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Cablegate: Calderon's Efforts to Cool Inflation Draw Mixed

VZCZCXRO3267
PP RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #5242/01 2741223
ZNR UUUUU ZZH
P 011223Z OCT 07
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC PRIORITY 9056
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE
RUEHRC/DEPT OF AGRICULTURE WASHDC
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 005242

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)
DOE FOR INTERNATIONAL AFFAIRS KDEUTSCH AND ALOCKWOOD
NSC FOR RICHARD MILES, DAN FISK
STATE PASS TO USTR (EISSENSTAT/MELLE)
STATE PASS TO FEDERAL RESERVE (CARLOS ARTETA)

E.O. 12958: N/A
TAGS: ECON ELAB EFIN EAGR PINR PGOV MX
SUBJECT: CALDERON'S EFFORTS TO COOL INFLATION DRAW MIXED
REVIEWS

REF: A. MEXICO 5044

B. MEXICO 391

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

1. (SBU) President Calderon on September 26 announced several
measures aimed at stemming inflation, including postponing
the enactment of a new gasoline tax and freezing prices of
gasoline, liquid petroleum gas, and electricity until
yearend. Mexico's annual inflation rate has remained above
the upper limit of the central bank's target range (4
percent) in eight of the past 12 months due largely to rising
international food prices -- including staple items such as
bread, tortillas, and eggs. Calderon cast the measures as a
means to contain inflation, but many local observers have
said his motivations were largely political. Some observers
have criticized the measures, arguing that they will not
contain inflation expectations and that Calderon will have to
"take the heat" for the gas tax now and again in January.
Others have applauded the announcement, saying that it will
help calm existing "anxiety" about inflation stemming from
non-food related sources. Post believes that the measures
should not be seen as a departure from free-market policies,
but rather as an attempt to deflect criticism about inflation
and the gasoline tax. End Summary.

--------------------------------------------- ---
President Announces Measures to Combat Inflation
--------------------------------------------- ---

2. (U) During a speech on September 26, President Calderon
announced several measures aimed at stemming inflation and
assisting low-income families. First, he postponed the
implementation of a 5.5-percent tax hike on gasoline and
diesel, included in the recently approved fiscal reform bill,
until January 1, 2008 (ref A). Calderon remarked that this
tax hike was "unfortunately" discussed at a time of high
international prices for key products such as wheat. (Note:
We understand Calderon will simply not sign the fiscal reform
bill until December so the gas tax won't come into effect
until January 2008. End Note.) Second, he ordered a freeze
on gasoline, diesel, liquid petroleum gas, and domestic
electricity prices for the rest of the year. He added that
the government would redouble its efforts to provide
marginalized groups with high-quality basic products at a low
cost, and he announced an agreement with a retailer
association to keep "pan de mesa" (a category of bread)
prices from exceeding one peso per piece. He also called on
the media, unions, manufacturers, and other social,
political, and economic actors not to make the situation
worse by "serving their own interests." He acknowledged that
the announced measures would impose a burden on government
finances.

----------------------------------
High Food Prices Lead to Inflation
----------------------------------

3. (U) Concerns about inflation are not unwarranted.
Mexico's annual inflation rate has remained above the upper
limit of the central bank's target range (4 percent) in eight
of the past 12 months, due largely to rising international
food prices. In the first half of September, consumer prices
jumped 0.62 percent fueled by a leap in fruit and vegetable,
dairy, and back-to-school expenses. Low-income Mexicans are
particularly sensitive to price increases in food products
because they spend such a large part of their income on food,
particularly staples such as bread, tortillas, and eggs --
products that have seen large price increases over the past

MEXICO 00005242 002 OF 003


year. Wheat price increases (resulting from, inter alia,
Australia's drought and significant switching from wheat to
corn production in the U.S. due to demand for ethanol) have
received the most attention in recent weeks in Mexico.

-----------------------
Motivation and Reaction
-----------------------

4. (SBU) Although Calderon cast the measures as a means to
contain inflation and inflation expectations, many local
observers have said his motivations were largely political.
Calderon appears to have been reacting to political pressure
regarding the gasoline tax and general concerns about rising
food prices. Opposition political parties have been vocal
claiming that the gasoline tax would put further pressure on
inflation and unfairly burden the poor (Comment: Many
economists have said the tax's impact on inflation would be
minimal since the tax will be implemented over an 18-month
period. End Comment.)

