GLG News by Jose Trevino

Implications: For Mexico, the election of Mr. Obama might imply a possible renegotiation of the labour and environmental chapters of NAFTA, and a reduction of the trade agenda. It would lead to adopt more strict environmental and labour disciplines and increase the possibilities that trade sanctions may be adopted as a result of non compliance with labour or environmental legislation. This would affect public and private interests in the three countries involved and have an important impact because close to 84 per cent of exports go to the U.S.

Analysis: Most Mexicans, together with a majority of worldwide opinion, favored Mr. Obama. Now that he has been elected, their views about the possible impacts of this event on U.S.-Mexico relations are divided.

Some analysts are particularly concerned about Mr. Obama’s promise of a departure from the Bush administration policy of pursuing free trade agreements, vowing instead to seek protections for workers and the environment in existing and new pacts. He said he would ask Mexico and Canada to renegotiate the North American Free Trade Agreement to include such provisions.

“We should use the hammer of a potential opt-out from Nafta as leverage to ensure that we actually get labor and environmental standards that are enforced'', he said in February during the primary race for the nomination.

There is also the risk of reopening other chapters and, above all, that the balance that resulted from the negotiation held 17 years agomay be broken. Another risk is that Mexico and Canada request changes in other areas in exchange for accepting Mr. Obama´s request. For Mexico, a possible renegotiation of NAFTA is relevant because close to 84 per cent of its exports go to the U.S.

Even though, Mr. Obama toned down his criticism of free trade in the last part of his campaign, his hand may be forced on the issue by powerful groups within his party, particularly labor unions and environmental groups. In this regard, Mr. Obama’s push for new conditions in trade deals “would invite retaliation” and could further reduce a bilateral trade which is already declining as a result of the financial crisis.

Another important issue pending resolution is the opening of the border for trucks from both countries. It is likely that the teamsters, who have always opposed this opening, receive full support from a new Democratic administration, thus impeding a solution favorable for Mexico.

This is particularly worrisome in light of the apparent lack of any visible rapprochement of the Mexican government toward Mr. Obama and a defined agenda to deal with the new administration. While Mr. Obama has never been to Latin America, during the campaign only Mr. McCain came to Mexico briefly and was better known and appreciated for his support of an immigration reform.

Some public figures in Mexico are now pressing to seek a prompt remedy setting up an encounter between Mr. Obama and President Calderon before the inauguration takes place in January. Other pending ones include the handling of the financial crisis and the war on drugs. Mexico is already benefiting from the currency swap agreement with the Federal Reserve as well as from the assistance derived from the Merida Initiative to combat drug violence.

Hopefully, a new window of opportunity to face the issues on the bilateral agenda has now been opened. As a former Mexican Secretary of Foreign Relations has said, “it will be easier for Mexico to be the neighbor, partner and friend of the United States”.

Implications: To Shiller's advices, one may add the following which are particularly relevant for Mexico and other emerging economies: convince better, avoid a "state of denial", learn the lesson from others and act now.

Analysis: The merit of this article is that it goes against the increasing belief that we are seeing the end of the capitalist system. More and more people are talking about the shift of financial decision power from the west to the east. But this is by no means certain and will not happen overnight. What is for sure is that the capitalist system as it exists today will undergo a massive transformation with more intervention from the state and regulation.  

Another no less important merit of the article is that it looks to the future. Japan wasted a lot of time in the nineties trying to understand why the crisis had emerged and who was to blame. At this point, it is much more helpful to prevent an aggravation of the crisis to seek solutions and deal with the explanations later.  

To the advices given, I would add the following:  

Convince better. Paulson and Bernanke did a fine job in presenting the implications of the crisis for Wall Street but did a very poor job in convincing Main Street or Global Street. Much more information about how the common people will be affected is needed. This will undoubtedly help in “selling” the bailout package. For this purpose, maybe Paulson is not the best messenger, given his background as Wall Street tycoon.  

Avoid a “state of denial”. We have numerous evidences that this is not only a U.S. crisis or a European crisis. The sooner emerging economies recognize the gravity and reach of the crisis and start taking action the better. This implies revising fiscal and monetary policies and supporting future growth to a larger extent on domestic demand.  

Learn the lesson from others. Although Mexico lags way behind the U.S. in the use of crazy financing schemes of the housing sector through derivatives, it did set up schemes such as SOFOLES which are starting to get into trouble because the way they are structured and because potential buyers of the securities are scared. How are the issuers going to deal with this refusal? What viable financing alternatives are there? Do Mexican banking institutions have also “toxic illiquid assets” in their balance sheets? Do they also need some sort of bailout or rescue?  

The time to act is now. The announcement today that the Irish government has placed an unlimited guarantee on all deposits and some debt in six Irish banks to “safeguard the Irish financial system”, and the possible guarantee of all deposits in U.K banks by the British government, is an outstanding signal of the need to take preemptive, and not only remedy actions.  

In a past presidential campaign the motto was “it’s the economy, stupid”. Now, some say that the motto should be “it’s the mortgage, stupid”.  

I rather think it is “we are all in the same boat, stupid”.  

Implications: According to the most optimistic scenarios, if the price of cell phones keeps falling, the earnings of mobile TV in the Mexican market will reach 18 percent of the total in Latin America, that is around 300 million dollars within five years.

Analysis: Mexico is becoming an interesting potential market for the mobile TV service through the cellular phone. According to an analysis of The Competitive Intelligence Unit, there are estimates that point to the more than 70 million users of mobile phones in Mexico, of which 7.25 could access this technology given the equipment that they currently own. Out of this number, 2.5 million could be interested in paying for the service.  

Currently, only two companies in Mexico offer mobile TV services to their clients: Telcel and IUSACELL. But it is likely than in the upcoming auction of frequencies issued by COFETEL, the Federal Telecom Commission, other firms such as TELEFONICA will look for a concession to be able to offer this service also.  

