Mexico s General Economic Preliminary Policy Guidelines 2018

Transcription

1 Guidelines 2018 Analysis Report Contacts Felix Boni Chief Credit Officer Mireille García Economics Associate Alfonso Sales Economic Analysis Manager HR Ratings comments on Mexican government guidelines for 2018 fiscal policy and its estimate updates for 2017 which suggest a reduction in total federal public sector debt relative to GDP. The annual Pre-Criterios18 1 document, issued in April by the Mexican Treasury Ministry (SHCP, by its acronym in Spanish), represents a preliminary look at what the current administration expects to formally propose to the Congress in the Fall for the subsequent fiscal year beginning in January. It also represents an update on the expectations for the current fiscal year based on recent developments. Our overall conclusion is that the expectations of reductions in the debt to GDP ratio for 2017 and 2018 are reasonable. However, achieving them will not only require peso stability, which thus far this year appears largely to be the case, it will also require a substantial degree of fiscal discipline in the area of discretionary spending. We have already seen such discipline exercised in 2015 and 2016 and we expect that to continue on into However, the goal set out for 2018 in the Pre-Criterios18 is rather ambitious and we have our doubts as to the government s ability to meet them should the guidelines shown there be approved by Congress in November. As for 2017, a significant question is the final disposition of the large 2016 Banco de México (Banxico) operating surplus (BMOS) of P$321.7bn (billion) handed over to the SHCP in March. Although 70% must be spent to reduce the debt, by lowering the deficit this effectively gives the SHCP some room to increase discretionary spending. Thus, we will see over the course of the year how much of this amount will in effect be spent to reduce the budgetary deficit relative to the official goal of P$495bn and, consequently, the debt. We discuss a possible scenario in this report. GDP Growth We begin our analysis by mentioning the SHCP s GDP assumptions on which its budgetary forecasts are significantly based. These are seen in Table 1 below. The 1.50% growth forecast is significantly in line with consensus assumptions, especially earlier in the year when nervousness about the impact of the Trump Administration s anti NAFTA polices was at its peak. Still, concerns remain and in fact recent comments from the Trump Administration have exacerbated them. In any event, the direct impact of any changes in the accord would not come in 2017 but rather in 2018 at the earliest. The danger for 2017 comes from the delays or cancelations of investment projects in Mexico, whose viability could be reduced as a result of unknown changes in the treaty. In this context, it is relevant to point out the negligible increase in capital formation during 2016 of only 0.39%, mostly before NAFTA concerns became relevant. Thus, the SHCP assumes a limited 2017 recovery from an already weak As for trade, the SHCP is assuming much stronger growth for both exports and especially for imports. However, in statistical terms at least, the impact is a marginal contribution from the external sector to GDP growth. From this narrow statistical perspective, GDP growth without the external sector would increase by 1.94% in The impact of the external sector is even weaker in In English, formally known as the General Economic Preliminary Policy Guidelines 2018, referenced in this report as either the Pre-Criterios18 or the GEPPG18. Hoja 1 de 12

2 Table 1: GDP based on Assumptions of Pre-Criterios 2018 In billions of real 2009 pesos Variation vs. Prior Year p 2018p p 2018p Supply 19,077 19,457 19,859 20, % 2.06% 3.07% Imports 4,941 4,996 5,181 5, % 3.70% 4.70% Real GDP 14,136 14,461 14,678 15, % 1.50% 2.50% Private Consumption 9,476 9,741 9,977 10, % 2.42% 3.02% Public Consumption 1,552 1,570 1,595 1, % 1.55% 2.15% Fixed Capital Formation 3,105 3,117 3,142 3, % 0.80% 2.10% Inventory Variation % % 75.00% Exports 5,030 5,091 5,213 5, % 2.40% 4.10% Net exports % % % Discrepancies % % 22.75% Nominal GDP 18,242 19,523 20,846 22, % 6.78% 6.60% Deflator % 5.20% 4.00% Source: HR Ratings based on data from INEGI and forecasts from Treasury Ministry (SHCP). (Includes HR Ratings inferences for inventory variation for 17/18). The real growth driver during 2016 was