Cablegate: Congress Approves Most 2010 Revenue Legislation

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RR RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #3205/01 3142325
ZNR UUUUU ZZH
R 102325Z NOV 09
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC 8981
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RHMFISS/DEPT OF ENERGY WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHAAA/NSC WASHINGTON DC
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE

UNCLAS SECTION 01 OF 03 MEXICO 003205

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SENSITIVE

STATE FOR WHA/MEX, WHA/EPSC, EEB
NSC FOR RESTREPO, FROMAN
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GWORD
TREASURY FOR NANCY LEE, IA
ENERGY FOR WARD, LOCKWOOD AND DAVIS

E.O. 12958: N/A
TAGS: ECON EFIN ETRD ENRG ELTN EAIR PGOV SENV MX

SUBJECT: CONGRESS APPROVES MOST 2010 REVENUE LEGISLATION

REF: MEXICO 3110

1. Summary. Legislators watered down the original GOM revenue and
tax proposals (see reftel), eliminating some key elements of the
original package, but maintaining an increase in value added taxes
(IVA) and income tax rates. Finance Secretary Carstens said the
package will help revive the economy. While President Calderon
welcomed approval of the legislation, he emphasized that that
declining oil production left the country with no fiscal leeway, and
called for all political actors to work together to boost growth and
employment. It is unclear whether this bill will help the GOM avoid
a significant increase in the medium-term fiscal deficit, or a
public debt downgrade from the main ratings agencies. With the
economy expected to contract by about 7% during 2009 (its worst
performance since the early 1930s), momentum for a downgrade may be
unstoppable End Summary.
2. While President Calderon, publicly welcomed the November 2
approval of most 2010 revenue legislation, he emphasized that
plunging oil production left the country with no fiscal leeway, and
made a vague call for all political actors to reach an accord on an
economic strategy to boost growth and employment. In a separate
speech, Secretary Carstens said tax increases approved this week by
lawmakers will generate public revenue of more than 1% of GDP and
help revive the economy. The tax legislation passed November 1 as
part of the 2010 budget package will provide MX$136 billion (US$10.2
billion) in extra revenue. He added that the extra money will be
used for public works projects, social programs and the fight
against organized crime.

3. The most significant defeat for the GOM was its proposal for an
additional 2% value-added tax (IVA) - called a "sales tax" in the
legislation -- that would cover all goods and services with no
exceptions. Goods and services assessed at the current 15% rate
would have paid 17%. Foodstuffs, health and education services,
which currently have a 0% VAT, would also been taxed at the new 2%
rate, which the GOM pledged to use to expand anti-poverty programs.
However, the attempt to expand this 2% generalized IVA was soundly
defeated, as was the case in the 2002 and 2004 budgets. Contacts in
the GOM said the idea behind the 2% no-exception tax was to
gradually replace the IVA, which has many exceptions, thereby
creating a broader tax base.

Electoral Fear
--------------

4. While the PRI formed an alliance with Calderon's Administration
to approve revenue legislation, the IVA defeat clearly showed that
the PRI remains unwilling to risk bold taxation action, fearful that
its chances of regaining the presidency in 2012 would be
jeopardized. (Comment: The PRI still blames the increase in the VAT
rate in 1995, from 10% to 15%, as a crucial factor in its defeat in
both the 2000 election (after holding power uninterruptedly since
1929) and their 1997 (first-time) loss of majority in the Chamber of
Deputies. Therefore, the possibility of radical fiscal reform before
2013 is extremely low. End Comment.)

5. The legislative approval process was also extremely contentious
and heavily politicized. President Calderon's hand-picked PAN party
president and former private secretary, Cesar Nava, hamfistedly
blamed the PRI for the tax increases in Chamber of Deputies revenue
proposals and for being responsible for a budget that is
"insufficient" in addressing Mexico's economic woes. His statements
came after it was widely known that a deal had been worked between
the GOM's budget team and key opposition deputies. The PRI in the
Senate took revenge, modifying several taxes -- notably cancelling a
3% duty on internet use. It also forced Secretary Carstens to accept
before the Senate that the GOM took full responsibility for tax
increases.

Tax Increases
-------------

6. Other than the IVA proposal, Congress approved the main tax
increases that the GOM had sought:

-- The top rate of income tax was increased from 28% to 30%. The
hike exempts those who earn 10,300 pesos ($780) per month or less,
who account for more than two-thirds of taxpayers.

MEXICO 00003205 002 OF 003

-- The general VAT rate was increased from 15% to 16% (and 10 to 11%
at the border), the first rise since the 1995 crisis.

-- The tax on bank cash deposits of 15,000 pesos and above was
increased from 2% to 3%. The bank-deposit tax is aimed at the large
informal economy in Mexico, where transactions are largely carried
out in cash. It applies to cash deposits of 15,000 pesos or more per
month.

