure A.Change in Nominal Exchange Rate

Sources: Bloomberg; and IMF staff estimates.

After approximately one and a half months, fundamentals became increasingly important in explaining exchange rate movements (Figure B). This is consistent with the fact that in the second month after the taper talk, the Mexican peso showed the largest appreciation among emerging markets—reflecting its robust fundamentals and potential benefits from the recovery in the United States.1 The econometric analysis confirms that emerging markets with smaller current account deficits and REER misalignments, and lower inflation experienced lower cumulative currency depreciation between May and November.

Figure B.Differentiation on Macro-Fundamentals and FX Market Liquidity Post-Taper Talk in 2013

(Estimated Coefficients from Regressions)

Sources: Authors’ calculations.

The presence of an FCL arrangement also reduced foreign exchange pressures, even after accounting for the role of fundamentals. Countries with an FCL experienced, on average, 3 percent lower depreciation between May 21st and July 22nd compared to other countries (Figure B).

Methodology: Successive OLS cross-sectional regressions were run of cumulative depreciation between May 21st 2013 and each following day through November 21st on a set of explanatory variables capturing fundamentals:

CumΔNER is the percentage change in the nominal exchange rate between May 21st 2013 and each subsequent date t for country i (a positive value indicating a depreciation); X is a set of fundamentals measured as of end-2012 (and thus pre-determined); REERmis is the real effective exchange rate misalignment (where a positive value indicates an overvalued exchange rate); and FCL is a dummy indicating an FCL arrangement. The explanatory variables are: inflation; current account deficit as a share of GDP, real GDP growth, public sector debt as a share of GDP; reserves to external debt, FX market turnover, and a dummy indicating whether the exchange rate regime is fixed or floating.

For each variable, the econometric results yield a set of time-varying coefficients, which are plotted in the chart. The color of the plot indicates the degree of statistical significance at window t, and the dotted vertical lines indicate the day when the effect of the given variable becomes consistently statistically different from zero. In all cases, the coefficients have the expected sign.

1 Poland, and Colombia which also have an FCL arrangement, showed the second-largest appreciation across EM countries and Latin-American countries, respectively.

15. The authorities are requesting a new FCL arrangement for two years at the same level of access. In their view, the risk of a rapid rebalancing of investor portfolios away from emerging markets remains elevated. They are concerned that the process of normalization of U.S. monetary policy carries risks of global financial market volatility that could affect Mexico, given its close trade and financial links to the U.S. The requested 2-year duration would cover much of the transition period of U.S. monetary normalization. Mexico is now in the initial phase of implementation of important structural reforms, which will be financed in part by foreign investments, and financial market disruptions could endanger this process. In their view, a new FCL arrangement for the next two years would help limit the risk that disruptive financial conditions would halt the nascent economic recovery or diminish the effectiveness of the structural reforms.

A. Access Considerations

16. Global risks remain elevated, justifying the need for additional protection against balance of payments shocks. In particular, the risk of a surge in financial markets volatility continues to be high, geopolitical tensions have intensified, and the global growth outlook has deteriorated since the last approval of an FCL in 2012. The recent bout of financial market volatility in October 2014 highlights the risk of sudden shifts in investor risk appetite, which could lead to rapid reassessment of emerging market risk.

Global Financial Stability Map

Source: IMF staff estimates.

Note: Away from center signifies higher risks, easier monetary and financial conditions, or higher risk appetite.

  • Analysis in the latest GFSR report indicates that some key risks have increased over the last two years. In particular, risk appetite has gone up significantly. Reflecting the ongoing search for yield, financial markets have rallied in 2014 despite relatively weak global growth, pushing up asset prices and compressing risk spreads. Valuations across asset classes appear to be stretched relative to historical norms, and asset price volatility has declined to 15-year lows.4 These developments increase the risk that a correction in the underpricing of risk could trigger a sharp volatility in asset prices. Spillovers across asset classes could be exacerbated by the build-up of leverage among some investors and by heightened liquidity risks.

  • Potential triggers for financial instability include elevated concerns about global economic stagnation, an earlier or sharper-than-expected rise in U.S. interest rates (for example due to an unexpected rise in inflation, a rapid decompression of U.S. term premiums, or lack of agreement to raise the debt ceiling), geopolitical events, or investors’ reassessment of sovereign risks more generally. Uncertainty about the path of the U.S. interest rates runs high as demonstrated by the dispersion of the forecasts among FOMC participants (see chart), which could cause a sudden shift in market expectations.5 A materialization of these risks could lead to sudden capital outflows from emerging markets and a sharp increase in the volatility of asset prices. A generalized pullback from emerging markets is likely to affect initially particularly countries with open capital accounts and liquid financial markets such as Mexico, despite the long-term benefits of such policies. A protracted period of financial market instability could also have negative impact on the confidence of long-term investors, leading to lower-than-expected FDI inflows, and slowing the implementation of structural reforms.

