City of Queretaro 'BBB' Global Scale And 'mxAA+' National Scale Ratings Affirmed; Outlook Still Stable


OVERVIEW
  • We expect that the city of Querétaro will continue to pursue disciplined fiscal policies in 2019-2021 that will allow it to preserve sound budgetary results.
  • Currently, the city has no debt burden and has large cash reserves. Its population also benefits from strong socioeconomic conditions.
  • We're affirming our 'BBB' global scale and 'mxAA+' national scale ratings on the city.
  • The outlook on both rating scales remains stable.
RATING ACTION
On January 10, 2019, S&P Global Ratings affirmed its long-term 'BBB' global 
scale and 'mxAA+' national scale issuer credit ratings on the city of 
Querétaro. The outlook remains stable.

OUTLOOK
The stable outlook reflects our expectation that Querétaro will maintain an 
operating surplus of around 25% of operating revenues in 2019-2021 and 
positive results after capital expenditures (capex), supported by prudent 
financial management practices and a growing real-estate sector. We also 
assume Querétaro will keep a solid liquidity position and a very low or no 
debt burden.

Downside scenario
We could lower the ratings on Querétaro in the next two years if the city 
reports deficits after capital accounts above 5% of its total revenues, 
because this would undermine the city's budgetary performance and liquidity 
position. It would also suggest less prudent financial management.  

Upside scenario
We could take a positive rating action in the next two years if the city 
continues to strengthen its budgetary flexibility by increasing its own source 
revenues. In addition, we would raise our ratings on the city in the next 
12-24 months if we were to improve our assessment of Mexican municipalities' 
institutional framework.


RATIONALE
The ratings reflect Querétaro's disciplined financial policies and our 
expectation that the city will maintain sound fiscal results. Its credit 
strengths also include a higher GDP per capita than most of its national 
peers, robust liquidity, the absence of a debt burden, and low contingent 
liabilities. On the other hand, the volatile and unbalanced institutional 
framework remains its main credit weakness, as for all Mexican municipalities. 

Querétaro's new administration will need to continue growing revenues while 
controlling current spending
Querétaro's current administration (PAN; 2018-2021) took office in October 
2018 and the transition process has been smooth. We expect continuity in 
Querétaro's prudent financial policies. The city has distinguished itself by 
its longer-term financial planning than most of its peers, although it could 
improve on particular issues such as the pension system liabilities. We assume 
the management will continue to support measures to enhance own source 
revenues and control operating spending. The latter remains a challenge given 
the city's rapid growth, which results in high demand for services and 
infrastructure. 

Querétaro's economy has consistently grown in recent years, reflected in a GDP 
per capita of $16,012 in 2017, which is higher than the national average. The 
city's prosperous real estate sector and diversified economy underpin its 
relatively good socioeconomic conditions (including security, infrastructure, 
skilled employment, and political stability) which have been key in attracting 
domestic and foreign investment. Although these favorable economic conditions 
have benefited the city in terms of revenue collection, rapid urban expansion 
also represents challenge as demand for services and infrastructure increases.
 
Querétaro operates under the Mexican municipalities' institutional framework, 
which we consider volatile and unbalanced. For example, the framework reflects 
the municipalities' limited capacity to oppose decisions from higher tiers of 
government, the short timeframe for financial planning, and the low level of 
institutionalization of financial management decisions and budgeting 
practices. In our view, the Financial Disciplinary Law (FDL) has provided 
greater visibility and predictability to the municipal sector's finances. 
Nevertheless, the national political landscape has shifted after the July 2018 
national elections, and how the new administration implements and or adjusts 
the FDL is yet to be determined.

We expect fiscal results and cash reserves to remain robust, despite large 
spending needs
We predict that Querétaro's financial management will control current spending 
growth, despite structural pressure and the city's recent rapid growth, in 
order to maintain sound budgetary results. Our base-case scenario assumes that 
the city will post average operating surpluses just below 25% of operating 
revenues during 2019-2021, below the average of the past two years. As of 
September 2018, the city posted weaker fiscal results compared to the previous 
year, mainly due to pressures for higher current spending and a significant 
rise in capital spending. We expect Querétaro's capex to average around MXN1.6 
billion in 2019-2021, equivalent to 22% of its total spending. For the next 
two years, we project the city's surplus after capex to average 5% of total 
revenues. Our budgetary performance assessment captures the volatility of 
Querétaro's historical after-capex results. On the other hand, the city's high 
cash reserves could offset unexpected budgetary deficits.

We believe the current management will keep supporting measures to improve 
revenue collection and modernize the cadastral base as the real estate sector 
continues to grow. The measures undertaken by the previous administration have 
enhanced the city's capacity to raise own source revenues compared to peers, 
making it less vulnerable to sudden changes in the distribution of federal 
transfers. We expect tax revenue growth to average 17% annually in 2019-2021, 
while revenue transfers should continue to expand broadly in line with GDP 
nominal growth. We estimate that modifiable revenues will continue to 
increase, exceeding 70% of operating revenues, on average, in the next two 
years. Nevertheless, Querétaro's limited ability to reduce current and capital 
spending because of its growing population constrains its budgetary 
flexibility. 

Querétaro's record of robust budgetary performance is reflected in strong cash 
reserves. As of September 2018, the city's cash and equivalents were MXN1.067 
billion, which represents 18% of its operating revenue projected for 2018, 
while its account payables were at MXN226 million (4% of operating revenues). 
Querétaro has no debt service payments in the next 12 months. However, in our 
opinion, Querétaro's liquidity position could be hurt by its high funding 
needs for infrastructure and public services. 

We don't expect the current administration to take out new loans in the next 
two years given the high level of cash reserves. Querétaro's pension system is 
currently underfunded; its annual costs still represent only a small share of 
the annual budget (less than 2% of the annual operating revenues projected). 
However, unfunded liabilities related to the pension system could pressure 
municipal finances over the medium to long term if no reform is carried out. 
The magnitude of these unfunded liabilities negatively affects our view of the 
city's debt profile. Finally, Querétaro's contingent liabilities are low and 
relate to small legal claims, the payment for which should not exceed 2% of 
the city's operating revenue. 
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