Summary: KEY ISSUES Context: Over the past year, Mexico has maintained macroeconomic stability and has made significant progress in advancing growth-oriented structural reforms. The country’s close ties with the global economy, while a source of strength, heighten the economy’s exposure to external risks. The transition to a less accommodative monetary policy in the U.S. and other advanced economies is a key risk. Recent Developments: In 2013, the economy has begun to operate below capacity, with growth expected to slow to 1.2 percent and core inflation running at historically low rates. Demand policies are consistent with preserving macroeconomic stability, while supporting a recovery in growth. The external current account deficit and real effective exchange rate are broadly in line with fundamentals and desirable policy settings. Mexico’s asset markets showed more resilience than many other emerging markets after the Fed initiated its discussion of tapering on May 22. Structural reforms: Over the past year, more than a half dozen major reforms have been approved to upgrade several areas, including labor markets, telecommunications, and education. Most recently congress approved a comprehensive fiscal reform. It is also considering an energy reform that opens the door for private investment in hydrocarbons and a financial sector reform that seeks to increase intermediation, promote competition and enhance financial stability. Staff estimates that these reforms will boost potential output growth to 3½ to 4 percent a year, compared with the pre-reform estimate of 3 to 3¼ percent a year, with upside risk to this outlook. Fiscal reform: The recently approved fiscal reform should provide for a more transparent and effective fiscal anchor, while limiting the procyclicality of spending. In this context, the government defined a path for the public sector borrowing requirement (PSBR) through 2018 that entails a gradual decline in the PSBR to 2.5 percent of GDP by 2017. The authorities have introduced several legal provisions that give assurances that spending growth will fall in line with this objective, but care will be needed to avoid remaining risks of fiscal slippage. Advice from Previous Article IV Consultation: The ambitious agenda of structural reforms is in line with Fund advice from past consultations and the financial sector reform implements a number of key recommendations of the 2011 FSAP Update. Staff supports the authorities’ plan for the pace of medium-term fiscal consolidation in light of the economic slowdown in 2013, although this pace is not as rapid as envisaged in the 2012 consultation.

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