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