Markets focus on the US...

The US fiscal year runs from October 1 - September 30. Hours before the fiscal year is to end, the country still doesn't have a budget.

Tomorrow, October 1, parts of the US Government will shut down unless Congress approves a continuing resolution by midnight tonight. That could happen but, if it doesn't, it wouldn't be the first time the US has begun the fiscal year without a budget in place. We've danced this dance 18 times since 1977. The average shutdown last 6.5 days. The last shutdown took place nearly 18 years ago during the Clinton Administration. The longest ever, it lasted 21 days.

What's the impact of a government shutdown on the economy? Historical experience tells us the median reduction in the growth rate during the quarter the government was shutdown was 0.9 percentage points. That's rather significant in a year when the economy is expected to grow 1.6%. Naturally, the duration and implementation of the shutdown will influence how deep the hit to growth will be.

This time around, the shutdown is the least of markets' worries. Following hard on the heels of the looming shutdown is the prospect that the US may default on its debt payments. The last time it looked like Congress would not raise the debt ceiling - in August of 2011 - the US lost its AAA debt rating.

The shutdown and the debt ceiling are two discrete events. It's especially unfortunate that the two votes are happening so close together. The shutdown is what will happen if Congress doesn't approve a budget for fiscal year 2014. The vote to raise the debt ceiling is, effectively, voting to pay for what you've bought. By voting to raise the debt ceiling, Congress is authorizing the Treasury to borrow the money to pay for expenditures Congress has already authorized.

When Congress votes on the debt ceiling depends on when the US government exhausts its authorized borrowing capacity. This year, Treasury estimated that date to be October 15. However, juggling payments could win a few extra days or weeks.

Markets can live with a government shutdown. The real concern is whether Congress will raise the debt ceiling. If it doesn't and the Administration doesn't find a way to pay its bills, the US Government will default on its debt. No one wants to find out what the impact on the markets would be if the "full faith and credit" of the US Government were questioned.

Mexican migration to the US...

The Pew Hispanic Center estimates that 11.7 million unauthorized immigrants lived in the US in 2012, just over half of whom are Mexican. That's half a million fewer people than in 2007, the year before the "Great Recession" began, and the same estimate as for 2008. Although the number dropped to a low of 11.3 million in 2009, the increases in subsequent years aren't statistically significant. However, it does look like immigration is beginning to pick up.

A couple of points worth making....

1) Unauthorized immigrants accounted for 28% of the immigrant population in the US in 2012.

2) While the largest number of unauthorized immigrants -- 52% of the total -- were from Mexico in 2012, there have been some significant changes in that pattern.
     a) The unauthorized Mexican immigrant population was estimated at 6.0 million in 2012, well below 2007's peak of 6.9 million.
     b) That's not the case for unauthorized immigrants from other countries, estimated at 5.65 million in 2012 compared to 5.25 million in 2007.
     c) Annual apprehensions of Mexicans peaked at 1.64 million in fiscal year 2000. In fiscal year 2012, annual apprehensions were down to 266 thousand.

How do tax burdens compare?

Ever wonder how the direct tax income collected by the Mexican central government compares to what's collected in Brazil, Chile and Colombia? If you did, here's the answer for 2011, stated as a percentage of GDP.

• Mexico:     5.4%
• Brazil:       9.2%
• Chile         7.6%
• Colombia   6.9%

If you include direct taxes collected by all levels of government, the order remains the same:

• Mexico      6.0%
• Brazil       10.5%
• Chile          8.2%
• Colombia   7.5%

What's especially interesting is how direct taxes paid by individuals and companies (as a percentage of GDP) compares in Mexico, Brazil and Chile. (Colombia doesn't provide the breakdown.) Remember: these percentages of GDP are from 2011. If approved, Mexico's proposed fiscal reform will increase the percentage paid by individuals.

Companies

• Mexico   2.4%
• Brazil     3.7%
• Chile      3.9%

Individuals

• Mexico    2.7%
• Brazil      0.5%
• Chile       1.4%

US$38,000 a year...

Earning US$38,000 a year (Ps$500,000) a year in Mexico puts you in the top 1% of the population, according to Hacienda.

INEGI's income and expenditures survey says that in 2012 earning the equivalent of US$3,419 a month put a household in the top 10% of the household income distribution. (The average household was comprised of 3.7 members, 2.5 of whom are between 14 and 65 years old. The dollar figure was calculated using the 2012 average annual exchange rate.)

