Economic and financial context
From the Country Report document, Annex II on macrofinancial linkages:
Risks are tilted to the downside. On the downside, an unexpected slowdown in China or setbacks from pending adjustments in Brazil could dampen exports and investment, and tighten financing conditions as investor risk aversion increases. Sustained uncertainty about U.S. domestic policies, a shift towards protectionism, and faster than expected tightening of monetary policy could dampen external demand while raising inflation as the peso depreciates. Domestically, the recovery in confidence could be further delayed by a drawn-out resolution of legal uncertainty embedded in the new labor bill.
The impact of downside risks materializing could be amplified through macro-financial linkages. Although balance sheets in key sectors appear to be healthy (Annex II.A), historically high household debt (60 percent of GDP), high leverage among non-financial corporates, and strong inter-sectoral balance-sheet linkages are sources of vulnerability (network chart). Among large corporates, foreign currency debt is substantial (55 percent in 2016Q1), although long maturities, a substantial share of FDI related debt, and financial and natural hedges are containing risks from currency mismatches.
Severe stress tests of corporate balance sheets, which substantially raise default probabilities of externally exposed firms, show that credit losses would be substantial. Even so, the banking sector would manage to absorb a rise in credit costs thanks to sufficient capital buffers.
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