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Cablegate: Inflation a Key Challenge for the Mexican

VZCZCXRO8858
PP RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #0063/01 0101343
ZNR UUUUU ZZH
P 101343Z JAN 08
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC PRIORITY 0088
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE
RHEHNSC/NSC WASHDC
RHMFIUU/CDR USSOUTHCOM MIAMI FL
RHMFIUU/CDR USNORTHCOM
RUEHC/DEPT OF LABOR WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RHMFIUU/DEPT OF ENERGY WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 03 MEXICO 000063

SIPDIS

SENSITIVE
SIPDIS

STATE FOR A/S SHANNON
STATE FOR WHA/MEX, WHA/EPSC, EB/IFD/OMA, AND DRL/AWH
STATE FOR EB/ESC MCMANUS AND IZZO
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GERI WORD
USDOC FOR ITS/TD/ENERGY DIVISION
TREASURY FOR IA (ALICE FAIBISHENKO, ANNA JEWEL)
TREASURY FOR IA (ALICE FAIBISHENKO)
DOE FOR INTL AFFAIRS KDEUTSCH, ALOCKWOOD, AND GWARD
NSC FOR RICHARD MILES, DAN FISK
EXIM FOR MICHELE WILKINS
STATE PASS TO USTR (EISSENSTAT/MELLE)
STATE PASS TO FEDERAL RESERVE (ANDREA RAFFO)

E.O. 12958: N/A
TAGS: ECON ELAB EFIN PINR PGOV MX
SUBJECT: INFLATION A KEY CHALLENGE FOR THE MEXICAN
GOVERNMENT IN 2008

REF: A. 07 MEXICO 5242

B. 07 MEXICO 391
C. MEXICO 13

------------------------
Summary and Introduction
------------------------

1. (SBU) A key challenge for the Calderon administration this
year will be containing inflation expectations and bringing
the overall inflation rate closer to 3%. The annual consumer
price inflation rate hovered around the top end of the
government's target range throughout 2007, with end-of-month
annual rates exceeding 4.0% four times during the year.
Headline inflation closed 2007 at 3.76%, but core inflation
jumped to 4.00%. Mexico will face some new sources of
inflation in 2008, including a new corporate tax and a gas
tax hike, both of which went into effect this month. The
government is trying to keep these taxes and general concerns
about high food prices from becoming generalized. Calderon
cut highway tolls, convinced retailers to sell basic food
products at a discount in the first quarter of 2008, and cut
industrial power rates by up to 30 percent. While these
measures are not the most effective tools for dealing with
inflation, Calderon probably wants to be seen as doing
something to ease inflationary pressures to counter any
potential political heat that would result from a generalized
increase in prices. End Summary.

------------------------------------
Headline Inflation Slows in December
------------------------------------

2. (U) The National Consumer Price Index rose a slightly
more-than-expected 0.41% in December. This figure brought
the annual inflation rate to 3.76%, within the Bank of
Mexico's (BOM) inflation target of 3%, plus or minus one
percentage point. The yearend rate is down from 4.05% at the
end of 2006, and is the second lowest since Mexico began
tracking inflation in 1973. The BOM said that higher prices
for tourism packages, tomatoes, limes, and eggs boosted
inflation in December, while prices for local telephone
service and a number of fruits and vegetables dropped. The
overall inflation rate slowed, but core inflation jumped
0.46% in December -- bringing the 12-month rate to 4.00%, the
highest reading since 2002, fueled by higher costs for
tourism services, snack bars, and air transport. According
to a BOM survey from December, market expectations for 2008
overall and core inflation are 3.86% and 3.67%, respectively.

------------------------------------------
Inflationary Pressures To Continue in 2008
------------------------------------------

3. (SBU) In addition to high prices for some foodstuffs,
Mexico will have to deal with new sources of inflation in
2008. Specifically, the 5.5% gasoline and fuel tax increase
that was approved as part of the 2007 fiscal reform went into
effect on January 5. While its effect on inflation should be
limited because the tax hike will be implemented over an
18-month period, some observers have argued that it will be
used as an excuse to increase public transportation rates and
have noted that, in the past, producers and retailers have
used higher gasoline prices to justify other price hikes.
The Single Rate Corporate Tax (IETU) also went into effect
this month, and economists are unsure how the new tax will
affect firms' pricing strategies. Moreover, some tortilla
producers are threatening to hike prices nationwide. Local
press reports say tortillas prices increased to 11.50
pesos/kg in some states, from a previous 8 pesos. While some

MEXICO 00000063 002 OF 003


observers argue that the price increases probably will be
short lived, these reports are worth monitoring since
tortillas are a staple in the Mexican diet and an important
component of the CPI. Moreover, last January the government
faced harsh criticism when tortilla prices spiked (Ref B).

--------------------------------------------- -----
Government Trying To Anchor Inflation Expectations
--------------------------------------------- -----

4. (U) In a speech from his residence on January 7, President
Calderon pledged that his government would watch closely the
behavior of prices and that it would act firmly to avoid
unjustified price hikes that could affect households.
Calderon added that despite high prices for various
commodities, Mexico posted one of the lowest inflation rates
in the country's history last year.

5. (SBU) The Calderon administration has announced a number
of measures aimed at containing inflation expectations, given
that such expectations greatly influence actual inflation.
Calderon on January 7 issued a decree that permanently
reduced peak electricity tariffs for industrial use by up to
30 percent. (Note: the electricity sector in Mexico is state
run. End Note.) The power-rate-adjustment will cost 7.8
billion pesos ($716 million), an expense that was planned for
in the 2008 federal budget. He also announced that the
government will not adjust federally administered toll road
fees for inflation in 2008, and that it will discount fees on
several other toll roads through yearend. The administration
also convinced retailers to sell a number of household goods
that weigh heavily in the consumption basket of low-income
households at a discount in the first quarter of 2008.

6. (SBU) In addition to the above measures, in late December
the GOM announced the country's new negotiated minimum wage
for 2008 with an eye toward fighting inflation. The new
daily minimum wage, which took effect on January 1, 2008,
increased 4% over 2007 from 48.67 pesos to 52.59 pesos. The
4% increase was considerably less than the 10% raise sought
by Mexico's organized labor unions. However, since the
minimum wage is used throughout Mexico as a standard of
reference for such things as job salary offers, private
service fees, government fines, tax tables, and a broad range
of other financial indicators, the GOM ultimately sided with
the private sector in wage negotiations on the need for a
small increase as a way to hold down inflation (Ref C).

-------
Comment
-------

7. (SBU) The Calderon government undoubtedly wants to avoid a
repeat of last January, when it took political heat from
ballooning tortilla prices. While the measures he has
announced to date are not the most effective tools for
dealing with inflation, Calderon probably wants to be seen as
doing something to ease inflationary pressures -- especially
since the negative effects of inflation tend to
disproportionately hit poorer households. While anything
that worsens the situation of Mexico's large poor population
(roughly 40%) is bad unto itself, this also would give the
left fodder to criticize Calderon. Another important reason
for keeping inflation low is that the central bank would be
under pressure to hike interest rates if inflation rises --
something that would work against the Mexican economy's
ability to continue growing in the face of an economic
slowdown in the U.S.

MEXICO 00000063 003 OF 003


Visit Mexico City's Classified Web Site at
http://www.state.sgov.gov/p/wha/mexicocity and the North American
Partnership Blog at http://www.intelink.gov/communities/state/nap /
GARZA

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