May 19, 2009 / 4:38 PM / 11 years ago

Oil decline boosts pressure for Mexico tax reform

MEXICO CITY (Reuters) - Mexico is under growing pressure to ratchet up its paltry tax take as sliding oil revenues threaten a pillar of public finance that is central to its efforts to claw back from a deep recession.

Mexico, which funds about a third of its budget from crude oil sales, has put off the tough choice of hiking taxes in recent years as sky-high world oil prices masked a steady decline in crude output and a grim prognosis for 2010 production.

But with oil prices now well below their highs, sliding output has caught up with Mexico as it wrestles with its worst economic slump since its mid-1990s Tequila crisis.

Standard & Poor’s jolted the already battered peso this month when it revised its outlook for Mexico’s credit rating to negative — the first step toward a downgrade. It cited an urgent need for a fiscal reform and doubts that the government has the political will to pull it off.

Once mid-term congressional elections are through in early July, the ruling conservatives are expected to push an intense debate over a tax overhaul in tandem with talks for the 2010 budget.

“It is really urgent that once we are through the elections a medium-term fiscal program be designed and passed,” Central Bank Gov. Guillermo Ortiz said this week in one of the bluntest comments yet from the bank on the issue.

“Obviously raising taxes in the middle of a recession is not a good idea, but it is fundamental that we have a medium-term project of fiscal consolidation,” he added.

Income and sales taxes account for only 8.8 percent of Mexico’s gross domestic product, less than half the average level of developed nations and below the 11.3 percent average in Latin America, according to the central bank.

Talk among government officials has increased in recent weeks and months about the need for a tax reform, though public campaigning for the July 5 congressional election has focused on more popular issues like job creation and fighting crime.

President Felipe Calderon is due to present his 2010 budget proposals in early September once the new Congress convenes, and analysts say the government will push to agree on a reform proposal with Congress before then.

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Calderon’s predecessor, Vicente Fox, failed to convince Congress on his proposal to raise value-added taxes, which was seen as a way to get workers in Mexico’s vast underground economy to pay more taxes.

Calderon hiked company taxes after taking office in December 2006, but Mexico’s tax take remains extremely low.

Mexican oil output has slipped by more than a fifth since 2004, denting exports, and the government forecasts that export volumes will drop another 18 percent in 2010.

Mexico is currently benefiting from a market hedge that allows it to pocket $70 a barrel for its exported oil, even with its export blend currently priced at $54.59 a barrel, according to Reuters data.

But the hedge expires at the end of 2009 and cannot easily be extended under current market conditions. Oil futures indicate Mexican crude prices will languish below $70 in 2010.

Finance Minister Agustin Carstens recently suggested Mexico could adopt a policy of tying fiscal balances to the economic cycle, a move analysts say is likely the first step to running a bigger deficit in 2010.

Congress authorized the government to run a deficit of 1.8 percent of GDP in 2009, and the finance ministry has so far forecast a similar debt level for next year.

“They will likely plant the seeds of a gradual program of fiscal reform but at the same time there will be a fiscal margin in the form of a deficit that will likely be larger than this year,” said Ignacio Trigueros, director of the Center for Economic Analysis and Research at ITAM university.

The government is likely to run a deficit of as much as 2.9 percent of GDP next year, even if it raids rainy day funds for as much as 131 billion pesos ($9 billion) to help cover revenue shortfalls, Banamex economist Alberto Gomez wrote in a report.

“A delicate equilibrium will need to be found between maintaining the confidence of public debt markets in fiscal policy and the undesirability of a less expansive fiscal policy in the context of economic weakness,” Gomez wrote.

($1=14.6 pesos as forecast by finance ministry for 2010)

Writing by Robert Campbell; Editing by Catherine Bremer and Dan Grebler

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