In Mexico there are more than 40,000 users of mobile TV. IUSACELL was the first company to introduce the service in Mexico and currently has largest number of clients due to its 3G CDMA technology. Recently, TELMEX also entered the market.   It is estimated that Mexico has around 29 million TV viewers that have access to some sort of pay TV service. Mexicans spend an average of 5 percent of their income in telecom services.  

Mexico already has the equipment, the networks and the contents. What is missing is the consolidation of elements to be able to make a wider offer of mobile TV services. Companies in the field are expecting that the regulatory authorities set aside spectrum to increase the supply of multimedia services and support a neutral technology that allow operators to choose the model that best suits their interests.  

Also, it would be important to deal with the pricing issue. One of the main barriers to the penetration on mobile TV in Mexico is the cost of the service and the equipment. Firms will have to undertake aggressive marketing campaigns and offer attractive programming to the users. The production of more contents that are specifically designed for the cellular phone is needed.  

Implications: A decisive measure to boost competition in the telecoms industry and lower phone rates, portability started to be implemented last July 5 in 40 of the largest Mexican cities. Amid technical problems, only six out of 22 operators involved in the portability program have been able to complete 100 per cent of calls.  Reluctantly, Telmex and Telcel agreed to participate in exchange for being allowed to provide TV services.

Analysis: Last July 12, Mexico became the first country in Latin America to deploy number portability for fixed and mobile lines. Subscribers are now able to change operator while maintaining the same phone number.

The Convergence Agreement, launched in October 2006 to boost competition in the telecoms industry, included three conditions to allow Telmex to provide TV services: interconnection, interoperability among networks and number portability. The former two conditions are already in place and now it is the turn of portability. At the outset, Telmex fiercely resisted it but ended up embracing the plan and its network was the best prepared to initiate the program.

Some analysts forecast that in the next months portability may cause phone rates to decline up to 30 per cent. Currently, Telmex controls 90 percent of the country's land lines. Telmex faces competition from Axtel SAB, as well as cable companies that sell phone service. Telcel controls three-quarters of the Mexican mobile-phone market. Competitors include Grupo Iusacell and Spain's Telefonica. In all, 22 operators participate in the program.

In March 2008, COFETEL awarded the country's number portability clearinghouse contract to Telcordia. This company will serve as a central number repository and a central point to process number porting transactions for 13.62 pesos (US$1.26) per port. Telcordia selected Neoris, a global business and IT consulting company, as its partner for the nationwide implementation.

Portability has involved three major adjustments: 1) Changes of network and systems. Telcel, for example, invested US$45m in technical and operational adjustments to its platform; 2) Pilot tests. All operators had to perform interconnection tests with the central data base administration system and other operators; and 3) Regulation. COFETEL set up a Technical Committee for Number Portability starting on July 5. Since then, this Committee has been in permanent session.

What are the results so far? In a press release dated July 14, Telcordia said that “the solution was successfully deployed”. However, the implementation has caused numerous technical problems. Only Telmex, Telcel, Cablecom, Cablemas Opcom, Iusacell, and Marcatel were able to complete 100% of calls. In a couple of weeks we will be able to have a more complete view of the results and to make a more balanced assessment of the kind of problems occured.

What impact will portability have on Telmex and Telcel? The measure is expected to weaken the market power of Telmex and Telcel because it is highly likely that they will end up being net donors, at least in the first 12 months after portability implementation. Already, Canitec (the chamber of cable companies) has accused both companies of obstructing the new regulation by attempting to complicate the procedure consumers would have to use to change companies.

In the meantime, Telmex continues to argue that it has been forced to comply with certain requirements before offering TV services whereby cable operators can participate in telecoms immediately. It contends that cable firms are now allowed to cherry-pick Telmex's high-income customers in urban markets without being required to offer telephone services to low-income consumers or invest in rural areas, as it has been forced to do. The company accuses COFETEL of being "anti-consumer" and protecting "monopolistic" cable companies.

Implications: Few sectors better show the struggles and dilemmas in the Mexican competitiveness arena than the telecom industry. There coexist monopolistic structures with the lack of reforms, both viewed as main hurdles to boosting world-class competition. Following is a summary of the highlights of the half-day conference held on October 29 to honor the Day of Competition, where the antitrust commission, Comisión Federal de Competencia (CFC), announced the upcoming investigation on Telmex/AMX dominance.

Analysis: A common view between the World Bank or OECD and think-tanks like the Mexican Institute for Competitiveness (IMCO) is that the Mexican economy grows, but not at the pace it should. In some industries there are encouraging signs of increasing competition, but still not the competition in strategic sectors nor the competition levels that are required to attract and retain greater amounts of investment.

Few sectors better show the struggles and dilemmas in the Mexican competitiveness arena than the telecom industry. There coexist monopolistic structures with the lack of reforms, both viewed as main hurdles to boosting world-class competition.

This was one of prevalent perceptions in the half-day conference held on October 29 to honor the Day of Competition, an event sponsored by the antitrust commission, Comisión Federal de Competencia (CFC).

CFC clearly achieved its goal of facilitating an intense and participative debate among the players of the telecom industry. There was a positive note with regard to the imminent availability of a large alternative network to Telmex’s relevant network. The Mexican utility, Comisión Federal de Electricidad (CFE), announced that on November 5 it will sign the first contracts as carrier’s carrier for the use of its 20,000 kilometers of fiber optic by long distance operators (Telmex has 22,000 kms.). This will function as a trunk network connecting cities. Over time, CFE will also be able to provide telecom operators with a secondary network by using its power distribution network all over the territory – a huge network to be added to the significant capacity which is currently available.

The conference was partly devoted to airing proposals to strengthen competition – such as liberating fixed telephony to foreign investment and allowing for the establishment of a third large TV channel – but also served well to the exchange of recriminations.

