SCENESETTER FOR THE VISIT OF USOAS AMBASSADOR AND

UNCLAS SECTION 01 OF 04 MEXICO 002890

SIPDIS

STATE PLEASE PASS TO USOAS (ASIERRA)

E.O. 12958: N/A
TAGS: ECON MX PGOV PREL OVIP MORALES HECTOR
SUBJECT: SCENESETTER FOR THE VISIT OF USOAS AMBASSADOR AND
SUMMIT COORDINATOR HECTOR MORALES TO MEXICO, SEPTEMBER 29-
OCTOBER 1, 2008


1. (U) My staff and I warmly welcome you and your colleague
to Mexico City and Monterrey. President Calderon recognizes
the broad-ranging challenges his country faces and has the
vision and political will to address them strategically. He
has demonstrated resolve in implementing his key policy
objectives: improving security and the rule of law, attacking
poverty, and creating jobs. The U.S. and Mexico have
developed a solid set of institutional relationships that
allow us to work productively on most of our priorities,
including fundamental issues of homeland security and North
American prosperity. Those links are set to expand. Your
visit is a sign of continuing U.S. support for the Calderon
government and dedication to this complex, interdependent
relationship.


Bilateral Relations and Hemispheric Integration
-------------- --


2. (U) Calderon has demonstrated pragmatism in his posture
toward the United States and is building on an already modern
and mature U.S.-Mexico relationship. The President's message
is that Mexico will seek what it needs from us on the basis
of equality, respect, and the close cooperation expected of
neighbors that share wide-ranging interests and challenges.
Our common border, responsible for extensive commercial,
community, and family ties, is transforming our societies
into two of the most deeply and broadly connected on earth.


3. (U) Calderon's top officials have been supportive of our
new ideas for hemispheric integration, the Pathways to
Prosperity, announced September 24th by President Bush in New
York. President Calderon participated in that meeting,
signed the communiquQ and the Mexican government has played a
constructive role behind the scenes in helping shape the
initiative. Nevertheless they are anxious to see how this
new initiative might fare in a new Administration, as well as
how it would fit in with others, such as SOA, the FTAA and
such Latin American initiatives such as the Pacific Arc
Forum. Calderon is eager to deepen commercial integration
with the United States and the rest of the region, and is
likely to support any forum that promotes economic
development and broadening the benefits of free trade
agreements.

Security
--------------


4. (U) There is increasing public concern over the rise in
violence in Mexico. On August 30, more than 100,000 Mexicans
marched peacefully throughout the country to demand
government action against kidnappings and killings. The
Calderon administration has moved forcefully to improve
public security, significantly increasing the security
budget; launching surge operations against drug traffickers
in ten of the most conflictive states; engaging the military
in a significant way; working to overhaul Mexico's national
police organization; getting the Congress to pass a major
criminal justice reform; and authorizing the extradition to
the United States of a record number of wanted criminals,
including drug king-pins. The President's actions reflect his
commitment to intensify security-related cooperation with the
U.S., and his willingness to incur political risk in doing
so. On June 30, President Bush signed the Merida Initiative,
a 450 million USD package that provides funding for technical
assistance and equi
pment for Mexico to use in their fight against
narco-trafficking. This assistance is a key example of our
cooperation in the counter narcotics arena.

Strong Leader in a Conflictive Environment
--------------


5. (U) President Felipe Calderon is showing strong
leadership at home and abroad in a manner much appreciated by
Mexicans. Although he won election with a bare 36% plurality
in a three-way race, an opinion poll published Sept. 1 in the
major daily Reforma showed that 62% of Mexicans approve of
his performance to date. Nevertheless, the political climate
overall remains conflictive, with a congress closely divided
between the president's right-of-center National Action Party
(PAN),the leftist Democratic Revolutionary Party (PRD) and
the left-of-center Institutional Revolutionary Party (PRI).
Calderon faces significant domestic challenges in pursuing
his security, economic and social reform agendas. At the
same time, he must chip away at the historic Mexican
ambivalence toward the U.S. that has slowed progress on many

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common fronts, including security. Because of this divided
political environment, it is difficult to predict the results
of the mid-term Congressional elections to be held in July

2009. PRD' s fortunes seem to be waning and good showings by PRI
candidates in state and local elections over the past year
may be a harbinger of strong gains in next year's mid-term
elections.

