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Challenges and Opportunities at the Turn of the Century
Ministry of Finance

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I. Recent Economic Performance
II. The Economic Program
III. Structural Reforms
IV. The Mexican Economy in the Year 2000: A Smooth Transition
V. Concluding Remarks

September, 1999

The series of responsible economic policies implemented in the past have strengthened Mexico's fundamentals and increased its resilience to external shocks. During the last three years, Mexico's economic performance has been positive, despite the international financial turmoil. In particular, GDP grew by 4.8% in real terms during 1998, positioning Mexico as the fourth fastest growing economy among the 30 largest economies in the world. Moreover, we expect that in 1999 and in the year 2000, the Mexican economy will grow 3% and 5% respectively.

Monetary policy has been focused on the reduction of inflation. Accumulated inflation during the first eight months of 1999 was 8.5%, the lowest figure for that period since 1994. This result is consistent with the Government's inflation target of 13% for 1999. Inflation is expected to fall further to 10% by the year 2000.

The cornerstone of Mexico's economic program has been its strong commitment towards sound public finances. The overall public sector deficit is projected at 1.25% of GDP this year and at 1% of GDP in the year 2000. In addition, the current account deficit has remained within sustainable levels, and is expected to do so, determined by the availability of foreign direct investment.

During the past two decades, Mexico has implemented a series of broad-based structural reforms. These reforms have made the economy more efficient and competitive, with the North American Free Trade Agreement (NAFTA) guaranteeing sustained access to the largest market in the world.

Overall, there are several important factors that place Mexico in a favorable position with respect to other emerging economies, and will allow the country to achieve a smooth transition into the next Administration:



I. RECENT ECONOMIC PERFORMANCE

In the last two years we have witnessed considerable turmoil in international financial markets, beginning with South East Asia in 1997, followed by Russia in 1998 and most recently Brazil in January 1999.

However, Mexico's economic performance in this period has been positive. During the 1996-2006 period, GDP grew at an average annual rate of 5.6% in real terms. During the first half of 1999, GDP grew by 2.5% in real terms as compared with the same period of 1998, and is expected to grow 3% for the whole year, after a deceleration in the last quarter of 1998 and the first quarter of 1999.

In fact, the Mexican economy has had a very positive performance as compared to other countries, registering a 4.8% GDP growth in real terms during 1998, positioning Mexico as the fourth fastest growing economy among the 30 largest economies in the world.

This positive performance of economic activity was the result of the favorable evolution of both domestic and external demand. During the first half of 1999, gross fixed investment grew at an accumulated annualized rate of 5.0%, while non-oil exports grew by 10.8% during the first seven months of the year.

Industrial production accelerated during the second quarter of 1999, growing at an annual rate of 4.4%, as compared with a growth rate of 1.8% in the first quarter, for a total growth rate of 3.2% during the first half of the year.

Industrial growth has been balanced across most sectors. In fact, the only component of industrial production that did not grow during the first half of 1999 was mining, due in part to the reduction in the volume of oil production in accordance with international agreements.

As a result of Mexico's strong economic performance, unemployment has maintained its downward trend as a significant number of new jobs have been created in the formal sector of the economy.

During the first seven months of 1999, the total number of workers registered with the Mexican Social Security Institute (IMSS) increased by 432,531, while the open unemployment rate averaged 2.68%, its lowest level for the first seven months of a year since 1991.

Monetary policy has been focused on the reduction of inflation. Accumulated inflation during the first eight months of 1999 was 8.5%, the lowest figure for that period since 1994. This result is consistent with the Government's inflation target of 13% for 1999 as a whole.

RESILIENCE TO EXTERNAL SHOCKS

The instability that has been present in international markets throughout the year has affected Mexico's financial markets. However, Mexico is today better prepared to face external events than in the past.

For example, even though Mexico's financial markets experienced some turbulence after the outbreak of the Brazilian crisis in January 1999, its effects were short-lived. The Mexican stock exchange has quickly surpassed its level prior to the Brazilian crisis, while interest rates and the nominal exchange rate are both lower than their levels at the end of 1998. The following graphs illustrate the time that the different financial markets took to recover after the outbreak of the Brazilian crisis.

