Sheinbaum’s First Challenge: Fiscal Consolidation

Delia Paredes & Genevieve Signoret

(Hay una versión en español de este artículo aquí.)

One strong headwind facing the Mexican economy in the short run is a planned deficit reduction. The deficit widened to 5.1% in June 2024 from last year’s 4.3% and is projected to close 2024 at 5.9%. The proposal is to narrow it to 3.0% all at once in 2025. This could trigger a recession.

The current plan is not viable

The fiscal deficit has two components: income (tax revenue) and expenditure. Sound fiscal strategy requires looking at both.

The incoming government has mentioned plans to cut infrastructure spending (once AMLO’s flagship projects are complete), lower interest costs, and reduce budgeted spending. According to a report by the Center for Economic and Budgetary Research (Centro de Investigación Económica y Presupuestaria, CIEP), the size of such an adjustment would exceed that which was carried out in 1995 during the Tequila Crisis.

The government’s proposed spending cut for 2025 implies a drastic cut in capital spending

Public finance estimates in Pre-Criterios (% of GDP)

Source: CIEP, Pre-Criterios 2025.

Nearly two-thirds of net government spending, which today contributes about 27% of GDP, is already earmarked for interest on debt, “participations”[1], pensions, and outlays for Pemex and CFE. The rest goes to investment, education, health, and personal services[2], items hard to cut given that doing so risks incurring welfare costs and delaying public works.

On the revenue side, the president-elect does plan to strengthen tax collection but has ruled out enacting any major tax reform during her term.

The CIEP points out that there’s room to increase tax collections, which, they estimate, fall short of their potential. Both consumption and income tax collections, they conclude, have room for efficiency gains. For example, they estimate the effective Value Added Tax rate to be 5.9% when it should be 16%. Of course, any improvement in collection efficiency would require shrinking the relative size of the informal economy.

We deem the government’s plan to slash the deficit by nearly half all at once to be neither realistic nor desirable. It fails to consider the fiscal support Pemex will require and the fact that it’s based on a GDP growth projection (2.5%) far higher than that of the market consensus (1.6%).

Here’s what you should watch for

Watch for November 15, when the incoming government will present its budget proposal. If it entails gradual, viable, credible deficit reduction and a coherent plan for Pemex support, then its impact on near-term growth will be limited. If, by contrast, it calls for abrupt deficit reduction, it will hurt prospects for growth by eroding policy credibility, heightening uncertainty and market volatility both.

 
TransEconomics delivers serenity to high–net-worth families and individuals. To learn more, request an appointment with an advisor.

[1] Federal government revenue transfers to state and local governments.

[2] Resources allocated to the payment of salaries, wages, benefits and other compensation of personnel working for the public sector.