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

Arrangement Under the Flexible Credit Line and Cancellation of Current Arrangement-Press Release; and Staff Report

Abstract

Arrangement Under the Flexible Credit Line and Cancellation of Current Arrangement-Press Release; and Staff Report

Introduction

1. This note assesses the impact of the proposed Flexible Credit Line (FCL) arrangement for Mexico on the Fund’s finances and liquidity position, in accordance with the policy on FCL arrangements.1 The proposed arrangement would cover a 24-month period and, as was the case for previous FCL arrangements with Mexico, the authorities intend to treat the arrangement as precautionary.

2. The proposed access would be in an amount of SDR 44.56 billion (500 percent of quota), representing a further reduction compared with the current FCL arrangement. This would continue the gradual reduction in access under the current FCL arrangement—initially SDR 62.39 billion (700 percent of quota) upon approval of the arrangement in November 2017, reduced to SDR 53.48 billion (600 percent of quota) at the mid-term review in November 2018. In line with the authorities’ FCL exit strategy, they have also indicated their intention to request, at the time of the mid-term review of the proposed arrangement, a further reduction in access to 400 percent of quota, conditional on a reduction of external risks facing Mexico. The current FCL arrangement would be cancelled upon approval of the proposed arrangement.

Background

3. Mexico has not made purchases under any of its FCL arrangements over the past decade (Annex I). Since the global financial crisis, Mexico has had seven FCL arrangements, including the existing arrangement. Mexico has a history of strong performance under earlier Fund arrangements and an exemplary record of meeting its obligations to the Fund. All of Mexico’s FCL arrangements have remained precautionary.

4. Mexico’s very strong policies and policy frameworks, complemented by the successive FCL arrangements, have supported market confidence in a challenging external environment.2 Economic growth was robust during 2010–18, helped by relatively strong demand from the United States, to which Mexico’s economy is closely connected, and robust private consumption growth underpinned by steady wage growth and rising employment. Mexico has been resilient in the past few years to several bouts of market volatility associated with shifts in global risk aversion, uncertainty regarding the outcome of trade negotiations with the U.S. and Canada, and domestic policy uncertainty. These factors have, however, contributed to a slowdown in the economy and real GDP is projected to remain broadly unchanged in 2019.

5. Total external and public debt levels remain moderate and are expected to remain stable over the medium term under the baseline. Mexico’s external debt has been broadly stable around 36–38 percent of GDP over the past 4 years (Table 1), remaining at modest levels compared to other emerging markets. External public debt accounts for about 25 percent of GDP. Gross public debt is estimated to have increased from 49 percent of GDP at end-2014 to nearly 54 percent of GDP at end-2018, of which about one third was denominated in foreign currency. The public debt-to-GDP ratio is projected to edge up slightly in the next two years and would broadly stabilize at around 55 percent of GDP over the medium term under the baseline scenario. Debt sustainability analyses suggest that both external and public debt would remain manageable under a range of standardized scenarios.

Table 1.

Mexico: External Debt and Debt Services, 2014–191/

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Sources: Mexican Authorities and IMF Staff Estimates.

End of period, unless otherwise indicated.

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

The New Flexible Credit Line Arrangement-Impact on the Funds Finances and Liquidity Position

6. The proposed FCL arrangement would be among the largest Fund commitments to date and, if drawn, would result in a record high credit exposure in nominal terms. The Fund’s commitment under the proposed FCL arrangement would be surpassed only by its commitments to Mexico under previous FCL arrangements. The full amount of access proposed would be available throughout the arrangement period in one or multiple purchases.3 If the full amount available under the proposed FCL arrangement were drawn, Mexico’s outstanding use of Fund resources would reach SDR 44.5635 billion, the largest credit exposure in the Fund’s history.4 Relative to quota, however, the size of the arrangement would be significantly less than the 2018 arrangement for Argentina and arrangements for several earlier euro area exceptional access cases such as Greece, Ireland, and Portugal.

