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Cablegate: Mexico's Calderon Submits Budget to Congress

VZCZCXRO9620
PP RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #6823/01 3412324
ZNR UUUUU ZZH
P 072324Z DEC 06
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC PRIORITY 4510
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
RHEBAAA/DEPT OF ENERGY WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 03 MEXICO 006823

SIPDIS

SENSITIVE
SIPDIS

STATE FOR A/S SHANNON
STATE FOR WHA/MEX, WHA/EPSC, EB/IFD/OMA
STATE FOR EB/ESC MCMANUS AND IZZO
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/ARUDMAN
USDOC FOR ITS/TD/ENERGY DIVISION
TREASURY FOR IA (ALICE FAIBISHENKO)
DOE FOR INTERNATIONAL AFFAIRS KDEUTSCH AND SLADISLAW
STATE PASS TO USTR (EISSENSTAT/MELLE)
STATE PASS TO FEDERAL RESERVE (CARLOS ARTETA)
NSC FOR DAN FISK, CYNTHIA PENDLETON

E.O. 12958: N/A
TAGS: ECON ELAB EFIN PINR PGOV MX
SUBJECT: MEXICO'S CALDERON SUBMITS BUDGET TO CONGRESS

REF: MEXICO 6157

-------
Summary
-------

1. (SBU) The new Mexican government of President Felipe
Calderon, which took office on December 1, submitted its 2007
budget proposal to the Chamber of Deputies on December 5.
The $205-billion budget is based on assumptions of 3.6% real
GDP growth, inflation of 3.0%, a Mexican oil mix price of
$42.50 a barrel, and an average nominal exchange rate of
11.20 pesos to the dollar. The proposal reflects Calderon's
emphasis on job creation, poverty reduction, and public
security. When compared to the approved 2006 budget, the
proposal increases social spending by 6.9%, anti-crime
spending by 12.4%, and transfers to state-owned energy
company PEMEX by 32.5%. Although the fiscal deficit
increases from 0.8% of GDP in the 2006 budget to 1.6% in
Calderon's proposal, the budget is fiscally responsible. The
budget does not include fiscal reform measures, but Finance
Secretary Agustin Carstens has said a fiscal reform package

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SIPDIS
is likely in 2007. The proposed budget replaces the
controversial 20-percent "beverage tax" on fructose-sweetened
soft drinks with a 5-percent tax on drinks sweetened with
either sugar or fructose syrup -- a move that Carstens says
brings Mexico into compliance with a WTO ruling. Although
the current political environment will complicate the
process, Calderon should be able to secure congressional
approval of the budget without major difficulties before the
December 31 deadline. End Summary.

------------------------
The 2007 Budget Proposal
------------------------

2. (SBU) Finance Secretary Carstens on December 5 presented
the newly installed Calderon government's 2007 budget
proposal to the Chamber of Deputies. Calderon has called the
bill "realistic" and said it is based on expectations of an
economic slowdown due to lower growth in the U.S. and a drop
in Mexico's oil production. The budget proposal assumes real
GDP growth of 3.6%, consumer price inflation of 3.0%, an
average nominal exchange rate of 11.2 pesos per dollar, a
real interest rate (28-day Cetes) of 3.9%, a current account
deficit of 2.3% of GDP, and an oil price estimate of $42.5
per barrel for 2007. The proposal balances the budget using
the narrow definition of the budget balance (which excludes
contingent liabilities), but the broader measure of the
budget balance, the Public Sector Borrowing Requirement
(PSBR), is a deficit of 1.6% of GDP. This figure is up from
the 0.8% of GDP deficit targeted in the 2006 budget.
Proposed net expenditures total $205.0 billion, up 9.4% from
the 2006 budget in real terms, while programmable
expenditures total $149.7 billion, up 12.1% from 2006.
(Note: total net expenditures actually fall by 2.9% in real
terms when compared to actual 2006 spending. End Note.) The
budget is based on the underlying assumptions of U.S. real
GDP growth of 2.5% and a real expansion of U.S. industrial
production of 3.0%.

--------------------------------------------- ----
Emphasis on Security, Poverty Reduction, and Jobs
--------------------------------------------- ----

3. (SBU) Calderon said publicly that the budget seeks to
concentrate spending on programs oriented toward his
administration's three priorities: public security, the
fight against poverty, and job creation. Calderon -- who is
under pressure to focus more heavily on poverty alleviation
to earn the support of the millions of Mexicans who voted for
his leftist opponent -- increased spending on social programs
by 6.9% in real terms. Calderon boosted spending on public

MEXICO 00006823 002 OF 003


security by 12.4% in real terms compared with the 2006
budget. Among the administration's anti-crime initiatives
are plans to establish a unified police force, create a
technology-based criminal information system, and increase
funds for counter-narcotics work. The government, which
expects oil prices and its oil production to fall in 2007,
increased transfers to PEMEX by 32.5%. The budget proposal
also boosted spending on education by 4.2% and spending on
health by 9.3% in real terms. The largest spending cuts went
to financial services (-20.9%), communications and
transportation (-20.5%), sustainable development (-18.7%),
and agrarian issues (-13.3%).

