Mexico: 2022 Article IV Consultation-Press Release and Staff Report

1. While still rebounding from the pandemic, Mexico is facing a challenging new environment as global inflation has surged. The economy has rebounded more gradually than in many peers, but even so, inflation has accelerated, in line with global developments. Financial conditions tightened in the past year, while growth prospects for the U.S., Mexico’s main trading partner, have weakened. Risks of capital flow reversals in emerging market economies have increased. Mexico is well placed to navigate the challenges and risks, given prudent macroeconomic policy conduct, strong monetary and fiscal frameworks, and no major macroeconomic imbalances. Nonetheless, difficult policy trade-offs lie ahead.


1. While still rebounding from the pandemic, Mexico is facing a challenging new environment as global inflation has surged. The economy has rebounded more gradually than in many peers, but even so, inflation has accelerated, in line with global developments. Financial conditions tightened in the past year, while growth prospects for the U.S., Mexico’s main trading partner, have weakened. Risks of capital flow reversals in emerging market economies have increased. Mexico is well placed to navigate the challenges and risks, given prudent macroeconomic policy conduct, strong monetary and fiscal frameworks, and no major macroeconomic imbalances. Nonetheless, difficult policy trade-offs lie ahead.


1. While still rebounding from the pandemic, Mexico is facing a challenging new environment as global inflation has surged. The economy has rebounded more gradually than in many peers, but even so, inflation has accelerated, in line with global developments. Financial conditions tightened in the past year, while growth prospects for the U.S., Mexico’s main trading partner, have weakened. Risks of capital flow reversals in emerging market economies have increased. Mexico is well placed to navigate the challenges and risks, given prudent macroeconomic policy conduct, strong monetary and fiscal frameworks, and no major macroeconomic imbalances. Nonetheless, difficult policy trade-offs lie ahead.


Manufacturing Exports

(In percent of GDP)

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Source: Banxico.

2. These challenges, alongside scarring from the pandemic, compound Mexico’s long-standing problems of low growth, weak productivity, and high inequality. Investment weakened in the pandemic downturn, reinforcing the impact of increased policy uncertainty in some sectors in recent years. Important obstacles to higher, more inclusive growth remain pertinent in several areas, such as rule of law, corruption, and crime issues; regional disparities; and weak outcomes in education and health.


Real GDP

(Index, 2019 = 100)

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Sources: INEGI and IMF staff calculations.

Recent Developments

3. The economic recovery picked up pace in the first half of 2022. Real GDP expanded at an above-trend rate of 1.8 percent, reversing an unexpected stagnation in the second half of 2021. The latter reflected temporary factors, notably the impact of the new subcontracting law on production (Annex IV) and the impact of the spread of COVID-19 in the summer. The subsequent pickup largely reflects continued catch-up momentum, but also improving wages and fiscal policy support. Growth of domestic demand was more resilient than that of output in the past year, and the external current account recorded a small deficit of 0.4 percent of GDP in the period. The external position in 2021 was broadly in line with the level implied by medium-term fundamentals and desirable policies (Annex I).

4. The recovery and slack continued to be uneven across sectors. Labor market conditions improved ahead of output in the past year, with steady increases in employment and decreases in un- and under-employment. Across sectors, many goods producing and some services sectors recently produced above pre-pandemic levels, while construction and some other sectors remained below. Overall, staff estimates that the output gap, which was about -21/2 percent in early 2021, was nearly closed in mid-2022, reflecting both the recovery and potential output growth temporarily below pre-pandemic rates.

5. After accelerating in 2021, inflation has increased further in 2022, as elsewhere, despite an increase in fuel subsidies. Headline inflation rose from about 3 percent at the end of 2020 to 7.4 percent by end-2021 and to 8.7 percent by August this year. After an initial surge in 2021, energy price inflation has moderated due to an increase in fuel subsidies (see below). Food inflation, which has consistently exceeded the 3-percent target over the past decade, has risen steadily to 14.1 percent in August and has accounted for over 50 percent of the increase in headline inflation above target. Nevertheless, core inflation has also risen to 8.1 percent as price pressures have broadened. Near-term inflation expectations have increased above the upper limit of the target range, medium-term expectations are rising notably, but longer-term expectations remain broadly stable.


Retail and Counterfacual Fuel Prices

(Index, current MXN)

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Sources: EIA, Banxico; and Haver Analytics.Note: Chart presents counterfactual fuel prices with no fuel subsidies but full reduction of fuel excise taxes, and assuming a full passthrough from subsidies to prices.
Sources: Haver Analytics, Banxico; and EIA.

Sources: INEGI, Banxico, Haver Analytics; and IMF staff calculations.

6. Banco de México (Banxico) has responded to the inflationary pressures with an acceleration in the pace of monetary tightening. Starting with 25 basis-point (bp) hikes initially, Banxico resorted to 50 and, more recently, 75 bp hikes when it became clear that inflation was becoming increasingly broad-based. At 9.25 percent, the policy rate is currently about 6 percentage points above that of the U.S. Fed. Markets were pricing in a terminal policy rate of about 10.5 percent in this tightening cycle, to be reached in the first quarter of 2023.

7. Financial conditions have tightened. The IMF’s Financial Conditions Index (FCI)1 for Mexico indicates a moderate increase by end-June 2022 but to levels still well below past peaks.


Financial Conditions Index

(Deviations from mean)

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Source: IMF staff estimates.
  • Interest rates and bond yields on peso-denominated debt securities have risen to their highest levels since the Global Financial Crisis (GFC). The increase has been especially large at the front-end, in response to Banxico’s rate increases. The yield on a one-year government bond has risen by over 250 bps so far this year, compared to a 100-bp increase for a 20-year bond. The real yield on an inflation linked Udibono2 maturing in 2031 has risen by 80 bps.

  • Yields on foreign-currency denominated Mexican securities have also risen, reflecting in part diminished risk appetite for emerging market assets and higher yields on safe assets. Across emerging market economies, the sovereign risk spread on Mexican 10-year U.S. dollar bonds has widened less than those for most other sovereigns with similar credit ratings (see chart).

8. Moderate portfolio outflows continued in the past year, but the peso remained broadly stable. The outflows primarily reflected sales of peso-denominated government bond markets by nonresident investors, a development that predates the pandemic and has affected other large issuers of domestic currency-denominated bonds among emerging market peers. This has been offset by strong buying by domestic institutional investors, notably pension funds (Annex V). The peso has remained stable against the U.S. dollar, supported by a rising interest rate differential compared to the U.S., relatively strong fiscal fundamentals, monetary policy commitment to price stability, and solid remittance inflows. Mexico’s gross international reserves slightly declined from their peak value after the SDR allocation of USD 12 billion in August 2021 but have remained adequate in terms of the ARA metric coverage at 125 percent.3


Portfolio Flows

(USD, billions)

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

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

9. Credit growth is recovering despite the tighter financial conditions. Loans to non-financial corporates began to pick up late last year. Foreign currency-denominated (FX) loans recently reached their nominal pre-pandemic levels and peso-denominated loans have recovered after stagnating for a year. Loans to households picked up earlier, led by public non-bank mortgage lending, which was almost unaffected by the pandemic. Corporates are entering this tightening phase with healthy financial buffers, albeit smaller than a decade ago (Figure 10).


Bank Credit to Private Sector

(Dec 2019=100, nominal) 1/

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Source: Haver Analytics.1/ Corporate FX credit connverted to dollars before indexing at end-of-period exchange rates. Index weighted by perso shares of total in December 2019.

