Mexico
Arrangement Under the Flexible Credit Line and Cancellation of the Current Arrangement—Staff Report; Staff Supplement; and Press Release on the Executive Board Discussion

The report discusses the important role of the Flexible Credit Line (FCL) in helping Mexico to survive in the fragile global economic environment. The FCL’s contribution in maintaining an orderly financial market in Mexico is noteworthy. IMF staff reaffirms their commitment toward Mexico in taking the necessary actions to manage unforeseen risks. According to the IMF staff report, Mexico meets the qualification criteria for access to FCL resources, and staff recommends approval of a fund of SDR 47.292 billion for a period of 24 months.

Abstract

The report discusses the important role of the Flexible Credit Line (FCL) in helping Mexico to survive in the fragile global economic environment. The FCL’s contribution in maintaining an orderly financial market in Mexico is noteworthy. IMF staff reaffirms their commitment toward Mexico in taking the necessary actions to manage unforeseen risks. According to the IMF staff report, Mexico meets the qualification criteria for access to FCL resources, and staff recommends approval of a fund of SDR 47.292 billion for a period of 24 months.

I. Context

1. Mexico’s strong economic performance attests to its strong fundamentals and sound policy management. The strength and resilience of the recovery after the global crisis have been underpinned by Mexico’s sound balance sheets, strong policy frameworks, and skillful macroeconomic management. The recognition of Mexico as a predictable and prudently managed economy, with market-friendly and transparent regulations for foreign investment, and open and liquid financial markets, have bolstered large foreign investment in recent years. Amid persistent global financial uncertainty, the successive FCL arrangements have supported Mexico’s economic policies by providing a significant buffer against global downside risks. At the conclusion of the 2012 Article IV Consultation, Executive Directors commended the authorities for Mexico’s strong rules-based policy framework and their skillful macroeconomic management.

2. Despite Mexico’s strong fundamentals, external risks continue to loom large in the context of its open capital account and large foreign portfolio investment. Given its high integration with international capital markets, a surge in global risk aversion from an intensification of the crisis in Europe could affect even strong sovereigns like Mexico. The substantial equity and debt portfolio holdings of foreign investors (30 percent of GDP), including short-term government paper, mean that a generalized pullback from the emerging market asset class would be a material risk. The presence of two large Spanish bank subsidiaries also represents risks, which Mexico’s subsidiary model and effective oversight help to contain. Moreover, a significant U.S. slowdown would be a major drag on growth in Mexico given its close integration with the U.S. economy, particularly the manufacturing sector.

3. Since the approval of the current FCL, global conditions have remained highly unsettled, particularly with respect to potential downside risks that could trigger a surge in global risk aversion and generalized financial contagion. Despite recent temporary respites in financial market turbulence, heightened risks to global financial stability persist, with a more adverse environment for emerging markets than in 2010. Key downside risks are associated with a re-intensification of the euro area crisis triggered by market reaction to insufficiently decisive policy action. Abrupt tightening of U.S. fiscal policy or uncertainty about raising the debt ceiling could also hurt markets and growth. Potential spillovers from the euro area crisis remains a significant concern for Mexico, including from Spain’s banking system given the presence of two large Spanish bank subsidiaries.1

A01ufig1

Global Financial Stability Map

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

Source: IMF staff estimates.

II. Recent Developments

4. Mexico’s growth has been resilient, supported by both external and domestic demand. Growth in 2011 and 2012 has remained above potential and is expected to help close the output gap that opened during the global crisis (Figure 1). Since the crisis, Mexico has benefited from both the relatively good performance of the U.S. manufacturing sector and a strong recovery in market share in the U.S. (due in part to improved relative unit labor costs). In turn, domestic demand has been supported by sustained growth in employment and in corporate and consumer lending.

  • Inflationary pressures have remained contained, despite the recent uptick in headline inflation associated with food prices, while medium-term inflation expectations remain firmly anchored (Figure 2). Amid relatively slack labor market conditions (with lower migration to the U.S. implying higher labor market participation), wage pressures have remained subdued.

