Mexico’s two main economic policy challenges are to fully entrench stability and to remove remaining obstacles to economic growth, necessary to end poverty. The floating exchange rate policy continues to serve Mexico well. An essential part of Mexico’s stability is the resilience of the financial system. The oil sector poses a policy dilemma, exacerbated by institutional constraints and governance issues. Although the near-term growth outlook remains closely linked to that of the U.S. economy, medium-term growth depends on structural reforms.
The following information has become available since the staff report was issued to Executive Directors. The thrust of the staff appraisal remains unchanged.
1. Latest data on economic activity confirm a continued strong rebound from the soft spot in the first part of 2005. GDP growth in the first half of 2006 reached 5.1 percent on a yearly basis, somewhat above expectations. Employment in the formal sector increased at an annual rate of more than 6½ percent in June. This momentum, which has been driven by strong manufacturing exports and domestic demand, appears to have continued into the third quarter, as manufacturing exports and consumption goods imports both grew by about 20 percent in dollar terms in July.
2. The inflation outlook has remained broadly stable, with annual rates of both headline and core inflation at 3.3 percent as of mid-August. In the July survey, expectations for headline inflation at end-2007 edged down, from 3.5 percent to 3.4 percent, while expectations for core inflation stayed close to 3.2 percent. In its monetary policy meeting in late August, the central bank again decided to hold the policy interest rate floor at 7 percent.
3. In August, the authorities implemented the debt management operations they had announced in June, but expanded their scale. The government purchased about US$12.5 billion of international reserves from the central bank, by transferring new government paper to the central bank, which the bank in turn exchanged in the market for outstanding central bank bills. The government will soon use these funds to buy back about US$9 billion of external debt owed to the IDB and the World Bank; US$3.5 billion already was used to retire outstanding external sovereign bonds. As a result, net international reserves declined to about US$65.5 billion by August 18, compared to about US$77.5 billion in late July.
4. In the financial markets, the sharp gains seen in early July have been maintained. During August, the stock market, sovereign bonds, long-term domestic bonds, and the Mexico peso all strengthened.
5. On August 28, Mexico’s electoral court announced that a partial recount of the July 2 presidential vote had not altered the result that Mr. Calderon (PAN) had narrowly edged Mr. Lopez Obrador (PRD).