Mexico: Assessment of the Impact of the Proposed Flexible Credit Line Arrangement on the Fund’s Finances and Liquidity Position

Mexico continues to grow at a moderate pace. Inflation remains close to the target and medium-term inflation expectations are well anchored. The authorities have taken a number of policy measures to contain the effect of external shocks and remain committed to maintaining prudent policies. Nevertheless, Mexico is susceptible to changes in investor sentiment given its high integration with the global economy.

Abstract

Mexico continues to grow at a moderate pace. Inflation remains close to the target and medium-term inflation expectations are well anchored. The authorities have taken a number of policy measures to contain the effect of external shocks and remain committed to maintaining prudent policies. Nevertheless, Mexico is susceptible to changes in investor sentiment given its high integration with the global economy.

Introduction

1. This note assesses the impact of the proposed Flexible Credit Line (FCL) arrangement for Mexico on the Fund’s finances and liquidity position, in accordance with the policy on FCL arrangements.1 The proposed arrangement would cover a 24-month period and access would be in an amount of SDR 62.389 billion (700 percent of quota). It would succeed the existing FCL arrangement which would be cancelled upon approval of the proposed arrangement. The full amount of access proposed would be available throughout the arrangement period, in one or multiple purchases.2 The authorities intend to treat the arrangement as precautionary.

Background

2. Since the 2008 global economic and financial crisis, Mexico has entered into five FCL arrangements with the Fund on which no drawing has been made. A one-year FCL arrangement equivalent to SDR 31.5 billion was approved on April 17, 2009. This arrangement was succeeded by another FCL arrangement on identical terms approved on March 25, 2010. Subsequently, three two-year FCL arrangements in the amount of SDR 47.292 billion each were approved. The first, approved on January 10, 2011, was cancelled before its expiration upon approval of a successor FCL arrangement on November 30, 2012. The 2012 arrangement was cancelled on November 26, 2014 when the current arrangement was approved. Mexico’s very strong policy framework and fundamentals have helped it weather the sluggish global economic recovery and bouts of stress in global financial markets. In the past couple of years, relatively strong demand from the US to which Mexico’s economy is closely connected and robust private consumption growth underpinned by steady wage growth and rising employment have supported Mexico’s economic recovery. Nevertheless, Mexico has also been exposed at times to shift in global risk aversion, as discussed in the main staff report (See ¶15). No drawing has been made under the existing FCL arrangement as in all Mexico’s previous FCL arrangements. As discussed in Annex I, Mexico has a history of strong performance under earlier Fund arrangements and an exemplary record of meeting its obligations to the Fund.

3. Total external and public debt levels are moderate and are expected to remain stable over the medium run under the baseline. External debt has increased by nearly 12 percentage points of GDP over the period 2010-2015. Nonetheless, it remains moderate and stands at about 36½ percent of GDP as of end-2015, of which nearly 24¾ percent of GDP is accounted for by public external debt. Gross public debt is estimated to have increased from 49½ percent of GDP at end-2014 to 54 percent of GDP at end-2015 and is projected to fall to 52½ percent of GDP over the medium term. The depreciation of the peso is the main reason behind the estimated increase in the public debt-to-GDP in 2015. Debt sustainability analyses suggest that both external and public debt would remain manageable under a range of scenarios.

Table 1.

Mexico: External Debt and Debt Service, 2010-16 1/

article image
Source: Mexican Authorities and IMF Staff Estimates

End of period, unless otherwise indicated.

Assumed potential disbursement under the proposed FCL and related interest are not included.

The New Flexible Credit Line Arrangement—Impact on Fund’s Finances and the Fund’s Liquidity Position

4. The proposed FCL arrangement would be the largest Fund commitment to date and if drawn, it would result in a record high credit exposure in nominal terms. The proposed FCL arrangement is nearly 1.3 times as large as the largest nominal General Resources Account (GRA) arrangement in the Fund’s history, i.e., the existing FCL arrangement for Mexico. If the full amount available under the FCL arrangement were drawn, Mexico’s outstanding use of GRA resources would reach SDR 62.389 billion, almost 2.7 times as large as the Fund’s largest credit exposure to date.3

5. If the full amount available under the proposed FCL arrangement were disbursed, Fund exposure to Mexico would be large as noted above and debt ratios would deteriorate while remaining relatively moderate over the medium term.4

  • Access would be at a record high in Fund’s history in absolute terms but moderate in quota terms. In terms of quotas, it would be significantly below recent euro area exceptional access cases such as Greece, Ireland, and Portugal.

  • Mexico’s external debt would remain moderate, with Fund credit representing a non-trivial share of this debt. Total external debt would rise to about 49 percent of GDP initially, and public external debt would rise to close to 34¾ percent of GDP, with Fund credit representing just over 8 percent of GDP (Table 2). Mexico’s outstanding use of GRA resources would account for almost 16½ percent of total external debt, 23⅓ percent of public external debt, and almost 50⅓ percent of gross international reserves.

