USA / MEXICO – Despite an expansionary fiscal stance, growth is slowing to around 1½ percent this year, due to binding capacity constraints and tight monetary policy.
Continuing monetary restraint and slowing activity are expected to lower inflation to Banxico’s 3-percent target by 2025. The current account deficit is expected to widen slightly in 2024 as investment- and consumption-related imports outpace exports. Risks to growth are tilted to the downside while inflation risks remain on the upside. Weaker-than-expected growth in the US, an increase in global risk aversion, and unforeseen effects from recent institutional reforms could weigh on output. On the other hand, better-than-expected import demand from the US or the ongoing reshaping of global value chains could boost activity and inward investment.
A medium-term fiscal strategy is needed to reduce deficits and debt, raise tax revenues, and create fiscal space for investments in human and physical capital. This would require putting in place a comprehensive tax reform early in the new administration, durably reducing the fiscal deficit while carefully prioritizing public spending, and reducing inequities in the pension system. Addressing the imbalances between the federal budget and Pemex, and enhancing corporate governance of the latter, are also important priorities.
The ongoing reshaping of global value chains offers the incoming administration an important opportunity to deepen the already-strong economic links with the US. Taking advantage of these prospects, however, requires a wide-ranging set of supply-side reforms to complement the well-established, very strong institutional framework for macroeconomic policies. Regulatory reforms, better-targeted public investment that further relieves infrastructure bottlenecks, broader access to financial services, and a more predictable supply of energy and water would all support private sector-led growth. Other priority measures include governance reforms that address corruption and tackle organized crime.
Recent judicial reforms create important uncertainties about the effectiveness of contract enforcement and the predictability of the rule of law. The replacement of judges at various levels of the judiciary in the coming year creates a new source of uncertainty that may impinge upon private investment decisions. It is critical that this reform be implemented in a clear and predictable way that ensures the independence and professionalism of the judiciary and strengthens the rule of law. Staff’s current baseline does not incorporate potential headwinds from these uncertainties.
Fiscal policy
The authorities are committed to achieving their 2024 fiscal target. The overall deficit for the year is currently projected to be 5.9 percent of GDP, a fiscal impulse of around 2 percent of GDP that is expected to bring gross public sector debt close to 58 percent of GDP by end-2024. Increased spending on large infrastructure projects, wages, pensions, and social spending are all adding to fiscal support for the economy. There is, however, a risk that additional support for Pemex and/or greater-than-expected spending on infrastructure projects could lead to a modest fiscal overrun by end-year.
Mexico needs to put in place a credible medium-term fiscal consolidation underpinned by well-identified policy measures. The incoming authorities’ plan to initiate an important fiscal consolidation in 2025 that should lower the deficit to below 3 percent of GDP over the medium term, underscoring Mexico’s commitment to fiscal prudence. This will require the identification and implementation of additional fiscal measures, preferably including an overarching tax reform. In particular, the 2025 budget should focus on reducing tax expenditures and reassessing both tax rates and thresholds, particularly for the personal income tax. Further expenditure rationalization, including tax exceptions, and improved tax administration would contribute to this needed adjustment and help bolster market confidence.
A review of policies regarding support for Pemex, and the energy sector more generally, would enhance the credibility of the government’s fiscal plans. Federal government support for Pemex in the form of various tax reliefs, investments, and transfers have cost 1 percent of GDP in 2024. Further support should be conditioned on Pemex developing a viable business strategy and improving its corporate governance. This could include focusing Pemex activities on profitable fields, selling non-core assets, developing a new strategy for unprofitable refinery operations, and incentivizing public-private partnerships (including via equity participation). The strategy should also examine the implications for, and linkages with, the federal electricity company.
More is needed to address structural inequities in the pension system. Public pension spending has increased by 0.6 percent of GDP over the past three years and will continue to rise over the medium term. While the recent reform to raise the replacement rate,aimed to equalize treatment across workers, inequities remain between and within cohorts. A broader review is therefore needed of the benefit structure and the minimum contribution requirement.
Further deepening of financial intermediation would make growth more inclusive. The recent development of fintech products and digital payments have expanded access to financial products. In addition, financial regulations that lower loan-loss provisioning for female borrowers have increased women’s access to credit. These efforts could be complemented by expanding the adoption of digital payment systems and eliminating institutional barriers to entry for new products and entities that are deemed to be financially sound.