10. The Mexican banking system remains well-capitalized, and its profitability continues to recover from the impact of the pandemic. The banking system has managed to navigate the worst of the pandemic while maintaining healthy balance sheets (Figure 9). The total capital adequacy ratio has increased to over 19 percent, from 16 percent before the pandemic. The large institutions that comprise the bulk of the financial system maintain ample liquidity buffers.

11. As global oil prices have risen, the authorities have smoothed retail fuel prices and took steps to stabilize prices of some essential food items. The fiscal cost of the long-standing fuel pricing regime rose following the Russian invasion of Ukraine, resulting in higher-than-budgeted subsidies in 2022H1 (Annex VI). In a nonbinding agreement, several food producers and distributors agreed to stabilize the prices of 24 items initially for six months. In addition, the authorities provided a temporary tariff reduction on certain foods, while taking steps to reduce distribution costs and promote food production, especially by small farmers.

Sources: SCHP, Bloomberg, National Authorities, IMF staff calculations.Note. Subsidy is the negative of excises.

12. PEMEX has benefited from higher global oil prices. Reported earnings more than doubled to over USD 23 billion in the first six months of 2022 compared to the same period last year.4 Most of the increase reflects higher oil prices and a modest increase in production. The improved cash generation has allowed for a rise in capital expenditures but will mostly be used for debt amortization. PEMEX’s total debt outstanding has declined somewhat in recent years but remains high, including to suppliers, and spreads on Pemex’s external debt continue to be above those on bonds of the Mexican government and most oil sector peers.

Outlook and Risks

13. After the pickup in the first half, economic activity is expected to slow in the second half of 2022 and in 2023, given tighter global financial conditions and cooling U.S. growth. The outlook assumes a moderate further tightening in financial conditions, as Banxico and other central banks are expected to raise policy rates further, and fiscal policy stance is expected to be neutral based on budget developments to date in 2022 and the proposed 2023 budget (Box 1). Based on past patterns, the recent tightening in financial conditions will modestly weaken domestic demand, consistent with the impact of higher costs of debt, lower free cash flow and retained earnings, and weaker investment and spending on durables. A more material impact is expected from the ongoing weakening of U.S. growth (Annex VII).

14. Staff projects economic growth of 2.1 percent in 2022 and 1.2 percent in 2023. With the projected weakening of both domestic and U.S. demand in the second half of 2022 and in 2023, employment growth would also slow, reinforcing the deceleration in activity. The current account balance is expected to slightly widen to about 1 percent of GDP in 2022–23, as import prices are increasing faster than export prices.

The 2023 draft budget targets a small increase in the overall deficit due to the increase in interest payments, 3.8 to 4.1 percent of GDP. On this basis, staff estimates that the fiscal stance (based on the change in the structural primary balance) will be about neutral in 2023. Compared to the authorities estimated 2022 outturn, expenditure in 2023 is increased by 8.5 percent in nominal terms (or by 0.1 percentage points of authorities’ projected GDP). This increase accommodates higher spending of interest payments, some social programs—particularly (non-contributory) social pensions for the elderly—and priority infrastructure projects. In addition, the allotted funding for social programs related to fertilizers, procurement of national milk, and rural supplies has also been increased, though the size of the programs remains modest. On the revenue side, the budget entails no change in the tax code but highlights continued efforts to reduce tax evasion and avoidance. The authorities project oil price to be well below 2022 levels, and excise collections are expected to improve (including from fuels).

Staff Projection of 2022 and 2023 Budget (Share of GDP)

article image
Source: IMF staff calculations.

Fuel excises within excises include the revenue effects of using the excise rate to smooth market prices. Fuel subsidy includes mostly direct fuel subsidy.

15. Inflation is projected to plateau at around 81/2 percent in the second half of 2022 and then decline gradually. Core and headline inflation are expected to return to the midpoint of the target band in mid-2024. This assumes that the policy rate will be raised to around 10 percent by early 2023 and be maintained at that level before being gradually reduced starting in late 2023. On balance, risks to this inflation outlook are judged to be tilted to the upside.

16. Economic activity is projected to pick up in 2024 and the following years, in tandem with the U.S. The output gap will narrow after widening somewhat in 2023. However, without significant structural reforms, the growth rebound is expected to be modest, to about 2 percent. Potential output growth per capita would recover to a rate only slightly above one percent.5 The current account deficit is projected to stabilize at around 1 percent of GDP in the medium term.


Chain-Weighted Wage Growth


Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Sources: ENOE and IMF staff calculations.

17. The balance of risks to the near-term outlook for economic growth is tilted to the downside.

  • Higher global inflation and a sharper tightening of global financial conditions, or a sharper deceleration in economic global or U.S. growth, are the main downside risks. Additional external prices shocks, including from the Russian invasion of Ukraine, could put upward pressure on inflation, especially for food items, and inflation expectations. An illustrative global inflation scenario presented in the July 2022 World Economic Outlook Update could result in a peak output loss of 2 percent or more and stalling real GDP in Mexico (Box 2). Tighter-than-expected monetary policy could lead to an upswing in capital outflows, potential system-wide liquidity stress, downward pressure on the peso, and higher imported inflation. This could be exacerbated by a fall in remittances as the U.S. economy slows or worsening competitiveness relative to competitors that have seen a real depreciation in recent months. A sharper U.S. slowdown would be particularly consequential—in the short-term Mexican GDP has an elasticity of more than one with that of the U.S. (Annex VII).

  • On the domestic side, the inflation surge might reverse more slowly than expected, as it may have led to more backward-looking price dynamics or impending further increases in inflation expectations. In both cases, a tighter monetary policy stance would be required.

  • Risks loom along other dimensions as well. The emergence of new COVID-19 variants with greater evasion of previous immunity or higher hospitalization and mortality rates could result in lower mobility and higher precautionary saving. Additional large negative supply shocks from China could also be in train if continued zero COVID-19 policies motivated lockdowns similar to those seen this year. Rising inflation, declining incomes, and worsening crime and inequality could lead to social unrest and political instability.

  • Among medium-term risks are the possibility that scarring from the pandemic or policy uncertainty lowers potential output, as could climate-change induced risks (such as more frequent severe hurricanes and floods, or earlier emergence—or larger amounts of—stranded assets in the carbon-intensive energy sector).

  • Upside risks include the continuation of nearshoring dynamics in Mexico or smaller spillovers from an economic slowdown in the U.S. than was seen in the past. The former entails the buildup of productive and distribution capacity in Mexico, with a view to serve the North American markets. The latter could reflect continued robust service sector performance as the domestic economy recovers, or delayed effects on the manufacturing sector from the U.S. slowdown. Mexico’s exports could also get some boost in the near-term due to trade diversion effects from geopolitical tensions (Annex VIII, Annex VII of 2021 Staff Report).

Authorities’ Views

18. The authorities agreed that the current conjuncture of high and rising global and domestic interest rates, high inflation, and downside risks to growth presented elevated uncertainty with risks tilted to the downside. The budget contemplates growth for 2023 in the range of 1.2 to 3.0 percent in 2023, with a central estimate of 2.1, while the latest Banxico forecast puts it between 0.8 and 2.4 percent with a central estimate of 1.6 percent. The authorities see inflation falling in 2023 from a high level under the normalization of supply shocks, fiscal measures to contain fuel prices pass-through, and decisive monetary policy. They agreed disappointing growth in the U.S. is the headline risk. However, they noted that the manufacturing sector, which represents the bulk of trade exposure, might this time be less affected than services in a U.S. slowdown. At the same time, they expected that Mexico could benefit from the nearshoring trend. Faster-than-expected global monetary tightening could also spark a steepening credit curve and pressures on capital flows, though experience through the tightening cycle so far attenuates these concerns.

