MEXICO 2007 INVESTMENT CLIMATE STATEMENT -- PART II

UNCLAS SECTION 01 OF 07 MEXICO 000173

SIPDIS

SIPDIS

STATE FOR EB/IFD/OIA
STATE FOR WHA/MEX

E.O. 12958: N/A
TAGS: ECON EINV KTDB OPIC USTR ELAB ETRD EFIN PGOV
MX
SUBJECT: MEXICO 2007 INVESTMENT CLIMATE STATEMENT -- PART II

REF: 06 SECSTATE 178303

This is part two of a two part cable that provides suggested
text for the 2007 Mexico Investment Climate Statement.

Transparency of Regulatory System

The Federal Commission on Regulatory Improvement (COFEMER)
under the management of the Secretariat of Economy is the
agency responsible for reducing the regulatory burden on
business. The Mexican government has made progress in the
last few years. On a quarterly basis, these agencies must
report to the Presidency on progress achieved toward
Presidential goals for reducing the regulatory burden. In
December 2006, President Calderon replaced the Regulatory
Moratorium Agreement, issued by the previous administration
to ensure agencies streamline their regulatory promulgation
processes, with the Quality Regulatory Agreement. The new
agreement intends to allow the creation of new regulations
only when agencies prove that they are needed because of an
emergency, because of the need to comply with international
commitments, or because of obligations established by law.

The federal law on administrative procedures has been a
significant investment policy accomplishment. The law
requires all regulatory agencies to prepare an impact
statement for new regulations, which must include detailed
information on the problem being addressed, the proposed
solutions, the alternatives considered, and the quantitative
and qualitative costs and benefits and any changes in the
amount of paperwork businesses would face if a proposed
regulation is to be implemented. Despite these measures, many
difficulties remain. Foreign firms continue to list
bureaucracy, slow government decision-making, lack of
transparency, a heavy tax burden, and a rigid labor code
among the principal negative factors inhibiting investment in
Mexico.

The Secretariat of Public Administration has made
considerable strides in improving transparency in government,
including government contracting and involvement of the
private sector in enhancing transparency and fighting
corruption. The Mexican government has established several
Internet sites to increase transparency of government
processes and establish guidelines for the conduct of
government officials. "Normateca" provides information on
government regulations; "Compranet" allows for on-line
federal government procurement; "Tramitanet" permits
electronic processing of transactions within the bureaucracy
thereby reducing the chances for bribes; and "Declaranet"
allows for on-line filing of income taxes for federal
employees.

Efficient Capital Markets and Portfolio Investment

The Mexican banking sector has strengthened considerably
since the 1994 peso crisis left it virtually insolvent. Since
the crisis, Mexico has introduced reforms to buttress the
banking system and to consolidate financial stability. These
reforms include creating a more favorable economic and
regulatory environment to foster banking sector growth by
reforming bankruptcy and lending laws, moving pension fund
administration to the private sector, and raising the maximum
foreign bank participation allowance. The bankruptcy and
lending reforms passed by Congress in 2000 and 2003
effectively made it easier for creditors to collect debts in
cases of insolvency by creating Mexico's first effective
legal framework for the granting of collateral. Pension
reform allows employees to choose their own pension plan.
Allowing banks or their holding companies to manage these
funds provides additional capital to the banking sector,
while the increased competition focuses fund managers on
investment returns.

The financial profile of the banking sector has improved due
to the reduction in the problem assets brought about by
write-offs, problem loan sales, and the conclusion of most
debt-relief programs. These developments, combined with more
stringent capital requirements, have contributed to an
improvement in the level and composition of capital across
the banking system, particularly among the larger
institutions.

Foreign bank participation, at over 80 percent of the banking
system, is having a positive effect on Mexico's banking
sector. The most apparent impact is the large size of equity

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investments, which have been used to clean the acquired
institutions' balance sheets. Additionally, higher foreign
participation should improve the technology and risk
management techniques (i.e. standards in auditing, accounting
and disclosure) of the banking system. Examples of changes
implemented by foreign bank owners include improvements in
credit approval processes, loan documentation, and
credit-related management information systems. With the
support of strong international shareholders, these banks
should also benefit from greater access to funding.

Bank lending, especially consumer lending and mortgages, grew
rapidly in 2005 and 2006, fueled by lower interest rates and
historically low inflation. Small and medium-sized
businesses still complain of a lack of access to credit, but
government-owned development banks have expanded their
lending to this sector. Despite the expansion, such lending
remains low as a percentage of GDP. Private banks argue that
due diligence in lending to such business is difficult given
the large amount of revenue kept off the books to avoid
increased tax liability.

