Mexico: Plunge in oil prices drives government to cut spending
February 16, 2015
Oil-producing countries are in a difficult position due to the recent sharp fall in global oil prices and Mexico is not an exception. As oil-related revenues finance about one-third of the non-financial public sector budget in Mexico, the recent drop in prices by more than half prompted the government to announce a series of substantial cuts to the 2015 budget on 30 January. According to the Ministry of Finance (Secretaría de Hacienda) the reduction in spending totals around MXN 124.3 billion (USD 8.3 billion), which accounts for around 0.7% of GDP.
The Mexican Mix of crude (Mezcla Mexicana), which is generally priced below Brent and West Texas Intermediate (WTI), fell below USD 40 per barrel in January—the lowest level since the global financial crisis hit in 2009. In recent days, the price of the Mexican Mix has recovered only part of the ground lost, trading at USD 47.5 per barrel on 12 February. Still, the price is considerably below the USD 81 per barrel that was projected in the 2015 budget and although the government had various mitigation strategies to cushion the sharp price drop—the government hedged a substantial portion of the budget (around 57%) at a price of USD 76.4 per barrel—it had to implement important adjustments to the budget and will have to continue implementing them if low prices persist over the course of the year.
The steps taken to reduce the budget are substantial. Petróleos Mexicanos (PEMEX, the state-owned oil firm) and the Electricity Federal Commission (CFE, the state-owned electricity company) will assume the largest burden from the cuts. Together, PEMEX and CFE will account for over half of the budget cuts required (MXN 72 billion) and the rest will be borne by the federal administration, which will have to reduce current spending. Key social programs have been protected such as Prospera, which is a conditional cash transfer program, and housing subsidies. However, some important capital spending projects have been put on hold. Notably, a trans-peninsular railway in Yucatán and a bullet train that would connect Mexico City and Querétaro.
"There is no doubt that the cuts will streamline the government’s current spending. Some analysts also point out that concerns have resurfaced regarding the budget cuts’ potential harmful effect on domestic demand and economic growth. As Joan Domene, Mexico Economist at INVEX, adds:
While we consider the adjustments important, we do not see them weighing proportionally on GDP, thus we revised down our estimate for the current year by 40 basis points from 3.6% to 3.2%. Although one of our requirements for the initial growth estimate is public sector support for the economy, this is based on higher infrastructure spending as well as on transfers and direct subsidies to households. In this sense, the 124.3-billion-peso cut is mainly focused on the federal government’s current spending, and the pending cuts, which PEMEX and CFE have not yet announced, are expected to be carried out under the same objectives."
The impact of the cuts on growth in the coming year remains to be seen. Should oil prices recover, the government could amend some cuts. On the positive side, the actions avoided the government’s need to raise taxes or raise debt. However, administration of President Peña Nieto faced significant criticism, given its previous claim that the government was fully hedged against lower oil prices.
Author: Ricardo Aceves, Senior Economist