DBRS Confirms BBB Ratings of Mexico, Trend Remains Stable

DBRS Ratings Limited (DBRS) has confirmed its ratings on the United Mexican States’ (Mexico) long-term foreign currency securities at BBB and long-term local currency securities at BBB (high), and maintained Stable trends on both ratings. The Stable trends reflect Mexico’s proven track record of decisive and predictable macroeconomic management, which has provided resilience during the international financial crisis.

The ratings are underpinned by Mexico’s strong policy response over the past four years in the form of well-managed public finances with moderate debt ratios, well-engineered monetary easing with low and stable inflation, targeted assistance to financial intermediaries and a strong commitment to a flexible exchange rate regime. This coordinated policy mix provided the backdrop for a strong economic rebound in 2010, with real GDP growth reaching 5.4%, and should continue to provide an important buffer to potential pressures arising from the global slowdown. In addition, healthy external accounts anchored in solid FDI and portfolio inflows, a sound financial system and robust international reserves add to Mexico’s ability to weather financial volatility.

The ratings are constrained by relatively low GDP growth prospects, limited fiscal flexibility due to reliance on oil revenues, and structural weaknesses that dampen economic activity. Despite some partial improvements in trade diversification, close synchronicity with the U.S. business cycle leaves the Mexican economy exposed to deterioration in U.S. conditions. Downward revisions to GDP growth forecasts for the United States suggest that Mexico could post weaker growth in 2011-2012 than originally anticipated. The subdued growth outlook is further weakened by the slow progress of structural reforms in important sectors (such as telecommunications, labor and energy), which continue to limit Mexico’s growth potential. As a result, the economy is set to continue to grow at a slower pace than its BBB-rated peers, and DBRS expects this gap to persist over the medium-term.

The risk of a more pronounced global economic crisis stemming from the sovereign debt crisis in Europe and its effect on the European banking system also weigh heavily on the ratings and provide additional downside risk for Mexico. Increasing global risk aversion could prompt a slowdown or reversal of foreign capital flows to Mexico, which have contributed to abundant liquidity in the country. While Mexico cannot escape a global slowdown, its government does have some flexibility to mitigate external shocks through policy actions.

As a result, DBRS does not expect a deterioration in public finances that could endanger the Stable trends. Mexico’s credit profile resilience is attributable to: i) disciplined public finances with moderate net general government debt (35.7% of GDP in 2010), and a well-managed debt structure, which provides fiscal flexibility and reduces debt vulnerability, ii) low and stable inflation providing room for monetary policy intervention, iii) a small current account deficit largely covered by solid FDI and portfolio inflows, which also allows the exchange rate to function as a buffer, and iv) substantial international reserves of $130 billion and a $73 billion contingent credit line with the International Monetary Fund (IMF).

DBRS also recognizes that the Mexican economy’s direct exposure to the sovereign debt crisis in the Euro zone remains relatively limited because of Mexico’s small trade volume with Europe. Mexico’s main indirect exposure to the Euro zone is the large presence of Spanish banks in its domestic banking system. DBRS believes that this potential contagion channel is relatively well insulated, as the Mexican subsidiaries of Spanish banks are autonomous with regard to capital and liquidity management. In addition, local regulation tightening and enhanced supervision should reduce the credit risk stemming from this potential channel.

Despite progress on recent reform proposals, such as the approval of a new competition law in 2011, Mexico’s political parties have already started to shift to election mode ahead of the 2012 presidential elections. This reduces the likelihood of progress on economic reforms, especially the broadening of the tax base and diversifying tax revenues away from oil. The anticipated policy slowdown is, however, unlikely to affect fiscal policy as adherence to the balanced-budget rule and windfall revenue gains on the back of high oil prices should reduce fiscal pressures. Moreover, DBRS does not expect the election cycle to have a material impact on Mexico’s creditworthiness as fundamental changes to the existing policy framework are unlikely under an Institutional Revolutionary Party (PRI) or National Action Party (PAN) led government.

Public security issues, which appear to be acting as a drag on economic activity, are likely to dominate the political debate in 2012. In 2011 the government has introduced money-laundering laws and is organizing police forces at the state rather than the local level in an effort to reduce corruption and improve coordination among law enforcement agencies. However, it will likely take several more years for these initiatives to produce lasting results.

In spite of these concerns, DBRS takes comfort in Mexico’s long-term prospects. Decisive and predictable macroeconomic management during the crisis and the resilience of the economy have stabilized Mexico’s ratings. DBRS views Mexico as well-positioned among BBB-rated credits to weather a more adverse macroeconomic environment. Just as in 2009, when DBRS maintained a Stable trend on consideration that Mexico’s BBB rating was sufficiently robust to weather shocks, DBRS does not anticipate negative rating changes in spite of a challenging environment. Equally, DBRS could raise the ratings if Mexico's GDP growth were stronger than anticipated, facilitating better fiscal dynamics, if the outlook for the oil sector were to improve, or should the government implement further structural measures to strengthen its fiscal flexibility.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on our website under Methodologies.

The sources of information used for this rating include Secretaría de Hacienda y Crédito Público (SHCP), Banco de México, INEGI and the International Monetary Fund. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Giacomo Barisone
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 28 July 2006
Most Recent Rating Update: 31 August 2010

For additional information on this rating please refer to the linking document under Related Research.