During 1998, world financial markets were characterized by a high degree of uncertainty and volatility. Overall, Mexico was affected by two external events: the collapse of oil prices, which generated strong pressures on the government’s fiscal accounts, and tighter liquidity conditions that resurfaced in international financial markets following the Russian financial crisis. Despite these events, the Mexican economy showed significant strength, maintaining strong growth, containing inflation and sustaining employment levels.

In 1998, GDP grew 4.8% in real terms. GDP in current prices reached US$424,524 million in 1998. The increase in GDP is largely explained by an expansion of private investment, which grew 16.9% in real terms during the year. Total gross fixed investment grew 10.7% in real terms in 1998. This increase was partially offset by the decline in public fixed investment, which decreased by 20.4% in real terms.

Private consumption was positively influenced by the increase in disposable income resulting from employment growth and higher average real wages in many sectors. Private consumption increased 6.4% in real terms for the year. At the same time, primary public expenditures–defined as total public sector expenditures other than interest payments on public debt–decreased by 1.1% in real terms in 1998.

GDP growth was also driven by the export sector. Merchandise exports increased by 6.4% in 1998, mainly due to non-oil exports, which grew 11.3%.

In terms of sectoral performance, the primary sector (agriculture, livestock, fishing and forestry) grew 0.5% in real terms in 1998, the industrial sector (mining, manufacturing, construction and electricity) grew 6.6% in real terms, while the services sector (which includes commerce, transportation, storage, communications, and financial services) expanded at a real rate of 4.4%.

As expected, during the first quarter of 1999 the Mexican economy slowed down, mainly reflecting the instability of financial markets experienced at the end of 1998 and the drop in international oil prices. The annual real GDP growth rate registered during the first three months of 1999 was 1.9%.

In 1998, financial market volatility along with uncertainty regarding the approval by the Mexican Congress of the proposed financial reform legislation and the 1999 budget adversely affected the peso/dollar exchange rate. The significant depreciation of the peso, coupled with mid-year wage hikes and increases in the prices of basic consumer goods generated upward pressures of the price level. Thus the 1998 inflation rate of 18.61% was higher than the official forecast of 15%.

In 1999 the increase in the general price level showed signs of slowing down. Inflation for the first quarter of the year was 4.87%, the lowest level registered in this period since 1994.

Employment growth continued to show a positive trend in 1998. The number of permanent workers insured by the Mexican Institute of Social Security (IMSS) reached 10,140,861, an increase of 303,504 permanent workers. If urban temporary workers are included, the total number of insured workers increased by 759,952 in 1998.

The number of permanent insured workers in the commercial and services sectors increased 101,305 and 65,317 workers, respectively, or 5.5 and 1.8% respectively. In the industrial sector, employment increased by 153,744 workers, or 3.8%. On the other hand, the number of insured workers in the farming sector fell by 21,339 workers in 1998, a 5.1% decrease.

The increase in employment levels led to a reduction in the open unemployment rate during 1998. In December 1998 the unemployment rate was 2.6% or 0.2 percentage points lower than the level registered in December 1997. In 1998, the average unemployment rate was 3.2%, a decrease of 0.5 percentage points from the 1997 average rate, and the lowest rate since 1992.

In 1998, the trade balance registered a deficit of US$7,742.2 million, a sharp contrast with the US$623.6 million surplus observed in 1997. The change in the trade balance in 1998 can be explained by: (1) the reduction in the international price of oil that resulted in lower oil export revenues, (2) the expansion of the domestic economy that led to increased imports of consumer and capital goods, and (3) the fact that the continued increase in exports of manufactured goods required greater import levels of intermediate goods. Total merchandise trade for 1998 was US$242,742.8 million, or 57% of GDP.

Total exports increased 6.4% in real terms in 1998, mainly due to the behavior of non-oil exports, which grew 11.3%. The most dynamic component of non-petroleum exports was manufactured goods, which increased by 11.7% in 1998. Total exports value in 1998 was US$117,500.3 million.

Even though import growth was significant in 1998, it had slowed compared with 1997. Imports grew 14.1% and totaled US$125,242.5 million for 1998, 8.6 percentage points lower than in 1997. This slower rate of growth was largely explained by the depreciation in the peso/dollar exchange rate. Imports of consumer goods increased by 19.1%, while imports of capital and intermediate goods increased by 14.6% and 13.7% respectively.

