MEXICAN GOVERNMENT MOVING FORWARD ON LONG-AWAITED

UNCLAS SECTION 01 OF 04 MEXICO 001389

SIPDIS

SENSITIVE
SIPDIS

STATE FOR A/S SHANNON
STATE FOR WHA/MEX, WHA/EPSC, EB/IFD/OMA, AND DRL/AWH
STATE FOR EB/ESC MCMANUS AND IZZO
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GERI WORD
USDOC FOR ITS/TD/ENERGY DIVISION
TREASURY FOR IA (ALICE FAIBISHENKO)
DOE FOR INTERNATIONAL AFFAIRS KDEUTSCH AND SLADISLAW
NSC FOR CYNTHIA PENDLETON
STATE PASS TO USTR (EISSENSTAT/MELLE)
STATE PASS TO FEDERAL RESERVE (CARLOS ARTETA)

E.O. 12958: N/A
TAGS: ECON ELAB EFIN PINR PGOV MX
SUBJECT: MEXICAN GOVERNMENT MOVING FORWARD ON LONG-AWAITED
PENSION REFORM

REF: MEXICO 921

--------------
Summary
--------------


1. (SBU) The Finance and Social Security Committees in the
Mexican Chamber of Deputies (lower house) on March 20
approved new draft legislation to reform the Social Security
and Services Institute for State Workers (ISSSTE),the agency
responsible for providing pension and health care services
for government employees. The centerpiece of the reform is
that it would replace the current "defined-benefit,"
pay-as-you-go pension system with a defined-contribution
scheme based on individual retirement accounts -- similar to
the system created in 1997 for private sector employees. An
important aspect of the reform proposal is that it would
allow employees to keep their pension benefits if they move
from the public sector to the private sector, or vice versa.
To make the proposal more palatable to Mexico's powerful
unions, the bill doubles the size of the minimum guaranteed
pension and increases government contributions to some ISSSTE
funds. Although the proposal seems assured of more than
enough votes for passage, the Democratic Revolution Party
(PRD) and some unions are opposing it -- arguing that it will
lead to the privatization of social security for state
workers. This reform would relieve significant pressure on
government finances and would be the first major economic
reform passed under the Calderon administration. End
Summary.

-------------- -
Lower House Committees Advance Pension Reform
-------------- -


2. (U) The Finance and Social Security Committees in the
Mexican Chamber of Deputies (lower house) on March 20
approved new draft legislation to reform the Social Security
and Services Institute for State Workers (ISSSTE),the agency
responsible for providing pension and health care services
for government employees. The measure is currently before
the full Chamber. If the lower house approves it quickly as
expected, the bill would go to the Senate as early as March

22.


3. (U) The reform bill would replace the current
"defined-benefit," pay-as-you-go pension system with a
defined-contribution scheme based on individual retirement
accounts -- similar to the system created in 1997 for private
sector employees. Under the bill, public sector workers who
have already retired would see no change in their pensions.
Active employees could remain in the current system, with
some adjustments to the minimum retirement age and the
obligatory contribution, or move to an individual retirement
account system run by a public "Afore" (a pension fund
managing company) that will be called "Pensionissste."
Current employees opting for the new system would receive
government bonds in compensation for their acquired pension
benefits. All new public sector workers would be
automatically enrolled in Pensionissste.


4. (U) Pensionissste would be subject to oversight by pension
regulator Consar, but it would have its own special
investment regime prioritizing investments in housing, roads,
petrochemical, and energy projects. Pensionissste would have
a board composed of the Director General of ISSSTE and
members from the union and various secretariats.


5. (U) A key aspect of the reform proposal is that it would
allow employees to keep their pension benefits if they move
from the public sector to the private sector, or vice versa.

MEXICO 00001389 002 OF 004


The reform would bring contract and temporary workers into
the new pension system, and it would raise the retirement age
from 48 to 58 for women and from 50 to 60 for men, over a
20-year period. The reform also would introduce an incentive
scheme to increase voluntary savings. For each peso a worker
contributes, the government would add 3.25 pesos, up to 2% of
the worker's salary. The reform would raise the obligatory
contribution from 7% to 12.7% of the quoted salary over a
five year period, with the employee paying 6.125% and the
government paying 6.625%.


6. (U) To make the proposal more palatable to Mexico's
powerful unions, the government pledged to increase
government contributions to the various ISSSTE funds,
including medical. Notably, the reform would double the
guaranteed minimum pension to 3,034 pesos (US$278, equivalent
to 2 minimum wages),indexed to inflation. The government
also would contribute a social fee to improve health services
equivalent to 3.5% of the quoted salary; contribute US$733
million to strengthen medical services and US$183 million to
the Fund for Personal Loans; and create a mechanism to offer
7,000 mortgages to retirees.


7. (SBU) Under the reform proposal, Pensionissste would be
the only pension fund manager allowed to manage the
individual pension accounts for 36 months. Government
workers would be allowed to leave Pensionissste and choose an
Afore at the end of this time period. HSBC economist Juan
Trevino (strictly protect) on March 16 told econoff that he
did not view the 3-year restriction as a problem. He said
this time would allow private sector companies to see how
things work and get ready to enter this new, attractive
market. The creation of a public Afore was critical in
gaining PRI support for the draft legislation and in helping
deflect criticism that the reform would privatize ISSSTE.