  • An external economic stress index for Mexico (Box 2) shows that external conditions are expected to remain broadly unchanged in the baseline scenario, but could deteriorate rapidly if risks materialize. The downside scenario illustrated with the index is based on an abrupt surge in global financial market volatility. Bouts of market volatility and higher-than-expected increases in long-term rates could occur as the U.S. exits from unconventional monetary policy. Market expectations of the speed of interest rate adjustment in the U.S. could be revised upward and trigger a sustained reversal of capital flows, a broad-based correction in valuations, and an intensification of liquidity strains. The scenario is assumed to entail an increase in long-term U.S. interest rates of 100 basis points in the absence of stronger growth, driven by inflation shocks, a decompression of the term premiums, or a shock to confidence.6 The rise in interest rates is likely to affect negatively U.S. growth (the specific assumption is that growth would decline by ½ percentage point). The increase in interest rates is assumed to be accompanied by stress in financial markets, with the emerging market volatility index increasing by two standard deviations. Under this scenario, the index would fall to post-Lehman lows.

FOMC Participants’ Forecast of the Target Federal Funds Rate 1/

1/ As of June 2014.

17. Mexico is highly exposed to external financial shocks given its open capital account and sizeable stock of foreign portfolio investment. Foreign portfolio exposures have increased significantly since the global financial crisis, particularly in the sovereign debt markets. There has also been a notable increase since the last FCL request in 2012 (see chart). The strong investor appetite for Mexican assets has been based on Mexico’s strong fundamentals, growth prospects, and policy frameworks; the absence of controls on the capital account and a stable regulatory and tax environment; and the depth and liquidity of its financial markets. This is a positive development that has lowered the cost of finance and diversified the investor base not only for sovereign debt, but also for the Mexican private sector. The stock of foreign portfolio investment in Mexico reached US$473 billion (about 38 percent of GDP) in 2013. Foreigners currently hold 37 percent of all local-currency public debt (and about 55 percent of the most liquid segment of local-currency denominated sovereign bonds, Mbonos, and short-term paper, Cetes), and most of Mexico’s foreign currency-denominated sovereign and corporate debt.7 A surge in global risk aversion and a pullback from emerging markets, including from countries with strong economic policies such as Mexico, represent a material risk to the balance of payments.

Stock of Non-Resident Portfolio Investment in Emerging Markets

(In percent of GDP)

Sources: National authorities; and IFS.

Non-Residents’ Holdings of Domestic Sovereign Debt

(Billions of USD)

Source: Banxico.

1/ As of Sep. 25, 2014

Box 2.The Calculation of the External Economic Stress Index

Staff calculated an external economic stress index based on the methodology suggested in The Review of Flexible Credit Line, the Precautionary and Liquidity Line, and the Rapid Financing Instrument, IMF Policy Paper, May 2014. The calculation of the index requires three main choices: (i) selection of relevant external risks, (ii) selection of proxy variables capturing these risks, and (iii) choice of weights for these variables. For Mexico, these were chosen as follows:

Risks. Mexico’s exports, remittances, and inward FDI are closely related to economic developments in the United States. The open capital account and the significant stock of debt and equity portfolio investment increase Mexico’s susceptibility to changes in global financial conditions. Finally, the profitability of oil production and fiscal revenues depend on world energy price developments.

Variables. Risks to exports, remittances and inward FDI are all proxied by U.S. growth. Risks to debt and equity portfolio flows are proxied by the emerging market volatility index (VXEEM) and the change in the U.S. Treasury 10-year yield. Risks to the oil industry are proxied by the change in world oil prices.

Weights. The weights were estimated using balance of payment and international investment position data, all expressed as shares of GDP. The weight on U.S. growth (0.47) corresponds to the sum of exports, FDI, and remittances; the weights on the change in the U.S. long-term yield (0.31) and the VXEEM (0.17) correspond to the stocks of foreign debt and equity; and the weight on the change in the oil price (0.05) corresponds to oil exports.

Baseline scenario. This scenario corresponds to the WEO projections for U.S. growth, oil prices, and the U.S. 10-year bond yield. The VXEEM is assumed to remain unchanged at its level as of October 20, 2014.

Downside scenario. This scenario is in line with the first layer of the downside scenario in the 2014 Spillover report, which is based on a “sooner than expected tightening of financial conditions caused by normalization in major advanced economies.”1 Specifically it assumes that U.S. long-term interest rates rise more than expected, for reasons other than a positive U.S. growth shock (for example, financial stability concerns, an inflationary shock, a decompression of term premiums, or a shock to investor confidence). This shock leads to a reduction in U.S. growth and an abrupt surge in global financial market volatility. The associated volatility surge prompts a general tightening of global financial conditions and an abrupt reversal of capital flows into risk assets, including those in emerging markets. The downside scenario is illustrated in the chart by dots, which represent the points to which the index would fall if the shock materializes in any given quarter. The specific assumptions underlying the scenario are as follows:

  • The U.S. long-term interest rate is assumed to increase by 100 basis points above the baseline, as assumed in the 2014 Spillover Report.

  • As a result, U.S. growth is assumed to drop by 0.5 percentage points (which is less pessimistic than the October 2014 WEO downside scenario of 1 percentage point decline in growth of the advanced economies and the 2014 spillover report, which allows for a deterioration of almost 0.8 percentage points over the year, without specifying the quarterly pattern).

  • These developments are accompanied by stress in financial markets and the VXEEM is assumed to rise by two standard deviations.2 This is qualitatively line with the 2014 Spillover Report, which mentions intense financial pressures on emerging markets in such a scenario, although without quantifying them.