  • Credit conditions have remained supportive of domestic demand. The banking system, including the domestic subsidiaries of Spanish banks, has been shielded so far from unsettled external conditions. Underpinned by strong capital and liquidity ratios, bank credit has expanded at a sustained pace. Market access conditions for corporates have remained favorable thus far, with spreads near historic lows.

  • The exchange rate has fluctuated substantially, linked to the recurrent bouts of global risk aversion, but without major balance sheet or pass-through effects. Exchange rate flexibility has been a key shock absorber, while sovereign and financial markets have remained stable, including the banking sector. Capital inflows have continued, particularly into local-currency sovereign paper and across the whole yield curve. During periods of high global uncertainty, foreign investors have responded mainly by covering currency exposures (Figure 3), which has induced significant exchange rate volatility while maintaining stable interest rates on sovereign paper.

Figure 1.
Figure 1.

Mexico: Real Sector, 2007–2012

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

Sources: INEGI, Haver Analytics, Banxico, CNBV, and IMF staff calculations.1/ Projection for 2012.
Figure 2.
Figure 2.

Mexico: Prices and Monetary Policy, 2007–2012

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

Sources: INEGI, Haver Analytics, Banxico, and Bloomberg.
Figure 3.
Figure 3.

Mexico: Financial Sector, 2007–2012

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

Sources: INEGI, Banxico, and Bloomberg.1/ Non-commercial positions are those taken by traders that are not involved in the physical receipt/delivery of a commodity or asset.

5. Mexico’s external position has remained sound. The Fund’s current account models and a range of exchange rate metrics suggest that the external position and real exchange rate are consistent with underlying fundamentals and desirable policy settings. The balanced recovery in activity has meant that the current account deficit has remained moderate at about 1 percent of GDP (Figure 4). In the context of Mexico’s rule-based reserve accumulation policy, the central bank bought US$16 billion in the first three quarters of 2012, with the bulk coming from Pemex’s net FX balance; international reserves now amount to US$166 billion.2 At the same time, capital inflows have increased the stock of foreign portfolio liabilities by US$48 billion in the first half of 2012, to US$355 billion (30 percent of GDP).

Figure 4.
Figure 4.

Mexico: External Sector, 2007–2012

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

Sources: INEGI, Haver Analytics, Banxico, and IMF Staff Calculations1/ Data based on IMF staff estimates.2/ 2012 data based on data available through September 2012.3/ Group of countries listed in Figure 8 and Figure 9.

6. Mexico’s policy stance has judiciously balanced the need to support the recovery while gradually rebuilding policy buffers in the context of heightened global risks. Mexico has continued to implement sound economic policies. Mexico’s exchange rate flexibility has continued to play a key buffering role during the repeated bouts of global risk aversion. The central bank’s rule-based intervention policy has sought to limit excess currency volatility.3 Together with the flexible exchange rate regime, the policy mix—combining a gradual fiscal consolidation with stimulative monetary policy—has helped Mexico cope with capital inflows (Figure 5). The monetary authorities have maintained the policy rate at 4½ percent since 2009, and medium-term inflation expectations remain firmly anchored. Continuing with the fiscal consolidation, after the fiscal stimulus during the crisis, the primary deficit is expected to fall by about 1 percent of GDP in 2012 and return to balance. These consolidation efforts have helped stabilize public debt at around 43 percent of GDP.

Figure 5.
Figure 5.

Mexico: Fiscal Sector, 2007–2012

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

Sources: INEGI, Banxico, Bloomberg, SHCP, and IMF Staff Calculations1/ 2012 data based on IMF staff calculations.2/ Fiscal primary spending includes budgetary adjustments.

III. Outlook and Near-Term Policies

7. Growth is expected to moderate towards Mexico’s potential rate in 2013. Growth next year is envisaged to converge to 3½ percent, close to Mexico’s long-term potential growth rate. External demand is expected to contribute moderately while domestic demand is envisaged to maintain its momentum, underpinned by sustained business and consumer confidence. High capacity utilization rates are expected to continue to underpin the recovery in fixed investment, while favorable credit conditions and sustained employment growth should help to support consumption. As food price shocks dissipate, headline inflation is expected to revert towards the inflation target.

