This Selected Issues paper analyzes the sources of Mexico’s economic growth since the 1960s, and compares various decompositions of historical growth into trend and cyclical components. The role of the implied output gaps in the inflation process is assessed. The paper presents medium-term paths for GDP based on alternative productivity growth rates. The paper also describes the significant steps Mexico has taken to strengthen the structure of its public debt in recent years, both in terms of currency composition and maturity.


This Selected Issues paper analyzes the sources of Mexico’s economic growth since the 1960s, and compares various decompositions of historical growth into trend and cyclical components. The role of the implied output gaps in the inflation process is assessed. The paper presents medium-term paths for GDP based on alternative productivity growth rates. The paper also describes the significant steps Mexico has taken to strengthen the structure of its public debt in recent years, both in terms of currency composition and maturity.

V. Mexico—Sub-Sovereign Public Finances and Debt1


This paper analyzes the institutional framework for subnational debt, as well as its structure and financing sources. Total subnational debt has been gradually rising since 1995, although it remains low. As part of fiscal decentralization, the federal government implemented in 2000 a market-based approach to discipline the finances of states and municipalities. This approach promotes the pricing of credit to reflect its underlying risk, rewarding prudent behavior with lower interest costs. The framework has eased access to local capital markets, benefiting states and municipalities by increasing financing at relatively low domestic interest rates and widening the investor base (mainly institutional investors). States and municipalities have generally accessed the market through a master fund structure, however, pledging either federal transfers or own revenues to service debt, which results in a more rigid financial structure. States have been able to extend maturities, but measures to improve further their debt structure and management would be desirable.

A. Introduction

1. Subnational levels of government in Mexico are progressing toward further autonomy, fiscal responsibility, and accountability. Initiatives have been taken since the mid-1990s to decentralize spending responsibility and improve the framework for subnational borrowing. This chapter analyzes the institutional framework for the debt management of subnational entities, its implications in terms of diversifying financing sources, and the structure of subnational debt.

2. Importantly, reforms in 2000 introduced a regulatory framework for debt management for states and municipalities, combining market discipline and new regulatory requirements. The regulation disciplines fiscal finances of states and municipalities and eliminates bailouts by the federal government. The framework promotes investor assessment of the credit quality of states and municipalities when providing financing, and safeguards to ensure credit risks are covered adequately. The regulation also provides incentives for registration of the debt within the Ministry of Finance, and for enhanced transparency and publication of debt and fiscal statistics by states.

3. The structure of this chapter is as follows. Section B summarizes the 2000 regulatory framework for public finances of states and municipalities. Section C then analyzes the credit ratings of states. Section D considers how the framework has helped sub-sovereign governments access local capital markets for financing. Section E then looks at the structure of debt, taking also into account the structure of states’ revenues and expenditures. Section F concludes.

B. Institutional Framework: Historical Background

4. Subnational government borrowing is partly regulated by the National Constitution in Mexico. The constitution states that subnational governments can borrow only in Mexico and from Mexican investors, and only for productive investments.2 Nevertheless, federal development banks and other financial institutions can lend to subnational governments in pesos with funds obtained in foreign currencies from international financial institutions, typically hedging the exchange rate risk.

5. Article 9 of the National Fiscal Coordination Law (NFCL), created in 1980, allowed states and the Federal District to use their federal transfers as collateral for loans. The law stated that around 20 percent of federal tax income must be transferred to state and local governments, establishing Mexico’s revenue-sharing system. Federal transfers have been the main revenue source for subnational governments. The article requires states to get authorization for new borrowing from the local congress, and debt can only be contracted for investment projects. In the preparation of the state budget, each state would propose debt levels, and the state congress would approve a ceiling (including debt levels for its municipalities). For federal transfers to be used as collateral, states only needed to register the debt with the Ministry of Finance (SHCP). In case of arrears or a threat of default, the federal government would deduct debt-service payments on registered debt from revenue-sharing transfers before the funds were sent to states on a monthly basis.

