Fitch Affirms Mexico's Sovereign Ratings; Outlook Stable

Business Wire,  July 10, 2008  

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NEW YORK -- Fitch Ratings today affirmed Mexico's sovereign ratings as follows:

--Long-term foreign currency Issuer Default Rating (IDR) at 'BBB+';

--Long-term local currency IDR at 'A-';

--Short-term IDR at 'F2';

--Country Ceiling at 'A'.

The Rating Outlook is Stable.

A comparatively strong macroeconomic policy framework, well-entrenched macroeconomic stability, and healthy external finances, including a modest external debt burden, support Mexico's investment-grade ratings. Mexico's relatively diverse economy, a robust financial system and strengthening political institutions are additional credit strengths. On the other hand, less dynamic growth, structural weaknesses in public finances as well as its relatively weak social indictors, which continue to exert budgetary pressures, constrain Mexico's ratings.

'While the authorities continue to face a challenging environment of slowing growth and rising inflation, the Mexican economy is in a better position to cope with a U.S. slowdown due to its more entrenched domestic demand, healthy credit growth to the private sector, some diversification of its trading partners and implementation of counter-cyclical fiscal policies' said Shelly Shetty, Senior Director in Fitch's Sovereign Group. Fitch projects GDP growth to slow to 2.5% this year below 3.2% recorded last year. Despite the negative impact of the U.S. downturn on Mexican manufacturing exports and overseas worker's remittances, Fitch expects Mexico's current account deficit to remain below 1% of GDP and it is likely to be fully funded by foreign direct investment flows. In addition, Mexico's external solvency ratios are either better or in line with the 'BBB' median.

Similar to other emerging markets, inflation has continued to rise in Mexico and it is expected to remain above the ceiling of the interval band of the inflation target of 3+/-1% in 2008. Fitch believes that Banxico's task continues to be challenging, as it has to balance the upside risks to inflation from further supply shocks (food and energy prices) as well as eventual elimination of voluntary price agreements against downside risks arising from weakening external demand. However, on a relative basis, Mexico's average inflation rate is among the lowest in the 'BBB' category and considerably lower than that of peers like Russia ('BBB+'), South Africa ('BBB+') and Latvia ('BBB+') and the deviation from the inflation target is less than seen in some of the other emerging markets in this rating category. 'The central bank's recent interest rate hike reflects its commitment to fighting inflation and should help in anchoring inflationary expectations and limiting second-round effects from rising food and energy inflation', added Shetty.

While the passage of the fiscal reform boosted fiscal flexibility and credibility last year, structural weaknesses in public finances remain. Dependence on oil revenues is high and the fiscal cushion against a sharp correction in oil prices is limited as resources in Mexico's Oil Stabilization Fund amount to less than 1% of GDP, which is quite modest in comparison with oil exporters such as Russia and Kazakhstan (also in the 'BBB' category). Budgetary pressures would rise if oil production declines persist, although in the near term the country continues to benefit from a highly favorable oil price environment.

Beyond the cyclical downturn that Mexico is confronting, structural factors - including relatively weak infrastructure, relatively low savings and investment levels, labor market rigidities, and limited competition in the key utilities sector - continue to constrain the growth potential of the country. Five-year growth average for Mexico remains relatively low at 3.3% compared to the 'BBB' median of 5.5%. While higher infrastructure spending that is expected in the coming years could boost productivity of investment and improve the business climate, the extent to which this affects potential growth of the economy will depend on project selection and execution. Although the energy sector reform has been submitted to Congress, it is unclear whether it will pass a significant reform that attracts private investment, especially in deep-sea exploration.

Passage of structural reforms and further improvement in business climate indicators that allow for faster economic growth and enable Mexico to bridge its gap on per capita income level with the 'A' median would be viewed positively. Further improvement in fiscal and external solvency ratios as well as a reduction in the vulnerability of public finances to oil income could also boost sovereign creditworthiness. On the other hand, a significant and persistent decline in oil production that compromises public finances (especially in a less favorable oil price environment) and results in higher public debt burden would be negative for the rating.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

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