The Mexican economy has performed well since the last Article IV Consultation. Executive Directors commended the authorities for maintaining prudent fiscal and monetary policies in the face of financial turbulence in emerging markets and the slowdown in the United States. They appreciated the improved fiscal transparency and the robust banking system, and stressed the need to maintain macroeconomic stability. They appreciated the adequate international reserves, and agreed that the country's data are of good quality and adequate to conduct surveillance effectively.

Abstract

The Mexican economy has performed well since the last Article IV Consultation. Executive Directors commended the authorities for maintaining prudent fiscal and monetary policies in the face of financial turbulence in emerging markets and the slowdown in the United States. They appreciated the improved fiscal transparency and the robust banking system, and stressed the need to maintain macroeconomic stability. They appreciated the adequate international reserves, and agreed that the country's data are of good quality and adequate to conduct surveillance effectively.

1. Economic indicators released since the staff report (SM/01/223) was issued suggest a continued weakness of the economy. In light of this, staff now projects that real GDP growth in 2001 would be under 2 percent. The thrust of the staff appraisal is unchanged by these developments.

Recent economic developments

2. Recent indicators point to continued weakness of domestic economic activity, reinforcing the downside risk to output growth mentioned in the staff report. In the 12 months to May 2001, the global index of economic activity fell 0.4 percent, retail sales expanded by a modest 3.5 percent; and real manufacturing wages rose by 5.5 percent; in the 12 months to June, employment growth fell to only 1.1 percent. At the same time, inflation expectations have continued to decline. According to one survey (Infosel), expected inflation during 2001 was 5.6 percent as of July 27, which is below the official target of 6.5 percent.

3. The public sector had a budget surplus of Mex$32 billion (0.5 percent of annual GDP) in the first five months of 2001, which taking seasonal factors into account, is in line with the end-year target. Preliminary information indicates that tax and public enterprise revenues were 0.2 percentage point of GDP lower than budgeted through end-June. Despite higher-than-projected oil prices during the period, PEMEX revenues were constrained by reduced export volumes, in line with international production cuts. The authorities indicated in public statements that with the expenditure cuts already announced in May and with proposed budget savings in current expenditures for the remainder of the year (0.1 percentage point of GDP), they were on track to meeting the end-year budget deficit ceiling.1

4. The seasonally adjusted non-oil trade deficit narrowed considerably in June, falling from an average of US$2.1 billion in the first five months of the year to US$1.7 billion. Both export and import growth decelerated further in June—non-oil exports increased by 2.4 percent year-on-year compared with a cumulative 5.7 percent in January-May. Imports declined by 3.4 percent in June (year-on-year), compared with a cumulative 6.8 percent increase in January-May.

Recent financial market developments

5. The peso depreciated to a low of Mex$9.3=US$1 on July 13. It has since appreciated to a range of Mex$9.1–9.2=US$1 as of end-July. The real exchange rate (on the basis of relative consumer prices) appreciated by 11 percent in May 2001 (12-month basis). Domestic real interest rates have risen to 3.9 percent as of mid-July.

6. Sovereign bond spreads widened to 364 basis points in mid-July (from 310 basis points at end-June), but have subsequently narrowed to 353 basis points as of July 30. Mexico’s spreads have been less affected by the recent market turbulence than those of the other emerging market economies.

7. Gross international reserves have been stable (at approximately US$41 billion).

Other information

8. In light of the continued weakness of economic activity, staff now projects that real GDP growth in 2001 would be under 2 percent. The lower growth reflects the expectation that the rebound of domestic economic activity in the second half of the year will be somewhat weaker than initially forecast. In line with the lower GDP growth, the external current account deficit in 2001 (3 percent of GDP) would be about half a percentage point of GDP less than previous projections.

9. On July 24, the government auctioned for the first time a fixed-rate ten-year bond (for the equivalent of about US$100 million) in the domestic market. The yield came in at 10.9 percent (compared with 9.4 percent on 28-day cetes in the weekly July 26 auction) and demand exceeded supply by three to one. The issuance of longer-term bonds is in line with the authorities’ strategy of improving the debt profile through a lengthening of maturities.

10. On July 31, the Bank of Mexico lowered the corto by Mex$50 million to Mex$300 million. This move reflects, in part, the favorable inflation performance, including the continuing downward trend in inflation expectations, and lower domestic demand.

Notes

1/

Traditional measure of the fiscal balance. Information on the augmented balance will be published on August 4.