The Role of the Federal Government in Subnational Debt: 1995-98

6. Subnational debt grew significantly in the years before the Tequila crisis. During 1988-93, state debt rose at an annual rate of 62 percent (Gamboa, 1994). Despite low levels of subnational debt in terms of state GDP (Figure 1.1), debt represented a fiscal problem for the majority of states partly because of the low disposable income3 available to service debt, and the states’ limited capacity to raise additional revenue. During 1994, states’ debt stood at 65 percent of the participaciones, the nonearmarked federal transfers and the main source of disposable income (Figure 1.2). The most indebted state was Sonora, with debt averaging around 250 percent of its participaciones.

Figure 1.
Figure 1.

Mexico: Subnational Debt by States, 1994

Citation: IMF Staff Country Reports 2004, 418; 10.5089/9781451825626.002.A005

Source: SHCP

7. The federal government took over the debt of the states after the Tequila crisis, leading to a restructuring of subnational debt. Subnational debt doubled during 1994-95 to MXN$40 billion (around 2.2 percent of national GDP) due to the 1995 financial crisis and the rise in the interest rate. With the one-month cetes rate rising from 14 percent in November 1994 to 75 percent in April 1995, states were not able to service their debt, and the federal government came under pressure to take over responsibility of their debt.4 The Fund for Strengthening State Finances (Programa de Fortalecimiento Financiero de los Estados) provided for extraordinary cash transfers and was set within Ramo 23 (a federal government budgetary item), with a cost of around MXN$7 billion in 1995 (about ½ percent of GDP). This represented around 17 percent of the participaciones for the year (or about 10 percent of subnational debt), and continued at that level in real terms until 1998. States were required to restructure their debts in Udis, a new unit of account indexed to inflation. For those states joining the program voluntarily, the maturity of their debt was extended by 10 or 15 years starting in 1995, with a two-year grace period. The federal government also granted a discount depending on the fiscal condition of each state.

8. In return for the debt takeover, the states were required to agree on a fiscal adjustment program with the SHCP. States needed to commit themselves to balance their budgets, to reduce debt ratios, to present their financial accounts in an uniform way, and to update and publish a state debt law to regulate and limit debt. By the end of 1995, all states had signed letters of intent with the federal government, although there was no mechanism in place to enforce them once the extraordinary transfers were provided. In 1998-99, as the fiscal agreements phased out, the fund ended, with the residual going to a national disaster relief fund.

9. To induce further fiscal discipline, Article 9 of the NFCL was reformed in 1997 to place new restrictions on state and local governments. The SHCP continued to play a part in ensuring debt service for defaulting states after 1994-95, so that creditors had no need to take account of credit risk in their lending to states. The 1997 modifications aimed at forcing states to exercise financial discipline, and banks to analyze project risk when providing financing. Subnational governments could still issue debt to finance investment projects, and use their federal transfers as collateral. However, banks could not ask the SHCP to discount the corresponding debt-service amount from a defaulting state’s federal transfer. Designation of collateral and repayment mechanisms needed to be established according to state debt laws and with the agreement by both parties. States would also be forced to present financial statements when seeking credit.

10. However, after modifying Article 9 in 1997, subnational governments faced constraints in accessing credit, especially from commercial banks, leading to a temporary scheme of “mandates.” The temporary scheme suspended the reform, and allowed states to give the federal government an authorization (or “mandate”) to deduct debt-service payments from revenue sharing. The federal government therefore acted as a trustee in servicing state debt that had been collateralized with the participaciones5 In practice, the mandates became a precondition for states to access the credit market, not only because of the collateral, but also because they were perceived as a guarantee by the federal government. Consequently, commercial banks allocated zero credit risk to these loans, evading the need to develop risk-assessment capacity.

11. In 1999, Ramo 23—the source of discretionary federal transfers—was eliminated and with it, the perception that the federal government would bail out states. As states and banks in Mexico had witnessed federal bailouts in the past, states came to expect them, making borrowing a means to obtain extra federal resources. Also, banking regulatory limits to single customer exposure did not apply to loans to subnational governments (an exceptional regime granted to states and municipalities),6 increasing the attractiveness to creditors of subnational lending. Discretionary federal transfers were also budgeted in a special and often large line item to be allocated at the executive’s discretion in Ramo 23. The cases of Nuevo León and Chihuahua in 1998-99 showed the power of states to demand ad hoc resource transfers. This practice changed in 1999 when Ramo 23 virtually disappeared as a source of discretionary transfers.