The impact of external events on Mexico was short lived as a result of the strengthening of the country's fundamentals. Among them, we can mention the following: The Government's commitment towards sound public finances has brought positive results. These efforts will continue in order to free resources for the private sector while promoting a more stable economic environment.

The ratio of total investment to GDP has increased significantly in the last few years. Domestic savings are substantially higher than five years ago, while the ratio of external savings to total investment has decreased. While in 1994, more than 30% of total investment was financed through external savings, today this ratio stands at 11%.

The Mexican Government is convinced that external savings should be used only as a complement to, not a substitute for, domestic savings. The current account has been kept within manageable levels, a trend that is expected to continue in the future.

Foreign direct investment has become an important source for the financing of the current account deficit (see section IV), covering 90.7% of the current account deficit during the first half of 1999. As a result, the economy is significantly less vulnerable to reductions or reversals of portfolio investment inflows.

Mexico's solvency indicators have also improved substantially. The following graphs show that total net public debt to GDP and total external debt to exports stand at much lower levels than in previous years. Similarly, the ratios of public sector's external debt service and interest payments to exports have both fallen significantly.

The public sector's external debt market amortization's for the second half of 1999 and for the years 2000 and 2001 are moderate, as discussed in Section II below.

In addition to the improved position of Mexico's external accounts, Mexico assembled the Financial Strengthening Program in June 1999, which amounts to US$16.9 billion and that is explained in detail in Section V.

Mexico has made significant efforts to minimize the effects of the Year 2000 on computer systems and applications (including embedded technology) on the Mexican economy. To this date, tests in many sectors, including the financial sector, have been made with positive results. Additional information about Mexico's year 2000 efforts is available at the web site of The Year 2000 National Conversion Commission of Mexico



II. THE ECONOMIC PROGRAM

In November 1998, for the first time in recent history, Mexico's Federal Government presented to Congress the objectives and strategy of its economic policy for a two-year period, that is, for 1999 and 2000. Mexican authorities are committed to the design and implementation of medium-term policies, therefore increasing certainty about the future.

Mexico's medium-term strategy emphasizes fiscal consolidation as one of its main elements. The reduction of inflation is also a priority of the present Administration's macroeconomic program. Public debt has been managed in order to reduce its financial costs, increase its maturity profile and to avoid the accumulation of payments over time.

Together, these elements will help to achieve macroeconomic stability in a context of a floating exchange rate regime, which will translate into higher growth rates. Finally, structural reforms are a key element to help boost domestic savings and increase productive efficiency, as discussed in more detail in Section IV.

MONETARY POLICY

The main objective of the monetary policy followed by Banco de Mexico will continue to be the reduction of inflation, which is critical to achieving higher levels of domestic savings and investment and a gradual decline in real interest rates.

Monetary policy has been successful in reducing inflation from 52.0% in 1995 to 18.6% in 1998 and a projected 13.0% and 10% in 1999 and 2000, respectively. This trend is expected to continue in the future.

The implementation of monetary policy is based on the following elements:

  1. The main task of monetary policy is to procure price stability.
  2. Banco de Mexico has an annual inflation objective.
  3. Intermediate monetary targets are still used in order to provide the market the certainty that Banco de Mexico will not create excess liquidity.
  4. Reliance on the referred intermediate monetary targets has been losing ground and "limited discretion", in the sense of an inflation target scheme, has gained dominance. Thus, monetary policy is tightened whenever the inflation objective is threatened.

FISCAL POLICY

Mexico has several key objectives in terms of fiscal policy. The first is to maintain a prudent fiscal policy. We expect the overall deficit of the non financial public sector to decline from 1.25% of GDP in 1999 to 1.0% of GDP in 2000, while the primary surplus should increase from 2.77% of GDP to 2.86% of GDP. On the revenue side, we intend to further reduce the public sector dependence on oil-related revenues.

Mexico has made significant efforts to increase the tax base and fight tax evasion. Although tax revenues still represent a low proportion of GDP, they have increased in the last few years. On the expenditure side, the Government plans to maintain spending within prudent levels, focusing on social development programs.

Programmable expenditures as percentage of GDP have been declining in line with the Government's prudent fiscal policies. Nonetheless, social expenditures as percentage of total programmable expenditures continue to increase, as can be seen in more detail in Section IV.