The Spanish company Telefónica Movistar denounced Telmex for denying in practice to grant interconnection, as it was requested 18 months ago. Telmex responded accusing Telefonica of violating the Foreign Investment Law by having an overwhelming share majority of 97.7 per cent in GTM (Grupo de Telecomunicación Mexicana), clearly exceeding the 49 per cent permitted. Cablevisión, the largest TV cable company, and Canitec, the chamber of cable companies, joined Telefónica in denouncing the violation of their right to interconnection.

But it was a brief statement what grabed the attention of participants and the media. The head of CFC, Eduardo Pérez, describing the commission’s policies and actions to foster competition, mentioned the establishment of asymmetric regulations for dominant players. Responding to a question from the audience, he said that within three weeks the CFC will initiate an investigation of dominance against Telmex and AMX. This assertion came as a confirmation of a previous announcement made on July by Mr. Pérez, in the sense that CFC was preparing to launch such an action, sending tremors along the industry and knocking down the shares of those companies in the market.

Whether this investigation by CFC will be well constructed and thus successful is another story. But with the mother of all battles looming on the horizon, it seems that the war for competition in the telecom industry is a more serious matter.

Implications: The implementation of the fiscal reform will not be an easy task. As it happened with previous changes to the tax law, experts say that many companies are now preparing a multitude of requests for constitutional relief (“amparos”) against one or more provisions of the new law.          

Analysis:

The fiscal reform which was approved last September is expected to increase the Mexican government's (non-oil) tax revenue from 10% of GDP to 12% by 2012, bringing in an extra $10.3 billion in 2008. It will close the gap of the traditional evasion of income tax by companies, reduce dependence on Pemex’s oil revenue and boost public investment by 50%.

However, its implementation will not be an easy task. As it happened with previous changes to the tax law, experts say that many companies are now preparing a multitude of requests for constitutional relief (“amparos”) against one or more provisions of the new law. In the past, tax lawyers and accountants had a handful of lawsuit “models” that could easily be applied when needed.

This time though, the “amparos” will not be presented against the new Single Rate Tax Law (IETU) as a whole because not all taxpayers are equally affected. Fiscal lawyers and auditing firms will have to work on a case by case basis, and the plaintiffs will opt for a “menu a la carte” of possible complaints.

Following are some contentious aspects of the new IETU tax law that have been raised by tax experts:

·        Dissallowance of fringe benefits and interest payments as deductions from the IETU.

·        Dissallowance of a deduction for royalties. According to tax experts, there is no justification for forbidding the deduction of royalties between related parties because they represent indispensable expenditures for earning the revenues (object of the tax).

·        Different treatment for investments. For investments pending to be amortized and acquired between January 1, 1998, and December 31, 2007, the taxpayers are granted a 50% credit under the IETU. For investments between September 1, 2007 and December 31, 2007, 100% of these investments may be credited. This different treatment is unjustifiable since both cases refer to investments that foster company production. Consequently, the tax equity principle is violated.

·        IETU tax. The rates that will be applied in the next three years (16.5% in 2008, 17% in 2009, and 17.5% in 2010) do not guarantee the proportionality of the tax.

When considering that the IETU is a new tax, Mexican courts do not have jurisprudence on which to base their rulings. An amparo should be requested within 30 days after the entry into force of the IETU Law, on January 1, 2008, or within 30 days after the submission of the first provisional payment of the tax.

Tax experts anticipate that a good number of amparos will be granted because the fiscal reform creates tax inequalities and violates the principles of proportionality and judicial certainty.

Implications: See details of the proposal issued on October 1 by the Mexican antitrust commission to improve competitivenes in the Mexico City and four surrounding cities' airports, including the sale of government holdings. 

Analysis: After a thorough analysis that lasted for more than a year, on October 1 the Mexican antitrust commission (Cofeco) issued an opinion on airport competition.

For Mexico to compete successfully in air transportation, the first and foremost condition is to have competitive airports. Its inefficient regulations in airport operation translate into higher airport tariffs, to the detriment of users who pay them as part of the cost of airfares. Prices of airport services are also high. In a list of the 50 most expensive international airports, the Guadalajara, Cancun and Monterrey airports, rank on 11th place, while the Mexico City airport occupies the 19th place.

To improve competitiveness, the antitrust commission, Cofeco, asks for the sale of state holdings in the International Airport of Mexico City and in four airports of surrounding cities. It also recommends the opening of fuel distribution to private companies to promote competition and help reduce airfares.

Other recommendations included in Cofeco’s opinion are:

1.To promote competition between nearby airports. Some regions in Mexico have the market potential to make more than one airport viable. Cofeco wants these airports to compete against each other, so that airlines and consumers can choose the best option in terms of quality and price. The agency seeks to have a say on new airport permits to ensure competition in areas that may be served by more than one airport.

2.To improve tariff regulation. Airport tariffs are set by the federal government based on a formula included in the airport concession titles. For existing airports, Cofeco proposes to give this task to an independent regulator who would apply the existing formula with the intent of reducing tariffs to the extent possible. For any new airport, it recommends to set a tariff based on the lowest price for the user and the tax goal of the government.

3.To increase competition in airport services. Users should have access to the largest number of options both in terms of airlines and providers of other services. Also, revenue obtained by airport operators from restaurants and other retail businesses would be included when considering the fees they can charge airlines and passengers.

The assignment of landing and take-off slots is an essential element of access of airlines to airports. The existing mechanism of slot auction in saturated airports should be more efficient in order to guarantee that all airlines have access to these airports in competitive conditions. In the case of land transportation service to and from airports, Cofeco wants to open this service to local permit holders of public transportation, guaranteeing the necessary safety measures.

If applied, these proposals can have far reaching consequences for airport operators as they will reduce the amount they can charge for services. Mexican airport companies such as Grupo Aeroportuario del Sureste SAB operate 34 facilities in the country. Local and federal governments control the remaining airports. Also, opening fuel distribution to competition would reduce prices and prevent practices that discriminate against some airlines.

