Mexico transitions towards a comprehensive risk management strategy

Challenge

In the 2012 “General Criteria of Economic Policy” (Criterios Generales de Política Económica 2012), the Government of Mexico underlines the relevance of fiscal risks associated with macroeconomics shocks, crises in the financial sector, and unexpected expenditure outlays related to adverse natural events. Macroeconomic risks stem from lower economic activity, oil price volatility, and interest rate and exchange rate movements.

Financial sector-related fiscal risks originate from contingent liabilities associated with rescues of financial institutions or financial systems. Population growth and the concentration of physical assets in urban areas are leading to increased exposure to natural disasters. Weather and commodity price shocks constitute a relevant source of risk for the agriculture sector. Overall, the materialization of fiscal risks generated by unexpected spending pressures or revenue losses may trigger disruptive and costly ad hoc adjustments during annual budget implementation.

Solution

The World Bank has supported Mexico for the past decade on risk financing and management through a complementary package of knowledge, financial, and convening services. The following examples are illustrative:

• Supporting an integrated risk management approach, promoting the institutionalization of risk mitigation policies, and highlighting critical elements of the risk management framework.
• Assisting the country to develop an integrated financing and insurance strategy for managing disaster-related risks and extending this strategy to the state level.
• Using IBRD’s Multi-Cat Program to help the country transfer catastrophe (cat) risk to the capital markets through the issuance of cat bonds.
• Supporting the agriculture sector through the development of a strategy to reduce the vulnerability of producers and rural communities, and evaluating the efficiency of existing public sector interventions in the area of agricultural insurance and commodity price risk management.
• Contributing to the regular assessment of the financial sector and supporting the development a better functioning annuity market to mitigate pension liabilities.
• Executing a total of USD14.5 billion of interest rate fixings and local currency transactions to help the government manage its interest rate and foreign exchange risks.

Results

• Advisory and knowledge services for moving from 2 million (2012) to 4 million hectares (expected 2015) under commercial agriculture insurance coverage; and for improving the safety net for small farmers (8 million hectares) against weather contingencies.
• Contribution to the stabilization of the mortgage financing markets in Mexico, helping 40,000 low-income families to gain access to housing finance during the global financial crisis. 
• Measures to boost productivity, support counter-cyclical policies and strengthen financial market resilience supported the strong economic recovery in 2010-11.
• Access to International Bank for Reconstruction and Development (IBRD) funding reduced the Government’s financing cost, supporting their fiscal expansionary efforts to mitigate economic and employment contraction. To illustrate, the extension of the temporary employment program increased by 15 percent the work-shifts of employees hired by this program.

Bank Group Contribution

• Since 2003, the World Bank has executed interest rate fixings for the Secretaría de Hacienda y Crédito Público, Banobras, Sociedad Hipotecaria Federal y Nacional Financiera totaling USD$13.4 billion.
• Since 2005, the World Bank has executed local currency transactions for Banobras and Sociedad Hipotecaria Federal totaling USD$1.1 billion equivalent.  
• In 2012, the World Bank approved a development policy loan (USD$300 millions) on fiscal risk management.
• The Bank Treasury supported Mexico in transferring risks to capital markets through the use of catastrophe bonds (2006 Cat Mex, 2009 MultiCat Mex, and 2012 MultiCat Mex+).
• An ongoing Reimbursable Advisory Service (RAS) responds to a request of the Ministry of Finance to support the development of the country’s comprehensive disaster risk management strategy under the framework of the “Programa de Prevención y Atención de Desastres Naturales” launched by former President Felipe Calderón in November 2010.

Partners

The International Bank for Reconstruction and Development (IBRD) has maintained close partnerships with other donors and multilaterals, especially the Inter-American Development Bank (IDB) and the International Monetary Fund (IMF). For example, the 2011 Financial Sector Assessment Update, conducted jointly by the World Bank and the IMF, formulates a series of recommendations to foster sound financial sector development in Mexico.

As part of the engagement supporting the Government of Mexico (GoM) to position disaster risk management (DRM) on the G20 agenda, the Bank coordinated closely with the Organisation for Economic Cooperation and Development (OECD) to bring together the experience from developing and developed countries to best position DRM at the G20 leaders summit.

Moving Forward

The government's experiences in implementing risk management programs have demonstrated the value of hedging the budgetary exposures to specific risks and for specific programs and there may be additional areas where risk management can be used to strengthen the Government’s resilience to exogenous shocks. The Government may therefore find it useful to develop an integrated risk management framework that maps the range of risks emanating from exogenous shocks, current approaches, recommended approaches, and obvious gaps and inefficiencies. A comprehensive plan could be developed for addressing the gaps, taking into consideration what types of instruments could be used to improve the overall risk management strategy and the cost/risk trade-offs associated with different approaches.

Beneficiaries

While the direct beneficiary of this engagement is the Mexican public sector, both at the federal level and at the subnational level, the ultimate beneficiaries are the middle- and low-income households in the country. Efficient risk management ultimately ensures that limited government resources in the aftermath of a shock are available to support the most affected groups in the population.