Reform in 2000

12. In April 2000, Mexico introduced a new regulatory framework for debt management7 by states and municipalities that combined market discipline and rules-based mechanisms. The provisions focused mainly on: imposing hard budget constraints on federal resources provided to states and municipalities; reducing moral hazard in subnational borrowing; and increasing the transparency, efficiency, and accountability of subnational fiscal management. The new framework contained the following six elements:

  • A renunciation and ensuing removal from the federal budget for 2000 of the executive’s power for discretionary transfers, indicating that no federal bail-outs would be made.

  • Second, the abolition of the “mandates,” leaving states and their creditors to make their own trust arrangements for collateralization, if required.

  • Third, the elimination of the “exceptional regime” for single-customer exposure ceilings, limiting the extent of financial damage that one state can cause, and signaling that state credit quality must be evaluated.

  • Fourth, the establishment of a link between the capital risk weighting of bank loans to subnational governments and those governments’ credit ratings, consistent with the Basle Committee’s recommendations of June 1999. States and municipalities must hold two current, public, global-scale, local currency credit ratings from at least two international credit rating agencies, to be used by regulators to assign capital risk weights (between 20 and 115 percent).

  • Fifth, loan registration with the federal government would be conditional on the borrowing entity being current on all its debt service obligations with development banks and on its publication of debt statistics. To make registration appealing, unregistered loans would be automatically risk-weighted at 150 percent.

  • Finally, development banks would lend to states and municipalities only when the loan qualifies for registration and its corresponding capital risk weight is less than 100 percent. Lending to a subnational with higher risk weights is permitted if the loan contains a technical assistance component funded by an international development bank or multilateral creditors, so that origination and supervision are subject to a neutral and independent party.

C. Credit Quality Of States

13. To date, states and municipalities have complied with the requirement of holding credit ratings. All states, with the exception of Campeche8, have obtained at least two credit ratings from international credit rating agencies (Table 1). Credit ratings are concentrated at the local-scale level of A/A+ (A1/A2 in Moody’s scale), indicating a medium-to-high credit quality. The Federal District has the highest credit rating among states, as it enjoys the same local-scale credit rating as the federal government. This is due to the solidarity principle that applies to the federal government regarding debt contracted by the Federal District.9 Fitch, an international credit rating agency, indicates that the credit rating of the Federal District would be BBB+(mex) if the implicit guarantee did not apply.

Table 1.

Mexico: Credit Rating of Mexican States, National Scale, Jun-04

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Assigned on September 23, 2004.

Source: Fitch, Moody’s, and S&P.

14. The State of Mexico holds the lowest credit rating. The State of Mexico is the only state with a rating below A according to the local scale. Credit rating agencies indicate that the rating is motivated by: (i) high debt indicators and financing deficits that weaken the state’s liquidity position; (ii) the high ratio of debt service to the state savings rate; and (iii) high infrastructure investment requirements. At present, and despite improvements in the state’s own-source revenues, the state is reliant on access to new borrowing to fund its budget, albeit such access is limited. Furthermore, all nonearmarked federal transfers allocated to the State of Mexico are devoted to servicing debt from the 1990s restructurings, which have a senior category.

15. Credit ratings have introduced discipline in the debt management of states and municipalities. First, credit rating agencies issue monthly reports on the evolution of credit ratings, indicating possible changes in the credit outlook, and, in particular, any downgrades and upgrades in credit quality. Second, credit ratings have improved the transparency of financial information and financial coordination at the state level. Third, credit ratings help discriminate the cost of capital for states and municipalities. The credit rating is a signaling device on the states’ ability to pay their obligations when seeking financing. As credit ratings improve, the cost of financing is reduced, not only for the debtor, but also for the creditor through lower capital provisions. Finally, credit ratings have boosted access to local capital markets, helping to deepen the domestic debt market (through the issuance of bonds, the so-called certificados bursátiles).

D. Local Capital Markets as a Financing Source

16. The 2001 stock market reform, together with the 2000 reform, has helped states and municipalities benefit from the development of the domestic bond market. With the stock market reform in July 2001, the regulatory framework for the use of bond financing was clarified, allowing states and municipalities to access local capital markets. The reform introduced an instrument, the certificados bursdtiles, which developed the local debt market.