Stable but Vulnerable Economy
--------------


6. (U) U.S. strategic interests in Mexico are tied to three
key economic factors: (1) a population of 110 million
bordering the United States with a poverty rate over 40
percent, (2) the second largest supplier of oil to the U.S.
in 2007 (though so far this year it has slipped to third
behind Canada and Saudi Arabia),(3) over one billion dollars
a day in two-way trade in goods and services, with a highly
integrated production cycle between factories in the U.S.,
Mexico and Canada.

Poverty and Economic Performance
--------------


7. (U) Mexico has the highest income inequality of any
nation in the OECD. The latest Mexican government figures,
(from 2006) show the poverty rate declined slightly to 42.6
percent overall, with 10.3 percent living in "food-based
poverty," unable to meet the nutritional needs of their
families. Widespread poverty encourages illegal immigration,
narcotics smuggling to the United States, and other forms of
illicit commerce. Growing income inequality fuels the
tensions that almost resulted in the election of a populist
President, Andres Manuel Lopez Obrador, who openly embraced
President Chavez of Venezuela.


8. (U) President Calderon inherited a stable, growing economy
tightly linked to U.S. economic cycles. Mexico chalked up an
estimated 3.3 percent growth rate in 2007, rebounding from
near zero growth in the first years of the decade. Real GDP
growth is expected to slow to around 2.6 percent this year,
primarily due to the U.S. economic slowdown. Inflation,
fueled by spiking international food and energy prices, has
risen in recent months to over 5 percent, prompting the
Central Bank to raise interest rates
in June 2008, shortly after the government had reduced import
tariffs for key food items, increased subsidies for poor
consumers, and obtained voluntary price controls from
producers. Most jobs currently being created in Mexico are
in the informal economy, which the World Bank estimates
employs 27-45 percent of the working age population. Many
here are growing concerned about Mexico's ability to compete
in an increasingly globalized world, as it loses market share
to China and other emerging economies. In his second State
of the Union Address, issued on August 27, Calderon claimed
that 800,000 formal jobs have been created in Mexico. Mexico
has achieved a 3 percent GDP growth, not bad for a global
environment characterized by recession and high inflation,
but still insufficient to progress. Calderon highlighted that
Mexico, except Canada, had the lowest inflation in America.

Need for Bolder Economic reform
--------------


9. (U) World Bank, OECD, Mexican and other economists say
Mexico would need sustained, long-term growth rates of at
least six percent to alleviate widespread poverty -- but
cannot achieve that level of growth without structural
economic reform beyond what President Calderon has currently
proposed. We agree with Finance Minister Agustin Carstens
that in order to compete internationally and develop the
poorest parts of Mexico, Mexico needs broad reform to improve
tax collection, reduce reliance on oil income, confront
growing pension liabilities and payments on government
borrowing outside the federal budget, and provide needed
spending on poverty alleviation, education, health and
infrastructure. Mexico desperately needs education reform,
since currently 60 percent of its people do not graduate high
school. In order to achieve sustained robust growth, Mexico
must improve competition in an economy long dominated by
business monopolies and oligopolies, and to take on powerful
labor unions (including the natio
nal teachers union) in order to amend labor laws that
discourage job creation in the formal economy.


10. (U) While President Calderon has achieved more reform in
his first two years in office than his predecessor did in six

MEXICO 00002890 003 OF 004


years, the lack of a majority in Congress has forced him to
compromise with the special interests that have long slowed
progress in Mexico's economy. While the President's skill at
pragmatic political negotiation has led to a series of
successful economic reforms, it has also meant the reforms
were watered down and are not yet sufficient to place Mexico
on a sustained growth path sufficient to alleviate widespread
poverty. Reforms to date include a tax reform that solved
about one-third of the need for additional collections, and a
pension reform that combined with that of his predecessor
solved about 80 percent of the insolvency crisis in Mexico's
pension systems.


