Mexico: Selected Issues
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International Monetary Fund
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This Selected Issues paper analyzes the sources of Mexico’s economic growth since the 1960s, and compares various decompositions of historical growth into trend and cyclical components. The role of the implied output gaps in the inflation process is assessed. The paper presents medium-term paths for GDP based on alternative productivity growth rates. The paper also describes the significant steps Mexico has taken to strengthen the structure of its public debt in recent years, both in terms of currency composition and maturity.

Abstract

This Selected Issues paper analyzes the sources of Mexico’s economic growth since the 1960s, and compares various decompositions of historical growth into trend and cyclical components. The role of the implied output gaps in the inflation process is assessed. The paper presents medium-term paths for GDP based on alternative productivity growth rates. The paper also describes the significant steps Mexico has taken to strengthen the structure of its public debt in recent years, both in terms of currency composition and maturity.

III. Mexico—An Update of the Medium-Term Fiscal Framework

Abstract

This paper describes the evolution of the government’s medium-term fiscal framework in recent years. It reviews revisions to macroeconomic assumptions and fiscal targets, and discusses the required fiscal adjustment effort. It also assesses the sensitivity of the public debt path to fiscal slippages and the macroeconomic outlook.

1. This note updates the 2003 Selected Issues chapter “Towards Sustained Debt Reduction: Mexico’s Fiscal Framework.”1 Recent Mexican administrations have developed a medium-term National Development Plan, backed by sectoral plans and a financing framework, PRONAFIDE (Programa Nacional de Financiamiento del Desarollo). The most recent PRONAFIDE was published in 2002, describing the objectives for the Fox administration through 2006. As discussed in last year’s analysis, however, the medium-term fiscal frameworks have lacked a formal connection to the annual budget process. In addition, prior to 2004, the macroeconomic and fiscal projections were not updated during their lifespan—as a result, these projections tended to be overtaken by events, especially for augmented measures of fiscal deficits and debt. For example, the 2002 PRONAFIDE aimed at substantial fiscal consolidation and debt reduction between 2002 and 2006. In the event, augmented debt levels edged up by 3 percentage points of GDP between 2001 and 2003, and the augmented deficit for 2004 is expected to lie only slightly below the 2002 level.2

2. In contrast to previous practice, the medium-term macroeconomic framework was updated for the first time for the 2004 budget, and it was revised again in the draft budget for 2005 (Table 1, Figure 1). Each update has extended the end year of the framework by one year, thus the end date of 2008 in the 2005 update is now two years beyond the life of the current administration. The updating of growth projections was particularly significant in the 2004 exercise, as actual GDP growth rates in 2002 and 2003 had fallen short of the PRONAFIDE “inertial” projections—the low growth scenario without significant structural reforms. Against this background, the 2004 update called for medium-term growth only slightly above that in the inertial scenario in the 2002 PRONAFIDE. While growth in 2004 is now expected to be slightly stronger than projected, the 2005 update further revises down medium-term growth to around the 2002 PRONAFIDE inertial scenario of about 4 percent per year (Figure 1). This is closer to, but still above, the staff’s current baseline projection, which is described in Chapter I.3 Despite higher-than-anticipated inflation in 2003 and so far in 2004, inflation projections have remained generally consistent with the Bank of Mexico’s target of 3 percent. Interest rate projections have followed trends in world and domestic interest rates. Following a significant decline in the 2004 budget, nominal interest rate projections were increased in the 2005 budget, albeit still below the initial assumptions of the 2002 PRONAFIDE. The authorities’ oil price assumptions have also been increased to reflect higher international prices, although the revisions have not kept pace with futures prices, as reflected in WEO projections.

Table 1.

Mexico: Medium-Term Macroeconomic Assumptions

article image
Source: Mexican authorities and staff estimates and projections.

2002 and 2003 actuals.

Figure 1.
Figure 1.

Mexico: GDP Growth Assumptions

Citation: IMF Staff Country Reports 2004, 418; 10.5089/9781451825626.002.A003

3. The authorities have broadly maintained their goals for fiscal balances by 2006 in the revised medium-term frameworks (Figure 2). The traditional balance is projected to move into a modest surplus, while the augmented deficit falls to about 1½ percent of GDP. Slight further improvements in fiscal balances are projected beyond 2006. The deficit targets for 2006 have been maintained in spite of some overshoot of deficits, especially for the augmented definition, in 2003 and 2004. In particular, the 2004 augmented deficit is currently projected at slightly over 3 percent of GDP, or a little more than ½ percent of GDP higher than in PRONAFIDE. Higher deficits have resulted from exceptional expenditures (such as the cost of a voluntary retirement scheme for civil servants), greater-than-assumed reliance on non-recurrent revenue, and higher off-budget financing needs (such as development bank financing, and PIDIREGAS financing in 2004). These slippages vis-á-vis the original consolidation plan in 2003-04 make the adjustment path during 2005-06 more challenging. In 2005, the augmented deficit is projected to decline by 1 percent of GDP in an environment of rising interest rates, somewhat slower growth, and (in the authorities’ framework) a sharp decline in oil prices.

