VZCZCXYZ0002
RR RUEHWEB

DE RUEHME #2673/01 2462220
ZNR UUUUU ZZH
R 022220Z SEP 08
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC 3128
RUEATRS/DEPT OF TREASURY WASHINGTON DC

UNCLAS MEXICO 002673 
 
SIPDIS 
 
FROM AMBASSADOR FOR EEB ASSISTANT SECRETARY SULLIVAN AND WHA PDAS 
KELLY 
STATE FOR EEB/TPP MIKAEL LURIE AND DEBORAH GROUT 
STATE FOR WHA/EPSC MATTHEW ROONEY 
STATE FOR WHA/MEX ELIZABETH WOLFSON AND IAN BROWNLEE 
TREASURY FOR LUYEN TRAN 
 
E.O. 12958: N/A 
TAGS: ECON MX
SUBJECT: SCENESETTER FOR ASSISTANT SECRETARY SULLIVAN'S VISIT TO 
MEXICO SEPTEMBER 3-5 
 
¶1. (U) My staff and I warmly welcome you and your colleagues to 
Mexico City. President Calderon recognizes the broad-ranging 
challenges his country faces and has the vision and political will 
to address them strategically.  He has demonstrated resolve in 
implementing his key policy objectives: improving security and the 
rule of law, attacking poverty, and creating jobs. The U.S. and 
Mexico have developed a solid set of institutional relationships 
that allow us to work productively on most of our priorities, 
including fundamental issues of homeland security and North American 
prosperity. Those links are set to expand.  Your visit is a sign of 
U.S. support for the right-of-center Calderon government and 
dedication to this complex, interdependent relationship. 
 
Bilateral Relations and AGP 
------------------- 
 
¶2. (U) Calderon has demonstrated pragmatism in his posture toward 
the United States and is building on an already modern and mature 
U.S.-Mexico relationship.  The President's message is that Mexico 
will seek what it needs from us on the basis of equality, respect, 
and the close cooperation expected of neighbors that share 
wide-ranging interests and challenges. Our common border, 
responsible for extensive commercial, community, and family ties, is 
transforming our societies into two of the most deeply and broadly 
connected on earth. 
 
¶3. (U) Calderon's top officials have been receptive to our Alliance 
for Growth and Prosperity (AGP) concept, though they are anxious 
that it not diminish the work of the Pacific Arc Forum.  Calderon is 
eager to deepen commercial integration with the United States and 
the rest of the region, and is likely to support any forum that 
promotes economic development and furthering the benefits of free 
trade agreements.  The GOM has informed us that it shares with us 
the broad objectives of the AGP, with the exception of our concerns 
over labor and environment.  The GOM will also need to be reassured 
that the AGP has the solid backing of the Bush Administration. 
Calderon has several times criticized us and, to a lesser degree, 
Canada for failing to advocate for NAFTA. 
 
Security 
-------- 
 
¶4. (U) There is increasing public concern over the rise in violence 
in Mexico.  On August 30, more than 100,000 Mexicans marched 
peacefully throughout the country to demand government action 
against kidnappings and killings.  The Calderon administration has 
moved forcefully to improve public security, significantly 
increasing the security budget; launching surge operations against 
drug traffickers in six of the most conflictive states; engaging the 
military in a significant way; working to overhaul Mexico's national 
police organization; getting the Congress to pass a major criminal 
justice reform; and authorizing the extradition to the United States 
of a record number of  wanted criminals, including drug king-pins. 
The President's actions reflect his commitment to intensify 
security-related cooperation with the U.S., and his willingness to 
incur political risk in doing so.  On June 30, President Bush signed 
the Merida Initiative, a 450 million USD package that provides 
funding for technical assistance and equipment for Mexico to use in 
their fight against narco-trafficking.  This assistance is a key 
example of our cooperation in the counter narcotics arena. 
 
Strong Leader in a Conflictive Environment 
------------------------------------------ 
 
¶5.  (U) President Felipe Calderon is showing strong leadership at 
home and abroad in a manner much appreciated by Mexicans.  Although 
he won election with a bare 36% plurality in a three-way race, an 
opinion poll published Sept. 1 in the major daily Reforma showed 
that 62% of Mexicans approve of his performance to date. 
Nevertheless, the political climate overall remains conflictive, 
with a congress closely divided between the president's 
right-of-center National Action Party (PAN), the leftist Democratic 
Revolutionary Party (PRD), and the left-of-center Institutional 
Revolutionary Party (PRI).  Calderon faces significant domestic 
challenges in pursuing his security, economic and social reform 
agendas.  At the same time, he must chip away at the historic 
Mexican ambivalence toward the U.S. that has slowed progress on many 
common fronts, including security.  Because of this divided 
political environment, it is difficult to predict the results of the 
mid-term Congressional elections to be held in July 2009. PRD's 
fortunes seem to be waning and good showings by PRI candidates in 
state and local elections over the past year may be a harbinger of 
strong gains in next year's mid-term elections. 
 
