Cablegate: Congress Approves 2010 Spending Legislation

DE RUEHME #3382/01 3352002
R 012002Z DEC 09




E.O. 12958: N/A


1. (SBU) Summary. On November 17, the Mexican Congress
approved the 2010 budget, voting 437-25 to pass the
spending bill, which includes MX$3.18 trillion (US$244
billion) in outlays. The budget for 2010 implies a
deficit of 0.75% of GDP excluding debt from state oil
monopoly Pemex, but with Pemex debt rises to 2.75% of GDP
-- the largest deficit since 1989. The spending bill
moves MX$96.6 billion of spending to infrastructure,
social programs, health, education, and agriculture.
Over MX$90 billion of this will be taken from operational
spending cuts. In addition, the average price forecast
for the Mexican basket of crude oil was increased to
US$59.0 per barrel from US$53.9 dollars per barrel in
President Felipe Calderon's original legislation. The
revenue side of the budget passed earlier this month,
with legislators watering down tax increases,
particularly a proposed additional 2% value-added tax
(VAT) on all goods and services. Instead, the general
VAT rate, which excludes foodstuffs, health, and
education services, was increased from 15% to 16% (from
10% to 11% at the border). The approved tax measures
will give the GOM additional resources equivalent to 1.1%
of GDP. The approved spending law was 0.5% lower than
the approved 2009 budget, with more resources going to
social development and infrastructure, but slightly fewer
resources to fund non-drug war-related security. Funding
for order, security, and justice will increase. While
relatively prompt approval of the budget is a success for
the GOM, changes to the original proposals highlight the
strength of the main opposition PRI in Congress. The
lack of structural reforms and insufficient tax increases
resulted in a sovereign debt downgrade from Fitch. End

Expenditures Budget for 2010

2. (U) Public expenditures approved by the Congress
total MX$3.18 trillion (US$244 billion), which is 0.5%
lower in real terms than that approved by the Congress in
2009, but MX$4 billion (US$305 million) higher to the
initial proposal. Programmable expenditures allocated
to social development, transport and communications and
sustainable development increased in real terms by 4.9%,
3.7% and 14.9% respectively, to expenditures approved in
2009. The Finance Secretariat affirmed that the 2010
budget will help promote growth as it will ensure
macroeconomic stability; inject additional resources
obtained from new tax measures into the economy to
stimulate domestic demand (Note: Additional resources
were used to service debt in the past. End Note), ensure
security funding to fight against organized crime, and
promote social development and infrastructure investment.

Impact on Growth, Employment, Inflation and Transparency
--------------------------------------------- ----------

3. (SBU) The GOM asserts that with the budget approved
for infrastructure, more jobs will be created next year.
Responding to criticism about the lack of transparency in
public spending and the growth in current expenditures
during the past years, lawmakers approved provisions to
force the GOM to submit a program to reduce public
spending due on March 15th, 2010. States will also be
required to adopt performance-based budgeting and submit
quarterly reports on the evolution of expenditures.
Embassy contact and respected economist Rogelio Ramirez
de la O wrote in his opinion column that he doubts the
economic package will promote growth as the new taxes
will have a negative impact on aggregate consumption,
particularly with the current high unemployment rate.
Echoing Ramirez de la O's concerns, former deputy
governor of the central bank Everardo Elizondo publicly
stated that the increase in taxes could affect
businesses' cash flow and the expected increase in
inflation could complicate monetary policy decisions for
next year.

4. (SBU) With regard to inflation, the tax increases
will have a one-time impact in 1Q10; as a result U/S
Alejandro Werner revealed that the Finance Secretariat

MEXICO 00003382 002 OF 004

may wait to begin increasing energy prices until 2Q10.
Most analysts do not expect Banxico to begin hiking until
2Q10, although Banamex speculated that it may implement a
preventive 25 bps hike in January to anchor expectations.
A survey conducted by Banamex revealed that inflationary
expectations for 2010 grew to 4.81% from the previous
4.54% as a result of the tax increases.

