INTERNATIONAL MONETARY FUND

Abstract

INTERNATIONAL MONETARY FUND

INTERNATIONAL MONETARY FUND

November 4, 2016

Prepared By

Staff of the International Monetary Fund

Public debt1 is expected to remain sustainable over the medium term, despite a slightly worse growth outlook. Under the baseline scenario, the public debt-to-GDP ratio is projected to decline to 54.3 percent by 2021 from the current level of 56.3 percent. Gross financing needs (projected at around 6 percent of GDP in 2016) are expected to remain contained below 10 percent over the medium term. The DSA also suggests that public debt is sustainable under various negative shocks. Only a drop in real GDP growth shifts the debt trajectory up significantly, but even under such a scenario, gross debt remains contained around 66 percent and begins to decline in 2021. With the exception of the share of debt held by non-residents (49 percent of total debt), public debt profile indicators remain below the upper early warning benchmarks. However, the risk from a high foreign ownership of debt is mitigated by the long maturity of this debt.

Public Debt Sustainability Analysis

A. Comparison with the Previous Assessment

The baseline debt projection is somewhat higher relative to last year’s DSA (2015 Mexico Article IV staff report). Gross public debt is 4.3 percentage points higher in 2016 relative to previous projections (from 52 to 56.3 percent to GDP) and 3.8 percentage points higher by the end of the projection period. The main factors explaining the higher debt path are:

  • Higher initial level of debt. While the previous DSA projected a debt to GDP ratio of 51.9 percent of GDP in 2015, the actual outcome was 54.1 percent of GDP. This was mainly due to the greater-than-anticipated peso depreciation and a 0.3 percent of GDP in PEMEX’s pension liability assumption by the federal government.

  • The government has assumed portions of PEMEX and CFE pension liabilities in 2016. These operations are estimated to add about 1.6 percentage points of GDP to the total stock of debt, in addition to the 0.3 percent of GDP assumed in 2015.

  • Lower growth over the medium term. The real GDP growth path is lower compared to last year’s projection over the entire projection period.

B. Baseline and Realism of Projections

  • Debt levels. Under the planned fiscal consolidation, gross debt levels are projected to decline from a peak of 56.4 percent of GDP in 2017 to 54.3 percent of GDP by 2021 (Figures 3 and 4). Gross financing needs over the medium-term are projected to average around 8 percent of GDP.

    Figure 3.
    Figure 3.

    Mexico Public Sector Debt Sustainability Analysis (DSA) - Baseline Scenario

    (in percent of GDP unless otherwise indicated)

    Citation: IMF Staff Country Reports 2016, 359; 10.5089/9781475556025.002.A004

    Source: IMF staff.1/ Public sector is defined as the central government, state-owned enterprises, public sector development banks, and social security funds.2/ Based on available data.3/ Defined as interest payments divided by debt stock at the end of previous year.4/ Derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).5/ The real interest rate contribution is derived from the denominator in footnote 4 as r - π (1+g) and the real growth contribution as -g.6/ The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1 + r).7/ For projections, this line includes exchange rate changes during the projection period.8/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
    Figure 4.
    Figure 4.

    Mexico: Public DSA - Composition of Public Debt and Alternative Scenarios

    Citation: IMF Staff Country Reports 2016, 359; 10.5089/9781475556025.002.A004

    Source: IMF staff.

  • Fiscal adjustment. The structural primary balance (adjusted by the cycle and oil prices) improves between 2016 and 2021 in the baseline projection. On the revenue side, the decline in one-offs observed in 2016 from the Bank of Mexico transfer and the hedging income would lead to lower revenues in 2017, which would then stabilize at a similar level over the medium term. On the spending side, projections assume compliance with the consolidation plan spelled out in the 2017 budget documents, which envisaged reducing the public sector borrowing requirement (PSBR) from 3 percent of GDP in 2016 to 2.5 percent of GDP in 2018. To this end, the plan encompasses compression of capital and current spending. Compared to the distribution of fiscal adjustment episodes provided in the DSA template (Figure 2), the projected 3-year adjustment of the cyclically-adjusted primary balance of around 1.5 percent of GDP seems feasible.