private consumption. Although expected to turn in weaker growth during 2017 it will still be the major contributor to economic expansion in 2017 according to the forecasts, becoming even stronger in Public sector consumer spending will remain weak in 2017, although should show stronger growth than in 2016 according to the SHCP s forecasts. Growth would accelerate even further in As we will see later in this report, the stronger growth from public spending comes despite limited growth in non-financial cost spending. Not surprisingly, the SHCP is assuming substantial GDP inflation during 2017 of 5.2%, even more substantial than the already high level observed for 2016 of 4.61%. Although HR Ratings expects weaker growth during 2017 than for 2016 we do not now place the bottom end of our range as low as the SHCP s specific forecast. We currently see growth in a range of from 1.8% to 2.15%. Although we share the concerns of NAFTA (through the impact on investment, at least in 2017) we believe they are not as great as the market apparently does. Although we de regard it as the most significant danger, it is closely followed by our expectation of continued weak growth in the US, which would limit the extent and duration of the current rebound in Mexican manufacturing exports, followed again closely by weakening consumer spending, the result of higher inflation, interest rates and tight fiscal policy. The outcome of current the debate on US fiscal policy, especially on taxes, is extremely important in terms of determining: 1) the level of US demand, affecting Mexican exports, and 2) the competitive impact for Mexico of significant reductions in the US corporate tax rate and whether this could pressure Mexico to lower its own with potentially negative implication for tax revenue. Fiscal Policy: no operating surplus from Banxico This is the base scenario presented by the SHCP including detailed actualized forecasts for 2017 and guidelines for The 2017 numbers are minor updates to the budget approved by the Congress in November The 2018 numbers represent the framework that the SHCP is currently expecting to present to Congress in the official Policy Guidelines for 2018 Hoja 2 de 12

3 in September. Significantly, and by law, the SHCP is not permitted to explicitly incorporate within its estimates or guidelines revenues obtained from Banxico s operating surplus. In Table 2 we show the expected evolution of the Historical Balance of the Public Sector Borrowing Requirements (HBPSBR or HB) 2. For 2017, the maximum level of the Traditional Balance is set at P$495bn. We infer the remaining numbers (most importantly the PSBR and the HB) largely from the percentages to GDP (as seen in Table 1 above) forecasts provided by the SHCP in the GEPPG18. Table 2: PSBR Historical Balance in billions of pesos (HBPSBR) p 2018p Public Sector Borrowing Requirements (PSBR)* Traditional Balance Other Balances Debt Registry Adjustments Contribution to FEIP Adjustments net of contribution Non-Balance changes to Debt** From currency movements Other non-balance changes Total change in HBPSBR** 1,187 1, PSBR Historical Balance 8,633 9,797 10,319 10,933 Source: HR Ratings w ith information from the Treasury Ministry (SHCP) incorporating the GEPPG18. *Negative numbers represent balance deficits, positive number surpluses. **Positive numbers represent an increase in the PSBR Historical Balance. It is important to emphasize that the change in the HB is inferred by HR Ratings from the 2017 end-of-year percentage to GDP assumptions given by the SHCP, as is the additional change reflected in the non-balance changes to debt line and its two components. However, our estimate of the change in the level of the HB as a result of the effects of the movements in the peso on foreign denominated debt is based on the SHCP s assumptions as to the average and year-end values of the currency relative to the dollar. 