Security, Social Development and Infrastructure Budget
--------------------------------------------- ---------

5. (SBU) The overall budget of the four GOM security
agencies - the Attorney General's Office, the Army, the
Navy and the Secretariat of Public Security - was cut by
1.8% from 2009. Total budget for those agencies will be
MX$103.8 billion (US$8 billion). However, President
Calderon kept his vow of protecting security funds aimed
at combating drug cartels. The security budget -
commonly known as "order, security and justice", which
includes funds for the National Security System,
Plataforma Mexico, prisons, the fight against organized
crime, etc. - proposed by Calderon amounts to MX$94
billion (US$7.2 billion), 4.9% more than what the
Congress approved in 2009. An advisor from the budget
committee of the lower house told Econ FSN that although
lawmakers have not yet officially issued the total
security figures, the amount approved by the lower house
will be quite similar to Calderon's proposal, since
security remains a priority for all political parties.
(Note: The official 2010 Spending Legislation must be
published in the Official Gazette by December 15 and will
include the total security figures. End Note)

6. (SBU) Expenditures for the Social Development and the
Communications and Transportation Secretariat grew 12.7%
and 5.9%, respectively. According to Jaime Hernandez,
Director General of Budgetary Policy of the Finance
Secretariat, expenditures in social and economic
development represent 60% and 35% respectively, of total
public spending. Public investment in infrastructure
will be 3.6% larger in real terms with respect to 2009.
Investment for Pemex for energy projects will grow 10.5%
in real terms. Private investment triggered by public
spending will grow 0.7% from the previous year. Total
investment in infrastructure will represent 4.9% of the
GDP. Expenditures for social programs, such as
Oportunidades and the Popular Health Insurance, grew by
12%, which will help provide support to a combined 16.4
million families in 2010. The approved budget for
Oportunidades was MX$64.4 million (US$5 million).

PRI and state governors led the budget negotiations
--------------------------------------------- ------

7. (SBU) The lower house approved the budget under the
overwhelming influence of the PRI majority and PRI state
governors. Lawmakers prioritized spending and the
political needs of state governors, especially those
holding elections in 2010 as well as Enrique Pena Nieto,
the governor of the State of Mexico, who appears to be
atop the list of potential candidates in the runup to the
2012 presidential election. Lawmakers reshuffled MX$96.6
billion of spending, about 3% of the total projected
spending to infrastructure, health, education and
agriculture programs in the states. Federalized
expenditures or resources (participaciones and
aportaciones) going to the states will be MX$6.3 billion
(US$480 million) higher than the Executive's proposal,
but 0.4% lower than what was approved last year.
Lawmakers also raised other resources transferred to the
states known as Budget Line 23 for public investment and
infrastructure programs in states and municipalities by
46.5% from what the Executive had initially proposed.
These additional resources were obtained by cutting
current expenditures and administrative costs in most of
the Secretariats, including the Office of the President.
Congress did not approve the elimination of three
ministries - Tourism, Agrarian Reform and Public
Administration - as proposed by President Calderon, but
this represents less than 10% of the expected new tax

