Mexico & Nafta - January 2007 (ISSN 1741-444X)

The new government of President Felipe Calderón Hinojosa sent the budget for 2007 to congress on 5 December. The revenue side was finally approved, after substantial amendments by first the lower chamber and then the senate, on 21 December. The spending side was finally approved by congress on 23 December.

The comparative speed with which the budget was approved is a tribute to the new finance minister, Agustí­n Carstens. He is widely reckoned to be more conciliatory and prepared to compromise that his autocratic predecessor, Francisco Gil Dí­az. 

The austere, virtually balanced budget envisages only modest spending increases, despite the lofty level of oil prices. President Calderón and his cabinet gave a national lead by accepting 10% cuts in their salaries. The government is imposing cuts on all other government employees, except the police and the armed forces, to demonstrate the scale of the economic challenge facing the new administration.

Calderón and his government have two big and related problems. The first is that the country's oil exports will, on present trends, start to decline very steeply very soon. Oil currently provides the government with about 37% of its total income. On most estimates the country will become a net oil importer sometime between 2010 and 2015. This change will have major budgetary implications for Mexico. The government is working on two hypothesises: an optimistic and a pessimistic. On the optimistic, the country's oil production will decline by only 3% over the term of the government, which ends in 2012. On the pessimistic (which most energy analysts regard as realistic), oil production will fall by 25% (or 800,000bpd) in the next six years.

There is not much fat to trim in the budget which is barely equivalent to 20% of GDP. Over 90% of budget spending goes on paying wages, pensions and social welfare programmes. Although tax collection rates in Mexico are improving, successive governments have long relied on oil revenues, which do not pose a burden on anybody, since the oil industry is a government monopoly, to provide their spending money. Lower oil revenues mean that this government will have to increase taxes. This in turn will mean that toleration of government waste and corruption will be even lower. 

Calderón's second problem is that he does not have a majority in the lower chamber of congress which had to approve first the budget for 2007 and will have to approve any substantial fiscal reform to wean the government off oil revenues. The ruling Partido Acción Nacional (PAN) only has 206 seats in the 500-seat congress. 

The budget was the first congressional test of the Calderón government. What was interesting was that the challenge to the government came not in the often-truculent lower house but in the senate, where the two main opposition parties, the Partido de la Revolución Democrática (PRD) and the Partido Revolucionario Institucional, combined to overturn a government measure to impose a 5% tax on soft-drinks. 

The government had two intentions with this tax: one was to discourage Mexicans from drinking so many sugary soft-drinks, which can cause health problems. The other intention was to generate revenue from the booming demand for soft-drinks: per capita Mexico is second only to the US in the consumption of carbonated drinks. The industry has been lightly taxed since the ending (at the World Trade Organization's instigation) of the import duty on high fructose corn syrup. This tariff had boosted the politically-well connected Mexican sugar industry by making high-fructose corn syrup more expensive than sugar. 

Overall, the budget the government sent to congress was balanced but allowed for a 9% increase in budgeted spending to M$2.21 trillion (US$205bn). In actual spending terms, the 2007 budget, even after the changes made by congress, allowed no rise in actual spending compared with what the government actually spent in 2006. Xóchtil Galvez, President Vicente Fox's highly regarded commissioner for the development of indigenous peoples, said that the reason why she had resigned is that her budget was being cut in real terms. 

The budget that emerged, on 21 December, from the lower chamber of congress, increased spending to M$2.26bn (US$207.4bn). On top of this, congress gave the government approval to use a further M$20bn (US$1.8bn) from the oil stabilization fund. This brought the total for the budget up to M$2.28 trillion (US$209.2bn).

The budget assumes that the growth rate in 2007 will be 3.6% (down from this year's 4.7%); inflation will be 3% (down from this year's 4.1%) and that oil prices will average US$42.5 per barrel. The budget also claims that the fiscal deficit, calculated at 0.3% of GDP in 2006, will vanish in 2007. This is not entirely correct: in fact the public sector borrowing requirement (which includes payments on off-balance sheet items such as the commercial bank bailout fund set up in the mid-1990s and payments of public private partnerships, known as Pidiregas) will rise in 2007 from 0.8% of GDP to 1.6%. 

