Mexico: 2019 Article IV Consultation—press Release and Staff Report

2019 Article IV Consultation-Press Release and Staff Report

Abstract

2019 Article IV Consultation-Press Release and Staff Report

A Domestic Political Shift in an Unsettled External Environment

1. The authorities are committed to very strong macroeconomic policies and policy frameworks. President Lopez Obrador took office in December 2018. He has since repeatedly pledged his government’s commitment to fiscal prudence and an independent central bank. Monetary policy has succeeded in returning inflation to target, and financial sector supervision and regulation remain robust. The flexible exchange rate is playing a key role in helping the economy adjust to external shocks, while Mexico’s external position remains broadly consistent with medium-term fundamentals and desirable policy settings.

2. But policy uncertainty has weakened the investment climate. Uncertainty has arisen in the context of decisions on the part of the administration that appeared to weaken policy predictability. These included the cancelation of energy auctions, the renegotiation of pipeline contracts, and a controversial public consultation that led the administration to cancel the construction of a new airport in Mexico City that had already been partially built. Meanwhile, concerns have arisen about the sustainability of drastic budget cuts and their potential impact on human capital and the role of some regulatory agencies and autonomous institutions. The resignation of the former Finance Minister and his reported criticism of some of the administration’s decisions reinforced uncertainty.

3. New policy priorities have created fiscal challenges. Large-scale investment projects and social transfers—and a commitment to not raise taxes until after 2021—have yet to be reconciled with the announced fiscal targets and the authorities’ objective of stabilizing public debt. A state-centered energy policy constrains the role of the private sector and puts the onus of stabilizing Pemex squarely on the government. Meanwhile, the structural reform agenda has mostly stalled.

4. An unsettled external environment further complicates policymaking. Although Mexico has ratified the new trilateral trade agreement (USMCA), Canada and the U.S. have yet to do so. Moreover, tensions between Mexico and the U.S. heightened in May, when the U.S. threatened to impose tariffs of up to 25 percent on all goods imports from Mexico, which was avoided only after a commitment by Mexico to curb migration to the U.S. The tariffs have been shelved for now, but the threat remains.

Recent Developments

5. The Mexican economy has slowed sharply. Growth came to a stand-still in 2019:H1 amid weak domestic demand—owing to policy uncertainty, tight monetary conditions and budget under-execution—as well as slowing global manufacturing activity (Box 1).1 Net exports supported economic activity, though largely due to a compression in imports. The long-awaited investment recovery has been held back by elevated uncertainty, while consumption, which had been the main engine of growth thus far, has started to show signs of weakness. The unemployment rate has edged up to 3.7 percent as real wage growth turned positive (Figure 2).

Figure 1.
Figure 1.

Mexico: Real Sector

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: National Authorities, Haver Analytics; and, IMF Staff estimates.
Figure 2.
Figure 2.

Mexico: Labor Market Indicators

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: National Authorities, Haver Analytics; and, IMF Staff estimates.

6. The current account improved as weak activity weighed on imports. In 2019:H1, import growth, notably of capital goods, declined significantly amid weak domestic demand, while exports held up relatively well, owing partly to trade diversion in the context of trade tensions between the U.S. and China (Box 3). The current account was also supported by strong remittances. Following a solid performance in 2019:Q1, portfolio and FDI inflows have slowed in the second quarter.

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Contributions to Growth

(Q/Q percent annualized growth, SAAR)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

7. Headline inflation has continued to fall, prompting a monetary policy easing. A very tight monetary policy stance amid a sizeable and widening negative output gap has helped bring headline inflation to Banxico’s 3 percent target. The decline from around 5 percent a year ago was driven by non-core inflation, particularly energy prices. However, core inflation remains stubbornly high at 3.8 percent—reinforced by strengthening real wage growth and, until recently, buoyant consumption—but weak activity and increasing slack should soften it going forward. Against this backdrop, and given U.S. policy easing, Banxico reduced the policy rate in two 25-basis-point steps in August and September to 7.75 percent. Meanwhile, it refrained from any FX intervention and allowed the peso to adjust freely to shocks.

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Monetary Policy rates and inflation

(In percent)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Source: Banco de Mexico, INEGI, and Federal Reserve Board.

8. Asset prices have reflected the increased uncertainty. The peso was relatively resilient in 2019 and strengthened relative to regional peers, due in part to its high carry. However, sovereign spreads widened against similarly rated issuers as some market participants expected ratings downgrades for both Pemex (Box 2) and the sovereign, while equities dropped in the context of increased policy uncertainty and weakening economic growth. Fitch downgraded Mexico’s BBB+ rating to BBB with a stable outlook in June and reduced Pemex’s rating in two steps from BBB+ to non-investment grade (BB+). S&P and Moody’s revised their outlook to negative in March and June, respectively.

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Mexico sovereign USD spread vs average of selected BBB EM issuers

(basis points)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: IMF staff estimates and Bloomberg.

9. The financial sector remains profitable and well capitalized. As of June, the sector’s Tier-1 capital ratio stood at 14.2 percent and the return on equity at 20.9 percent, driven by near record high net interest margins, while the NPL ratio remained at a near record low of 2.1 percent. Over the past year, commercial bank credit growth to the non-financial corporate sector has slowed from over 11 percent y-o-y to 9 percent in August, while consumer credit growth has remained stable at 7.2 percent y-o-y.

10. The structural reform agenda has mostly stalled. The authorities passed labor reforms to strengthen worker rights and labor unions and establish an independent labor dispute resolution mechanism. In the financial sector, they have taken several legislative initiatives to strengthen financial deepening and inclusion. However, promises to tackle some of Mexico’s salient structural challenges—namely, corruption, informality and crime—have yet to be followed by significant policy action. Prospects for increased private investment in the energy sector have weakened as the authorities halted oil and gas auctions and plans for further Pemex farm-outs.

Outlook and Risks

11. Uncertainty will weigh on the near-term outlook. Staff’s baseline scenario is predicated on the assumption that uncertainty will subside gradually in the context of an improving investment climate and the anticipated ratification of the USMCA by all signatories by next year. Furthermore, the scenario assumes that Banxico will continue easing monetary policy as domestic and external risks dissipate, and core inflation converges to the 3 percent headline inflation target, reaching a neutral policy stance by 2021.

12. Budget execution is expected to accelerate, and the fiscal stance to turn expansionary. A budget under-execution during the first half of the year prompted measures announced in July that would accelerate spending within budgetary limits and boost SME and consumer lending by development banks and other public institutions. While staff assumes expenditure to accelerate in line with these plans, revenues would continue to disappoint as growth remains weak. The Public Sector Borrowing Requirement (PSBR) would reach 2.8 percent of GDP in 2019—compared to the 2.5 percent target—which would imply a notable fiscal expansion (from a PSBR of 2.2 percent of GDP in 2018).2 The composition of spending is expected to shift away from goods and services and transfers to states toward social spending and Pemex investment. The authorities project a PSBR of 2.7 percent of GDP, with the deviation from the target explained by lower-than-budgeted revenues on account of slowing economic growth and lower-than-expected oil production.

Mexico: Key Macroeconomic Indicators, 2016–2024

(Percent of GDP, unless otherwise indicated)

article image
Sources: Bank of Mexico, Ministry of Finance and Public Credit, and Fund staff estimates.