5. (SBU) A senior Bank of Mexico (BOM) official and a Deputy
Director from Banamex were critical of Calderon's decision to
postpone the gasoline tax, qualifying it as a "political
decision" inspired by a desire to duck criticism from popular
sectors. The central bank official said he was not consulted
about the decision. He added that from an inflation
standpoint, the move was counterproductive, as speculation
had already contributed to price increases. Capping prices
artificially over the next three months would only mean they
would spike dramatically in January. Neither official could
understand the long-term political benefit. Calderon may
escape criticism now but should expect opponents of the
gasoline tax to come out strong with criticism come January
when it is implemented. A Senator from the conservative
faction of the PAN echoed these sentiments, noting that now
Calderon will have to "take the heat" twice.

6. (SBU) By contrast, some financial analysts and members of
the business community have applauded the announcement,
saying that it will help stop price speculation and calm
existing "anxiety" about inflation stemming from non-food
related sources. Larry Rubin from the American Chamber of
Commerce stated publicly that Calderon's decision to contain
energy prices this year was good news that would translate
into better financial planning by companies. The BOM
announced on September 28 that the measures will help anchor
short-term inflation expectations and will bring down yearend
headline inflation by around 9 basis points. When asked by
econoff if Calderon's recent moves are alienating the
business community, a local economist responded that
businessmen understand that "some things are just for show."

--------------------------------
Implications for Monetary Policy
--------------------------------

7. (SBU) Before Calderon's speech, concerns about inflation
had led many market analysts to predict the BOM will lift
interest rates between 25 and 50 basis points by year's end.
The BOM earlier this month held its benchmark lending rate
unchanged, but kept its hawkish bias.

8. (SBU) According to a Bank of America economist who
attended a meeting with Finance Secretary Carstens early this
week, Carstens said he did not see a need for the BOM to
raise interest rates again this year to mitigate inflation.
The economist noted that while Carstens probably knew about
the measures announced on 9/26, the economist was surprised.
While some market analysts have said the measures will take
pressure off the BOM to raise interest rates again this year,

MEXICO 00005242 003 OF 003


this economist still expects the BOM to hike rates by as much
as 50 basis points by yearend. That said, he emphasized the
importance of U.S. monetary policy decisions to Mexico by
adding that if the Federal Reserve cuts rates again this year
as many expect, Mexico would experience an "implicit
tightening" of its monetary policy because the spread between
U.S. and Mexican interest rates would be wider.

9. (SBU) The economist remarked that the BOM's ability to
contain inflation is limited because its "tools" are not
designed to deal with supply-side shocks. Several local
observers have commented publicly that the most effective way
to tackle inflation would be to level the playing field for
competition in areas where the major Mexican and foreign
companies are dominant, including telephones, broadcasting,
energy, banking, and food processing and distribution. The
prevalence of monopolies and oligopolies in Mexico reduces
the efficiency and productivity of many sectors and keeps
prices high.

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

10. (SBU) The measures Calderon announced this week should
not be seen as a departure from free-market policies, but
rather as an attempt to deflect criticism about inflation and
the gasoline tax. The level of food prices, as well as any
other issue that negatively affects Mexico's large poor
population, are particularly sensitive topics, and Calderon
would no doubt be happy to avoid the kind of political heat
caused by tortilla price hikes early this year (ref B).
Whether Calderon's decision to suspend the gas tax enables
him to escape longer term criticism from Mexico's left and
the poorer segments of society remains to be seen. He may
well be facing the prospect for similar criticism in some
months time, prompting a decision at that time about whether
he is prepared to weather the political attacks or push the
tax back again.

11. (SBU) Interestingly, the measures directly contradict
something a Finance Secretariat (Hacienda) official related
to econoff last week. This official explained how Mexico has
an "implicit subsidy" on the cost of gas because
international prices currently are higher than the local
price (which is a government administered price). He added
that Hacienda wants to get rid of this "subsidy" since the
government has to internalize the cost of the price
difference and because it aims to keep gas prices stable, not
necessarily low.


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 /
BASSETT

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