Mexico has shown its commitment to maintain sound public finances by adjusting expenditures in response to revenue shocks. The reduction in revenues due to the fall in the price of oil that took place in 1998 was offset by a reduction in expenditures.

  1. : Defined as total expenditures excluding interest payments and revenue sharing with states and municipalities.
  2. : Includes expenditures for education, health, social security, labor, social assistance and regional and urban development.

DEBT MANAGEMENT

The ratio of the stock of total net public debt to GDP has fallen significantly. The majority of public sector domestic debt is composed of government securities. As of June 30, 1998, these represented 86.5% of total gross domestic debt. Government securities outstanding consist of 4 types of instruments: Cetes, Bondes, Ajustabonos and Udibonos. Cetes are fixed rate, peso-denominated bonds; Bondes are floating-rate, peso-denominated coupon bonds; Ajustabonos are long-term, inflation-protected coupon bonds. Udibonos replaced Ajustabonos, which the Ministry of Finance stopped issuing in January 1995; Udibonos are long-term, inflation-protected coupon bonds. The average maturity of government securities in the domestic market continues to increase. However, domestic debt still has a relatively short maturity. Since the development of a long-term domestic debt market is of utmost importance for Mexico, fixed rate longer tenor (between 2-3 years) government securities will be issued shortly.

On the external front, as of July 31, 1999, the average maturity of Federal Government's bonds denominated in foreign currency was 15.3 years. From July 1, 1999 to December 31, 2000, the amortization payments related to market external public debt, which excludes liabilities owed to commercial banks, bilateral and multilateral sources, amount to US$2,357 million (US$457.2 million in 1999 and US$1,899.8 million in 2000). This figure represents approximately seven days of export receipts and 8% of Mexico's gross international reserves, which currently stand at historically high levels (around US$30 billion).

Amortization payments related to market external public debt for the years 2000 and 2001 stand below US$2.0 billion each year. Despite the unfavorable situation that has prevailed in international financial markets during 1999, Mexico's access to international capital markets was not severely affected. In particular, Mexico has been able to complete the following operations in international capital markets during 1999:

Thus, the Federal Government has been able to complete operations in international capital markets totaling US$5,419 million during 1999, which together with US$1,800 million of issus by public sector entities during the same period, add to a total of US$7,219 million for the public sector.

As a result of the improvement of Mexico's external position and the strengthening of its fundamentals, Moody's Investors Service recently upgraded Mexico's long-term foreign currency rating to Ba1 from Ba2 and assigned a positive outlook to the rating, placing Mexico one notch below investment grade.

EXCHANGE RATE POLICY

Mexico will maintain its floating exchange rate regime due to the considerable advantages associated with it. The floating exchange rate in Mexico has:

  1. Allowed gradual and frequent adjustments to external shocks instead of infrequent but large adjustments.
  2. Modified the composition of capital flows towards longer tenors in the form of foreign direct investment.
  3. Reduced the possibility of speculative attacks, in contrast with a fixed exchange rate where investors face a one-way-bet.
  4. Prevented large and substantial misalignments of the real exchange rate, maintaining the competitiveness in the tradable sector.


III. STRUCTURAL REFORMS

The structural reforms that Mexico has implemented during the last two decades have placed the economy in a stronger position to take advantage of the benefits of globalization while minimizing the risks inherent to this process. These reforms have focused on economic and financial liberalization, leading Mexico from a closed, heavily regulated economy with high government intervention to an open and market-driven economy.


THE MOVEMENT TOWARDS A MORE FLEXIBLE AND DYNAMIC ECONOMY

TRADE LIBERALIZATION

In 1985, Mexico formally joined the General Agreement on Trade and Tariffs (GATT). Since then, Mexico has undertaken fast and far-reaching trade liberalization measures, eliminating compulsory import licenses and abolishing official import prices.

In recent years, Mexico has signed several free trade agreements. In 1993 Mexico entered into the North American Free Trade Agreement (NAFTA) with the United States and Canada. Mexico also has free trade agreements with Chile, Costa Rica, Bolivia, Colombia, Venezuela and Nicaragua. Since 1991, the value of exports and imports has nearly tripled reaching US$243 billion in 1998. In addition, the value of trade as a share of GDP has doubled during this time span.