7. If Mexico were to purchase the full amount available under the proposed FCL arrangement, the Fund’s exposure relative to Mexico’s relevant economic indicators would remain moderate and Mexico’s debt burden manageable over the medium term:5

  • Mexico’s external debt is projected to remain moderate, though with Fund credit representing a non-trivial share. Total external debt would rise to about 42.3 percent of GDP initially, and public external debt would rise to close to 29.8 percent of GDP, with Fund credit representing almost 4.8 percent of GDP (Table 2). Mexico’s outstanding use of GRA resources would account for almost 11.4 percent of total external debt, 16.2 percent of public external debt. In addition, Fund credit would account for more than a third of Mexico’s gross international reserves.

  • External debt service would increase over the medium term but remain manageable under staff’s medium-term macro projections (Table 2). Mexico’s projected debt service to the Fund would peak in 2023 at about SDR 23.55 billion, or nearly 2.2 percent of GDP.6 In terms of exports of goods and services, debt service to the Fund would peak at about 5.5 percent. Public external debt service would peak at almost 15 percent of exports of goods and services and debt service to the Fund would then account for about 36.9 percent of total public external debt service.7

Table 2.

Mexico: Capacity to Repay Indicators, 2018–241/

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Sources: Mexican authorities, Finance Department, WEO, and IMF staff estimates.

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

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

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

8. The approval of the proposed FCL arrangement and cancellation of the existing one would have a positive net impact on the Fund’s liquidity as measured by the forward commitment capacity (FCC). As noted above (¶2), access under the proposed FCL arrangement would be lower than under the existing arrangement. Commitments for the new arrangement would continue to be covered in full from quota resources, with the cancellation of the existing arrangement freeing up SDR 53.48 billion, and SDR 44.56 billion committed upon approval of the proposed arrangement. Accordingly, other things equal, the positive net impact of the proposed FCL arrangement on the FCC would be SDR 8.91 billion (Table 3).

Table 3.

Mexico: Impact on GRA Finances

(Millions of SDR, unless otherwise noted)

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Sources: Finance and IMF staff estimates.

The FCC is defined as the Fund’s stock of usable resources less undrawn balances under existing arrangements, plus projected repurchases during the coming 12 months, less repayments of borrowing due one year forward, less a prudential balance. The FCC does not include resources from currently unactivated lines of credit, including the New Arrangements to Borrow or bilateral commitments from members to boost IMF resources.

Current FCC minus access under the proposed arrangement plus the quota-financed portion of the arrangement being cancelled. The arrangement to be canceled was approved after the February 2016 de-activation of the NAB and is, as the proposed successor arrangement, fully financed with quota resources. The concomitant cancellation of the existing arrangement and approval of the proposed arrangement improves the FCC as the access amount for the proposed arrangement is lower.

As of October 17, 2019.

Burden-sharing capacity is calculated based on the floor for remuneration at 85 percent of the SDR interest rate. Residual burden-sharing capacity is equal to the total burden-sharing capacity minus the portion being utilized to offset deferred charges and takes into account the loss in capacity due to nonpayment of burden sharing adjustments by members in arrears.

9. If a drawing were made, the proposed FCL arrangement could have a large impact on the Fund’s financing mechanism. A single drawing by Mexico for the full amount under the proposed FCL arrangement would be by far the largest single purchase in the Fund’s history and accordingly represent the largest funding requirement from participants in the Fund’s Financial Transactions Plan (FTP). Accordingly, all remaining FTP members would be expected to participate.8

10. If the resources available under the FCL arrangement were fully drawn, the GRA credit exposure to Mexico would be a large share of the Fund’s outstanding credit (Table 3).

  • Fund credit to Mexico would represent 65.3 percent of total GRA credit outstanding as of October 17, 2019, and 39.5 percent of GRA credit outstanding including Mexico’s purchase. It would also be the single largest Fund exposure. The concentration of Fund credit among the top five users of GRA resources would increase marginally to about 87.5 percent, from 86.2 percent as of October 17, 2019. However, the lending concentration to the Fund’s top two borrowers would increase more significantly, from 59.4 percent to 67.8 percent.

  • Relative to the Fund’s current level of precautionary balances, potential GRA exposure to Mexico would be substantial. Fund credit to Mexico would be about 2.5 times the Fund’s current precautionary balances.