If earning just over US$3,000 a month makes someone part of the 1%, wonder what number it takes to be included in the top 0.5% or 0.1%?

Turning back the clock on decentralization....

Tucked away in Mr. Peña's fiscal reform is a move to re-centralize some functions that states had assumed when "decentralization" was one of the few concepts on which all political parties could agree.

During Ernesto Zedillo's presidency, the federal government  began transferring monies to the states so that the states, instead of the federal government, would pay teachers. The federal government also has been transferring monies to states so that states could buy the medicines used by public sector health facilities.

Secretary of Hacienda Videgaray has announced that the federal government will once again pay teachers and purchase medicines, which it will then distribute to the states. In other words, governors will no longer have access to massive amounts of money to use with little or no supervision or transparency, monies with the potential to be employed for political purposes or siphoned off.

Recentralization will effectively control some of the abuse of public funds by governors about which we've been reading so much. It will also give the president more power than his immediate predecessors had.  The PRI is back.

Fiscal reform unveiled...

The fiscal reform unveiled last night by President Peña leaves businesses and the middle class cold. No wonder, since they'll be footing the bill.

In macro terms, the government plans to collect additional tax revenues equal to 1.4% of GDP. Half of that will come from additional income taxes collected from companies. Another 0.6% of GDP will come from additional personal income tax collections and IVA (half from each concept). IEPS (excise taxes) on gasoline and other products will contribute, respectively, 0.4% of GDP and 0.2%. On a net basis, the expected loss of income from eliminating the IETU will cancel out the additional income taxes businesses are expected to pay. The question, of course, is whether the same businesses that benefit from eliminating IETU will pay the additional income taxes.

Exports will have to be the motor of next year's growth, along with public sector spending. Consumers will quite simply have less disposable income after the tax bite.

The fiscal package itself was a surprise. The government floated trial balloons but the package itself was very tightly held. One surprise was the decision to abandon levying value-added taxes (IVA) on foods and medicines. It's said that the President himself made the call, one that was very much influenced by political calculations.

The other surprise was the reappearance of public sector deficits, excluding investments by Pemex. Hacienda is asking for approval to increase this year's deficit from the approved 2.0% of GDP (0.0% excluding Pemex investments) to 2.4% (0.4% excluding Pemex investments). Next year's deficit is to be 3.5% of GDP (1.5%, excluding investments by Pemex). Mexico's debt to GDP ratio remains enviable but there hasn't been the same commitment to reducing deficits that we saw in earlier Administrations. The deficit began creeping higher as a percentage of GDP in the Calderon Administration. "Deficit creep" has transcended the change of sexenio.

While Mexico cuts its interest rate, BRICS agree to combat currency outflows...

The Fed announced in June that at some unspecified point in the future it will begin to taper back its monthly bond purchases. Following that statement of intentions, capital flows to emerging markets slowed to a trickle or, in some cases, even reversed. Consequently, currencies weakened.

The peso fared well in comparison to emerging market currencies. Between April 30 and August 30, the peso depreciated 9.8%. The Turkish lira lost 14.0% of its value in the four-month period. The Brazilian real dropped 19.5%. The Indian rupee lost 22.1% against the dollar. The Russian ruble fared well by those standards, declining just 7.2%.


Banco de Mexico, Mexico's central bank, surprised the markets this morning by cutting the Mexican Reference Rate 25 basis points, to 3.75%. It's the second reduction in six months. That follows a period of nearly four years in which the Reference Rate stayed at 4.50%. The Board of Governors explained their decision on the basis of economic conditions in Mexico and the world. The risks to growth have increased at the same time  inflation is not likely to pose a problem. In Mexico, financial markets, including the currency market, have had an "orderly" adjustment to the anticipated change in Fed policy. The Board concludes that in light of the expected weak demand and the expected "significant advances in strengthening public finances", it was appropriate to cut the Reference Rate.

The Mexican authorities are NOT intervening to to support the peso. By cutting the benchmark short-term interest rate Banco de Mexico sends a signal that monetary policy is not designed to attract carry trade flows. Of course, the increase in longer-term interest rates over the summer has steepened the peso yield curve, which means that portfolio investors can still reap an attractive yield differential in longer-term peso obligations.

The BRICs (Brazil, Russia, India and China) have had a different reaction to the hit to their currencies, judging by a paragraph tucked deep in e New York Times September 6 account of the G-20 meetings in Russia. According to the Times story, the BRICs intend to create a collective fund of US$100 billion to defend their currencies. When the fund will be in place and how it will operate remains to be seen.