-- There will be a 3% tax on telecommunication services except
internet (instead of the 4% the GOM sought).

-- Taxes also were increased for beer, alcohol and tobacco
products.

-- Businesses will be required to pay deferred taxes within five
years. Mexico's leading business consortium, the Consejo
Coordinador Empresarial (CCE) said they will file injunctions
against this measure and appeal to the Supreme Court. (See Reftel)

Fiscal Meddling
---------------

7. Congress also amended key macroeconomic assumptions, increasing
elbowroom to boost fiscal revenues, at least on paper:

-- It increased the fiscal deficit target from 0.5% to 0.75% of GDP.

-- It raised substantially the expected average price for the
Mexican barrel of oil, from US$53.9 to US$59.0.

7. The oil price boost may well be realistic, as Mexican crude on
November 3 stood at US$73.16 per barrel. If the price stays at
similar levels throughout 2010, pressure on public finances would
diminish significantly (during January-September, the Mexican oil
price averaged US$52.9 per barrel). However, even if international
demand for oil increases in 2010, increased worldwide supply would
be expected to meet it. Therefore, it may be irresponsible for the
GOM to expect prices to maintain the trend observed in recent weeks.
Moreover, even if oil prices remain relatively high and stable,
production continues to decline. During January-September, crude
production averaged 2.6 billion barrels per day, a 6.6% fall from
levels recorded during the whole of 2008, and 22.9% plunge from the
production peak recorded in 2004.

8. There are no indications that the GOM would save any unexpected
oil windfall (if it materializes) to build a fiscal cushion. On the
contrary, there is strong pressure from state and municipal
governments to share any extra revenues (as in recent years).
Therefore, there is no sign of serious medium-term fiscal
consolidation.

Downgrade Momentum?
------------------

9. It is unclear whether this budget will satisfy rating agencies,
as revenue changes probably will not. Both Standard & Poor's and
Fitch assign Mexico's external debt BBB+, the third-lowest
investment grade rating, with a negative outlook. What Congress
approved appears to signal GOM inability to adapt to a situation
where oil production is falling rapidly, and the economy remains
extremely reliant on a volatile oil price. The most recent GOM
figures indicate that from January-September, income from oil
represented approximately 30% of all GOM revenues.

10. With the economy expected to contract by about 7% during 2009
(its worst performance since the early 1930s), momentum for a
downgrade may be unstoppable. Mexico's total public debt, according
to its broadest definition, is equivalent to 38% of GDP, well below
that of many developed countries recording significant fiscal
deficits. (Note: By comparison the U.S. runs a gross debt ratio
close to 100% and Japan almost double that, according to the OECD.
End Note.) However, it is open to question whether Mexico could
find the additional financing it will require in 2010 in
international capital markets without paying a higher cost.

Carstens Move?
--------------

MEXICO 00003205 003 OF 003

11. Another element of uncertainty is the future of Carstens, who
is tipped to become the next governor of the central bank (Banxico)
for 2010-15. Guillermo Ortiz, central bank governor since 1998, is
respected internationally. However, Calderon is unlikely to ratify
him for another term, as the two clashed repeatedly when Calderon
was a member of Congress in the late 1990s. Carstens also is
well-respected in the private sector and in the Congress, and
finding a replacement of similar stature to head the finance
ministry would be difficult. The Inter-American Development Bank
vice-president, Santiago Levy, is being mentioned as a potential
replacement as well as current Energy Secretary Georgina Kessel.
Calderon will probably announce his decision on Banxico (which needs
to be ratified in the Senate) after the budget has been approved.

Comment:
--------

12. The rejection of the 2% anti-poverty tax does represent a blow
for the GOM. Although the fiscal gap for 2010 is covered by the
weaker tax changes, the increase in the fiscal deficit to 0.75% of
GDP and a higher oil benchmark price, stop short of providing a
long-term solution to falling public revenue and generating
alternative income sources to replace its dependence on oil. While
showing that it is willing to work with the GOM, the PRI also has
shown that it fears the electoral consequences of supporting more
radical tax reform, which may have to wait until 2013. After
fighting the 2% tax and the IVA increase, PRI Senator Manlio Fabio
Beltrones and private sector groups are currently calling for broad
tax reform that includes general, indirect taxes. However, PRI
lawmaker Oscar Levin -- close to PRI President Beatriz Paredes --
publicly acknowledged that a comprehensive tax reform would be
likely when the PRI recovers the presidency in 2012, not before.
Nevertheless, a downgrading of government debt may indeed take place
as Congress has clearly shown that it is unable to respond with
tough choices and adapt to a situation where oil production is
falling rapidly.

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