3 HR Ratings expects that unless there are major changes to overall economic and political (including global) conditions the peso s level during 2017 will lead to a reduction in the value of the debt relative to GDP after the significant increases the devaluation produced in 2015 and In Table 3 below we present these same numbers in terms of their relationship to GDP. Thus, the Traditional Balance is expected to decline to 2.37% of GDP and thus continue the reduction observed in 2016 to 2.58% from the 3.50% level seen in The broader PSBR balance is expected to come in at 2.90% a bit higher than the 2.85% recorded in 2016 and substantially lower than the 4.07% registered for The slight increase in the PSBR for 2017 vs does not represent any weakening in the SHCP s austerity policy. Rather it reflects the fact that the 2017 forecasts do not incorporate the effect of the large inflow from 2 The Spanish acronym is the SHRFSP (or SH) for Saldo Histórico de los Requerimientos Financieros del Sector Público, the broadest measure of the federal sector s public debt. The SH/HB is the accumulated result of annual deficits measured most broadly in the RFSP, the Spanish acronym for the Requerimientos Financieros del Sector Público (PSBR in Table 2). Within the PSBR the most important component is the Traditional or Public Balance and within the Traditional Balance the overwhelmingly most significant element is the Budgetary or Economic Balance. 3 The SHCP assumes that the peso will close 2017 and 2018 at 19.0 and vs. the 2016 close of and current levels of around Hoja 3 de 12

4 Banxico s operating surplus while this is seen in 2016, partially in the FEIP contribution of 0.37% which reduced the deficit. Table 3: PSBR Historical Balance as % of GDP p 2018p Public Sector Borrowing Requirements (PSBR)* -4.07% -2.85% -2.90% -2.50% Traditional Balance -3.50% -2.58% -2.37% -2.00% Other Balances -0.09% -0.17% -0.23% -0.17% Debt Registry Adjustments -0.49% -0.11% -0.30% -0.33% Contribution to FEIP 0.05% 0.37% 0.00% 0.00% Adjustments net of contribution -0.54% -0.47% -0.30% -0.33% Non-Balance changes to Debt** 2.44% 3.11% -0.39% 0.26% From currency movements 2.09% 2.93% -1.42% 0.09% Other non-balance changes 0.35% 0.18% 1.02% 0.17% Total change in HBPSBR** 6.51% 5.96% 2.51% 2.76% PSBR Historical Balance 47.33% 50.18% 49.50% 49.20% GDP (in billions of pesos) 18,242 19,523 20,846 22,222 Source: HR Ratings w ith information from the Treasury Ministry (SHCP) incorporating the GEPPG18. *Negative numbers represent balance deficits, positive number surpluses. **Positive numbers represent an increase in the PSBR Historical Balance. These assumptions show that the HB would end 2017 at 49.50% of GDP, lower than the 50.2% close at Given the large level of revenues provided by the surplus 4 and assuming that the remainder of the SHCP s estimates for 2017 are met it is indeed likely that the debt to GDP coefficient will be lower than it was with the 2016 close. For 2018, the GEPPG18 assumes even smaller deficits of 2.0% for the traditional balance and 2.5% for the broader PSBR. The FX effect would be negligible based on the SHCP s peso assumptions. The subsequent relevant question then is how the SHCP plans to reduce the Traditional Balance in 2017 and in 2018 vs. the already lower level observed in 2016, and to do this without assuming any possible benefit from a Banxico operating surplus? Table 4 below presents the SHCP s updated estimates for 2017 and the guidelines for 2018 for the revenue side of the equation. Perhaps the most obvious conclusion is the substantial decline in total budgetary revenues as a percentage of GDP in 2017 and 2018 relative to both 2015 and Much of this is due to a lack of comparability between the period and the previous two years. However, before we discuss the issues involved on that point it is important to note that lower revenues as a percentage to GDP are expected for 2018 vs (numbers which are comparable). Thus, total Budgetary Revenues are expected to decline by 26bps (basis points) relative to GDP in 2018 vs due to 10bps drop in total petroleum revenue, a 5bps drop in tax revenue, a 4bps reduction in Federal Government non-tax revenues and a 4 We will analyze the possible effect of the transfer of the surplus in the next section of this report. 5 The P$4,440bn budget revenue estimate for 2017 is based on the 21.3% of GDP figure given in the GEPPE18 document. The amount originally assumed in the legislation approved in November was for P$4,360.9bn and represented 21.5% of the earlier GDP assumption of P$20,300bn and represents 20.9% of the current revised GDP assumption of P$20,848.8bn. Hoja 4 de 12