These efforts have led to a more diversified composition of exports, while the composition of imports has not changed significantly. In 1998, imports of intermediate goods represented 77.3% of total imports, while imports of capital and consumption goods represented 13.8% and 8.9%, respectively.

Mexico has moved away from commodity exports and has become a manufacturing goods exporting country. Non-oil exports as a percentage of total exports rose from 38% in 1983 to 94% in 1998. The Mexican economy is now more resilient to possible price changes in the international oil markets and less vulnerable to external shocks.

The process of trade liberalization is expected to continue. For example, negotiations are well advanced regarding the establishment of a free trade agreement with the European Union and other Latin American countries.

CAPITAL ACCOUNT LIBERALIZATION

The liberalization of the capital account has played a key role in Mexico's efforts towards achieving economic and financial integration with the world economy. The Mexican Government has eliminated all restrictions on capital inflows, abolishing limits on commercial borrowing from abroad, investment in securities and money market activities.

Similarly, Mexican investors are allowed to freely participate in foreign markets and hold accounts in foreign commercial banks. Controls on capital outflows have also been abolished.

The existence of a permanent and secure access to foreign markets and a more transparent regulatory framework have led to a considerable increase in foreign investment. For example, from 1984 to 1993 foreign direct investment (FDI) averaged US$3.1 billion a year, while in the 1994-1998 period FDI averaged US$10.6 billion a year, after the signing of NAFTA.

Today, a large share of the current account deficit is financed by FDI. This is a positive development, since FDI resources are long-term investments and thus are less vulnerable to changes in market sentiment. Moreover, FDI is associated with a transfer of technology, which in turn leads to productivity increases.

PRIVATE SECTOR INVOLVEMENT IN THE ECONOMY AND THE CHANGE IN THE GOVERNMENT'S ROLE

In the early 1980's, the Mexican Government was a key player in the economy as it participated in virtually every sector. Since then, the Government's participation in the economy has decreased considerably, significantly increasing the private sector's role in Mexico's economic activity. For example, while in 1983, 77% of total bank credit was channeled to the public sector, by 1998 this figure was reduced to only 12%. Moreover, from 1983 to 1998 public sector exports as a percentage of total exports decreased from 66% to 6%.

Structural reforms have included the sale of a large number of state-owned enterprises. In 1982 there were 1,155 state-owned enterprises in Mexico. Today, there are only 247, 52 of which are in the process of being privatized.

The private sector's increased involvement in the economy has resulted in important benefits in various sectors. The sale of two state-owned television channels has significantly increased the level of competition in that industry. The privatization of the telephone industry has led to 1.5 million new telephone lines since 1994. The competition in local telephone service is expected to begin in 1999. New participants in this industry have committed to invest in 9 million new telephone lines, which should double Mexico's telephone density. Regarding satellite technology, the privatization of the state-owned satellite company has made it possible to launch a more advanced satellite system.

The privatization process has led to improvements in the railroad, airport and port industries. The volume of cargo transported by railroad grew by 20% during 1998. The Government expects to grant concessions for the operation 35 of the 58 airports currently run by the Government. By mid-1999, 21 of these concessions had already been awarded. The privatization of ports has resulted in considerable increases in capacity and movement of commercial cargo.

The Mexican Government has allowed the private sector's role in other areas, such as mining, sugar refining, natural gas, and steel, to increase.

This Administration recently proposed to Congress that the private sector, national and foreign, should be allowed to invest in the generation, distribution and final commercialization of electricity. The State, however, would maintain the operational control over the national transmission network, the electrification programs in popular neighborhoods and rural areas, the allocation of subsidies and the operation of nuclear and some hydroelectric plants. These changes would help guarantee an adequate supply of reliable, high quality and competitively priced electricity in the long run. The Government's new strategy implemented for the development of the petrochemical industry also entails the participation of the private sector.

The substantial decrease in the Government's participation in Mexico's economic activity has led not only to a better management of the Government's fiscal accounts but also to a more efficient allocation of Government resources. The Mexican Government has focused its efforts successfully on the reduction of poverty levels through various social programs to improve the quality of education, health care and social security provided to the population. The Government has also worked towards improving the public administration's regulatory framework at the federal, state and municipal levels. The current deregulation program (ADAE) has permitted the reduction of regulatory costs and "red tape".

