Mexico Foreign Currency Rating Lowered To 'BBB' And Local Currency To 'BBB+' On Hit To Trend Growth; Outlook Negative

  • We expect a pronounced hit to the Mexican economy following the combined shocks of COVID-19--in Mexico itself and in the U.S., its main trading partner--and lower global oil prices.
  • These shocks, while temporary, will worsen already weak trend GDP growth dynamics for 2020-2023 that reflect, in part, low private-sector confidence and poor investment dynamics.
  • We are lowering our long-term foreign currency sovereign credit rating on Mexico to 'BBB' from 'BBB+' and our long-term local currency sovereign credit rating to 'BBB+' from 'A-'.
  • The outlook is negative, indicating the risks of a downgrade over the coming 12-24 months as a result of uneven or ineffective policy execution; potential weakening in public finances, reflecting a difficult trade-off between sustaining GDP growth given Mexico's low non-oil tax base and spending rigidities; and rising pressure on PEMEX, a potential contingent liability for the sovereign.

Rating Action

On March 26, 2020, S&P Global Ratings lowered its long-term foreign currency sovereign credit rating on Mexico to 'BBB' from 'BBB+' and its long-term local currency sovereign credit rating to 'BBB+' from 'A-'. The outlook on the long-term ratings is negative. At the same time, we affirmed our short-term ratings at 'A-2'. We also lowered our transfer and convertibility (T&C) assessment to 'A' from 'A+'.

Outlook

The negative outlook indicates the possibility of a downgrade over the coming 12-24 months due to uneven or ineffective policy execution, potentially weakening public finances, or higher off-budget contingent liabilities.
Managing pressure on Mexico's fiscal accounts in the face of economic and oil price shocks has been a challenge for policymakers across multiple administrations. This reflects a narrow non-oil tax base, notwithstanding some increase over the past five years, as well as limited accumulated savings in its oil stabilization funds during the era of high commodity prices, which were already partly rundown in 2019.
We assume that the government will take steps to contain our projected widening of the fiscal deficit and the increase in the sovereign's debt burden resulting from the economic downturn--caused by recent external shocks. However, prolonged poor fiscal performance and a resulting rising debt burden, or the risk of potentially weak policy implementation, could lead us to lower the rating.
In addition, potential increases in contingent liabilities from the energy sector could worsen the sovereign's debt burden and lead to a downgrade. The financial profile of government-owned energy company Petroleos Mexicanos (PEMEX) has weakened significantly over the past five years and has become more vulnerable amid the decline in oil prices.
At the same time, the shift in energy policy under the Administration of President Andrés Manuel López Obrador increases reliance on PEMEX for oil production and investment in Mexico. If the general government's fiscal profile remains weak for a prolonged period, notwithstanding some stabilization in production, PEMEX's poor operational and financial performance and technical capacity constraints could pose a more material contingent liability for sovereign creditworthiness.
Conversely, effective economic management that raises investor confidence, encourages private investment, and maintains moderate fiscal deficits could reverse the structural weakness in GDP growth prospects, helping to stabilize public finances and retain fiscal flexibility. That, along with steps to contain the potential contingent liability posed by state-owned companies in the energy sector or to broaden the non-oil tax base, could avoid an erosion of the sovereign's financial profile. We could revise the outlook to stable over the coming two years in that scenario.

