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Cablegate: Scenesetter for Assistant Secretary Sullivan's Visit To

VZCZCXYZ0002
RR RUEHWEB

DE RUEHME #2673/01 2462220
ZNR UUUUU ZZH
R 022220Z SEP 08
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC 3128
RUEATRS/DEPT OF TREASURY WASHINGTON DC

UNCLAS MEXICO 002673

SIPDIS

FROM AMBASSADOR FOR EEB ASSISTANT SECRETARY SULLIVAN AND WHA PDAS
KELLY
STATE FOR EEB/TPP MIKAEL LURIE AND DEBORAH GROUT
STATE FOR WHA/EPSC MATTHEW ROONEY
STATE FOR WHA/MEX ELIZABETH WOLFSON AND IAN BROWNLEE
TREASURY FOR LUYEN TRAN

E.O. 12958: N/A
TAGS: ECON MX
SUBJECT: SCENESETTER FOR ASSISTANT SECRETARY SULLIVAN'S VISIT TO
MEXICO SEPTEMBER 3-5

1. (U) My staff and I warmly welcome you and your colleagues to
Mexico City. President Calderon recognizes the broad-ranging
challenges his country faces and has the vision and political will
to address them strategically. He has demonstrated resolve in
implementing his key policy objectives: improving security and the
rule of law, attacking poverty, and creating jobs. The U.S. and
Mexico have developed a solid set of institutional relationships
that allow us to work productively on most of our priorities,
including fundamental issues of homeland security and North American
prosperity. Those links are set to expand. Your visit is a sign of
U.S. support for the right-of-center Calderon government and
dedication to this complex, interdependent relationship.

Bilateral Relations and AGP
-------------------

2. (U) Calderon has demonstrated pragmatism in his posture toward
the United States and is building on an already modern and mature
U.S.-Mexico relationship. The President's message is that Mexico
will seek what it needs from us on the basis of equality, respect,
and the close cooperation expected of neighbors that share
wide-ranging interests and challenges. Our common border,
responsible for extensive commercial, community, and family ties, is
transforming our societies into two of the most deeply and broadly
connected on earth.

3. (U) Calderon's top officials have been receptive to our Alliance
for Growth and Prosperity (AGP) concept, though they are anxious
that it not diminish the work of the Pacific Arc Forum. Calderon is
eager to deepen commercial integration with the United States and
the rest of the region, and is likely to support any forum that
promotes economic development and furthering the benefits of free
trade agreements. The GOM has informed us that it shares with us
the broad objectives of the AGP, with the exception of our concerns
over labor and environment. The GOM will also need to be reassured
that the AGP has the solid backing of the Bush Administration.
Calderon has several times criticized us and, to a lesser degree,
Canada for failing to advocate for NAFTA.

Security
--------

4. (U) There is increasing public concern over the rise in violence
in Mexico. On August 30, more than 100,000 Mexicans marched
peacefully throughout the country to demand government action
against kidnappings and killings. The Calderon administration has
moved forcefully to improve public security, significantly
increasing the security budget; launching surge operations against
drug traffickers in six of the most conflictive states; engaging the
military in a significant way; working to overhaul Mexico's national
police organization; getting the Congress to pass a major criminal
justice reform; and authorizing the extradition to the United States
of a record number of wanted criminals, including drug king-pins.
The President's actions reflect his commitment to intensify
security-related cooperation with the U.S., and his willingness to
incur political risk in doing so. On June 30, President Bush signed
the Merida Initiative, a 450 million USD package that provides
funding for technical assistance and equipment for Mexico to use in
their fight against narco-trafficking. This assistance is a key
example of our cooperation in the counter narcotics arena.

Strong Leader in a Conflictive Environment
------------------------------------------

5. (U) President Felipe Calderon is showing strong leadership at
home and abroad in a manner much appreciated by Mexicans. Although
he won election with a bare 36% plurality in a three-way race, an
opinion poll published Sept. 1 in the major daily Reforma showed
that 62% of Mexicans approve of his performance to date.
Nevertheless, the political climate overall remains conflictive,
with a congress closely divided between the president's
right-of-center National Action Party (PAN), the leftist Democratic
Revolutionary Party (PRD), and the left-of-center Institutional
Revolutionary Party (PRI). Calderon faces significant domestic
challenges in pursuing his security, economic and social reform
agendas. At the same time, he must chip away at the historic
Mexican ambivalence toward the U.S. that has slowed progress on many
common fronts, including security. Because of this divided
political environment, it is difficult to predict the results of the
mid-term Congressional elections to be held in July 2009. PRD's
fortunes seem to be waning and good showings by PRI candidates in
state and local elections over the past year may be a harbinger of
strong gains in next year's mid-term elections.

