Mexico’s fiscal reform bill, presented to congress earlier this week by the government of Felipe Calderon, would boost the prospects for an upgrade of Fitch’s ‘BBB’ foreign currency rating on the sovereign, analyst Shelly Shetty told Emerging Markets today. However, the bill must first navigate its way through congress, and investors believed the markets had already priced in a successful outcome.
Fitch put the ratings on Mexico on positive outlook in March this year, but emphasized that the government would need to reduce budgetary reliance on oil revenues and take action to avert a decline oil output, in order to secure an upgrade. Mexico is also rated ‘BBB’ by Standard & Poor’s, but with a stable outlook.
The bill aims to add up to 2.8% of GDP to fiscal revenues through the establishment of a 16% flat tax rate on corporate incomes in 2008 (increased to 19% from 2009), together with a number of other new levies, and an overhaul of tax administration to curb evasion.
Shetty said she believed these goals were realistic, and would also smooth the path to increased investment by the country’s state-owned oil and gas producer Pemex, to bolster production at its maturing fields.
“Our sense is that the authorities have done their homework on how much these reforms would raise. They are very aware of the situation at Pemex, and of the constitutional constraints that they face [on private investment in the company]. As such, a fiscal reform that gets them around 3% of GDP does give them some room to relieve Pemex from its high tax burden,” Shetty told Emerging Markets.
Any ratings action would have to wait until the bill had passed through congress, but Shetty was reasonably confident that the legislation would be left largely intact.
“I think a large part of the horse-trading has been done behind the scenes before the bill was submitted. The government has been more interested in a bottom-up approach than the Fox administration, which means they would prefer a reform that is more politically feasible,” she explained. “So they have stayed away from trying to expand the base on which tax can be imposed: politically, that was always a non-starter. But there is still scope for further dilution,” Shetty warned.
That said, the measures now before congress, combined with public sector pensions reform earlier in the year, have expended much of the government’s political capital. Shetty anticipates that the government will need to bed down such reforms over the next six to eight months, after which Mexico will enter the campaign period ahead of the mid-term elections, stifling prospects for further momentum.
Moreover, Siobhan Morden, Latin America local markets strategist at ABN Amro in New York, pointed out that Mexican bonds actually sold off in line with global turbulence on the day the bill was sent to congress, indicating that investors had already discounted its passage.
“For the most part, Mexico is trading at historically tight levels to US swaps and Treasuries, especially at the long end, so it is hard to see the market going further on this reform alone,” Morden told Emerging Markets.
Still, she noted that the prospect of an upgrade if the reform passed successfully would provide some support to Mexican assets if US markets remained nervous in the coming weeks.
“It is a positive development, so there will be a reluctance to sell short the bonds or pay the Mexico rates,” Morden concluded.