Greater Government efficiency has been bolstered by the decentralization of administrative powers. This measure has allowed state and local authorities to obtain resources directly and channel them according to each state's priorities.

For the first time in Mexico's history, state and local governments have direct control over more resources than the Federal Government. For every peso the Federal Government spends today, state governments and municipalities are spending 1.31 pesos, while for every peso the Federal Government spent in 1988, state governments and municipalities spent 51 cents.

TAX SYSTEM

The structural reform of the tax system is an ongoing process. Thus, every year the Government has tried to close any tax loopholes, while taking the necessary steps to make tax collection more efficient, transparent and equitable. As discussed above, the Government has also focused on reducing the public sector's dependence on oil related revenues.

The Mexican Government intends to implement several measures to increase the tax base and improve tax compliance, including a new law that considers tax evasion above a certain threshold as a serious crime, as is the case in other OECD countries.

In order to promote economic activity, the Government will gradually decrease the income tax rate (ISR) on corporations from 34% to 30%. On the other hand, the Government intends to increase the marginal ISR for individuals earning more than 1.5 million pesos annually from 35% to 37.5%, and to 40% for those earning more than 2 million pesos.

Finally, it is important to note that Mexico's tax rates are competitive when compared to other OECD countries.

LABOR MARKETS

The labor market has moved towards a more flexible structure, which reduces the time that workers who have lost their jobs need to find another position. Currently, almost 70% of workers who lose their jobs in Mexico find a new one between 1 and 4 weeks later.

The open unemployment rate has declined steadily over the last several years. During the first seven months of 1999, the open unemployment rate averaged 2.68%, its lowest level for that period since 1991.


FINANCIAL LIBERALIZATION

BANKING SECTOR

Over the past two decades, the Mexican banking system has undergone significant changes. In 1982, in the midst of the debt crisis, the Mexican banking system was nationalized and the banks used private deposits mainly to finance the Government's budget deficit. Thus, the risk management methods were not updated and the lending culture was lost. Towards the end of the 1980's and early 1990's, the Mexican Government implemented a series of policies aiming to liberalize the financial system, which allowed a credit expansion. However, the liberalization of the sector was not accompanied by a modernization of the supervision and regulatory framework.

The expansion of credit occurred in a major way at the financial system level, even when some banks moderated the granting of credit to concentrate on restructuring their institutions. Some banks sought to boost their market share, granting loans in an aggressive and imprudent way, increasing the vulnerability of the banking system. This situation was aggravated by the 1994-1995 crisis that deteriorated the payment capacity of debtors, significantly increasing banks' past due loans.

A strong and healthy banking system is needed in order to promote saving levels compatible with Mexico's investment needs and to channel those savings under competitive conditions to all the sectors of the economy. In this regard, the recent reforms of the Mexican financial system are a central component of the structural reform process.

In response to the 1994-1995 crisis, the Government implemented a series of programs intended to improve the solvency of the Mexican banking system.

Moreover, in December 1998, Congress passed a set of significant reforms of the banking laws. These measures are intended to accelerate the recovery of the financial sector and lay the groundwork for more solid and well-supervised financial institutions through the promotion of market discipline and the efficiency and capitalization of the banking system.

The most important action undertaken to date has been the creation of the new Institute for the Protection of Bank Savings (IPAB). The new entity assumed the role of the Banking Fund for the Protection of Savings (FOBAPROA) in managing deposit insurance. Total deposit coverage will be phased out gradually under the new system, leading to a maximum deposit insurance of 400,000 Investment Units (UDIs³ ), equivalent to approximately 110,000 dollars at the current exchange rate, per person, per institution by the year 2005. The limits on deposit insurance should foster market discipline and self-regulation by the banking institutions, while protecting small depositors' savings. The sale of the assets acquired through the various banking support programs will now be carried out by the IPAB.

In addition, the Mexican Congress has allowed foreign investors to hold a majority share of any Mexican commercial bank, regardless of its size. This measure will strengthen the banking system's capital base.

Important steps have also been taken towards the strengthening of supervision mechanisms and the creation of the necessary incentives for self-regulation. For example, in October 1998, the National Banking and Securities Commission (CNBV) introduced a regulation to avoid bad borrowers to access new credits by increasing the level of provisions to those banks that do not consult the Credit Bureau or when a loan is granted even if the Bureau provides negative information about that specific debtor.