-------------- --------------
Reform Would Help Defuse Pension System Time Bomb
-------------- --------------


8. (U) This reform measure would help relieve pressure that
ballooning pension and health care liabilities put on
government finances. ISSSTE is responsible for paying
pensions to nearly 600,000 beneficiaries and providing
medical and social services to about 10 million affiliates.
The agency has an actuarial deficit in pensions alone
equivalent to about 50% of GDP. In recent years, the federal
government has been forced to make special contributions to
ISSSTE to address the growing shortfall between its income
and pension outlays. This year the government will transfer
US$3.8 billion to cover ISSSTE's deficit. According to the
Secretariat of Finance and ISSSTE, this amount is expected to

SIPDIS
rise to US$25.6 billion in 2050 if changes are not
implemented.


9. (U) In 2007, revenues from the medical fund are expected
to cover only 69% of total expenditures. The difference has
to be covered by transfers from the federal government
(US$495 million) and resources from other ISSSTE funds,
particularly the Fund for Loans and Social and Cultural
Services (US$247 million). The reform proposal would allow
ISSSTE to upgrade medical equipment, reduce wait times for
life-saving medical procedures, and reduce overcrowding in
hospitals.

--------------
Reaction to Proposal Mostly Positive
--------------


10. (SBU) The bill has the backing of President Calderon's
administration, his National Action Party (PAN),the

MEXICO 00001389 003 OF 004


Institutional Revolutionary Party (PRI),the Green Party, the
New Alliance Party. Press reports say that the bill also has
the support of FSTSE (Federation of State Employees Unions)
leader Joel Ayala Almeida and National Teachers Union (SNTE)
leader Elba Esther Gordillo, and that these leaders had
significant input into the text of the bill (in part because
Gordillo placed one of her main allies, Miguel Angel Yunes,
as Director General of ISSSTE). A spokesman for Joel Ayala
confirmed to Labor Counselor that the FSTSE firmly supports
the reform legislation. Moreover, HSBC's Trevino told
econoff that everyone is optimistic the reform will be
passed, and that is it more matter of "when" than "if."


11. (SBU) Although the proposal seems assured of more than
enough votes for passage, its private account approach is
precisely the sort of reform guaranteed to arouse ire on the
Left. Indeed, Democratic Revolution Party (PRD) lawmakers
and some unions have spoken out against what they are calling
the "bankers law," opposing in particular the provision that
creates personal retirement accounts, which they have
characterized as privatization. They fear that it will lead
to the privatization of social security for state workers.
While the PRD and some unions are expected to protest against
the bill, Trevino told econoff that he did not think the
reform would spur major demonstrations. He noted that the
government had already done a significant amount of lobbying
and that the person in charge of the union actually helped
draw up the proposal.


12. (SBU) Most organized labor observers agree completely on
the need to reform ISSSTE, and there seems little doubt that
the proposed legislation will pass. However, even these
people have some reservations about the reform proposal. For
example, an analyst with Mexico City's Center for
Investigations and Advanced Studies in Social Anthropology
(CIESAS) pointed out that the proposed changes to ISSSTE
would make it more like IMSS; the pension system that now
exists for private sector employees. The analyst remarked
that IMSS is anything but a success in providing pension and
health care benefits to the average Mexican in the private
sector.


13. (SBU) The CIESAS analyst also raised concerns that
Pensionissste would be unduly influenced by labor leaders
Joel Ayala and Esther Gordillo. Both of these leaders have
considerable political power in Mexico and Gordillo, in
particular, is often pointed to as someone who exemplifies
the negative aspects of a corrupt labor movement that is
allowed to act with impunity. These reservations
notwithstanding, the analyst recognized that many parts of
the reform proposal, including the increase in the retirement
age, would significantly improve ISSSTE's long-term financial
stability.

--------------
Comment
--------------


14. (SBU) This reform would relieve significant pressure on
government finances and stimulate national savings.
Moreover, it would be the first major economic reform passed
under the Calderon administration. While it will likely be
more difficult to build consensus for other economic reforms
(fiscal, energy, etc.),the quick passage of this initiative
would send a positive signal about the government's
willingness and ability to pass reform legislation.


15. (SBU) It appears that the government worked
behind-the-scenes to build support for its proposal before
submitting the measure to Congress, as it did for the 2007
federal budget. A Finance Secretariat contact told econoff

MEXICO 00001389 004 OF 004


in mid-March that, unlike the previous administration, the
Calderon government planned to negotiate the provisions of
its proposals so it could send "passable" bills to Congress.
The contrast in modus operandi between the two
administrations suggests a far greater degree of political
sophistication in the current administration. And while the
bill has already generated the expected opposition from the
Left, it appears the Calderon administration's inclusion of
union officials in the drafting process may undercut the
resonance of any such opposition. If former PRD leader
Andres Manuel Lopez Obrador (AMLO) and others on the Left are
unable to generate the public opposition they have
threatened, it could represent an important defeat for his
movement.


16. (SBU) One aspect that is not clear is how the government
will fund the transition to the new pension system. The
government faces major transition costs over the next several
years as it pays the pensions of workers who retire under the
old system. In the event that all ISSSTE workers opt for the
new system, the transition costs would total about 30% of
GDP, according to the Finance Secretariat. The government
will also need to consider the Budget and Fiscal
Responsibility Law, which prohibits it from running a budget
deficit. Post will follow up on the pension reform proposal
in septel.


Visit Mexico City's Classified Web Site at
http://www.state.sgov.gov/p/wha/mexicocity
GARZA