---------------------------------------------
Reforms Notably Absent, But Promised for 2007
---------------------------------------------

4. (SBU) The budget does not include significant fiscal
reform measures, but during the presentation of the proposal,
Calderon said that the budget would be accompanied by efforts
to boost Mexico's chronically low tax collection, in part by
simplifying the system. During a television interview on
December 6, Carstens said that the government likely would
submit a fiscal reform package in 2007. Carstens said that
the government needs to increase revenues because of the
pressure pensions put on government finances and because
PEMEX needs significant investment over the next few years to
maintain its export platform. He said that without fiscal
reform, the fiscal deficit would increase to 3% of GDP by
2012. Calderon earlier this week slashed salaries of senior
officials in the executive branch by 10 percent -- including
his own -- and cut expenses, such as office and telephone
costs. Calderon said the measures were intended to free up
funds for social programs -- though some commentators noted
that the move was also at least partially intended to show up
his leftist opponents. (Note: Mexican government officials
are some of the highest paid in Latin America. End Note.)

--------------------------------------------- ------------
Carstens Says Budget Resolves Dispute Over "Beverage Tax"
--------------------------------------------- ------------

5. (SBU) The budget proposal included a measure that would
replace the controversial 20-percent "beverage tax" on sales
and imports of soft drinks that use sweeteners other than
cane sugar with a 5-percent tax on sales and imports of all
soft drinks regardless of which type of sweetener they use.
Carstens said publicly that the change brings Mexico in line
with a WTO ruling that demands the fructose soda tax be
eliminated. According to the local press, Mexican cane sugar
producers reacted favorably to the proposal because it
complies with the WTO ruling while not leaving them
completely totally unprotected.

----------------------------
Reactions to Budget Proposal
----------------------------

6. (SBU) Financial markets performed well after the
announcement of the budget, with the stock market continuing
to post records and the peso recovering to 10.87 pesos per
dollar. HSBC's Juan Pedro Trevino and JP Morgan's Alfredo
Thorne (strictly protect) agreed that the budget proposal is
fiscally responsible and that Calderon and Carstens would be
able to secure the budget's approval in Congress without
major conflicts. Both economists said that the budget was in
line with their expectations, but expressed confusion about
why the current account deficit assumption jumped from 0.3%
of GDP in 2006 to 2.3% in 2007. Trevino told Econoff that
expectations of slower U.S. growth and lower oil revenues
explained part of the jump, but he was at a loss to explain
why the current account deficit worsened so much. He also
told Econoff that the increase in the PSBR deficit was a

MEXICO 00006823 003 OF 003


signal that Mexico needs fiscal reform to increase the tax
base.

7. (SBU) Local press reporting shows that complaints have
already arisen regarding the amount of funds allocated to
infrastructure, education, and agriculture. Businessmen with
interests in infrastructure development have complained about
large spending cuts to the Secretariat of Communications and
Transportation, arguing that the cuts will give advantage to
foreign companies. (Comment: it is possible that Calderon is
looking to private-sector investment to help fill the gap.
End Comment.) The President of the lower house's Education
Committee said publicly that he would push for more resources
for the Secretariat of Public Education, saying that the
budget allocations in Calderon's proposal are insufficient,
particularly for higher education. Local agricultural groups
are protesting for additional resources.

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

8. (SBU) Calderon's budget proposal did not include any major
surprises, as it was in line with what the incoming
government team has been saying for the past few weeks. It
focuses on Calderon's three key priorities of job creation,
poverty alleviation, and public security. While it
represents a slight fiscal easing, it is fiscally
responsible. It appears that Calderon's strategy was to
submit a relatively non-controversial budget in order to help
build consensus in a difficult political environment during
his first year in office. Many analysts expect that he will
start pushing reforms forward in 2007. In this regard, one
of Finance Secretary Carstens' key challenges will be making
lawmakers understand the risks to the Mexican economy of
failing to implement reforms.

9. (SBU) Calderon should be able to secure congressional
approval of the budget without major difficulties before the
December 31 deadline. This is due in part to the budget's
emphasis on social spending, as well as the formula defined
in the new fiscal responsibility law for calculating the oil
price estimate. That said, the "political factor" will
undoubtedly complicate negotiations on the budget in
Congress, especially after Calderon's chaotic inauguration
ceremony last week. (Note: Self-declared "legitimate
president" of Mexico Andres Manuel Lopez Obrador has proposed
his own budget. The document proposes federal spending of
$193 billion and, like Calderon's budget, it cuts office
expenses and allocates more funding for infrastructure and
housing programs. End Note.)


Visit Mexico City's Classified Web Site at
http://www.state.sgov.gov/p/wha/mexicocity
BASSETT

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