17. All issuances of certificados bursátiles by subnational entities have been done through a master fund structure, allowing states to leverage resources, while providing a high legal certainty to the creditor. Under the master fund, a third party (the trustee) manages some of the states’ revenues devoted to service debt.76 The revenues are directly deposited in a trust fund according to a percentage defined at issuance (Figure 2). When pledging participaciones, the state provides an irrevocable instruction to the federal government to deposit a percentage of these federal transfers in the master fund account. When pledging state revenues to the master fund, banks and government agencies (who are usually receiving the payments) make regular deposits to the trust fund. The trustee is responsible for managing the funds, the payments (interest and principal), and the reserve deposits.77 In case of over-provision, the trustee must return the funds to the state.

Figure 2.
Figure 2.

Mexico: Structure of the Master Fund

Citation: IMF Staff Country Reports 2004, 418; 10.5089/9781451825626.002.A005

Source: Fitch

18. Credit risks under a master fund structure depend on the extent of guarantee, the financial terms and conditions, and other debt acceleration clauses.78 The master fund works as a shield for the revenues devoted to service the debt considered in its structure. Consequently, the master fund structure does not allow acceleration clauses to be exercised when the debtor fails to comply with debt obligations that are not included in the trust fund. In general, the risk of default would depend on the credit quality of the issuer, the volatility of the revenues devoted to the fund, and the level of debt contracted before April 2000 (as the federal government still holds the mandate to deduct payments due before transferring federal transfer to states’ accounts). Revenues devoted to the master fund are distributed pari-passu according to a predefined percentage for each instrument, and not according to outstanding principal. In case of default, intercreditor equity holds among creditors within the trust fund, while the debt is subordinate to that contracted prior to April 2000.

19. States and municipalities have improved the credit rating of their debt instruments through the master fund structure (Table 2). For example, the state of Hidalgo has been able to place two bonds with the maximum local-scale credit rating (AAA(mex)), well above its credit rating (A+(mex)). States and municipalities have pledged participaciones amounting to MXN$7.5 billion in the trust fund, while twelve issues (with total value of MXN$9.2 billion) have pledged own resources, mainly payroll taxes.

Table 2.

Mexico: Improving Credit Ratings through the Master Fund Structure

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Source: SHCP

20. States and municipalities have diversified their financing sources and extended the maturity of their debt, in part by accessing local debt markets. The financial characteristics of the bond issuances are as follows:

  • States and municipalities have taken advantage of low domestic interest rates and accessed local debt markets on 13 occasions since August 2001. Issuances in 2004, however, have come to a halt due to higher interest rates. Discussion with market participants indicate it is now cheaper to access banking financing.

  • Issuance by states and municipalities accounts for around 5 percent of total issuance in the local debt market. Chihuahua (2002) and the Federal District (2002) had the largest issuances for MXN$2.5 billion each.

  • About 30 percent of issuance has been for liability management purposes, to improve the debt service profile and to profit from lower domestic interest rates.

  • While most states and municipalities have issued bonds with nominal interest rates, 30 percent has been inflation-indexed.

  • Most bonds were issued with a variable coupon, with reference mainly to the 182-day Cetes rate. Spreads ranged from as low as 75 basis points (Federal District, 2003) to 300 basis points (State of Mexico in several issuances).

  • States and municipalities have been able to issue at relatively long terms. All issuances, except for Veracruz (2003), have had an original maturity of at least five years. Nuevo León issued in 2003 with an original maturity of nearly 12 years.

  • Subnational governments have pledged future flows of federal participaciones (for 45 percent of the total amount issued), and with respect to own revenues, payroll taxes have been pledged to about 25 percent of the total amount issued. Chihuahua has issued by pledging toll road revenues.

21. Despite good credit ratings, states and municipalities have not yet issued unsecured debt instruments. The master fund structure is requested by creditors under the clear understanding that federal government would not rescue troubled states and, therefore, creditors demand guarantees for payment. On the other hand, states and municipalities could prefer secured instruments in order to minimize financing costs. The collateralization however differs from issuances in the corporate sector, which have been mostly unsecured.