Mexican authorities have also directed their actions towards the disclosure of timely, transparent and accessible information (both public and private), and the adoption of internationally accepted accounting principles. They have also issued a set of minimum guidelines for the risk management process that includes market, credit, liquidity, operational and legal risks.

Moreover, an institution in charge of protecting the users of financial services and promoting a more solid and extended financial culture was created in April 1999 (the Financial Services Consumer Protection Commission).

Furthermore, a bill that provides greater legal security to both debtors and creditors was submitted to Congress in April 1999. This bill intends to reinforce the legal framework governing credit guarantees. In addition, Congress and the Executive Branch are currently working on the design of a new corporate bankruptcy law.

³ UDIs are units of account used to adjust financial and commercial operations to inflation. The value of one UDI in April 1995 was set at $1.0 pesos, and it is adjusted on a daily basis according to consumer inflation. Its value as of August 26, 1999 was $2.59 pesos.

DEVELOPMENT OF DOMESTIC CAPITAL MARKETS

In recent years, Mexican capital markets have grown significantly. The stock market capitalization level has increased from 1.37% of GDP in 1984 to 25.9% of GDP in the first half of 1999, while the size of the domestic fixed-income market has increased from 4.6% of GDP in 1984 to 17.5% of GDP in 1999.

Mexico currently does not have a government yield curve for fixed rate nominal interest bearing securities beyond 1 year. However, the Mexican Government recently announced its intention to issue fixed rate longer tenor (between 2-3 years) government securities.

One important action taken by the current Administration has been the establishment of a futures and options market in Mexico. This measure has the primary objective of providing market participants with better risk management mechanisms, while fostering greater depth, liquidity and stability in the financial markets.

The products currently traded in the Listed Futures Exchange, known as MexDer, include U.S. dollar-peso currency futures, stock market index futures¤ , futures on 91-day Treasury bills (Cetes), futures on the 28-day interbank interest rate (the TIIE rate), and futures on the stocks of the following companies: Banacci, Cemex, Femsa, Gcarso, GFBancomer and Telmex.

By the end of 1999, MexDer expects to introduce trading in UDI futures, and in futures of the most commonly traded individual stocks on the Mexican Stock Exchange. Additionally, during the year 2000 MexDer plans to introduce trading in options on peso-U.S. dollar currency futures, IPyC index futures, 91-day Cetes futures, 28-day TIIE futures, and UDI futures.

¤ The Mexican stock exchange index is known as the IP & C index, and is based on a basket of the most commonly traded stocks.

PENSION SYSTEM

The reform of the Mexican social security system went into effect in July 1997. This reform will gradually move the Mexican pension system from a pay-as-you-go to a fully funded one, playing an important role in the generation of domestic long-term resources to finance investment. In addition, it will help to deepen the capital market, by allowing the resources deposited in individual accounts (which are managed by fourteen pension fund managers known as Afores) to gradually participate in the stock market.

The Afores have offered average nominal returns of 26.4% during the first half of 1999, equivalent to 11.3% in real terms.

The participation in the new system is mandatory for all workers. However, during the transition from the old to the new system, workers may choose from the benefits under the previous system or the ones under the new law. The new system offers important benefits for retirees. These include a guaranteed minimum pension equivalent to the minimum wage adjusted yearly for inflation; a strong relation between benefits and contributions; and access by low-income workers to the financial markets. Furthermore, workers are allowed to make voluntary contributions to their individual accounts.

In the near future, the authorities are planning to allow pension fund managers (Afores) to invest in a wider range of instruments, including the stock market. This measure should help develop Mexico's different domestic capital markets even further.

To date, the number of workers affiliated with the new system has reached nearly 14.6 million. The resources deposited in individual accounts in the year 2000 are expected to represent about 3% of GDP.

The social security reform has contributed to the reduction in Mexico's dependence on foreign capital. In fact, the reforms have already played a key role in increasing domestic savings, which have grown from 14.8% of GDP in 1994 to 22.1% of GDP in the first quarter of 1999.



IV. THE MEXICAN ECONOMY IN THE YEAR 2000:

A SMOOTH TRANSITION.

The Mexican Government is determined to avoid an economic crisis such as the ones we have observed at the time around previous changes of Administration.

