NEW YORK--(BUSINESS WIRE)--Fitch Ratings has revised the Rating Outlook on Mexico's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) to Negative from Stable and affirmed them at 'BBB+'. The issue ratings on Mexico's senior unsecured foreign- and local-currency bonds are also affirmed at 'BBB+'. The Country Ceiling is affirmed at 'A' and the Short-Term Foreign and Local Currency IDRs at 'F2'.
KEY RATING DRIVERS
The revision in Mexico's Outlook reflects increased downside risks to the country's growth outlook and the challenges this could pose for stabilization of the public debt burden. Growth has been under-performing rating peers and the general government debt burden has been increasing steadily in recent years. The victory of Donald Trump in the U.S. presidential election has increased economic uncertainty and asset price volatility in Mexico as the President-elect has alluded to renegotiating or terminating the North American Free Trade Agreement (NAFTA) with Mexico and tightening immigration controls.
Mexico's modest growth profile is a rating weakness. Its five-year GDP growth average of 2.4% is weaker than the 'BBB' median of 3.1% and Fitch has cut its growth forecast for Mexico to below 2% for 2017, with downside risks continuing to persist. Fitch believes that domestic demand and economic growth will suffer from higher economic uncertainty reflecting doubts over possible NAFTA renegotiation and U.S. immigration policies, the volatility of the peso, a continued fall in oil production, and economic policy tightening. Higher inflation could also hinder consumption growth. Notwithstanding a more competitive peso, weak U.S. industrial production has hindered the performance of Mexico's manufacturing exports.
U.S. policy on trade and immigration has significant relevance for Mexico. Trade and financial ties between Mexico and the U.S. have increased significantly since the implementation of NAFTA in 1994. Several industries (particularly the auto industry) have seen increased integration between the two countries. Over 80% of Mexico's exports are destined for the U.S., which is also a leading provider of foreign direct investment flows to Mexico. Mexico also receives around 2% of GDP in annual workers' remittances, predominantly from the U.S.
Attempts to renegotiate NAFTA or hinder the outsourcing of activity from the U.S. to Mexico could prove to be disruptive for the Mexican manufacturing export sector and adversely impact employment, investment (including foreign direct investment) and the country's growth. Mexico's current account deficit has been worsening somewhat in recent years (from just over 1% of GDP in 2011-12 to close to 3% of GDP in 2015) and any hit to trade and remittances flows could lead to a continuing deteriorating trend. Moreover, the financing of the current account deficit could also become less favorable should foreign direct investment flows decline.
Public finances have been facing pressure from the decline in oil income, although the expansion of the non-oil revenue base from the 2013 revenue-enhancing reform and spending adjustments have helped absorb this shock. The government has also been consolidating public sector accounts despite the oil income shock, while Pemex is also adjusting its budget to confront the subdued oil price environment. Mexico's 2017 budget incorporates further consolidation and targets a non-financial public sector primary surplus of 0.4% of GDP, the first since 2008.
Weak growth and primary deficits in recent years along with one-off issuance of debt to the productive enterprises of the state have led to a steady increase in the government debt burden. Moreover, weaker growth along with peso weakness and volatility add downside risks for public debt stabilization. Fitch's estimate of general government debt is forecasted to reach around 47% of GDP in 2017, increasingly diverging from the 'BBB' median of 40.3%, and highlights the steady erosion of fiscal flexibility to confront shocks.
The significant presence of non-residents in the government's domestic bond markets can be a source of vulnerability especially during times of higher uncertainty and financial volatility. The foreign holdings of domestic debt have fallen somewhat in recent months, remaining at over 30% of total domestic debt government securities. However, adequate international reserves, the access to a fortified IMF Flexible Credit Line (amounting to USD88 billion, up from around USD67 billion previously) and a floating exchange rate should provide a buffer and flexibility to deal with capital outflows and market volatility.
The sharp depreciation of the currency will increase inflation, which until now has remained moderate. Headline inflation reached 3.3% in November, slightly above the center of the target range of 3%+/-1% and the central bank has already increased interest rates by 200 bps so far in 2016, including a 50 bps increase in November, in order to better anchor inflation expectations.
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.
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 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. However, in Fitch's view this relative strength is on a deteriorating path, as evidenced by weak GDP growth out-turns.
Fitch's SRM is the agency's proprietary multiple regression rating model which employs 18 variables based on three-year centered 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 downgrade are:
--A deterioration in the economic, trade, and financial links of Mexico with the U.S. that dampen Mexico's investment and growth prospects and/or weaken its external balance sheet.
--Weak economic growth performance and/or fiscal deterioration leading to a failure to place gross general government debt/GDP on a downward path. Materialization of contingent liabilities that undermine the sovereign's balance sheet.
--A deterioration in the consistency, flexibility and credibility of the macroeconomic policy framework.
The Rating Outlook is Negative. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a positive rating change. Future developments that could individually, or collectively, result in a stabilization of the Outlook include:
--Improved growth performance and successful fiscal consolidation that improves the outlook for the public debt trajectory.
--Reduced risks of disruption to trade and financial flows (including foreign direct investment) to Mexico.
KEY ASSUMPTIONS
--Fitch assumes that U.S. growth will grow at 2.2% in 2017 and 2.3% in 2018.
--Fitch assumes that oil (Brent) price recovers gradually to USD45/barrel in 2017 and USD55/barrel in 2018.
Additional information is available on www.fitchratings.com
Applicable Criteria
Country Ceilings (pub. 16 Aug 2016)
https://www.fitchratings.com/site/re/885997
Sovereign Rating Criteria (pub. 18 Jul 2016)
https://www.fitchratings.com/site/re/885219
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