22. The growing pool of domestic institutional investors has played an significant role in providing funds for long-term financing. The pension reform in 1999 originated a growing pool of institutional investors (the AFORES), that have played a crucial role in the development of local capital markets. In this regard, pension funds demand long-term investments in order to reduce maturity mismatches in their balance sheet. Pension funds are allowed to invest up to 35 percent of their portfolio in state and municipal debt above a certain minimum rating (AA-/aa3 local scale) with concentration limits of 5 percent of the portfolio on a single debtor. As of May 2004, CONSAR, the AFORES’ supervisory body, reports that private pension funds hold nearly MXN$4 billion of subnational debt, although this represents only a low share of their portfolios (around 1 percent of total assets).

23. Going forward, financing through domestic capital markets for states and municipalities may be facilitated by:

  • Pooling states/municipalities in accessing debt markets, as done in the United States with the municipal bond banks and state revolving funds. These instruments allow different entities to issue jointly, sharing the fixed costs of borrowing.

  • Introducing regulation on homogenizing accounting systems, and promoting consistent debt management regulation across states.

  • Investigating measures to facilitate partial guarantees in issuances and to ensure adequate risk management for states and municipalities.

E. Structure of States’ Debt

24. Before analyzing the debt structure at the state level, this section first discusses the federal transfer system, and the structure of state revenues. Understanding the federal transfer system helps define the flexibility of states to devote funds to service debt. The section then analyzes debt levels, debt to the relevant ratios of revenues and disposable income, and the financial terms of the states’ debt.

The Federal Transfers System

25. Under the Fiscal Coordination Law approved in 1980, major taxes are collected by the federal government, while states and municipalities levy taxes mostly on real estate and payrolls. Table 3 describes the structure of federal and local governments’ expenditures and taxes. States have been gradually given increasing expenditure responsibilities and now spend close to half as much as the federal government. The decentralization process has not resulted so far in improved revenue capacity for subnational governments. Expenditures at the state level are mainly financed with transfers from the federal government.

Table 3.

Mexico: Structure of Federal and Local Government Expenditure and Taxes

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Source: Ter-Minassian (1997).

26. Decentralization has been enabled by an increase in the number and variety of transfers. Transfers to states are made via transparent, nondiscretionary and publicly-known formulas. In 2001, federal transfers accounted for 85 percent of total states’ revenues. Tabasco is the state most reliant on federal transfers (97 percent of the state net revenues), while federal transfers for the Federal District represent 51 percent of its total revenue. Two main categories of transfers are the participaciones and the aportaciones. Participaciones were originally subnational revenues whose collection had been delegated to the federal government in the Fiscal Pact in 1980, mainly because of tax efficiency reasons. Participaciones are set at 20 percent of tax revenue and oil royalties of the federal government, mostly under Ramo 28. They were around 3½ times higher than own revenues in 2001. Aportaciones, in contrast, are conceived as federal money earmarked to pay for federal commitments, including for expenditures in health, education, social infrastructure, and institutional strengthening. These funds go under Ramo 33, and were almost 4½ times as large as states’ own revenues in 2001. States receive considerably more earmarked sources than freely disposable funding. Earmarked transfers accounted for 60 percent of total federal transfers in 2002.

27. States own revenues account only for around 11 percent of their total revenues. At the aggregate level, own revenues constitute around 11 percent of total net revenues of all the states (Table 4). Tax revenues account for around 45 percent of total own-state revenues in 2001, followed by rights (35 percent). The capacity to generate own revenues varies significantly across states. On average, states are able to collect 7 percent of their total revenue through own sources. The Federal District is the state with the highest capacity for own revenue collection, which accounts for almost 41 percent of total revenues because of the property tax; while Tabasco has the lowest capacity in this regard, at below 3 percent. The State of Mexico is only able to raise 7 percent of its revenues through own sources.

Table 4.

Mexico: Net Revenue Structure for States, 2001

(as a share of total revenue, unless otherwise specified)

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Source: INEGI.

28. The bulk of state government expenditure is concentrated on current expenditures, mainly transfers, followed by wages and salaries (Table 5). In 2001, states’ expenditures on transfers, reflecting mainly the distribution of subsidies and grants, represented 37 percent, followed by wages at almost 26 percent of total net state government expenditure. State expenditure in infrastructure and public works accounted for about 7 percent of total net expenditure, while revenue transfers to municipalities exceeded 15 percent. The fact that main expenditures are current would make more difficult to implement cuts if states come under financial difficulties.