Commercial loans to established companies with
well-documented accounts are available in Mexico, but many
large companies have resorted to utilizing retained earnings
to fund growth. Supplier credit is the main source of
financing for many businesses. The largest companies are
able to issue debt for their financing needs, tapping into a
growing pool of pension funds looking for investment options.
Non-bank financing is generally available, however, only to
large companies with strong credit ratings and important
commercial ties with their suppliers - i.e., companies that
could easily procure bank financing. The Secretariat of
Finance and Public Credit sets regulatory policy and oversees
the National Securities and Banking Commission (CNBV),which
is the primary banking regulator. Mexico's central bank, the
Bank of Mexico (BOM),also has a regulatory role in addition
to setting monetary policy. The Institute for the Protection
of Bank Savings (IPAB) handles deposit insurance and is
charged with finishing the work of the former insurance and
bank rescue fund, FOBAPROA, which took over large portfolios
of bad loans from the 1995 banking crisis.

Recent reforms creating better regulation and supervision of
financial intermediaries and fostering greater competition
have helped strengthen the financial sector and capital
markets. These reforms, coupled with sound macroeconomic
fundamentals have created a positive environment for the
financial sector and capital markets, which have responded
accordingly.

The implementation of NAFTA opened the Mexican financial
services market to U.S. and Canadian firms. Banking
institutions from the U.S. and Canada have a strong market
presence, holding approximately 40 percent of banking assets
(as of June 2006). Under NAFTA's national treatment
guarantee, U.S. securities firms and investment funds, acting
through local subsidiaries, have the right to engage in the
full range of activities permitted in Mexico. Foreign
entities may freely invest in government securities. The
Foreign Investment Law establishes, as a general rule, that
foreign investors may hold 100 percent of the capital stock
of any Mexican corporation or partnership, except in those
few areas expressly subject to limitations under that law
(Table I). Regarding restricted activities, foreign investors
may also purchase non-voting shares through mutual funds,
trusts, offshore funds, and American Depository Receipts.
They also have the right to buy directly limited or
non-voting shares as well as free subscription shares, or "B"
shares, which carry voting rights. Foreigners may purchase an
interest in "A" shares, which are normally reserved for
Mexican citizens, through a neutral fund operated by a
Mexican Development Bank. Finally, state and local
governments, and other entities such as water district
authorities, now issue peso-denominated bonds to finance
infrastructure projects. These securities are rated by
international credit rating agencies. This market is growing
rapidly and represents an emerging opportunity for U.S.
investors.

Political Violence

Potential investors should not find political violence a
source of major concern. It generally takes the form of
small localized conflicts and inter-communal disputes and has
occurred mostly in limited regions of Mexico's southern

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states. Since the initial January 1994 uprising of the
Zapatista National Liberation Army (EZLN) in the state of
Chiapas, government forces and the EZLN have clashed only
once, although Chiapas has also experienced unrelated local
violence. The Popular Revolutionary Army (EPR) and the
Revolutionary Army of the People's Insurgency (ERPI) emerged
in June 1996 and June 1998, respectively. They have carried
out a number of small attacks, principally confined to the
state of Guerrero. On November 6, 2006, three bombs exploded
in Mexico City, one of which damaged a branch of Scotia Bank.
The perpetrators and the motive of the bombings are still
unknown although political factors are believed to be to
blame; no injuries were reported, although property damage
was reported at several of the targets.

The last half of 2006 saw intense protests in the state of
Oaxaca demanding, principally, the state governor's
resignation. The capital city of Oaxaca was under siege by
demonstrators for more than five months. Businesses -
particularly those in the tourist sector -- reported millions
of dollars in losses and many Western countries, including
the United States, issued travel warnings advising their
citizens to avoid the area. At least 11 civilian deaths,
including that of an American journalist, occurred as a
direct result of the violence in Oaxaca and hundreds more
were injured and/or arrested. State police forces were
accused of denying due process to protestors and using
excessive force to break-up the demonstrations. In response
to the escalating violence, President Fox, and later
President Calderon, sent the Federal Protective Police to
restore order. With the presence of federal troops, the city
has been fairly calm with only sporadic public marches. The
situation, however, remains delicate as the main demand of
the protestors, the governor's resignation, remains
unfulfilled.

Narcotics trafficking-related violence is prevalent along the
northern border region of Mexico and has shown signs of
spreading to other areas -- including the states of Guerrero
and Michoacan -- as the federal government has attempted to
crack down on the trade. The Government of Mexico, reported
mixed results in reducing crime in the border region as a
result of its "Operation Secure Mexico" program. During the
first month of his tenure, President Felipe Calderon
initiated "Operation Together Michoacan" and "Operation
Tijuana" sending 7,000 troops to combat drug related gangs in
the Michoacan state and additional troops to Baja California.
He is planning on sending troop to additional states in the
future.