8. With the new administration taking office in December, policy continuity is underpinned by a strong consensus in Mexico about macroeconomic stability. Mexico has continued to implement sound macro policies supported by its strong policy frameworks, and the incoming administration has stressed that it is firmly committed to maintaining prudent policies within the current frameworks. Monetary policy will continue to be guided by the inflation targeting framework, in the context of the floating exchange regime; fiscal policy will be anchored by the balanced budget rule; and financial oversight will be based on the sound regulatory and supervisory framework.

9. With Mexico’s economy operating close to potential but external risks looming large, the authorities aim to maintain an appropriate policy stance (from a cyclical perspective) and policy mix (to restore Mexico’s fiscal buffers).

  • Fiscal policy. Amid heightened global risks, continued consolidation efforts next year would help further rebuild fiscal buffers. Under the baseline scenario, fiscal consolidation in 2013 would turn the primary balance into a slight surplus and return to a balanced budget under the fiscal rule.4

  • Monetary policy. The Central Bank remains judiciously vigilant to risks from the possible persistence of recent supply shocks, domestic cyclical conditions and global headwinds. The authorities stressed that the breach of the inflation target variability interval has primarily been due to temporary supply shocks and that medium-term inflation expectations remain firmly anchored. Nonetheless, they are committed to monitor the determinants of inflation closely in order to adjust monetary policy as necessary to keep inflation in line with the target.

  • Exchange rate. The exchange rate will continue to play a key buffering role against potential shocks, with rules-based FX intervention limited to smoothing disorderly market conditions. In this context, the authorities, including the incoming administration, believe that Mexico’s level of international reserves appears adequate for normal times but that, amid heightened external uncertainty and Mexico’s high integration with international capital markets, the FCL would remain a critical insurance complement against global downside risks.

  • Financial sector. The authorities will continue to monitor financial sector developments closely, including the subsidiaries of foreign banks and credit segments that have expanded substantially in recent years. Moreover, preparatory work is underway to address recommendations in the recent FSAP Update that require legislative change.

IV. Role of the Flexible Credit Line

10. Persistent global uncertainty represents a significant risk to Mexico. Since the approval of the current FCL, downside risks to the global economy have intensified, associated to the potential re-intensification of the euro area crisis due to insufficiently decisive policy action, and the risk of an abrupt tightening of U.S. fiscal policy or uncertainty about raising of the debt ceiling. Increased external uncertainty so far has affected emerging markets transitorily (during the bouts of global risk aversion), but beyond temporary disruptions foreign investor flows have continued. However, if global downside risks were to materialize a surge in global risk aversion and a generalized pull back would be expected to affect the emerging market asset class, particularly those with open capital accounts and liquid financial markets. This risk is particularly relevant for Mexico, given the large and growing foreign portfolio inflows since 2010.

A01ufig2

Stock of Non-resident Portfolio Investment in Emerging Markets

(USD, Billions)

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

Sources: IFS

11. In this context, the authorities continue to see a critical need for insurance against external downside risks, and are requesting a new 2-year FCL arrangement maintaining access at SDR 47.292 billion (about US$73 billion), which they intend to treat as precautionary. This implies a reduction in quota access from 1,500 percent (originally approved in the current arrangement) to 1,304 percent.5 Mexico’s reserve accumulation over the last two years, in a context of very large capital inflows, has increased reserve coverage moderately, remaining relatively low in terms of balance sheet indicators. While the authorities are expected to continue taking advantage of favorable oil prices to increase their reserve cushion and to maintain an adequate level of reserves for normal times, they consider the FCL a critical pillar against global downside risks. Moreover, the authorities consider that the FCL has successfully supported their macroeconomic strategy amid persistent unsettled external conditions since the global crisis. They stressed the crucial importance of the FCL as a complement to reserves and to reinforce market confidence on Mexico’s strong policies and frameworks, particularly at the current juncture.

12. Exit strategy. While maintaining access in SDR terms, the authorities considered the reduction in quota access as appropriate given the current risk balance. They underscored their intention to take further steps towards exit when improved external conditions allow. The authorities are committed to maintain very strong policies in line with their frameworks and continue the fiscal consolidation efforts, while taking stock of evolving global conditions.

