Outlooks On Four Mexican Local And Regional Governments Revised To Negative From Stable; Ratings Affirmed

  • On March 26, 2020, we lowered our long-term foreign currency sovereign credit rating on Mexico to 'BBB' from 'BBB+' and the long-term local currency sovereign credit rating to 'BBB+' from 'A-'. The outlook on the long-term ratings remains negative.
  • We based the downgrade on our expectation of 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 the weak trend in GDP growth for 2020-2022 that reflect, in part, low private-sector confidence and poor investment dynamics.
  • The outlook on the sovereign remains 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.
  • As a result, we're revising the outlook on the global and national scale ratings on the Mexican states of Guanajuato and Querétaro to negative. In addition, we're revising our outlook on the state of Aguascalientes national scale rating to negative, and revising the global scale outlook on the city of Querétaro to negative (the national scale rating outlook remains stable). Our global scale ratings on the state of Guanajuato, state of Querétaro, and city of Querétaro are at the same level as the sovereign, and we don't believe that these entities meet the conditions for us to rate them above Mexico.

Rating Action

MEXICO CITY (S&P Global Ratings) March 27, 2020--S&P Global Ratings affirmed its 'mxAA+' national scale rating on the state of Aguascalientes, and its long-term 'BBB' global scale and 'mxAA+' national scale ratings on the state of Guanajuato, the state of Querétaro, and the city of Querétaro.
We revised the outlook on the ratings on the three states to negative from stable. We also revised the global scale outlook on the city of Querétaro to negative, while keeping the stable outlook on the national scale rating.

Outlook

The negative outlook indicates an at least one-in-three possibility that we could lower the ratings over the coming 12-24 months if we downgraded the sovereign. In our opinion, Mexican LRGs high dependence on federal transfers and their limited financial flexibility prevent local governments from having higher ratings than the sovereign.
We could revise the negative outlooks to stable over the next 12-24 months if we did the same on the sovereign.
The stable outlook on the national scale rating on the city of Querétaro reflects our opinion that over the next 12-24 months the city could maintain a robust budgetary performance, which would benefit from a larger portion of own-source revenues (67% of total revenues) compared to that of the three states (about 12% of total revenues).
We could lower the ratings on the city of Querétaro if harsher conditions erode the city's financial performance beyond our expectations. On the other hand, we would raise our ratings on the city if we were to improve our assessment of the Mexican municipalities' institutional framework, although we don't see this scenario as likely in the next two years.

