REVIEW OF MEXICAN STATE DEPENDENCE ON

UNCLAS SECTION 01 OF 02 MEXICO 004020

SIPDIS

SENSITIVE
SIPDIS

STATE FOR WHA/MEX, WHA/EPSC, AND EB/IFD
STATE PASS USAID FOR LAC:MARK CARRATO
USTR FOR JOHN MELLE
TREASURY FOR IA MEXICO DESK:JASPER HOEK
COMMERCE FOR ITA/MAC/NAFTA:ANDREW RUDMAN

E.O. 12958: N/A
TAGS: ECON EFIN ELAB ENRG PGOV MX
SUBJECT: REVIEW OF MEXICAN STATE DEPENDENCE ON
FEDERALLY-COLLECTED FUNDS (THIRD OF THREE-PART SERIES ON
MEXICAN FEDERAL-STATE RELATIONS)

REF: A. A. MEXICO 3961

B. B. MEXICO 3962

C. C. MEXICO 4019

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Summary
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1. (SBU) States and municipalities depend for the vast
majority of their revenue on federally collected value-added
tax and petroleum revenue funds, but the Fiscal Coordination
Law prohibits the GOM from conditioning transfers. On
average, 90 percent of state revenue and nearly 75 percent of
municipal revenue (which is channeled through the state) come
from federal transfers, although the exact amount varies
considerably by state and municipality. "Participaciones"
and "aportaciones" are the mechanisms for federal transfers.
Participaciones are unconditional and comprise each
underlying entity's share of oil and VAT revenues according
to a national formula that factors in population and poverty
level. Aportaciones are earmarked funds that cover the costs
of public services such as education and health care.
Specific federal budget lines are determined by an opaque
annual budget process that originates with Hacienda (Mexico's
national treasury),and works its way through Congress before
funds are distributed to the states. End summary.

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Feds Lack Fiscal Leverage Over the States
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2. (SBU) The Fiscal Coordination Law prevents the federal
government from conditioning transfers based on state support
for federal initiatives. Consequently, our contacts told us
that states do not have to bow to the national government
because of funding needs. The president has little
discretionary maneuver through this part of the budget
process, and no margin once Congress allocates the funds.
However, he may have an opportunity to influence governors
through the federal budget process during which the GOM
prioritizes national programs and releases technical studies
that impact the implementation of regional infrastructure
projects. As a senior official at Hacienda told us, if the
next president were to reverse President Fox's decision that
made the public safety ministry an independent entity (and
return it to sub-ministry status),then he would have an
additional pool of millions of pesos to leverage with the
states.


3. (SBU) States have their own revenue-generating
capabilities. They have become more adept at accessing the
domestic capital market as a consequence of macroeconomic
policies (designed to rebuild the banking system and restore
sovereign credit) following the 1994-95 peso crisis. The
constitution also gives them the right to levy state-wide
taxes, although their tax systems are generally weak.
Increases in oil revenues have reduced their incentive to
improve tax collection; however some states, such as
Michoacan, have implemented new taxes in order to diversify
their revenues and make themselves more attractive to
potential investors.


4. (SBU) Although states have no independent means to
influence national macroeconomic initiatives, they engage in
regular dialogue with Hacienda and have lobbied for and
against policy changes that affect the state share of
federally-collected revenues. States are able to finance
infrastructure by accessing bank loans or by issuing
"certificados bursatiles" in the capital market. Mexico's
sub-national bond market emerged in 2001 and has yielded $13
billion in financing to states and municipalities. By
contrast, NAD bank has financed just under $105 million in
loans to Mexico since 1994 and there remains an enormous
backlog in requests for project financing. Under Mexican
law, states may only borrow in the national currency; any
dollar-denominated loans from multilateral development banks
must be funneled through the federal government.


5. (SBU) As reported ref B, a Bank of Mexico concern is the
ability of states to make long-term employment and other
commitments based on petroleum-related revenues that may go
up and down based on oil prices and the national formula

MEXICO 00004020 002 OF 002


described above. A senior Bank of Mexico official saw the
issue of long-term state spending commitments not being tied
to guaranteed revenue flows as a major federal/state issue
and financial challenge for Mexico.


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