V. Access Considerations

13. In the context of high and persistent global uncertainty, Mexico’s access case rests on its very open capital account and large balance sheet exposures from foreign portfolio investment. The recognition of Mexico’s strong fundamentals and prudent policies have resulted in large capital inflows, particularly after the global crisis and Mexico’s inclusion in the World Global Bond Index (WGBI) in 2010. In this context, persistent global uncertainty and heightened downside risks remain material to Mexico, linked to a potential surge in global risk aversion and a generalized pullback from the emerging market asset class, even from strong countries like Mexico. While a gradual reserve accumulation has allowed Mexico to increase external buffers, they remain relatively low in terms of balance sheet exposures that could reverse during global financial distress.

  • As highlighted in the latest WEO and GFSR, global downside risks have intensified, as confidence in the global financial system has become very fragile. An intensification of the Euro Area crisis represents a major risk, particularly for emerging economies with open capital accounts and liquid financial markets, like Mexico. A materialization of the U.S. fiscal cliff could drive the U.S. economy into a recession and unsettle global financial conditions, with significant spillovers on Mexico.

  • Foreign portfolio exposures in Mexico have increased significantly since the global crisis, particularly in sovereign debt markets. Increased investor appetite for Mexican assets has been associated with: (i) the recognition of Mexico’s strong fundamentals and policy frameworks; (ii) the absence of controls on the capital account and stability of taxes and regulations for foreign investment; and (iii) the liquidity of its sovereign and FX markets. The stock of foreign portfolio investment in Mexico has increased by almost 80 percent during the last three years, from about US$200 billion as of mid-2009 to US$355 billion in mid-2012. Capital inflows have been particularly large in domestic sovereign debt markets where the stock of foreign portfolio holdings increased from about US$20 billion in 2009 to about US$110 billion in 2012, which added to the already significant stock of foreign equity holdings (US$143 billion in 2012). A significant part of portfolio inflows has been from institutional investors into the long-end of the yield curve, driven largely by Mexico’s strong fundamentals and its inclusion in the WGBI.6 More recently, though, flows to short-term government paper (CETES) have increased considerably, driven in part by carry trade operations. Given the impact that a surge in global risk aversion can have on the emerging asset class as a whole, including sound countries like Mexico, the large portfolio exposures represent a significant source of risk under adverse external scenarios.

  • While reserve coverage has increased somewhat since the global crisis, it remains relatively low in terms of balance sheet exposures that could reverse in case of global financial distress. The increased investor appetite for Mexican assets has meant that the efforts to build up reserve buffers have increased the coverage ratio vis-à-vis foreign portfolio liabilities only modestly since 2009.7 The coverage of monetary aggregates shows a similar picture, with the increase in coverage in this period from 16 to 21 percent of broad money.8 Both metrics of reserve coverage remain low compared to peer countries. The ARA metric and reserves as months of imports show that Mexico is in line with other emerging market peers. Other metrics show that Mexico has relatively lower coverage than other emerging market peers in the case of reserves to GDP, and larger coverage of short-term debt at residual maturity plus the current account deficit. However, Mexico has low short-term debt and current account deficits, and high correlation between exports and imports, which suggests that less weight should be given to metrics including these variables as indicators of potential external drains.

A01ufig3

Mexico: Foreign Holdings of Domestic Government Debt

(Billions of USD)

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

Sources: Banxico

Mexico: Comparisons under various reserve adequacy metrics

(end 2011)

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Source: WEO and IFS

Countries included are: Argentina, Bosnia and Herzegovinia, Brazil, Bulgaria, Chile, China, Colombia, Costa Rica, Croatia, Dominican Rep., Ecuador, Egypt, El Salvador, Guatemala, India, Indonesia, Jamaica, Jordan, Latvia, Lithuania, Malaysia, Morocco, Pakistan, Panama, Peru, Philippines, Poland, Romania, Russia, Serbia, South Africa, Thailand, Tunisia, Turkey, Ukraine, Uruguay, Venezuela.

