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RPT-Fitch: Mexico's fiscal reform neutral for sovereign credit
September 11, 2013 / 3:32 PM / 4 years ago

RPT-Fitch: Mexico's fiscal reform neutral for sovereign credit

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CHICAGO, September 11 (Fitch) The Mexican government's recently proposed fiscal 
reform and the 2014 budget are broadly neutral for its sovereign 
creditworthiness, according to Fitch. The positive impact from the expansion of 
the government's revenue base needs to be counterbalanced by the near-term 
weakening of the economy and higher-than-expected fiscal deficits in the coming 
years. 

Fitch upgraded Mexico's sovereign ratings by one notch (Long-Term Foreign 
Currency IDR to BBB+ from BBB and Long-Term Local Currency IDR to A- from BBB+) 
on May 8, 2013, to reflect the country's improving fundamentals and the 
greater-than-anticipated reform momentum under the Pena Nieto administration. 

One of the key assumptions underpinning our upgrade of Mexico was the 
expectation that Mexico will continue to make progress on reforms that improve 
its fiscal flexibility and promote economic growth. In this regard, the 
announced tax reform proposal highlights the continued commitment of the 
government to make progress on its reform agenda.

The fiscal reform seeks to increase the overall federal government revenues by 
1.4% of GDP in 2014, increasing to 2.9% of GDP by 2018. The package involves an 
increase in the marginal income tax rate for Mexicans earning above MXN500,000, 
introduction of a 10% tax on capital gains from stock market transactions and 
dividends, and imposition of taxes on soft drinks.

A positive feature includes the elimination of several income tax breaks and 
exemptions that have traditionally plagued the tax code. Authorities also 
estimate greater revenues from the excise taxes on gasoline. Moreover, the 
reform includes a new fiscal regime for Pemex to enhance its investment 
flexibility. Measures to reduce high labor informality are positive too. 
However, the government refrained from imposing the value-added tax (VAT) on 
food and medicines that could have had a large positive impact on revenues.

A narrow, non-oil tax base for the federal government (only about 10% of GDP) 
and the high dependence on oil for non-financial public sector revenue (over 
33%) have been highlighted as key structural weaknesses of Mexico's public 
finances. In this regard, the proposed reform should allow progress on expanding
the overall tax base, although fiscal dependence on oil revenue will remain 
high. A broader revenue base will enhance the capacity of the government to deal
with spending pressures such as the provision of universal pension and 
unemployment insurance included in this package. 

The creation of a Sovereign Wealth Fund and the implementation of a structural 
fiscal balance rule, including caps on current spending, represent progress on 
strengthening the institutional framework. However, the effectiveness of these 
measures will depend on how the final rules are defined and implemented, as well
as the actual economic and fiscal performance of Mexico. 

It remains to be seen whether the current package will be passed without 
significant changes that dilute its final impact. Moreover, even after passage, 
the effectiveness of the measures to raise the government's revenue intake can 
only be judged over the coming years and will depend critically on their 
implementation. Effective implementation will help ensure that the projected 
expansion of the tax base materializes, especially in light of the new spending 
commitments. 

Despite the revenue enhancing measures, the 2014 budget envisions a 
non-financial public sector deficit (excluding Pemex investment) of 1.5% of GDP 
for next year (higher than our expectations) as the government responds to the 
weakening economy. The authorities estimate a gradual reduction in this deficit,
which is expected to reach a balanced position by 2017. The new fiscal 
trajectory could moderately increase the general government debt/GDP ratio. 
Mexico's general government debt burden, at close to 40% of GDP, is currently in
line with the 'BBB' median. 

Mexico's revenue base will remain moderate in comparison to its rating peers, 
even if the current reform is passed. Currently, Mexico's general government 
revenue base of below 20% of GDP is materially lower than the 'BBB' median and 
the proposed tax reform will only facilitate some bridging of this gap. We do 
not anticipate an immediate positive rating impact from the passage of the 
fiscal reform. Instead, we will monitor how well the reform is implemented and 
to what extent it boosts the country's fiscal flexibility over time. 

We have noted that a sustained period of high growth that bridges Mexico's 
wealth gap with the higher rated sovereigns and material gains in fiscal 
flexibility will be the key considerations for improving Mexico's credit 
profile. 

Contact:

Shelly Shetty

Senior Director

Latin American Sovereigns

+1 212 908-0324

Bill Warlick

Senior Director

Fitch Wire

+1 312 368-3141

Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549, Email: 
brian.bertsch@fitchratings.com; Elizabeth Fogerty, New York, Tel: +1 (212) 908 
0526, Email: elizabeth.fogerty@fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market 
commentary page. The original article can be accessed at www.fitchratings.com. 
All opinions expressed are those of Fitch Ratings.

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