We intend to achieve this goal by correcting for those factors that have prompted previous economic crises, as well as reinforcing other aspects of the Mexican economy.

In addition, the challenge facing Mexico in the medium term is to consolidate the gains made during the 1996-98 period, and to place the economy on a higher, sustainable growth path that will expand employment opportunities and improve living standards in a context of low inflation.

Sound economic policies and structural reforms after the 1995 crisis have considerably strengthened Mexico's economic fundamentals.

A smooth transition into the next administration will be a very strong signal confirming the fundamental changes in the Mexican economy.

FINANCIAL STRENGTHENING PROGRAM

As an essential component of the Government's strategy to achieve a smooth transition in the year 2000, in June 1999 Mexico assembled a package of financial resources known as the Financial Strengthening Program. This package totals US$16.9 billion, and includes the IMF US$4,200 million Stand-by Arrangement.

The Financial Strengthening Program is composed of the following elements:

Financial Strengthening Program 1999-200 (million dollars)

¹ Approved on July 7, 1999
² Loans expected to be disbursed during the period 1999-2001

In addition, close cooperation on economic and financial issues with our NAFTA partners will continue to help protect stability and growth. We renewed the North American Framework Agreement (NAFA) with our North American partners through December 2000. Were it to be activated, this facility would comprise up to US$3.0 billion from the Federal Reserve System, US$3.0 billion from the United States Treasury Department, and approximately US$670 million from the Bank of Canada, totaling US$6.7 billion.

MARKET EXPECTATIONS

As a result of the strengthening of Mexico's fundamentals and the Government's proven commitment to maintain sound macroeconomic policies, Mexico has established a reliable track record among domestic and foreign market participants.

Many of the concerns that market participants had at the beginning of 1999 regarding the evolution of the Mexican economy have dissipated.

During 1999, domestic and foreign market expectations« have been converging gradually towards the official targets, reflecting a higher degree of confidence in the Government's economic policy and the future outlook of the Mexican economy.

Real GDP growth expectations for 1999 have surpassed the Government's target, increasing from an average» of 2.4% in January 1999 to 3.1% in August.

Annual inflation expectations for 1999 have been coming down from an average of 16.35% in January 1999 to 13.5% in August.

Expectations regarding the public sector deficit as a percentage of GDP for 1999 have shown a similar trend, declining from an average of 1.50% in January 1999 to 1.19% in August.

Expectations for the year 2000 have also been gradually converging to the official targets. We expect to see faster convergence as it becomes clear in the future that Mexico will have a strong performance in the year 2000.

Real GDP growth expectations for the year 2000 have increased from an average of 3.65% in January 1999 to 3.9% in August.

Annual inflation expectations for the year 2000 have declined from an average of 13.35% in January 1999 to 11.5% in August.

«: Banco de Mexico's monthly economic survey among an average of 30 Mexican economic consulting groups (domestic expectations) and Mexico's Ministry of Finance calculations using data from 9 foreign investment banks (foreign expectations).
»: Average of domestic and foreign expectations.



V. CONCLUDING REMARKS

Mexico's recent economic performance has been favorable, driven mainly by investment and exports. Industrial production and employment continued to grow at considerable rates during the first half of 1999.

Government policies in the fiscal, monetary and debt fronts have led to a substantial increase in the resilience of the economy to external shocks.

Mexico's fiscal, monetary and exchange rate policies should provide an environment that allows higher and sustainable growth rates.

We will continue to take steps to improve the maturity and the amortization schedule of public sector debt.

Mexico is a radically different country from what it was before. Mexico is much more integrated with the world economy, with the private sector being the key player in economic activity.

The Government's role in the economy is now largely limited to the provision of public services and an adequate legal framework, guaranteeing competition and undertaking social development programs.

Financial markets have been considerably deregulated in comparison to the 1980's, leading to an increase in the amount of intermediated resources. However, the Mexican Government is convinced that an adequate supervisory and regulatory framework is necessary, so resources are allocated to their most efficient users in a prudent way.

In spite of the uncertain situation in international financial markets, the Mexican economy is set to grow at high rates in 1999 and the year 2000.

Past sources of vulnerability have been reduced considerably and the Mexican Government has established a substantial financial support program.

Thus, Mexico has set the ground for a crisis-free transition to the next administration.

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