December 14, 2018 / 6:15 PM / 6 months ago

Mexico's new budget: fiscal miracle or a December disaster?

MEXICO CITY (Reuters) - Nervous bond holders will pore over Mexico’s budget like never before this weekend to see if leftist President Andres Manuel Lopez Obrador can pull off higher social spending, tax cuts and pricey oil ventures without increasing debt.

On Saturday, Lopez Obrador submits his 2019 budget to lawmakers, with markets on tenterhooks to see how he will marry his commitment to fiscal discipline to a long list of campaign pledges.

If he fails to convince the market he has a savings plan to fund welfare programs and new infrastructure, it could deepen a run on Mexican assets, and put Mexico on course for ratings downgrades as early as next year, investors and analysts said.

“We are at a crossroads here where delivery is going to be as important as the numbers themselves,” said Andrew Stanners, an emerging markets fund manager at Aberdeen Standard.

“The budget is going to be super scrutinized. If it is not credible, then you have the international community that can wobble on its commitment to Mexico.”

The government must show it is ready to rein in spending if its saving plans do not pan out as expected, Stanners added.

During the last two decades, global markets have warmed to Mexico’s U.S.-trained technocrats, who backed orthodox policies and drew in a tide of investment to build up one of the world’s most liquid local-currency bond markets.

But Lopez Obrador has promised a radical break from that era, which he has described as “neo-liberal” and which he blames for widespread corruption.

Finance Minister Carlos Urzua has promised a budget with a primary surplus of about 1 percent, excluding debt payments, while his deputy, Arturo Herrera, has said the government will use conservative economic estimates to realize its plan.

The big question is how they will achieve enough savings to fund plans to boost spending on youth unemployment and the elderly, plus major building projects that include a new oil refinery and two rail lines in southern Mexico. Lopez Obrador this week hinted that roll-out of the programs could be gradual.

His team has sought to court wary international investors. However, debt yields have spiked since late October after he used a straw poll to justify scrapping a partly-built $13 billion airport.

As the peso tanked following the decision, Lopez Obrador declared that democracy, not markets, governed Mexico.

BELIEVING THE NUMBERS

Backed by the first outright majority in Congress in two decades, Lopez Obrador is better placed to make bolder cuts in discretionary spending than his predecessors.

“You need these strong-arm presidents to make the tough decisions like this,” said Aaron Gifford, an emerging markets analyst at T. Rowe Price, calling the president a “fanatic” on cost-cutting.

Lopez Obrador won office promising to root out graft, claiming he could save billions of dollars. But analysts warn he could worry investors if the budget projects significant gains from such measures.

Already, public sector pay cuts he has ordered have been temporarily frozen by the Supreme Court, raising questions about his room for maneuver.

Questions also remain over the cost of his plan to lower value-added tax and income tax along Mexico’s northern border, which he hopes will stem migration into the United States. Private sector analysts calculate those tax cuts could cost around 120 billion pesos ($6 billion).

If the administration’s estimated gains in tax revenue outstrip growth estimates, the market and rating agencies could see them as unrealistic and react negatively.

On Thursday, Lopez Obrador said several arms of government would receive higher spending, such as the military, which is battling a record surge in violence.

Aside from pay reductions, he has not flagged where the cuts will come. That will require close scrutiny of the budget.

“I don’t think the market is going to completely believe the fiscal responsibility of the Lopez Obrador administration until they see the execution,” said Ernesto Revilla, head of Latin America economics at Citigroup. “Nobody is going to take their eyes off of Mexico, even if the budget looks good.”

Reporting by Michael O'Boyle, Editing by Rosalba O'Brien

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