5 6bps decline in non-pemex parastate income. From this perspective, at least, the 2018 assumptions would appear to be reasonably conservative. With respect to 2017, the estimates show that total budgetary revenues will decline by a substantial 350bps relative to A significant assumption here is the 66bps drop in tax revenue. This may be due to the reduced level of GDP growth but also to the assumption that the increase in revenues to GDP in recent years is partially due to largely non-recurring income which will begin to dissipate in Table 4: Budgetary Revenues (in billlions of nominal pesos and as a % of GDP) p 2018p p 2018p Federal Government 3,180 3,566 3,299 3, % 18.27% 15.83% 15.68% Non-Petroleum Revenues 2,766 3,258 2,915 3, % 16.69% 13.98% 13.89% Tax Revenues 2,361 2,716 2,762 2, % 13.91% 13.25% 13.20% Income Taxes 1,217 1,420 1,444 1, % 7.28% 6.93% 6.83% Value Added Tax % 4.06% 3.83% 3.83% Special Excise Tax % 2.11% 1.92% 2.00% Oil % 1.42% 1.20% 1.31% Other % 0.69% 0.72% 0.70% Other Tax Revenue % 0.47% 0.58% 0.54% Non-Tax Revenues % 2.78% 0.73% 0.69% Oil Revenues % 1.58% 1.84% 1.79% State Institutions and enterprises 1,087 1,275 1,141 1, % 6.53% 5.47% 5.36% Pemex % 2.47% 1.96% 1.90% Others* % 4.06% 3.52% 3.45% Budgetary Revenues 4,267 4,841 4,440 4, % 24.80% 21.30% 21.04% Real GDP Growth 2.63% 2.30% 1.50% 2.50% n.a. n.a. n.a. n.a. GDP Deflator Change 2.99% 4.61% 5.20% 4.00% n.a. n.a. n.a. n.a. Real GDP (billions of 2009 pesos) 14,136 14,461 14,678 15,045 n.a. n.a. n.a. n.a. Nominal GDP (billions) 18,242 19,523 20,846 22,222 n.a. n.a. n.a. n.a. Source: HR Ratings based on informaction from the Mexican Treasury Ministry (SHCP), including the GEPPG18, and the INEGI. As previously stated there were various elements which made revenues in 2017 not totally comparable with 2016 income. For example, revenues for Pemex and the CFE 6 were largely due to the Federal Government s support for the pension liabilities of these two state enterprises. This support was simultaneously accounted for as Federal Government spending and as revenues for Pemex and the CFE, with no effect on the Economic Balance. The level of pension support registered as revenues was P$134bn for Pemex and P$161bn for the CFE. Federal Government non-tax revenues were also extraordinarily high due to the receipt of P$239bn for the 2015 BMOS received in As for expenditures, these are seen in Table 5. 7 Total budgetary expenditures reached 27.37% of GDP in 2016 vs % in For 2017, they are estimated to decline to 23.67% and to fall still further to 23.04% in As in the case of revenues the sharp decline in 2017 is significantly due to the fact that spending is not expected to repeat the P$294bn in pension support provided by the Federal Government in 2016 to Pemex and the CFE. Neither does it include the 30% of the P$239.7bn in BMOS, or P$72bn financial investment in a budgetary emergency fund. All of these expenditures were registered as discretionary spending by the Federal Government and substantially explain the 380bps decline relative to GDP in that account for Within discretionary spending, the financial 6 Federal Electricity Commission or CFE for its acronym in Spanish, which is one of the components of Other state institutions and enterprises. 7 Total budgetary outlays of P$4,935bn are larger than the P$4,837.5bn originally established in the budget in November and corresponds to the 23.7% estimate that appears in the CGPPE17 and returns the deficit of P$495bn as originally approved in the budget. Hoja 5 de 12

6 investment account reflects these extraordinary amounts reaching P$454bn in 2016 and budgeted to reach, by our estimate, only P$20bn in Table 5: Budgetary Outlays and Balances (in billions of nominal pesos) p 2018p p 2018p Discretionary 3,827 4,160 3,525 3, % 21.31% 16.91% 16.26% Federal Government 2,749 3,095 2,513 2, % 15.85% 12.05% 11.51% State Institutions and enterprises 1,078 1,066 1,013 1, % 5.46% 4.86% 4.75% Non-Discretionary % 3.64% 3.83% 3.81% Revenue Sharing Participations % 3.55% 3.67% 3.65% Pmts. of Prior Year Obligations % 0.09% 0.16% 0.15% Interest and other Financial Costs % 2.42% 2.93% 2.97% Federal Government % 1.90% 2.32% 2.32% State Productive Companies % 0.53% 0.61% 0.65% Total Budgetary Outlays 4,893 5,344 4,935 5, % 27.37% 23.67% 23.04% Specific Expenditure Categories Federalized Spending 1,656 1,724 1,784 1, % 8.83% 8.56% 8.83% Pensions % 3.32% 3.41% 3.56% Financial Investments % 2.33% 0.10% 0.10% Physical Investment Spending % 3.73% 2.95% 2.93% Primary excluding Financial Investment 4,321 4,417 4,303 4, % 22.62% 20.64% 19.96% Adjusted Primary Discretionary* 3,075 3,058 2,795 2, % 15.66% 13.41% 