| | |  Business News | November 2009 
Mexico Has ‘Long Way to Go’ on Budget, Garza Says
 Jens Erik Gould & Joshua Goodman - Bloomberg
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November 02, 2009
| | Former U.S. ambassador Tony Garza in Mexico City, December 2007 | |
Mexico has a “long way to go” in its effort to strengthen the economy by reining in its budget deficit and boosting investment in the oil industry, said Tony Garza, former U.S. ambassador to the Latin American country.
The tax increases that President Felipe Calderon pushed through congress yesterday form part of a reform plan aimed at making growth sustainable after years of policy stalemate following the 1993 signing of the North American Free Trade Agreement, or Nafta, said Garza. Mexico is seeking to widen its tax base as the fastest drop in oil output since World War II and the worst recession since the Great Depression swell the budget gap.
Mexico has “a long way to go in terms of fiscal, energy, labor and other core reforms,” said Garza, who advises U.S. companies as counsel for White & Case LLP in Mexico City after ending a seven-year stint as ambassador earlier this year. “This severe of a downturn is exposing much deeper and systemic challenges in terms of competitiveness.”
Credit-default swaps, contracts investors use to protect against non-payment of debt, show Mexico trading as high-yield, or junk - placing it three levels below the nation’s BBB+ grade from Standard & Poor’s and Fitch Ratings - on concern the tax increases will fail to stave off downgrades.
Opposition-controlled congress approved a watered-down version of Calderon’s plan to offset declining oil revenue in the income portion of the 2010 budget. Lawmakers voted to increase the sales tax to 16 percent from 15 percent instead of adopting the administration’s 2 percent consumption tax proposal, which would have generated more than double the revenue, according to the government.
Telecommunications Taxes
Legislators approved some of Calderon’s measures, such as increasing the income tax, raising the duty on cash deposits and creating a telecommunications tax. Congress is still debating the spending portion of the budget and must vote on it by Nov. 15.
They also raised the forecast for next year’s average oil price to $59 a barrel from $53.90 a barrel in the original bill, boosting projected revenue.
The income portion of the budget approved by Congress has an estimated deficit excluding investment by state-owned oil company Petroleos Mexicanos, known as Pemex, of 0.75 percent of gross domestic product, up from 0.5 percent in the government’s original bill. The government’s proposed 2010 budget had projected a 2010 deficit, including Pemex investment, of 2.5 percent of GDP, up from 2.1 percent this year.
S&P and Fitch say they may downgrade Mexico should the government fail to offset the drop in oil production, which funds 38 percent of the budget, and contain the deficit. Production at Pemex fell 4.5 percent in September to 2.599 million barrels a day, underscoring the shortage of investment to tap crude reserves.
‘Second-Best Solution’
RBS Securities Inc. estimates the budget gap will equal about 2.8 percent of GDP this year, the widest since 1989. Mexico, which in 2000 became the second country in Latin America after Chile to earn an investment-grade rating, has a negative outlook from both S&P and Fitch.
While the tax increases approved by congress reduce the chance of a downgrade, Aberdeen Asset Management’s Edwin Gutierrez said he “wouldn’t be surprised if Fitch and/or S&P still pulls the trigger.”
“It’s definitely a second-best solution as it does little to reduce Mexico’s structural dependence on oil for its revenue, which is what the ratings agencies wanted to see,” said Gutierrez, who manages about $5 billion of emerging-market assets in London. He said he’s been buying Mexican bonds because they’ve “been laggards.”
Bonds Fall
Mexico’s dollar bonds lost 2 percent last month, their biggest monthly decline since a 4.4 percent tumble in January, on speculation the government will fail to avoid a downgrade, according to JPMorgan Chase & Co.’s benchmark emerging-market index, known as EMBI+. The drop compares with a 0.5 percent slide for emerging-market debt overall.
The extra yield investors demand to own Mexican bonds instead of U.S. Treasuries has narrowed 1.86 percentage points to 1.90 points this year at 12:06 p.m. New York time - less than the average 3.74-point drop in the spread on emerging- market bonds, according to JPMorgan.
The cost of protecting Mexican debt against default for five years is 1.69 percentage points, according to data compiled by CMA Datavision. By comparison, it costs 1.65 points to protect securities issued by Colombia and 1.57 points to protect bonds sold by Panama, countries that S&P rates three levels below Mexico at BB+.
Record Low
A basis point equals $1,000 on a swap protecting $10 million of debt against default. Credit-default swaps, conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.
Mexico’s peso has gained 4.5 percent to 13.0967 per dollar this year, the second-worst performer after Argentina’s peso among the major Latin American currencies. It plunged 20 percent in 2008 and sank to a record 15.5892 amid the global credit crisis in March, prompting Calderon to turn to the International Monetary Fund for a $47 billion credit line.
Both Lisa Schineller, an S&P analyst in New York, and Shelly Shetty, an analyst at Fitch Ratings in New York, said in interviews last week that the companies are waiting to see the final budget before deciding whether to cut the rating.
Mexican bonds may rebound this week after congress made the 1 percentage-point sales tax increase a permanent measure, quelling speculation it would have a one-year duration, said Pablo Cisilino, who manages $10 billion of emerging-market debt at Stone Harbor Investment Partners in New York.
‘False Sense’
“It’s enough for them not to a get downgrade,” Cisilino said in a telephone interview. “Mexico is tightening the budget in a massive recession. That’s a good sign.”
The $1.09 trillion economy, the second biggest in Latin America, shrank 10.3 percent in the second quarter and will contract as much as 7.5 percent this year as the U.S. recession erodes demand for the country’s exports, according to the central bank. The U.S. buys about 80 percent of Mexican goods sold abroad.
Annual economic growth averaged 2.4 percent over the past eight years, less than half the 5.5 percent pace from 1996 to 2000, according to the International Monetary Fund.
“Some say that Nafta created a false sense of economic modernity,” Garza said. “There may be some truth to what those folks are saying. That feeling that economic integration was enough never really forced the country to address the issues which underlie real competitiveness.”
To contact the reporters on this story: Jens Erik Gould in Mexico City at jgould9(at)bloomberg.net; Joshua Goodman in Rio de Janeiro at jgoodman19(at)bloomberg.net
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