Mexico proposes sound fiscal plan, says CSFB

I discussed Mexico’s fiscal woes and compared them to Brazil’s in a previous post.  Today, financial market analysts reacted positively to the Mexican government’s fiscal plan, set to limit the widening of the federal deficit in 2010.  Like Barack Obama’s unwillingness to confront Congress on the cap-and-trade carbon emissions plan or health care reform, Felipe Calderon’s government once again skirted the issue of expanding Mexico’s narrow VAT tax to cover food and medicines.  Instead, the government will tax income more heavily.  CreditSuisse’s Alonso Cervera applauds this move because of the virtual impossibility of moving a budget through the Mexican legislature with a VAT expansion in it.  Calderon faces a congress in which his PAN party is dwarfed by the opposition PRI party, unlike the commanding position of Obama’s Democrats in both houses of the U.S. Congress. Nevertheless, Mexico’s budget, if passed, is a step in the right direction, especially since it controls spending and raises the share of non-oil taxes in government revenues. 

Read Alonso Cervera at CreditSuisse and Alfredo Thorne at JPM below:  

 From CreditSuisse’s Emerging Markets Economics Daily, Sept 9, 2009

“The government presented an ambitious budget proposal for 2010 that seeks to limit the widening of the deficit to 0.4% of GDP mainly by strengthening non-oil tax collections. The government released the comprehensive documents last night. Our first impression is a positive one, in that the government will seek to gain congressional approval for tax hikes equivalent to 1.4% of GDP, and for spending cutbacks equivalent to 0.5% of GDP. By applying an additional 0.7% from non-recurring revenues (those

currently existing in stabilization funds as well as projected ones), the government seeks to limit the widening of the fiscal deficit to 0.4% of GDP, from 2.0% this year to 2.4% of GDP next year. The government will also seek to strengthen the fiscal responsibility law by, among others things, eliminating the maximum reserve levels for stabilization funds so that the government can capitalize on the materialization of a revenue windfall.

The government presented in its policy guidelines document relevant comparisons that make it clear that non-oil tax revenues in Mexico are particularly low. The government made the comparison versus other OECD countries, Latin American countries and Brazil in particular. The government’s proposal to enhance non-oil tax revenues does not rest on the introduction of a value-added tax on food and/or medicines. We view this as a wise decision, given the strong opposition that both the PRI and the PAN had voiced in recent days regarding this potential proposal. Instead, the government is seeking to

achieve a combination of higher excise and income taxes, as well as the introduction of a new tax that has been labeled the “anti-poverty tax”.

Specifically, the government’s proposals on the tax front include: 1) the introduction of a 4.0% excise tax on telecommunication services that use a public network (excluding services in rural areas as well as public telephones); 2) increasing the excise tax on tobacco by 10.9 percentage points in 2010; 3) increasing the excise tax on beer from 25%to 28% in 2010-2012 and then reducing it back to 25% by 2014; 4) increasing the excise tax on lottery games to 30% from 20%; 5) hiking the maximum income tax rate on individuals and corporations to 30% in 2010-2012 from 28% at present, and then reducing it gradually back to 28% by 2014; and, 6) increasing the tax on cash deposits from 2% to 3% and broadening its application to cover smaller transactions.

Finally, the so-called antipovertytax would be a “2% tax on revenues generated by all types of economic activities, applied in all stages of production  in a non-cumulative manner”, according to the document. The proceeds, estimated at 72bn pesos (0.6% of GDP), would be applied to selected anti-poverty  programs. The government estimates that non-oil tax revenues could increase from 9.2% of GDP in 2009 to 10.8% of GDP next year. The bulk of the increase would come from income taxes, which would increase from 5.0% of GDP in 2009 to 5.6% of GDP next year. The government is also proposing some changes to the taxation of Pemex. Specifically, one of the proposals is to create a new flat tax rate of 15% for natural gas and crude oil extraction activities in selected fields, as opposed to taxing them based on a variable rate that is capped at 20%.

