Measuring up: Fiscal austerity planned for 2015 and 2016

The sharp decline in international oil prices has forced the government to cut its fiscal spending plans for 2015 and 2016. In part this is because the administration has already committed itself to introducing no further tax increases in 2015, following the hikes that took place at the beginning of 2014 as part of the structural reform programme. The deficit can therefore only be reduced by an adjustment on the spending side. The finance minister, Luis Videgaray, is seeking to do this and to maintain his reputation for fiscal responsibility. He has also decided to introduce a zero-based budget exercise in 2016, an initiative that could lead to a major reallocation of central government resources.

Under Pressure

On average, around a third of government revenue has come from taxes and royalties levied on the oil and gas industry. While the industry is now only a small part of overall GDP (around 5-6%) it remains an outsized contributor of government revenue. It has been calculated that for every $10 drop in the average price of a barrel of oil, public revenues decline by around 0.8% of GDP in a year. In the first quarter of 2015 oil revenues slumped by 42.6% year-on-year (y-o-y) to MXN173.72bn ($11.7bn), reflecting sharply lower prices and moderately lower exports of crude oil.

In January 2015, responding to the slump in oil prices, the government announced it was cutting the expenditure budget for that calendar year by MXN124.3bn ($8.4bn). The cut was equivalent to around 0.7% of GDP. Much of the burden of savings was due to fall on state oil and gas firm Petróleos Mexicanos (Pemex), which was being asked to deliver around half the overall saving target of MXN62bn ($4.2bn). The 2015 budget was calculated on the assumptions of an average Mexican crude oil price of $79 and GDP growth in the range of 3.2-4.2%. Subsequently, the oil price assumption was lowered to an average of $50 a barrel. The real impact of the reduction in 2015 was nevertheless softened by the oil price hedging programme at the Ministry of Finance (Secretaría de Hacienda y Crédito Público, SHCP). In its initial submission to Congress in March 2015 decline by around 0.8% of GDP in a year. In the first quar-for the 2016 budget the government said it was planning to cut expenditure by a further 4.3%, or MXN135bn ($9.1bn). The indicative 2016 budget had been calculated assuming an average oil price of $55, down from the $79 originally used for 2015. It assumed GDP growth would be in the 3.3-4.3% range. By 2016 non-oil tax revenue would represent 11.5% of GDP, up by 1.8 percentage points when compared to 2013, the SHCP said. In April 2015 it was announced that the central bank operating surplus of MXN31.45bn ($2.1bn) generated in 2014 would be transferred to the government in 2016 to help fund infrastructure investments.

Better Value For Money

There have been differing assessments of the impact of the cuts. The available information suggests they are distributed between current spending on the one hand, and capital expenditure on the other. Implicit in the cuts is the belief that a shift to greater private sector involvement in infrastructure funding is possible. Videgaray has said more private sector participation would be required in the government’s long-term infrastructure development plan, including greater private sector financing, extending existing concessions and making greater use of public-private partnerships. However, this re-orientation will take time and it is possible the multiplier effect of public sector investment on the wider economy will thus be reduced in 2015/16.

According to credit rating agency Moody’s, a weaker Mexican peso could be expected to boost manufacturing exports despite lower oil revenues. The credit impact of currency depreciation would be limited because government debt denominated in foreign currency amounted to only 20% of the total. Moody’s believed that the potential public revenue shortfall in 2015 would be 1.2% of GDP, before the effect of price hedging was taken into account. Fitch Ratings had a similar view: in February 2015 it reaffirmed its long-term foreign and local currency ratings for Mexico at BBB+ and A-, welcoming the 2015 budget cuts as demonstrating “the commitment of authorities to maintain fiscal stability”, and noting government plans to gradually consolidate its fiscal accounts in the coming years.

“Mexico’s BBB+ credit rating is due to the country’s solid macroeconomic standing, but also in large part due to the structural reforms,” Victor Herrera, managing director of Standard & Poor’s in Mexico, told OBG. “For now the outlook of the rating is stable; however, if the reforms begin to show positive results, one could start talking about a credit rating increase.”

Zero-Based Budget Exercise

The idea behind the government’s zero-based budgeting exercise to be introduced in 2016 is that by building up a new budget from scratch Mexico’s ministries and spending departments will have to scrutinise and justify the use of resources anew, thereby eliminating wasteful “inertia” in the growth of public spending. The deputy finance minister, Fernando Galindo, has confirmed that the government expects the 2016 austerity programme to include public sector job losses.

As an example of overlapping programmes, Galindo said work had already begun to “re-engineer” 11 or 12 separate programmes in the Ministry of Education that grant scholarships into a single department. “We have a fundamental challenge to spend less and to spend better next year,” Galindo said, noting, however, that there were some items that could not be reduced, such as pension payments or debt servicing. The 2016 budget exercise is being supported by the World Bank, which will help benchmark comparisons with other countries.

Political Challenge

The SHCP noted that, aided by strong oil revenues in the past, current federal government spending rose at an average annual rate of 5.2% in 2000-13, increasing from 10.9% to 15.2% of GDP. The newspaper El Universal claimed that public spending has grown y-o-y without interruption since 1980.

Turning back this long-term rise will be a politically challenging task. While the ruling coalition gained seats in the Chamber of Deputies in the mid-term elections of June 2015, the government could still face more vocal opposition in the federal and state legislatures.

Precautionary Measures

The government has also been taking other, precautionary measures, to keep public spending under control. In May 2015 a new financial discipline bill achieved the necessary legislative approvals to become law. It limits the ability of Mexican states and the federal district to incur debt. According to an estimate by Amden, the Mexican association of financial intermediaries, total state and municipal debt stood at over MXN509bn ($34.3bn) at the end of 2014. The finance ministry calculates that these debts represent 3.1% of GDP. It estimates total public sector debt at the end of 2014 was 43.7% of GDP, below the Latin American average. In its Article IV consultation report in November 2014 the IMF had described Mexico’s debt-to-GDP ratio as “low and sustainable”.

In the medium term the current government is committed to a gradual narrowing of the fiscal deficit, down to 2.5% of GDP by the end of its term in office, in 2018.