Mexico: Review Under the Flexible Credit Line Arrangement
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International Monetary Fund. Western Hemisphere Dept.
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This paper discusses Mexico's Review Under the Flexible Credit Line (FCL) Arrangement. Mexico has navigated successfully a complex external environment, characterized by falling commodity prices, a sharp appreciation of the U.S. dollar, and heightened volatility in international financial markets. The economy continues to grow at a moderate rate and inflation is close to the target. Looking ahead, activity should be supported by strengthening external demand and by the implementation of the structural reforms. The IMF staff's assessment is that Mexico continues to meet the qualification criteria for access to FCL resources

Abstract

This paper discusses Mexico's Review Under the Flexible Credit Line (FCL) Arrangement. Mexico has navigated successfully a complex external environment, characterized by falling commodity prices, a sharp appreciation of the U.S. dollar, and heightened volatility in international financial markets. The economy continues to grow at a moderate rate and inflation is close to the target. Looking ahead, activity should be supported by strengthening external demand and by the implementation of the structural reforms. The IMF staff's assessment is that Mexico continues to meet the qualification criteria for access to FCL resources

Context

1. The Mexican economy has been resilient in the context of a complex global environment. International oil prices declined by more than 50 percent since mid-2014. In addition, emerging market asset prices have been affected by a rise in global financial volatility and a portfolio shift away from emerging markets, driven by slowing growth in key economies and uncertainty related to the path of U.S. monetary policy. Along with other emerging market currencies, the Mexican peso depreciated sharply against the U.S. dollar over the last year. Nonetheless, the yields on local-currency government bonds have increased only mildly, economic activity continues to grow at a steady pace, and inflation remains low and stable.

2. Mexico’s macroeconomic policies and policy frameworks remain very strong. The flexible exchange rate has helped the economy adjust to external shocks. Monetary policy is guided by an inflation-targeting framework, and the financial regulatory and supervisory framework is strong. Fiscal policy is guided by the fiscal responsibility law, and the authorities are committed to a consolidation path that would lead to a gradual reduction of public debt over the medium term. The external current account deficit is low and stable, and there are no restrictions on capital flows. Steady implementation of the structural reform agenda would help raise the economy’s potential growth in the medium term. At the conclusion of the 2015 Article IV Consultation, Executive Directors expressed confidence in Mexico’s very strong economic fundamentals and policy frameworks.

3. Mexico’s successive FCL arrangements have supported the authorities’ policies by providing a buffer against tail risks. Mexico is deeply integrated into the global economy through both trade and financial channels, with particularly strong links to the United States. International investors held 45 percent of total public debt and 36 percent of local-currency-denominated sovereign bonds in 2015. Total foreign portfolio investment in Mexico reached US$ 478 billion (37 percent of GDP) at the end of 2014. High foreign participation in domestic financial markets brings substantial benefits, such as lower cost of finance and a more diversified investor base. However, it also exposes Mexico to abrupt shifts in investor sentiment toward emerging markets. Based on BIS data, the Mexican peso is the most actively traded emerging market currency in the world, with a daily global trading volume of US$135 billion. The authorities consider the FCL arrangement a valuable insurance against tail risks and continue to treat it as precautionary.

Recent Economic and Policy Developments

4. The economy continues to grow at a moderate pace. Growth is projected to be 2¼ percent in 2015, and to accelerate over the medium term (Figure 1). Stronger U.S. growth and the real depreciation of the currency should support Mexico’s manufacturing production and exports, with positive spillovers to domestic demand. The boost to activity from lower electricity prices should largely offset the growth effects of lower public spending. Private consumption growth would continue to be supported by steady wage growth and rising employment. Inflation is low, and is expected to remain close to the 3-percent target over the next year. The structural reforms are expected to raise potential growth over the medium term. Some of the benefits of the reform are already visible: private investment in gas pipelines, electricity generation, and telecommunications has picked up, the first auctions of oil fields have been completed, and the financial reform has helped spur competition in the banking sector.

Figure 1.
Figure 1.

Mexico: Recent Economic Developments

Citation: IMF Staff Country Reports 2015, 322; 10.5089/9781513503158.002.A001

Sources: National authorities; Haver Analytics; Bloomberg; and IMF staff calculations.