Rationale

We believe that the state of Aguascalientes, state of Guanajuato, state of Querétaro, and city of Querétaro do not meet the conditions established in our criteria to be rated above the sovereign. We believe that Mexican local and regional governments' (LRGs) high dependence on federal transfers, coupled with their limited financial flexibility, prevent local governments from having higher ratings than the sovereign. About 88% of the three states' operating revenues relate to transfers, leaving limited room for adjustment. Moreover, states could face increasing limitations to levy local taxes or cut operating expenditures given the evolving situation with COVID-19. The city of Querétaro depends less on federal transfers (33% of its operating revenues). However, the city operates under the Mexican municipalities' institutional framework, which we consider volatile and unbalanced, which limits the ratings by those on the sovereign.
Our economic assessment of the states of Guanajuato and Aguascalientes incorporates limited economic growth prospects, because we now project Mexico's GDP per capita 10-year weighted average growth at 0.3%, below the average of about 2.0% for peers in the same GDP per capita category. We expect these two entities to perform in line with national average, with low private-sector confidence and poor investment dynamics, while the state and city of Querétaro's economies could support a faster recovery over the next couple of years and stronger growth than the national average.
We expect federal transfers to be reduced in real terms in 2020, although this could be partially compensated by the federal compensation fund, Fondo de Estabilización de los Ingresos de las Entidades Federativas (FEIEF). We also forecast operating expenditure pressure due to shocks from the impact of COVID—19. Despite these factors, we expect the three states and the city to continue to post sound budgetary performance, supporting overall strong liquidity indicators and very low debt burdens. Those rating strengths reflect a record of sound financial results and these LRGs' historical commitment to prudent fiscal policies.
State of Aguascalientes
  • We affirmed our 'mxAA+' national scale rating on State of Aguascalientes and revised the outlook to negative.
  • Despite expected federal transfers' reduction in 2020 and operating expenditures pressure due to the COVID-19 impact, we believe the state will continue to post a solid budgetary performance. This would result in operating surpluses close to 5% of operating revenue--down from 7% in 2017-2019--and a deficit after capital expenditures (capex) of slightly less than 2% of total revenue in the next two years, which Aguascalientes will finance with a mix of planned long-term debt and cash reserves.
  • The state's debt should increase this year following an expected disbursement of MXN801 million for long-term debt. We expect debt-to-operating revenues will remain very low and hover at about 12% of operating revenue by 2022.
  • Aguascalientes is part of the country's automotive manufacturing hub, and its concentration in this economic sector could limit the local economy's recovery. We estimate the state's 2019 GDP per capita at $12,110, above the national average of $9,872. In our view, the hit to domestic demand due to COVID-19 and a contraction in the U.S. economy outweigh the potential for growth this year stemming from the passage of the U.S.-Mexico-Canada Agreement (USMCA).
State of Guanajuato
  • We affirmed our 'BBB' global scale and 'mxAA+' national scale ratings on state of Guanajuato and revised the outlook on both rating scale to negative from stable. .
  • Despite expected federal transfers' reduction in 2020 and operating expenditures pressure due to COVID-19 shocks, we believe the state will continue to post a solid budgetary performance, resulting in operating surpluses close to 8% of operating revenue, down from 10% in 2017-2019. We also project an overall planned deficit after capex of about 5% in 2020 and deficit after capex close to 2% of total revenue in the next two years, which Guanajuato will finance with long-term debt and cash reserves.
  • Guanajuato's total long-term debt should increase in the next two years following a recent authorization to issue new debt of up to MXN5.35 billion. We expect the state's debt-to-operating revenue to increase to a still low 8% by 2022 from 5% in 2019.
  • Guanajuato is part of an important auto industry hub in the country and is also one of Mexico's largest leather goods producers. We estimate the state's 2019 GDP per capita at $8,664, below the national average of $9,872. In our view, the hit to domestic demand from COVID-19 and a contraction in the U.S. economy, paired with security issues, outweigh possible support for growth this year from the passage of the USMCA. Moreover, the state's reliance on auto manufacturing is a challenge to growth prospects.
State of Querétaro
  • We affirmed our 'BBB' global scale and 'mxAA+' national scale ratings on the state of Querétaro and revised the outlook on both scales to negative from stable.
  • Assuming expected federal transfers' reduction in 2020 and operating expenditures pressure due to COVID-19 shocks, we expect the state of Queretaro to post operating surpluses of 1.7% of operating revenues on average during 2020-2022; down from 4% in 2017-2019. We forecast deficits after capex of about 2% of total revenues. We consider that the state's accumulated cash will sufficiently cover its funding needs and consequently, we don't expect new borrowings in 2020-2021.
  • The state's debt burden is the lowest among its national peers. At year-end 2019, total debt was below 1% of its operating revenue and the current administration aims to end its term in October 2021 with zero debt.
  • The state of Querétaro has attracted investment in the manufacturing sectors and in the services and knowledge economy. We estimate the state's 2019 GDP per capita at $13,156, above the national average of $9,872. Due to a relatively more diversified economy, higher average income, and better business conditions, we predict that the state could recover more quickly and see stronger growth compared to the national average in the next two years.
City of Querétaro

  • We affirmed our 'BBB' global scale and 'mxAA+' national scale ratings on the city of Querétaro. We revised the global scale outlook to negative from stable, while the national scale outlook remains stable.
  • Amid expected federal transfers' reduction in 2020 and operating expenditures pressure due to COVID-19 shocks, we expect the city's operating surpluses to hover near 20% of operating revenues on average in 2020-2022; down from 28% in 2017-2019. We forecast overall balanced results after capex. Querétaro's record of robust budgetary performance is reflected in its strong cash reserves and lack of debt burden.
  • The city benefits from a strong capacity to raise own-source revenues compared to peers. We forecast its own-source revenues to be about 67% in 2020-2022, making it less vulnerable to sudden changes in the distribution of federal transfers and providing it with resilient financial flexibility.
  • The city of Querétaro's economy has consistently grown in recent years: we estimate the city's 2019 GDP per capita at $16,908, above the national average of $9,872 and one of the highest among its national peers. The region is an important auto and aerospace industries hub in the country. The city's competitive economy is backed by relatively good socioeconomic conditions for its population (including security, infrastructure, skilled employment, and political stability).
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