Global Tightening and Inflation Scenario

A global tightening and inflation scenario was simulated with the IMF’s G20MOD multi-country DSGE model to better understand the consequences of multiple downside shocks on the Mexican economy.1 The model results are presented in cumulative layers, with each successive layer adding another shock on top of those in the previous layer.

An initial layer simulates the direct effect of a temporary shock to global oil and food prices, which would rise by 10 and 50 percent, respectively, relative to the baseline. The shock would raise headline inflation in Mexico by nearly 1 percent above an already elevated baseline in year-on-year terms for a few quarters, but it would only have limited direct effects on output in the absence of a significant monetary policy response.

In a second layer, the commodity shock on top of the baseline, which already includes inflation at a 20-year high, causes a temporary dislocation of inflation expectations globally, including in Mexico. This results in a sharper increase in the domestic (and global) policy interest rate, in line with the increase in inflation expectations, to bring expectations back in line with the inflation target and limit second-round effects. In this case, output levels fall substantially below baseline, peaking at more than 1 percent below in the first half of 2023. Higher policy rates also present elevated systemic liquidity risk, discussed in detail in the accompanying 2022 Financial System Stability Assessment (FSSA) for Mexico.

Last, a third layer us added with a 1 percent decline in domestic demand, inspired by diminished real earnings expectations, or perhaps an un-modeled credit contraction. This brings output to more than 2percent below baseline at the trough while somewhat attenuating prices pressures. The three layers put substantial cumulative pressure on the corporate interest rate though a capital flow shock is not modeled directly.

1 The simulation is consistent with the global downside scenario presented in the July 2022 World Economic Outlook Update. It was constructed on the basis of shocks to economic variables relative from their baseline levels and, as such, the results generally are not sensitive to the baseline levels.

Policy Discussions

A. Tackling High Inflation

Monetary Policy

19. Banxico has taken a proactive approach to address increasingly broad-based inflation. Since June 2021, successive and gradually larger increases in the reference rate brought the ex ante real policy rate (i.e., the nominal rate adjusted for one-year ahead inflation expectations) to a moderately restrictive level by September 2022 at about 4 percent.6 This has been an appropriately calibrated response to the upward surprises to inflation and sequential delays in returning to the inflation target. In recent monetary policy statements, Banxico has also rightly indicated its intention to further increase the policy rate. It is expected that a policy rate of at least 10 percent would be required for inflation to reverse close to the central bank’s 3-percent target within the usual two years or so.

Sources: Banxico and Haver Analytics.

20. Inflation risks are expected to remain heightened for some time. The proactive policy tightening already put in place, alongside further increases in the policy rate, and weakening global demand are expected to lead to a slowdown in activity and a decline in inflation. However, there is significant uncertainty about the timing, speed, and durability of the downward path for inflation. This uncertainty arises from the possibility of: (i) further shocks, including spillovers to local raw and processed food prices from global commodity prices and domestic food prices, especially resulting from severe drought conditions in some Mexican states; (ii) if inflation imported from advanced economies is more persistent than expected; (iii) longer-lasting price pressures from supply chain constraints; (iv) further expected increases in the minimum wage feeding into costs and prices; (v) inertia resulting from more frequent domestic price adjustments; and (vi) further upticks in near-term inflation expectations that then feed in to wages and prices. The inflation surge in Mexico reflects both shocks in standard determinants (such as relative food and import prices, falling slack, and rising inflation expectations), but also a series of positive residual factors, and preliminary signs of greater inertia (Annex IX).

Sources: Haver Analytics and Banxico.

21. Risk considerations call for further increases in the policy rate and maintaining it at that higher level. The risks to inflation are not only high but also asymmetric in the usual one-to-two-year monetary policy horizon: upside surprises to inflation seem more likely than downside shocks. One contributing factor is backward-looking elements in the inflation process in Mexico according to Philips curve estimates for Mexico (Annex IX), which suggests additional risks from recent inflation shocks. Given these asymmetric risks and the substantial costs of de-anchoring wage and price formation, a risk management approach would argue for policy rates to rise further and stay firmly restrictive for some time, so as to keep wage and price formation anchored. Such an approach would entail a real ex ante policy rate that would peak at over 5 percent in 2023, broadly consistent with market expectations for nominal rates and staff’s inflation forecast.

22. Clear monetary policy communication will increase policy effectiveness during this period of significant inflation uncertainty. Banxico has appropriately taken steps to help the public better understand its policy decisions in this context. Steps have included the publication of updated inflation forecasts with every rate decision since August 2021 and, more recently, guidance on the direction of the next policy rate change in the monetary policy statement. These efforts have helped the public better understand the Governing Board’s policy decision. To further strengthen this understanding, Banxico could begin publishing more information on the policy rate path that underpins its macro forecast, including the expected rate and length of its stay at the peak of the tightening cycle, and possible triggers for changes in policies. If clearly presented as expectations and not a policy commitment, changes in the expected policy rate path would provide valuable information on how the central bank expects to adjust policy as economic conditions change. A broader review of the experience with Banxico’s inflation targeting framework over the past two decades could provide useful suggestions for further improvements to the policy framework and the communications toolkit.

Fiscal Measures

23. The authorities have used largely untargeted subsidies to mitigate the rise in the cost of living. The authorities expect that these subsidies will cost around 2 percent of GDP (see Annex VI for a description of the authorities’ anti-inflationary fiscal measures) which include:

  • Retail fuel price stabilization has directly reduced cost pressures, lowering inflation by an estimated 2 percentage points this year. The measure has come at a sizeable budgetary cost, estimated at around 1.5 percent of GDP, and has disproportionately benefited higher income households. Furthermore, by diluting price signals, the policy has short-circuited the desirable adjustment in fuel demand.

  • The measures to mitigate the impact of higher food prices have come at a smaller budgetary cost. They have mostly relied on preexisting programs (e.g., increased emphasis on direct fertilizer provision to small farmers or support for subsistence farming), and their direct impact on inflation has been minimal.

24. Overall, these fiscal and preexisting redistributive measures have helped support real incomes. The higher food and energy prices have only increased the deficit by around 1/4 percent of GDP with fuel subsidies offset by higher oil revenues and food-related measures funded from reducing other expenditures. However, in the event of a renewed increase in energy prices, the fiscal effects would depend on the level of refining margins (“crack spread”) and the duration of the higher global prices. In addition to these efforts to lessen the increase in the cost of living, the administration has increased the universal social (noncontributory) pensions and is projected to raise the minimum wage from 42 percent of the median formal sector wage in 2018 to 59 percent in 2022). Overall, in the context of a stronger economic recovery and record-high remittance inflow, these fiscal efforts, the higher minimum wage, and other labor market measures may have contributed to an increase in real per capita labor income of about 5 percent (y/y) by mid-2022.

25. The proposed neutral fiscal stance in 2023 strikes a balance between supporting monetary policy in its disinflation efforts while avoiding a material fiscal drag on activity. With the economy currently operating at close to potential the priority is to restore low and stable inflation. A restrictive monetary stance and a broadly neutral fiscal stance provide an appropriate policy mix to achieve this goal. However, continuing large minimum wage increases will likely add to inflation pressures, working at counter purpose to monetary and fiscal policies and potentially reducing formal employment for lower income workers (see below).

