Mexico Fiscal Q4 2016


Mexico: Mexican monetary and fiscal authorities announce major changes in policy framework

March 14, 2016

In a joint statement on 17 February, Central Bank Governor Agustín Carstens and Finance Minister Luis Videgaray announced major changes to the economic policy framework, which included an inter-meeting interest rate hike, discretionary intervention in the foreign exchange market and further budget cuts. The measures, while surprising, were welcomed by the markets and came at a time when the Mexican peso is overly-depreciated and within a deteriorating fiscal outlook in light of lower oil prices.

The monetary measures announced by the Central Bank (Banxico) included a surprising 50-basis-point inter-meeting increase in the overnight interest rate to 3.75% and discretionary intervention in the foreign exchange market. The interest rate hike—which took place ahead of a meeting scheduled for 18 March—was particularly surprising, given that markets were not expecting such a large rate increase given that the U.S. Federal Reserve has hinted that it will undertake a much slower pace of tightening this year. Furthermore, the Central Bank emphasized that the move does not represent the beginning of a tightening cycle and stated it will monitor inflation expectations and the evolution of the peso.

Until this decision, Banxico had relied only on dollar auctions to stem the weakening of the Mexican peso. However, this measure had little impact on the currency, which hovered above 18.0 MXN per USD in the first six weeks of the year and resulted in a noticeable deterioration in the country’s international reserves. According to Banxico, the intervention will now be discretionary and the Bank will only release information regarding the level of foreign reserves on Tuesdays, when authorities report balance sheet information.

Equally dramatic were the measures announced by Finance Minister Videgaray. According to the Minister, the government will go ahead with new budget cuts that will amount MXN 132 billion (USD 7.5 billion), which are equivalent to about 0.7% of GDP. The cuts are primarily focused on Petróleos Mexicanos (PEMEX)—on which MXN 100 billion in cuts will fall—as well as on the government’s current spending. Since global oil prices began to fall sharply toward the end of last year, PEMEX has been under pressure and the Ministry of Finance wants it to bear a larger share of cuts. Meanwhile, the local press suggests that it is possible that these hefty measures are also linked to plans to streamline the state-owned company under its new director, José Antonio González. Regarding social spending, Videgaray claimed that that area will remain ring-fenced from the wave of cuts.

It is clear that containing the depreciation of the Mexican peso is the main short-term objective of the monetary policy. However, further interest rate increases could have a detrimental impact on lackluster economic growth. What is far from clear is whether this strong increase in the interest rate was a one-off move designed to signal Banxico’s commitment to keeping the peso from falling further and whether it will be enough for the currency to face the headwinds of global sentient. Benito Berber, Senior Latin America Strategist at Nomura comments:

“Will this change in policy successfully stabilize the exchange rate? We hope so, but we believe that authorities will need some help from external conditions to stabilize the MXN. If the MXN does not initially settle, authorities will need to be ready to hike the policy more and sell more dollars until they can’t. Banxico has around US$230bn (including the line from the IMF) of fire power, but of course it cannot sell it all. How much reserves can Banxico really sell? We don’t know, but the market will start to ask this question soon.”

The sharp fall in oil prices in 2015 and higher government spending weighed heavily on Mexico public accounts. The fiscal deficit reached 3.5% of GDP in 2015, which marked the highest shortfall since the early 1990’s. In addition, the public debt stock rose to 46.5% of GDP, which is the highest level registered since 1990. The Consensus view among analysts is that Mexico’s fiscal performance will not improve this year, which is likely to fuel criticism over the government’s fiscal management. Analysts expect the fiscal deficit to narrow slightly and reach 3.1% of GDP in 2016. For 2017, the panel expects the fiscal deficit to narrow further and reach 2.7% of GDP. Meanwhile, debt levels are expected to remain at virtually the same level this year and in 2017. Analysts expect the public debt to remain at 46.5% of GDP in 2016 and 46.4% of GDP in 2017.

Author:, Senior Economist

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Mexico Fiscal Chart

Mexico Public Debt March 2016 2

Note: Non-financial public sector balance and government debt as % GDP.
Source: Mexico Ministry of Finance (Secretaría de Hacienda).

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