External Economic Stress Index

1 The 2014 Spillover Report also considers a second layer, which is “a deeper than expected structural slowdown in emerging markets.” For Mexico, this would be an internal rather than external threat, so we have not considered this in the construction of the index.2 For comparison, the VXEEM increased by 4 standard deviations in 2008Q4 and 2011Q3.

18. While steady reserve accumulation has increased external buffers, reserve coverage remains relatively low in terms of balance sheet exposures that could unwind in the case of global financial distress. The ratio of reserves to GDP has increased steadily, while international reserves have been broadly stable in terms of months of imports and in percent of broad money (Table 7). However, as foreign holdings of domestic assets increased rapidly, reserves have declined significantly as a share of short-term external debt by residual maturity. In international comparison, Mexico has one of the lowest coverage ratios of reserves to total portfolio investment (Figures 5 and 6). Relative to the ARA metric, reserves have been broadly unchanged since 2009, and amounted to 116 percent at end-2013.

B. Adverse Scenario

19. In an estimate of financing needs in a global adverse scenario, the main drains on reserves would come from a turnaround in portfolio flows and a reduction in FDI inflows. The access case is based on a tail risk scenario of a surge in risk aversion, in which rollover rates for external debt coming due would be reduced, FDI inflows would be lower than projected, and foreign holdings of domestic equity would fall (Box 3). Domestic institutional investors are also assumed to increase the share of foreign assets in their portfolios.8

20. The shocks in the risk scenario are the same or less severe than those used in the current FCL arrangement for Mexico, and are in line with historical cross-country experiences. In particular, the scenario no longer includes a shock to the external current account, even though a rise in U.S. interest rates driven by an inflation shock or a decompression of risk premiums could affect U.S. growth and the housing market, with potential negative effects for Mexico’s exports and remittances. Debt rollover rates are close to the median observed in a large sample of emerging markets during an external shock, and are the same or more favorable than the rollover rates in the 2012 Mexico FCL arrangement (Box 3: Figure A). Unlike in previous FCL requests, a drawdown of accumulated reserves is built in the risk scenario. The 2012 request had no drawdown, and previous requests envisaged continued accumulation even in the downside scenario. Nonetheless, the increase in foreign liabilities in recent years implies that the potential financing needs remain significant and would justify access at the same level (US$72 billion, Box 3Table A).

C. Exit Strategy

21. In making their request for a new FCL arrangement, the authorities emphasize that Mexico has no intention of using this facility on a permanent basis. However, they take the view that it would be premature to scale back the use of the FCL in the current global environment. They noted that global risks remain elevated, with ongoing risks of a surge in financial market volatility and continuing geopolitical tensions amid a weaker outlook for global growth. Conditional on a reduction of global risks affecting Mexico, including risks related to the normalization of U.S. monetary policy, they intend to cut access to Fund resources in any subsequent FCL arrangements, with a view to gradually phasing out Mexico’s use of the facility.

Box 3.Illustrative Adverse Scenario

An illustrative adverse scenario suggests that the requested access level of SDR 47.292 billion (US$72 billion) remains justified. The proposed access level, combined with a drawdown of reserves of about US$5–7 billion, would help fill the estimated potential financing needs of US$79 billion in 2015 and US$77 billion in 2016.

The main assumptions underlying the scenario are as follows (Table A and Figure A):

Portfolio investment. The assumption is that investors do not fully rollover the debt coming due, though there is no net divestment of government paper in secondary markets.

  • For public debt, the assumed rollover rates are 95 percent for medium and long-term (MLT) foreign currency-denominated bonds (higher than in 2012); 85 percent for MLT local-currency bonds (higher than in 2012), and 90 percent for short-term debt (same as in 2012).

  • For private debt, foreign investors are assumed to renew 95 percent of MLT debt coming due and 90 percent of short-term debt. Both are the same assumptions as in 2012.

  • Foreign investors would sell about 5 percent of the stock of equity they currently hold (equivalent to a 1½ standard deviation shock to equity portfolio inflows, less severe than assumed in 2012).

Other private sector financing flows

  • Foreign direct investment inflows are assumed to be lower than in the baseline. In the baseline projection, FDI is projected to rise as a result of structural reforms in the energy and telecommunication sectors. A rise in financing costs or an increase in uncertainty may cause delays or cancelations of investment plans. Net FDI inflows are assumed to fall to 90 percent of the average of the previous 3 years (close to the median of the cross-country distribution of historical outcomes). The assumed fall in FDI is comparable to reductions experienced in 2012 (the year following the euro area crisis), and is milder than the reduction after the global financial crisis.

  • The rollover rate of foreign banks’ cross-border lending to the private sector is assumed to remain relatively resilient at 95 percent (same as 2012). No rollover shocks are assumed for public bank debt.

  • Finally, 1½ standard deviation shock is assumed for resident portfolio outflows (same as in 2012). The magnitude of the shock is similar to the experience in mid-2013, when residents increased their foreign asset holdings by over $20 billion in response to the taper tantrum.

