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UPDATE 1-Mexico's budget needs to balance weak growth, fiscal discipline

Anthony Esposito

(Adds finance minister quotes)

MEXICO CITY, Sept 8 (Reuters) - The Mexican government's 2020 budget will have to strike a careful balance, weighing the realities of slowing economic growth and dwindling income with commitments to fiscal discipline.

Market watchers, credit ratings agencies and investors will pore over the budget proposal when Finance Ministry officials present it to the Lower House of Congress on Sunday evening for guidance on President Andres Manuel Lopez Obrador's spending priorities for Latin America's second-largest economy.

Finance Minister Arturo Herrera previewed the budget blueprint on Saturday by highlighting three priorities he said will see more funding: social welfare programs, the new National Guard security force as well as heavily indebted state oil firm Pemex.

"It will be an extraordinarily responsible budget," he said, stressing that the government is being careful with public spending.

"We recognize the limits of fiscal policy."

Mexico's central bank, meanwhile, has underscored in its most recent statements that next year's budget must "generate confidence."

Lopez Obrador, a leftist nationalist who won a landslide election victory last year, has promised another austere spending plan with no new taxes, tax increases or gasoline price spikes beyond inflation.

But the government has limited room to cut from programs after it reduced funding for several ministries in order to centralize spending, fight public sector corruption and honor a campaign pledge to implement fiscal austerity in its first budget in December.

Mexico's hospitals, the immigration service and shelters for victims of domestic violence were among the services hit by the steep budget cuts.

"We have to recognize that we have a serious income problem, we have the decision and commitment of maintaining a surplus, of fulfilling the financial obligations of the Mexican state," said Alfonso Ramirez Cuellar, who chairs the budget committee in the Lower House.

Falling oil production and prices, as well declining resources from income and value-added taxes as Mexico's economy barely escaped entering a recession, have meant lower government resources, said Ramirez Cuellar, who is also a member of Lopez Obrador's leftist National Regeneration Movement (MORENA).

He said the government's spending priorities next year will include the key energy sector, health, education and beefing up the National Guard, a new security force created by Lopez Obrador to bring down record homicide rates.

ALL EYES ON THE FISCAL SURPLUS

Security Minister Alfonso Durazo has said he expected the budget to set aside 56 billion pesos ($2.87 billion) for the National Guard.

The National Guard has placated President Donald Trump by patrolling the border to stem the flow of U.S.-bound migrants, down 56% between May and August, according to Mexican government figures on Friday.

Other spending priorities will likely include infrastructure projects such as a new refinery, the so-called Mayan Train project and transfers to state-owned oil company Pemex.

One of the most salient measures of Lopez Obrador's commitment to fiscal responsibility will be the primary fiscal surplus targeted for next year.

To keep markets happy, the primary fiscal surplus needs to be above 0.5% of GDP, since going below that "would signal a weakening commitment to fiscal discipline," according to Alberto Ramos, head of Latin American research at Goldman Sachs in New York.

A preliminary budget forecast sent to lawmakers in April forecast a primary surplus of 1.3% of GDP for 2020.

"We have to keep looking for ways to stabilize the debt trajectory. We have to have some level of primary surplus and we have to look for sources so that income continues to grow," Herrera said.

Ramirez Cuellar said the primary surplus would hover around 1%.

If the budget ultimately targets that level, "that wouldn't be a disaster, though, since two consecutive years of primary surpluses is good going, particularly for a left-wing government," said Edward Glossop, emerging market economist at Capital Economics.

($1 = 19.5293 Mexican pesos) (Additional reporting by David Alire Garcia; Editing by Darren Schuettler and Lisa Shumaker)