Press Release No. 14/511

Press Release: IMF Executive Board Concludes 2014 Article IV Consultation with Mexico

November 12, 2014

On November, 7, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Mexico.

Mexico has completed the legislative process underpinning its comprehensive structural reforms agenda. More than a dozen reforms have been approved over the last year and a half including on energy, telecommunications, anti-trust, labor markets, education, and the financial sector. By enhancing competition, reducing labor market frictions, and encouraging investment, the reforms are expected to boost productivity and output over the medium term.

After a sharp slowdown in 2013—reflecting weak external demand and a decline in construction activity—growth is projected to recover to 2.4 percent this year. The strong recovery in the U.S. in the second quarter of 2014 has triggered a rebound in Mexico’s manufacturing production and exports (especially in the automotive sector). In addition, construction activity is firming up, supported by a rebound of residential investment and an increase of government spending on infrastructure.

Labor market indicators suggest that the economy continues to operate below potential, helping to contain inflationary pressures. The unemployment rate has inched up since early 2013, and real wage growth has been subdued. Headline inflation rose to 4½ percent year-on-year in early 2014, reflecting one-off effects from tax changes. It is expected to stay around 4 percent in the remainder of 2014, driven by increases in livestock and government-administered prices, before declining gradually in 2015. Core inflation remains close to 3 percent and long-term inflation expectations are well anchored.

The Bank of Mexico cut the policy rate by 50 basis points to 3 percent in June in the context of limited inflationary pressures and a weak economy while fiscal policy remains broadly neutral. The fiscal outturn for the first half of 2014 has been broadly in line with the Public Sector Borrowing Requirement (PSBR) budget target of slightly over 4 percent of GDP.

Commercial bank credit growth slowed down in the first half of 2014 for households and firms. Among corporate borrowers, the deceleration has been concentrated in construction: banks reduced sharply lending to the sector after the financial difficulties of the three largest builders surfaced last year. On the household side, consumer credit growth moderated to 8 percent (from 16 percent last year). In contrast, lending by the public-owned development banks is growing rapidly, although from a low base, as the financial sector reform gave development banks a new mandate of promoting micro-financing and lending to underserved sectors, including SME’s.

The share of non-performing loans (NPLs) in total loans by commercial banks has stabilized, reaching 3¼ in June up from 2½ percent in 2012, reflecting mostly a rise in impaired loans in the construction sector. However, NPLs have been fully provisioned, and profitability and capitalization of the banking sector remains strong.

Mexico’s external position remains broadly consistent with fundamentals and desirable policy settings. The current account deficit widened to 2.1 percent of GDP in 2013, reflecting higher net factor payments, while the trade balance remained stable. In 2014, the current account deficit is projected to remain unchanged with an improving trade balance offset by a continued increase in factor payments. The nominal and real effective exchange rates have depreciated modestly since end-2013. The current level of foreign reserves is adequate for normal times according to a range of standard reserve coverage indicators. Gross portfolio inflows have rebounded after a sharp slowdown in Q2 of 2013. In February, Moody’s raised Mexico’s foreign currency sovereign rating to Aa3, citing the expected positive impact of structural reforms on potential growth. Looking forward, the structural reforms in energy and telecommunications are expected to attract significant foreign direct investment.

Executive Board Assessment²

Executive Directors welcomed the rebound in economic activity in Mexico, boosted by strong external demand and a recovery in the construction sector. They also commended the completion of the legislative process underpinning the country’s comprehensive structural reform agenda. Directors noted that a potential surge in volatility in global financial markets poses risks. They expressed confidence in Mexico’s strong policy fundamentals and noted that the FCL arrangement has provided insurance against tail risks.

Directors considered that the current stance of monetary policy remains appropriate. They welcomed the Bank of Mexico’s commitment to adapting monetary policy in case of upward pressure on prices. Directors took note of the staff assessment that the real exchange rate and the current account balance are broadly consistent with underlying fundamentals. They observed that a high level of international reserves in the context of Mexico’s free floating exchange rate regime, as well as Mexico’s deep and liquid financial markets, should help the country weather well a rise in volatility.

Directors supported the authorities’ plans to reduce the public sector borrowing requirement to 2.5 percent of GDP by 2018. They emphasized that strict adherence to the announced fiscal path will strengthen the credibility of the new fiscal framework. Some Directors stressed that boosting non oil revenues would be needed, especially if oil revenues are lower than anticipated. Directors encouraged the authorities to improve budget implementation further through more realistic expenditure budgeting and stricter control of budget execution. Directors welcomed the creation of an oil stabilization and saving fund, and the plan to reform the pension system of the two large state owned companies.

Directors observed that the monitoring and control of state and municipal finances need to be strengthened. Full adoption of the uniform accounting methodology for reporting local government finances and introduction of a formal legal framework to anchor fiscal policymaking at the local level would be important.

Directors commended Mexico’s sound financial sector and the progress in strengthening the regulation and consolidated supervision of large financial conglomerates. They advised careful monitoring of the rise in non performing loans in housing and foreign currency borrowing among some large companies. While welcoming the increased role of development banks in improving financial inclusion, they recommended caution to avoid displacing private bank lending or relaxing credit standards.

Directors underscored the importance of strong and steady implementation of the structural reform agenda. Properly sequenced and executed, these reforms would boost productivity and output growth over the medium term.