Mexico turns to mining to plug its fiscal gap

Monterrey, Mexico — Opposition lawmakers in Mexico are pushing for a royalty on Mexican mining production as the country faces a fiscal gap of 3% of gross domestic product next year following its worst economic recession since the 1930s.

To the unease of miners who have made Mexico one of the world’s top places for mining investment this decade, lawmakers are proposing a 4% levy on output to generate around 4.7 billion Mexican pesos (US$350 million) a year in extra revenue.

The move would increase by more than fivefold the tax take from mining, a sector that has historically been safe from the resource nationalism that has burdened Mexico’s energy sector and state oil monopoly Pemex.

Mining has become one of Mexico’s fastest-growing industries, with its rich gold, copper and silver deposits in relatively accessible geography, an open mining code and a surge in investment from companies such as Fresnillo (FNLPF-O, FRES-L), Kings Minerals, Frontera Copper (FCC.NT-T) and Goldcorp (G-T, GG-N).

Mexico’s top copper miner Grupo Mexico (GMBXF-O, GMEXICOB-M) is also a major investor and the government said earlier this year it is in talks with Barrick Gold (ABX-T, ABX-N) to invest in Mexico and that Chinese companies are also keen to invest.

The senator behind the royalties proposal, Francisco Arroyo, hails from the central mining state of Guanajuato and says mining towns in Mexico have long suffered while mining companies have made huge profits.

He says mining companies have paid exceptionally light taxes for years, paying taxes on land concessions that vary from around 5 pesos (US37¢) to 101 pesos (US$7.75) per hectare. It is a familiar complaint that has driven legislators in Chile, Peru and Ecuador to levy contentious royalties in the past few years.

“The communities are left with the destruction of the environment and the extraction of non-renewable resources without receiving any benefits in exchange,” Arroyo, of the opposition Institutional Revolutionary Party, or PRI, told Mexican newspaper Reforma in an interview last month.

Arroyo says the new royalty would generate money to go directly to state, rather than federal, coffers in a potential boost for mining states that are mainly in northern Mexico near the U.S. border, such as Coahuila, Chihuahua and Sonora.

Given its mineral potential and current lack of royalties, Mexico ranks above Chile and Argentina as one of the world’s best places to mine, according to the Fraser Institute’s 2008/09 Mining Survey.

Mexico has become the world’s fourth-most popular destination for mining exploration after Canada, Australia and the United States, capturing 6% of global exploration spending last year, according to the Metals Economics Group in a study of more than 1,900 mining companies.

Mexico’s gold output has grown by around a quarter every year since 2003 and could jump 40% to almost 85 tonnes as five new mining operations reach full capacity, including Goldcorp’s Penasquito mine.

Around three-quarters of Mexico’s territory is believed to hold significant mineral resources.

Indeed the royalties debate never gained much traction even as Ecuador introduced the taxes last year and Peru kicked up protests as it brought in royalties in 2005 and 2006.

But this year, Mexico is scraping around for extra income as its oil production tumbles after years of underinvestment and deadlock in Congress has meant several bills aimed at widening the country’s low tax base have floundered.

PRI lawmakers with the backing of other leftist senators are trying to take advantage of an unpopular tax package drawn up by President Felipe Calderon that seeks to levy a 2% sales tax on consumer goods and increase income tax to plug the fiscal gap next year.

As popular opposition grows to the sales tax, a mining tax looks like an attractive way of raising revenues without too much fuss, as the industry has always had a relatively low profile in Mexican politics.

Members of Calderon’s ruling conservative National Action Party (PAN) say they are studying the bill and have yet to criticize it in what some analysts see as a possible sign of approval.

“The increase in taxes is not considered in our projections although we believe the likelihood of it happening is high,” says metals analyst Luis Miranda at Banco Santander in Mexico City, noting that the PRI and the main leftist party, the Revolutionary Democratic Party, or PRD, control 62% of the Mexican lower house and together have 45% of the Senate. “It could have a significant impact on Grupo Mexico’s mining revenues,” he adds.

Not that miners are going down without a fight. In interviews with local and international media, Grupo Mexico has warned the royalties will “halt mining development” and mining executives are quietly lobbying senators not to push ahead with the tax.

While not directly criticizing the royalty proposal, Mexico’s mining chamber said investment in new exploration is set to fall by a quarter to US$2.7 billion this year and could drop to US$1.7 billion next year as mining companies suffer from the global financial crisis.

Metals analysts in Mexico City also warn the royalty is clumsily drawn up, as it is a proposal to tax production rather than sales and meaning miners would have to pay royalties even in times of recession or low metals prices.

They also say that it does not differentiate between large and small-scale miners. Even in Ecuador, where the government is considered hostile to many foreign investors, the new mining law includes a sliding-scale tax on sales, rather than a fixed tax on production.

“It would be more appropriate to levy the charges on sales volumes and not on production, since otherwise, the tax would be levied on the inventory levels that are indispensable in this cyclical industry,” Rodrigo Heredia, an analyst at Ixe brokerage, wrote in a report last month.

Senator Arroyo appears to be flexible, saying he wants to hear from miners and is willing to debate details and technical issues surrounding the tax, although not the tax itself. “We know that it has generated discontent in the industry, but we are open to listening to their (miners’) position. Maybe we could lower the rate, or we could raise it,” he told Reforma.

— The author is a freelance writer focused on mining issues and based in Monterrey, Mexico. She can be reached at lozanoleticia@yahoo.com .