    Figure 2.
    Figure 2.

    Mexico Public DSA - Realism of Baseline Assumptions

    Citation: IMF Staff Country Reports 2016, 359; 10.5089/9781475556025.002.A004

    Source : IMF Staff.1/ Plotted distribution includes all countries, percentile rank refers to all countries.2/ Projections made in the spring WEO vintage of the preceding year.3/ Mexico has had a cumulative increase in private sector credit of 4 percent of GDP, 2012-2015. For Mexico, t corresponds to 2016; for the distribution, t corresponds to the first year of the crisis.3/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.

  • Growth. Past projections of growth outcomes suggest moderate forecast errors, with the median forecast error in line with other emerging markets. Hence, even though Mexico’s debt dynamics continue to be highly sensitive to surprises in GDP growth, there seems to be no evidence of a systematic projection bias in the baseline assumption for growth that could undermine the DSA assessment. The current output growth projection of 2.2 percent for 2017 is within the authorities’ projected growth rate range of 2-3 percent for 2017. Medium-term growth is expected to pick up gradually as the effects from structural reforms take hold, stabilizing at 2.7 percent of GDP in the second half of the projection horizon. The boom-bust analysis is triggered (Figure 2) because the three-year cumulative change in the credit-to-GDP ratio exceeds 15 percent in Mexico. This is due to the strong growth in private sector credit, which is driven by financial reform measures and broadly consistent with trend financial deepening.

  • Sovereign yields. Despite the volatility observed in most emerging markets in recent months, Mexico’s sovereign yields remain low, with the 10-year local-currency bond yield remaining stable and reaching 6.1 percent as of mid-October. The spread with U.S. government bonds yields of the same maturity has remained on average at 436 basis points for the last three months, while spreads on foreign-currency denominated bonds have averaged 287 basis points over the same period. Taking into account the upward projections for the medium-term U.S. Libor rates, the effective nominal interest rate on Mexico’s sovereign debt is projected to rise from 6 percent in 2015 to 7.1 percent by 2021.

C. Debt profile

D. Stochastic Simulations

  • Fan charts. The fan charts illustrate the possible evolution of the debt ratio over the medium term and are based on both the symmetric and asymmetric distributions of risk (Figure 1). Under the symmetric distribution of risk, there is a 75 percent probability that debt will be below 60 percent of GDP over the medium term. If restrictions are imposed on the primary balance (i.e., the asymmetric scenario, where it is assumed that there are no positive shocks to the primary balance), there is still 50 percent chance that the debt path will remain below 60 percent of GDP over the projection horizon.

    Figure 1.
    Figure 1.

    Mexico Public DSA Risk Assessment

    Citation: IMF Staff Country Reports 2016, 359; 10.5089/9781475556025.002.A004

    Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ An average over the last 3 months, 13-Jul-16 through 11-Oct-16.

E. Stress Tests

  • Real GDP growth shock. The debt ratio would remain below 60 percent of GDP under all scenarios except the growth shock where it peaks at 62.6 percent of GDP in 2018 before reaching 60.9 percent by the end of the projection period. This scenario also results in a drastic increase in public gross financing needs in the period 2017-2019, in excess of 10 percent.

  • Real exchange rate shock.3 A permanent real exchange rate depreciation of 15 percent increases debt by around 2 percentage points of GDP. As a result, gross financing needs increase by an average 0.2 percentage points of GDP.

  • Combined shock. A combined shock incorporates the largest effect of individual shocks on all relevant variables (real GDP growth, inflation, primary balance, exchange rate and interest rate). Under this scenario, debt would stabilize at around 66 percent of GDP, without showing an explosive trajectory. Gross financing needs would peak at around 12 percent of GDP in 2019, before stabilizing at around 11 percent by the end of the period.