On the spending front, the government is seeking a reduction of 0.6% of GDP in programmable expenditures as well as the re-allocation of other expenses in favor of pension payments, health coverage and overall anti-poverty measures. Some specific measures to cut spending include the closing of three major government offices, 5% headcount reductions for high ranking officials and administrative staff, and 10% cutbacks in Mexico’s representative offices abroad. On the debt financing front, we highlight that the government will seek a net domestic indebtedness ceiling of 340bn pesos, which compares favorably to the ceiling it requested (and got from congress) of 380bn pesos for 2009. We think that this should be a relief for the local market, as the government will seek more actively than usual non-market financing sources abroad (mainly IFIs and other non-traditional sources). As for market debt issuance in external markets, the government’s plan is to simply issue an amount equivalent to market amortizations coming due in 2010 ($2.9bn).

Finally, the government’s outlook on the global economy in 2010 is somewhat cautious. The government’s documents presented to Congress yesterday state that the global situation continues to show a significant degree of fragility and that the global economic recovery will be moderate. Mexico’s real GDP is projected to expand at an average rate of 3.0% in 2010, with average annual growth seen at 4.2% in 2011-2015. This is partly based on the Blue Chip survey that puts US real GDP growth at 2.3% in

2010 and US industrial output growth at 2.5%. The government’s oil price assumptions are based on the formula set out in the budget responsibility law. Taking historical and projected prices, the formula yields an estimate of $53.9 per barrel for Mexico’s crude oil export mix in 2010 (roughly $60 for the WTI mix), which increases gradually towards $64.6 by 2015, which we view as conservative. Finally, in terms of oil output, the assumption is that it will average 2.5mn barrels per day in 2009 and in subsequent years, down from slightly over 2.6mn barrels per day in 2009. This assumption may be on the optimistic side, in our view.

In the remainder of this week we will expand our analysis of the comprehensive documents issued by the government last night. We reiterate that our initial reaction is positive, in that the government is putting on the table several measures that seek to close the gap created by falling oil and non-oil prices due to structural and cyclical factors. We also view the decision to keep off the negotiating table any proposal to introduce a valueadded tax on food and medicines as a good move by the government, one that may make negotiations smoother with the main political parties.

Finally, and on a separate note, the central bank will publish today at 10:00 am EST the inflation results for August; we estimate headline inflation was 0.28% last month (relative to July). If our estimate proves accurate, annual headline inflation will drop to 5.1% from 5.4% in July. Meanwhile, we estimate that core prices rose by 0.24% last month, which would put the 12-month reading at 5.1%, down from 5.3% in July. These would be the lowest 12-month readings since May 2008 in the case of headline inflation,

and since July 2008 in the case of core inflation. Market expectations are generally in line with our own. The latest survey released yesterday showed average forecasts of 0.26% and 0.25% for headline and core inflation, respectively. The survey also showed that the overwhelming majority of analysts (19 out of 24) thought that the central bank will keep the overnight rate unchanged at 4.5% in the remainder of the year.”

From JPMorgan’s Emerging Markets Today, Sept. 9 2009

“President Calderón yesterday announced the 2010 economic

package, calling for an austere budget with changes in the

public sector’s administration structure. To reduce expenses,

Calderón presented four administrative changes for next year

to be discussed by Congress. First, the Ministries of Tourism,

Agricultural Reform, and Public Ministry will be eliminated.

The first two entities will be reallocated to the Ministry of

Economy and Ministry of Social Development and

Agriculture, while the third will fall under executive powers.

Second, the federal government will reduce the large number

of civil servants and freeze salaries and compensation. Third,

spending on embassy, councils, and foreign activities will be

reduced. Fourth, other administrative expenses will be

reduced. The measures together are expected to reduce

budgetary expenses by MXN80 billion. Calderón

estimated that these expenditure cuts, combined with the

fiscal package (still pending at the time of writing), will

narrow the fiscal gap to MXN180 billion (1.4% of GDP).

Calderon also reiterated the government’s commitment to

reducing poverty noting that none of these expenditure cuts

will include social programs.”

Alfredo Thorne (52-55) 5540-9558  alfredo.e.thorne@jpmorgan.com

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