Speech

Remarks by Rodrigo de Rato, Managing Director of the International Monetary Fund

November 8, 2004

Remarks by Rodrigo de Rato
Managing Director of the International Monetary Fund
to Members of the Mexican Congress
November 8, 2004
Mexico City, Mexico

Introduction

1. It is a great pleasure to be here in Mexico, for the first time as Managing Director. Mexico now serves as an example to other countries of the rewards—in terms of growth and financial stability—of sound and disciplined policies, and vigorous democratic institutions. This successful transition, together with its political and economic importance, gives Mexico an important voice in the Fund and other multilateral fora. Of course, the Fund's relationship with Mexico has changed over time to one of providing technical and policy advice, in the same way as we conduct economic surveillance with all our member countries. In this capacity, we work as an advisor in partnership with authorities to improve national and international economic performance. Then it is up to the authorities themselves to make the use of our analysis as they see fit and in light of country circumstances.

2. In this context, I am honored to meet Congressional representatives today. We had the pleasure of hosting a group of parliamentarians in Washington just a few months ago, and we found that exchange of views most productive. On this occasion, I know your energies are currently devoted to finalizing a budget for the coming year, and I would like to share some of our views on the issues facing Mexico both in the near and medium terms. Taking stock of the broad challenges is particularly important at a time when economic conditions are favorable, as they are now. It is always tempting to relax efforts when conditions are improving, yet experience teaches us that wise use of good conditions to build on past successes is the surest course to continued progress.

Global Background

3. First, the global picture. As you know, world growth has picked up strongly—we expect to around 5 percent in 2004. We still project global growth to continue at a robust pace next year, although vulnerabilities in the oil market do pose some risks. Latin America has participated fully in this recovery, with growth in 2004 expected to be around 4½ percent, the fastest pace since 1997. While external factors have been favorable, improved domestic fundamentals have also played an important role, with private consumption and business investment both growing briskly.

Mexico: Achievements and Challenges

4. Here, in Mexico, 2004 is also proving to be a year of strong growth. Mexico has established a credible and resilient macroeconomic policy framework combined with much sounder financial institutions, boosting its resilience to shocks. Pension reform in the private sector has led to a robust, expanding base of domestic investors that is contributing to significant deepening of domestic financial markets. Together, these policies have restored international investor confidence, and provided a foundation for sustained and stable growth.

5. Looking forward, Mexico's achievements suggest that the economy is moving within reach of the group of advanced nations. The structural reform agenda that is part of the public debate in Mexico—promoting competition, increasing legal certainty, reducing market rigidities, and efficiently harnessing Mexico's rich energy and other resources—is, in my view, the appropriate one. This is the lesson from other country experiences. Certainly, in my own country, Spain, its strong growth—higher than 4 percent for almost a decade—owed a large part to comprehensive labor market reforms, steps to liberalize domestic markets, as well as fiscal policy discipline.

6. In Mexico's case, at this juncture, I realize that difficult actions, requiring political consensus across different groups, are needed to move the agenda forward. At the same time, favorable external circumstances now present Mexico with an important window of opportunity. It will be key to seize that opportunity to cement Mexico's place in the league of fast-growing emerging market economies and improve the living standards of all Mexicans.

7. Let me illustrate with a simple calculation the important benefits for Mexico of tackling these reforms. The government's medium-term economic program put forward in 2002 showed that structural reforms could about double annual economic growth from 3¼ percent to 7 percent by 2006. A difference of this kind, continued year by year, would transform the outlook for the next generation. After 20 years—by 2024—real income per capita would be almost double that in the absence of reforms, reaching around US$25,000 in terms of today's prices.

8. Experience around the world shows that strong growth, maintained over time, is key to reducing poverty. Of course, it is important that the benefits of growth be broadly shared, and the policies to deliver equitable growth have been among the IMF's special interests. Mexico has already made much progress in reducing poverty and improving social indicators. A continuation of these efforts will be greatly supported by robust economic expansion—with better employment opportunities, more jobs, improved health care and schools and so on. This better future is an essential and feasible objective for Mexico, that would allow a continuation of the promising transformation of social conditions that has already begun.

Main Reform Agenda for Mexico

9. You hear much about the need for reform. It is worth remembering the enormous benefits that come, over time, when countries do undertake these measures. Chile is an example in this region of a nation that has pursued fiscal discipline combined with social and institutional reforms, while avoiding the devastating financial crises that have hit elsewhere.

10. Let me briefly elaborate on the key economic reforms needed in the Mexican context. As many of you, we see the need for action in three key areas: oil revenue management; fiscal reforms more broadly; and structural reforms in the energy sector, labor markets, and the regulatory and judiciary systems. Decisive steps in these areas would help raise competitiveness, investment, and growth in Mexico.