Rationale

The ratings on Mexico reflect strengths and weaknesses in its democracy, which has brought political stability and regular changes of government over the last two decades. However, it has not created economic dynamism compared with other emerging markets or improved public security. The pronounced COVID-19 and oil price shocks, in our view, exacerbate Mexico's already modest growth. The downgrade reflects our revised expectations that real per capita GDP growth will remain below that of peers with a similar level of economic development.
Our revised growth projections include a decline in real GDP of about 2%-2.5% in 2020, followed by growth of a bit over 2% in 2021 and 1.8% in 2022-2023. We forecast a second year of economic contraction in 2020, as well as only a moderate recovery afterward.
The subdued growth performance reflects, in part, the inability of the López Obrador Administration to improve private-sector confidence and investment dynamics. Business confidence remains low and has not improved since the administration outlined its infrastructure investment initiative last November. The release of a more detailed and complete version of the infrastructure investment initiative has been delayed. Even if the administration moves to enlarge the scope for private investment in the energy sector (which it deems strategic and, as a result, largely reserved for public investment), current oil prices will make it more challenging to secure such investment in refineries and pipelines.
In addition to the hit to domestic demand from COVID-19 in Mexico, we are also now forecasting a contraction in the U.S.--Mexico's key trading partner. The U.S. accounts for about 80% of Mexico's merchandise exports (mostly manufactured goods), the majority of its tourism, and its remittances, which are an important source of consumption at the lower end of the income distribution. Our outlook for the U.S. is for a contraction in growth in 2020, with a U-shaped recovery. In our view, these negative shocks outweigh possible support for growth this year in Mexico from the national infrastructure plan outlined in November 2019 or the passage of USMCA (United States–Mexico–Canada Agreement).
Furthermore, the decline in global oil prices weighs on Mexico's fiscal position, affecting both the Mexican budget directly and the financial strength of PEMEX. On March 19, 2020, S&P Global Ratings materially lowered its oil price assumption for 2020. This follows an earlier significant downward revision of its price assumptions on March 9, 2020. Prices for crude oil in spot and futures markets are more than 55% lower than levels observed during the summer of 2019 when prices increased due to rising geopolitical tensions. When we last reviewed Mexico ("Mexico 'BBB+/A-2' Foreign Currency Ratings Affirmed; Outlook Remains Negative," Dec. 19, 2019), we expected Brent oil prices to average $60 per barrel (/bbl) in 2020 and to gradually decline to $55/bbl from 2021. We now assume an average Brent oil price of $30/bbl in 2020, $50 in 2021, and $55/bbl from 2022 (see "S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure," published March 19, 2020).
President López Obrador has underscored a commitment to fiscal prudence. However, the combination of social, economic, and health challenges; only moderate fiscal flexibility; and recent external shocks could particularly weigh on fiscal out-turns and debt levels over the next several years.
Current prices for the Mexican oil mix are below $20/bbl, well below the $49/bbl assumed in the budget. The federal government can recover a large part of the potential lost oil revenues in 2020 thanks to an oil hedge it has in place and draw down on money in the federal oil stabilization fund (FEIP)--which totaled almost Mexican peso (MXN) 160 billion at year-end 2019, less than 1% of GDP. However, the small cushion the fund provides is expected to erode by 2021.
We assume a widening in the general government deficit (and greater annual increase in general government debt that incorporates the impact of a weaker Mexican peso) this year and over the forecast period through 2023, compared with our prior expectations. The main reasons for this are the pronounced hit to growth, as well as the lingering impact from oil prices and challenges of stabilizing oil production.
But we also assume fiscal slippage is contained. This is in line with Mexico's longer track record of policy adjustment and the administration's commitment to fiscal prudence, with the government containing expenditures amid a more strained revenue base.
We project still moderate fiscal deficits that average 3% of GDP in 2020-2023 and a rise in net general government debt toward 49% of GDP in 2023 from 42% in 2019.
Our ratings and fiscal assessment currently incorporate limited contingent liabilities. This is despite our expectation of almost certain extraordinary support, as needed, for PEMEX whose stand-alone credit profile is significantly lower than the sovereign. Amid a sharper-than-forecast rise in Mexico's general government debt and fiscal deficits, PEMEX could become a moderate contingent liability for the sovereign.
Our ratings on Mexico incorporate a track record of cautious fiscal and monetary policies and a floating exchange-rate regime that has supported investor confidence and general economic stability despite many adverse global trends. The credible inflation-targeting monetary policy is underpinned by Mexico's independent central bank, which has broad political support. The central bank has stepped in quickly amid more stressed global financial market conditions--resulting from the COVID-19 pandemic and oil price shocks--to contain market volatility.
The Mexican peso is a floating currency and, by our definition, actively traded. This eases external financing constraints and, coupled with narrow net external debt averaging 30% of current account receipts, supports a solid external position. Given that Mexico is a net oil importer (of $21 billion in 2019), the decline in oil prices underpins an improvement in Mexico's current and trade accounts.
In addition, Mexico has access to the International Monetary Fund's Flexible Contingent Credit Line for up to $61 billion, boosting the sovereign's external liquidity and reflecting long-standing prudent macro management. As it has done in the past, the Central Bank of Mexico on March 19 announced that it established a $60 billion SWAP line with the U.S. Federal Reserve, which established lines with other central banks globally.

