Press Release No. 15/519

Press Release: IMF Executive Board Concludes 2015 Article IV Consultation with Mexico

November 17, 2015

On November 9, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Mexico.

Mexico has faced a complex global environment over the last year, characterized by a rise in global financial market volatility and the collapse of oil prices. Nonetheless, the economy has continued to grow at a moderate pace, and capital outflow pressures have been limited. The flexible exchange rate has helped the economy adjust to external shocks, while inflation has remained low and stable. The Mexican peso has depreciated by 16 percent in real effective terms in the last twelve months. Mexico is implementing a broad range of structural reforms, which should help lift potential growth over the medium term.

The economy is projected to grow by 2.25 percent this year. Construction activity has moderated after a strong rebound in the second half of last year. Manufacturing and services remain the main driver of growth, although weaker-than-expected U.S. demand affected manufacturing exports in early 2015. A fall in domestic oil production continues to be a drag on growth. Real GDP growth is expected to accelerate modestly to 2.5 percent in 2016, supported by strengthening external demand. Lower electricity prices and the real depreciation of the peso should boost Mexico’s manufacturing production and exports, with positive spillovers to domestic demand.

Inflation remains close to the target and medium-term inflation expectations are anchored. Year-on-year headline inflation dropped below the target in early 2015 on account of lower telecommunication service prices, smaller adjustment in administered fuel prices, and the reversal of effects related to last year’s tax hikes on some food items. The exchange rate pass-through has been very limited so far. Real wage growth has been broadly in line with productivity growth.

The policy mix has shifted to a gradual fiscal tightening. The public sector borrowing requirement (PSBR) is projected to decline to 4.1 percent of GDP this year (from 4.6 percent in 2014). The sharp decline in oil revenues has been offset by higher-than-expected fuel excises and income taxes (related to the 2013 tax reform) and by the oil-price hedge of oil export receipts. At the same time, monetary policy conditions remain very accommodative. The Bank of Mexico has maintained the policy rate at 3 percent since June last year. The Foreign Exchange Commission has reactivated two foreign exchange intervention schemes, with the goal of increasing liquidity and reducing volatility in exchange rate markets.

Commercial bank credit growth has strengthened to 10 percent in the first half of 2015. The improvement has been broad-based across sectors. Bank balance sheets remain strong, with capital levels well in excess of requirements and low non-performing loans. Corporate and household balance sheets are also reasonably healthy, despite some increase in corporate borrowing in foreign currency in recent years.

Implementation of the key structural reforms is broadly on track. The telecommunications reform has led to a decline in service prices, and the opening of the sector has already attracted foreign direct investment. The latest auction of oil fields under the energy reform was very successful. The financial reform has strengthened consumer protection and led to increased competition in the banking sector.

The external sector position remains broadly consistent with medium-term fundamentals and desirable policy settings. The current account deficit is projected to widen to 2.25 percent in 2015, reflecting a reduction in the hydrocarbons trade balance. The 2015 cyclically-adjusted current account balance is broadly consistent with medium-term fundamentals and desirable policies.

Executive Board Assessment²

Executive Directors noted that, despite unfavorable external conditions, the Mexican economy continues to grow steadily while financial stability has been well safeguarded. However, given Mexico’s open capital account, substantial external risks weigh on the outlook, notably weaker-than-expected growth in its major trading partners and key emerging market economies, and a potential resurgence of global financial market volatility. Directors considered that Mexico’s strong fundamentals and credible policy frameworks will help the economy weather shocks, while the Flexible Credit Line arrangement with the Fund has provided additional insurance against tail risks. Meanwhile, steadfast implementation of the structural reform agenda, alongside progress in improving security and the rule of law, should help lift potential growth in the medium term.

Directors commended the authorities for their commitment to gradually consolidate public finances and set the ratio of public debt to GDP on a downward trajectory. They welcomed the targeted reduction in the public sector borrowing requirement and the proposed reform of fuel excise taxes aimed at reducing carbon emissions and stabilizing tax revenues over the medium term. Directors encouraged the authorities to also eliminate inefficient electricity subsidies while protecting vulnerable households through targeted transfers.

Directors welcomed ongoing efforts to enhance fiscal discipline and accountability, while at the same time retaining sufficient flexibility to respond to changing circumstances. They supported the proposed fiscal responsibility framework for state and local governments, stressing that capacity building at the local government level is key to its success. Directors also recommended that the authorities explore possible initiatives to further strengthen the Fiscal Responsibility Law over time, including considerations of a long-term nominal anchor and tighter exceptional circumstance clauses, as well as institutional enhancements to better inform the debate on fiscal issues.

Directors considered that the accommodative stance of monetary policy remains appropriate for the near term in light of the remaining slack in the economy and the absence of wage and price pressures. However, they called on the authorities to stand ready to tighten the monetary stance if the exchange rate pass-through to inflation intensifies and second-round effects emerge.

Directors took note of the staff assessment that the external position is in line with economic fundamentals and desirable policy settings. They emphasized that the flexible exchange rate should continue to be the main absorber of external shocks. While recognizing that the temporary foreign exchange intervention schemes have helped enhance market liquidity and reduce volatility, they encouraged the authorities to limit the use of international reserves to periods of disorderly market conditions and to gradually rebuild them once pressures on asset prices subside.

Directors noted that the financial sector remains sound and that financial reforms have progressed well. They underlined the importance of close monitoring of corporate leverage, further strengthening the judicial process of contract enforcement, and improving access to finance while maintaining high credit standards especially at development banks.