Mexico & Nafta - August 2016 (ISSN 1741-444X)

The Mexican government will present its 2017 draft budget to the federal congress in early September. With a zero deficit target, financing needs look tight.

Last month, Mexico’s finance ministry (SHCP), announced an additional budget cut of M$31.8bn (US$1.7bn), by way of a pre-emptive response to international market volatility on the back of the shock caused by the vote by the United Kingdom to leave the European Union (‘Brexit’) five days earlier. The SHCP stressed that the government’s objective was to ensure that it would remain on track to meet its 2016 fiscal deficit target of 3% of GDP. As earlier this year, the fiscal move was closely accompanied by a central bank (Banxico) move to increase interest rates in defence of the peso (see sidebar), the most traded emerging market currency.

The vast bulk of the new cut – 91.7% – the SHCP noted, would come from current expenditure, in line with a promise by President Enrique Peña Nieto that there should be no new tax increases in support of fiscal adjustment efforts. The SHCP also made very clear that none of the latest adjustment would fall on the struggling state-owned oil company, Pemex. Despite this latest adjustment, the SHCP said that it remained confident of meeting its zero deficit target (exclusive of investments) on schedule in 2017 (albeit this is already a year later than originally planned).

In late July, the finance minister, Luis Videgaray, gave more details of the latest cuts, saying they would impact current expenditure at the education (SEP) and health (SSA) ministries. Videgaray also reiterated that Pemex would be ring-fenced.

The Peña Nieto government has now slashed a massive US$18bn (M$339bn) off 2016 budget spending. While Videgaray insisted that combined expenditure cuts, the equivalent of about 3.8% of GDP in the space of 18 months (inclusive of a US$11.9bn cut in the 2015 budget), would not significantly affect the domestic economy, cuts of this scale to government spending inevitably have a dampening impact, and all the more so when the global economy remains volatile, and both domestic consumer and business confidence remains uncertain – in other words, the private sector is not likely to take up the slack (see sidebar).

In this context, Videgaray, who was addressing the national governors’ conference (Conago), warned that the government would have to continue its belt tightening in 2017 in order to safeguard macroeconomic stability, admitting that public spending would continue to feel the pinch. Videgaray therefore urged governors to contain spending and efficiently manage their finances as per the new (April) Ley de Disciplina Financiera de Estados y Municipios, which all 32 governors will have to work under when preparing their own budgets for next year.

Videgaray said that the federal government intended to focus its 2017 budget around the need to protect jobs and maintain low inflation. In a report presented to the federal congress on 1 April, Videgaray had already announced a pre-emptive reduction of almost M$175bn (US$10bn) in planned outlays for 2017, citing the need for Mexico to cut its coat according to its cloth. At that point, Videgaray said that the SHCP was projecting real annual GDP growth in a range of 2.6%-3.6% in 2017, with an average crude export price of US$35 per barrel (/b), up from US$25/b this year. Videgaray admitted that the SHCP was projecting national oil output to fall further, from 2.12m barrels per day (bpd) in 2016 to 2.03m bpd in 2017, a tacit acknowledgement of the difficulties at Pemex. Minister Videgaray also indicated that he planned another oil hedge for 2017, which is normally arranged in August and covers up to half of the country’s oil exports (roughly 212m barrels).

Four months on, those modest 2017 budget assumptions may be over-stated. While Mexican crude averaged US$37.4/b in May, the highest price to date this year, (it troughed at just US$23.9 in January), and in line with Videgaray’s 2017 draft budget projection, it remains well under its May 2015 average of US$54/b (and a world away from the heady May 2014 average of US$96.7/b).

At the same time, the federal government insists that it is making progress with its fiscal consolidation efforts. According to the latest SHCP data, the 2016 first half fiscal deficit came in at M$116.6bn (US$6.22bn), down by an impressive 68% over the comparable year-earlier period. Public sector income rose by 11.4% year-on-year in real terms, the SHCP emphasised. Non-oil sector revenues grew by 18.5%, thanks to a 10.7% increase in tax revenues, which helped compensate for the continuing fall in oil sector income. Income from the oil sector fell by almost a fifth (19.6% year-on-year) in the first half to M$314.96bn (US$16.8bn), which the SHCP said reflected a 40% year-on-year fall in the price of Mexican crude on international markets, a 27% fall in the price of natural gas and a 2.7% fall in Mexico’s crude output.

The debt question

Despite the reported increase in the tax take, Mexico’s federal government may struggle to finance its 2017 budget, given that oil prices remain stuck below US$40 per barrel (/b) and the global economic outlook remains distinctly blurry. And while the government may yet reach its zero deficit target by 2017-2018 (exclusive of structural investments) and keep President Enrique Peña Nieto’s pledge not to foist any more taxes on Mexican businesses and consumers, there is a cost to this fiscal probity, and that is a significant increase in total public debt. According to the Centro de Estudios Económicos del Sector Privado (Ceesp), a local think-tank, Mexico’s public debt/GDP ratio was 39.3% of GDP in 2012, the year Peña Nieto was elected, but now stands at an estimated 50.6%, an increase of 12 percentage points in four years and pushing the limit of what is acceptable for an economy the size of Mexico’s, the Ceesp argues. The Ceesp is not alone in raising this red flag. US investment bank JP Morgan’s latest (July) Mexico risk report noted that its in-house risk indicator for Mexico stood at 151 points in 2012, but has since risen by 142 points to 362, much of which also correlates to the increase in public sector debt.

• Business confidence dips

On 1 August, Mexico’s national statistics institute (Inegi) reported that its business confidence indicators (ICE), which measure sentiment in the manufacturing, construction and retail sectors, fell overall in July over July 2015. The construction sector ICE was down by 2.4 points overall, while that of the retail sector fell by 1.7 points over the previous year. The manufacturing ICE dipped by 0.3 points. In similar vein, Inegi’s business expectations index (EE), which measures forward-looking sentiment in the three sectors, was also largely down in July over the previous year, albeit with some positive sentiment for job stability in manufacturing and retail.

• América Móvil profits fall 45% in second quarter

América Móvil, the telecommunications firm owned by Mexican billionaire Carlos Slim, reported a net profit of M$7.7bn (US$4422m) in the second quarter of 2016, a fall of 45% year-on-year, with an 11% drop in its Earnings before interest, taxes, depreciation and amortization (Ebitda) to M$61bn (US$3.2bn). As market prices continue to fall quickly in Mexico following the government’s 2014 telecoms reform, the company’s profit margin in Mexico narrowed to 33%, from 41.4% a year earlier, accounting for much of the headline result. América Móvil, the largest telecoms firm in Latin America, still controls 70% of Mexico’s wireless market, but is now facing fierce competition from the US’s AT&T and Spain’s Telefónica, while smaller new entrants are also snapping at its heels.