It is clear that regulators are looking to set better conditions of price and quality at airports, in favor of users of air transportation. But it is still unclear whether Congress and the federal government will incorporate Cofeco’s proposals in the law and the regulation that rule this important sector.

Implications: The recent approval of fiscal and electoral reforms in Mexico has aroused mixed reactions. Those who applaud them – like rating agency Fitch - consider that they augur well for the future of the country. Mexico has overcome the legislative gridlock that kept the Fox administration paralyzed, positioning President Calderon as a successful dealmaker. Most importantly, the reforms pave the way forward for more urgent structural reforms, particularly energy, justice and labor.

Analysis: The tax reform will increase the government's (non-oil) tax take from 10% of GDP to 12% by 2012, bringing in an extra $10.3 billion next year, according to Agustin Carstens, the finance minister. It will close the gap of the traditional evasion of income tax by companies, reduce dependence on Pemex’s oil revenue and boost public investment by 50%.

However, important issues remain unclear. The American Chamber of Commerce in Mexico and other business associations keep warning that there is still no agreement with the US government to allow companies doing business in Mexico to deduct the new flat tax (IETU) that they will be forced to pay in Mexico and avoid double taxation.

The electoral reform, through constitutional amendments, will curve the exorbitant cost of Mexican politics. It cuts by half the length of presidential campaigns, gives the Federal Electoral Institute (IFE) power to regulate party primaries, reduces public funding to political parties and bans all political advertising in electronic media except the one handled by the IFE through official time slots.

Many analysts and organizations have denounced the replacement of the institute's president and five others among its nine directors, well before their term expires, as an act of political revenge for the way IFE participated in 2006 election and as an infringement of the institute's autonomy.

The banning of political advertising was received with a vociferous opposition by the TV companies and the broadcasting industry, one of the most powerful lobbies in Mexico. In 2006, Televisa received 70 MM dollars for political ads, 2.6 percent of the total sales of the company, during the most expensive presidential campaign in Mexico’s history.

In an aggressive reaction, Televisa compared the actions of the Mexican government to those taken in Venezuela when Chavez cancelled the Radio Caracas Television concession. We are not yet there, the company stated, but the measures adopted are an unacceptable attack on free speech. “We are worried by the threat that if somebody violates the new law, it will be taken off the air”, said Televisa’s head, Mr Emilio Azcarraga in Miami last week.

To complicate matters further for incumbent TV giants, some congressmen are openly speaking of the need to end the TV duopoly Televisa-TV Azteca by allowing more concessionaires into the Mexican market.

There are more battles ahead for Televisa and TV Azteca in light of the upcoming discussion in Congress of the Radio and TV Law. The approval of this bill a few months before the 2006 elections raised suspicions of hidden arrangements between the government and the TV companies. In May 2007, the Supreme Court declared unconstitutional several provisions of the law in connection with the duration of concessions, appointment of the regulators and award of the spectrum without payment to the state.

An overwhelming revision by Congress of these and other changes will probably add fuel to the fire already ignited by the electoral reform. It remains to be seen who will be the final beneficiaries of the realignment of forces in the TV sector, and at the cost of whom.

Implications: Mexico is a late player in the online gambling business, but the passing of regulation on this matter paves the way for a growing and lucrative business. Thus, it looks as quite a safe bet.

Analysis: Concerned about the rapid rise of internet gaming, the U.S. Congress passed the Unlawful Internet Gambling Enforcement Act (UIGEA) in 2006. The law prevents credit-card companies from collecting payments for online bets.

Critics of this legislation have said that the U.S. government's fight to rein in internet gaming is doomed to fail, among other reasons, because by nature, the internet transcends geographical boundaries and renders the idea of physical jurisdiction obsolete. Another and not less important reason is that the regulation on online gaming in other parts of the world is much more liberal than in the U.S. Mexico is a case in point.

Mexico has an old Federal Gaming and Raffles Law than was issued back in 1947. It was not until 2004 that a gaming law Regulation was published. Based on this legislation, the Mexican government awarded around 200 permits in 2006, most of them to Apuestas Internacionales, a subsidiary of the TV giant Televisa.

The opposition parties PRI and PRD disputed the award before the Supreme Court on the basis that the said Regulatory Law was unconstitutional. On January 2007, the Supreme Court ratified the constitutionality of the regulation. “It is preferable” to have gaming sites regulated and supervised by the Ministry of the Interior, than to have other betting mechanisms over which there is no control, the Court stated.

Televisa went full speed ahead with its gaming business. Investment banks have estimated the company could generate revenues of around $200 million from the games this year and more than double that amount in 2008. The company had total revenue of around $3.45 billion in 2006. It has 25-year permits to operate 65 “centers for remote betting” (CARs), six of which are already in operation.

It is estimated that the Mexican gaming market may be worth some US$4.6 billion – equal to the country's media advertising market -. Until now the gaming business has been dominated by the government-run National Lottery but it has a substantial private-sector potential in the future. Online gambling is expected to become one of the most lucrative niches of the business.

Through Mexican sites (ending in mx) of the online casinos, it is possible to access international sites of companies such as BWin, Intercontinental Global, Gaming Net, Fastengine Limited or Vegas Technology. Backgammon Masters Group has opened an office in Mexico City as recently as July 2007. In addition to international sites with sites in Mexico, there are more than 20 companies with new permits from the Ministry of the Interior to receive online bets in CARs.

Mexican CARs allowed to receive online bets must keep an internal control system of all transactions. Credit cards are accepted in the case of online bets.

For the time being, Mexican CARs that do online gambling are operating as legal and potentially lucrative businesses under the watchful eyes of regulators and tax collectors. Their most immediate challenge is to remain as such.