Table 5.

Mexico: Net Expenditure Structure for States, 2001

(as a share of total net revenue, unless otherwise specified)

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Source: INEGI.

Debt Profile of States

29. Subnational debt has risen gradually in relation to GDP since 1993, although the level remains modest, at 1.8 percent of GDP in 2003. The debt stock does not provide a complete picture of states’ financial health, however. First, the relatively small size of subnational debt does not reflect capitalization of past fiscal deficits, as the federal government has repeatedly supported the states through extraordinary and discretionary transfers, by taking over indebtness. Second, federal government transfers reflected the existence of soft budget constraints for states. Third, access to local capital markets has been restricted by their limited borrowing capacity, although this changed in 2001 when states and municipalities started issuing debt instruments in local capital markets.

30. Subnational government debt is concentrated in a few states. During 1993-2003, out of the nation’s 32 states, the Federal District, State of Mexico, Nuevo León, and Sonora represented, on average, 65 percent of total subnational government debt. Among these, the most indebted states are the State of Mexico and the Federal District with shares of total subnational debt of 25 and 34 percent respectively, by end-2003 (Figure 3). The same concentration pattern is observed when considering subnational debt as a ratio to GDP or federal transfers. The Federal District and the State of Mexico’s debt represent 3 and 5 percent of state GDP, respectively. Despite total subnational debt being around 54 percent of total federal transfers, the Federal District and the State of Mexico’s debt levels reached 149 and 115 percent of federal transfers in 2003, followed by Nuevo Leon with a share of 80 percent.

Figure 3.
Figure 3.

Mexico: Subnational Debt as a Share in Total, by States, 1993-2004

Citation: IMF Staff Country Reports 2004, 418; 10.5089/9781451825626.002.A005

Source: SHCP

31. There is large dispersion in indebtedness among Mexican states when considering the ratio of debt to different measures of revenues. Some financial vulnerabilities can be observed due to the limited fiscal autonomy of the states. Debt to total revenues varied from a maximum of 54 percent (State of Mexico) to a minimum of 0.2 percent (Zacaletas) in 2001. The Federal District reports the second largest debt level in terms of total revenues (53 percent). However, this measure does not fully indicate the burden of debt since most transfers are earmarked. Disposable income needs to consider only non-earmarked revenues (participaciones and own revenues). As described in Table 6, total subnational debt in terms of participaciones has declined in the last decade, but continues to be high (above 50 percent). The State of Mexico and Federal District are the only states with debt levels above 100 percent. The State of Mexico, generates only around 7 percent of total revenues through own sources, while the Federal District’s own revenues account for 40 percent of its total revenues.

Table 6.

Mexico: Public State Debt as a Ratio of Participaciones, 1994-2004.

(In percent)

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Source: SHCP.

As of March 2004

32. On the structure of subnational debt, the main features are:

  • As mentioned in the first section, subnational debt is not exposed to exchange rate risks.

  • About 44 percent of total debt with commercial and development banks is indexed to inflation, i.e. in Udis-denominated instruments (Table 7). Banobras, the public development bank, has provided around 58 percent of its credit in udis-denominated instruments; while 34 percent of total portfolio from commercial banks is denominated in udis.79

Table 7.

Subnational Debt with Commercial and Development Banks, by States, March 2004

(in million of MXN)

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Source: SHCP
  • Subnational governments have borrowed mainly from development and commercial banks (Table 7). Around 57 percent of total subnational bank debt is with commercial banks. Of this, 60 percent accounts for credit to the State of Mexico and the Federal District. Development banks’ portfolio is allocated mainly in three states (State of Mexico (33 percent); Federal District (28 percent) and Nuevo León (12 percent)).

  • Overall, states have increased the average maturity of debt by 3 years since 1994 (Table 8).

Table 8.

Mexico: Maturity of Debt, by State

(In years)

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Source: SHCP.

F. Improvements In States’ Debt Management and Contingent Liabilities

33. Although the framework put in place in 1999-2000 has moved Mexico toward a market-driven approach to state borrowing, further work is required to improve debt management practices across states. The federal government, for instance, has an important role to play in motivating and facilitating improved accounting standards and public disclosure for states and municipalities, and to promote financially prudent behavior by creditors and debtors. This section briefly discusses needed measures in debt management for states, mainly through further accounting harmonization across states and disclosure of information, and accountability of contingent liabilities.