Table A.Mexico: External Financing Requirements and Sources(In billions of U.S. dollars)
201420122014
ProjectionAdverseContributionAdverseContributionRolloverRollovervs. 2012
201220132014201520162015to Gap2016to Gap/Shock/Shockshock
Gross external financing requirements109.4136.1170.5161.0176.8140.8−20.3158.2−18.6
No net$10 bn
Current account deficit15.326.327.027.933.927.933.9shockshockLower
Amortization of Bonds and Loans76.396.7128.8119.8129.2119.8129.2
Public sector MLT coming due10.915.921.319.216.019.216.0
FX denominated bonds1.83.95.24.02.94.02.9
Local currency bonds3.67.110.910.310.210.310.2
FX Bank Financing5.44.85.24.92.94.92.9
Private sector MLT amortization11.712.316.314.319.214.319.2
FX denominated bonds6.38.010.711.813.211.813.2
Bank Financing5.54.35.62.56.12.56.1
Short term debt coming due50.568.790.484.691.284.691.2
Public sector17.136.653.844.844.844.844.8
FX denominated2.17.49.00.00.00.00.0
Local Currency15.029.244.844.844.844.844.8
Private sector18.714.518.119.624.119.624.1
Trade credit14.817.618.420.322.320.322.3
USD 5-7No use of
Change in international reserves17.813.214.713.313.7−6.9−20.3−4.9−18.6bnreserves
Available external financing109.4136.1170.5161.0176.868.892.386.290.6
Net FDI inflows−4.726.014.018.528.010.67.917.610.490%37%Lower
Gross Equity Portfolio Inflows9.9−0.90.80.80.9−7.88.6−7.88.61.5 std dev1.9 std devLower
Financing through Bonds and Loans135.4161.5154.3159.6162.6107.2114.7
Public sector MLT financing48.128.544.043.139.217.514.4
FX denominated bonds12.015.111.210.710.33.86.92.87.995%86%Lower
Local currency bonds36.013.527.627.526.08.818.88.717.385%80%Lower
FX Bank Financing0.00.05.24.92.94.92.9
Private sector MLT financing18.742.525.725.329.313.518.2
FX denominated bonds21.026.218.120.821.211.29.612.58.895%95%Same
FX Bank Financing−2.416.37.64.58.12.32.15.72.395%95%Same
Short-term financing68.790.484.691.294.176.282.1
Public sector36.653.844.844.844.840.340.3
FX denominated7.49.00.00.00.00.00.0
Local Currency29.244.844.844.844.840.34.540.34.590%90%Same
Private sector14.518.119.624.124.717.66.521.73.090%90%Same
Trade credit17.618.420.322.324.518.24.120.14.590%90%Same
Other flows−31.2−50.31.4−17.9−14.7−41.2−38.0
Residents’ foreign portfolio & other investment−6.3−27.3−8.6−13.6−13.6−36.923.3−36.923.31.5 std dev1.5 std devSame
Financing Gap (USD billions)72.072.0
SDR47.347.3
Percent of quota1,3041,304
Sources: Mexican authorities and IMF staff estimates.
Sources: Mexican authorities and IMF staff estimates.

Figure A.Comparing Adverse Scenario Assumptions to History, and Current and Previous Arrangements

Review of Qualification

22. Mexico continues to meet the qualification criteria for an FCL arrangement according to staff’s assessment (Figure 3). The authorities have in place a very strong policy framework. Monetary policy is guided by an inflation-targeting framework in the context of a flexible exchange rate regime, and fiscal policy is anchored by the fiscal responsibility law.

Figure 3.Qualification Criteria

Sources: Bloomberg L.P.; Datastream; EMED; Haver Analytics; and IMF staff calculations.

1/ Combined permanent ¼ standard deviation shocks applied to interest rate, growth, and primary current account balance.

2/ Red bar shows ratio for end-year 2010, when FCL was approved.

3/ Not taking into account offsetting measures required under the balance budget rule.

4/ Combined permanent ¼ standard deviation shocks applied to real interest rate, growth rate, and primary balance.

5/ One-time 10 percent of GDP increase in debt-creating flows.

  • Sustainable external position. The external current account deficit is small (around 2 percent of GDP) and is envisaged to remain moderate over the medium term, while the exchange rate remains broadly in line with fundamentals. The updated external debt sustainability analysis shows that Mexico’s external debt is relatively low, and would rise only moderately over the medium term even under negative shocks (Figure 4).

  • Capital account position dominated by private flows. The bulk of Mexico’s external debt is owed to private creditors. Private portfolio flows (debt and non-debt creating) and FDI continue to be large relative to the overall balance of payments flows.

  • Track-record of steady sovereign access to international capital markets at favorable terms. Mexico is among the highest-rated emerging markets and its 10-year sovereign bond spread remains low at about 173 basis points (as of September 15, 2014). Five-year CDS spreads have come down to around 78 basis points (as of September 15, 2014), close to historic lows. Public debt has average maturity of close to 8 years, and Mexico continues to place successfully sovereign bonds in international capital markets at historically low yields.9

  • Relatively comfortable international reserve position. Gross international reserves reached US$193 billion at end-August 2014, compared to US$168 billion in November 2012, when the previous FCL arrangement was approved. This level is comfortable relative to standard reserve coverage indicators (Figures 5 and 6).