  • External debt service would increase over the medium-term, but remain manageable under staff’s medium-term macro projections (Table 2). Mexico’s projected debt service to the Fund would peak in 2020 at about SDR 32.2 billion, or about 3½ percent of GDP.5 In terms of exports of goods and services, debt service to the Fund would peak at about 8¼ percent. Public external debt service would peak at almost 25¼ percent of exports of goods and services and debt service to the Fund would account for about 32½ percent of total public external debt service.6

Table 2.

Mexico—Capacity to Repay Indicators (2015-21) 1/

article image
Sources: Mexican authorities, Finance Department, World Economic Outlook, and IMF staff estimates.

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

Includes surcharges under the system currently in force and service charges.

Staff projections for external debt ratios (to GDP, gross international reserves, and exports of goods and services) adjusted for the impact of the assumed FCL drawing.

6. The immediate net liquidity impact of the proposed arrangement would be to lower the Fund’s forward commitment capacity (FCC) by SDR 38.74 billion (or 14.2 percent of the FCC). The cancellation of the existing arrangement would free up SDR 23.65 billion representing half of that arrangement under the 1:1 quota-to-NAB financing mix, whereas approval of the proposed arrangement would reduce the FCC by the full amount of the arrangement (SDR 62.389 billion), as NAB resources are no longer available to finance new arrangements. Other things equal, the net impact of the proposed FCL would be to reduce the FCC from SDR 272.7 billion to SDR 234.0 billion (Table 3).

Table 3.

Mexico—Impact on GRA Finances

(millions of SDR unless otherwise noted)

article image
Sources: Finance Department and IMF staff estimates.

The FCC is defined as the Fund’s stock of usable resources less undrawn balances under existing arrangements, plus projected repurchases during the coming 12 months, less repayments of borrowing due one year forward, less a prudential balance. The FCC does not include the figure for the 2012 bilateral pledges from members to boost IMF resources. These resources will only be counted towards the FCC once: (i) individual bilateral agreements are effective and (ii) the associated resources are available for use by the IMF, in accordance with the borrowing guidelines and the terms of these agreements.

Current FCC minus new access plus the quota-financed portion of the expiring program (about SDR 23.7 billion or half of total access under the expiring arrangement based on the current 1:1 NAB-to-quota financing mix).

As of April 21, 2016.

Burden-sharing capacity is calculated based on the floor for remuneration at 85 percent of the SDR interest rate. Residual burden-sharing capacity is equal to the total burden-sharing capacity minus the portion being utilized to offset deferred charges.

7. The proposed FCL arrangement with Mexico would have a large impact on the Fund’s financing mechanism:

  • The current Financial Transactions Plan and Resource Mobilization Plan (RMP) would need to be amended to accommodate a new and enlarged FCL arrangement for Mexico.7

  • A single drawing by Mexico for the full amount under the new FCL Arrangement (about SDR 62.4 billion) would be by far the largest single purchase in the Fund’s history and accordingly represent the largest funding requirement from FTP members. Accordingly, all remaining 50 FTP members would be expected to participate.8

8. If the resources available under the FCL arrangement were fully drawn, credit concentration would increase and potential GRA credit exposure to Mexico would be large.

  • Fund credit to Mexico would represent about 130½ percent of total GRA credit outstanding as of April 21, 2016 and just over 56½ percent of GRA credit outstanding after Mexico’s purchase. It would be the single largest Fund exposure. The concentration of Fund credit among the top five users of GRA resources would increase to about 90¾ percent, from 86¾ percent as of April 21, 2016.

  • Relative to the Fund’s current level of precautionary balances, potential GRA exposure to Mexico would be substantial. Fund credit to Mexico would be nearly four times the Fund’s current precautionary balances.

  • Were Mexico to accrue arrears on charges after drawing under the proposed arrangement, the Fund’s burden sharing mechanism would be clearly insufficient. In a low interest rate environment, such as the current one, potential charges for Mexico would substantially exceed the Fund’s limited capacity to absorb charges in arrears through the burden-sharing mechanism.

Assessment

9. The proposed FCL arrangement would have a significant but manageable impact on the Fund’s liquidity position. The current liquidity position appears sufficiently strong to accommodate the proposed arrangement, and the cancellation of Mexico’s existing FCL would partially offset the liquidity effect from the proposed new FCL arrangement. The overall impact of the proposed arrangement is to reduce the FCC by just over 14 percent. However, the persistent uncertainty in the global economy and especially downside risks facing the emerging markets universe could result in an increased demand for Fund resources. Therefore, a close monitoring of the Fund’s liquidity position remains important. The proposed FCL arrangement would also have a large impact on the Fund’s financing mechanism and a single drawing for the full amount would be by far the largest single purchase in the Fund’s history.