5. Asset prices in Mexico have been affected by the rise in volatility in global financial markets. The peso had depreciated 30 percent against the U.S. dollar, and by 15 percent in real effective terms between mid-2014 and September 2015. Foreign exchange bid-ask spreads and stock market volatility increased to levels last seen during the euro area sovereign debt crisis in November 2011 and the taper tantrum, respectively. In response, the Foreign Exchange Commission reactivated two foreign exchange intervention schemes intended to reduce the risk of disorderly market conditions by increasing liquidity in exchange rate markets.1 In contrast, the sovereign bond market has been relatively calm: the long end of the domestic-currency yield curve has shifted up only modestly over the last year. Total non-resident ownership of sovereign debt has been broadly stable since the end of 2014, though there has been a decline in non-resident holdings of short-term paper (Figure 2). Portfolio capital inflows moderated, but stayed positive in the first half of the year. Higher frequency partial data from ETF’s and mutual funds suggest that outflow pressures intensified in July and August, and corporate bond issuance in foreign currency trailed off in the third quarter.

Figure 2.
Figure 2.

Mexico: Recent Financial Developments

Citation: IMF Staff Country Reports 2015, 322; 10.5089/9781513503158.002.A001

Sources: National authorities; Haver Analytics; Dealogic; EPFR; Bloomberg; and IMF staff calculations.
uA01fig01

Bid-Ask Spread and Financial Market Volatility

Citation: IMF Staff Country Reports 2015, 322; 10.5089/9781513503158.002.A001

Sources: Bloomberg L.P.; and IMF staff calculations.

6. Monetary policy remains appropriately accommodative. Year-on-year inflation has fallen below the 3-percent target in 2015. The pass-through from the currency depreciation to inflation has been very low and limited only to durable goods prices, with no signs of spillovers to other prices or wages so far. Inflation expectations remain well anchored. Real wage growth has been modest and broadly in line with productivity gains. Slack in the economy is expected to diminish only gradually going forward, keeping inflation pressures in check.

7. The authorities are committed to a gradual fiscal consolidation over 2015–18, as announced last year. The public sector borrowing requirement (PSBR) is projected to decline to 4.1 percent of GDP this year (from 4.6 percent in 2014). It would be reduced further by about ½ percentage point per year to reach 2½ percent of GDP in 2018, despite a significant decline in oil prices and a downward revision of oil production forecasts. This plan will help set the public debt-to-GDP ratio on a downward path. Delivering on this commitment would be important to restore fiscal buffers and keep financing costs low. Mexico’s sovereign debt ratings are high, with a stable outlook.

8. Mexico’s external sector position remains strong. The current account deficit is projected to widen to 2¼ percent of GDP in 2015 (from 1.9 percent in 2014), reflecting a reduction in the hydrocarbons trade balance. The non-hydrocarbon trade balance should benefit from the depreciation of the currency going forward. Over the medium term, the current account deficit could increase temporarily due to higher FDI related to the structural reforms, and then improve as oil production and exports pick up. The current account deficit in 2015 is broadly in line with fundamentals and desirable policy settings. The real effective exchange rate is assessed to be temporarily undervalued (by 3–12 percent), reflecting an overshooting of the nominal exchange rate related to heightened volatility of the prices of risky assets. The net international investment liability position is broadly stable at around 33 percent of GDP. Foreign exchange reserves remain adequate according to a range of indicators, although the recent intervention has led to a decline in the level of gross reserves from US$195.7 billion at end-2014 to US$177 billion in October 2015 (Figure 5 and Table 7).

Figure 3.
Figure 3.

Mexico: Qualification Criteria

Citation: IMF Staff Country Reports 2015, 322; 10.5089/9781513503158.002.A001

Sources: Bloomberg L.P.; Datastream; EMED; Haver Analytics; and IMF staff calculations.1/ Combined permanent 1/4 standard deviation shocks applied to interest rate, growth, and 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 balanced budget rule.4/ Combined permanent 1/4 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 4.
Figure 4.

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

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2015, 322; 10.5089/9781513503158.002.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 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2014.
Figure 5.
Figure 5.

Mexico: Reserve Coverage in an International Perspective, 2014 1/

Citation: IMF Staff Country Reports 2015, 322; 10.5089/9781513503158.002.A001

Sources: World Economic Outlook, Balance of Payments Statistics Database, and IMF staff estimates.1/ The assessing reserve adequacy (ARA) metric for emerging markets comprises four components reflecting potential balance of payment drains: (i) export income, (ii) broad money, (iii) short -term debt, and (iv) other liabilities. The weight for each component is based on the 10th percentile of observed outflows from emerging markets during exchange market pressure episodes, distinguishing between fixed and flexible exchange rate regimes.
Figure 5.
Figure 5.

Mexico: Reserve Coverage in an International Perspective, 2014

Citation: IMF Staff Country Reports 2015, 322; 10.5089/9781513503158.002.A001

Sources: World Economic Outlook, and IMF staff estimates.
Table 1.