14. The main sources of reserve drains in an adverse scenario would stem from the capital account, and in particular portfolio flows (Box 1). The access case rests on a plausible downside scenario involving primarily a situation of a sudden stop rather than outright divestment of portfolio holdings in secondary markets. In particular, the shocks underpinning the size of potential drains are in line with the current FCL arrangement (except that the present scenario assumes no accumulation of reserves as in the past).

Illustrative Adverse Scenario

An illustrative adverse scenario developed by staff suggests possible annual financing gaps of US$73 in 2013 and US$80 billion in 2014. This scenario illustrates the potential impact on Mexico’s balance of payments of adverse external shocks associated with a surge in global risk aversion (amplified by slower global growth). The scenario applies independent shocks in 2013 and in 2014 to generate an access envelope.

The shocks in the 2013 adverse scenario can be summarized as follows (Table A):

Table A.

Mexico: Adverse Scenario

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  • Current account. The current account is assumed to deteriorate, reflecting: (i) a 20 percent fall in oil prices; (ii) a negative shock to the non-factor services balance; and (iii) a drop in remittances similar to the one observed in 2009. Weaker external demand is assumed to have a small impact on the non-oil trade balance, given the high import content of Mexico’s exports.

  • Net foreign direct investment. Global economic and financial distress is assumed to cause FDI to decline, although by about half of the fall in 2008–2009 (since FDI flows are yet to recover to their pre-crisis levels).

  • Public external financing. Reflecting their prudent debt management and their strong track-record of securing external access, the authorities secure financing covering 86 percent of debt coming due.

  • Foreigners’ investments in domestic sovereign bond markets. Rollover of sovereign debt by foreign investor is assumed to fall to 90 percent for short-term paper, and 80 percent for long-term instruments.3/

  • Foreign equity outflows. Equity sales represent approximately 5 percent of the total stock of equity portfolio liabilities held by non-residents, similar to the experience during the global crisis.

  • Private sector FX medium and long-term issuances. The adverse scenario assumes lower bond placements in international markets and rollover rates above 95 percent.

  • Short-term private external financing. This is mostly associated with a reduction in foreign banks cross-border lending, with a rollover rate at 89 percent.

  • Resident investments outflows. These flows have been sizeable and volatile in the past, and the scenario assumes an increase in residents’ assets abroad, mostly in the form of portfolio investments.

Table B.

Roll-Over Rates

(in percent)

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Local bond issuances in pesos.

Local bond issuances in pesos and external issuances in dollars.

Assumptions in the adverse scenario are plausible compared with Mexico’s experience during the global crisis. The reduction in the stock of foreign holdings of short-term and long-term domestic public bonds—as percent of the total stock—are below those observed during 2008–2009 (Figure A). The assumptions about changes in residents’ investment abroad and FDI (US$21 billion and US$10 billion) are also below those experienced during the crisis (US$45 billion and US$18 billion), while assumptions on foreign equity portfolio investment are in line with the global crisis (Figures B and C).

Figure A.
Figure A.

Foreigners’ Holdings of Mexican Domestic Government Bonds around the Global Crisis 2008-2009

(Billions of pesos)

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

Figure B.
Figure B.

Residents’ Capital OutFlows During Lehman Crisis

(change in billions of dollars)

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

Figure C.
Figure C.

BOP Capital Account OutFlows During Lehman Crisis

(changes in billions of dollars)

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

This current adverse scenario is broadly in line with that presented for the 2011 FCL (Table C), with two exceptions: (i) the present adverse scenario assumes no accumulation of international reserves, in contrast to the buildup assumed in the past; and (ii) the current scenario calibrates in more detail the potential outflows associated with portfolio investment, rather than including a generic buffer.

Table C.

Mexico: Comparison between Current Adverse Scenario and 2011 FCL Scenario

(in billions of dollars, except where noted)

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For 2014, the adverse scenario is built on the higher stock of foreign portfolio liabilities in 2013 under the baseline of no shock that year (assuming the same shocks in terms of standard deviations) and lower baseline reserve accumulation (Table D).

Table D.