Authorities’ Views

26. The authorities agreed with the need for a robust monetary policy to keep inflation expectations well-anchored. The early and decisive monetary policy response to the global inflation surge had been successful, noting that upside risks to inflation were recognized early even when the surge was still considered transitory in the baseline. They underscored that the real policy rate was now in restrictive territory despite continued upward surprises to inflation. The authorities highlighted their strengthened communication efforts, which had ensured smooth financial market adjustment in this hiking cycle. They will continue to evaluate other tools that could improve communication.

27. The anti-inflationary fiscal measures have helped to mitigate the effects of inflation on those most exposed. The authorities emphasized that, despite these measures, they sustained momentum on the administration’s flagship reforms. Fuel price stabilization in particular had been central to efforts to support households and restrain inflation, in line with the President’s commitment to the people. They highlighted analysis suggesting that, in addition to supporting households, the pricing mechanism has dampening second-round inflation effects. Other anti-inflation measures had largely leveraged existing policies, especially in agriculture and for basic necessities other than fuels. The authorities underscored that the main goal of these policies was to support historically underserved agricultural communities, although they also expected positive effects on agricultural yields.

B. Managing Potential Downside Risks

Fiscal Policy

28. Fiscal policy could better prepare for downside risks. The neutral fiscal stance could be maintained if growth were to slow modestly. However, more could be done to be ready to provide targeted support for poorer households. In the event of a significant weakening of activity, additional discretionary fiscal support should be considered.

29. Under Mexico’s fiscal framework—which includes both a balanced budget rule and constraints on debt issuance—the scope to pursue a countercyclical fiscal policy is limited. Modest steps could, however, increase the ability of fiscal policy to provide targeted support in the event of a negative shock.

  • Changing the retail fuel price regime could create room for more targeted support in case of a prolonged global oil price increase. More market-based fuel pricing could allow for a passthrough of global fuel prices to domestic retail prices, encourage transition to greener sources of energy, and reduce the budgetary cost of subsidies. This would also strengthen the price signals for fuel demand and allow the fiscal savings to be, at least partially, reinvested in targeted support for vulnerable households7 by leveraging existing social safety nets (see Fiscal Policy for Mitigating the Social Impact of High Energy and Food Prices, IMF 2022) or relying on other tools (such as one-off cash payments, temporary energy bill discounts, or temporary public transport subsidies).

  • Implementing, and building upon, proposed reforms to the fiscal framework. Fiscal reserves in the Fondo de Estabilización de los Ingresos Presupuestarios (FEIP, also known as ’the stabilization fund) have fallen to less than 0.1 percent of GDP, given extensive usage during the pandemic and a restrictive replenishment mechanism under the Federal Budget and Fiscal Responsibility Law (FRBL).8 This is a potential constraint on the government’s ability to respond quickly to future shocks. The authorities estimate that a minimum of 0.3 percent of GDP would provide sufficient resources for a fiscal policy response. Recent amendments to the FRBL proposed by the authorities as part of the 2023 budget would bring FEIP reserves closer to this desired level, by enabling utilization of headroom against the government’s debt ceiling. This approach would enhance preparedness in the short-term. However, in the medium term, more extensive reforms are required to enhance flexibility more permanently, while also ensuring sustainability and credibility over the medium-term (Annex X). Such reforms could include (Annex IV of Staff Report 2019): (i) a well-calibrated debt anchor; (ii) broader coverage of expenditure in the structural spending rule; (iii) a medium-term fiscal strategy that specifies the post-shock adjustment path to return to the debt target; (iv) tighter triggers for the use of escape clauses; and (v) a strengthened role for the fiscal council.

30. A medium-term fiscal strategy could help to anchor expectations about future fiscal policy. The public debt ratio is expected to remain broadly unchanged in the next decade.9 Weaker-than-expected growth or adjustment slippages would thus result in a rising debt path. Nonetheless, the Sovereign Risk and Debt Sustainability Analysis (SRDSA) (Annex III) indicates that public debt remains sustainable. With the proposed fiscal framework reform, a credible debt anchor and a medium-term fiscal strategy could increase the scope to let fiscal policy act as a shock absorber and reduce the volatility in activity as a result.

Authorities’ Views

31. The authorities see advantages to maintaining the current retail fuel price stabilization mechanism. Given the current administration’s pledge that fuel prices will not rise in real terms above their November 2018 level and the legal basis of the pricing mechanism, the authorities prefer to continue with the current prompt and programmatic fuel price stabilization mechanism rather than more targeted support.

With oil prices expected to decline next year, the formula underpinning the fuel pricing mechanism is expected to result in lower subsidies in 2023. The authorities pointed to a track record of tapering subsidies when market price pressures abated. Other policies addressing food prices include the removal of tariffs on key food imports and regulatory agreements with retailers on food price passthrough. However, in anticipation of possible downside risks, they are interested in reforms to the fiscal framework that would enable the allocation of fiscal savings and funding from debt issuance to the stabilization fund, while respecting key tenets of the current framework. In case of a shock affecting vulnerable population, the authorities consider they can create space to provide support by reallocating spending away from public investment.

External Sector Policies

32. The peso has faced less downward pressure over the past year than other emerging market currencies. The relatively high interest rate differential between Mexico and the U.S. has made holding peso assets more attractive, which has helped in containing upside risks to inflation. In addition, the peso has been supported by strong remittances, a track record of fiscal discipline, and some inflows linked to the “nearshoring” of productive capacity.


Exhange Rates Against the U.S. Dollar

(Index: Jan 2020 = 100; increase = appreciation)

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Source: Bloomberg and IMF staff calculations.

Inflation and Policy Rate Gaps

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Source: Haver Analytics.

33. In the event of a weakening of the balance of payments, peso depreciation should be allowed to act as a shock absorber. Standard financial frictions underpinning concerns about depreciation generally are not relevant in Mexico’s case. In particular, peso foreign exchange (FX) markets are deep and liquid and even during the turbulence in 2020 saw below-average rises in the UIP premium and in bid-ask spreads. FX mismatches in balance sheets are contained. The economy and financial sector (see below) are thus expected to remain resilient if downward pressure on the peso materialized. However, in the case of a large shock resulting in sizeable depreciation, policy rate hikes might be needed to counter the inflation passthrough. If such a shock triggered market illiquidity and sharply higher bid-ask spreads, temporary FX intervention could be considered. The IMF’s Flexible Credit Line (FCL) provides an additional external buffer against such external risks and will help contribute to market confidence.

Authorities’ Views

34. The authorities consider that the country’s external buffers served them well during the pandemic and in the recent tightening period. The flexible exchange rate helped support the recovery by stimulating manufacturing. Portfolio outflows have proved manageable in the context of substantial remittances and recently resurgent FDI, while the level of foreign participation in local currency sovereign bond market, now back to earlier levels, lowers risks to future external shocks.

C. Maintaining a Robust Financial System

35. The financial system has emerged from the pandemic in good health. Non-performing loans (NPLs) rose modestly from low levels during the pandemic and began declining last year. Capital adequacy ratios are high and rising, and liquidity ratios are comfortable. With these buffers, the banking system demonstrated strong resilience to severe macrofinancial shocks in the solvency and liquidity stress tests conducted under the 2022 FSAP (although some smaller banks may require additional buffers to handle such stresses). Overall, systemic vulnerabilities and liquidity risks in the financial system appear broadly contained, given high capital buffers, low private sector leverage, and no sign of stretched asset prices.