12.60% Primary Economic Balance % -0.15% 0.56% 0.97% Primary Bal. Exclud. Financial Investment % 2.17% 0.66% 1.07% Total Economic Balance % -2.58% -2.37% -2.00% Source: HR Ratings based on informaction from the Mexican Treasury Ministry (SHCP), including the GEPPG18, and the INEGI. *Primary spending less non-discretionary, pensions (formally classified as discretionary) and financial investment. Significantly, financial costs are expected to continue to rise relative to GDP reaching 2.93% in 2017 and 2.97% in 2018 vs. 2.24% in Also noteworthy is the fact that revenue sharing participations (revenues sent to the states and municipalities) will continue to rise equaling 3.67% of GDP and stabilizing at that level in They were a smaller 3.45% of GDP in In a context of fiscal austerity, the rise in participations, together with the increase in financial costs, intensifies the pressures to reduce discretionary spending. Participation spending is non-discretionary as it reflects preexisting formulas based on revenues. Given the large and in some cases extraordinary and largely non-discretionary levels of spending in financial investment, financial costs and participations we believe that a more appropriate measure of fiscal austerity is discretionary spending less financial investment. We also deduct pension spending which we estimate for 2017 and Pension spending is classified as discretionary but which without special legislation and negotiations with unions is based on preexisting formulas and agreements. The evolution of theses outlays is seen in the Adjusted Primary Discretionary line in Table 5. Spending declined 119bps to GDP in 2016 and on the basis of our analysis of the GEPPG18 we expect it to fall another 225bps in 2017 and an additional 81bps in Thus, in our view the estimates for 2017 and the preliminary guidelines which show declines in the ratio of debt to GDP as measured by the HB of the PSBR are reasonable. However, they depend upon the ability of the government to continue to make substantial cuts in discretionary spending which although possible require a substantial degree of budgetary and political discipline. Hoja 6 de 12

7 Fiscal Policy: with operating surplus from Banxico The above analysis was undertaken without the incorporation of the receipt of the BMOS as the SHCP is required to do by current Mexican financial legislation for budgetary purposes. In this section, we will engage in an exercise in which we estimate what the impact of the BMOS could be. On March 31, the SHCP received P$321.7bn from Banxico which compares favorably to the P$239.7bn received in This year s amount represents 1.5% of the SHCP s estimate of 2017 GDP. The income is registered as nontax Federal Government revenue. According to legislation, 30% of the BMOS has to be invested in a special emergency fund (the FEIP). This represents an outlay which is classified as a financial investment and, as such, is also considered as a discretionary expenditure. Thus the 30% outlay nullifies the reduction in the Traditional Balance deficit that the BMOS income would otherwise represent. However, at the level of the PSBR the investment in the FEIP is accounted for as a debt registry adjustment thus nullifying the effect of the financial investment expense on the Traditional Balance. 8 Consequently, although at the level of the Traditional Balance only 70% of the BMOS has the effect of reducing the deficit, at the level of the PSBR the deficit is reduced by the entire amount, assuming there are no other changes. In this context then it is relevant to look at what occurred in 2016 with the proceeds from the BMOS generated during The Budgetary Balance deficit expected for 2016 as incorporated within the Federal Expenditures Budget 9 (PEF) was P$577bn. The actual amount registered was P$503bn, or P$74bn less. In contrast, 70% of the BMOS, or P$167.9bn, could have reduced the deficit (all other things being constant) to P$409bn or P$94bn less than the observed amount. 