F. Authorities’ Views

  • The authorities recognize the risks posed by the rising debt burden and are committed to putting public debt on a declining trajectory over the medium term. They agreed that it is critical to adhere to the fiscal consolidation plan, maintain strong debt management practices, and to continue undertaking structural reforms to boost growth.

External Debt Sustainability Analysis

Mexico’s external-debt-to GDP ratio continues to be low and sustainable (expected at 42 percent projected for end-2016), and is expected to remain stable over the medium term.

Most shock scenarios would increase external debt by just a few percentage points. The largest increase would occur under a depreciation scenario. However, even in the unlikely event of a further 30 percent real exchange rate depreciation, the debt-to-GDP ratio would increase to 58 percent, which would still be manageable. The reason for this contained increase is that 42 percent of Mexico’s public external debt is denominated in pesos (this is less than before the recent depreciation, though, when the ratio stood at around half). Debt dynamics also benefit from the low interest rates and long maturities of the existing debt.

Figure 8.
Figure 8.

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

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2016, 359; 10.5089/9781475556025.002.A004

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 2016.
Table 1:

Mexico: External Debt Sustainability Framework

(In percent of GDP, unless otherwise indicated)

article image
1/

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

2/

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

3/

For projection, line includes the impact of price and exchange rate changes.

4/

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period, excluding reserve accumulation.

5/

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

6/

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Statement by the IMF Staff Representative on November 16, 2016

1. This supplement provides an update on economic and market developments since the issuance of the staff report on November 4, 2016. It does not change the thrust of the staff appraisal.

2. There have been some movements in Mexico’s financial markets in recent days.

The Mexican peso depreciated by about 14 percent between November 8 and November 11, following the U.S. election. Over the same period, the 10-year local currency sovereign bond yield increased by about 100 basis points, compared to a 30 basis point increase in the U.S. 10-year bond yield, and the stock market declined 7.5 percent in local currency terms. On November 9, the authorities held a press conference emphasizing that Mexico’s fundamentals remained strong, underpinned by the structural reforms underway, sound fiscal management, and the credible inflation targeting framework, supported by exchange rate flexibility. They added that net international reserves remained adequate and in addition the country was eligible to draw up to US$86 billion under the Flexible Credit Line. No policy actions were required, although they would continue to monitor the situation closely.

3. The state-owned oil company PEMEX released a five-year business plan in early November. The plan envisages the company will return to a primary surplus in 2017 and will have a balanced budget by 2020. In the short term, the focus will be on improving efficiency and profitability by focusing investment on high-return activities. In the medium term, PEMEX will rely increasingly on partnerships with the private sector to increase investment and production, and improve the efficiency of operations in certain business areas. The company has already announced three auctions for joint oil exploration and production, to be completed by April 2017. PEMEX has also pursued an active debt management strategy in recent months, extending its average debt maturity.

1

Public debt reported in this annex excludes state and local governments, but includes central government, social security, state-owned enterprises and public development banks. As of June 2016, the stock of subnational debt was reported at around 530 billion pesos, or about 2.7 percent of GDP, and therefore does not pose a systemic risk to debt sustainability.

2

Average maturity is about 8 years, more than 80 percent of government securities have been issued at fixed interest rates, and around 25 percent of debt is denominated in foreign currency.

3

This shock uses a pass-through elasticity of 7 percent (staff estimate) rather than the default value of 25 percent.

Mexico: 2016 Article IV Consultation-Press Release; Staff Report; and Informational Annex
Author: International Monetary Fund. Western Hemisphere Dept.
  • View in gallery

    Mexico Public Sector Debt Sustainability Analysis (DSA) - Baseline Scenario

    (in percent of GDP unless otherwise indicated)

  • View in gallery

    Mexico: Public DSA - Composition of Public Debt and Alternative Scenarios

  • View in gallery

    Mexico Public DSA - Realism of Baseline Assumptions

  • View in gallery

    Mexico: Public DSA - Stress Tests

  • View in gallery

    Mexico Public DSA Risk Assessment

  • View in gallery

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

    (External debt in percent of GDP)