Implications: After three months of debate, the PRI and PRD have reached an agreement on changes to the fiscal reform package proposed by the Calderon administration. There is a good chance the reform will be passed by Congress in September. 

Analysis:

The bad news on the fiscal front in Mexico is that there is a zero chance of an extraordinary period in the Mexican Congress to vote on the fiscal reform. The good one is that, after almost three months of intense debate, the opposition parties PRI and PRD have reached an agreement on changes to make to the original draft submitted by President Calderon, which opens the way to its approval.

The changes include:

With regard to wages and employment:

§The proposed CETU (Contribución Empresarial de Tasa Unica) is replaced by an ITU (Impuesto de Tasa Unica or Single Flat Tax), which is kept at 16 per cent in 2008 and 19 per cent thereafter.

§Social security expenses become deductible.

With regard to investment and inventories:

§100 per cent of investments made in 2007 will be deductible, as well as the total amount of inventories held at the end of 2007.

§Companies will be able to credit those losses previously accumulated under the income tax.

With regard to the “tax on informality”:

§There will be no changes with regard to the current fiscal regime

With regard to the stock market:

§A new tax will be imposed on stock market operations when they imply a change or transfer of the control of the companies. There are no details as to how this tax would be applied.

With regard to tax on gasoline:

§Instead of a state tax, there would be a federal tax of between 4 to 5 per cent. The states would share the revenues.

With regard to donations:

§Philanthropic institutions and schools will not be subject to flat tax.

With regard to control of the expenditure:

§The resources obtained through the reform would be labeled for specific purposes, instead of just adding them to the general budget.

By the end of next week, the Treasury Commission of the Lower House will conclude its analysis of the proposed reform. This pronouncement will then be brought to the floor of Congress on September 3. Presumably, the proposal would be voted on September 5 so that the Ministry of Finance may take it into consideration in their budget for 2008.

Some informed political analysts argue that there is still a chance that the reform could be passed until mid or late September because the PRI wants to obtain additional electoral concessions out of the government.

Bottom line: there is optimism about the consensus reached and a good chance that the fiscal reform will be approved. Instead of the 2.8 per cent GDP that the Treasury sought from the reform, it will only get 2.6 per cent. It is not a high price to pay by the Calderon administration in view of current financial turbulence and bigger economic woes in the future.

Implications: One month after the new fiscal reform was submitted to Congress, the debate has centered on changes to the flat tax (CETU) that will eventually substitute the revenue-based tax regime. Business organizations are lobbying to reduce the CETU from 19 percent to 12 percent. Ironically, the key to the final outcome may lay in the hands of PRI senators.

Analysis: Almost a month ago, the Mexican Treasury sent to Congress its proposal of fiscal reform. Since then, the critiques from all sides of the political spectrum have gradually gained momentum.

On the domestic business front, the Consejo Coordinador Empresarial (CCE), the most influential business council, demands a lowering of the CETU (the flat tax contained in the proposal) from 19 to 12 per cent. The CCE also wants a clarification as to how long the existing revenue tax will coexist with the CETU and assurances that the new tax will be covered under the international taxation treaties so that companies are not subject to a double taxation. Representatives from the maquiladora industry are lobbying to obtain the deduction of payroll and inputs which are temporarily imported into the country. The real estate industry wants the allowance of the Treasury to credit the land owned as part of the assets of a company.

The visit of the Spanish President, José Luis Rodriguez, to Mexico was the occasion for some of the leading Spanish businessmen to also voice openly their concerns about the reform. They argued that the new scheme will have a very negative impact on the hotel industry since the calculation of the CETU will not allow deductions of payroll expenditures nor of interests on debt.

On the political front, the Frente Amplio Progresista, which groups the PRD and other leftist parties, has continued to promote its own version of the reform based on the elimination of fiscal privileges and a large reduction of public expenditure. Although the leader of the PRD and former presidential candidate, Andrés Manuel López Obrador, gave an instruction of “zero negotiation” with the Calderon administration, his followers in Congress have decided instead to actively defend the party’s proposal among legislators.

Some leading PRI Congressmen have conditioned their support to the fiscal reform to the inclusion of changes to the fiscal regime of PEMEX. The National Confederation of state Governors, CONAGO, requests the right for states to administer the VAT and the revenue tax imposed on public workers and individuals.

Nobody questions the need for a reform for a very simple reason: the level of taxation in Mexico is extremely low (11% of GDP) and there is a dangerous dependence of fiscal revenue on oil income (40%), which in all probability will tend to be lower and increasingly volatile. In other words, there are no other choices at this moment, and Mexico desperately needs a reform.

Yet, the growing critiques to this package signal two things: that it will be very difficult for Congress to pass the reform during an extraordinary session as was expected when the proposal was disclosed, and that it will probably include some major changes. From the recent approval of pension reform, the Calderon administration has learned that it might be better off to negotiate a watered-down version of the fiscal reform than paying the political cost of no reform at all.

Implications: The perception of the Financial Times looks overly optimistic in light of the many hurdles ahead for success on the security side of Calderon's policy, as well as on the achievement of support from all political parties for fiscal reform now being considered by Congress.

Analysis:

In general, President Felipe Calderon (FC) has a positive image in the international press. A good example is this week´s article on the Financial Times (FT), which makes a balance of the first six months of his administration. The text starts by contrasting the atmosphere of stability that the country is breathing now, with the almost political chaos that existed in Mexico just a year ago. FC “is governing his country with a sure touch”, states the FT.

Among the salient achievements of FC so far, this newspaper highlights the new public pension rules introduced in March and a recent Supreme Court judgement overturning legislation that could have enshrined the duopoly in the country's media sector.

The article joins ranks with those who welcome the proposed changes to the tax system announced last week, setting a minimum 19 per cent rate of corporate tax and a new tax on cash deposits designed to attract small, informal businesses into the banking system.