10 Consequently, while the 70% in BMOS has to be used to pay off existing debt it also has the effect of increasing revenues without an offsetting increase in outlays. Consequently, it also leads automatically to a reduction in the budgeted deficit thus indirectly permitting additional spending to reach up to that level. Thus, in consequence, and for the sake of conservatism, we also perform an analysis assuming that the budgeted deficit is reduced, in this case by an amount equal to 50% of the 70% of the BMOS. Table 6 presents the results of this exercise of including the BMOS as well as the effect of assuming that half of the 70% effectively permits additional spending. The results should be compared to the numbers appearing in Table 2 above. The two changes are: 1) the P$113bn reduction in the Traditional deficit to P$382bn vs. the P$495bn without any BMOS and 2) the P$97bn in the FEIP contribution vs. P$0bn in Table 2. The reduction of P$113n represents 50% of the 70% of the BMOS proceeds of P$321.7bn. The contribution to FEIP represents the 30% of BMOS. In Table 7 we show these amounts as a percentage of the SHCP s assumed GDP. The PSBR and Traditional Balance deficits reach 1.89% and 1.83% of GDP vs. 2.90% and 2.37% in Table 3 without any BMOS. The registry adjustment account s FEIP line reaches 0.46% of GDP vs. 0% in Table 3 and 0.37% for 2016 reflecting that fact that the BMOS for 2017 is larger than the gain from The final result is that under this exercise the 8 That is, by increasing a financial asset it reduces debt in net terms. 9 Presupuesto de Egresos de la Federación, by its acronym in spanish. 10 We assume that the P$295bn in pension support did not prevent a lower deficit as that incremental expenditure was offset by additional revenues for Pemex and the CFE. Hoja 7 de 12

8 increase in the debt measured by the HB would represent 1.50% of GDP vs. the 2.51% assuming no BMOS and as a percentage of GDP the debt would reach 48.5% vs. 49.5% in Table 3 and constitute a significant 168bps drop from the level at the close of This evolution in the debt would constitute a positive improvement in Mexico s debt position vs. the prior year. Table 6: PSBR Historical Balance in billions of pesos (HBPSBR): With BMOS p 2018p Public Sector Borrowing Requirements (PSBR)* Traditional Balance Other Balances Debt Registry Adjustments Contribution to FEIP Adjustments net of contribution Non-Balance changes to Debt From currency movements Other non-balance changes Total change in HBPSBR** 1,187 1, PSBR Historical Balance 8,633 9,797 10,110 10,725 Source: HR Ratings w ith information from the Treasury Ministry (SHCP) incorporating the GEPPG18. *Negative numbers represent balance deficits, positive number surpluses. **Positive numbers represent an increase in the PSBR Historical Balance. Table 7: PSBR Historical Balance as % of GDP p 2018p Public Sector Borrowing Requirements (PSBR)* -4.07% -2.85% -1.89% -2.50% Traditional Balance -3.50% -2.58% -1.83% -2.00% Other Balances -0.09% -0.17% -0.23% -0.16% Debt Registry Adjustments -0.49% -0.11% 0.16% -0.34% Contribution to FEIP 0.05% 0.37% 0.46% 0.00% Adjustments net of contribution -0.54% -0.47% -0.30% -0.34% Non-Balance changes to Debt 2.44% 3.11% -0.39% 0.26% From currency movements 2.09% 2.93% -1.42% 0.09% Other non-balance changes 0.35% 0.18% 1.02% 0.17% Total change in HBPSBR** 6.51% 5.96% 1.50% 2.77% PSBR Historical Balance 47.33% 50.18% 48.50% 48.26% GDP (in billions of pesos) 18,242 19,523 20,846 22,222 Source: HR Ratings w ith information from the Treasury Ministry (SHCP) incorporating the GEPPG18. *Negative numbers represent balance deficits, positive number surpluses. **Positive numbers represent an increase in the PSBR Historical Balance. In Table 8 we show the effect of recognizing the entirety of the BMOS on Budgetary revenues. This is seen in non-tax revenues which reaches P$475bn or 2.28% of GDP vs. P$153bn without incorporating the receipt of the operating surplus seen in Table 4, with total revenues of P$4,762 equivalent to 22.84% of GDP vs. P$4,841bn 24.8% in Note that the decline in total budgetary revenues in 2017 vs of P$79bn is more than explained by the extraordinary pension support of P$295bn given in Hoja 8 de 12

