Public Information Notice No. 11/111

Public Information Notice: IMF Executive Board Concludes 2011 Article IV Consultation with Mexico

August 8, 2011

On July 27, 2011, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Mexico.¹

Background

Mexico has recovered rapidly from the fallout of the global crisis. After a sharp contraction in 2009, growth in Mexico picked up strongly in 2010, reaching 5.4 percent. Robust growth has brought output back to pre-crisis levels, with manufacturing exports leading the recovery and the rebound in domestic demand helping sustain the momentum. This rapid rebound in output has been underpinned by Mexico’s sound public and private sector balance sheets, strong prudential framework, and the effective countercyclical policy response, with the floating exchange rate providing also an important buffer to the fallout from the global crisis and supporting the recovery. The three successive Flexible Credit Line arrangements (currently with an access equivalent to US$73 billion) have backed the authorities’ macroeconomic strategy by providing a significant buffer against potential tail risks.

Strong growth is envisaged to continue this year and next, at about 4.5 and 4.1 percent respectively. The near term outlook is supported by the expected continued recovery in the U.S. and solid domestic demand growth in Mexico. In this context, inflation has remained benign, with headline and core inflation declining to the 3 percent target. With demand pressures still subdued and inflation expectations well-anchored, the central bank has maintained the policy rates at 4.5 percent (since mid-2009). The current account deficit is projected to widen moderately this year to 1 percent of Gross Domestic Product (GDP), and to 1.5 percent over the medium term.

Capital inflows have increased in 2010 and 2011, on the back of sizable flows to peso-denominated government securities. This has reflected Mexico’s improved outlook and its inclusion in the global bond index WGBI in 2010, which has attracted long-term institutional investors. In this context, the peso has appreciated by some 25 percent in real effective terms since the depth of the crisis, but still is somewhat below the pre-crisis levels. International reserves have increased by US$27 billion over the last 12 months, with gross reserves now at US$131 billion, mostly through the sale of oil revenues, with rules-based interventions playing only a limited role. The banking system continues to be liquid and well-capitalized, with funding mainly from domestic deposits. Private sector credit growth has picked up in line with the economic recovery, with household and corporate leverage ratios broadly stable.

Executive Board Assessment

Executive Directors commended the authorities for their strong rules-based policy framework, which has underpinned skillful macroeconomic stewardship and a rapid turnaround in activity. With the recovery expected to remain firm, a gradual withdrawal of the policy stimulus that takes due account of the significant global uncertainty is warranted in the near term. Directors noted that the main medium-term challenges for Mexico are to bolster its growth potential and address long-term fiscal challenges.

Directors supported the authorities’ fiscal consolidation plans, including returning to the balanced budget rule next year and lifting the ceiling on the accumulation of resources in the oil stabilization fund to save oil revenue windfalls. They welcomed the planned adjustment of gasoline prices to bring them gradually in line with international prices, while strengthening the social safety net to protect the most vulnerable. Directors encouraged further efforts to rebuild fiscal buffers over the medium term, particularly in view of population aging and the projected decline in oil revenues relative to GDP. This requires a combination of expenditure restraint and non-oil revenue mobilization, including at the sub national government level. Consideration should be given to adopting a structural budget rule to reduce policy pro-cyclicality, and broadening the coverage of fiscal accounts to include sub-national governments.

Directors supported the accommodative monetary policy stance, given contained inflationary pressures and well-anchored expectations. However, they noted the challenge of calibrating the policy settings in a way that balances domestic cyclical considerations against global uncertainties as fiscal consolidation is underway. Directors underscored the need for the authorities to remain vigilant and stand ready to take action as needed.

Directors agreed that Mexico’s flexible exchange rate has played an important role in absorbing external shocks and managing capital inflows. They took note of the authorities’ limited intervention through the transparent, rules-based mechanisms.

Directors welcomed the resilience of Mexico’s financial sector—the result of the authorities’ efforts to strengthen the regulatory and supervisory framework. They considered that financial supervision has been further bolstered by the establishment of the Financial Stability Council to monitor systemic risks and address potential vulnerabilities, and that Mexico is well placed to meet Basel III prudential standards ahead of schedule. Directors looked forward to a comprehensive review of progress in the forthcoming Financial Sector Assessment Program (FSAP) update.

Directors emphasized that ambitious structural reforms are crucial to increase productivity and promote investment. They welcomed steps to improve anti-trust regulations, and called for a comprehensive strategy to address the most pressing constraints and prioritize reform efforts. Key among them is to improve labor flexibility, access to credit for small- and medium-sized enterprises, and job opportunities in the formal sector. Enhancing the efficiency and governance of state energy companies is also a priority.

Directors underlined the importance of closely monitoring cross-border spillovers, noting that a surge in global risk aversion could affect Mexico despite its strong fundamentals. They continued to view the Flexible Credit Line arrangement as a useful insurance against potential global tail risks. In this context, some Directors saw a further build-up of international reserves as part of an exit strategy from the arrangement, while a few others considered Mexico’s reserve coverage to be adequate.