Key Statistics

Table 1

Mexico--Selected Indicators
20132014201520162017201820192020f2021f2022f2023f
Economic indicators (%)
Nominal GDP (bil. LC)16,27717,47418,55120,11821,91223,49224,27224,70526,06227,32828,650
Nominal GDP (bil. $)1,2761,3131,1691,0761,1591,2221,2611,1231,1981,2861,364
GDP per capita ($000s)10.810.99.68.89.39.79.98.79.29.810.3
Real GDP growth1.42.83.32.92.12.1(0.1)(2.0)2.21.81.8
Real GDP per capita growth0.11.52.11.81.00.3(1.2)(3.0)1.20.80.8
Real investment growth(2.1)1.74.31.4(1.6)0.3(5.1)(7.0)1.11.92.0
Investment/GDP22.521.923.323.823.022.719.918.918.718.718.8
Savings/GDP20.019.920.621.521.220.919.719.318.217.516.9
Exports/GDP31.331.934.637.137.739.339.040.440.540.040.1
Real exports growth1.47.08.43.64.25.92.9(1.2)4.13.53.3
Unemployment rate4.94.84.43.93.43.33.54.74.54.24.3
External indicators (%)
Current account balance/GDP(2.5)(2.0)(2.7)(2.3)(1.8)(1.9)(0.2)0.4(0.5)(1.2)(1.9)
Current account balance/CARs(7.4)(5.7)(7.1)(5.6)(4.3)(4.3)(0.4)0.8(1.2)(2.8)(4.2)
CARs/GDP33.934.537.340.341.343.142.944.644.644.043.9
Trade balance/GDP(0.1)(0.2)(1.3)(1.2)(0.9)(1.1)0.51.50.5(0.2)(0.9)
Net FDI/GDP2.61.82.02.92.62.31.41.21.11.00.9
Net portfolio equity inflow/GDP(0.2)0.40.30.90.90.20.00.00.00.00.0
Gross external financing needs/CARs plus usable reserves93.791.790.287.485.487.082.779.882.484.486.3
Narrow net external debt/CARs40.843.046.840.440.537.136.133.532.233.333.7
Narrow net external debt/CAPs38.040.743.738.338.935.636.033.831.932.432.3
Net external liabilities/CARs153.2143.1146.1127.2124.9113.6113.4119.9115.8114.5112.5
Net external liabilities/CAPs142.6135.4136.3120.4119.8108.9112.9120.9114.4111.4107.9
Short-term external debt by remaining maturity/CARs22.522.423.617.512.911.69.310.310.29.69.0
Usable reserves/CAPs (months)4.34.55.04.64.33.83.94.54.23.93.6
Usable reserves (mil. $)180,188195,655177,601177,980175,494176,394185,857187,791187,405187,019187,019
Fiscal indicators (general government; %)
Balance/GDP(2.1)(2.5)(2.7)(2.8)(0.8)(1.8)(1.8)(2.7)(2.8)(3.1)(3.4)
Change in net debt/GDP3.54.34.64.40.92.42.94.83.03.33.6
Primary balance/GDP(0.5)(0.9)(1.0)(1.0)1.10.20.4(0.4)(0.5)(0.7)(0.9)
Revenue/GDP18.318.218.819.419.218.218.318.218.118.318.5
Expenditures/GDP20.520.821.622.220.020.020.120.920.921.421.8
Interest/revenues9.19.29.29.59.810.911.912.712.913.013.2
Debt/GDP39.240.842.944.542.342.243.147.247.748.750.0
Debt/revenues214.0223.8227.9229.8220.8232.0235.8259.5263.6266.4270.6
Net debt/GDP38.540.242.443.540.840.542.046.146.747.849.1
Liquid assets/GDP0.70.70.51.01.51.71.01.11.01.00.9
Monetary indicators (%)
CPI growth3.84.02.72.86.04.93.63.93.23.03.0
GDP deflator growth1.54.42.85.46.75.03.53.93.23.03.0
Exchange rate, year-end (LC/$)13.0814.7217.2120.7319.6719.6518.9322.0021.5021.0021.00
Banks' claims on resident non-gov't sector growth12.37.715.717.15.95.29.01.96.16.76.7
Banks' claims on resident non-gov't sector/GDP28.628.731.233.732.832.233.934.034.134.735.4
Foreign currency share of claims by banks on residents0.00.00.00.00.00.00.00.00.00.00.0
Foreign currency share of residents' bank depositsN.M.N.M.N.M.N.M.N.M.N.M.N.M.N.M.N.M.N.M.N.M.
Real effective exchange rate growth5.8(1.0)(10.4)(12.9)2.40.1N/AN/AN/AN/AN/A
Definitions: Savings is defined as investment plus the current account surplus (deficit). Investment is defined as expenditure on capital goods, including plant, equipment, and housing, plus the change in inventories. Banks are other depository corporations other than the central bank, whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial-sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. N/A--Not applicable. LC--Local currency. CARs--Current account receipts. FDI--Foreign direct investment. CAPs--Current account payments. e--Estimate. f--Forecast. The data and ratios above result from S&P Global Ratings' own calculations, drawing on national as well as international sources, reflecting S&P Global Ratings' independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.