9 Table 8: Budgetary Revenues (in billlions of nominal pesos and as a % of GDP): With BMOS p 2018p p 2018p Federal Government 3,180 3,566 3,621 3, % 18.27% 17.37% 15.68% Non-Petroleum Revenues 2,766 3,258 3,237 3, % 16.69% 15.53% 13.89% Tax Revenues 2,361 2,716 2,762 2, % 13.91% 13.25% 13.20% Income Taxe 1,217 1,420 1,444 1, % 7.28% 6.93% 6.83% Value Added Tax % 4.06% 3.83% 3.83% Special Excise Tax % 2.11% 1.92% 2.00% Oil % 1.42% 1.20% 1.31% Other % 0.69% 0.72% 0.70% Other Tax Revenue % 0.47% 0.58% 0.54% Non-Tax Revenues % 2.78% 2.28% 0.69% Oil Revenues % 1.58% 1.84% 1.79% State Companies and Entities 1,087 1,275 1,141 1, % 6.53% 5.47% 5.36% Pemex % 2.47% 1.96% 1.90% Others* % 4.06% 3.52% 3.45% Budgetary Revenues 4,267 4,841 4,762 4, % 24.80% 22.84% 21.04% Real GDP Growth 2.63% 2.30% 1.50% 2.50% n.a. n.a. n.a. n.a. GDP Deflator Change 2.99% 4.61% 5.20% 4.00% n.a. n.a. n.a. n.a. Real GDP (billions of 2009 pesos) 14,136 14,461 14,678 15,045 n.a. n.a. n.a. n.a. Nominal GDP (billions) 18,242 19,523 20,846 22,222 n.a. n.a. n.a. n.a. Source: HR Ratings based on informaction from the Mexican Treasury Ministry (SHCP), including the GEPPG18, and the INEGI. In Table 9 we show the impact on the expenditure side. The most immediate impact is in financial investments which increases by P$97bn over the amount shown in Table 5, or 30% of the BMOS. This increase goes directly to Federal Government discretionary spending. However, as we are assuming that spending will also rise by half of the remaining 70% of the BMOS, or P$113bn, Federal Government discretionary spending would rise an additional P$210bn, for a total of P$2,722bn, bringing the Economic Balance deficit to P$382bn vs. the P$495bn in Table 5. Table 9: Budgetary Outlays and Balances (in billions of nominal pesos): With BMOS p 2018p p 2018p Discretionary 3,827 4,160 3,735 3, % 21.31% 17.92% 16.26% Federal Government 2,749 3,095 2,722 2, % 15.85% 13.06% 11.51% State Institutions and enterprises 1,078 1,066 1,013 1, % 5.46% 4.86% 4.75% Non-Discretionary % 3.64% 3.83% 3.81% Revenue Sharing Participations % 3.55% 3.67% 3.65% Pmts. of Prior Year Obligations % 0.09% 0.16% 0.15% Interest and other Financial Costs % 2.42% 2.93% 2.97% Federal Government % 1.90% 2.32% 2.32% State Productive Companies % 0.53% 0.61% 0.65% Total Budgetary Outlays 4,893 5,344 5,144 5, % 27.37% 24.68% 23.04% Specific Expenditure Categories Federalized Spending 1,656 1,724 1,784 1, % 8.83% 8.56% 8.83% Pensions % 3.32% 3.41% 3.56% Financial Investments % 2.33% 0.56% 0.10% Physical Investment Spending % 3.73% 2.95% 2.93% Primary excluding Financial Investment 4,321 4,417 4,416 4, % 22.62% 21.18% 19.96% Adjusted Primary Discretionary* 3,075 3,058 2,907 2, % 15.66% 13.95% 12.60% Primary Balance % -0.15% 1.10% 0.97% Primary Bal. exclud. Financial Investment % 2.17% 1.66% 1.07% Total Economic Balance % -2.58% -1.83% -2.00% Source: HR Ratings based on informaction from the Mexican Treasury Ministry (SHCP), including the GEPPG18, and the INEGI. *Primary spending less non-discretionary, pensions (formally classified as discretionary) and financial investment. Hoja 9 de 12

10 Conclusions Our analysis of the GEPPG18 suggests that the debt to GDP ratio for Mexico s federal public sector is likely decline vs. the 2016 level. One key factor is the exchange rate and the assumptions in this report, at the time of this writing, appear to be conservative and we could well have some upside risk (i.e. a lower debt/gdp ratio). The other element is the ability of the government to lower discretionary spending relative to GDP as is planned, especially the 2018 numbers, which still have to be finalized and approved by the Congress. This requires substantial fiscal discipline which the Mexican government has been able to show in times of stress over the last several administrations. The announcement of the amount of the central bank s operating surplus is another major factor although questions about its amount have been favorably resolved, being larger than the large amount received in Another area of upside risk is real GDP growth which at the assumed 1.5% may be conservative. Our analysis infers additions (the non-balance changes to debt line) to the HB debt other than those expected from the PSBR derived from the final debt levels expected by the SHCP in the GEPPG18. We have furthermore divided this component into two parts: 1) our calculations based on the SHCP s expected movements in the peso and 2) a residual amount. In addition to the peso risk this residual factor also contains risk which are difficult to evaluate but which could be overstating the increase in the HB. A final question is whether the full effect of the BMOS will be reflected in the Economic Balance and in the PSBR. This was not the case in 2016, at least relative to the deficit specified in the 2016 PEF. We have assumed that roughly one-third (50% of 70%) of the full BMOS will not be reflected in the PSBR and consequently in the debt to GDP coefficient. However, assuming that the full effect is reflected in the debt, the debt to GDP ratio would fall still further, approaching 48% which although still substantially higher than the levels recorded at the end of 2012 and 2013 of 37.7% and 40.4% would still represent a significant one-year improvement over the 50.2% level at which it ended Hoja 10 de 12