Mexico: Indicators of Fund Credit

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Sources: IMF Finance Department; Mexican authorities, and Fund staff estimates

End of period. Assumes full drawings under the FCL upon approval of the review. The Mexican authorities have expressed their intention to treat the arrangement as precautionary.

Based on the rate of charge as of October 22, 2015. Includes GRA charges, surcharges under the system currently force and service charges.

Table 2.

Mexico: External Financing Requirements and Sources, 2011–20

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Sources: National authorities and IMF staff estimates.
Table 3.

Mexico: Selected Economic, Financial, and Social Indicators

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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.

CONEVAL uses a multi-dimensional approach to measuring poverty based on a “social deprivation index,” which takes into account the level of income; education; access to health services; to social security; to food; and quality, size, and access to basic services in the dwelling.

Percent of population enrolled in primary school regardless of age as a share of the population of official primary education age.

Contribution to growth. Excludes statistical discrepancy.

2015 based on data available through July 2015.

2015 based on data available through September 2015.

Includes public sector deposits.

Data exclude state and local governments and include state-owned enterprises and public development banks.

Table 4a.

Mexico: Financial Operations of the Public Sector, Authorities’ Presentation 1/

(In percent of GDP, except where noted)

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Sources: Mexican authorities and IMF staff estimates.

Data exclude state and local governments and include state-owned enterprises and public development banks.

From 2015 onwards, in line with the 2015 Income Law, gasoline and diesel excises are classified as non-oil tax revenue.

For 2015, it includes estimated inflows from the oil-price hedge for 107 billion pesos.

Includes pensions and social assistance benefits.

Due to lack of disaggregated data this item includes both financing and capital transfers.

The 2014 amendment to the FRL introduced a cap on the real growth rate of structural current spending. The latter is defined as total expenditure, excluding: (i) interest payments; (ii) non-programable spending; (iii) cost of fuels for electricity generation; (iv) direct physical investment of the federal government; and expenditure by state productive enterprises and their subsidiaries.

The cap on structural current spending real growth was set at 2.0 percent for 2015 and 2016.

Adjusting revenues for the economic and oil-price cycles.

Table 4b.

Mexico: Financial Operations of the Public Sector, GFSM 2001 Presentation 1/

(In percent of GDP, except where noted)

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Sources: Mexico authorities; and Fund staff estimates and projections.

Data exclude state and local governments and include state-owned enterprises and public development banks.

Revenue and expenditure figures differ from official data, because gasoline and diesel subsidies have been classified as expense in this table.

For 2015, it includes estimated inflows from the oil-price hedge for 107 billion pesos, which are treated as revenues arising from an insurance claim.

Interest payments differ from official data due to adjustments to account for changes in valuation and interest rates.

Includes revenue sharing between federal government and state and local governments.

Includes pensions and social assistance benefits.

Includes Adefas and other expenses, as well as the adjustments to the “traditional” balance not classified elsewhere.

This category differs from official data on physical capital spending due to adjustment to account for Pidiregas amortizations included in budget figures.

Adjusting revenue for the economic and oil-price cycles.

Corresponds to the gross stock of PSBR. It is calculated as the net stock of PSBR as published by the authorities, plus adjustments (to reflect additional public sector’s liabilities not included in the headline official figures) plus public sector financial assets.

Corresponds to the net stock of PSBR (i.e., gross stock net of public sector financial assets) as published by the authorities.

The 2014 amendment to the FRL introduced a cap on the real growth rate of structural current spending. excluding: (i) interest payments; (ii) non-programable spending; (iii) cost of fuels for electricity generation; (iv) government; and expenditure by state productive enterprises and their subsidiaries. The latter is defined as total budgetary expenditure, direct physical and financial investment of the federal

The cap on structural current spending real growth was set at 2.0 percent for 2015 and 2016, and equal to potential growth thereafter.

Table 5.

Mexico: Summary Balance of Payments

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

Total exports are defined net of imports by the maquila sector. Correspondingly, total imports do not include maquila sector imports.

Goods procured in ports by carriers.

Oil, oil derivatives, petrochemicals and natural gas.

Table 6.

Mexico: Financial Soundness Indicators 1/

(In percent)

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Sources: Financial Soundness Indicators

End of period, unless otherwise noted.

Data for end-August.

Table 7.

Mexico: Financial Indicators and Measures of External Vulnerabilities

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Sources: Bank of Mexico; National Banking and Securities Commission; National Institute of Statistics and Geography; Secretary of Finance and Public Credit; and IMF staff estimates

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.

The ARA metric was developed by the Strategy and Policy Review Department at the IMF to assess reserve adequacy. Weights to individual components were revised in December 2014 for the whole time series.