Mexico: Baseline and Adverse BOP Scenarios

(in billions of dollars)

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1/ Standard deviations for each BOP component are calculated on annual changes since the mid-1990s. The magnitude of the shocks in terms of standard deviations indicates that this is a plausible adverse scenario.2/ Standard deviation calculated for 2009 onwards, using annualized quarterly data, as foreign holdings of domestic government paper have increased sharply in recent years (from about US$20 billion in 2009 to almost US$110 billion in 2012, or 32 of the total stock). Using data before 2009 would underestimate the relevant standard deviation for the scenario.3/ For a comparison of rollover rates in this scenario with those assumed in previous FCLs, see Appendix 1.

VI. Review of Qualification

15. The staff assesses that Mexico continues fully to meet the qualification criteria for an arrangement under the FCL (Figure 6). The authorities have in place very strong policy frameworks, which include monetary policy guided by an inflation targeting framework in the context of a flexible exchange regime, fiscal policy anchored by a balanced budget rule and financial oversight based on a sound regulatory and supervisory framework. The incoming administration is firmly committed to maintaining Mexico’s strong policy frameworks and prudent policies, which they have explicitly endorsed in the letter accompanying the authorities’ letter. At the conclusion of the 2012 Article IV Consultation, Executive Directors commended the authorities for Mexico’s strong rules-based policy framework and their skillful macroeconomic management.

  • Sustainable external position. The current account deficit is small 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 (Figure 7) continues to show that Mexico’s external debt remains moderate and is expected to fall over the medium term, even in the presence of potential shocks.

  • Capital account position dominated by private flows. The bulk of Mexico’s external debt continues to be owed to private creditors, and private portfolio flows (debt and non-debt creating) and FDI continue to be large relative to 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 sovereign spreads remain low at about 125 basis points (compared to 260 basis points on average for emerging economies), while CDS spreads (at around 100 basis points) are close to the historical minimum reached in 2008. Moreover, taking advantage of favorable market conditions, Mexico has continued to improve its debt profile, successfully placing sovereign longer-dated bonds in international capital markets at historically low yields.9

  • Relatively comfortable reserve position. Gross international reserves reached US$166 billion by end-September, about US$16 billion above the level of end-2011. As assessed in the recent Article IV consultation, this level of reserves is relatively comfortable according to standard reserve adequacy indicators (see Figure 8).

  • Sustainable public debt position and sound public finances. Fiscal policy remains guided by the balanced budget rule, which underpins the authorities’ commitment to keep the augmented public sector deficit at a level that ensures overall public sector debt sustainability. The authorities have pursued a gradual fiscal consolidation after the fiscal stimulus put in place during the global crisis, which attests to their strong track record of policies to maintain sound public finances. The updated debt sustainability analysis continues to show a gradual decline in the public debt to GDP ratio and indicates that the debt trajectory is broadly robust to most standard shocks (Figure 9). The fiscal outlook is sensitive to growth dynamics and the evolution of oil revenues, but the balanced budget rule provides assurances of fiscal sustainability.

  • Low and stable inflation. Inflationary pressures remain contained, despite the recent uptick in headline inflation linked to higher food prices. Core inflation remains within the inflation target variability interval, particularly in services, indicating limited demand pressures. Headline inflation developments are viewed as temporary and supply-driven, with medium-term inflation expectations remaining firmly anchored.

  • Absence of systemic bank solvency problems that pose an immediate threat of a banking crisis. The recent FSAP Update found that Mexico’s banking system remains sound, with good levels of liquidity, capital, and profitability. The authorities are planning to implement most Basel III capital requirements by next January, as most banks already have sufficient high quality capital to meet the 2019 ratio for capital plus conservation buffer of 10½ percent. Mexico’s banking system has remained resilient to the effects of unsettled market conditions in Europe.

  • Effective financial sector supervision. The FSAP Update also concluded that Mexico’s overall financial sector supervision framework is effective, and that the institutional set-up for macro-financial oversight and systemic crisis management has been strengthened with the establishment of the Financial System Stability Council. The authorities have taken steps to address portfolio concentration issues including by tightening rules on relevant party transactions and applying concentration limits on bank loans to subnational governments that are not guaranteed by federal transfers. Preparatory work is advanced to address FSAP recommendations that require legislative change.