  • Sustainable public debt position and sound public finances. Fiscal policy remains prudent, and the level of public debt to GDP is moderate. The updated debt sustainability analysis shows that the debt trajectory is overall robust to standard shocks (Figures 7 and 8). The debt projection is sensitive to growth and the evolution of oil prices, but debt would remain moderate even under negative shocks. Overall, the rules embedded in the Fiscal Responsibility Law provide an assurance that the fiscal position would be adjusted as needed to maintain debt sustainability.

  • Low and stable inflation. Inflationary pressures remain contained and inflation expectations are anchored. Core inflation has remained close to target of 3 percent, though headline inflation is temporarily elevated due to one-off effects from the tax reform and high food prices.

  • Sound financial system and the absence of solvency problems that may threaten systemic stability. As of July 2014, the banking system’s capital adequacy ratio stood at 15.9 percent, broadly unchanged from a year ago. All banks meet the Basel III capital requirements, and the new liquidity coverage ratios will be introduced gradually starting in 2015. The broader financial system is also sound. Private pension funds, which held assets of 12.5 percent of GDP at end-2013, have a conservative investment profile. Capital in the insurance sector also exceeds the minimum requirements, and all insurance companies are expected to satisfy the new capital requirements under the Solvency II regime to be adopted in 2015. Real estate investment trusts have grown since 2011, but remain small and are financed mostly by equity, with new statutory limits on their leverage.

  • Effective financial sector supervision. The 2011 FSAP Update concluded that Mexico’s overall financial sector supervision framework remains effective. Since then, Mexico has adopted early the Basel III capital requirements. The regulation of financial groups was enhanced in January 2014 through the implementation of supervision at the group level. The authorities monitor closely the operations of foreign bank subsidiaries—about 70 percent of banking system assets—to ensure compliance with regulatory norms and restrict potential funding drains.

  • Data transparency and integrity. The overall quality of Mexican data continues to be very good as described in the October 2010 data ROSC update. Mexico remains in observance of the Special Data Dissemination Standards (SDDS). STA recently conducted a ROSC assessment of the national income accounts and concluded that statistics were generally of high quality and adequate for effective surveillance.

Figure 4.External Debt Sustainability: Bound Tests 1/2/

(External debt in percent of GDP)

Sources: International Monetary Fund, Country desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.

3/ Permanent ¼ standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2014.

Figure 5.Reserve Coverage in an International Perspective 2013 (1) 1/

Sources: World Economic Outlook, and IMF staff estimates.

1/ Horizontal lines represent median in all the charts.

2/ Reserves at the end in percent of short-term debt at remaining maturity and estimated current account deficit in 2013. The current account is set to zero if it is in surplus.

Figure 6.Reserve Coverage in an International Perspective 2013 (2) 1/

Sources: World Economic Outlook, Balance of Payments Statistics Database, and IMF staff estimates.

1/ Horizontal lines represent median in all the charts.

2/ The ARA metric was developed by SPR to assess reserve adequacy. For the stock of porfolio liabilities, data on 2013, 2012, or 2011 is used depending on data availability.

Figure 7.Public DSA—Composition of Public Debt and Alternative Scenarios

Source: IMF staff.

Figure 8.Public DSA—Stresr Tests

Source: IMF staff.

23. International indicators of institutional quality show that Mexico has above average government effectiveness. According to the World Bank’s Worldwide Governance Indicators, Mexico’s government effectiveness ranks at the 63rd percentile among all countries. Mexico is at the 43rd percentile on control of corruption, slightly below the median. However, the recently approved structural reforms, once implemented, are likely to lead to an improvement on both measures. The strengthening of the powers of the anti-trust authorities, for example, would improve governance and competition; while the education reform would help increase government effectiveness. The institutional quality of economic policy is underpinned by the inflation-targeting framework (anchored by a strong, independent central bank), the fiscal responsibility law and the strong prudential and regulatory framework for financial supervision as assessed by the 2012 FSAP update.

Impact on Fund Finances, Risks, and Safeguards

24. Access under the proposed FCL arrangement for Mexico of 1,304 percent of quota (SDR 47.292 billion) is substantial, but the impact on Fund liquidity is manageable. As with the current arrangement, if drawn, the proposed FCL arrangement would become the Fund’s largest single credit exposure. However, the Fund’s liquidity is expected to remain adequate after an approval of the proposed FCL arrangement for Mexico.

25. Notwithstanding the size of the possible commitment, the risks to the Fund are judged to be low. The authorities have stated that they intend to treat the arrangement as precautionary. Even if a full drawing under the arrangement were to be made on approval, Mexico’s external debt would remain moderate at about 40.7 percent of GDP in 2016, when debt service peaks (Table 1). Peak debt service ratios would be broadly in line with those in recent years and remain well within the range seen in other emerging market countries. Moreover, Mexico has an excellent track record of meeting its obligations to the Fund.

26. Staff has completed the safeguards procedures for Mexico’s 2012 FCL arrangement. The authorities provided the necessary authorization for Fund staff to communicate directly with the Bank of Mexico’s external auditor, PricewaterhouseCoopers (PwC) México. PwC issued an unqualified audit opinion on the Bank of Mexico’s 2012 financial statements on March 27, 2013. Staff reviewed the 2012 audit results and discussed these with PwC. No significant safeguards issues emerged from the conduct of these procedures. In preparation of the prospective successor arrangement, the Bank of Mexico has agreed to provide the authorizations needed for an update of the safeguards procedures to be conducted connected to the proposed arrangement.