The current account deficit in 1998 was US$15,786.3 million. This figure was more than double the deficit registered in 1997. The current account deficit was of 3.8% of GDP. The trade balance explains, to a large extent, the increase in the current account deficit.

The capital account registered a surplus of US$16,230.4 million in 1998, 467.6 million more than the surplus registered in 1997. Inflows of foreign capital in 1998 were mainly due to foreign direct investment. FDI was US$10,337.5 million and foreign portfolio investment reached US$1,292.8 million during the year. The surplus in the capital account amounted to 4.0% of GDP, while FDI amounts to 2.0% of GDP.

During the first three months of 1999, the trade balance registered an accumulated deficit of US$1,151.5 million, 34.0% lower than the level shown during the same period of 1998. Total exports grew 6.5% in real terms despite the fact that oil-related exports fell 23.1%. Total imports grew 4.1%, with capital imports growing 10.0%.

On 31 December 1998, net public sector external debt totaled US$82,222 million, an increase of US$2,927 million with respect to 1997. Net public sector external debt was 19.1% of GDP at the end of 1998. On 31 March 1999 net public debt had decreased to US$81,655.0 million, or 18.7% as a proportion of GDP.

Mexico’s access to the international capital markets was significantly constrained in 1998. The Federal Government obtained approximately one-third of the resources obtained in 1997, due to the adverse effects of the financial crises in Southeast Asia, Latin America and Russia. The government’s limited access to the capital markets, coupled with the fall in international oil prices, led the Mexican authorities to draw down in October 1998 the entire amount of the US$2,661 million that it had negotiated in November 1997 with 33 international financial institutions. The purpose of the liquidity facility was precisely to provide a funding source for the government in situations of significant volatility in the international markets. In March 1999 the government agreed to refinance most of the liquidity facility.

The amortization schedule for 1999 is manageable, and most of the principal payments due relate to non-market debt, which will be refinanced through multilateral and bilateral sources. For the last three quarters of 1999, total debt payments amount to US$9,558.2 million. Non-market debt amortization for the three last quarters of the year amount to US$8,714.60 million, while market debt due amounts to US$843.6 million.

Improved market sentiment has allowed the Mexican government to successfully carried out two sovereign bond issues in 1999, one in February and one in March, equivalent to US$2,000 million.

The uncertainty and volatility in the international financial markets that took place in 1998 led to a significant depreciation of Mexican peso. On 10 September, the interbank rate-selling price closed at 10.6500 pesos per US dollar, the highest level of the year.

It should be noted that the Mexican peso floats freely against other currencies. The flexible exchange rate policy has proven to be an efficient means to avoid the accumulation of external imbalances and to discourage short-term capital inflows.

The exchange rate showed a more stable behavior during the last quarter of 1998, despite market volatility resulting from speculative attacks on the Brazilian real in October and November and from the large decline in international oil prices at the end of November. Thus, the interbank spot exchange rate closed the year at 9.9080 pesos per US dollar, 22.85% higher than the 1997 level. However, after the devaluation of the Brazilian real, once again the exchange rate depreciated. On 14 January 1999 the peso/dollar exchange rate reached 10.6400 pesos per US dollar.

In recent months overall market sentiment has improved considerably. In particular, Mexico has benefited from higher oil prices, the market’s recognition of the economy’s strong fundamentals, and the continued strength of the US economy. As a result, the peso has appreciated considerably. On 19 May 1999 the interbank rate selling price was 9.3150 pesos per US dollar.

The collapse of oil prices had a strong impact on the Mexican economy because government revenues largely depended on oil-related activities. During 1998, 32.6% of total public sector revenues were oil related. The reduction in the average price of the Mexican oil mix in 1998, from an estimate of US$15.50 per barrel back in November 1997 to an actual price of US$10.16 per barrel, translated into lower fiscal revenues of 1.3% of GDP. Despite the fall in oil prices and its effects on public revenues the public sector deficit in 1998 was only equivalent to 1.24% of GDP, lower than the official estimate of 1.25%.

Two sets of factors enabled Mexico to reach this result. (1) The three budgetary adjustments implemented during the year totaling 0.79% of GDP, and (2) higher non-oil tax revenues resulting from both strong economic activity and improved tax collection.

