Abstract
This 2003 Article IV Consultation highlights that Mexico’s real GDP remained subdued in the first half of 2003, with growth of 1.4 percent in the four quarters ending in the second quarter. While recent indicators of activity have been mixed, most observers still expect the economy to recover in the second half of the year, in line with the United States recovery. The government has made significant progress in strengthening the structure of public debt. Public external debt has fallen further from 15 percent of total debt in 2000 to 13½ percent in 2002.
The following information has become available since the staff report was issued to Executive Directors. The thrust of the staff appraisal remains unchanged.
1. The government has reduced its official growth forecast for 2003 from 3 percent to 1.5 percent, in line with the latest WEO projection. Recent indicators confirm the slow pace of recovery. Growth in the global indicator of economic activity weakened further in July, as the 12-month change fell to 0.9 percent from 1.2 percent in June. The consumer confidence index continued to decline in August and September, while business confidence improved somewhat. In line with sluggish activity, unemployment reached a new peak of 4 percent in August, while formal sector employment fell to its lowest level since December 1998.
2. The peso has depreciated sharply since July, reflecting weak economic activity and concerns about prospects for structural reforms. The exchange rate has fallen to a new low of about MEX$11.3/US$ in recent days, following the announcement by Moody’s that PEMEX’s debt rating is being reviewed for possible downgrading (currently its rating is higher than that of the federal government). Since the peak in May, the peso has depreciated by almost 12 percent against the U.S. dollar, while the real effective exchange rate has depreciated by about 8 percent.
3. CPI data for September indicate that the 12-month change in headline inflation was stable at 4 percent, while core inflation remained subdued at around 3½ percent. Inflation expectations for end-2003 have continued to decline, reaching 3.7 percent in September, suggesting that the recent fall in the peso has not jeopardized prospects for reducing inflation to below 4 percent by end-year (the upper limit of the central bank’s “variability interval”).
4. With monetary conditions having eased further as a result of peso depreciation, the Bank of Mexico (BOM) left the corto unchanged at its meeting last week, citing the favorable prospects for inflation to decline within the target range by end-year. After remaining close to 5 percent since the spring, short-term market interest rates have risen by almost 100 basis points in recent days in response to the weakness in the peso.
5. Trade data for August showed a smaller-than-expected deficit. Imports declined by 3.4 percent from the year-ago level, while exports have declined marginally as higher oil exports partially compensated for a 5 percent decline in manufacturing exports. Net international reserves stood at US$52.1 billion on October 3, compared with the peak of US$54.0 billion in early May. On October 7, the government issued US$1 billion of 10-year bonds to pre-fund 2004 financing requirements. The bond was issued with a yield of 6.063 percent, implying a spread of 179 basis points over U.S. treasuries.
6. Fiscal data through end-August suggest that the objectives for the traditional and augmented deficits for 2003 are likely to be met. Public finances continue to be boosted by higher-than-projected oil revenues. Through end-September, the price of the Mexican mix has, on average, been about US$6 above the budget assumption of US$18.35 per bond, while the exchange rate has been significantly more depreciated than anticipated. Spending has also exceeded budget estimates, however, and income tax receipts remain weak.
7. Political negotiations on structural reforms continue, without any major breakthroughs. A working group, chaired by Secretary of Finance Gil Díaz, has been deliberating on tax reform, with a proposal having been advanced to reduce the VAT rate from 15 percent to 10 percent, while broadening the base. The states would also introduce a common 2 percent VAT. The administration has also presented a draft bill to opposition legislators that would increase the scope for private-sector involvement in electricity generation.
8. The 2004 draft budget will be submitted to congress by mid-November. The Secretary of Finance has indicated an objective for the narrow definition of the deficit of 0.3 percent of GDP, broadly in line with the 2002 medium-term framework (PRONAFIDE). No objective has yet been announced for the augmented deficit.