36. Bank loans and the financial health of non-financial corporations should be monitored in the context of the recent rapid rise of interest rates. The increase itself should, all else equal, increase banks’ net interest margin, especially for larger institutions. On the other hand, with Mexican banks having increased their holdings of domestic government bonds, they could face mark to market losses on their holdings (although the impact is not expected to be large since their holdings are of short duration). A large fraction of non-financial corporate credit is floating rate, so higher interest payments could strain liquidity for some corporates and possibly increase default rates. Offsetting the pressures from higher interest rates, Mexican corporates retain relatively strong buffers and FSAP stress tests imply that heightened default risks under the adverse scenario from currently low levels would be manageable for the banking sector.

Sources: Bloomberg and BIS Statistics.

37. The authorities should take steps to further enhance the resilience of the financial system. The authorities have already rolled out critical Basel reforms, including the introduction of Total Loss Absorbing Capacity (TLAC) requirements and improved supervisory techniques and methodologies. The 2022 FSAP offers several recommendations for further steps (Annex XI).

  • Capacity of regulatory agencies. The autonomy and resources of regulatory government agencies and the legal protection of supervisors could be strengthened, to equip them to deal with the evolving risk environment.

  • Banking supervision and regulation. The banking regulator (CNBV) should continue to improve supervisory techniques, by simplifying its risk-based rating system and using methodologies that are principles-rather than rules-based. It should also be enabled to supervise effectively all financial conglomerates on a consolidated basis. Currently, such conglomerates can voluntarily request authorization to operate as a financial group, but some have not done so. The authorities should amend the 2014 Financial Groups law to make application mandatory for all such conglomerates.

  • Systemic liquidity management. System-wide liquidity risks appear contained, with commercial banks well-placed to provide liquidity to other financial institutions during periods of stress. Moreover, the authorities have demonstrated the effectiveness of their toolkit to support systemic liquidity during the pandemic. But conditions bear continued monitoring, particularly in a context of severe downside risks, and high levels of short-term wholesale funding of development banks deserve further consideration, though risks are attenuated by their liabilities guaranteed by the sovereign. Banxico’s Emergency Liquidity Assistance framework could be further enhanced.

  • Safety nets. CNBV should closely monitor risks from loan concentration risks and contingent credit lines to non-financial corporates and apply Pillar 2 requirements as needed. Bank resolution and recovery could be strengthened by removing impediments to banks’ resolvability, eliminating barriers to the effective use of the purchase and assumption and bridge bank tools, and expanding the resolution regime’s remit to financial holding companies. Board vacancies at the Deposit Insurance and Resolution Authority (IPAB) should be filled.

  • Cybersecurity. Banxico and CNBV could enhance their approach to strengthening cybersecurity in the financial system, by further developing their strategy and enhancing oversight, inspection, and investigative powers and instruments.

  • Climate risks. Financial system exposure to physical and transition risks from climate change is manageable but financial tail risks will worsen, particularly if investments in resilience are not made and global climate policy action is delayed, resulting in higher corporate defaults and lower bank capital.

38. The macrofinancial toolkit could benefit from additional instruments. While banking system and corporate sector risks appear contained, the mortgage market is less well regulated. Mortgages are still small as a share of bank capital and GDP, but they are growing rapidly (Figure 9). Introducing loan-to-value and debt-to-income requirements at this early stage would be prudent, ahead of a possible risk build-up. Publishing a macroprudential strategy and counter-cyclical buffer guidelines would further advance macroprudential policy.

39. Financial deepening should remain a policy priority. The authorities have undertaken various efforts in recent years, including to increase access to bank branches and financial products, improve transparency and broaden access with more digital connectivity. These efforts should continue. Mexico’s relatively poor financial depth is a headwind to inclusive growth. Difficulties in collateral recovery and perceptions of judicial quality are also headwinds (see below).

40. The authorities should continue to foster the development of Fintech to increase competition in the financial sector and broaden financial inclusion. Mexico’s 2018 Fintech law was an important step in developing the digital financial services industry, and helped foster the rapid creation of new firms, primarily in the e-payments sector. Additionally, Banxico has recently undertaken a plan to launch a central bank digital currency (CBDC). A primary objective of this initiative is to promote greater financial inclusion. As CBDC implementation raises complex legal, regulatory, and operational issues with little global experience so far, Banxico should continue to engage with stakeholders and ensure sufficient resources are allocated, including to ensure that safeguards to financial stability and integrity remain robust.

41. The authorities should build on their good progress in aligning the legal and regulatory framework with the Financial Action Task Force (FATF) standard by enhancing effectiveness. Efforts should continue to ensure that adequate, accurate and timely information on beneficial ownership is available. The authorities’ plans to establish a beneficial ownership register and strengthen the legal framework applicable to designated non-financial business and professions are key elements of this endeavor. Efforts should remain to strengthen Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) consolidated supervision, allocate adequate resources and reinforce enforcement to ensure effective, proportionate, consistent, and dissuasive sanctions. Emerging financial integrity risks, including those related to fintech and virtual assets (i.e., registration, customer due diligence, and supervision) also need monitoring.

Authorities’ Views

42. The authorities underscored their commitment to monitoring and containing emerging systemic risks in the context of their risk-based prudential oversight. They concurred that the Mexican financial system is robust and resilient to possible future adverse shocks. They shared the view that the policy framework performed well during the pandemic shock and are considering further analysis of potential system-wide liquidity risks, as new global shocks emerge. They intend to continue strengthening the risk-based supervisory framework and take note of the recommendations to expand the application of the consolidated supervision framework. As for other potential risks and recommendations, the authorities did not fully share the concern on the risks associated to contingent credit lines (the vast majority of such lines are revocable) or on liquidity risks from development banks (as these institutions are fully backed by the sovereign government). They agreed, however, to monitor and continue assessing these issues. They also noted that the institutional arrangements governing the autonomy of regulatory agencies are defined legislatively, emphasizing that there is a track record of supervisors and regulators operating with a high level of independence. The authorities are committed to boosting cyber resilience and will continue to develop new areas, such as climate risk and fintech, including in the context of their CBDC project, which focuses on promoting financial inclusion.

D. Policies for Higher and More Equitable Growth

43. Productivity growth has been weak despite successful trade opening and a stable macroeconomic environment. The 1994 North American Free Trade Agreement (NAFTA) eliminated almost all tariffs among Canada, Mexico, and the U.S. This opening reshaped the Mexican economy, with exports as a share of GDP rising threefold. Foreign direct investments also increased. Simultaneously, cautious fiscal and monetary policies have achieved moderate inflation, exchange rate stability, and stable public debt. This growth strategy should have spurred investment, productivity, and growth. Other supply side impediments, however, appear to have held back productivity gains.10


Structural Indicators, 2021 or Latest Available Year

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Sources: OECD, World Bank; and Worldwide Governance Indicators.Note: Higer values indicate values more favorable to growth. The Worldwide Governance Indicators (WGI) database reports normalized data, the blue arrows show 90 percent confidence intervals. Other indicators are rescaled so that the standard deviation across advanced economies and LA5 countries is equal to the average standard deviation across the 6 dimensions of the WGI for the same countries.

44. Alongside weak per capita income growth, poverty rates in Mexico have remained stubbornly high. Poverty rates have consistently hovered around 40 percent but rose in 2020 due to the pandemic. With the economic recovery, real income has rebounded, and poverty rates have fallen back to pre-pandemic levels.11


Trends in Labor Income and Poverty

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Source: CONEVAL1/ Real per capita labor income is taken from CONEVAL's Cuadro de Indicadores ITLP statistical release and defined as per capital labor income (including informal labor income) deflated by CPI. Data on per capita labor income is missing for 2020Q2 due the impact of the COVID-19 pandemic on data collection.2/ The official labor income poverty line is determined by CONEVAL using its labor poverty index methodology.

