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Cancun Partiers Hit With Tax That’s Lifting CPI: Mexico Credit

Mexico’s tax increase package will drive up costs for everyone from spring-break revelers in Cancun to dog owners and junk-food eaters. It’s also ratcheting up bond traders’ inflation expectations.

The two-year break-even rate, a gauge of investors’ estimates for cost-of-living increases based on the yield difference between inflation-linked and fixed-rate bonds, surged 0.30 percentage point over the past month, the biggest jump since June. By comparison, the break-even rate in Brazil, the region’s largest economy, was unchanged during the period.

President Enrique Pena Nieto’s tax overhaul was implemented Jan. 1, boosting the rate on sales in border towns and some coastal states and applying it to additional products, as part of an effort to reduce Mexico’s reliance on oil proceeds. Grupo Financiero Banorte SAB predicts annual inflation will jump to a three-year high of 4.89 percent this month, helping extend the rally in securities whose payments are linked to consumer prices, known as Udibonos.

“There’s a good opportunity in the Udibonos,” Gabriel Casillas, the chief economist and head of research at Banorte in Mexico City, said in a telephone interview.

Growing investor demand for protection against inflation drove yields on Udibonos due in June 2016 down 0.25 percentage point in the past month to 0.58 percent. Banorte, which began telling investors to buy the securities on Jan. 6, predicts that yields will drop to 0.45 percent.

BBVA Outlook

Grupo Financiero BBVA Bancomer SA has been recommending the Udibonos since mid-November.

“The unifying of the sales taxes will have an impact, but the junk food tax will also be significant,” Pedro Uriz, a strategist at BBVA, said in a telephone interview from Mexico City. “The effects of the fiscal overhaul are making this a good time to invest in bonds that pay real rates.”

The bonds gained on Jan. 9 when the government reported that annual inflation (MXCPCHNG) accelerated in December to 3.97 percent, the highest rate since June, as Mexico City raised subway fares and the cost of farm products climbed.

Analysts in a Jan. 7 survey by Citigroup Inc.’s Banamex unit forecast consumer prices will rise at a faster monthly pace of 0.86 percent in January, compared with the increase of 0.57 percent reported later last week.

Texas, California

The sales tax increased on Jan. 1 to 16 percent from 11 percent along the border and in some coastal states including Quintana Roo, home to the beach resort city of Cancun, and Baja California Sur. That brought it in line with the rest of the country as part of a tax plan that Pena Nieto’s Institutional Revolutionary Party pushed through Congress in October. Goods including dog food joined electronics and restaurant meals among the purchases subject to the value-added levy, which applies to most products and services, with the exception of produce and medicine.

Mexico had kept the sales tax along the border lower than the rest of the nation for decades to give consumers incentive to buy products at home rather than cross into Texas, California, Arizona and New Mexico, where the rates are lower. In the Caribbean and Pacific coast states, the lower tax rate had been used to entice tourists to spend at stores, hotels and restaurants.

Junk Food

The tax package also imposed a new 8 percent levy on junk food and a 1 peso-per-liter duty on sugary drinks. The overhaul increased the maximum income tax rate to 35 percent and created a 10 percent levy on capital gains in an effort to diversify government revenue away from oil and boost tax collection that’s the lowest as a percentage of gross domestic product among 34 members of the Organization for Economic Cooperation and Development.

The plan will reduce dependence on oil revenue to about 31 percent of the federal budget this year from 34 percent last year, and to as low as 27 percent by 2018, Miguel Messmacher, the deputy finance minister for revenue, said in a Nov. 1 interview.

While the tax increase will spur inflation in the short term, the effect will be transitory, Finance Minister Luis Videgaray said in a speech in Mexico City on Jan. 10. The tax overhaul will add 40 basis points, or 0.4 percentage point, to the annual inflation rate this year, the central bank estimated in November.

Tijuana Prices

In the border city of Tijuana, the tax increase is already being felt, according to Antonio Tapia, director of the local chamber of commerce. Businesses are raising prices, and the brunt of the increase is being felt by the poor and working class, who are less likely than wealthier Mexicans to have visas allowing them to cross into the U.S. to make purchases, he said.

“Combined with the junk food and soda duties, the higher sales tax is having a major impact,” Tapia said in a phone interview. “Businesses can’t absorb all of the tax increase, so they pass it on to the final consumer, and this is reflected in higher costs of living.”

Prices for some goods and services in the northern border states were already at the same level as in other parts of the country, which may prompt some retailers to try to absorb the cost rather than pass it on to customers, said Alexis Milo, the chief Mexico economist at Deutsche Bank AG in Mexico City.

Smooth Transition

“Inflation on average in 2014 is going to be higher because of the fiscal plan, but I don’t think we will have a spike in inflation in the beginning of the year,” Milo, who projects the inflation rate will end 2014 at 4 percent, said in a telephone interview. “The transition to higher inflation levels is going to be smooth.”

The pickup in inflation won’t last long enough to prompt the central bank to raise borrowing costs this year, according to Banorte’s Casillas. Inflation will ease to 3.1 percent by the middle of the year, within the central bank’s 2 percent to 4 percent target range, provided there is no shock like the frost that sent farm prices soaring last year, he said.

Policy makers cut borrowing costs by one percentage point to a record-low 3.5 percent in 2013 to shore up an economy that grew at the slowest pace since the 2009 recession, according to the median estimate of economists surveyed by Bloomberg.

Analysts expect no change in the benchmark rate until policy makers increase it in March 2015, according to the median estimate in the Banamex survey.

Banorte estimates bringing the border and coastal sales tax in line with the rest of Mexico will add 0.41 percentage point to the annual inflation rate this year, accounting for most of the 0.55 point increase that it says can be attributed to the package.

“Inflation could go up to nearly 5 percent, and market participants are not thinking of that,” Casillas said.

To contact the reporter on this story: Eric Martin in Mexico City at emartin21@bloomberg.net

To contact the editors responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net; Michael Tsang at mtsang1@bloomberg.net

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