Debt Management at the State Level

34. Despite improvements in debt management, obstacles remain in comparing and analyzing states’ public finances. The major issues are: the lack of harmonization between the concepts for revenues, expenditures and debt across states; the absence of accounting standards; and weak coordination across states in the way the information is reported to local congress and the public in general. Although all state laws require state congress approval of debt operations, the regulation across state laws varies. Some states have introduced regulation limiting the debt contraction levels in a year, while others have introduced limits to the overall degree of indebtedness. Most indebted states do not contain such restrictions in their state debt laws.

35. Registration of state debt with the SHCP could improve monitoring of indebtedness. Despite incentives to register debt contracted by states, registration with the SHCP is done on a voluntary basis and serves only for information. Subnational debt statistics at the SHCP refer to debt contracted with commercial and development banks, without incorporating debt issuance in local capital markets. It is also unclear whether adequate mechanisms are put in place to ensure that debt flows are devoted to finance infrastructure projects as prescribed. Finally, when additional federal transfers are available during the fiscal year (e.g. due to higher-than-budgeted oil prices), states receive the added transfer upon presentation of the infrastructure project where the sources are going to be committed to. However, this investment is not necessarily in addition to that envisaged in the annual state budget, so the additional transfer could ultimately be financing current expenditures.

36. The authorities, in the National Public Finance Convention, have identified some legal constraints on states’ debt management at the three levels of government.

  • At the federal level, the authorities listed the following elements: (i) the absence of a constitutional chapter regulating public finance federalism, including revenues, expenditure, and debt at the three levels of government; and (ii) the lack of a macro-fiscal law ensuring sustainable federal debt paths (including direct and indirect debt, and contingent liabilities);.

  • At the state level, the authorities have identified: (i) the lack of homogenous regulation across states; (ii) lack of common criteria in terms of transparency and public finance reporting; and (iii) the absence of a public finance coordination law that would substitute the current Fiscal Coordination Law to include regulation with respect to revenues, expenditures, and public debt.

  • At the municipal level, the identified factors that constrain debt management are: (i) the lack of regulation in terms of municipal indebtedness; and (ii) the lack of normative measures on the supervision of the executive and local congress.

Accounting for Contingent Liabilities

37. States and municipalities need to make explicit accounting of their contingent liabilities. The analysis in the previous section indicated that debt levels do not threaten macroeconomic stability. However, the statistics do not give a sense of the real burden that states and municipalities could be facing. Contingent liabilities are important, due largely to underfunded state pension funds. State pension fund deficits may surpass debt levels. Most Mexican states have not made provisions for pension liabilities in line with financial stability over the medium term. The SHCP has reported the contingent liability of state pension funds, as of 1998, at around 25 percent of GDP. This contingent liability represents about half the actuarial deficit of the Social Security Institute.80 Although the lack of a long-term vision has undermined allocations to state pension funds, some states have undertaken reforms to increase retirement age, employee contributions, and pension provisions to strengthen their system.

38. Public enterprises and other state institutions also generate contingent liabilities. States and municipalities have provided guarantees on loans to their respective decentralized agencies and public enterprises, as most public enterprises regularly report weak financial positions. Public enterprises usually charge prices below costs, usually without taking into consideration asset depreciation. In order to facilitate credit to these institutions, or to reduce financing costs, states have provided guarantees, although there is no indication about their extent.

39. The authorities have discussed the need to identify contingent liabilities for states and municipalities. In the National Public Finance Convention, the following factors were identified as constraining an adequate planning for contingent liabilities: (i) the absence of a national pension system; (ii) the lack of uniform concepts and methodology across states to evaluate contingent liabilities; (iii) the lack of adequate incentives to face the problem; and finally, (iv) the need to find consensus to identify the problems and propose solutions.

G. Conclusions

40. This chapter has analyzed the institutional framework for subnational debt contraction, its implications in terms of financing diversification, and the debt structure for states. Since the crisis in 1995, Mexico has taken a proactive strategy in designing decentralization. In this sense, Mexico has been progressing toward more autonomy, fiscal responsibility, and accountability of subnational levels of government. After the government’s takeover of state debt during the Tequila crisis, the federal government eliminated discretionary federal transfers, and in 2000 introduced a regulatory framework for debt management for states and municipalities that combined market discipline and rules-based mechanisms.