11. First and foremost is how best to use Mexico's oil wealth at this time of high world prices. While important efforts have been made to use revenue windfalls for priority social and investment spending, greater emphasis needs to be given to securing long-term financial savings. Financial savings can provide a cushion so that important expenditures on investment and social programs can be protected in difficult times. They also bolster resistance to crisis by reducing public sector debt. Finally, they provide for a more equitable sharing of the oil wealth across generations. International experience indicates several reform strategies, relying on structural fiscal rules, as in Chile, or oil funds provided these are fully-integrated with the budget and based on adequate medium-term planning, as in Norway.

12. Some spending out of windfall oil revenues is inevitable and desirable, to the extent that it is used to increase productive investment in public infrastructure. Yet the availability of additional revenues makes it even more important to critically evaluate the efficiency—and reversibility—of public spending. Allowing a weakening of spending discipline during periods of temporary revenue excesses is a problem that many countries have faced, and is usually a source of painful future adjustments. Let me encourage you to keep the need for prudence in spending firmly in mind, precisely because of the need to preserve the important benefits that fiscal discipline has brought to Mexico.

13. The conclusions of the recent National Fiscal Convention, whose broad political basis and high technical expertise were exemplary, give an excellent guide to priorities for other fiscal reforms. Tax reforms, focusing on broadening tax bases and improving administration, are needed to bolster Mexico's ability to finance the public sector and increase its resilience to shocks. Mexico's tax base is the lowest among OECD countries and a full 6 percentage points below Korea's, which has the second lowest. The public sector relies on the oil sector for a third of its revenue, although it is only 3 percent of the economy. The tax efficiency of the VAT in Mexico is well below that in other countries, reflecting many exemptions. And, as in many other countries, public pension reform is urgent. The current system is widely seen as inequitable and financially untenable. The fiscal costs of delaying reforms would be high, taking away scarce resources from spending programs pivotal for growth.

14. Improved oil management and these other fiscal structural reforms will help entrench medium-term fiscal sustainability in Mexico. In this context, it is crucial to give a longer-term framework for the conduct of fiscal policy, as demonstrated by the experience in many countries. Indeed, a comprehensive framework of fiscal responsibility "principles" can ensure that day-to-day budget discussions take place in structured way, consistent with medium-term fiscal constraints and objectives, as for instance in Brazil and New Zealand. Experience in these countries has shown that fiscal responsibility laws can help contain fiscal deficits and expenditure biases, reduce borrowing costs and output variability, and enhance transparency and accountability.

15. Turning to structural reforms more broadly, here too, the energy sector is of great strategic importance for Mexico. Moreover, since this natural resource is rightly considered the property of the people at large, as opposed to narrow interest groups, it is crucial to use it efficiently for the maximum benefit of the country. A more efficient and fuller exploitation of natural resources has the potential to boost Mexico's competitiveness, investment, and standards of living. As it brings scarce expertise and a large investment capacity, the private sector should be given a greater role in this effort. Private sector participation has brought significant benefits in several other resource-rich countries, like Norway or Canada, as well as in countries with fast-growing energy needs such as in the East Asia region. Reforms will need a high degree of transparency. At the same time, confidence that PEMEX is operated properly will need to be enhanced, including through improved accountability on its operational and financial performance and rationalizing its cost structure.

16. Another critical structural challenge for Mexico is labor market reform—essential to secure the full benefits of an increasingly integrated world economy. Recent analysis by the OECD suggests that Mexico's labor market institutions affect the efficiency of the economy and the budget, as it has been estimated that only about 30 percent of the economically active population in Mexico contributes to social security. Many are left without worker protection, while the federal budget is also losing tax revenues. Successful reforms within the OECD, for instance in Denmark, the Netherlands, or Spain, may serve as useful guides to improving the balance between concern for workers' job security with the need for labor market adjustment and dynamism.

17. Finally, the costs of living and doing business in Mexico continue to be higher than warranted as a result of a lack of competition and a weak judiciary system. First, competition has been artificially limited in particular domestic markets such as the telecommunication sector, where tariffs count among the highest in the world, and regulatory reforms would help level the playing field. Second, Mexicans need to be provided with a reliable, rapid, efficient, and transparent justice system and root out corruption. The perception of a lack of legal protection is currently widespread among individuals and businesses in Mexico, which discourages new economic activity. Indeed, recent World Bank research indicates that Mexico is lagging the main OECD countries with respect to regulatory quality, and is lagging emerging market competitors in Asia and Eastern Europe from the perspective of the rule of law.

18. We at the IMF have been impressed to see the government and Congress debating these reforms actively. Our experience is that all too often, countries fail to act when economic conditions are favorable and the costs of reform would be easier to accommodate. In today's increasingly competitive and globalized world, Mexico cannot afford to lag other countries' reform efforts. And with growth picking up and substantial revenue windfalls from high oil prices, now is the time to implement comprehensive reforms and prepare for future challenges. I would like to finish by reiterating the readiness and deep commitment at the IMF to support Mexico as it moves forward to join firmly the rank of successful countries.

Thank you.