Stable but Vulnerable Economy 
 
----------------------------- 
 
¶6. (U) U.S. strategic interests in Mexico are tied to three key 
economic factors:  (1) a population of 110 million bordering the 
United States with a poverty rate over 40 percent, (2) the second 
largest supplier of oil to the U.S. in 2007 (though so far this year 
it has slipped to third behind Canada and Saudi Arabia), (3) over 
one billion dollars a day in two-way trade in goods and services, 
with a highly integrated production cycle between factories in the 
U.S., Mexico and Canada. 
 
Poverty and Economic Performance 
-------------------------------- 
 
¶7.  (U) Mexico has the highest income inequality of any nation in 
the OECD.  The latest Mexican government figures, (from 2006) show 
the poverty rate declined slightly to 42.6 percent overall, with 
10.3 percent living in "food-based poverty," unable to meet the 
nutritional needs of their families.  Widespread poverty encourages 
illegal immigration, narcotics smuggling to the United States, and 
other forms of illicit commerce.  Growing income inequality fuels 
the tensions that almost resulted in the election of a populist 
President, Andres Manuel Lopez Obrador, who openly embraced 
President Chavez of Venezuela. 
 
¶8. (U) President Calderon inherited a stable, growing economy 
tightly linked to U.S. economic cycles.  Mexico chalked up an 
estimated 3.3 percent growth rate in 2007, rebounding from near zero 
growth in the first years of the decade.  Real GDP growth is 
expected to slow to around 2.6 percent this year, primarily due to 
the U.S. economic slowdown.  Inflation, fueled by spiking 
international food and energy prices, has risen in recent months to 
over 5 percent, prompting the Central Bank to raise interest rates 
in June 2008, shortly after the government had reduced import 
tariffs for key food items, increased subsidies for poor consumers, 
and obtained voluntary price controls from producers.  Most jobs 
currently being created in Mexico are in the informal economy, which 
the World Bank estimates employs 27-45 percent of the working age 
population.  Many here are growing concerned about Mexico's ability 
to compete in an increasingly globalized world, as it loses market 
share to China and other emerging economies.  In his second State of 
the Union Address, issued on August 27, Calderon claimed that 
800,000 formal jobs have been created in Mexico.  Mexico has 
achieved a 3 percent GDP growth, not bad for a global environment 
characterized by recession and high inflation, but still 
insufficient to progress. Calderon highlighted that Mexico, except 
Canada, had the lowest inflation in America. 
 
Need for Bolder Economic reform 
------------------------------- 
 
¶9.  (U) World Bank, OECD, Mexican and other economists say Mexico 
would need sustained, long-term growth rates of at least six percent 
to alleviate widespread poverty -- but cannot achieve that level of 
growth without structural economic reform beyond what President 
Calderon has currently proposed.  We agree with Finance Minister 
Carstens that in order to compete internationally and develop the 
poorest parts of Mexico, Mexico needs broad reform to improve tax 
collection, reduce reliance on oil income, confront growing pension 
liabilities and payments on government borrowing outside the federal 
budget, and provide needed spending on poverty alleviation, 
education, health and infrastructure. Mexico desperately needs 
education reform, since currently 60 percent of its people do not 
graduate high school.  In order to achieve sustained robust growth, 
Mexico must improve competition in an economy long dominated by 
business monopolies and oligopolies, and to take on powerful labor 
unions (including the national teachers union) in order to amend 
labor laws that discourage job creation in the formal economy. 
 
¶10.  (U) While President Calderon has achieved more reform in his 
first two years in office than his predecessor did in six years, the 
lack of a majority in Congress has forced him to compromise with the 
special interests that have long slowed progress in Mexico's 
economy.  While the President's skill at pragmatic political 
negotiation has led to a series of successful economic reforms, it 
has also meant the reforms were watered down and are not yet 
sufficient to place Mexico on a sustained growth path sufficient to 
alleviate widespread poverty.  Reforms to date include a tax reform 
that solved about one-third of the need for additional collections, 
and a pension reform that combined with that of his predecessor 
solved about 80 percent of the insolvency crisis in Mexico's pension 
systems.  To overcome a key to economic growth, President Calderon 
has announced a National Infrastructure Plan, under which his 
government would spend five percent of GDP for the next five years 
to improve Mexico's long-neglected infrastructure.  The President 
 
recently joined with the leader of the national teachers union to 
announce a program to improve primary education, although many are 
skeptical that the union will allow real reform.  On August 6, 
Calderon named his pro-business former chief of staff, Gerardo Ruiz 
Mateos, to be the new Secretary of the Economy to aid him in the 
battles against rising inflation, falling remittances, and the 
informal sector. While Calderon's government has taken incremental 
steps to reduce the market dominance of monopolists and oligopolists 
in key sectors like telecommunications and banking, Congress has 
blocked serious reform.  Currently, Mexico is in the midst of a 
heated debate over the President's rather modest energy reform 
proposal (see below). 
 