11. (U) To overcome a key barrier to economic growth,
President Calderon has announced a National Infrastructure
Plan, under which his government would spend five percent of
GDP for the next five years to improve Mexico's
long-neglected infrastructure. The President recently joined
with the leader of the national teachers union to announce a
program to improve primary education, although many are
skeptical that the union will allow real reform. On August
6, Calderon named his pro-business former chief of staff,
Gerardo Ruiz Mateos, to be the new Secretary of the Economy
to aid him in the battles against rising inflation, falling
remittances, and the informal sector. While Calderon's
government has taken incremental steps to reduce the market
dominance of monopolists and oligopolists in key sectors like
telecommunications and banking, Congress has blocked serious
reform. Currently, Mexico is in the midst of a heated debate
over the President's rather modest energy reform proposal
(see below).

Actively Seeking to Expand Trade and Investment
-------------- --

12. (U) President Calderon has made increased international
trade and investment a cornerstone of his presidency. In
June 2007, he created ProMexico, a federal entity charged
with promoting Mexican exports around the world and
attracting foreign direct investment to Mexico. He has also
worked to strengthen economic relations with European and
Asian countries in order to lessen Mexico's dependence on the
U.S. economy. Last year, Mexico's FDI inflows reached a
record 23 billion USD while at the same time the percentage
of such inflows originating in the U.S. decreased to 47.3
percent, only the second time since NAFTA implementation that
the U.S. has accounted for less than half of Mexico's FDI.
Mexico has also seen its percentage of exports to the U.S.
decrease from 87 percent in 2004
to 82 percent in 2007. As the U.S.'s economic slowdown
continues, Mexico will expand efforts to diversify away from
a U.S. centered economy.


13. (U) That said, Calderon is eager to deepen commercial
integration with the United States and the rest of the
region, something his government views as essential to
strengthening competitiveness vis-a-vis competitors,
especially from Asia. In March, Calderon stated that Mexico
was ready to talk to Panama about restarting stalled
discussions on a free trade deal. Discussions over a
Mexico-Peru FTA have entered the final round. Mexico sees
the August 15 entry into force of the CAFTA-DR textile
accumulation provisions as a model for linking together the
free trade agreements among common partners in the
Hemisphere, and is working with like-minded Latin countries
in the Pacific Arc Forum to harmonize rules of origin among
common free trade partners.

Energy
--------------


14. (U) After Canada, Mexico was the largest source of U.S.
oil imports last year. We therefore have a strong strategic
interest in continued stable supplies of Mexican oil. Within
Mexico, energy is an extremely sensitive topic tied to
national sovereignty, but the energy sector requires
difficult reforms urgently. Mexico's oil production and
reserves continue to decline due to a lack of investment in
oil exploration and production. Sufficient investment funds
are not available because of the constitutional prohibition
on private investment and the fact that most of Pemex's
revenue goes to pay for as much as 38% of the government's
budget. Pemex's liabilities have grown so large that it can
no longer fund investment in exploration through borrowing in
international markets. President Calderon understands that
declining oil production can only be addressed through fiscal
reform to reduce the amount of Pemex revenue sucked into the
government budget, and through energy reform to improve the

MEXICO 00002890 004 OF 004


efficiency of Pemex operations and allow for private and foreign
investment in the petroleum sector.


15. (U) A comprehensive tax reform package was passed last
year and there is currently a mild energy reform package
being heatedly debated in the Mexican Congress as well as in
the court of public opinion. Initial indications are that
some type of energy reform is likely to pass and could
provide some additional flexibility for PEMEX and pave the
way for further reform. Analysts anticipate an intense month
plus of congressional discussions which could lead to a
consensus package being passed by early October. (The
Mexican Constitution requires that the federal revenue and
appropriations bills be approved at the end of October and
mid-November respectively, and both of these will be heavily
impacted by any reform to PEMEX.) While the package that the
Calderon administration submitted to Congress would not open
Pemex up to the level of investment that it sorely needs, it
seems to be a small but important step toward the large task
of reforming Pemex. While polls indicate that most Mexicans
now understand som
ething needs to be done with PEMEX, unions and opposition
parties reflect the views of many Mexicans who are skeptical
of foreign involvement. Even seemingly benign, factual
statements by U.S. officials about Mexico's petroleum sector,
such as those made by President Bush in March 2007 or former
Fed Chairman Greenspan several months later set off a tempest
of responses and front page condemnations, including from
officials largely supportive of opening the sector.
Visit Mexico City's Classified Web Site at
http://www.state.sgov.gov/p/wha/mexicocity and the North American
Partnership Blog at http://www.intelink.gov/communities/state/nap /
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