11 HR Ratings Senior Management Management Chairman of the Board Vice- President Alberto I. Ramos Aníbal Habeica Chief Executive Officer Fernando Montes de Oca Analysis Chief Credit Officer Chief Operating Officer Felix Boni Álvaro Rangel Public Finance / Infrastructure Financial Institutions / ABS Ricardo Gallegos Fernando Sandoval ricardo.gallegos@hrratings.com fernando.sandoval@hrratings.com Roberto Ballinez roberto.ballinez@hrratings.com Corporates / ABS Methodologies Luis Quintero Karla Rivas luis.quintero@hrratings.com karla.rivas@hrratings.com José Luis Cano joseluis.cano@hrratings.com Regulation Chief Risk Officer Head Compliance Officer Rogelio Argüelles Laura Mariscal rogelio.arguelles@hrratings.com laura.mariscal@hrratings.com Business Development Rafael Colado rafael.colado@hrratings.com Business Development Francisco Valle francisco.valle@hrratings.com Hoja 11 de 12

12 Mexico: Avenida Prolongación Paseo de la Reforma #1015 torre A, piso 3, Col. Santa Fe, México, D.F., CP 01210, Tel 52 (55) United States: One World Trade Center, Suite 8500, New York, New York, ZIP Code 10007, Tel +1 (212) *HR Ratings de México, S.A. de C.V. (HR Ratings), is a Credit Rating Agency authorized by the National Banking and Securities Commission (CNBV), registered by the Securities and Exchange Commission (SEC) as a Nationally Recognized Statistical Rating Organization (NRSRO) for the assets of public finance as described in clause (v) of section 3 (a) (62) (A) of the US Securities Exchange Act of 1934 and certified as Credit Rating Agency (CRA) by the European Securities and Markets Authority (ESMA). HR Ratings de México SA de CV (HR Ratings) ratings and/or opinions are opinions of credit quality and/or regarding the ability of management to administer assets; or opinions regarding the efficacy of activities to meet the nature or purpose of the business on the part of issuers, other entities or sectors, and are based exclusively on the characteristics of the entity, issuer or operation, independent of any activity or business that exists between HR Ratings and the entity or issuer. The ratings and/or opinions assigned or issued do not constitute an investment recommendation to buy, sell, or hold any instrument nor to perform any business, investment or other operation. The assigned ratings and/or opinions issued may be subject to updates at any time, in accordance with HR Ratings methodologies. HR Ratings bases its ratings and/or opinions on information obtained from sources that are believed to be accurate and reliable. HR Ratings, however, does not validate, guarantee or certify the accuracy, correctness or completeness of any information and is not responsible for any errors or omissions or for results obtained from the use of such information. The degree of creditworthiness of an issue or issuer, opinions regarding asset manager quality or ratings related to an entity s performance of its business purpose are subject to change, which can produce a rating upgrade or downgrade, without implying any responsibility for HR Ratings. The ratings issued by HR Ratings are assigned in an ethical manner, in accordance with healthy market practices and in compliance with applicable regulations found on the rating agency webpage. There Code of Conduct, HR Ratings rating methodologies, rating criteria and current ratings can also be found on the website. Ratings and/or opinions assigned by HR Ratings are based on an analysis of the creditworthiness of a country, entity, issue or issuer, and do not necessarily imply a statistical likelihood of default, HR Ratings defines as the inability or unwillingness to satisfy the contractually stipulated payment terms of an obligation, such that creditors and/or bondholders are forced to take action in order to recover their investment or to restructure the debt due to a situation of stress faced by the debtor. Without disregard to the aforementioned point, in order to validate our ratings, our methodologies consider stress scenarios as a complement to the analysis derived from a base case scenario. Hoja 12 de 12