Institutional statement
States and municipalities in Mexico: 2021 a challenging year ahead
The COVID-19 pandemic has heightened fiscal pressures on Mexican subnational governments as evidenced by an increase in the number of negative rating actions on states and municipalities rated by S&P. In our view, the ability of local and regional governments (LRGs) to enhance their financial management policies and medium-term planning capacity remains critical to avoid further slippages in 2021, amid an incipient economic recovery.
The pronounced hit to the Mexican economy in 2020, following the combined shocks of COVID-19 and lower global oil prices, has eroded sovereign revenues and consequently, federal transfers to subnational governments. We currently estimate a drop of non-earmarked federal transfers (Participaciones Federales) to LRGs of about 5.6%[1] in 2020. Given the structure of the Mexican fiscal federalism and the historically weak tax collection capacity, states and municipalities have a large dependence on federal transfers, which account on average for 90% and 65%, respectively, of rated entities operating revenues. Therefore, a large decline of these transfers could impact their budgetary performance and liquidity positions.
To compensate for the reduction in federal transfers, the federal government has facilitated a structure to leverage the Stabilization Fund (FEIEF, for its Spanish acronym) obtaining resources for up to MXN110 billion[2]. FEIEF fund was established in April 2006 with the purpose of compensating for unexpected drops of Participaciones Federales transfers to LRGs below the annual budget estimates. A similar FEIEF leverage scheme was done in 2009. In addition to this transaction, legislation changes to the operating rules of the Fund were done in Aug. 2020, to allow monthly and complete compensations of non-earmarked federal transfers’ shortfalls, instead of quarterly disbursements and partial compensations of the shortfall previously.
In our opinion, with these new rules, FEIEF support has been timely and significant to contain the impact of the pandemic on subnational governments´ budgetary performance and alleviate their liquidity pressures in 2020. Looking into 2021, FEIEF transfers are less likely to occur as, by law, they can only be triggered if there is a reduction on Participaciones Federales throughout the year relative to what was estimated in the federal budget. Federal budget proposal for 2021 considered a 3.2% nominal reduction on non-earmarked federal transfers vs. 2020 budget. As a result, LRGs maybe constrained to cut their expenditure budget or boost their own-source revenues amid an incipient economic recovery, and/or increase their borrowings.
In our view, the ability of rated LRGs to enhance their financial management policies and medium-term planning capacity remains critical to avoid further slippages in their financial performance. Consequently, the implications of a more challenging outlook on LRGs creditworthiness may vary from one entity to another and ultimately depend on the level of institutionalization of prudent financial practices.
Mexican LRGs indebtedness has posted a slow growth over the last five years. In terms of GDP, LRGs debt will likely account for 2.8% in 2020 from 3.1% in 2015. Going forward, as most sources of revenues for LRGs will remain subdued in 2020-21, and despite some capacity to delay capex or use cash reserves in certain entities, overall we expect an increase of their financing needs in the short-term. As a result, we expect the aggregate debt of Mexican LRGs to increase at a higher pace in 2021, when we expect an increase around 10% on overall LRGs debt, while it would remain slightly below 3% of GDP.
During the 2021 political transition period of subnational entities, an additional challenge for some governments will be to pay all their short-term debt three months before leaving office, in line with the legislation[3]. In this regard, as short-term debt has provided an important relief for immediate budgetary pressures during the pandemic, its use has been expanding among Mexican LRGs. We expect an acceleration at year-end considering larger liquidity pressures, as a result of LRGs fiscal slippage. The debt planning strategy will likely inform the future creditworthiness of our rated LRGs. In the recent past, whenever we have seen an aggressive raise on short-term financing, without sophisticated financial planning, the risk of rating downgrades increases.
[1] Non-earmarked federal transfers expected contraction without revenues from the leverage of the stabilization fund FEIEF.
[2] As of Nov.30, 2020, MXN 80 billion has been contracted, and still pending to issue up to MXN30 billion. Funds from the leverage are added to FEIEF balance of MXN63 billion by the end of July 2020.
[3] By the time this article was written, a proposed reform to the Fiscal Discipline Law (Ley de Disciplina Financiera de las Entidades Fedrativas y Municipios) has not been yet approved, which could modify current requirements.