  • Data transparency and integrity. The overall quality of Mexican data continues to be adequate for surveillance as described in the October 2010 data ROSC Update. Mexico remains in observance of the Special Data Dissemination Standards (SDDS).

Figure 6.
Figure 6.

Mexico: Qualification Criteria

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

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.
Figure 7.
Figure 7.

Mexico: External Debt Sustainability: Bound Tests 1/2/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

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 2012.
Figure 8.
Figure 8.

Mexico: Metrics of Reserve Coverage in a Cross-Country Perspective, 2011

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

Sources: World Economic Outlook, and IMF staff estimates.1/ Portfolio liabilities only available until 2010.Note: Black line represents the cross-country median.
Figure 8.
Figure 8.

Mexico: Metrics of Reserve Coverage in a Cross-Country Perspective, 2011 (concluded)

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

Sources: World Economic Outlook, Balance of Payments Statistics Database, and IMF staff estimates.1/ The ARA metric was developed by the Strategy and Policy Review Department to assess reserve adequacy. The blue lines denote the 100-150 percent range of reserve coverage regarded as adequate for a typical country under this metric.2/ Portfolio liabilities only available until 2010.Note: Black line represents the cross-country median.
Figure 9.
Figure 9.

Mexico: Public Debt Sustainability: Bound Tests 1/2/

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2012, 327; 10.5089/9781475575095.002.A001

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/ This mechanical exercises assumes that the budget rule does not hold.4/ Permanent ¼ standard deviation shocks applied to real interest rate, growth rate, and primary balance.5/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2010, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

16. The authorities’ letter, endorsed by the incoming administration, attests to their continued commitment to very strong policy frameworks and implementing sound macroeconomic policies. The authorities underscore their continued commitment to implement prudent policies underpinned by Mexico’s strong policy frameworks, and point to the fact that policy continuity is firmly anchored on a broad consensus in Mexico in support of macroeconomic stability. The incoming administration has explicitly endorsed the authorities’ letter, highlighting that it remains firmly committed to maintaining prudent policies within the current frameworks. See Attachments 1 and 2.

VII. Impact on Fund Finances, Risks, and Safeguards

17. Access under the proposed FCL for Mexico of 1,304 percent of quota (SDR 47.292 billion) is large, but the impact on Fund liquidity and the risks to the Fund are 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 the approval of the proposed FCL arrangement for Mexico, as further discussed in the supplement assessing the impact on the Fund’s finances and liquidity position.

18. Notwithstanding the large size of the commitment, the risks to the Fund are judged to be low. The authorities have given clear indications 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 26¼ percent of GDP in 2017, when debt service peaks (Table 7). Further, even 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 a demonstrated excellent track record of meeting its obligations to the Fund.

19. Staff completed the safeguards procedures applicable to FCL arrangements for the current FCL approved in January 2011. Under these procedures, staff reviews the most recent independent external audit of the member’s central bank. The authorities provided the necessary authorization for staff to communicate directly with the Banxico’s external auditor, PricewaterhouseCoopers (PwC) Mexico. PwC issued an unqualified audit opinion on the Banxico’s 2010 financial statements in March 2011. Staff has reviewed the 2010 audit results and discussed them with PwC on September 8, 2011. No significant safeguards issues emerged from the conduct of these procedures. Banxico publishes only its balance sheet and audit opinion as part of the annual report. In light of Mexico’s request for a successor FCL, Banxico provided the authorizations needed for similar safeguards procedures to be conducted by Fund staff in line with the specific safeguards requirements for FCL arrangements.

VIII. Staff Appraisal

20. The FCL arrangement for Mexico has provided significant insurance against external downside risks, contributing to maintaining orderly financial market conditions amid persistent unsettled external conditions. The lowered perception of risks, along with skillful policy management, has been instrumental in Mexico’s rapid recovery after the global financial crisis and in reinforcing Mexico’s resilience during the recurrent bouts of global risk aversion.

