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Emerging Markets

Mexican government grasps the fiscal nettle

Mexico is facing an uphill battle to redress its fiscal performance, in the wake of a punishing recession caused by the global crisis.

The government has tabled a tough budget bill, due to be passed by Congress this month, but some analysts believe the proposals will have to be watered down to get through.

Government officials have admitted that the fiscal credibility of the second largest Latin American economy was at risk.

“I am confident we will have a responsible decision taken by Congress,” said Agustin Carstens, Mexico’s finance minister told Emerging Markets.

“There are always adjustments [to the budget, as part of the legislative process]. It would be important to address the issue of permanent reduction in income... Congress in one way or another will address this,” he said.

The budget proposals focus on raising existing taxes and imposing new ones, including a 2% sales tax and another excise tax. Three ministries were abolished as part of efforts to curb public expenditure.

Some have warned that Mexico has been on a slippery slope for some time, due to a combination of falling oil output and revenues against a background of rising expenditures.

Alejandro Werner, the Mexican deputy minister of finance, told a seminar in Istanbul: “Once a [fiscal] deficit becomes politically acceptable, we run the risk of postponing the fiscal adjustment for too long and generating problems for the future.”

The Mexican government’s actions have won praise from the IMF. Nicolas Eyzaguirre, the IMF’s western hemisphere director, said: “The stance on fiscal policy is the appropriate one, in terms of not withdrawing the fiscal stimuli. At the same time, it has been very realistic and courageous in terms of trying to finance it through additional taxes that are not particularly popular in the middle of a recession.”

David Robinson, the Fund’s deputy director for the western hemisphere, said: “The budget is trying to draw a complex balance between the short term needs of the economy and putting the public debt on a declining trend in 2010. Our judgment is that the policies that the administration has put forward in this draft budget are a very good start.”

Market analysts’ view of the budget bill has been more cautious. Daniel Volberg, a New-York based Morgan Stanley economist wrote in a recent report on Latin America: “Even if congress passes the tax reform in its current form, avoiding meaningful medium-term fiscal deterioration would still require a firm efforts to contain spending growth down the road.”

Mexico was severely hit by the global financial meltdown. Its currency came under extreme pressure and Mexico was the first country to access the new so-called flexible credit line of the IMF last year.

A preventive $46 billion package, the largest amount granted under the IMF’s Flexible Credit Line programme to date, helped Mexico to defuse a potentially destabilizing crisis.

Eyzaguirre said: “It meant that pressures on the currency abated completely, it is not an issue anymore. The FCL was a very important element to stabilize the foreign exchange markets.”

Carstens said: “The FCL allowed us to maintain access to capital markets and avoid financial contagion. We managed to steer clear from any form of financial contagion.”

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