41. The framework, while improving discipline in debt management and allowing subsovereign Mexico to diversify financing sources, results in a more rigid financial structure. States and municipalities are complying with the requirement of holding credit ratings, which helps discriminate the cost of capital across states and municipalities in line with financial risks and costs. States and municipalities have accessed local debt markets, favored by low domestic interest rates, the 2001 stock market reform, and the development of a solid base of institutional investors after the 1999 pension reform. Capital market financing has allowed states and municipalities to diversify their financing sources and investor base, and to extend the maturity of their debt. However, all issuances have been done through a master fund structure, which pledges state revenues (mainly non-earmarked federal transfers). While this structure improves the credit quality of states’ debt instruments, the finances of the states become more rigid as more future revenues are allocated to predetermined debt service. Despite good credit ratings, states and municipalities have not yet issued unsecured debt instruments.

42. Mexico’s subnational government debt has risen gradually since the end 1990s although it remains low and concentrated in a few states, while states continue to rely heavily on federal transfers as their main revenue source. The debt stocks of Mexican states do not provide a complete picture of their financial health, as they do not include debt taken over, or financed by, the federal government through extraordinary and discretionary transfers. Despite increased decentralization, states continue to be reliant on federal transfers as their main source of revenue. Own revenues account only for 12 percent of their total revenues, and the bulk of state government expenditure is concentrated on current expenditures. Debt levels only reach 2 percent of national GDP, but subnational government debt is concentrated in a few states. The Federal District, State of Mexico, Nuevo León, and Sonora represent, on average, 65 percent of total subnational government debt.

43. Although the framework put in place in 1999-2000 has moved Mexico toward a market-driven approach to state borrowing, further work is required to improve debt management practices across states. First, obstacles remain to obtaining financial results from the analysis of states’ public finances, mainly due to the absence of an harmonized framework for public finance accounting and disclosure of information. Registration of state debt within the SHCP could improve subsequent monitoring of indebtedness. Secondly, states and municipalities need to make an explicit accounting of their contingent liabilities. In this regard, the authorities have discussed proactively the need to identify the contingent liabilities for states and municipalities. States also need to identify the extent of their contingent liabilities in public enterprises and other state institutions.


  • Amieva-Huerta, J. (1997), “Mexico,” in Federalism in Theory and Practice: A Collection of Essays, International Monetary Fund.

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Prepared by M. Vera Martin (ICM).


Productive investments are not defined.


Disposable income is measured as the sum of own revenues and the nonearmarked component of federal transfers to states (participaciones, excluding transfers to municipalities), which is the main source of revenues for the states. See Section F for a more detailed analysis on the revenue structure of states.


The inability to service debt was not due to short maturities. Average maturity of subnational debt stood at 6.5 years by end-1994, with San Luis de Potosi being the state with lowest average maturity (at 2.7 years).


When participaciones are used as collateral, all transfers received through Ramo 28 are considered, including the 20 percent of the federal revenues (Recaudacion Federal Participable, RFP), 2.1 percent of RFP for economic incentives, and 1 percent of RFP for coordination rights.


According to bank regulation, the exceptional regime implied that all subnational lending was exempted from normal provisioning requirements and exposure concentration limits.


The internal structure of the Secretary of Finance was modified for its coordination unit with federal entities (UCEF) to act as the only window for states and municipalities, and to take over the registry of subnational debt.


The state of Campeche received an A local-scale rating from Standards&Poors on September 23, 2004.


Debt contracted by the Federal District needs approval from the federal government and is incorporated in the annual budget.


In pledging resources to the master fund, some states have defined a percentage of its revenues to be allocated for an specific issuance. Other states have allocated that percentage to the master fund, without assigning a particular percentage to each financing instrument.


The reserve account can be called on if the principal and interest accounts do not hold sufficient funds.


An acceleration clause is a provision in the bond that typically allows the bondholders to declare the full amount due and payable immediately upon occurrence of some event of default as described in the bond’s features.


There is not sufficient data available to analyze interest rate risks on subnational debt.


The study was prepared by Hewitt and Associates and refers to 29 states.