The consulate in Tijuana has noticed that security concerns
have increasingly been an issue for companies looking to
invest in the Baja peninsula. The National Chamber of
Electronics in Baja California has called for a State plan
addressing security issues. Peaceful mass demonstrations are
common in the larger metropolitan areas such as Mexico City,
Guadalajara, and Monterrey.

Corruption

Corruption has been pervasive in almost all levels of Mexican
government and society. President Calderon has stated that
his government intends to continue the fight against
corruption and government agencies at the federal, state and
municipal levels are engaged in anti-corruption efforts. The
Secretariat of Public Administration has the lead on

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coordinating government anti-corruption policy.

Other government entities, such as the Supreme Audit Office
of the Federation (equivalent of the GAO),have been playing
a role in promoting sound financial management and
accountable and transparent government with limited success
as most Mexican external audit institutions (mostly at the
state level) lack the operational and budgetary independence
to protect their actions from the political interests of the
legislators they serve. Technical assistance is being
provided to them by USAID to promote the use of modern
auditing practices.

Mexico ratified the OECD convention on combating bribery in
May 1999. The Mexican Congress passed legislation
implementing the convention that same month. The legislation
includes provisions making it a criminal offense to bribe
foreign officials. A bribe to a foreign official cannot be
deducted from Mexican taxes. Mexico is also a party to the
OAS Convention against Corruption and is one of 13 countries

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that have signed and ratified the United Nations Convention
against Corruption.

The government has enacted strict laws attacking corruption
and bribery, with average penalties of five to ten years in
prison. A Federal Law for Transparency and Access to Public
Government Information Act, the country's first freedom of
information act, went into effect in June 2003 with the aim
of increasing government accountability. With USAID
assistance, 20 of Mexico's 31 states have replicated federal
efforts by passing similar freedom of information
legislation, the vast majority of which meets international
standards in this field. Three years after its passage,
transparency in public administration at the federal level
has noticeably improved, but access to information at the
state and local level has been slow.

Mexico is ranked 70th in international NGO Transparency
International's Corruption Perception Index for 2006, on par
with China, India, and Brazil. Local civil society
organizations focused on fighting corruption are still
developing in Mexico. The USAID-funded Project Atlatl has
worked to coordinate and promote anti-corruption activities
with Mexican civil society (www.atlatl.com.mx) and other key
players in the anticorruption arena, such as federal and
state audit institutions. The Mexican branch of Transparency
International also operates in Mexico. The best source of
Mexican government information on anti-corruption initiatives
is the Secretariat of Public Administration (www.sfp.gob.mx).

Bilateral Investment Agreements

NAFTA governs U.S. and Canadian investment in Mexico. In
addition to NAFTA, most of Mexico's ten other free trade
agreements (FTAs) cover investment protection, with a notable
exception being the Mexico-European Union FTA. The network of
Mexico's FTAs containing investment clauses encompasses the
countries of Bolivia, Chile, Costa Rica, Colombia, El
Salvador, Guatemala, Honduras, Japan, Nicaragua, and
Venezuela.

Mexico has enacted formal bilateral investment protection
agreements with 21 countries: 13 European Union Countries
(Austria, Belgium, Luxemburg, Czech Republic, Denmark,
Finland, France, Germany, Greece, Italy, Netherlands,
Portugal, Spain, Sweden),as well as Australia, Argentina,
Cuba, Iceland, Panama, South Korea, Switzerland, and Uruguay.
Agreements with Australia, Iceland and Panama were signed in
2005, but the Senate still has to ratify them. Mexico
continues to negotiate bilateral investment treaties with
China and India.

The United States and Mexico have a bilateral tax treaty to
avoid double taxation and prevent tax evasion. Important
provisions of the treaty establish ceilings for Mexican
withholding taxes on interest payments and U.S. withholding
taxes on dividend payments.

Mexico and the United States also have a tax information
exchange agreement to assist the two countries in enforcing
their tax laws. The Financial Information Exchange Agreement
(FIEA) was enacted in 1995, pursuant to the Mutual Legal
Assistance Treaty. The agreements cover information that may
affect the determination, assessment, and collection of
taxes, and investigation and prosecution of tax crimes. The
FIEA permits the exchange of information with respect to
large value or suspicious currency transactions to combat
illegal activities, particularly money laundering. Mexico is
a member of the financial action task force (FATF) of the
OECD and has made progress in strengthening its financial
system through specific anti-money-laundering legislation
enacted in 2000 and 2004.

