2019 fiscal budget: the government approves its first big test - BBVA Research
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Economic Analysis 2019 fiscal budget: the government approves its first big test Macro Unit Mexico The fiscal package is sound in macroeconomic terms but introduces some microeconomic distortions It is built on reasonable and market-aligned economic assumptions Revenue and spending projections are conservative As we expected, market reaction was slightly positive The public budget for 2019 eases concerns on Mexico as the federal government shows commitment to fiscal discipline with a 1.0% of GDP primary surplus target based on sensible projections for public revenue and spending on top of reasonable macroeconomic assumptions. Macroeconomic forecasts are as follows: 2.0% GDP growth (BBVA Research: 2.0% with a downward bias), headline inflation of 3.4% (BBVA Research: 3.6%), foreign exchange rate at 20 pesos per USD and the Mexican oil mix at USD 55 per barrel on average (it is now trading at around USD 52). The government forecasts that total public revenue will decrease 0.5% in real annual terms in relation to its own estimations of public income for 2018. Regarding total public expenditure, the government projects a real annual drop of 0.2% when compared to its own public spending estimate for 2018. The projections for public revenue assume that tax revenue (62.3% of total public revenue) will increase 3.8% in real annual terms or 1.4% without the gasoline and diesel tax revenue (5.8% of total tax revenue). Consequently, next year such fuel tax revenue should go up by around 42% in real annual terms to make it possible for tax revenue to have such projected increment. Freezing local gasoline and diesel real prices for next year in conjunction with stable or lower international prices of these fuels would help to increase the fuel tax revenue but uncertainty remains as to whether such target will be reached. The federal government is also providing fiscal stimuli to municipalities in Mexico that are along the border with the US. The value added and marginal corporate income taxes were lowered to 8% and 20% from 16% and 30%, respectively. According to the government, such new measures will reduce next year’s fiscal intake by 40,000 million pesos. In our opinion, this estimated reduction in public revenue looks fairly optimistic as these measures are also distortionary and could incentivize corporations located somewhere else to change their fiscal address along the northern border of Mexico. The government mentions that the public spending plan for 2019 was designed around austerity and savings policies to channel more public resources to social needs and infrastructure spending. Despite knowing that a primary surplus is always economically contractionary, allocating more resources to infrastructure projects could spur economic growth. Nevertheless, investment projects like the Mayan train and the new refinery would not necessarily help improve growth as they could mean capital misallocations if they make losses instead of profits as seems likely. Pemex stands out as one of the few beneficiaries of the new public budget as more capital will be allocated to its upstream and downstream lines of business. The government’s injection of new capital (125,000 million pesos of which Mexico Economic Watch – 17 December 2018 1
50,000 will go to the new refinery) will keep Pemex from significantly increasing its debt in the short term and thus
reduces the probability of a rating downgrade. Nevertheless, looking ahead, providing the government goes ahead with
its plans of strengthening the downstream business at the expense of exploration and production of crude oil, agencies
could downgrade Pemex’s credit rating as lower crude oil production would translate into heavier losses, more
financing needs and currency mismatch problems since around 85% of Pemex debt is denominated in US dollars.
The public spending plan for 2019 allocates fewer resources to autonomous institutions like the Energy Regulation
Commission and Hydrocarbon National Commission. These institutions will see their appropriations drop by 31% and
30%, respectively. In our opinion, these expenditure cuts are not surprising in light of the federal government doubts
about the effectiveness of the energy reform to keep crude oil production from declining and lower fuel prices.
The stabilization of public debt as a share of GDP is one of the federal government goals. Our own forecasts indicate
that, ceteris paribus, the historical balance of public sector borrowing requirements (as a share of GDP) could remain
stable at a level around 46.6% of GDP by 2019 year-end with a primary surplus of at least 0.2% of GDP (Figure 1).
Given that the federal government has set a target of 1.0% of GDP for the primary surplus, it is very likely that this wide
definition of public debt will remain stable in 2019. Nevertheless, economic growth below 2.0% (not driven by public
underspending) and/or a foreign exchange rate above 20 pesos per USD could require a higher minimum primary
surplus to achieve such stability. Moreover, lower economic growth than anticipated could translate into a lower
primary surplus if the federal government does not adjust its spending plan (Figure 2).
Figure 1. Historical balance of public sector borrowing Figure 2. Economic growth and primary balance
requirements (% of GDP) (YoY % change and % of GDP)
55
2.5
2.2
50 48.7 2.0
46.2
46.0 2
1.8
45 46.6 1.6
1.5 1.4
BBVA
40 1.2
Research
forecasts 1.0 1.0
for 2018- 1
35 2019 0.8
0.6
30 0.5 0.3
0.1
25 0
-0.1
20 -0.3
-0.5
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Real GDP growth Primary balance
Source: BBVA Research with data from SHCP Source: BBVA Research with data from SHCP
As we expected, market reaction was slightly positive, as this fiscally responsible public budget was not enough to
reduce uncertainty on the future public policy decision-making process. Yet, it is a good sign that this fiscal package
did not add concerns on the macroeconomic front. As shown in the graphs, financial variables had a small recovery.