13. Monetary and financial conditions are also expected to ease but will remain tight. With the ex-ante real rate just below 5 percent in staff’s projection as of October—and thus still notably above staff’s and Banxico’s estimates of the neutral rate of 2.0–2.5 and 1.8–3.4 percent—policy remains very tight and is expected to loosen only gradually. Credit growth would edge down slightly, including due to continued policy uncertainty and weak growth prospects. Financial sector profitability could come under pressure given the slowing economy and the projected easing of financial conditions but should remain high. Policy uncertainty, trade risks and concerns about Pemex could also weigh on credit spreads, while still-high interest rates could impact repayment capacity.

14. Economic activity is projected to benefit from less contractionary macroeconomic policies going forward and should recover as uncertainty subsides. Growth is projected to reach 0.4 percent in 2019, with an acceleration in public spending supporting a modest growth pick-up during 2019:H2. It would reach 1.3 percent in 2020 as monetary conditions ease further, uncertainty gradually subsides, and private consumption recovers. Staff has revised medium-term growth down to 2.4 percent, in part reflecting several years of sub-par investment and the stalling of structural reforms, particularly in the energy sector. Headline inflation is expected to remain around Banxico’s 3-percent target, while core inflation should reach the headline inflation target by mid-2020. The authorities held a somewhat more upbeat view on the short-term outlook, projecting growth in 2020 to accelerate to around 2 percent, including driven by strengthening private consumption, increasing oil production and development bank lending. There was broad agreement on the medium-term outlook.

15. There was agreement that the external position remains broadly in line with medium-term fundamentals and desirable policy settings. Following a temporary narrowing in 2019, staff projects the current account deficit to widen slightly over the medium term, and, at these levels, it is broadly in line with medium-term fundamentals and desirable policy settings (Annex II). At end-September, the peso was 2 percent stronger in real effective terms relative to its 2018 average. In staff’s assessment, the peso is currently broadly in line with the level suggested by fundamentals. The net international investment position would improve modestly to below 46 percent of GDP over the medium term. Foreign exchange reserves are adequate, while the FCL provides an effective complement.

16. The balance of risks is tilted to the downside (Annex I). External risks that could weaken Mexico’s growth outlook include a fall in global growth originating, for example, from a U.S. slowdown. At the same time, uncertainty about Mexico’s trade relationship with the U.S. persists as the USMCA has yet to be ratified by Mexico’s trade partners, while the U.S. tariff threat related to migration issues remains. Mexico is also exposed to the risk of financial market volatility, increased risk premia, and a sharp pull-back of capital from emerging markets. On the domestic front, medium-term growth could be lower, and investors could reconsider Mexico’s credit quality, should the administration weaken its commitment to fiscal prudence, strong institutions and a favorable business environment. A Pemex downgrade to non-investment grade by a second major rating agency would lead to selling pressure, while lower oil revenues could make it harder to achieve the fiscal targets. On the other hand, concrete steps to enhance good governance and the rule of law, and advance productivity-enhancing structural reforms, constitute upside risks. The authorities highlighted continued uncertainty about trade relations with the U.S. and volatility in global financial markets as key risks. They agreed with staff that uncertainty generated by rising global trade tensions remains a significant risk for the Mexican economy, although trade diversion effects may mitigate part of the adverse impact. Finally, they considered that a USMCA ratification would reduce uncertainty, boost FDI and strengthen the domestic investment climate.

Strengthening Inclusive Growth While Ensuring Strong Macroeconomic Policies

A. Fiscal Policy: Raising Non-Oil Tax Revenues and Improving Spending Efficiency with a More Growth-Friendly and Inclusive Policy Mix

17. Staff welcomed the commitment to fiscal prudence but emphasized that medium-term targets need to be more ambitious to put public debt on a downward path. The authorities’ deficit target of 2.6 percent of GDP for 2020 appropriately balances fiscal prudence with the need to avoid a contractionary policy stance in the context of a large negative output gap. While the overall macro policy mix will likely not be accommodative—as monetary policy is expected to ease only gradually from a very tight stance—preserving a prudent fiscal stance as an anchor of stability remains important. The authorities’ medium-term fiscal projections target a PSBR of 2.2–2.4 percent of GDP, which would keep debt broadly stable at around 55 percent of GDP over the medium-term. While a broadly stable debt path would help preserve policy credibility, staff recommended more ambitious fiscal targets over the medium term—as the output gap closes—with deficits low enough to rebuild buffers against shocks and put debt on a declining path, while accommodating higher levels of social, investment and aging-related spending. The authorities noted that their projections— assuming higher nominal growth—do see the debt ratio decline over the medium-term.

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PSBR and Gross Public Debt Projections

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Source: SHCP and Staff Calculations

18. Staff urged the authorities to specify additional measures to underpin their fiscal targets. Staff projects a fiscal gap of about 0.5 percent of GDP in 2020, and up to 1.5 percent of GDP thereafter. Compared to the authorities’ projections, gaps arise from less optimistic assumptions for nominal growth, oil production and revenue administration gains as well as doubts about the feasibility of sharp cuts to goods and services spending. Staff also voiced concern about the low level of non-Pemex capital spending, which would additionally be crowded out by large priority projects (e.g., the Maya train and the Trans-Isthmus railway). In an adverse scenario in which the fiscal gap persists, staff projects debt to increase to 63 percent of GDP by 2024 (Annex III). The authorities were confident that they would not exceed their deficit targets. They highlighted that they would continue to prioritize a non-increasing net debt-to-GDP ratio in line with the existing fiscal framework, and that they stood ready to cut spending—including capital expenditure—or take revenue-enhancing measures in the event of shortfalls.

19. Staff recommended reformulating Pemex’s business plan, with a view to strengthening the company and reducing risks to the budget. The plan limits cooperation with private firms in Pemex’s upstream business to service contracts, envisages investing heavily in its loss-making downstream business, does not lay a focus on selling non-core assets, and lacks credible measures to reduce operating costs. The mission recommended reconsidering these decisions as they place the onus of stabilizing Pemex squarely on the government (Box 2). The authorities were confident that Pemex’s business plan would deliver the projected increases in oil production, reserves and refining capacity, and do not see a reason to reconsider it at this stage.3

20. The authorities agreed with staff that there was a need to boost tax revenues and increase the progressivity of the tax system. Mexico stands out compared to peers with only 13 percent of GDP in tax revenues. The authorities are envisaging a reform that would deliver at least 2 percent of GDP in additional tax revenues. It would center on rationalizing inefficient and regressive income tax expenditures, broadening the income tax and VAT bases, and widening the top personal income tax bracket. They would start preparatory work shortly and seek advice from the Fund. The reform would be effective in 2022. Staff recommended an earlier implementation date to help underpin the 2021 fiscal target.

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Total Tax Revenue

(As percent of GDP, 2018)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: IMF World Economic Outlook1/ OECD unweighted average excluding Austria, Japan, Lithuania, United Kingdom, and United States.2/ LAC unweighted average including Argentina, Brazil, Colombia, Peru, and Uruguay.
  • a. VAT. Staff welcomed proposals to collect VAT from digital service providers that was previously forgone. Steps to broaden the narrow VAT base could usefully include taxing (non-export related) zero-rated goods at the standard 16 percent rate, which could boost revenues by around 1 percent of GDP, while targeted benefits would need to offset the impact on the poor.