OPIC and Other Investment Insurance Programs

In June 2003, Mexico and the U.S. Overseas Private Investment
Corporation (OPIC) signed an agreement that will enable OPIC
to offer all its programs and services in Mexico. The
Mexican Senate approved full OPIC operations in August of

2004. Since then, OPIC has aggressively pursued potential
investment projects in Mexico. OPIC increased its support
for U.S. investment in Mexico more than tenfold when it
approved 570 million USD in financing for new projects in
February of 2005.

OPIC-supported funds are among the largest providers of

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private equity capital to emerging markets. Since 1987, OPIC
has committed (as of FY 2005) over 2.6 billion USD in funding
to 32 private equity funds. The OPIC funds currently
investing in Mexico include Darby-BBVA Latin America Private
Equity Fund, LP with a primary focus on equity investments in
media and communications, transportation, consumer goods,
housing, energy, and non-bank financial services and Latin
Power III, L.P. focusing on equity investments in independent
power projects ("IPPs") in Latin America and the Caribbean
with a focus on renewable energy and Mexico.

Details of OPIC programs and recent investment project
announcements can be found at their website: www.opic.gov.

Mexico is not a member of the World Bank's Multilateral
Investment Guarantee Agency (MIGA),and has no plans to join.
According to the World Bank, the Secretariat of the Economy
provides the relevant services that MIGA would offer in
Mexico.

Labor

Mexico's Federal Labor Law, enacted in 1931 and revised in
1970, is based on article 123 of the Mexican constitution.
Under the law, Mexican workers enjoy the rights to associate,
collectively bargain, and strike. The law sets a standard
six-day workweek with one paid day off. For overtime, workers
must be paid twice their normal rate and three times the
hourly rate for overtime exceeding nine hours per week.
Employees are entitled to most holidays, paid vacation (after
one year of service),vacation bonuses, and an annual bonus
equivalent to at least two weeks pay. Companies are also
responsible for these additional costs. These costs usually
add about 30 to 35 percent to the average employees' salary.
Employers must also contribute a tax-deductible two percent
of each employee's salary into an individual retirement
account. Most employers are required to distribute ten
percent of their pre-tax profits for profit sharing. The
recently installed Labor Secretary has named labor reform as
one of the top issues he will address during the next
administration.

There is a large surplus of labor in the formal economy,
largely composed of low-skilled or unskilled workers. On the
other hand, there is a shortage of technically skilled
workers and engineers. Labor-management relations are uneven,
depending upon the unions holding contracts and the industry
concerned. Mexican manufacturing operations are experiencing
stiff wage competition from Central America, China, India,
and elsewhere in low technology work, such as textile and
garment manufacture.

For the past few years, strikes have been limited and usually
settled quickly. Strikes that are more difficult will
usually draw government mediators to help the settlement
process. Independent unions have been playing an
increasingly significant role, particularly since the
formation of the new Labor Federation (National Union of
Workers) in November 1997. Information on unions registered
with federal labor authorities is supposed to be available to
the public via Internet (www.stps.gob.mx),but this database
is incomplete.

Foreign-Trade Zones/Free Ports

In addition to the IMMEX programs that operate as quasi-free
trade zones, in 2002 Mexico approved the operation of more
traditional free trade zones (FTZ). Unlike the previous
"bonded" areas that only allowed for warehousing of product
for short periods, the new FTZ regime allows for
manufacturing, repair, distribution, and sale of merchandise.
There is no export requirement for companies operating within
the zone to avail themselves of tax benefits. Regulatory
guidance for the new regime is still being amended; therefore
investors should consult a tax lawyer for detailed
information. Most major ports in Mexico have bonded areas
("recinto fiscalizados") or customs agents ("recintos
fiscal") within them. There are currently two approved FTZ's,
both operating in San Luis Potosi. The first major plant in
the FTZ is currently under construction. Several states have
filed to convert their bonded areas into Free Trade Zones.