10. If drawn, Mexico’s FCL would become the Fund’s largest credit exposure, but risks to the Fund are mitigated by several factors. As has been the case with all its FCL arrangements to date, Mexico intends to treat the proposed FCL arrangement as precautionary. The risks from the Fund’s potential credit exposure to Mexico would be mitigated by Mexico’s adequate buffers and the credibility of its policy framework. Mexico has a sustained track record of implementing very strong policies, including during the global financial crisis, and the authorities are committed to maintaining implementation of such policies in the future. Also, while Mexico’s overall external debt and debt service ratios are expected to deteriorate, they would generally remain in the range of recent exceptional access cases assuming full drawing under the proposed arrangement, though external public debt service relative to exports would be relatively high, reflecting also the large presence of non-residents in the peso debt market. Against this backdrop, Mexico’s capacity to repay is projected to remain strong.

Annex I. History of IMF Arrangements

This annex provides a brief overview of Mexico’s Fund arrangements from 1983 to present.

Prior to the FCL arrangements approved in April 2009, March 2010, January 2011, in November 2012, and in November 2014, Mexico had several Fund arrangements in the 1980s and 1990s. It fully repaid its remaining outstanding credit in 2000 (Table I.1). Mexico has an exemplary track record of meeting its obligations to the Fund.

Annex Table I.1.

Mexico: IMF Financial Arrangements, 1983-2014

(In millions of SDR)

article image
Source: Finance Department.

As of end-December.

Includes a first credit tranche purchase of SDR 291.4 million.

Includes a purchase of SDR 453.5 million under the Compensatory Financing Facility.

From 1983 to 2000, Mexico had two arrangements under the Extended Fund Facility (EFF) and three Stand-By Arrangements (SBAs). Below is a brief description of the two most recent SBAs:

• In February 1995, the Fund approved an SBA equivalent to SDR 12.1 billion (688 percent of quota) to support Mexico’s adjustment program to deal with a major financial and economic crisis. Under that arrangement, Mexico made purchases totaling SDR 8.8 billion, and its outstanding credit peaked at SDR 10.6 billion (607 percent of quota) at end-1995 (Figure I.1). After regaining access to international capital markets in the second half of 1996, Mexico made sizable advance repurchases.

• In July 1999, an SBA equivalent to SDR 3.1 billion was approved as the recovery in economic performance was disrupted by unsettled conditions in international capital markets. Solid performance under the program supported by this SBA allowed Mexico to fully repay all its outstanding obligations to the Fund through a series of advance repurchases before the SBA expired in November 2000.

Since the global financial crisis, Mexico has had five FCL arrangements under which no drawings have been made. A one-year FCL arrangement equivalent to SDR 31.5 billion was approved on April 17, 2009 to support Mexico’s economic policies and bolster confidence during the crisis. A successor FCL arrangement on identical terms was approved on March 25, 2010. This arrangement was cancelled and a new two-year FCL was approved in January 2011 increasing the access to SDR 47.3 billion. On November 30, 2012, a two-year successor FCL arrangement was approved for the same access as the January 2011 FCL. On November 26, 2014, a two-year successor FCL was approved for the same access.

1

See GRA Lending Toolkit and Conditionality—Reform Proposals (3/13/09) and Flexible Credit Line (FCL) Arrangements, Decision No.14283-(09/29), adopted March 24, 2009 as amended by Decision No. 14714-(10/83), adopted August 30, 2010; the Fund’s Mandate—The Future Financing Role: Reform Proposals (http://www.imf.org/external/np/pp/eng/2010/062910.pdf, 6/29/2010) and the IMF’s Mandate—The Future Financing Role: Revised Reform Proposals and Revised Proposed Decisions (http://www.imf.org/external/np/pp/eng/2010/082510.pdf, 8/25/2010); Review of the Flexible Credit Line, the Precautionary and Liquidity Line, and the Rapid Financing Instrument—Specific Proposals (http://www.imf.org/external/np/pp/eng/2014/043014.pdf, 5/1/2014 and Decision No. 15593-(14/46)).

2

If the full amount is not drawn in the first year of the arrangement, subsequent purchases can only be made following completion of a review of Mexico’s continued qualification for the FCL arrangement.

3

The largest GRA credit exposure has been SDR 23.359 billion to Brazil in 2003.

4

As for other precautionary arrangements, the baseline indicators should be interpreted with caution. The economic situation could weaken considerably in circumstances where Mexico chooses to draw under its FCL arrangement, and the indicators would be affected in such a scenario.

5

The figures on debt service used in this report are calculated assuming that full amount available under the arrangement is purchased upon approval of the arrangement, and that all repurchases are made as scheduled.

6

External public debt service is boosted by the large presence of foreign investors in peso debt, and in particular short-term debt.

7

This non-NAB eligible FCL arrangement with potential drawings of up to SDR 62.4 billion would be financed solely with quota resources, compared to the existing (NAB eligible) arrangement of SDR 47.3 billion which is financed equally with quota and NAB resources under the current FTP and RMP plans.

8

If Mexico were to draw under the FCL it would automatically be excluded from the list of members in the FTP bringing the total number of participants to fifty.