Staff Appraisal

27. The staff’s assessment is that Mexico continues to meet the qualification criteria for access to FCL resources. As noted in the staff appraisal for the Article IV, Mexico has a very strong policy framework and economic fundamentals. The authorities have a successful record of sound policy management and are firmly committed to maintaining prudent policies going forward. At the same time authorities are in the process of implementation of an ambitious structural reform package, which is expected to boost medium-term economic prospects.

28. Staff considers the proposed access level of SDR 47.292 billion (1,304 percent of quota) to be appropriate. Uncertainties surrounding the global outlook, including risks related to the tightening of monetary policy in the United States, remain high. Mexico, with its open capital account and significant stocks of foreign portfolio investment is exposed to changes in investors’ preferences. The recent bout of financial market volatility in October 2014 highlights the risk of sudden shifts in investor risk appetite, which could lead to rapid reassessment of emerging market risk. The new FCL arrangement would continue to support the authorities’ overall economic strategy, and would supplement Mexico’s external buffers by providing insurance against tail risks. Staff supports the authorities’ view that a reduction in access under the FCL is not advisable in the case of Mexico, given the proximity to the takeoff window for the policy interest rate in the U.S. and the country’s close trade and financial ties with the U.S. Staff welcomes the authorities’ exit strategy, which foresees a reduction in access in any future arrangements, subject to a reduction in global risks affecting Mexico.

29. Staff judges the risks to the IMF arising from the proposed FCL arrangement to be low. The authorities have an excellent policy implementation track record, and they intend to maintain a very strong policy framework. Risks to the Fund are further contained by the authorities’ intent to treat the FCL arrangement as precautionary; Mexico’s strong repurchase record with the Fund, and its manageable external debt service profile even if the full amount of the FCL were to be drawn.

Table 8.Baseline Medium-Term Projections
Staff projections
2010201120122013201420152016201720182019
(Annual percentage change, unless otherwise indicated)
National accounts (in real terms)
GDP5.14.04.01.12.43.53.83.83.83.8
Consumption5.14.54.62.31.53.34.13.63.43.2
Private5.74.84.92.51.62.84.43.83.43.1
Public1.72.43.41.20.72.02.42.73.54.4
Investment4.55.45.5−2.41.85.09.35.85.06.8
Fixed1.37.84.5−1.80.45.29.66.05.17.0
Private1.912.18.8−1.33.45.410.56.15.27.5
Public−0.5−4.1−9.5−3.6−2.64.26.34.84.94.6
Inventories 2/0.7−0.50.2−0.20.30.00.00.00.00.0
Exports of goods and services20.58.25.91.26.84.45.47.67.66.9
Imports of goods and services20.58.05.51.55.65.110.18.57.57.5
Consumer prices
End of period4.43.83.64.04.03.23.03.03.03.0
Average4.23.44.13.83.93.53.13.03.03.0
External sector
Current account balance (in percent of GDP)−0.4−1.1−1.3−2.1−2.1−2.0−2.3−2.2−2.2−2.1
Non-hydrocarbon current account balance (in percent of GDP) 1/−1.5−2.3−2.3−2.8−2.3−2.1−2.5−2.5−2.8−2.8
Exports29.917.16.12.53.96.99.410.49.39.8
Imports28.616.45.72.83.66.810.29.79.49.2
Terms of trade (improvement +)7.66.8−3.6−0.1−0.31.34.12.20.41.7
Crude oil export price, Mexican mix (US$/bbl)72.5101.1101.898.597.294.092.190.389.188.2
(In percent of GDP)
Non-financial public sector
Overall balance−4.3−3.3−3.7−3.8−4.2−4.0−3.5−3.0−2.5−2.5
Primary balance−1.7−1.0−1.1−1.3−1.5−1.4−0.70.00.80.9
Saving and investment 3/
Gross domestic investment22.122.323.121.521.622.023.323.723.924.6
Fixed investment21.121.722.421.020.921.322.623.123.424.1
Public5.65.24.64.34.04.04.14.24.24.3
Private15.516.517.816.716.917.318.518.919.219.8
Gross domestic saving21.721.221.819.519.519.920.921.421.722.4
Public0.91.40.40.20.00.40.60.80.70.5
Private20.719.821.419.319.619.620.320.621.021.9
Memorandum items
Output gap−2.1−0.60.8−0.7−1.1−0.40.00.00.00.0
Sources: Bank of Mexico; National Institute of Statistics and Geography; Secretary of Finance and Public Credit; and IMF staff projections.

Excluding oil exports and petroleum products imports.

Contribution to growth. Excludes statistical discrepancy.

Reported numbers may differ from authorities’ due to rounding.

Sources: Bank of Mexico; National Institute of Statistics and Geography; Secretary of Finance and Public Credit; and IMF staff projections.

Excluding oil exports and petroleum products imports.

Contribution to growth. Excludes statistical discrepancy.

Reported numbers may differ from authorities’ due to rounding.