Stable but Vulnerable Economy

-----------------------------

6. (U) U.S. strategic interests in Mexico are tied to three key
economic factors: (1) a population of 110 million bordering the
United States with a poverty rate over 40 percent, (2) the second
largest supplier of oil to the U.S. in 2007 (though so far this year
it has slipped to third behind Canada and Saudi Arabia), (3) over
one billion dollars a day in two-way trade in goods and services,
with a highly integrated production cycle between factories in the
U.S., Mexico and Canada.

Poverty and Economic Performance
--------------------------------

7. (U) Mexico has the highest income inequality of any nation in
the OECD. The latest Mexican government figures, (from 2006) show
the poverty rate declined slightly to 42.6 percent overall, with
10.3 percent living in "food-based poverty," unable to meet the
nutritional needs of their families. Widespread poverty encourages
illegal immigration, narcotics smuggling to the United States, and
other forms of illicit commerce. Growing income inequality fuels
the tensions that almost resulted in the election of a populist
President, Andres Manuel Lopez Obrador, who openly embraced
President Chavez of Venezuela.

8. (U) President Calderon inherited a stable, growing economy
tightly linked to U.S. economic cycles. Mexico chalked up an
estimated 3.3 percent growth rate in 2007, rebounding from near zero
growth in the first years of the decade. Real GDP growth is
expected to slow to around 2.6 percent this year, primarily due to
the U.S. economic slowdown. Inflation, fueled by spiking
international food and energy prices, has risen in recent months to
over 5 percent, prompting the Central Bank to raise interest rates
in June 2008, shortly after the government had reduced import
tariffs for key food items, increased subsidies for poor consumers,
and obtained voluntary price controls from producers. Most jobs
currently being created in Mexico are in the informal economy, which
the World Bank estimates employs 27-45 percent of the working age
population. Many here are growing concerned about Mexico's ability
to compete in an increasingly globalized world, as it loses market
share to China and other emerging economies. In his second State of
the Union Address, issued on August 27, Calderon claimed that
800,000 formal jobs have been created in Mexico. Mexico has
achieved a 3 percent GDP growth, not bad for a global environment
characterized by recession and high inflation, but still
insufficient to progress. Calderon highlighted that Mexico, except
Canada, had the lowest inflation in America.

Need for Bolder Economic reform
-------------------------------

9. (U) World Bank, OECD, Mexican and other economists say Mexico
would need sustained, long-term growth rates of at least six percent
to alleviate widespread poverty -- but cannot achieve that level of
growth without structural economic reform beyond what President
Calderon has currently proposed. We agree with Finance Minister
Carstens that in order to compete internationally and develop the
poorest parts of Mexico, Mexico needs broad reform to improve tax
collection, reduce reliance on oil income, confront growing pension
liabilities and payments on government borrowing outside the federal
budget, and provide needed spending on poverty alleviation,
education, health and infrastructure. Mexico desperately needs
education reform, since currently 60 percent of its people do not
graduate high school. In order to achieve sustained robust growth,
Mexico must improve competition in an economy long dominated by
business monopolies and oligopolies, and to take on powerful labor
unions (including the national teachers union) in order to amend
labor laws that discourage job creation in the formal economy.

10. (U) While President Calderon has achieved more reform in his
first two years in office than his predecessor did in six years, the
lack of a majority in Congress has forced him to compromise with the
special interests that have long slowed progress in Mexico's
economy. While the President's skill at pragmatic political
negotiation has led to a series of successful economic reforms, it
has also meant the reforms were watered down and are not yet
sufficient to place Mexico on a sustained growth path sufficient to
alleviate widespread poverty. Reforms to date include a tax reform
that solved about one-third of the need for additional collections,
and a pension reform that combined with that of his predecessor
solved about 80 percent of the insolvency crisis in Mexico's pension
systems. To overcome a key to economic growth, President Calderon
has announced a National Infrastructure Plan, under which his
government would spend five percent of GDP for the next five years
to improve Mexico's long-neglected infrastructure. The President

