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A Mexican Fuel-Flavored Fiscal Crisis

By Santiago Arroyo - Ursus Energy
Director

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By Santiago Arroyo | Director General - Tue, 08/23/2022 - 10:00

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Recently, the Ministry of Finance and Public Credit (SHCP) published the results of the fiscal and public account balances for the last quarter with an extremely alarming view: a fiscal loss above US$1.5 billion only in the month of June, derived from the massive tax incentives applied to the Special Tax on Production and Services on Fuels (IEPS).

As background, since November 2021, a series of incentives have been applied by the SHCP based on a zero rate to the IEPS on gasoline and diesel: that is, the Mexican government chose to stop collecting a tax that represents almost 15 percent of the country's tax revenues, tax policy aimed at cushioning the increase in fuel prices derived from the international inflationary context, as well as the geopolitical circumstances that dominate international headlines.

However, the international context and fuel markets, together with the seasonal changes of fuel formulas for US Gulf Coast benchmarks (the origin of 70 percent of the fuel imported by companies for consumption in Mexico), mean that price pressures have continued, causing the SHCP in March 2022, to decree additional measures to fuel tax incentives related to the Income Tax (ISR) and the Value Added Tax (IVA). The result is that the final consumer prices of fuels in Mexico enjoy a "discount" close to US$0.50 per liter of fuel, which represents just under 45 percent of the real price, leading to a huge fiscal loss for the Mexican state.

That is the real reason why the Mexican government, just in June 2022, managed to lose not only 15 percent of the country's tax revenues but an additional 3 percent of the taxes derived from the additional incentive on the ISR and VAT, making for an 18 percent loss in the country's tax revenues in a single month. In the previous months, that is, in the period from March to May 2022, the losses were also very significant, but they are slightly lower than those of the month analyzed in this article.

All this data, in the eyes of any tax minister or business CFO, would represent a tremendous scandal and would worry more than one person.

Of course, this does not yet contemplate the tax incentives and guaranteed prices applied to LPG.

Even so, the Mexican state has managed to substantially increase its tax capacity by 3.3 percent overall, according to data from the SHCP within the same second quarter of 2022. But it is not enough to cushion the huge losses suffered in an unfortunate strategy to reduce domestic and global inflationary effects. And yes, someone has to say it clearly: the Mexican government has completely lost its financial operability.

Also, we must remember that the Law of the Special Tax on Production and Services, as well as the Law of Fiscal Coordination, establishes that the IEPS is a tax that the Mexican federal government distributes with the state and the municipal governments, so that the federation only loses a small part of its tax capacity. Not so the other levels of government that subsist from the IEPS which, in many cases, represents more than 70 percent of their income and operational capacity at the financial level. Yes, President López Obrador's most recent statement on "Franciscan austerity" (referring to the aesthetic way of life of Saint Francis of Assisi), was not addressed to his Cabinet, but to governors and municipal officials, mainly and, collaterally, to the financial capacity of federal social and educational programs that have already lost more than 40 percent of their financial and operational capacity since the 2022 Federal Expenditure Budget (PEF 2022),  approved by the Mexican Congress in November 2021.

In this way, it can be inferred that Mexico is facing one of the largest fiscal crises in its history, which would put the country’s entire public administration system in serious trouble.

Also, it should be noted that the tax outlook for the rest of 2022 is negative, regardless of whether fuel tax incentives are removed; the damage is done.

As a result, the solution to these problems related to the policy of tax "support" in fuel consumption will be painful, especially for the poorest people, but also for the policies and ideals of President López Obrador; especially given the need for a new fiscal reform to straighten the situation under a tax and public spending regime that is extremely careful and strict.

Given this situation, there are also international conflicts around the regulatory and trade obstacles demanded by the US and Canadian governments in the recent consultation and dispute resolution panels opened against the Mexican government for the evident breaches of the USMCA trade agreement, which, according to experts in the field, the Mexican government will lose or end up agreeing to unfavorable tariff conditions and economic sanctions that will likely add financial pressures to the already difficult Mexican situation.

For this reason, the author of this article regrets not being able to be more optimistic or propose an exit that generates a better projection for the near future, but the main point will be to stop the current energy policy of the federal government, bet on competition and diversification as well as the aforementioned tax reform.

Photo by:   Santiago Arroyo

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