45. There are persistent, stark regional inequalities that show no sign of narrowing. Both the Northern and Central regions of Mexico have greatly benefitted from proximity to the U.S. Meanwhile, the South of the country has suffered from little integration with the rest of the country and the U.S., and limited economic opportunity. This has resulted in low levels of investment in health, education, and infrastructure, thereby reinforcing a significantly poorer economic performance and lower real incomes.

Sources: CONEVAL, INEGI; and IMF staff calculations1/ Real per capita labor income is taken from CONEVAL's Cuadro de Indicadores ITLP statistical release and defined as per capital labor income (including informal labor income) deflated by CPI. Data on per capita labor income is missing for 2020Q2 due to the impact of the COVID-19 pandemic on data collection. Regional averages are calculated as the average of state-level per capita income from CONEVAL weighted by the share of the economically active population aged 15+ that the state contributes to the broad geographic region. This data is taken from INEGI's National Survey of Occupation and Employment statistical release.2/ Northern Mexico includes the states of Aguascalientes, Baja California, Baja California Sur, Coahuila de Zaragoza, Chihuahua, Durango, Nayarit, Nuevo León, San Luis Potosí, Sinaloa, Sonora, Tamaulipas, and Zacatecas. Central Mexico includes the states of Colima, Ciudad de México, Guanajuato, Guerrero, Hidalgo, Jalisco, México, Michoacán de Ocampo, Morelos, Puebla, Querétaro, Tlaxcala, and Veracruz de Ignacio de la Llave. Southern Mexico includes the states of Campeche, Chiapas, Oaxaca, Quintana Roo, Tabasco, and Yucatán.

46. The supply side policy agenda should be broadened to unlock Mexico’s growth potential. The current administration’s policy agenda has focused on redistribution, trade promotion, infrastructure investment, and trade integration to foster development, especially in Southern states. Flagship reforms include (i) the implementation of the U.S.-Mexico-Canada Agreement (USMCA); (ii) increases in the minimum wage and the subcontracting law to reduce wage inequality; (iii) increases in the general social pension to reduce old age poverty; and (iv) the development of trade infrastructure in the Isthmus of Tehuantepec (“Isthmus corridor”) in the South of Mexico. While this agenda addresses some obstacles to higher productivity and growth, additional efforts are needed. Priorities include corruption, crime and rule of law issues; addressing human capital and infrastructure shortfalls; and lessening labor and product market rigidities.

A Budget for Higher, More Equitable Growth

47. A pivot to a more equitable and pro-growth budget would entail a gradual increase in productive government spending, financed by revenue-increasing tax reforms. To lift the growth potential and reduce socioeconomic gaps, Mexico should address spending shortfalls in education, health, public investment, and social safety nets (IMF Staff Report 2021/2020; IMF Selected Issues 2019, Paper 2; IMF WP/20/215). Structural indicators such as spending per student, the teacher-to-student ratio, and public health spending per capita are well below the OECD averages and somewhat below emerging market averages (IMF WP/21/244). The pandemic has further increased spending needs, particularly in education (following 18 months of school closures). Separately, there is scope, and a need, to increase revenue through tax reform, to support the additional spending and secure tax buoyancy.12


Growth Decomposition

(Annual averages in percent)

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Sources: INEGI and IMF staff calculations.

48. A gradual, permanent increase in spending of around 2 to 3 percent of GDP could foster inclusive growth, reduce poverty, and address pandemic legacies. This feasible step would help make progress in achieving the Social Development Goals (SDG; IMF WP/21/244). The gains from higher spending on education, health, public investment, and social safety nets could be enhanced with more efficiency in programs. For example, social assistance could reduce the leakage of benefits to high-income groups and eliminate overlaps and coverage gaps with the creation of single beneficiary registry. Efficiency gains in public investment could be achieved through better coordination across government levels, effective national and sector strategies to guide planning, and better multi-year budgeting (IMF 2019).

49. While higher oil prices have lowered immediate debt service pressures on Pemex, restructuring efforts need to continue. Changes to the business plan should remain a priority, including focusing on production in profitable fields, selling non-core assets, and reforming its pension scheme. More partnerships with private firms in upstream projects could help in maintaining or increasing production capacity at lower cost and reducing risks to Pemex’s financial position and the government budget.

50. A credible, well-designed medium-term tax reform could generate additional revenues to finance the permanent increase in spending on health, education and social assistance. Mexico’s non-oil revenue was nearly 6 percent of GDP below Latin American peers (and only about half the OECD average) before the pandemic. Actions to strengthen tax administration should continue (Annex XII) but tax policy reforms would also be essential:

  • Value Added Tax (VAT). Eliminating zero-ratings, except for a few essential foodstuffs, and rationalizing exemptions and differences in rates increase collection. A comprehensive risk management strategy and a high-coverage audit process for VAT returns could also reduce the compliance gap.

  • Personal income tax. Eliminating exclusions (e.g., of income on personal business activities and independent services), reducing tax expenditure, and widening the top personal income tax bracket. These measures could yield around 3/4 percent of GDP.

  • Subnational taxes. Property taxes could be increased gradually to raise over 3/4 percent of GDP. Updating the cadaster and enhancing policy coordination between the federal and subnational governments would be essential. Simplifying and better enforcing the local vehicle tax could increase revenue for states and municipalities.

  • Carbon tax. While carbon pricing coverage through both the Emission Trading Scheme (ETS) and carbon taxation is high relative to peers, Mexico could further raise the carbon price to levels consistent with the Nationally Determined Contributions (NDCs; Black and others, 2021). The carbon tax remains relatively narrow in scope with a de facto exemption of natural gas.13 Also, the tax rate (USD 3 per ton of CO2) is very low and should be raised to USD 75 by 2030 (along the lines of the global carbon tax floor proposed for G20 economies by the IMF). Such a carbon price, combined with an expansion of emissions pricing coverage, would raise additional revenues of close to 1.8 percent of GDP by 2030 (Black and others, 2021). A compensation scheme would be needed for those who are most negatively affected by the resulting energy price increase.

51. Overall, the comprehensive fiscal package of higher spending financed with higher revenues should have positive complementarities between growth and equity.

  • The higher permanent spending aims to close above-discussed socioeconomic gaps that have held back investment in human capital and productivity. In the context of Mexico where the socioeconomic gaps are concentrated in specific regions, the increased and more efficient productive spending, especially in those regions, should enhance both growth and equity.

  • The trade-offs between growth and increased revenues are likely to be small as a significant part come from VAT reforms, which should not distort factor supplies or affect long-term growth especially since the reforms would be accompanied by compensation for poor households. Increases in the personal income tax would largely be through simplifying and expanding the tax base, which would have minimal effects on labor supply.

  • Together, such budget reforms would increase growth and place public debt on a firm downward trajectory over the medium term (IMF Staff Report 2021, IMF Staff Report 2020, IMF WP/20/215).

Authorities’ Views

52. They are supportive of a pro-growth productive spending increase supported by tax reforms. But note such measures would require time to be implemented. In the meantime, they remain confident that the administrative measures to combat tax evasion and tax fraud taken by the current administration would continue to maintain robust revenues.