Table 9.External Debt Sustainability Framework(In percent of GDP, unless otherwise indicated)
ActualProjections
20092010201120122013201420152016201720182019Debt-stabilizing
non-interest
current account 6/
1Baseline: External debt21.724.725.531.133.334.935.636.236.436.836.9−2.0
2Change in external debt3.13.00.85.62.21.60.70.60.20.30.1
3Identified external debt-creating flows (4+8+9)3.6−3.5−1.70.1−1.40.2−0.5−0.9−0.9−1.0−1.4
4Current account deficit, excluding interest payments−0.5−1.0−0.4−0.40.20.1−0.10.10.0−0.2−0.2
5Deficit in balance of goods and services1.71.31.41.21.00.90.91.10.90.90.7
6Exports27.429.931.232.731.831.832.033.334.635.636.8
7Imports29.031.232.633.932.832.732.934.335.436.537.5
8Net non-debt creating capital inflows (negative)−1.3−0.8−0.4−0.4−2.0−1.1−1.4−2.0−2.0−1.9−2.2
9Automatic debt dynamics 1/5.5−1.7−0.91.00.41.31.01.01.01.11.1
10Contribution from nominal interest rate1.41.31.51.71.82.02.12.32.32.42.4
11Contribution from real GDP growth1.1−0.9−0.9−1.0−0.3−0.8−1.2−1.3−1.3−1.3−1.3
12Contribution from price and exchange rate changes 2/3.0−2.1−1.50.3−1.2
13Residual, incl. change in gross foreign assets (2-3) 3/−0.56.52.55.53.61.41.21.41.21.31.5
External debt-to-exports ratio (in percent)79.582.881.895.2104.9109.9111.2108.9105.5103.4100.1
Gross external financing needs (in billions of US dollars) 4/65.454.784.188.4123.1155.8147.7163.1167.7173.5188.9
in percent of GDP7.35.27.27.59.810-Year10-Year11.910.611.210.810.610.9
Scenario with key variables at their historical averages 5/34.935.435.836.136.637.3−1.3
HistoricalStandard
Key Macroeconomic Assumptions Underlying BaselineAverageDeviation
Real GDP growth (in percent)−4.75.14.04.01.12.62.92.43.53.83.83.83.8
GDP deflator in US dollars (change in percent)−15.311.67.1−2.75.23.47.41.42.41.42.12.02.0
Nominal external interest rate (in percent)6.37.36.86.86.37.51.26.46.56.86.87.06.9
Growth of exports (US dollar terms, in percent)−20.928.316.46.03.49.212.74.06.99.210.29.19.6
Growth of imports (US dollar terms, in percent)−22.526.016.55.43.08.912.83.56.79.89.49.18.9
Current account balance, excluding interest payments0.51.00.40.4−0.20.40.4−0.10.1−0.10.00.20.2
Net non-debt creating capital inflows1.30.80.40.42.01.60.81.11.42.02.01.92.2

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period, excluding reserve accumulation.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period, excluding reserve accumulation.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Appendix. Letter from the Authorities Requesting FCL

Mexico City, November 7, 2014

Ms. Christine Lagarde

Managing Director

International Monetary Fund 700 19th Street NW

Washington, DC 20431

Dear Ms. Lagarde,

For many years, the United Mexican States (Mexico) has been implementing very strong economic policies that have promoted macroeconomic stability and anchored confidence in the country’s economic outlook. As a signal of that confidence, Moody’s upgraded Mexico’s foreign currency sovereign debt to A3 earlier this year, the government placed a 100-year bond in the United Kingdom in mid-2014 and spreads on government securities and the volatility of the Mexican peso remain relatively low. As highlighted in the 2014 Article IV Consultation, the adoption of transformative structural reforms in many areas is expected to boost potential output growth.

At the same time, Mexico remains prone to tail risks arising from global economic developments given its open capital account and active participation of non-resident investors in its financial markets. These tail risks could come from several sources-the possibility of a disorderly process of normalization of monetary policy in the United States, heightened regional geopolitical tensions, or spillovers from slower growth in other developed and emerging market economies. If they materialize, they could lead to surges in global risk aversion and possibly lead to potentially destabilizing financial conditions that could adversely affect Mexico. These risks are highlighted in the International Monetary Fund (IMF) latest World Economic Outlook and Global Financial Stability Report. Moreover, these risks could surge precisely at a moment when the process of implementation of the critical, growth-enhancing structural reforms is still at an early stage.

For this reason, we hereby request a successor 24-month Flexible Credit Line (FCL) arrangement for Mexico at the same level of access of 1,304 percent of quota (SDR 47,292 million) as in the current arrangement. We believe that the renewal of the FCL arrangement, which we again intend to treat as precautionary, will continue to play a strong role in insuring against tail risk events and supporting confidence. We would like to emphasize that we do not intend to make permanent use of the FCL. Conditional on a reduction of global risks, including those related to the normalization of U.S. monetary policy, we intend to request reduced access in any subsequent FCL arrangements.

Our economic policies will continue to preserve economic and financial stability, while strengthening policy buffers. Most importantly, we are laying the foundations for strong and sustainable medium-term growth through the structural reforms. We are one of the few countries in the world that have been able to achieve such breadth and depth of reform in a non-crisis period. Among these reforms, the energy reform should be highlighted, which ends the 75-year old monopoly of the state in the hydrocarbons sector and opens the door for active private sector participation in all phases of this sector. Our country also made fundamental changes to create more competition in all of its markets through the reforms to the telecommunications sector, financial sector and antitrust framework.