Mexico Economic Watch – 17 December 2018 2Figure 3. USDMXN intraday, Dec 14-Dec17 Figure 4. 5Y CDS spread intraday, Dec 14 – Dec 17
(Pesos per USD) (Basis points)
20.35 147
20.30
145
20.25
143
20.20
141
20.15
139
20.10
137
20.05
Dic 14 Dic 17
Dec 14 Dec 16 Dec 17
20.00 135
12:00
13:00
14:00
13:00
14:00
17:00
18:00
19:00
22:00
23:00
00:00
03:00
04:00
05:00
15:00
12:00
15:00
16:00
20:00
21:00
01:00
02:00
1:30
2:30
3:30
4:30
5:30
6:30
7:30
8:30
9:30
12:00
13:00
14:00
15:00
16:00
10:30
11:30
12:30
13:30
14:30
Source: BBVA Research with data from Bloomberg Source: BBVA Research with data from Bloomberg
Figure 5. YTM Mbono 10yr, Dec 14-Dec17 Figure 6. PEMEX bond prices
(%) (USD)
8.98
103
8.96
NAIM
98 cancellation
8.94
8.92
93
8.9
8.88 88
8.86
83
8.84
8.82 78
Nov-18
Dec-18
Apr-18
Oct-18
Oct-18
Aug-18
Sep-18
Feb-18
Mar-18
Mar-18
Jul-18
Jul-18
May-18
May-18
Jun-18
Dic 14 Dic 17
8.8
7:00
7:30
8:00
8:30
9:00
9:30
12:30
13:00
13:30
14:00
14:30
15:30
10:00
10:30
11:00
11:30
12:00
13:00
13:30
14:00
14:30
15:00
12:00
15:00
12:30
15:30
2025 2048
Source: BBVA Research with data from Bloomberg Source: BBVA Research with data from Bloomberg
Figure 7. CFE bond prices Figure 8. 5Y CDS spread oil companies
(USD) (Basis points)
400
110
NAIM 350
105 cancellation
300
100
95 250
90 200
85 150
Dec-18
Apr-18
Oct-18
Oct-18
Nov-18
Aug-18
Sep-18
Feb-18
Apr-18
Oct-18
Oct-18
Nov-18
Dec-18
Mar-18
Mar-18
Aug-18
Sep-18
Jul-18
Mar-18
Mar-18
Jul-18
Feb-18
Jul-18
Jul-18
May-18
May-18
May-18
May-18
Jan-18
Jan-18
Jun-18
Jun-18
2027 2042 2048 PEMEX Petrobras
Source: BBVA Research with data from Bloomberg Source: BBVA Research with data from Bloomberg
Mexico Economic Watch – 17 December 2018 3Figure 9. UMS 10Y – T10 yield spread
(%, USD denominated)
2.0
1.9
1.8
1.7
1.6
1.5
1.4
1.3
1.2
1.1
1.0
May-18
May-18
Jan-18
Jan-18
Apr-18
Jun-18
Oct-18
Oct-18
Mar-18
Mar-18
Aug-18
Sep-18
Feb-18
Jul-18
Jul-18
Nov-18
Dec-18
Source: BBVA Research with data from Bloomberg
Bottom line
The public budget for 2019 is based on within reach macro forecasts and reasonable projections for incomes and
expenditures. Yet, there are still doubts on what the government would do if for some reason the fiscal targets were
unlikely to be met –i.e., whether they would choose to miss the fiscal targets or reduce promised spending if needed.
The increase in spending on social programs and infrastructure projects is financed with savings coming from austerity,
the elimination of around half of the current 156 social programs, and a steep reduction in the discretional allocation of
resources to the states (Ramo 23). The latter is positive since it significantly reduces politically driven discretionary
spending.
The promised reduction in taxes along the border is included in the budget and the estimate of a decline of around
40,000 million pesos seems optimistic to us. The 3.8% real annual increase in tax revenue seems challenging as a
sizable rise in fuel tax revenue would be needed. All in all, total income projection seems reasonable considering that it
would have increased 5% in real terms during 2018 if there had not been a windfall from Banxico in 2017. No
significant windfall is expected this time around, as this year-end foreign exchange rate would be similar to 2017 year-
end corresponding figure.
On the negative side, the reduction in taxes along the border constitutes a major policy mistake, as it will result in lower
fiscal revenues and significant distortions. Moreover, the significant reduction in resources to autonomous institutions is
a cause for concern.
The budget does not contemplate the use of fiscal resources for the cancellation of the airport. Bondholders are
unlikely to accept the enhanced buyback offer and the government announced that there would not be another. Thus,
we should assume that the cost of repurchasing the bonds (except for USD 1.8 billion sitting in the airport trust) would
be incurred by either the federal government or development banks. In either case, this would represent a contingent
fiscal liability.
Mexico Economic Watch – 17 December 2018 4Disclaimer This document was prepared by Banco Bilbao Vizcaya Argentaria’s (BBVA) BBVA Research and BBVA Bancomer S. A., Institución de Banca Múltiple, Grupo Financiero BBVA Bancomer on behalf of itself and is provided for information purposes only. The information, opinions, estimates and forecasts contained herein refer to the specific date and are subject to changes without notice due to market fluctuations. The information, opinions, estimates and forecasts contained in this document are based upon information available to the public that has been obtained from sources considered to be reliable. However, such information has not been independently verified by BBVA Bancomer, and therefore no warranty, either express or implicit, is given regarding its accuracy, integrity or correctness. This document is not an offer to sell or a solicitation to acquire or dispose of an interest in securities. Mexico Economic Watch – 17 December 2018 5
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