Other Structural Policies

53. A determined implementation of the anticorruption framework would help in addressing corruption and other governance issues. Contract enforcement by civil justice is very weak, discouraging business expansion and formal employment. This also complicates collateral seizure and impedes financial development. Corruption undermines the provision on public services. Organized crime increases transport and insurance costs and discourages entrepreneurs and business formation. Improving governance would unlock investment and growth potential. A new law treating corruption and fraud as felony offenses is expected to enable more comprehensive investigations on corruption. The challenge lies in implementing and assessing effectiveness of the anti-corruption policies, and in further coordinating state levels. Prevention, facilitation of reporting including with whistleblowing protection and further empowering the institutions in charge of investigation, prosecution and oversight can improve implementation. Mexico should participate in the next round of voluntary assessments of transnational aspects of corruption by the Fund.

54. Recent labor market reforms should be complemented by measures to reduce informality. The 2021 pension reform risks reducing formal labor supply incentives, including by reducing the number of qualifying weeks for pension eligibility and raising contribution rates (Annex XIII). At the same time, the share of informal employment remains elevated and is associated with low productivity. Recent reforms to reduce inequality—notably increases in the minimum wage— risk increasing incentives for informality and reduce opportunities for workers to transition to the formal sector. It would be preferable, therefore, to align real minimum wage increases more closely with average productivity growth of low wage workers. Other steps that could help reduce informality could include: (i) continuing to improve labor dispute resolution mechanisms (building on the experience of the 21 states that have already implemented the mechanism); (ii) lowering restrictions to layoffs; and (iii) reducing regulatory costs of formalizing a business. Also, improving access to, and the quality of, childcare would increase female labor force participation.

Sources: ENOE and IMF staff calculations. Income and minimum wages are monthly as recorded in ENOE exluding municipalities along the northern border with the U.S. Minimum wages for 2023 and 2024 are estimated based on assumption of 50.4 percent cumulative growth.


Informality Rate in Mexico

(Percent of total employment)

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Source: INEGI.Note: Data on informality is missing for 2020Q2 due to the impact of the COVID-19 pandemic on data collection.

55. The USMCA trade agreement and its implementation remain important catalysts for higher growth and reform.

  • The agreement with the U.S. and Canada reduces regulatory divergence, complementing the elimination of many tariffs under NAFTA. Implementation efforts include the establishment of new, independent labor adjudication courts at the state level.

  • An important challenge for Mexico is to increase the domestic value-added content of exports to abide by the tighter rules of origin, including in the automotive and textile sectors. Meeting these rules calls for complementary reforms, including through the structural fiscal reforms discussed earlier (e.g., to support education and training).

  • Mexico could also take steps to reduce trade barriers with other important partners, including China, the EU, and Latin America. Strengthening customs cooperation could further increase trade integration with neighboring Central America (Annex XIV).

  • The implementation agenda should be complemented with regulatory moves fostering more competition. High rates of firm creations suggest that the regulatory framework provides for a low entry cost for businesses in many sectors. Yet regulatory hurdles in some sectors with critical forward linkages (e.g., foreign direct investment restrictions in surface, maritime and air transport) limit competition and, through the implications for input costs, harms the competitiveness of other sectors. Also, cumbersome licenses and permits procedures create vulnerabilities to corruption (e.g., road transport, custom brokerage and restaurants licenses, construction permits). Streamlining licensing and permit procedures would reduce vulnerabilities to corruption and improve competitiveness. Finally, the autonomous competition authority should be strengthened by reversing recent budget cuts and preserving its statutory independence.

56. Restoring a more predictable and independent energy policy would also boost competitiveness and investment. Actions to reverse the 2013 energy reforms remain incomplete, as Parliament rejected the change in the constitution needed for a full reversal, which has introduced policy uncertainty about the way forward. A new electricity law, however, was approved and has replaced auctions by nonmarket-based policies, with regulatory power given to the Comisión Federal de Electricidad (CFE), the state-owned electricity company. This has created conflicts of interest and disrupted contracts signed under the 2013 reform. Policies should instead aim to encourage private sector participation in the energy sector. Restoring market-oriented regulatory frameworks would leverage Mexico’s large and diverse renewable energy resource base. It would also provide for cheaper, more reliable, sustainable, and competitive energy supply to the economy and people and secure the needed investment.

57. Mexico established a climate change mitigation and adaptation agenda early but reducing greenhouse gas emissions will require determined steps, including through ambitious carbon pricing.14 The expansion of the emission trading system (ETS) in 2023 will be an important step towards pricing emissions comprehensively. However, questions remain regarding the scalability and parameters of the ETS, which is currently in a pilot phase covering a small number of large entities. Although these are responsible for around 40 percent of emissions, the ability to expand coverage is not clear. Additionally, the size of the allocated allowances and the absence of legally binding emissions caps mean that the market created by the pilot is limited. Ensuring adequate enforcement and monitoring of polluting activity, introducing legally binding emissions caps, and introducing the planned auction system for allowances are key to making the ETS fully functional. Further, sectoral measures, such as feebates, public investment in clean energy infrastructure networks, and regulatory reforms in the energy sector as discussed above could enhance the impact of carbon pricing.

Authorities’ Views

58. The authorities pointed to a sharp increase in public investment especially in underdeveloped areas, to support growth and reduce regional disparities. They considered industrial policy and strengthening human capital as major priorities to increase productivity. They agreed on the need to continue advancing the governance agenda and improve the effectiveness of the anti-corruption and AML/CFT framework. They noted that their efforts to improve governance also included greater reliance on the army to curb crime and the removal of conditionality in transfer programs, the latter to lower the programs’ vulnerability to corruption. They were pleased that the implementation of the 2019 labor law had already resulted in accelerated resolution of labor disputes. The authorities were seeking to increase labor market formality with the outsourcing law and tax administration reforms. They considered that a regulatory framework strengthening their energy state-owned enterprises served the economy better.

Staff Appraisal

59. Mexico is well placed to navigate a more challenging, potentially turbulent global environment. The post-pandemic recovery has been relatively gradual, but domestic inflation has accelerated in line with developments elsewhere. Near-term growth prospects for the U.S. have weakened and global financial conditions have tightened as central banks have responded to high inflation, increasing the risks of capital flow reversals in emerging market economies. In this environment, Mexico will benefit from its very strong macroeconomic policies and policy frameworks but should also prepare contingency plans to react quickly to downside scenarios.

60. Growth is expected to slow in the near-term and the balance of risks is tilted to the downside. After strong outturns in the first half of 2022, growth is projected to decline in the next few quarters, while inflation is expected to gradually fall. More persistent global or domestic inflation, another spike in international oil or food prices, a greater-than-expected tightening of global financial conditions, or a sharper slowdown in U.S. growth are the main downside risks. On the upside, an acceleration in nearshoring of production for better access to the North American market could moderate the impact of lower U.S. growth.

61. Tackling high inflation calls for further increases in the policy rate and maintaining it there for some time. With significant uncertainty about the path for inflation in 2023 and important upside risks, a clearly restrictive policy stance for some time would be appropriate. Further steps in using policy communication as a tool, including further information on the rate path consistent with Banxico’s inflation forecast, could reinforce the proactive approach to re-anchoring near-term inflation expectations and minimizing disruptions in financial markets.

62. The envisaged neutral fiscal stance in 2022 and 2023 is appropriate. With the economy currently operating at close to potential and restoring low and stable inflation a priority, a restrictive monetary stance and broadly neutral fiscal stance is an appropriate policy mix.

63. The untargeted fiscal measures deployed to mitigate the impact of rising living costs raise efficiency concerns but have supported real incomes. Retail fuel price smoothing has reduced cost pressures for the economy but at a sizeable cost to the budget. Shifting to targeted support could safeguard priority spending and insulate the budget from swings in oil prices.

