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Markets skeptical on Mexican fiscal reforms

Sep 9, 2013

Enrique Peña Nieto’s sweeping overhaul of Mexico’s fiscal architecture could disappoint markets surprised by plans for a large fiscal deficit

     
     
  Mexican President Enrique Peña Nieto, July 2013
Source: Presidencia de la República Mexicana
 
Plans to overhaul Mexico's fiscal system have met with a mixed market reaction as analysts digest the implications of a watered down reform which could mean a total public deficit as high as 3.5% of GDP for 2014.

Luis Videgaray, Mexican finance minister under president Enrique Peña Nieto, announced plans Sunday to increase the top individual tax rate, introduce a capital gains tax and lower the rate levied on Pemex, as part of a broader fiscal reform package which he first outlined in an interview with LatinFinance last December.

Including the government's investment in state oil company Pemex, the reforms could lead to a fiscal deficit of 2.4% of GDP this year.

The plan will address some of the loopholes that weakened tax collection, says Benito Berber, Latin America strategist at Nomura. Overall though, he says the reform has potential to disappoint.

But the measures did not include a widening of a sales tax to food and medicine - a move which analysts say would have proved a significant boost to revenue.

"Mexico didn't want to tax food and medicine, and on top of that they are asking congress for a [larger] fiscal deficit, one of the largest since the 1990s, and there is the possibility of dilution by congress. If [you] put everything together, the message might disappoint the market."

Still, ratings agencies will take their time to assess the impact, he says.

"Probably we will see ratings agencies more cautious next year and will probably wait a year or two before considering Mexico for an upgrade," he tells LatinFinance.

The bill is likely to be passed by congress, winning broad support by removing value-added tax on food and medicine, say analysts at Barclays. The bank deems the tax changes positive. But increases in the deficit could put up problems, they say. The 3.5% of GDP deficit projected for 2014 would be the highest since 1989, they say. Funding it could be difficult at a time when the US is rolling back an extraordinary period of stimulus.

"Financing the deficit by the federal government, which will be 35% higher in nominal terms to the one planned in 2013, could be quite challenging in a context in which the Federal Reserve is signaling the end of the monetary stimulus, increasing the sovereign rates for the emerging markets," Barclays analysts said.

Meanwhile, the reforms only partly tackle the government's high dependency on oil revenues, Capital Economics economists said. The firm calculates that a $10 fall in the per-barrel oil price would cut government tax revenue by 1% of GDP.

"The reforms announced over the weekend will help to raise revenues and broaden the tax base - but only up to a point." LF



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