NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed Mexico's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'BBB+'. The issue ratings on Mexico's senior unsecured Foreign and Local Currency bonds are also affirmed at 'BBB+'. The Rating Outlooks on the Long-Term IDRs are Stable. The Country Ceiling is affirmed at 'A' and the Short-Term Foreign Currency IDR at 'F2' and Short-Term Local Currency IDR at 'F2'.
KEY RATING DRIVERS
Mexico's 'BBB+' ratings are supported by the country's diversified economic base and a track record of disciplined economic policies that has anchored macroeconomic stability and curbed imbalances. These strengths counterbalance Mexico's rating constraints, which include its historically moderate economic growth, structural weaknesses in its public finances, such as low fiscal buffers in the context of oil dependence of fiscal accounts, a relatively low level of financial intermediation and institutional weaknesses highlighted by the high incidence of drug-related violence and corruption.
Mexico has been hit by the sharp decline in oil prices, continuing international financial volatility and a sluggish U.S. industrial sector. Despite these headwinds, the economy has proven to be relatively resilient and the authorities are adjusting economic policies to adjust to the new external environment in a timely and orderly manner. The peso has depreciated, monetary policy has been tightened twice in 2016 by a cumulative 100 basis points (bps), and the government continues to remain committed to its fiscal consolidation plan despite the shock to oil income. In addition, Pemex, the state oil company, has announced spending cuts to facilitate the adjustment to the new subdued oil price outlook, which if successfully executed could reduce risks for the sovereign balance sheet.
Fitch projects growth will reach 2.4% in 2016, led mainly by private consumption (and services on the supply side), which is being supported by low inflation, job creation and credit growth. Growth is expected to accelerate moderately to an average of 3% in 2017-2018 on the back of a competitive peso, improved external conditions and some boost from the implementation of structural reforms that were passed a few years ago. The risks are mainly to the downside and stem from possible intensification of the above-mentioned headwinds. The government has made some progress on conducting auctions of oil fields to attract private investment and has announced additional rounds but subdued oil prices could pose challenges for the successful execution.
Macroeconomic stability is well-anchored by low inflation and a moderate (although increased) current account deficit that is predominantly financed by foreign direct investment flows. Despite the peso depreciation and volatility, Mexico's inflation remains below the center of the target range of 3%+/-1% so far in 2016 and the monetary tightening should help in better anchoring inflation expectations in the context of peso weakness. Fitch forecasts the current account deficit to deteriorate and average 3% of GDP during 2016-2018 from 1.5% of GDP during 2010-2014. However, adequate international reserves, the elimination of the rules-based FX intervention mechanism, the access to a fortified IMF FCL (now amounting to USD88 billion, up from around USD67 billion previously) and a flexible exchange rate should facilitate an orderly adjustment to the tighter external financing environment.
Reduced oil income represents a challenge for fiscal accounts, although the expansion of the non-oil revenue base as a result of the 2013 tax reform has provided an important cushion to absorb the shock. Fitch projects that the federal government fiscal deficit will reach 3% of GDP in 2016. The 2016 fiscal results will be supported by the oil hedge, favourable non-oil revenue growth, and non-recurrent revenues, mainly related to the transfer of the operating surplus of the central bank to the government (1.2% of GDP) although the financial support provided to Pemex will prevent a faster federal government consolidation.
Fitch expects the government to implement spending adjustments in 2017 to meet its medium-term non-financial public sector deficit targets. In April, the government announced its intention to cut spending by 0.9% of GDP in 2017. Downside risks to fiscal consolidation come from weaker growth, further shocks to oil income, and difficulty in executing spending adjustments. The implementation of cost adjustments at Pemex will be important for preventing fiscal slippage and reducing an important element of broader fiscal uncertainty for the future.
Continued primary deficits, subdued growth and FX depreciation have led to a steady increase in the government debt burden in recent years. Fitch projects that the general government debt could peak in 2016 before declining slightly over the forecast period. This assumes that the government provides the remaining support to Pemex (approximately 0.7% of GDP) this year for securing a pension deal with its union.
Mexico's prudent liability management, excellent access to international capital markets and relatively deep local markets provide financing flexibility to the sovereign. The non-resident participation in local markets has grown in recent years and exposes Mexico to the U.S. Fed tightening cycle and shifts in international investor appetite. The foreign holdings of domestic debt have fallen somewhat in recent months, remaining relatively high at around 33% of total domestic government securities.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Mexico a score equivalent to a rating of 'BBB' on the Long-Term Foreign Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
Macro: +1 notch, to reflect Mexico's long track record of prudent, credible and consistent economic policies. The authorities continue to emphasize macroeconomic stability in their policy actions, which has contained macroeconomic imbalances.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
RATING SENSITIVITIES
The main factors that could, individually or collectively, lead to a negative rating action are:
--Weak economic growth performance and/or fiscal deterioration leading to a worsening of government debt dynamics. Materialization of contingent liabilities that undermine the sovereign's balance sheet;
--A deterioration in the consistency, flexibility and credibility of the macroeconomic policy framework.
--A deterioration in the economic, trade, and financial links of Mexico with the U.S.
The main factors that could, individually or collectively, lead to a positive rating action are:
--Improved investment and growth prospects that help reduce Mexico's income gap with higher-rated sovereigns over the medium term;
--Reduced fiscal vulnerability related to lower reliance on oil income, successful fiscal consolidation and a reduction in government debt burden that boosts flexibility to confront shocks;
--Improvements in governance indicators that address Mexico's institutional weaknesses.
KEY ASSUMPTIONS
--Fitch assumes that U.S. growth will be broadly supportive for Mexico's economic performance during 2016-2018.
--Fitch assumes that oil (Brent) price recovers gradually to USD45/barrel in 2017 and USD55/barrel in 2018.
--Fitch assumes that the Mexican government adheres to its medium term fiscal consolidation plan with the narrow non-financial public sector deficit reaching a balanced position by 2017.
Additional information is available on www.fitchratings.com.
Applicable Criteria
Country Ceilings (pub. 20 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869287
Sovereign Rating Criteria (pub. 18 Jul 2016)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=885219
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1009641
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1009641
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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