In 1998, public revenues decreased by 8.1% in real terms, and the ratio of oil-related revenues to total revenues decreased from 36.4% in 1997 to 32.6% in 1998. Tax revenues increased by 9.8% in real terms during 1998, due mainly to expanded economic activity and to the efforts carried out to increase the number of tax payers (income tax collections increased by 4.0% and value added tax collections grew by 5.2%, both in real terms).

Public sector net budgetary expenditures totaled 823,859 million pesos in 1998, 5.4% less in real terms than in 1997. Primary expenditures, defined as total public sector expenditures other than interest payments on public debt, decreased 1.1%.

The 1999 budget, as approved by Congress last December, contemplates a fiscal deficit equivalent to 1.25% of GDP, confirming the government’s firm determination to maintain strict fiscal discipline.

In accordance with its constitutional mandate to ensure price stability, Banco de México’s monetary policy during 1998 was geared towards containing the adverse effects caused by the volatility in international financial markets. On 11 March 1998, Banco de México modified its monetary policy from neutral to restrictive, by establishing a "short," the mechanism Banco de México uses to reduce market liquidity.

In August and September, the central bank carried out additional measures. Banco de México reduced the daylight overdraft capacity of commercial banks in the payments system and established a compulsory deposit by commercial banks in the central bank. Moreover, in order to reduce interest rate exposure, Banco of México twice offered interest rate swaps to commercial banks. Under the swap agreement, the central bank paid a floating rate, whereas commercial banks paid a fixed rate.

The monetary base, defined as the sum of bills and coins in circulation and bank deposits with the central bank grew to 131,528 million pesos in December 1998, a 1.8% increase in real terms from the level at the end of 1997.

The structural reforms implemented by the Mexican government since 1994 have two main objectives. Firstly, to promote the participation of the private sector in a number of economic activities, and secondly, to establish a sound regulatory framework that provides certainty and fosters private investment and growth.

One of the most important structural reforms being implemented in Mexico is the strengthening of the financial sector. Following the 1995 crisis, the Mexican government implemented various programs in order to restructure the financial system. With this in mind, various capitalization schemes, debtor support programs and regulatory and supervisory reforms were implemented.

Financial sector reforms continued in 1998. The IPAB, a new entity similar to the FDIC in the United States, was created. This entity will help strengthen the Mexican banking system by: (1) establishing a clear legal framework to manage FOBAPROA’s liabilities and divest its assets efficiently and (2) the promotion of market discipline by gradually limiting deposit insurance. Moreover, Congress amended financial legislation to allow foreign investors to hold majority shares in the capital of banks, regardless of their size. This measure will foster the capitalization of institutions, strengthening their financial conditions and reducing their vulnerability.

In 1998, the National Banking and Securities Commission introduced regulation that increased required contingent reserves to at least 60% of non-performing loans or 4% of the total loan portfolio, whichever is larger. Supervision of financial institutions was reinforced to ensure that they would comply with the required capitalization and liquidity ratios at all times.

In 1998 the government continued its efforts geared towards further opening of key sectors of the economy such as telecommunications, electricity, ports, airports and railroads.

Mexico is an open economy with sharp income inequalities that have to be overcome. In this sense, the Mexican government’s main economic objectives are to attain an average annual GDP growth rate of 5% with inflation kept within single digits, and to turn these achievements into a better standard of living for the Mexican population.

Given the difficult global environment, in 1999 the Mexican governments expects the economy to decelerate and grow 3.0% in real terms. However, in 2000 economic activity is expected to pick up with a growth in GDP of 5.0% in real terms.

The 1999 and 2000 budget contemplates a fiscal deficit equivalent to 1.25 and 1.00% of GDP respectively, confirming the government’s firm determination to maintain strict fiscal discipline. The current account deficit is expected to decrease from 3.8% of GDP in 1998 to 2.2 and 3.2% of GDP in 1999 and 2000, respectively. The deficit is expected to be financed almost entirely by foreign direct investment.

The containment of inflation is another important goal. Through the maintenance of sound monetary policies the Mexican government expects the inflation rate to be of the order of 13% in 1999 and 10% in 2000.

Source: Data are as submitted by member economies, unless otherwise specified.

Table 2. Forecasting Summary (% change from previous year)

Note: The IMF forecast is from the World Economic Outlook (IMF, April 1999). The OECD forecast is from the OECD Economic Outlook (OECD, June 1999).