If approved by Congress, the reforms will help to clamp down on pervasive tax evasion by Mexican companies. Mexico's tax take stands at 11 per cent of GDP, one of the lowest levels in Latin America. On the other hand, they will provide much-needed resources for extra spending on social welfare and infrastructure. These economic reforms are considered to be “Mexico's most important for more than a decade”.

The article recognizes that the fiscal package has defects, among others, that it could send people away from the banking system, which is exactly the opposite of one of the goals that it supposedly seeks. And, most importantly, even if the government earned extra revenues from the reform equal to 3 per cent of GDP, it will still remain heavily dependent on Pemex, the state oil company.

The toughest challenge ahead for President Calderon is the cracking down on drug-related violence. Although much more remains to be done, he has at least brought greater energy to bear on one of Mexico's most intractable problems, a fact evidenced by a recent decision to demote more than 250 top-ranking police officers. It is estimated that nearly 200 police and soldiers and more than 1,000 other people have been killed this year in a wave of violence.

Mr Calderon must also now tackle the monopolies in telecommunications, T.V. broadcasting and many other business sectors, which hamper the competitiveness of the economy as a whole.

But on balance, Calderon has succeeded in imposing a more effective style of governing than Fox. He has demonstrated his qualities as an adept politician, able to negotiate effectively and willing to tackle the vested interests that have consistently dogged reform and blocked development.

This leads us to believe that perhaps FC is looking good partly because of the sharp contrast between his style of government and that of his predecessor. In recent weeks, criticism to Fox from every side of the political spectrum has been steadily rising. Of course, the sharpest critic of all has been Andres Manuel López Obrador - former presidential candidate from the PRD- who in a book published just this week strongly denounces Fox´s excessive meddling in the last Presidential election campaign.

In this context, it might be more appropriate to guard oneself from scenarios such as the one posed by the FT, which looks somewhat overly optimistic. There is no doubt that the achievements of FC augur well for this sexenio, but still much more is needed than just keeping the momentum.

Implications: The new fiscal reform package pays more attention to the expansion of the fiscal basis and the reduction of tax evasion than to the dependence on oil revenue. Contrary to what happened with the fiscal proposals of Fox, the current fiscal package has a very good chance of approval by Congress.

Analysis: In recent weeks, there were many voices –among them that of Mr. Alan Greenspan, former Chairman of the Federal Reserve—saying that a change in Mexico´s fiscal dependence on Pemex is urgently needed. Currently, Pemex provides some 40 per cent of government revenue and consequently it lacks resources to invest in further exploration.

On June 20, Mexico unveiled a new fiscal reform package that pays more attention to the expansion of the fiscal basis and the reduction of tax evasion than to the dependence on oil revenue.

According to The Economist, the highlights of the new fiscal reform are as follows:

On the income side:

·Creation of a new alternative minimum tax (initially 16%, rising to 19%) imposed on companies. This would work by taxing income minus investment and physical inputs rather than simple profits per se, as operating presently.

·A new “informality tax” of 2% on cash deposits exceeding a cumulative monthly 20,000 pesos ($1,850), which formal workers will be able to deduct from their taxes.

·Increase of penalties for tax evaders.

·Power to the states to levy an additional sales tax on goods and services already taxed by the federal government. The states are expected to raise an additional 1% of GDP in taxes, while new federal-level taxes should account for an additional 2% by the end of Mr Calderón's term, with 1.2-1.5% already achieved by next year.

On the expenditure side:

·Increase the efficiency in government spending by trimming 0.5% of GDP, or some $4.2 billion, from total expenditures.

·Establishment of a new National Council for the Evaluation of Public Policy to evaluate the budgets of both the federal and state governments.

Coincidentally with the Mexican media on the subject, the article considers that the proposed fiscal reform is a step in the right direction. With the reform, the income of the federal government is expected to increase by 2% of GDP in 2012 thus improving the margin of maneuver to face a possible decrease in oil income.

Even if it goes through in Congress, the main pitfall of the reform is the fact thatMexico's total tax burden as a share of GDP, at present 10-11%, will remain lower than the OECD average (24.9%). Also, the reform falls short of tackling the energy sector's problems, presumably in a bid to reduce legislative opposition.

Three signs point towards a sooner, rather than later, approval of the fiscal reform package. First, the fact that the fiscal package does not contain any controversial measures such as the VAT on food and medicines, which caused the failure of the fiscal reform during the Fox administration.

Second, Mr Calderón has already succeeded in pushing some economic reforms through early in his term, notably an overhaul of pensions for public employees. With the help of the opposition Institutional Revolutionary Party, said initiative sailed through Congress in a matter of days.

Third, the fiscal reform package has been intensively lobbied by President Calderon with the leaders of the three main political parties in Congress. The Mexican government intends to get the approval of the reform before the start of the next congressional session on September the 1^st and include its results in the budget for 2008.

As a senior vicepresident of Moody recently stated, “there is a much better chance, or a much better probability, than there has been in many years, to pass the fiscal reform. Other Latin American countries that have done so, have gained one or two GDP percentage points in tax collection”. In the coming months, we will see if this is indeed achievable in Mexico.

Implications: During a videoconference at the venue of the Expo Management Meeting in Mexico City on the second week of June, 2007, Alan Greenspan, former Chairman of the Federal Reserve, caused havoc in the Mexican media by asserting that if Pemex did not increase the level of its crude oil reserves and if the price of oil did not increase, Mexico would face a fiscal crisis.

Analysis:  “If Pemex is not opened to foreign investment, there will be a fiscal crisis in Mexico” - Alan Greenspan

This, he said, is due to the fact that between 35 and 40 per cent of the income of the Mexican federal government is dependent on oil sales. Greenspan stated that the Mexican Constitution should be changed to allow foreign investment. “There is a lot of oil in the Gulf of Mexico that Pemex is unable to exploit. The state-owned company needs the support of foreign investment to take advantage of the richness of those wells”, he said.