Macroeconomic policies will continue to be anchored by a strong medium term fiscal framework. The Fiscal Responsibility Law was amended to strengthen the commitment to keep public debt on a sustainable path and control the procyclicality of spending through the introduction of a cap on the real growth in structural current spending. We also created a new sovereign Oil Stabilization and Savings Fund to provide greater stability in oil revenues for budget purposes, and to ensure that a large share of any future oil income windfall would be saved. We are committed to reducing the overall fiscal deficit gradually over the next four years, so as to place public debt on a downward path in relation to GDP over the medium term.

Our monetary policy remains underpinned by the inflation-targeting regime, which has effectively anchored medium-term inflation expectations. Despite a temporary rise due to one-off effects from tax changes in early 2014, inflationary pressures have remained contained, and we expect headline inflation to converge to the target of 3 percent during 2015. The central bank remains fully committed to adjusting the policy interest rate as necessary to keep inflation in line with the target over the medium term.

Another critical component of our policy framework is the flexible exchange rate regime, which proved to be a key shock absorber during periods of global financial turmoil. We have continued to build our international reserves by accumulating net foreign exchange receipts from oil production and the Federal Government. This policy would allow the central bank to maintain reserve coverage ratios at adequate levels for normal precautionary purposes.

The financial sector remains sound, underpinned by a strong regulatory framework. Banks are profitable, well capitalized, liquid and resilient to credit and market risks, as proven by the stress tests presented in the latest report of Mexico’s Financial System Stability Council. Insurance companies are well capitalized, while pension funds maintain conservative investment profiles. We have continued to take steps to improve our financial regulation and supervision, which would allow for the adoption of the Basel Ill framework. In fact Mexico adopted the Basel Ill capital requirements in early 2013 and the liquidity coverage ratio will be mandatory starting in early 2015. Insurance companies are immersing in a transitory regime to gradually adopt the Solvency II, and fully comply during 2016. The National Banking and Securities Commission (CNBV) has put in place stronger provisioning rules on bank loans and has strengthened the framework for bank resolution and consolidated supervision. Furthermore, in light of the presence of foreign banks in our financial system, we continue to monitor developments closely, including through home-host supervisory colleges, and active involvement in international regulatory forums for banks and derivatives.

In sum, as Executive Directors acknowledged in the latest Article IV consultation discussion, Mexico’s policy framework remains very strong, and economic policies have responded in a timely and appropriate fashion in managing the impact of the global crisis and subsequently to support economic activity and rebuilding buffers. As external risks remain elevated, we are maintaining the same basic strategy as the one we have adopted under the current FCL arrangement. We will continue to react as needed within this framework to any future shocks that may arise. We would like to add that we regard the IMF’s support through the Flexible Credit Line as an integral part of our strategy and we greatly appreciate this support.

Sincerely yours,

/s//s/
Luis Videgaray CasoAgustín Guillermo Carstens Carstens
Secretary of Finance and Public CreditGovernor of Banco de México

Oil production is projected to increase gradually over the medium term as a result of the energy reform.

Structural current expenditure, comprising about 50 percent of total public expenditure, is defined as indirect capital spending plus current spending minus pensions, electricity subsidies, transfers to states and municipalities from oil revenue-sharing agreements, and interest payments. It also excludes the expenditure of Pemex and the state electricity company.

Review of the Flexible Credit Line, the Precautionary and Liquidity Line, and the Rapid Financing Instrument, IMF, January, 2014.

October 2014 Global Financial Stability Report, Chapter 1.

There is substantial uncertainty about the degree of slack in the U.S. labor markets, reflected in significant dispersion of the federal funds rate forecasts among FOMC members.

An increase in interest rates driven by stronger U.S. demand, however, would probably be beneficial for Mexico, as rising exports would compensate for the negative effect of the interest shock.

Total external debt has increased from 19 percent of GDP in 2008 to 35 percent of GDP in 2014.

Analysis by Adler, Djigbenou, and Sosa (“Global Financial Shocks and Foreign Asset Repatriation: Do Local Investors Play a Stabilizing Role?” IMF Working Paper No. 14/60, 2014) shows that in periods of global financial stress, with non-residents pulling out of emerging markets, residents tend to play an offsetting role if the shock is a generalized increase in risk aversion (a rise in the VIX), but behave the same way as non-residents in response to a rise in U.S. interest rates. Staff analysis of resident and non-resident mutual fund behavior in Mexico reaches a similar conclusion (2014 Article IV Selected Issues Paper, Chapter 3).

In January, Mexico issued US$1 billion bonds due in 2021 at 3.6 percent, and US$3 billion in debt maturing in 2045. In March 2014, Mexico issued a 100-year bond denominated in GBP equivalent to US$1.6 billion with a yield of 5.75 percent—becoming the only country to have issued two century bonds. In April, Mexico raised US$2.8 billion in Euro-denominated bonds, with yields of 2.4 (maturing 2021) and 3.7 percent (maturing 2029).

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