64. Fiscal reserves should be restored and the institutional framework for fiscal policy should be strengthened. Rebuilding the FEIP stabilization fund to around 0.3 to 0.5 percent of GDP would create room for fiscal policy to respond to near-term shocks. In the longer term, more fiscal policy flexibility to respond to shocks could be achieved through the introduction of an explicit debt anchor with narrowly defined escape clauses and a clear mechanism to return to the debt path following periods of deviation.

65. The floating exchange rate should continue to serve as a shock absorber. The economy is expected to remain resilient if downward pressure on the peso materializes, benefiting from deep FX markets and contained FX mismatches in balance sheets. In the event of large shocks to capital flows, monetary policy could be used to counter the potential inflationary impact of a weaker peso. FX intervention could be considered to mitigate a material worsening of market illiquidity.

66. Additional measures would help the financial system remain resilient in a changing financial and regulatory landscape. While systemic vulnerabilities are found to be contained, the 2022 FSAP flags the need for upgrading the financial sector oversight and crisis management frameworks to close some gaps and address emerging challenges. After aligning the legal and regulatory AML/CFT framework with Financial Action Task Force standards, the focus should now be on strengthening the AML/CFT regime, including through adequate resourcing, ensuring the availability of high-quality beneficial ownership information, and monitoring emerging financial integrity risks related to fintech.

67. Unlocking growth potential and reducing inequality require a broad supply side agenda. Despite increased trade openness and macroeconomic stability, productivity growth has been weak and the growth in output per worker has averaged close to zero over the past 15 years. The authorities’ agenda addresses some obstacles to higher productivity and growth, but additional efforts are needed to address corruption, crime, and the weak rule of law; increase human capital investments and address infrastructure bottlenecks; and reduce labor and product market rigidities.

68. Financial inclusion should be deepened to support inclusive growth. The potential of digital finance to increase financial access and depth should be fostered through increased competition in the financial sector, while maintaining safeguard to ensure financial stability and integrity. Efforts to broaden digital connectivity and to improve the transparency of financial services should continue.

69. Determined implementation of the anticorruption framework will be key to enhancing its effectiveness. Steps should include strengthening prevention, facilitating reporting including whistleblower protection, and further empowering institutions in charge of investigation, prosecution, and oversight.

70. A gradual increase in productive government spending, financed by reforms to raise tax revenues, would promote growth and equity. Higher spending on education, health, public investment, and social protection is critical to improve human and physical capital and to narrow the significant variation in social outcomes across states. To be effective, this higher spending would need to be accompanied by more efficient public spending, building on recent steps taken to improve spending control and program design. Recent tax administration reforms have buoyed revenue, but a well-designed tax policy reform is needed to reduce differences in VAT rates, reduce tax expenditures, and widen the top personal income tax bracket. These reforms should be combined with adequate compensation to offset the impact on poorer households.

71. Recent labor market reforms should be adapted to lessen their negative effects on formal sector employment. The current strategy could be complemented by continued implementation of the labor dispute resolution mechanisms; lowering firing restrictions; reducing the regulatory costs of formalizing a business; and aligning increases in the real minimum wage to increases in the productivity of lower wage workers.

72. A more predictable energy policy that is more open to private sector participation would boost competitiveness and investment. Reestablishing more market-oriented regulatory frameworks would leverage Mexico’s large and diverse renewable energy resource base. It would incentivize investments to create a cheaper, more reliable, sustainable, and competitive energy supply.

73. Further steps toward carbon pricing would reduce greenhouse emissions. The expansion in 2023 of the emission trading system (ETS) will be an important step towards comprehensively pricing emissions. Ensuring adequate coverage, enforcement, and monitoring of polluting activity, introducing legally binding emissions caps, and introducing the planned auction system for allowances are key to making the ETS fully functional. Other measures, such as increasing the carbon tax, introducing feebates, expanding public investment in clean energy infrastructure, and regulatory reforms could help Mexico achieve its NDCs.

74. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Figure 1.
Figure 1.

Mexico: High Frequency Indicators

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Sources: National authorities, Oxford University, Google Mobility, Haver Analytics, Bloomberg, Refinitiv Eikon.1/ In the top left panel, all dots reflect new forecasts.2/ Stringency calculated as the Oxford University Stringency index of the health policy response.

Figure 2.
Figure 2.

Mexico: Labor Market Indicators

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Sources: National Authorities, Haver Analytics, and IMF staff calculations.

Figure 3.
Figure 3.

Mexico: Real Sector

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Sources: National Authorities, Haver Analytics, and IMF staff calculations.1/ Employment is calculated as employment as a share of the economically active population.2/ Formal employment is calculated as the number of IMSS-reporting employees, which does not capture self-employed formal workers.

Figure 4.
Figure 4.

Mexico: Prices and Inflation

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

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

Figure 5.
Figure 5.

Mexico: External Sector

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Sources: National Authorities, Haver Analytics, and IMF staff calculations.

Figure 6.
Figure 6.

Mexico: Reserve Coverage and FCLs in an International Perspective 1/

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Sources: World Economic Outlook; IFS; and IMF staff estimates.1/ The sample of countries included in these charts includes all EMEs for which data is available.2/ The ARA metric provides a tool to help inform reserve adequacy assessments, but individual circumstances (for example, access to swap lines, market maturity, etc.) require additional judgment and, for this reason, mechanistic comparisons of the ARA metric do not provide a complete view.3/ The ARA Metric is a weighted sum of potential drains on the BoP, depending on the country’s exchange rate regime. For fixed exchange rates, ARA Metric = 10% × Exports + 10% × Broad Money + 30% × Short-term Debt + 20% × Other Liabilities. For floating exchange rates, ARA Metric = 5% × Exports + 5% × Broad Money + 30% × Short-term Debt + 15% × Other Liabilities. See “Guidance Note on the Assessment of Reserve Adequacy and Related Considerations", IMF, 2016.4/ The upper and lower lines denote the 100-150 percent range of ARA metric, which are considered broadly adequate for precautionary purposes.5/ The current account balance is set to zero if it is in surplus.

Figure 7.
Figure 7.

Mexico: Fiscal Sector

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Sources: National authorities, World Economic Outlook, Fitch Ratings, and IMF staff calculations.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 8.
Figure 8.

Mexico: Financial Markets

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Sources: Bloomberg, Haver Analytics, National authorities, and IMF staff calculations.1/ Flows associated with Pemex transaction on 11/20/2020 have been removed.

Figure 9.
Figure 9.

Mexico: Banking System

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

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

Figure 10.
Figure 10.

Mexico: Nonfinancial Corporate Sector 1/

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Sources: Bloomberg, Haver Analytics, National authorities, and IMF staff calculations.1/ Totals exclude any hard currency issuance in local lawLTM= Last 12 months, 2021Q3-2022Q2.

Figure 11.
Figure 11.

Mexico: Social Indicators in Regional Context

Citation: IMF Staff Country Reports 2022, 334; 10.5089/9798400224669.002.A001

Source: 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 measure 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 social assistance benefits.

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

The 2020 PSBR is adjusted for some statistical discrepancies between above-the-line and below-the-line numbers.

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.

Interest payments differ from official data due to adjustments 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.

The 2020 PSBR is adjusted for some statistical discrepancies between above-the-line and below-the-line numbers.

Adjusting revenues for the economic and oil-price cycles and excluding one-off items (e.g. oil hedge income 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)

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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.

Table 4b.

Mexico: Summary Balance of Payments

(In percent of GDP)

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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.