MEXICO 00003382 003 OF 004

Fitch takes the first step in downgrading Mexico
--------------------------------------------- ---
8. (U) As expected, on November 23rd Fitch downgraded
Mexico's sovereign debt one notch to BBB from BBB+ with a
stable outlook. For Fitch the tax measures were a step
in the right direction, but insufficient to reduce the
high reliance on oil revenues, which still accounts for
over 30% of total revenues. The rating company is also
concerned about the GOM debt's reaching 37% of GDP in
2009, which is above peer median. (Note: U/S Werner
said that total debt would rise to 38% of GDP in 2010 to
begin falling by 2011. End Note) Falling oil production
has accentuated the weakness in public finances, leaving
Mexico with limited fiscal manipulation in the face of
future oil income shocks. Fitch also noted that chances
for approval of a more comprehensive tax reform were not
bright as the opposition controls the lower house and
political dynamics will be heavily influenced by the 2012
presidential elections. Fitch also adjusted the ratings
in local and foreign currency for development and
commercial banks: Nafin, Banobras, Bancomext and HSBC.
It is unlikely that Moody's will downgrade Mexico in the
medium term as its Mexico City branch director Alberto
Jones recently stated the likelihood for Mexico to be
downgraded is very low. It is still uncertain whether
S&P will follow Fitch. S&P gave Mexico a negative
outlook early in the global recession (March 2009). Now
that Mexico is on the recovery path, there is more
justification for S&P to avoid a downgrading. S&P could
also take into consideration President Calderon's
considerable effort in securing an unpopular reform in
the middle of a recession and with a Congress controlled
by the opposition.

Implications of a downgrade

9. (SBU) A downgrade will likely cause the peso to
depreciate temporarily and increase GOM borrowing costs.
For JP Morgan analysts markets had already "priced-in" a
downgrade from Fitch. On November 23, right after
Fitch's pronouncement, the IPC - the Mexican Stock
Exchange's main index - rose 1.50% and the peso
appreciated 0.05% to 13.10 pesos to the dollar. However,
JP Morgan notes that markets have not priced-in a
downgrade from the other two rating companies. A
downgrade could have important implications for major
Mexican corporations. The lower rating will make it more
costly for Mexico to borrow abroad, and sovereign debt
downgrades generally hurt companies based in emerging
markets by increasing their cost of capital. Investors
tend to demand higher yields from emerging market
companies when their home government's ratings are cut,
which increases borrowing costs. Sometimes emerging
market companies can be better rated than their own
governments, although this is generally limited to those
that have exceptionally strong balance sheets or
extensive operations outside the country where they are
based. The week of November 16, after meeting with
rating companies Finance Secretary Carstens said that a
downgrade would not be good, but would not be disastrous.
He later acknowledged that the country's opportunities to
get financing from abroad would be narrowed. Several
experts have noted that Mexico will still be two notches
above investment grade, although closer to Brazil.

GOM Announces New Infrastructure Projects

10. (U) On November 19, the GOM held a joint conference
in New York City with the Mexican-American Chamber of
Commerce to present new infrastructure projects. The GOM
announced that there will be 480 infrastructure projects
in toll roads, ports, water treatment plants, etc. which
will require public-private investment. Mexico's
Infrastructure and Public Services Development Bank
(Banobras) expects to spend about MX$45 billion (US$3.5
billion) in 2010. The GOM had hoped that this event and
the 2010 budget could shield Mexico from a downgrade
since it would show that the GOM was doing something to

MEXICO 00003382 004 OF 004

stimulate domestic demand, economic activity, and job

11. (SBU) Comment. The main signal to financial markets
was that even in times of economic hardship, a fragmented
Congress is unwilling to rein in spending, and Calderon's
cabinet was unable to achieve a more comprehensive tax
reform to reduce long-term oil dependence. The GOM was
unable to mount a political counteroffensive when the PRI
shot down the central plank of its revenue proposals, a
general 2% VAT rate. There was broad disappointment with
the outcome and the intense politicization of the whole
budget process. While some applauded the fact that the
new taxes will be recycled into the economy, others
lamented that the reform did not eliminate tax loopholes
or increase efficiency of public spending. The general
view going forward is that Mexico will not collapse, nor
will it achieve its growth potential, and it will
continue to take short-term measures to salvage the next
year rather than making medium- or even long-term
reforms. Mexico has been deemed as "the champion of
muddling through," and unless the GOM is willing to
undertake structural reforms in the energy,
telecommunications, financial sectors as well as sound
improvement in competition and tax collection, Mexico
will continue to lose its appeal compared to other
emerging economies such as Brazil. End comment.


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