Foreign Direct Investment Statistics

Foreign Direct Investment in Mexico(USD Million)
2002 2003 2004 2005 2006*

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Total FDI Inflow: 19,344 15,348 22,283 18,934 14,112
-New Investments 11,385 6,012 13,328 9,463 5,106
-Earnings Reinvestment 2,440 2,067 2,330 3,460 3,048
-Inter-company 3,476 5,308 4,150 3,190 3,688
Investment
-Maquiladora Investment 2,044 1,961 2,475 2,821 2,274
in fixed assets

Foreign Direct Investment Realized in Mexico By Industry
Sector Destination (USD Million)
2002 2003 2004 2005 2006*
Inflow Total 19,344 15,348 22,283 18,934 10,864
Agriculture 93 11 16 3 2
Extractive 248 78 146 24 70
Manufacturing 8,647 6,685 12,694 11,363 7,092
Electricity and Water 398 323 202 192 (97)
Construction 348 83 385 277 125
Retail 1,778 1,394 1,183 2,648 208
Transport and 832 1,631 1,254 1,173 368
Communication
Financial Services 5,765 3,306 5,489 944 956
Others 1,237 1,838 913 2,311 2,141

Foreign Direct Investment Inflows Realized By Country/Economy
of Origin (USD Million)
2002 2003 2004 2005 2006* 5 year
Total Inflow 19,344 15,348 22,283 18,934 10,864 86,773
United States 12,970 9,630 8,188 9,685 6,683 47,156
Spain 735 1,776 7,418 1,396 609 11,934
Holland 1,475 553 3,322 2,213 973 8,536
United Kingdom 1,249 1,056 138 967 613 4,023
Canada 221 255 499 256 319 1,550
Switzerland 462 312 1,100 169 340 2,383
Germany 596 463 399 347 67 1,872
Japan 166 122 363 88 56 795
Denmark 208 54 116 89 145 612
Singapore 59 (6) 30 12 22 117
South Korea 32 37 35 49 20 173
Taiwan 17 10 8 7 9 51
China (2) 26 12 5 3 44
France 350 530 145 403 157 1,585

Notes FDI Investment Charts: 1) Sources: Inflow - Secretariat
of Economy, Director General of Foreign Investment 2) Period:
2006 data January through September 3) Data: Millions of U.S.
Dollars (USD),unless noted. 4) The Secretariat of Economy
has recalculated values for past years. All values for past
years are the most up to date data provided from the
Secretariat of Economy. 5) The total FDI inflow for 2006 by

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sector and country is less than the total FDI in Mexico
because it does not include an estimate that has been
reported in the total FDI.

FDI INFLOW AS PERCENT GDP
2002 2003 2004 2005 2006*
GDP 648,629 638,797 683,069 768,437 599,381
FDI Inflow 19,344 15,348 22,283 18,934 14,112
Percent GDP 3 2.4 3.3 2.5 2.4

Notes on "FDI as Percent GDP" chart: 1) GDP figures are taken
from United Nations website. All Mexican sources give GDP in
pesos only. Figures in millions of dollars 2) 2006 GDP is 3
quarter estimate using a 4 percent growth rate.

U.S. FDI Flow and Stock in Mexico (USD Millions)
2002 2003 2004 2005
U.S. FDI flow in Mexico 7,656 3,664 6,361 6,771
U.S. FDI Stock in Mexico 56,303 56,851 63,502 71,423

Notes U.S. FDI Flow and stock in Mexico chart: 1) Source:
U.S. Department of Commerce Bureau of Economic Analysis

Mexico FDI Flow and Stock in U.S. (USD Millions)
2002 2003 2004 2005
Mexico FDI Flow in U.S. 2,349 2,173 (363) 349
Mexico FDI Stock in U.S. 7,829 9,022 8,167 8,653

Notes U.S. FDI Flow and stock in Mexico chart: 1) Source:
U.S. Department of Commerce Bureau of Economic Analysis

In 2006 there were several large foreign investments in
Mexico by U.S. and other nations' companies, including:

1) Isolux Corsan (Spanish) invested USD 355 million to
construct a highway from Saltillo-Monterrey.

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2) Daimler Chrysler invested 1 billion USD to modernize its
plant in Toluca.
3) Ford invested 2 billion USD for equipment acquisition at
its Hermosillo plant.
4) BBVA invested 110 million USD in Mexico for technological
platform increases
5) Arcelor Mittal Steel invested 300 million USD in its
Mexican operations.
6) Jatco (Japan) invested 200 million USD to increase
production at its Aguascaliente plant
7) Mitsubishi Heavy Industries (Japan) announced a 600
million USD investment to construct an electricity generation
plan in Guerrero state.

Web Resources
Secretariat of the Economy: http://www.economia.gob.mx

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Department of State, Office of Legal Advisor:
http://www.state.gov/s/l/
Mexican Development Bank: http://www.nafin.gob.mx
Mexican Foreign Trade Bank: http://www.bancomext.gob.mx
Mexican Civil Society: http://www.atlatl.com.mx
Overseas Private Investment Corporation: http://www.opic.gov
Secretariat of Labor and Social Security:

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http://www.stps.gob.mx
United States Department of Commerce Bureau of Economic
Analysis:
http://www.bea.doc.gov/


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