The production of Cantarell, which is the main oil producing well, has been declining since 2005 and it is imperative to increase investments. However, Pemex can not do it with its own resources. The opening of the Mexican energy sector is a difficult political problem but it will have to be faced one day.

Greenspan’s alert signals are well founded. Latest figures from BP show that while the rate of replacement of reserves averaged 164 per cent worldwide in the last ten years, Mexico’s crude oil reserves have decreased to reach only 30 per cent of total production in the last four years. In other countries, the increase in production has been done in parallel with an increasing exploration, thus allowing an average life of reserves of around 40 years for more than a decade. Between 2000 and 2004, the production of crude and national gas in Mexico increased by 9 per cent, but the productive life of reserves between 2000 and 2006 decreased by 50 per cent, from 18 to 9.6 years, a decrease of 9.9 per cent.

The first to respond to Greenspan was Jose Angel Gurria, current Secretary General of the OECD and former Finance Minister of Mexico. In his view, the root problem is the lack of a fiscal reform in Mexico. “It is not a matter that depends on the opening or lack of opening of Pemex to foreign investment. The problem is that the state needs to reduce its fiscal vulnerability so it does not have to depend any more on Pemex to get 40 per cent of its income and take away two thirds of the company gross income”, he stated.

In line with Gurria, legislators from the main three parties were prompt to express their dissent with Greenspan. Francisco Labastida, Chairman of the Senate Energy Commission, accused Greenspan of lobbying in favor of U.S. interests to privatize Pemex. Other senators from the PAN said that the warnings of Greenspan missed the point and are not welcome. On the contrary, what should be done is to reduce the fiscal burden on Pemex. PRD congressmen stressed that there is no real possibility of changing article 27 to open Pemex to foreign investment.

On his part, President Calderon avoided any confrontation and took advantage of his presence at the inauguration of a new ALFA petrochemical plant in Altamira, Tamaulipas, to ascertain that the upcoming Pemex’s petrochemical projects for 850 million dollars in the Cangrejera complex are intended to complement and detonate more private investments as the one launched by the Monterrey group. “Hopefully, one day we can have the changes that allow us to produce locally the inputs that the petrochemical industry needs and is now importing from other countries”, he said.

In balance, Greenspan´s statements did not contribute much to change regulation on foreign investment in the oil sector. The Mexican congressmen announced they are on the verge of reaching an agreement for an energy reform that will not include constitutional change. The statements awakened the old Mexican nationalism, always on guard against the slightest insinuation about opening the doors of the energy sector to foreign investment. But they were, by contrast, highly useful in reinforcing the need for a fiscal reform that is currently at the top of Mexico´s political agenda.

Implications: Most comments in the Mexican media on the ruling of the Supreme Court on the old Televisa Law and the Telecom Law have been largely positive. The decision regarding the unconstitutionality of some provisions of these laws did lower the price of Televisa´s stock but did not have a negative impact on its investment grade. However, in the medium term there is concern about what will be the shape of the concession regime in the new legislation that will be considered in Congress.

Analysis: The ruling of the Supreme Court on the unconstitutionality of several provisions of the Radio and TV Law and the Telecom Law has been widely applauded by numerous analysts and commentators in the Mexican media.

In political circles, there is unanimity in considering that the debate and its outcome was very positive, particularly because the judges:

• made public through the Internet the draft of the final ruling of 546 pages before it was even discussed by the Court;
• held public consultation hearings with experts who clarified technicalities;
• confronted their points of views in public sessions that could be followed through the TV or the Internet;
• made preliminary votes on each one of the specific points of the law under discussion and, in that process, interested parties were able to follow the reasoning of each judge.

Political analysts emphasize that the debate at the Supreme Court contrasted sharply with the way the old Televisa Law was voted by Congress in 2006. Back then, there was an almost total void of public debate. The legislation was passed under a fast track mainly because the presidential elections were about to take place and practically no congressman wanted to risk losing the support of the media. It is said that President Fox himself exerted pressure for a quick approval of the legislation, in spite of the opinion of its own Secretary of Communications and Transportation and the head of Cofetel, the telecom regulator.

In financial circles, the ruling of the Supreme Court was also well taken. Analysts from Moody Mexico stated that the current financial situation of Televisa is stable and that the ruling of the Supreme Court will not change the image that investors have of the company. The analysis to determine the investment grade takes around three years. During this period, other factors may occur which will have a stronger impact on the price of the stock of the company than changes in regulation. A factor that could have an adverse effect on its financial status would be the appearance of a new TV chain or the strengthening of the competitor one (TV Azteca).

As to what lies ahead, articles in the Mexican media coincide in stating that until a new legislation is passed, there will be uncertainty among concessionaires as to how it is best to go ahead with many investment projects.

The main issue here is what the future holds for the regime of concessions for broadcasting and telecoms in Mexico. Evidently, any concession should be revoked if it violates the spirit of the law. It is not possible that in the case of telecom, which changes constantly as a result of technological progress, concessions remain unchanged in the hands of existing concessionaires. But the risk is that Mexico may go back to a discretionary regime to grant concessions that could easily become arbitrary.

The good news is that the duopoly broadcasting powers were defeated. The bad news is that the political coalition that achieved this defeat may end up reinstating a system of concessions which turns out to be bad for competition and for democracy.

Implications:

In an unprecedented decision, the Mexican Supreme Court voted as unconstitutional crucial provisions of the Radio and TV Law and Telecom Law. This opens a window of opportunity for President Calderon to prepare and send a new version of this legislation to Congress trying to avoid the vices and biases of the so-called "Televisa Law".

Analysis:

Implications: After two weeks of debate, only one major change has been introduced: by a majority of eight votes, judges ruled that when the term of concession expires, concession holders will have to bid for a renewal. Other crux matters will be decided in the first week of June.

