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Mexico: Tax Increases Contribute To Second Ratings Downgrade

by Mike Godfrey,, Washington

16 December 2009

Mexico is now just one step above the lowest investment grade, representing a lack of confidence in President Felipe Calderon's promised economic and tax reforms.

"The downgrade reflects our assessment that Mexico's recent steps to raise non-oil revenues and improve efficiencies in the economy will likely be insufficient to compensate for the weakening of its fiscal profile," explained Standard & Poor's credit analyst Lisa Schineller, adding that:

"This weakening stems from a combination of modest GDP growth prospects and diminished oil production over the coming years."

Standard & Poor's (S&P) Ratings Services has announced a lowering of its foreign-currency sovereign credit rating on the United Mexican States to "BBB/A-3" from "BBB+/A-2" and the local-currency credit rating to "A/A-1" from "A+/A-1."

S&P also revealed that it had lowered the transfer and convertibility assessment on Mexico to "A" from "A+", but affirmed the "mxAAA/Stable/--" national-scale rating. The outlook is stable.

S&P explained the stable outlook reflects fiscal and external indicators that are consistent with the "BBB" median, the absence of macroeconomic imbalances in the Mexican economy, and the Mexican government's longstanding commitment to macroeconomic stability.

In the midst of the deepest contraction in real GDP (estimated at 7%) in decades, the Mexican Congress passed a number of tax increases, including raising the controversial VAT, replacing lost oil revenue in the short term.

S&P reportedly considers that the effect on public-sector revenues is more likely to be worse than government estimates and lie closer to 19% of GDP, albeit much lower than the 35% for the "BBB" median.

S&P questioned Mexico's capacity to contain fiscal pressures from diminished oil production, even if oil output declined more slowly than in recent years, citing the failure to broaden the tax base meaningfully and address the many loopholes and exemptions in the tax regime. S&P expected general government deficits to average 3% of GDP (2009-2011), comparable with that of the "BBB" median.

However, on the positive side, S&P referred to Mexico's "prudent macroeconomic management", conservative management at the Finance Ministry and independent central bank, and recent steps to improve tax administration.

The ratings agency also welcomed efficiency gains associated with the closure of Luz y Fuerza del Centro (the main supplier of electricity in the central region of Mexico), new management of its assets, and forthcoming telecommunications concessions.

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