This content is from: Local Insights

Financing of states and municipalities

The income of states and municipalities in Mexico highly depends on the participations (participaciones) and other contributions (aportaciones) transferred to them by the federal government. Since the early eighties, the fiscal structure of Mexico has been completely changed and local sale taxes and more than 400 state taxes have been repealed in exchange for a centralised taxation by the federal government. Currently, more than 80% of the income of the states and municipalities depends on such participations and contributions and the balance, on the collection of state and municipal taxes.

After years of easy access to the financial markets and loans, Mexican states and municipalities are facing tight markets and more expensive and scarce loans. Their situation is not exclusively due to the volatility in the financial markets but also the decrease of both federal and local income.

For many foreign institutions, the Mexican states and municipalities market is unknown and only a few with a local presence in Mexico have explored this market. Financing of states and municipalities has been made through (i) direct bank loans granted by Mexican financial institutions, or (ii) offering of debt securities on the Mexican Stock Exchange.

Under the Mexican Constitution, states and municipal governments are prohibited from incurring liabilities denominated in a currency other than Mexican Pesos or to borrow money from foreign entities or individuals. Therefore, the presence of international lenders in this market has been through their Mexican subsidiaries. In addition, the Mexican Constitution establishes that states and municipalities may only incur debt when the proceeds are exclusively used for public productive investments (inversión pública productiva) on the basis established in the local public debt laws and for the concepts and in the amounts established every year in their local public budgets.

An issue which has been greatly discussed in the past is the meaning of the term "public productive investments" and most of the state laws that govern public debt define this concept. In general, "public productive investments" are deemed to be all kinds of capital investments (infrastructure works, acquisition of capital assets) and those works or actions that directly or indirectly produce benefits for the population, which generate or release public funds or which generate additional income for the entities. Nevertheless, we note that there are no binding judicial precedents that limit or define the term "public productive investments". The general consensus is that the term does not include current expenses (wages, services) of the states and municipalities.

Another issue that creditors have faced is that, as a general rule, under the Mexican Constitution, the Fiscal Coordination Law (Ley de Coordinación Fiscal) and local laws, the assets and the federal participations and contributions of the states and municipalities may not be subject to attachment nor may be affected for specific purposes. The Fiscal Coordination Law establishes an exception and allows states and municipalities to affect their federal participations and contributions as security or source of payment for their obligations with the federation, Mexican credit institutions or Mexican individuals or entities, and the lien has to be registered with the Ministry of Finance and Public Credit (Secretaría de Hacienda y Crédito Público). In addition, the local debt laws of many states specifically allow the states to destine, as security or source of payment, income derived from the collection of local taxes and other contributions and income. Local laws also provide that the approval of Congress is required to transfer the participations into the trust as security for the repayment of the financing.

Due to the limited self-generated income of states and municipalities, most of the financing granted by financial institutions to states and municipalities and most debt offerings of states and municipalities have as the principal source of payment federal participations or contributions. This enhancement of the financings has been structured by means of administration trusts in which the states or municipalities irrevocably transfer, exclusively for the payment of their obligations derived from specific loans or debt offerings, the right to receive the income derived from specific federal participations or contributions. This structure has allowed creditors to take away the risk of non-payment from the states and municipalities, since the Federal Treasury is irrevocably instructed to make all payments of the transferred participations and contributions directly to the trustee of the administration trust and not to the relevant state or municipality.

In respect to financings which have as a source of payment local taxes, similar structures are used with the issue that under Mexican law, only the states are entitled to collect taxes. Therefore, only the proceeds obtained from the collection of such local taxes are transferred into the relevant administration trusts and therefore creditors are subject to the exercise by the relevant state of its collection authority in respect to the local taxes used as source of payment.

The markets for state and municipal financing in Mexico are evolving and all the time local laws and state laws are being amended to allow new assets to be used as source of payment. For example, until last year, no federal contributions could be used as source of payments and after an amendment of the Fiscal Coordination Law, certain contributions and in limited percentages were allowed to be used.

Javier Domínguez Torrado

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