Figure 2.
Figure 2.

Mexico: Medium-Term Fiscal Frameworks

(in percent of GDP)

Citation: IMF Staff Country Reports 2004, 418; 10.5089/9781451825626.002.A003

Source: SHCP

4. These fiscal consolidation plans, combined with faster economic growth, are projected by the authorities to achieve the original debt reduction objective of PRONAFIDE. The latest medium-term framework targets a public debt-to-GDP ratio close to 40 percent of GDP by 2006, broadly in line with the 2002 PRONAFIDE. This convergence toward the original PRONAFIDE objective can be attributed to a more favorable growth-interest rate differential and higher nonrecurrent revenues than in the original projections, offsetting the effects of higher deficits and currency depreciation in 2002-03. These favorable factors have been particularly significant in 2004, as the debt ratio is projected to decline by 1½ percent of GDP during this year (both official and staff projections). The debt ratio then falls significantly further to around 35 percent of GDP by 2008.

5. In light of future spending pressures, achieving the medium-term fiscal targets without tax reform would require significant spending compression. The medium-term plans contain no details on specific measures that would be implemented to meet the deficit objectives. Based on the authorities’ projected reductions in oil and nonrecurring revenues, however, and assuming no tax reform, staff estimate that programmable expenditures would have to be compressed by around 1 percent of GDP annually between 2004 and 2006 (from the 2003 base).4 The required expenditure reductions in discretionary areas would be even larger, as additional pressures amounting to 1½ to 3 percent of GDP are expected to arise from pension and wage payments, the health and education spending laws, and PIDIREGAS projects.5 Some savings in oil-related expenditures are expected, but these would be limited in relation to their level in 2003 (when the average oil price was below $25 per barrel). Protecting social spending and public investment may also be difficult. Austerity measures at the federal level in the 2004 budget have already brought some savings but these have been partly offset by growth in other outlays, including public enterprises’ operating and wage costs.6 The quality of fiscal adjustment will hinge the authorities’ ability to extend fiscal consolidation to the whole of the public sector.

6. Sustained high oil prices would lessen the required fiscal effort. If oil prices remain as high as current WEO projections suggest, staff estimates that the target for the traditional deficit could be met with half the fiscal restraint described above (with net spending cuts of about ½ percent of GDP annually between 2004 and 2006). Meeting the augmented deficit targets would largely depend on developments in servicing costs for bank restructuring debt, the financial requirements of the development banks, and the extent of PIDIREGAS investment.

7. The staff’s baseline scenario shows a more gradual decline in the augmented debt ratio than the authorities’ framework (Figure 3). The difference is largely due to the staff’s lower growth forecast of 3¼ percent on average during 2005-2008, versus about 4 percent underlying the 2005 medium-term framework. If the authorities’ projections were adjusted to reflect staff macroeconomic assumptions, the projected debt paths would be similar. Of course, the margin of error for medium-term growth forecasts is known to be wide, and the recovery may strengthen beyond the current forecasts. Aside for the possibility of higher growth in the U.S., recent financial reforms and possible regulatory reforms that would boost competition may produce a durable expansion of private investment. This could result in a faster pace of debt reduction than currently projected by the authorities or staff. The staff also constructs an “unchanged policies” scenario, calculated by holding non-oil related primary spending and tax revenues constant as a percentage of GDP. In this case, the augmented debt ratio would edge up over the medium term.

Figure 3.
Figure 3.

Mexico: Medium-Term Debt Trajectories

(Net augmented debt, percent of GDP)

Citation: IMF Staff Country Reports 2004, 418; 10.5089/9781451825626.002.A003

1/ Holding non-oil related primary spending and tax revenues constant in relation to GDP.
1

Chapter II in IMF Country Report No. 04/250.

2

Exchange rate depreciation contributed significantly to the increase in the debt-to-GDP ratio (approximately 2 percentage points).

3

Given that no major structural reforms were enacted, and GDP growth fell short of the PRONAFIDE inertial scenario, we limit our comparison to the assumptions underlying the latter scenario, as the Mexican authorities commonly do. Figure 1 demonstrates the sharp divergence in 2002 and 2003 between actual and projected growth rates from the PRONAFIDE reforma scenario.

4

This compression assumes that non-oil recurring revenues would remain broadly constant in relation to GDP. While administrative reforms would be desirable to raise the revenue yield of the existing tax system, the experience of recent years suggests that revenue increases from this source would be modest.

5

Reflecting growing investment needs in the energy sector and the assumption of PIDIREGAS-related debt by the government when completed projects are handed over to the public sector.

6

Included cuts in administrative outlays and a wage freeze for middle- and higher-level federal workers.

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Mexico: Selected Issues
Author:
International Monetary Fund