21. The staff’s assessment is that Mexico continues to meet the qualification criteria for access to FCL resources. Mexico has very strong policy frameworks and economic fundamentals. The authorities have also demonstrated a sustained track record of excellent policy implementation. The incoming administration is firmly committed to maintaining Mexico’s strong policy frameworks and prudent policies, which they have explicitly endorsed in the letter accompanying the authorities’ letter.

22. The staff recommends approval of an FCL arrangement for Mexico of SDR 47.292 billion for a period of 24 months. Highly unsettled global conditions have persisted since the approval of the previous FCL arrangement, with heightened downside risks for Mexico in the context of its open capital account and liquid financial markets. The new FCL arrangement would continue to support the authorities’ overall macroeconomic strategy and bolster Mexico’s external buffers. The authorities considered the reduction in quota access as appropriate given the current risk balance. They underscored their intention to take further steps towards exit when improved external conditions allow.

23. The staff judges the risks to the Fund arising from any potential drawing under the proposed FCL arrangement as low. The authorities have an excellent policy implementation track record. Their letter reaffirms their commitment to maintain Mexico’s very strong policy frameworks and to take needed actions to manage unforeseen risks. Together, these provide a strong assurance that the authorities would react appropriately to any future balance of payments difficulties. Risks to the Fund are further contained by the authorities’ intent to treat the FCL arrangement as precautionary, Mexico’s very strong repurchase record with the Fund, as well as the manageable external debt service profile even if the full amount of the FCL were to be drawn up-front.

Table 1.

Mexico: Selected Economic, Financial, and Social Indicators, 2008–2013

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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.

Broadest national definition (CONEVAL).

2012 based on data available until June 2012.

Authorities’ definition. The break in the series in 2009 is due to definitional and accounting changes of PIDIREGAS.

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

Estimated as the difference between the augmented fiscal balance, as reported by SHCP, and public investment, as reported in the national accounts.

Table 2.

Mexico: Financial Operations of the Public Sector, 2008–2017

(In percent of GDP)

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Sources: Mexican authorities; and IMF staff estimates. Data refer to non-financial public sector, including PEMEX and other public enterprises but excluding state and local governments (except as noted).

Total tax revenue excluding excise tax on gasoline.

Includes transactions in financial assets and capital transfers.

Includes transfers to IPAB and the debtor support programs.

The break in the series in 2009 is due to definitional and accounting changes.

Public Sector Borrowing Requirements excl. nonrecurrent revenue.

Treats transfers to IPAB as interest payments.

Excludes oil revenue (oil extraction rights, PEMEX net income, oil excess return levies, excise tax on gasoline) and PEMEX operational expenditure, interest payments, and 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 3.

Mexico: Summary Balance of Payments, 2008–2017

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

Including the financing of PIDIREGAS.

Includes pre-payment of external debt.

Break in the series in 2009 due to accounting changes.

Excluding oil exports and petroleum products imports.

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.

In percent of short-term debt by residual maturity. Historical data include all prepayments.

Includes gross external debt issued by the federal government, development banks and nonfinancial public enterprises. Adjusted for PIDIREGAS, and includes nonresidents’ holdings of domestic-currency debt.

Includes amortization on medium and long-term bonds and debt, and interest payments.

Table 4.

Mexico: External Financing Requirements and Sources, 2008–2014

(In billions of U.S. dollars)

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Sources: Mexican authorities and IMF staff estimates.

Including PIDIREGAS.

On a BoP basis.

Includes bonds and loans. For 2006-08, staff estimates based on the stock of debt at original maturity, estimated duration, and net financing data from the Balance of Payments. In 2009, assets from the PEMEX’s Master Trust were used to pay down the stock of PIDIREGAS debt.

Gross financing figures for 2006-09 are staff estimates based on data on the stock of debt by residual maturity, estimated duration, and net financing data from the Balance of Payments.

Loans and money market instruments, estimates on original maturity basis.

Includes accounts payable to suppliers and long-term trade credit.

The adverse scenario applies independent shocks in 2013 and 2014 to generate an access envelope; thus the gaps in 2013 and 2014 should not be added together.