  • Were Mexico to accrue arrears on charges after drawing under the proposed arrangement, charges for Mexico would substantially exceed the Fund’s limited capacity to absorb charges in arrears through the burden-sharing mechanism.

Assessment

11. The proposed FCL arrangement would have a significant but manageable impact on the Fund’s finances. On approval of the proposed new FCL arrangement, the Fund’s liquidity position would increase as the cancellation of Mexico’s existing FCL arrangement would more than offset the liquidity effect from the proposed new arrangement. However, a single drawing for the full amount of Mexico’s proposed FCL arrangement would be by far the largest single purchase in the Fund’s history and would have a large impact on the Fund’s financing mechanism. Given a highly uncertain global growth outlook that is subject to elevated downside risks, there is a potential for an increased demand for Fund resources, and it remains essential to continue monitoring the Fund’s liquidity position closely.

12. If drawn in full, Mexico’s FCL arrangement would become the Funds largest credit exposure, but risks to the Fund are mitigated by several factors. Mexico intends to treat the proposed FCL arrangement—like its predecessors—as precautionary. The risks from the Fund’s potential credit exposure to Mexico are mitigated by Mexico’s adequate buffers and the overall credibility of the country’s policy framework, notwithstanding recent policy uncertainty that has weakened the investment climate and new priorities that have created fiscal challenges. Mexico has a sustained track record of implementing very strong policies, including during the global financial crisis, and the authorities are committed to continue to implement very strong policies in the future and to further enhance Mexico’s resilience to external shocks. Also, while Mexico’s overall external debt and debt service ratios would deteriorate assuming full drawing under the proposed arrangement, they would generally remain in the range of recent exceptional access cases, though external public debt service relative to exports would be relatively high. Looking ahead, a further mitigating factor is the authorities’ intention to request, at the time of the mid-term review of the proposed arrangement, a reduction in access to 400 percent of quota, conditional on a reduction of external risks facing Mexico. Overall, Mexico’s capacity to repay is projected to remain strong.

Annex I. History of Arrangements with the IMF

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

Mexico has an exemplary track record of meeting its obligations to the Fund under past purchasing arrangements. Mexico had several Fund arrangements in the 1980s and 1990s and fully repaid its remaining outstanding credit in 2000 (Table I.1).

Annex Table I.1.

Mexico: IMF Financial Arrangements, 1983–2018

(In millions of SDR)

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Source: Finance Department.

As of end-December.

Includes a first credit tranche purchase of SDR 291.4 million.

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

This is not a new arrangement but rather a reduction in access under the 2017 FCL arrangement.

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

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

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

Since the global financial crisis, Mexico has had seven FCL arrangements,1 but made no drawings.

  • April 17, 2009: approval of a one-year FCL arrangement equivalent to SDR 31.5 billion to support Mexico’s economic policies and bolster confidence during the crisis.

  • March 25, 2010: approval of a successor FCL arrangement on identical terms.

  • January 10, 2011: approval of a two-year FCL arrangement with access increased to SDR 47.3 billion.

  • November 30, 2012: approval of a two-year successor FCL arrangement for the same access.

  • November 26, 2014: approval of a two-year successor FCL arrangement for the same access.

  • May 27, 2016: approval of a two-year FCL arrangement with access increased to SDR 62.389 billion.

  • November 29, 2017: approval of a two-year successor FCL arrangement for the same access. Access under this arrangement was reduced to SDR 53.4762 billion at the time of the mid-term review concluded on November 26, 2018.

1

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

2

Mexico – 2019 – Staff Report for the Article IV Consultation (SM/19/242).

3

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

4

The largest GRA credit exposure has been SDR 31.914 billion to Argentina since mid-July 2019, out of a total commitment of SDR 40.714 billion under the current Stand-By Arrangement. The largest previous GRA credit exposure was SDR 23.359 billion to Brazil in 2003.

5

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

6

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

7

For a broader analysis of public and external debt sustainability, see Annex III, 2019 Article IV report (SM/19/242).

8

If Mexico were to draw under the FCL, it would automatically be excluded from the list of members in the FTP, which currently comprises 52 participants.

1

Upon approval of a new FCL arrangement, the member’s existing unexpired FCL arrangement is cancelled.