Under the new Ley de Presupuesto y Responsibilidad Hacendaria, the budget has to balance and there is an agreed formula for calculating the oil price. This law did not, however, prevent the lower chamber of congress from increasing the official forecast for the oil price by US$0.30 to US$42.85 a barrel. This change produced an extra M$7.83bn (US$715m) in revenue for congress to allocate.

Agustí­n Carstens, the finance minister, reckoned that the government's income in 2006 was around M$280bn (US$25.6bn) ahead of what had been budgeted partly because of the surge in international oil prices (M$110bn) and faster-than-budget growth which produced extra tax revenues of M$168bn. 

Most political analysts were surprised that the government was able to get the budget approved before Christmas. Traditionally, the budget is approved in two parts. First the revenue raising side (the Ley de Ingresos) has to be approved; then the more polemical spending side (Ley de Egresos) comes up for congressional scrutiny. In 2005, under President Fox, deputies interfered with this side of the budget, prompting a constitutional crisis when Fox refused to approve the changes the deputies had made. 

The only substantial modification to the Ley de Ingresos was the 5% tax on soft-drinks. This acted as a sort of lightening rod allowing the government to introduce a tax on companies' fixed assets. Equally uncontroversial was the increase in cigarette tax. Companies grumbled about changes to the way they can claim back expenses on company cars and entertainment, but congress did not interfere substantially with this tax. 

What is interesting is that the lower house of congress proved less susceptible to lobbying by special interest groups than the senate. The budget committee in the lower chamber of congress agreed, unanimously, to increase the revenue side of the government's budget by M$30.07bn (US$2.75bn). 

The main revenue increases came from a 140% increase in the tax on cigarettes and an increase in the government's forecast for oil prices. The amended budget went to the senate which voted, conclusively, to throw out the controversial 5% tax on soft-drinks. 

Congress decided to use the extra revenues for education, especially higher education; welfare spending and road building. 

Even in the lower chamber there was plenty of evidence that the opposition parties were unhappy about the controversial 5% tax on soft-drinks: only the PAN lined up, in committee, behind the government's proposal. The PRI split over it and the leftwing parties, which represent sugarcane-growing states in the south, voted against. 

The tobacco tax is much less controversial. The tax on cigarettes will rise from 110% to 140% in 2007; then go to 150% in 2008 and 160% in 2009. This extra tax is likely to raise M$5.5bn more in 2007, the deputies calculated. The government had hoped the tax would raise an extra M$6.8bn. Even with the increase cigarettes are still cheap in Mexico: even by the end of 2008 they will only cost around M$4 (US$0.35) per pack of 20. 

The other big change by congress was to reduce the proposed corporate assets tax (Impuesto a los Activos de las Empresas) from 1.80% to 1.25%. The deputies also stopped companies deducting their liabilities when calculating their tax bills. Agricultural companies will see their tax rates rise from 16% to 22%, still well below the normal corporate tax rate.

López Obrador's budget: Just before Calderón published the official budget, Andrés Manuel López Obrador, the defeated leftwing candidate in the presidential election (who does not accept that he was defeated fairly), published his own budget: his oil forecast, US$42 a barrel, is in line with the government's and while his total budget of M$2.1 trillion is marginally more conservative.

Inflation: Independent analysts reduced their forecasts for inflation in 2006 to 3.89%, according to the monthly survey by the Banco de México. Previously the consensus had been 3.97%. The central bank polls 29 analysts each month. Their forecast for 2007 is for an inflation rate of 3.46%. 

Growth: The analysts polled by the Banco de México are forecasting that growth in the final quarter of 2006 will be 3.9% and that the rate for the full year will be 4.7%. They forecast growth of 3.5% in 2007 and 3.8% in 2008.