Actively Seeking to Expand Trade and Investment 
--------------------------------------------- -- 
 
¶11.  President Calderon has made increased international trade and 
investment a cornerstone of his presidency.  In June 2007, he 
created ProMexico, a federal entity charged with promoting Mexican 
exports around the world and attracting foreign direct investment to 
Mexico.  He has also worked to strengthen economic relations with 
European and Asian countries in order to lessen Mexico's dependence 
on the U.S. economy.  Last year, Mexico's FDI inflows reached a 
record 23 billion USD while at the same time the percentage of such 
inflows originating in the U.S. decreased to 47.3 percent, only the 
second time since NAFTA implementation that the U.S. has accounted 
for less than half of Mexico's FDI. Mexico has also seen its 
percentage of exports to the U.S. decrease from 87 percent in 2004 
to 82 percent in 2007.  As the U.S.'s economic slowdown continues, 
Mexico will expand efforts to diversify away from a U.S. centered 
economy. 
 
¶12. (U) That said, Calderon is eager to deepen commercial 
integration with the United States and the rest of the region, 
something his government views as essential to strengthening 
competitiveness vis-a-vis competitors, especially from Asia.  In 
March, Calderon stated that Mexico was ready to talk to Panama about 
restarting stalled discussions on a free trade deal.  Discussions 
over a Mexico-Peru FTA have entered the final round.  Mexico sees 
the August 15 entry into force of the CAFTA-DR textile accumulation 
provisions as a model for linking together the free trade agreements 
among common partners in the Hemisphere, and is working with 
like-minded Latin countries in the Pacific Arc Forum to harmonize 
rules of origin among common free trade partners. 
 
Energy 
------ 
 
¶13. (U) After Canada, Mexico was the largest source of U.S. oil 
imports last year.  We therefore have a strong strategic interest in 
continued stable supplies of Mexican oil. Within Mexico, energy is 
an extremely sensitive topic tied to national sovereignty, but the 
energy sector requires difficult reforms urgently.  Mexico's oil 
production and reserves continue to decline due to a lack of 
investment in oil exploration and production.  Sufficient investment 
funds are not available because of the constitutional prohibition on 
private investment and the fact that most of Pemex's revenue goes to 
pay for as much as 38% of the government's budget.  Pemex's 
liabilities have grown so large that it can no longer fund 
investment in exploration through borrowing in international 
markets.  President Calderon understands that declining oil 
production can only be addressed through fiscal reform to reduce the 
amount of Pemex revenue sucked into the government budget, and 
through energy reform to improve the efficiency of Pemex operations 
and allow for private and foreign investment in the petroleum 
sector. 
 
¶14. A comprehensive tax reform package was passed last year and 
there is currently a mild energy reform package being heatedly 
debated in the Mexican Congress as well as in the court of public 
opinion.  Initial indications are that some type of energy reform is 
likely to pass and could provide some additional flexibility for 
PEMEX and pave the way for further reform.  Analysts anticipate an 
intense month plus of congressional discussions which could lead to 
a consensus package being passed by early October.  (The Mexican 
Constitution requires that the federal revenue and appropriations 
bills be approved at the end of October and mid-November 
respectively, and both of these will be heavily impacted by any 
reform to PEMEX.) While the package that the Calderon administration 
submitted to Congress would not open Pemex up to the level of 
investment that it sorely needs, it seems to be a small but 
important step toward the large task of reforming Pemex. While polls 
indicate that most Mexicans now understand something needs to be 
done with PEMEX, unions and opposition parties reflect the views of 
many Mexicans who are skeptical of foreign involvement.  Even 
 
seemingly benign, factual statements by U.S. officials about 
Mexico's petroleum sector, such as those made by President Bush in 
March 2007 or former Fed Chairman Greenspan several months later set 
off a tempest of responses and front page condemnations, including 
from officials largely supportive of opening the sector. 
 
 
Visit Mexico City's Classified Web Site at 
http://www.state.sgov.gov/p/wha/mexicocity and the North American 
Partnership Blog at http://www.intelink.gov/communities/state/nap / 
GARZA