Analysis: The shutdown of Venezuelan TV channel RTVC has caused more uproar in the Mexican media than the discussion about the constitutionality of the Radio and TV Law and the Telecomm Law in the Supreme Court. Has this been an intended effect?

Some analysts have interpreted that the two TV moguls, Televisa and TV Azteca, wanted to distract the public attention away from the Supreme Court affair by exaggerating the risks of state intervention to curtail freedom of expression.

However, one can also argue that the debate in the Supreme Court has not produced all the expected changes to the contested laws, and therefore the initial anxiety about the debate has gradually faded.

After two weeks of discussion, the number of reforms that have been validated by the judges (8) is almost double the one of reforms considered to be unconstitutional (5). This outcome derives from the fact that eight votes out of nine are needed to rule the unconstitutionality of any provision. So far, opponents to the Radio and TV Law have scored only one, although a very important point, with regard to Article 16: eight judges voted against the automatic renewal of concessions of radio and TV to current concessionaires. This means that when the concession period ends, concession holders will have to (a) demonstrate full compliance with the law, and (b) bid for the renewal of concession and pay for it.

In the category of the reforms that have been validated, the main ones are: creation of the regulatory body, Cofetel, as a semi autonomous (desconcentrado) body; tacit derogation of regulations ordered by the Executive; no violations of the legislative process; differentiated legal regimes for telecoms and radio and TV; differentiated treatment for public and private owners of licenses; transfer of responsibilities from the Ministry of Communications (SCT) to Cofetel; ability of SCT to request reports from other agencies in order to grant radio and TV permits.

Contested reforms are: interdiction for Cofetel’s former commissioners to be ratified in their posts; discretionary power of SCT to define criteria to grant permits; differentiated system to grant concessions and radio and TV permits; different system to appoint new Cofetel commissioners.

In the course of next week, the Supreme Court will discuss what are considered to be the crux matters, namely, a) requirement of a favorable opinion from the Competition Commission for concession holders to participate in radio and TV bids; b) obligation to inform the Federal Electoral Institute about propaganda contracted by political parties; c) objection of the Senate to appointments at Cofetel; d) regulatory frame of the concessions regime; e) the 20 year period of radio and TV concessions; f) bid system of concessions through auction; g) approval to provide telecom services without bid nor payment to the State; h) violations to Foreign Investment Law; and, i) the omission of legislating about access of Indian villages to media.

The evolution of this debate at the Supreme Court leads us to anticipate a Salomonic final outcome, one that gives gains to both proponents and detractors of the laws.

Implications: In response to the appeal of unconstitutionality of the so called Televisa Law passed in 2006, the Supreme Court is reviewing the legal basis of several key articles. This is an unprecedented debate in the telecoms sector in Mexico.

Analysis: A historic debate is currently taking place at the Mexican Supreme Court. At stake is the discussion of the constitutionality of two reforms: the Federal Telecoms Law (FTL) and the Federal Radio and TV Law (so-called “Televisa Law”).

The debate in the Mexican court is a result of an appeal made by a group of 47 senators in May 2006. Last week, one of the Supreme Court judges, Sergio Aguirre Anguiano, presented a 546 pp. resolution which will be voted by the plenary sometime in the course of a few days.

The main issues under discussion are:

1- Article 9-C of the FTL which was reformed to give to the Mexican Senate the right to oppose the appointment of the members of the Federal Telecom Commission (Cofetel) made by the Executive. The Supreme Court ruled last week that this reform was indeed unconstitutional. Two current officials of the Secretariat of Communications and Transportation who were originally appointed by President Fox to become members of Cofetel appealed to the Supreme Court when they were rejected by the Senate. To this date it is still unclear if these officials will remain at the SCT or if they will be reappointed to the regulatory body.

2- Articles 17 y 17-G of the Radio and TV Law considered by the senators as unconstitutional because they make bidding through public auction one of the decisive factors in the granting of concessions. In their opinion, this judgment makes economic power prevalent over all other criteria in the granting of licenses.

3- Article 16 which set a period of 20 years for the concessions granted and the priority that owners of the title of the concession have to obtain the renewal of said concession. The senators argue that this article implies a renunciation by the Mexican State of its right to the “rectorate of the economy” (“rectoria economica”). There is no consensus on how “rectoria economica” should be understood. 

4- Finally, and most important of all, is article 28 of the Radio and TV Law. This article states that the radio and TV concessionaires “who wish to provide additional telecom services to those of radio transmission through those bands of frequencies concessions should present a request to the Secretariat. To this effect, the Secretariat may require a payment…”

Judge Aguirre objects to this article because he considers that it gives an advantage to current concessionaires over potential ones. In his opinion, the article does not require a compulsory payment in case the concession holders wish to offer another service. This objection has profound implications. If approved, some analysts consider that it would level the telecom playing field in Mexico.

This week, the Supreme Court judges were involved in hearings to clarify technicalities with the help of experts in the field. In order for the resolution of non constitutionality to be approved, eight votes are required. The problem is that out of the 11 judges, two can not vote for different reasons, so only 9 judges will vote. In case the resolution is approved by a simple majority, there would have to be a minimum of five rulings in the same direction to create jurisprudence.

There is no doubt that the debate is worth following for a simple reason: to know if the Mexican telecom sector will finally be freed from the lack of legal certainty that has characterized its development in the past and that has paralyzed numerous investment projects planned for the future. Hopefully, the Supreme Court will provide the necessary legal definitions. We can anticipate an uphill battle.

Implications: Two Mexican regulators of the telecom sector, COFETEL and the Competition Commission, have just recommended to the Secretariat of Communications and Transportation the derogation of the Convergence Agreement. From now on, any progress in the opening of convergent services -particularly interconnection and portability-will be subject only to the terms of the Radio and TV Federal Law.

Analysis: