A factory in Tijuana: Mexico’s economy has remained resilient despite difficult external environment (photo: Tim Johnson/MCT/Newscom)
Annual Health Check
Economic activity has remained resilient despite the difficult external environment. Growth is expected to reach 2.2 percent in 2015, and accelerate to 2.5 percent in 2016, thanks to stronger exports to the United States and robust domestic demand. The unemployment rate fell to a post-crisis low of 4¼ percent in the second half of 2015.
The rise in global financial market volatility and a portfolio shift away from emerging markets caused a sharp depreciation of the peso vis-à-vis the U.S. dollar over the past year. Nonetheless, inflation remains low, and the yields on domestic currency bonds have been relatively stable.
As a highly open economy, with large participation of foreign investors in the domestic bond market, Mexico remains exposed to external shocks. However, the positive growth outlook and strong policy frameworks increase the country’s resilience and ability to withstand financial market stress. Mexico’s growth prospects are very favorable: the implementation of far-reaching structural reforms is expected to lift potential growth to 3-3½ percent over the medium term.
Fiscal policy is geared toward ensuring sustainable debt levels, while monetary policy is guided by a credible inflation-targeting regime. The flexible exchange rate acts as a buffer against external shocks. At the same time, Mexico’s deep and liquid financial markets allow investors to hedge exchange rate risks. Reserve buffers are strong, and the Flexible Credit Line with the IMF provides additional insurance against tail risks.
Strengthening resilience
The IMF report welcomes the authorities’ commitment to gradual fiscal consolidation. The planned reduction of the overall fiscal deficit from 4.1 percent of GDP in 2015 to 2.5 percent of GDP by 2018 would help lower the ratio of public debt to GDP, which is critical to maintain confidence in the strength of public finances.
Mexico has been at the forefront of emerging markets in setting clear commitments to reduce carbon emissions and implementing policies to protect the environment. The authorities eliminated fuel subsidies in recent years. Starting in 2016, they plan to gradually liberalize domestic fuel prices, while taxing fuel at a level that reflects the negative environmental, health, and congestion effects of fossil fuel use. From a fiscal perspective, fixing the gasoline and diesel excise taxes would help stabilize tax revenues.
Monetary policy has been appropriately accommodative over the past year, with a real policy rate close to zero. Inflation is close to the 3 percent target and inflation expectations remain anchored. The pass-through from the currency depreciation to inflation has been very limited so far, in part due to the sharp decline in commodity prices, which has helped keep production costs down.
Maintaining a strong financial sector
Mexico’s banks are well capitalized, liquid, and profitable. Commercial banks maintain capital adequacy ratios well in excess of regulatory requirements. The banking system is funded primarily by domestic deposits, which reduces vulnerability to external liquidity shocks. The IMF report presents analysis which suggests that the balance sheets of corporations are also overall sound, and would be resilient to further changes in the exchange rate or funding rates.
Mexico has relatively low credit to the private sector as a share of GDP compared with other emerging markets, although credit has been growing at a steady pace in recent years. This is due to a number of factors, including a large informal sector, difficulties with collateral repossession, and a history of banking crisis in the 1980s and 1990s. Mexico therefore faces the challenge of fostering financial deepening while safeguarding financial stability. The recently implemented financial reform aims to address some of the structural impediments to credit growth by enhancing reporting requirements to credit bureaus, simplifying the transfers of mortgage loans and personal accounts among banks, and strengthening consumer protection.