Ratings Score Snapshot

Table 2


Mexico--Ratings Score Snapshot
Key rating factorsScoreExplanation
Institutional assessment3Generally effective policymaking in recent years has promoted sustainable public finances and balanced economic growth. Mexico has good transparency in fiscal and monetary policy and timely/reliable economic data. Gradually deepening democracy, with stable and regular changes of government. However, these strengths have not translated into economic dynamism or improved public security. Mexico has also had long-term challenges regarding rule of law.
Economic assessment5Based on GDP per capita ($) as per Selected Indicators in table 1.
Weighted average real GDP per capita trend growth over a 10-year period is at 0.3%, which is well below sovereigns in the same GDP category.
External assessment2Based on the Mexican peso as an actively traded currency and narrow net external debt as per Selected Indicators in table 1.
Fiscal assessment: flexibility and performance3Based on the change in net general government debt (% of GDP) as per Selected Indicators in table 1.
Fiscal assessment: debt burden4Based on net general government debt (% of GDP) and general government interest expenditures (% of general government revenues) as per Selected Indicators in table 1.
Monetary assessment3The peso is a free-floating currency.
The central bank has a track record of operational independence and has the ability to act as lender of last resort for the financial system; CPI as per Selected Indicators in table 1.
Indicative ratingbbb-As per table 1 of "Sovereign Rating Methodology."
Notches of supplemental adjustments and flexibility1Strength in monetary policy credibility not fully captured in monetary assessment as capital markets are deepening; access to a $61 billion two-year Flexible Contingent Credit Line with the IMF underscores solid fundamentals and track record of policy adjustment and access to financing, which is not fully captured in our assessments.
Final rating
Foreign currencyBBB
Notches of uplift1Default risks apply differently to foreign- and local-currency debt. The sovereign has an independent monetary policy and floating exchange rate regime; active local currency fixed income and money market, which accounts for about 50% of GDP.
Local currencyBBB+
S&P Global Ratings' analysis of sovereign creditworthiness rests on its assessment and scoring of five key rating factors: (i) institutional assessment; (ii) economic assessment; (iii) external assessment; (iv) the average of fiscal flexibility and performance, and debt burden; and (v) monetary assessment. Each of the factors is assessed on a continuum spanning from 1 (strongest) to 6 (weakest). S&P Global Ratings' "Sovereign Rating Methodology," published on Dec. 18, 2017, details how we derive and combine the scores and then derive the sovereign foreign currency rating. In accordance with S&P Global Ratings' sovereign ratings methodology, a change in score does not in all cases lead to a change in the rating, nor is a change in the rating necessarily predicated on changes in one or more of the scores. In determining the final rating the committee can make use of the flexibility afforded by §15 and §§126-128 of the rating methodology.
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