recently joined with the leader of the national teachers union to
announce a program to improve primary education, although many are
skeptical that the union will allow real reform. On August 6,
Calderon named his pro-business former chief of staff, Gerardo Ruiz
Mateos, to be the new Secretary of the Economy to aid him in the
battles against rising inflation, falling remittances, and the
informal sector. While Calderon's government has taken incremental
steps to reduce the market dominance of monopolists and oligopolists
in key sectors like telecommunications and banking, Congress has
blocked serious reform. Currently, Mexico is in the midst of a
heated debate over the President's rather modest energy reform
proposal (see below).

Actively Seeking to Expand Trade and Investment
--------------------------------------------- --

11. President Calderon has made increased international trade and
investment a cornerstone of his presidency. In June 2007, he
created ProMexico, a federal entity charged with promoting Mexican
exports around the world and attracting foreign direct investment to
Mexico. He has also worked to strengthen economic relations with
European and Asian countries in order to lessen Mexico's dependence
on the U.S. economy. Last year, Mexico's FDI inflows reached a
record 23 billion USD while at the same time the percentage of such
inflows originating in the U.S. decreased to 47.3 percent, only the
second time since NAFTA implementation that the U.S. has accounted
for less than half of Mexico's FDI. Mexico has also seen its
percentage of exports to the U.S. decrease from 87 percent in 2004
to 82 percent in 2007. As the U.S.'s economic slowdown continues,
Mexico will expand efforts to diversify away from a U.S. centered
economy.

12. (U) That said, Calderon is eager to deepen commercial
integration with the United States and the rest of the region,
something his government views as essential to strengthening
competitiveness vis-a-vis competitors, especially from Asia. In
March, Calderon stated that Mexico was ready to talk to Panama about
restarting stalled discussions on a free trade deal. Discussions
over a Mexico-Peru FTA have entered the final round. Mexico sees
the August 15 entry into force of the CAFTA-DR textile accumulation
provisions as a model for linking together the free trade agreements
among common partners in the Hemisphere, and is working with
like-minded Latin countries in the Pacific Arc Forum to harmonize
rules of origin among common free trade partners.

Energy
------

13. (U) After Canada, Mexico was the largest source of U.S. oil
imports last year. We therefore have a strong strategic interest in
continued stable supplies of Mexican oil. Within Mexico, energy is
an extremely sensitive topic tied to national sovereignty, but the
energy sector requires difficult reforms urgently. Mexico's oil
production and reserves continue to decline due to a lack of
investment in oil exploration and production. Sufficient investment
funds are not available because of the constitutional prohibition on
private investment and the fact that most of Pemex's revenue goes to
pay for as much as 38% of the government's budget. Pemex's
liabilities have grown so large that it can no longer fund
investment in exploration through borrowing in international
markets. President Calderon understands that declining oil
production can only be addressed through fiscal reform to reduce the
amount of Pemex revenue sucked into the government budget, and
through energy reform to improve the efficiency of Pemex operations
and allow for private and foreign investment in the petroleum
sector.

14. A comprehensive tax reform package was passed last year and
there is currently a mild energy reform package being heatedly
debated in the Mexican Congress as well as in the court of public
opinion. Initial indications are that some type of energy reform is
likely to pass and could provide some additional flexibility for
PEMEX and pave the way for further reform. Analysts anticipate an
intense month plus of congressional discussions which could lead to
a consensus package being passed by early October. (The Mexican
Constitution requires that the federal revenue and appropriations
bills be approved at the end of October and mid-November
respectively, and both of these will be heavily impacted by any
reform to PEMEX.) While the package that the Calderon administration
submitted to Congress would not open Pemex up to the level of
investment that it sorely needs, it seems to be a small but
important step toward the large task of reforming Pemex. While polls
indicate that most Mexicans now understand something needs to be
done with PEMEX, unions and opposition parties reflect the views of
many Mexicans who are skeptical of foreign involvement. Even

seemingly benign, factual statements by U.S. officials about
Mexico's petroleum sector, such as those made by President Bush in
March 2007 or former Fed Chairman Greenspan several months later set
off a tempest of responses and front page condemnations, including
from officials largely supportive of opening the sector.


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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