Mexico’s fiscal reform is mixed blessing for banks

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By:
Rob Dwyer
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Focus on income tax and capital gains; Measures promised to reduce number of unbanked

Mexico’s long-awaited tax proposals were given a muted welcome by bankers and economists, who had been hoping for a more fundamental reform of Mexico’s fiscal base.

Marco Oviedo, chief economist of Barclays in Mexico City
Marco Oviedo, chief economist of Barclays in Mexico City
The government stepped back from widely expected extensions of value-added tax to food and medicine – judging that previous education, labour and energy reforms had expended much of the new government’s political capital. "It’s disappointing in terms of the structural scope of the reform, as it only really sorts out the flaws in income – and it has been done in a very timid way," says Marco Oviedo, chief economist of Barclays in Mexico City. "It was a pragmatic approach to maintain a certain level of cooperation from the [opposition party] PRD. In addition food prices have been rising in recent months, so having extra inflationary pressure from VAT would have been too much."

The government expects that its reforms will increase aggregate tax receipts from the private sector by 3% by 2018. The government needs to increase the proportion of its tax revenue from non-Pemex sources to be able to reform the state energy company as part of its energy reforms and free up Pemex’s cashflow for greater investment. Most of the additional tax burden will come from the middle class, with income tax for those earning over $38,100-equivalent rising to 32% from 30% and lots of loopholes being closed. There is also a new 10% tax on dividends and capital gains that will hit insurers and equity fund managers. Moody’s says the new capital gains tax on equities "will constrain earnings and capital generation given that currently all capital gains are tax-exempt".

As of December 2010 insurers had 11% of total investments in equities. "In recent years investment returns have contributed significantly to internal capital generation, mainly in asset-intensive insurance companies such as life and pension companies." Moody’s estimates that the industry’s five year return on capital has been about 20%, and these new taxes will lower profitability.

The impact on the banking sector is less clear, with the increased taxation on the middle classes likely to reduce this segment’s ability to invest and buy insurance, as well as a new VAT on mortgages and the elimination of tax deductibility of real interest on mortgage payments. However, the government expects that its reforms to increase the participation of the unbanked working population – which in some estimates represents 60% of the workforce – will increase the bancarization of the Mexican population, first through deposits and over time through credit and other bank services.

The government is hoping to give incentives to open bank deposits through eliminating taxes on deposits, as well as by creating social security programmes to encourage Mexican workers to opt in to the formal economy.

However, Oviedo is unsure how effective these measures will be. "It is going to be very hard to reduce informality, at least that which is related to under-reporting and non-payment of taxes with this fiscal reform," he says. "I am not sure the benefit of access to social security and health programmes will offset the benefit of not paying tax."

Oviedo also says the introduction of financial stability laws as a basis for a Mexican sovereign wealth fund is aspirational. "The government already has a fund [they could use to save excess revenues] but the problem is that every year they face expenditure pressures and these excess revenues are basically spent on closing budget gaps and the cost of its fuel-hedging programme."