  • b. CIT and PIT. Tax expenditures for CIT and PIT accounted for 1.5 percent of GDP in 2018. The authorities consider that at least 0.7 percent of GDP of these are inefficient or regressive. There was agreement that these could be rationalized while the threshold for the top PIT bracket should be lowered.

  • c. Gasoline excise tax. The current formula guarantees cumulative retail fuel price growth below CPI inflation since November 30, 2018. Staff noted that this policy disproportionately benefits the rich and should be revoked, which could provide some 0.2 percent of GDP in additional revenues relative to the projection for 2019. The authorities did not agree that the formula should be revoked and considered that it provides stability to energy prices and does not constitute a risk to public finances.

  • d. Subnational taxes. Staff recommended raising additional revenues from property taxes which currently collect 1.5 percent of GDP less than the average Latin American country. A reform could be facilitated by creating an agency at the federal level to update the cadaster, as well as by policy coordination at the subnational level. Along with a redesigned vehicle registration tax, it would allow for a reduction in transfers to states and municipalities. The authorities agreed that there was justification for subnational taxes, although they saw implementation challenges for property taxation.

  • e. Border tax regime. Staff advised to cancel the VAT and CIT tax reductions at the border, which create distortions and erode the tax base (foregone revenues of about 0.2 percent of GDP). The authorities highlighted that the border tax regime is a temporary special tax regime for 2019–20 and were of the view that it is instrumental in providing employment and economic opportunities in the border region.

  • f. Revenue administration. Staff welcomed the abolition of the right to offset excess tax credits against other taxes—which should reduce fraud once the backlog of grandfathered claims clears—and other initiatives including strengthening sanctions against tax fraud.4 Staff highlighted that Mexico already has an adequate toolkit to combat tax evasion and recommended adopting a comprehensive strategy to tackle non-compliance in line with IMF technical assistance, while moving towards a high-coverage audit process for VAT returns. The authorities agreed that such measures could strengthen tax collections and will seek advice from the Fund on tax and customs administration.

Tax Expenditures

(Percent GDP)

article image
Source: SHCP
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Bottom and Top Personal Income Tax Brackets

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

21. Enhancing expenditure efficiency can help shift spending toward a more growth-friendly and inclusive mix. While efficiency gains are needed, the proper functioning of public services should be a priority, while the redistributive role of fiscal policy needs to be strengthened. Moreover, public investment should be increased from current low levels. Staff analysis underscores this point by highlighting the crucial role for basic infrastructure investment in boosting firm productivity, including for the large number of Mexico’s micro firms (Selected Issues Paper 1).5

  • a. Social protection spending. Efficiency gains could be achieved by improving targeting and rationalizing the numerous social protection programs—about 8,000 at the federal, state and municipal levels. Staff analysis (Selected Issues Paper 2) also notes the need to reduce errors of inclusion and exclusion, beneficiary overlaps, and program overlaps.

  • b. Wage bill. Stricter standards and more transparency in the use of temporary personnel, along with the consistent application of merit-based recruitment and the establishment of a centralized payroll system would contain the wage bill. However, maintaining pay competitiveness will be important to ensure staff quality and mitigate corruption incentives.

  • c. Education spending. Careful payroll audits to identify ghost workers and curb absenteeism, along with a rebalancing of spending towards investment in equipment and facilities, would help increase education spending efficiency. Improving the quality of early-childhood education, and access to education in low-coverage regions and for disadvantaged children, would strengthen education outcomes (Selected Issues Paper 2).

  • d. Pension system. Staff welcomed the reduction in management fees for pension funds and recommended further improving pension adequacy by increasing the contribution rate for the defined-contribution system.6 An increase in the effective retirement age and consolidating federal and local non-contributory pension pillars could also be considered.

  • e. Health sector. Investment should target rural and impoverished areas with deficient access to services. There is also room for reducing administrative and insurance costs. Improving the portability of insurance and building an information infrastructure compatible across subsystems would improve continuity of care, health outcomes, and reduce beneficiary duplication.

  • f. Public procurement. Making further progress on centralizing procurement and adopting a digital platform could yield savings, while reducing the risks of corruption and bid rigging.

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Gini Before and After Taxes

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Source: OECD

22. The authorities agreed that there was scope for efficiency gains. They emphasized the administration’s spending efficiency improvements to date. They also underscored the importance of raising public investment, better targeting social benefits to those most in need, and reforming the pension system.

23. There was also agreement that the fiscal framework should be strengthened. The authorities plan to propose a revamp of the fiscal framework as part of the 2021 budget following a broad consultation with stakeholders. Staff and the authorities broadly agreed that: (i) the framework could benefit from a well-calibrated debt anchor, (ii) the structural spending rule should cover a broader expenditure envelope, (iii) the framework lacks a well-defined adjustment path to return to target after a shock, (iv) triggers for the use of escape clauses should be tightened, and (v) a non-partisan, adequately-sourced fiscal council should be created with a formal mandate to provide an independent evaluation of fiscal policy (Annex IV). Staff also recommended putting in place a modern medium-term budget framework and reiterated the recommendations of the 2018 Fiscal Transparency Evaluation.

B. Monetary and Exchange Rate Policies: Supporting the Economy While Ensuring Stability

24. Staff noted that there is scope to continue easing monetary policy. With policy still very tight despite a large negative output gap, staff advocated continuing to lower the policy rate so long as inflation remains close to the target and inflation expectations are anchored. The authorities agreed that there could be scope for further easing but hold the view that caution in policy decisions is required since domestic and external risks remain elevated. They also highlighted that sticky core inflation above the target remained a concern.

25. Staff commended Banxico for recent improvements in its communication. It encouraged the bank to keep communication concise, while limiting the focus on exchange rate movements and U.S. monetary policy decisions only to the extent that these have an important bearing on the inflation trajectory. Staff also noted that strong forward guidance can strengthen the efficiency of monetary policy transmission. The authorities agreed that recent steps to strengthen communication had been an important improvement and noted that Mexico’s complex risk environment limited their ability to engage in forward guidance.

26. There was agreement that exchange rate flexibility should remain the key shock absorber. Staff and the authorities agreed that exchange rate flexibility is indispensable in restoring equilibrium in response to permanent shocks, and intervention should be limited to incidences of disorderly market conditions. In this context, staff highlighted the important role the flexible exchange rate has played by inducing a gradual strengthening of the non-oil balance to offset Mexico’s shift from net oil exporter to net oil importer (Box 3). The authorities agreed that the flexible exchange rate has served Mexico well. There was also agreement that foreign currency reserves were adequate at the current juncture, with the FCL providing an important buffer.

C. Macro-Financial Policies: Ensuring Stability While Fostering Growth and Inclusion

27. The financial sector remains resilient to various shocks, but close monitoring remains crucial. The authorities’ stress tests confirmed that, even under adverse scenarios (e.g., tariff hikes, rating downgrades) most banks—except for a few very small ones—will remain above the regulatory minimum capital ratios. Staff’s stress tests of the largest corporates suggest that debt-at-risk would remain manageable even under severe exchange rate and earnings shocks (Annex VI). Nevertheless, the banking system remains subject to concentration risk given that most banks are exposed to a handful of large corporates. The authorities noted that the financial sector’s capital buffers would shield it from shocks and that they are closely monitoring concentration risks, especially in the case of Pemex and CFE.

28. Financial sector resilience could be boosted by closing regulatory and supervisory gaps. In line with the 2016 FSAP recommendations, staff advocated: (i) increasing operational independence, budget autonomy, and legal protection of the banking and securities supervisor; (ii) integrating prudential supervision under one authority for all financial institutions: (iii) in the area of bank exposures, enhancing the definition of “common risk” and “related party”; and (iv) expanding the resolution regime to cover financial holding companies and strengthening the authorities’ powers in banking resolution. The authorities noted that the current governance structure has worked well and did not see the need to merge regulators. They noted that they are evaluating the revision of the supervisory regime for financial holding companies and are discussing a draft regulation that will implement Basel standards on large exposures.

29. Staff emphasized that a multi-pronged strategy to boost financial deepening and inclusion should be a policy priority. The authorities have announced a diverse set of measures to boost deepening and inclusion.7 There was agreement that financially vulnerable groups should be prioritized, particularly women and the rural population.

  • a. Improving financial infrastructure. Staff argued in favor of improving credit reporting systems to facilitate the development of value-added services and pushing ahead with earlier plans to improve the movable collateral registry and install specialized bankruptcy courts. The authorities agreed that there is scope for improvements in credit reporting systems and that it will be beneficial for the retail payments market to have alternatives to the existing payment schemes, especially in the context of cash usage reduction efforts. They also noted upcoming fintech regulation for Open Banking that will promote information sharing among financial institutions and initiatives to improve the banking infrastructure in far flung areas through Banco del Bienestar.

  • b. Boosting competition and transparency in financial products. Staff commended Banxico on initiatives to enhance client mobility in payroll loans and recommended such initiatives for additional products to boost competition. The authorities agreed on the need for further actions to improve competition and cited complementary initiatives by CONDUSEF and Banco de Mexico that would improve transparency by assisting clients in comparing the cost of financial products.

  • c. Reducing the use of cash. Promoting a wide use of the payment platform CoDi should boost the use of bank accounts and competition with other electronic payment methods, and lower fees. Staff noted that it would be advisable to migrate all government programs to electronic payments. The authorities agreed that a reduced reliance on cash is a priority and were optimistic regarding the positive externalities from the adoption of CoDi.

  • d. Balancing competing priorities for Fintech. Staff stressed that secondary regulation for Fintech should balance the priorities of promoting competition and improving financial inclusion while strengthening financial stability and consumer protection. The authorities noted that these are the main principles in the Fintech law, which are the basis for developing secondary regulation. Moreover, they agreed on the need to monitor Fintech related risks.

  • e. Focusing development banks on underserved sectors. Staff argued that lending to sectors that are served by commercial banks would commit scarce resources and would risk crowding out. Staff advised against setting quantitative targets and instead supported the targeting of financial inclusion metrics. In addition, the board composition and selection of CEOs of development banks should be aligned with international best practices. The authorities noted that financial inclusion metrics are already taken into consideration and highlighted measures taken to consolidate development banks.

D. Macro-Structural Policies: Reinvigorating the Reform Agenda to Lift Growth and Make It More Inclusive

30. Staff stressed the need to foster strong, sustainable and inclusive growth by reinvigorating productivity-enhancing reforms. Despite important transformations of the Mexican economy, growth has continued to disappoint, and the medium-term outlook has weakened. Growth has also been insufficient to narrow the income gap with the U.S. and other advanced economies. Poverty and inequality have improved only modestly and have failed to do so in Mexico’s South, which is increasingly trailing other regions along a broad set of socioeconomic indicators (Box 5). Reinvigorating productivity-enhancing reforms would be central in this context.

31. The administration’s strong mandate would allow prioritizing politically difficult reforms. Staff’s analytical work underpinning the 2017 and 2018 Article IV consultations showed that corruption, labor informality and crime are key drivers of Mexico’s disappointing productivity growth. Staff and the authorities agreed that priority should be given to addressing these key challenges.

  • a. Combating corruption and money laundering. With most of the elements of the National Anticorruption System (NACS) now in place and the 2018 Fund-led AML/CFT assessment at hand (Box 6), the authorities should focus on effective implementation, prevention and enforcement. To this end, the authorities should support interagency cooperation8 and strengthen accountability through mutual performance agreements and public sharing of performance results. The authorities should also ensure that sufficient funding is available to train, retain and protect the staff in the relevant agencies. Meanwhile, pending legislation to address recommendations from the recent AML/CFT assessment should be enacted in a timely manner. In addition, the authorities should introduce comprehensive criminal liability for legal persons, and reconsider statutes of limitations. To ensure an effective follow-up to Financial Intelligence Unit (UIF) disseminations, the federal prosecutor (FGR) should implement measures to rectify identified fundamental shortcomings in its functioning and consideration should be given to set up or appoint specialized courts or judges to handle complex financial crime cases. Finally, an inter-agency task force should design and implement a legal framework that ensures that accurate, verified and up-to-date basic and beneficial ownership information is available with company registers, Mexican banks and notaries as well as the companies. The authorities agreed with the need to focus on implementation and for pending AML legislation to be enacted. They also noted steps already taken to improve the availability of beneficial ownership information and other relevant customer due diligence measures taken by supervisory authorities—including for politically-exposed-persons—for all financial institutions.

  • b. Reducing Mexico’s labor informality. The share of informal workers has declined but remains high at 56 percent. Efforts to reduce hiring and firing restrictions need to be reinvigorated and could be replaced with an unemployment insurance scheme, which should be financed at least in part by non-labor taxes. Staff analysis also highlights the importance of reducing entry costs for formal firms, e.g., by reducing the procedural costs and time burdens of starting and formalizing a business.9 Recent labor reforms need to be implemented effectively to establish a more efficient labor dispute resolution mechanism, improve enforcement of worker right protections, and strengthen the even-handed application of labor union regulations.

  • c. Improving the security situation. The President’s approach is based on long-term prevention—aimed at halting criminal recruitment of youth through education and training— and the creation of a National Guard. To prevent oil theft, the government guarded and shut-off pipelines in early-2019. Staff highlighted that enhancing the efficiency and quality of law enforcement and judicial institutions10 is critical to strengthening the rule of law.

32. There is also a need to continue addressing gender gaps. Gender parity in education contrasts with low female labor force participation and pay gaps (Box 7). Lowering participation barriers for mothers remains a priority as gender gaps increase during child-bearing years, and women with more children participate less. Child care and maternity/paternity benefits remain well below OECD peers and should be expanded. Staff raised concern over the cancelation of subsidies for child care facilities and their replacement with direct transfers to families. Promoting the financial inclusion of women should be a pillar of the government’s upcoming financial inclusion initiatives.

33. Productivity growth would also benefit from strengthening competition and easing product market regulations. Staff analysis suggests that lack of competition reduces firm investment (2018 SIP) and weakens productivity growth (2017 SIP). Staff advocated removing barriers to trade in services, especially in the transportation and logistics sector. It also recommended restarting energy auctions and risk-sharing arrangements between Pemex and private firms. Finally, staff encouraged the authorities to promote efforts to strengthen the multilateral trading system, including through supporting the modernization of WTO rules, overcoming the WTO Appellate Body blockage, and advancing WTO plurilateral and multilateral initiatives.

34. Further adjustments in the minimum wage should be gradual to avoid short-term disruptions and adverse formal employment effects. The minimum wage fell sharply in real terms during the early 1990s. It was raised by 16 percent this year (41 percent over the past three years) across the country and was doubled in the U.S. border region. While acknowledging that increases in the minimum wage could help reduce inequality and bring minimum-to-median wage indicators closer to regional and OECD averages, staff recommended a gradual adjustment, in line with the evolution of labor productivity, to avoid short- and medium-term disruptions to formal employment growth (Box 8).

Staff Appraisal

35. Very strong policies and policy frameworks have contributed to Mexico’s resilience. The authorities’ commitment to fiscal prudence is strong, monetary policy remains prudent and has succeeded in bringing inflation to target, and financial sector supervision and regulation are robust. The flexible exchange rate is playing a key role in helping the economy adjust to external shocks, while Mexico’s external position remains broadly consistent with medium-term fundamentals and desirable policy settings. These policies have been instrumental in allowing Mexico to successfully navigate a complex external environment and should continue to do so going forward.

36. But growth has declined sharply, and fiscal pressures are mounting. Pressures have emerged in the context of new spending priorities and a commitment to not raise taxes until after 2021. Drastic budget cuts for some institutions have raised concern about their potential impact on human capital, while productivity-enhancing reforms have largely stalled. Growth is projected to reach 0.4 percent in 2019 and 1.3 percent in 2020 on the back of a modest recovery in domestic demand as uncertainty subsides and monetary conditions ease further.

37. The authorities’ announced fiscal targets remain prudent but would need to be more ambitious to put the public debt ratio on a downward path. The current PSBR targets of 2.2– 2.4 percent of GDP over the medium term would keep debt broadly stable at around 55 percent of GDP. While this level is sustainable, more ambitious medium-term fiscal targets would help rebuild buffers and insure against downside risks and demographics-related spending pressures.

38. Additional measures are needed to meet the announced fiscal targets. The recent cancelation of the universal tax offset as well as proposed measures to strengthen tax collection, such as on digital services, are welcome. Nevertheless, budget projections are based on optimistic assumptions for nominal GDP growth, oil production, tax revenue buoyancy, and the projected compression of spending on goods and services. In the absence of additional measures, a fiscal gap of 0.5–1.5 percent of GDP would emerge during 2020–24. Closing this gap with credible measures starting in 2020 is imperative to safeguard the credibility of fiscal policy.

39. Non-oil tax revenues should be boosted, while making the tax system more progressive to reduce income inequality. Mexico’s revenue performance significantly lags that of regional and international peers. Rationalizing regressive tax expenditures, broadening the tax base, lowering the threshold for the top PIT bracket, abolishing border incentives and fuel price support, as well as raising subnational property and vehicle registration taxes could help boost revenues. Enhancing public expenditure efficiency could facilitate shifting spending toward a more growth-friendly and inclusive mix. Finally, revenue administration could be strengthened by adopting a comprehensive strategy to tackle VAT non-compliance, while moving towards a high-coverage audit process for VAT returns.

40. Pemex’s business plan should be reformulated with a view to strengthening the company and reducing risks to the budget. To support a significant increase in production and reserves, more cooperation with private firms and a stronger focus on the company’s upstream business would be important. Moreover, to strengthen profitability and limit risks to the budget, Pemex should make progress in selling non-core assets and provide convincing plans to reduce operating costs.

41. Strengthening the fiscal framework would support the administration’s commitment to fiscal responsibility. The framework would benefit from a permanent debt ceiling and a structural spending rule, paired with effective correction mechanisms and a non-partisan, adequately-sourced fiscal council. A modern medium-term budget framework would be an effective complement.

42. There is scope for further monetary easing. Given the very tight policy stance in the context of a large negative output gap, Banxico should continue to lower the policy rate so long as inflation stays close to the target and inflation expectations remain anchored. Central bank communication should be kept concise, while exchange rate flexibility should remain the key shock absorber. Foreign exchange intervention should be limited to incidences of disorderly market conditions, while the FCL provides an additional buffer.

43. Financial sector resilience remains strong and could be enhanced by closing gaps in the regulatory and supervisory framework. Increasing the operational independence, budget autonomy and legal protection of the banking and securities supervisor, and extending its authority to financial holding companies, would close some of the gaps identified in the 2016 FSAP. Prudential supervision functions could then be integrated under one authority for all financial institutions. The definitions of “common risk” and “related party” should be enhanced, and the resolution and crisis management framework should be strengthened.

44. Efforts to boost financial sector competition and inclusion should continue. The authorities’ resolve to improve financial inclusion through a diverse set of measures announced earlier in the year are welcome. Going forward, a multi-pronged strategic approach to boost lending and strengthen competition and inclusion should be a policy priority.

45. Reinvigorating the structural reform agenda is an imperative to foster strong, sustainable and inclusive growth. Structural reforms are central to raising growth, reducing poverty and inequality, and narrowing both regional income disparities and the income gap with other advanced economies. Restarting energy auctions and risk-sharing arrangements between Pemex and private firms would bring much needed private investment. Lowering participation barriers for women and removing constraints to trade in services, especially in the transportation and logistics sector, would narrow gender gaps and boost activity. High levels of informality could be addressed by reducing entry costs for formal firms, strengthening enforcement, and replacing hiring and firing restrictions with an unemployment insurance scheme. Further adjustments in the minimum wage should be gradual.

46. Concrete policy action is needed to fight corruption and strengthen the rule of law. The effective implementation of the National Anti-Corruption System would be an important step forward. Enhancing the effectiveness and quality of law enforcement and the prosecution, and addressing the shortcomings identified in the AML/CFT assessment should also be priorities.

47. It is proposed that the next Article IV Consultation with Mexico take place on the standard 12-month cycle.

Synchronization of Mexican Economic Activity with the U.S.

Growth in Mexico continues to be closely linked to the U.S. economy. The slowdown in U.S. manufacturing activity likely contributed significantly to the weak growth outturns in Mexico in 2019:H1.

Mexico’s economy is closely linked to the U.S. economy. The U.S. is Mexico’s main trading partner, accounting for 80 percent of Mexico’s exports and 46 percent of its imports. In 2018, the U.S. was the origin of 38 percent of FDI in Mexico and the source of 94 percent of remittances. Mexico and the U.S. are also deeply integrated through supply chains, especially in the automotive sector. More than two-thirds of Mexico’s exports are manufacturing products sold to the U.S., about a third of which are automotive exports.

Until recently, Mexico’s GDP growth closely tracked U.S. GDP growth and manufacturing activity. Since 1996, the correlation coefficient in GDP growth between the two countries was close to 0.8; however, overall economic activity seems to have decoupled during the last few years. While U. S. growth accelerated, growth in Mexico started to slow down in 2017 and declined further as U.S. manufacturing activities decelerated sharply.1

uA01fig08

Economic activity in Mexico and the U.S.

(SA, Y/Y percent growth)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: National Authorities, Haver Analytics: and IMF Staff estimates.
uA01fig09

Economic activity in Mexico and the U.S.

(SA, 3-month MA, Y/Y percent growth)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: National Authorities, Haver Analytics: and IMF Staff estimates.

The slowdown in U.S. manufacturing growth likely contributed to the weakening of Mexican growth in 2019:H1. Since late-2018, U.S. manufacturing activity has been slowing down and leading indicators (such as the PMI) indicate a further deceleration. Given Mexico’s deep integration with U.S. manufacturing activity, this is likely to have had a negative impact on Mexican growth, even though Mexican manufacturing activity has held up relatively well. While the global automobile industry contracted, Mexico maintained a robust trade surplus in the automotive sector and increased its market share in U.S. automotive imports, supported by a continued shift in Mexico’s production and exports toward higher unit-value vehicles.

uA01fig10

U.S.: Imports of motor vehicles and parts

(3-month MA, Y/Y percent growth)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: National Authorities, Haver Analytics: and IMF Staff estimates.
uA01fig11

Mexico: Vehicle production and exports

(3-month MA, Y/Y, in percent)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: National Authorities, Haver Analytics: and IMF Staff estimates.
1 Regression analysis using monthly proxies suggests that post-2016 U.S. manufacturing has become a bigger factor in driving GDP in Mexico. Relatedly, the large slump in U.S. manufacturing in 2015–16 is mostly explained by the impact the oil price decline had on shale gas activity and did not affect growth in Mexico.

Pemex’s Business Plan and Market Reaction

Pemex’s business plan relies on optimistic production and reserve projections, limits cooperation with private firms and envisages investing heavily in its loss-making refining business. Recent capital injections have improved short-term liquidity needs, but the medium-term financial outlook remains weak thus potentially putting further pressure on the government.

Pemex’s business plan, which was published in July, failed to reduce market uncertainty. Its main elements included: additional support through tax reductions and fiscal transfers, increased capital expenditures, production and refining targets, private participation limited to service contracts, and zero reliance on new net debt. As the plan did not offer any surprises, credit spreads were little changed, and rating agencies retained their negative rating outlook.

uA01fig12

Pemex dollar bond spreads

(basis points)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Additional support in September improved near-term liquidity needs but long-term spreads remain elevated. In September, the authorities announced additional support of $5 billion for debt buybacks, and Pemex issued $7.5 billion bonds, to cover maturing debt. This operation surprised markets and led to a decline in near-term (up to 5y) spreads. However, spreads at the long end of the curve remain elevated, pricing in further downgrades to below investment grade (IG). A downgrade by Moody’s to below IG rating could lead to some additional selling pressure of $6–10 billion given that Pemex bonds will become ineligible for some global investment grade bond indices.

The current investment plan focuses on increasing production from current low levels. Current plans focus on areas where the company had better success rates in the past. This strategy will likely lead to some short-term production gains, but the 60 percent increase in production by 2024—to 2.7mbpd—currently projected by Pemex appears optimistic.

Focusing the limited resources on increasing production risks crowding out the rebuilding of reserves. The plan assumes that Pemex will be able to add reserves of around 140 percent of its annual production every year. Commercial discoveries are set to increase from 4 fields per year in the preceding 5 years to 34 per year in the next 5 years. In terms of discoveries, rating agencies are more conservative and assume a 50 percent replacement rate ratio (RRR) which is in line with the average of the last 15 years. In a conservative scenario where production stabilizes at 2019 levels but RRR stays at 50 percent, reserve life would decline to around 5 years in 2024 almost half of its 2014 level. In a scenario where production targets were to be met but RRR was 50 percent, reserve life would decline to only 3 years.

uA01fig13

Reserves to Production Ratio

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: Pemex and IMF staff estimates

The investment in the Dos Bocas refinery will likely crowd out upstream investment even more. Most analysts expect the project to cost around $12–15 billion— compared to the authorities’ $8 billion estimate—and completion to last longer than the current target of mid-2022. The project is earmarked at around 13 percent of the 2019–22 capex plan. Given Pemex’s tight financing envelope, slippages could crowd out some of the much-needed investment in the upstream business which provides the bulk of the company’s EBITDA and tax payments.

uA01fig14

Pemex CAPEX Plan

(MXN billion)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: Pemex

The business plan offers limited details on how to rationalize costs and assumes large gains in operating profitability. Although some efficiencies are assumed through changes in the procurement strategy and reduction in fuel theft, the plan assumes very large improvements in EBITDA margins from 33 percent in 2018 to over 60 percent. While PEMEX generated similar margins at the start of this decade, this happened in an environment when its reserves portfolio was significantly higher and oil prices were closer to $100 per barrel. Additionally, outstanding pension liabilities continue to be sizeable.

uA01fig15

Pemex financing needs and sources

($ billion)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: Pemex Business Plan and IMF staff calculations based on analyst estimations

Pemex’s financial situation is projected to remain weak in the coming years, potentially putting further pressure on government finances. Assuming a stabilization of production, and full execution of the investment plan, free cash flow (FCF) will likely remain negative for the foreseeable future. Additionally, potential difficulties to refinance maturing debt at favorable rates over the medium term could weigh on government finances.

Adjustment in External Accounts

Mexico’s external accounts underwent significant shifts in composition in recent years. Since 2013, the oil trade balance shifted from a surplus of 0.7 percent of GDP to a deficit of around 2 percent, rendering Mexico a net oil importer. At the same time, however, the flexible exchange rate supported a significant strengthening in the non-oil trade balance that cushioned the impact on the current account.

Mexico was hit by a series of severe shocks in recent years that necessitated an improvement in the current account. Following a 40 percent fall in oil prices in 2014 and a gradual decline in Mexico’s oil production, Mexico’s oil trade balance swung from a surplus of 0.7 percent of GDP in 2013 to a deficit of around 2 percent in 2018. This dramatic shift occurred in the context of uncertain external financing prospects amid monetary policy normalization in advanced economies, tightening global financial conditions, and rising protectionism.1 An adjustment in the non-oil current account balance was thus crucial.

uA01fig16

Current Account Balance

(percent of GDP, 4q rolling)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Source: Banxico, Staff calculations

The strengthening of manufacturing exports took place on the back of substantial real exchange rate depreciation. Between 2013 and 2018, the non-oil trade balance improved by almost 2 percentage points of GDP as manufacturing exports increased by 8 percent of GDP. The adjustment was facilitated by significant real exchange rate depreciation since 2014, mostly on the back of peso depreciation vis-à-vis the U.S. dollar. At the same time, broadly stable FDI flows and positive, albeit more volatile, net portfolio flows helped avoid a disorderly macroeconomic adjustment. Meanwhile, foreign exchange reserves remained broadly constant as the central bank allowed the peso to adjust freely to shocks. More recently, Mexico likely also benefited from trade diversion in the short term, as indicated by the 11.8 percent growth rate of U.S. imports from Mexico in 2018:H2, following the introduction of U.S. tariffs on Chinese imports in June. Although export growth slowed down in the 2019:H1, in line with decelerating manufacturing activity in the U.S., it remained the main driver of U.S. imports. Moreover, while the U.S. has remained Mexico’s main export market throughout this period (about 80 percent of non-oil exports), the composition of import source countries has also shifted as the share of non-oil imports from the U.S. fell, while Chinese imports increased.

uA01fig17

Trade Diversion

(Contribution to U.S. imports, ppt y/y)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Source: U.S. Department of Commerce, Staff calculations
1 Banco de Mexico, 2019, Quarterly Report October-December 2018.

Financial Inclusion

Financial inclusion has strengthened but progress has been slow due in part to limited financial infrastructure and education, lack of competition in the banking sector and widespread informal activity.

Financial inclusion has shown limited progress while geographic and gender disparities remain. According to the 2018 ENIF survey, the proportion of adults with more than one financial product has remained largely unchanged at 45 percent since 2015; due mainly to high costs and informal employment. Despite progress facilitated by government programs, the gender gap in account ownership is at -8 percentage points (see: 2017 Findex survey). Moreover, large gender gaps remain in other areas such as holdings of retirement accounts and asset ownership (both at -18 percentage points). There are also geographic disparities, with the South lagging the rest of the country according to most measures of financial inclusion.

uA01fig18

Gender gap in account ownership

(percentage points)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources FINDEX

Cash remains the predominant means of payment. According to ENIF, more than 90 percent of rent, utility, and house service payments are made in cash. According to Findex, 38 percent of private sector wages are still paid in cash. By contrast, in the G-7 economies, private sector wages are paid almost exclusively into bank accounts. In 2017, the government provided close to one third of transfers and payments in cash, which is unchanged from 2014.

There are large geographic gaps in financial infrastructure, while the lack of financial education hampers growth in electronic payments. According to ENIF, regional disparities are large with 22 and 10 percentage points difference in the use of ATMs and branches, respectively, between the South and the Northwest. In terms of mobile services, according to Findex, 6 percent of Mexican adults (aged 15+) are mobile money users, which is close to the average of the LAC region. The main reasons for not using mobile money for holders of savings accounts is lack of trust or knowledge of the service as well as the complexity of use.

uA01fig19

Reasons for not using mobile banking among account holders

(percent)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: ENIF 2018

Low banking sector competition hampers financial inclusion. In recent years, mainly due to lack of competition, intermediation margins have increased, and overhead and administrative costs have not declined. Banks mostly serve known clients with credit based on strong balance sheets and penalize Micro and SMEs (MSMEs) with significant margins. According to INEGI, while MSMEs account for 95 percent of companies and provide over 70 percent of employment, only 11 percent have access to bank finance. Within those who have access, a large share is due to development banks. Over 60 percent of MSMEs reject bank loans due to high costs while education also has a role to play, as close to 50 percent of SMEs state not to be aware of any government programs.

Regional Economic Disparities

Regional economic disparities are significant in Mexico, with the Center and North outperforming the South according to a wide range of socioeconomic indicators. Moreover, the gap has been widening in recent years amid solid growth in the North and an economic contraction in the South.1

Mexico’s Center-North has grown at sizable rates in recent years while the South has been in recession. For the past 10 years, Mexico has struggled to achieve growth rates of more than 2 percent on average. However, the national growth rate conceals very different economic realities across regions. The economy of the North has been thriving at an annual average growth rate of 3.3 percent since 2015, while the South has been in recession.

uA01fig20

Real GDP Growth (y/y)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Source: INEGI; and IMF staff

Poverty rates are highest in the South and have failed to decline over the past decade. In 2018, just 24 percent of the population of the North was classified as poor compared with 61 percent of the South. While the North, Center-North, and Center have seen poverty rates declining over the last decade, poverty in the South has increased by 2.2 percentage points. Extreme poverty is also very high in the South with 19 percent of the population living under extreme poverty conditions, compared to 2 percent in the North.

uA01fig21

Poverty by regions (% of population)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Source: CONEVAL; and IMF staff calculations.

Labor market informality and underemployment are also highest in the South and show no sign of declining. Both informality and underemployment are much lower in the North than in the South. Moreover, in both cases the gap has widened further over the past decade.

uA01fig22

Informality and Underemployment Rates

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Source: INEGI; and IMF staff
1 The regional groupings used in the box are consistent with INEGI’s regional classification used in the Quarterly Indicator of State Economic Activity (ITAEE).

Corruption and AML/CFT Reforms

Over the past several years, Mexico has embarked on an anti-corruption reform. Mexico was assessed against the Financial Action Task Force (FATF) anti-money laundering / combating the financing of terrorism (AML/CFT) standards in 2018. The current administration was elected on an anti-corruption platform.

The National Anti-Corruption System (NACS) is a constitutionally mandated anti-corruption reform. The NACS contains several measures, of which the most important are: i) appointment of an operationally independent anti-corruption prosecutor; ii) appointments of 18 judges to fill the new anti-corruption chamber at administrative courts; iii) implementation of new transparency requirements for public officials; iv) drafting of a national anti-corruption policy; and v) creation of the National Digital Platform, to provide access to important data, such as procurement information. Except for the appointment of the judges, most other elements of the NACS are formally in place. However, the reform has yet to yield visible results and for the most part, enforcement, effective coordination and inter-agency peer pressure are still lacking.

A majority of the recommendations from a 2018 Fund staff-led AML/CFT assessment against the FATF standards have yet to be implemented. The FATF noted a range of shortcomings, notably related to the effectiveness of law enforcement and prosecution. Other major shortcomings were a lack of effectiveness of preventive measures in the financial sector, financial supervision and transparency of legal persons. Following the adoption of the assessment in November 2017, Mexico was placed in enhanced follow-up and given three years to enact legislation to address “most, if not all” legal shortcomings. Although the authorities have reported some progress so far, none of these measures were sufficient to warrant the necessary re-ratings. After this three-year period ends, FATF may consider additional enhanced follow-up measures (which include high level visits and public warnings). The authorities have prepared corresponding legislation which is, however, pending in Congress.

The Financial Intelligence Unit (UIF) has increased the number of money laundering cases disseminated to the federal prosecutor (FGR). As noted by the new Attorney-General and the AML/CFT assessment, the FGR is facing fundamental shortcomings. These also prevent FGR from effectively following up on UIFs disseminations and from achieving levels of investigations, prosecutions, confiscations and convictions that would correspond to Mexico’s corruption and money laundering risks. A lack of expertise and the effects of corruption have a negative impact on the judiciary’s ability to effectively handle complex financial cases.

Gender Gaps

While gender parity has been achieved in educational attainment, significant gaps remain in labor force participation and pay. At the political level, near gender parity has been achieved, while at the corporate level female representation lags. Violence against women remains the highest in the OECD.

Gender parity in enrolment and educational attainment has been achieved at all levels of education. However, Mexico’s graduation rates from upper secondary education remain 30 percentage points below the OECD average, notwithstanding improvements in the last decade. The share of female students graduating from the fields of engineering, manufacturing and construction, at 11 percent in Mexico, is well above the 6-percent OECD average. However, women have a lower employment rate and earn less than men.

Female labor force participation has increased but remains significantly below male participation. While female labor force participation has increased from 41 percent in 2005 to 44 percent in 2018, it remains 33 percentage points below the labor force participation of men. It also remains significantly below the OECD average for women (64 percent) and most other Latin American countries. Most Mexican women work in the informal economy and remain heavily underrepresented in the formal private sector. Among 18–24 year-olds, women are more at risk than men of being neither in employment nor in education or training—36 percent of women compared with 8 percent of men (in 2017). Child care and maternity/paternity benefits remain well below OECD peers.

Mexico’s gender wage gap declined but compares unfavorably with other Latin American countries. Since 2005, Mexico’s gender wage gap declined by one third to 11 percent by 2017, which is somewhat lower than the OECD average, though higher than in other Latin American countries. However, tertiary-educated women earn only two-thirds of the average earnings of tertiary-educated men.

In terms of financial inclusion, although some gender disparities have been reduced, large gaps remain. Progress has been achieved in closing gender gaps as the government opened accounts for over six million people to receive social or cash transfers out of which 80 percent belong to women. However, gender gaps in terms of account holders are still large at -8 percentage points (Findex, 2017). Additionally, large gaps remain in other areas such as retirement accounts and asset ownership (both at -18 percentage points)—the latter could be a major constraint for women in terms of accessing credit.

At the political level, near gender parity has been achieved, while at the corporate level female representation lags. In 2018, Mexico’s Congress achieved near gender parity for the first time in history, in part due to quotas in the electoral process. The cabinet has also equal numbers of women and men. In June, the constitution was amended to guarantee women’s equal participation in politics and government. However, female representation at the corporate level remains very low: women held only 5 percent of board seats of publicly listed companies in 2016, compared to 20 percent across the OECD.

Violence against women remains the highest in the OECD. Nearly every second Mexican woman has experienced domestic violence at some time in her life, the highest across OECD countries. The number of femicides—the killing of females because of their gender—continues to increase, reaching 861 in 2018.

Minimum Wage Policy

Mexico’s minimum wage was increased substantially this year, especially in the northern border region, with potentially significant adverse effects on formal employment.

In January 2019, the national minimum wage was raised by 16 percent, and the minimum wage was doubled in 43 municipalities in the border region. The national minimum wage increase is the first step in the administration’s objective to significantly raise the minimum wage by 2024. The immediate doubling in 43 municipalities of the newly created Northern Border Free Zone forms part of a wider package of incentives that include lower VAT and CIT rates.

The new minimum wage policy constitutes a significant change by historical and international standards. Mexico’s real minimum wage has remained low since the 1990s at levels that are well below regional and OECD peers. Thus, the 2019 increase constitutes the biggest policy shift in over two decades. While the minimum-to-median wage ratio remains below the OECD average at the national level, the ratio in the northern region has already risen well above the average. Moreover, the share of workers earning up to or less than a minimum wage in the northern region has doubled from 8 to 17 percent.

uA01fig23

Minimum to median wage ratio in 2017

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: OECD, ENQE, and staff calculations.

The effects of this rapid increase are hard to estimate, but past evidence points to adverse effects on formal employment. Minimum wages make formal employment relatively more expensive, influencing contractual decisions. Past minimum wage increases, which were significantly more moderate, were associated with lower formalization rates and decreases in overall inequality.1 Negative effects are likely to be concentrated in selected northern industries relying on formal contracts with limited scope for contractual adjustments.2 In 2019:H1, the policy has already produced an increase in wages of formal employees accompanied by slower formal employment growth in the border states. The effects on total employment, however, could be less prominent as there is the possibility of switching from formal to informal contracts in many industries located at municipalities at the north border.

uA01fig24

Formal employment growth

(yearly growth; percentage)

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: INEGI; and staff calculations
1 See “Formality and Equity: Labor Market Challenges in Mexico”, SIP, 2018.2 Staff analysis suggests that labor market duality—between informal and formal firms as well as salaried and non-salaried forms of contractual employment—introduces flexibility in hiring decisions and limits adverse aggregate productivity effects. See “Informality and Aggregate Productivity: The Case of Mexico”, 2019, IMF Working Paper.
Figure 3.
Figure 3.

Mexico: Prices and Inflation

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: National Authorities, Haver Analytics; and, IMF Staff estimates.1/ Based on hours worked.2/ Calculation using the average inflation expectation for the next 12 months (NSA, %). Source: Banco de Mexico. Survey on the Expectations of Private Sector Economists.
Figure 4.
Figure 4.

Mexico: External Sector

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: National Authorities, Haver Analytics; and, IMF Staff estimates.
Figure 5.
Figure 5.
Figure 5.

Mexico: Reserve Coverage in an International Perspective, 2018 1/

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.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.Sources: World Economic Outlook, Balance of Payments Statistics Database; and, IMF staff estimates.
Figure 6.
Figure 6.

Mexico: Fiscal Sector

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: National authorities, World Economic Outlook, Fitch Ratings; and, Fund staff estimates.1/ LA-6 excluding Mexico is comprised of Brazil, Chile, Colombia, Peru, and Uruguay.2/ EM comparator group is comprised of India, Indonesia, Poland, Russia, Thailand, and Turkey.3/ Fitch sovereign credit rating peer group includes Brazil, Chile, Colombia, India, Poland, Russia, South Africa, Thailand, and Turkey.
Figure 7.
Figure 7.

Mexico: Financial Sector

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: Bloomberg, Haver Analytics; and, National authorities.
Figure 8.
Figure 8.

Mexico: Banking System

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: Bloomberg, Haver Analytics, National authorities; and, IMF staff estimates.
Figure 9.
Figure 9.

Mexico: Nonfinancial Corporate Sector

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: Bloomberg, Haver Analytics, National authorities; and, IMF staff estimates.1/ Totals exclude PEMEX, CFE and its affiliates.
Figure 10.
Figure 10.

Mexico: Social Indicators

Citation: IMF Staff Country Reports 2019, 336; 10.5089/9781513519005.002.A001

Sources: World Development Indicators.
Table 1.

Mexico: Selected Economic, Financial, and Social Indicators

article image
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 Fund 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.

Excludes goods procured in ports by carriers.

Includes domestic credit by banks, nonbank intermediaries, and social housing funds.

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

Table 2.

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

(In percent of GDP)

article image
Sources: Ministry of Finance and Public Credit; and IMF staff estimates.

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

Includes revenues from the oil-price hedge for 0.6 percent of GDP in 2015 and 0.3 percent of GDP in 2016; and Bank of Mexico’s operating surplus transferred to the federal government for 0.2 percent of GDP in 2015, 1.2 percent of GDP in 2016, and 1.5 percent of GDP in 2017.

Includes 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 set at 2.0 percent for 2015 and 2016, and equal to potential growth thereafter. Structural current spending is defined as total budgetary expenditure, excluding: (i) interest payments; (ii) non-programable spending; (iii) cost of fuels for electricity generation; (iv) public sector pensions; (v) direct physical and financial investment of the federal government; and (vi) expenditure by state productive enterprises and their subsidiaries.

Table 3.

Mexico: Statement of Operations of the Public Sector, GFSM 2014 Presentation 1/

(In percent of GDP)

article image
Sources: Ministry of Finance and Public Credit; and Fund staff estimates and projections.

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

Includes revenues from the oil-price hedge for 0.6 percent of GDP in 2015 and 0.3 percent of GDP in 2016, treated as revenues from an insurance claim. It includes also Bank of Mexico’s operating surplus transferred to the federal governm ent for 0.2 percent of GDP in 2015, 1.2 percent of GDP in 2016, and 1.5 percent of GDP in 2017.

Interest paym ents differ from official data due to adjustm ents to account for changes in valuation and interest rates.

Includes transfers to state and local governments under revenue-sharing agreements with the federal government.

This category differs from official data on physical capital spending due to adjustments to account for Pidiregas amortizations included in budget figures and the reclassification of earmarked transfers to sub-national governments.

Adjusting revenues for the econom ic and oil-price cycles and excluding one-off item s (e.g. oil hedge incom e and Bank of Mexico transfers).

Negative of the change in the structural primary fiscal balance.

Corresponds to the gross stock of public sector borrowing requirements, calculated as the net stock of public sector borrowing requirements as published by the authorities plus public sector financial assets.

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

Table 4A.

Mexico: Summary Balance of Payments

(In billions of U.S. dollars)

article image
Sources: Bank of Mexico, National Institute of Statistics and Geography, and Fund staff estimates.

Crude oil, derivatives, petrochemicals, and natural gas.

Excludes goods procured in ports by carriers.