S&P: Mexico Outlook Revised To Negative; 'BBB+/A-2' Foreign Currency Ratings Affirmed
We project that general government debt will rise, on average, by 4% of GDP annually in the next three years, while the general government interest burden (interest to revenues) will remain below 10%. Low GDP growth will make it difficult for the government to meet its ambitious target of stabilizing and gradually reducing its debt as a share of GDP over the next three years. The debt burden may continue to rise moderately due to fiscal deficits, potential currency depreciation, and periodic financial assistance to public-sector enterprises like Pemex, the state-owned petroleum company, and the Federal Electricity Commission (CFE).
We project that the government will meet or come close to its fiscal targets in 2016, with the general government deficit staying below 3% of GDP. Higher revenues from tax reform have partly compensated for a loss of over four percentage points of GDP in public-sector oil revenues in the last five years. In 2016, we project that oil-related revenues for the public sector could decline below 4% of GDP from 8.9% in 2012. Oil revenues accounted for less than 15% of public-sector revenues in the first half of 2016, compared with 35% in 2013. The government has been able to absorb much of the fiscal loss, in large part because of timely tax reform in late 2013. The reform, which introduced new taxes and cut tax exemptions, among other changes, boosted central government tax collections to 13% of GDP last year from 9.7% in 2012.
Financial-sector intermediation in Mexico is low but rising, and we view the banking system as being solid. We place the Mexican banking system in our Banking Industry Country Risk Assessment (BICRA) group '4', with '1' being the lowest risk category and '10' the highest (see "Banking Industry Country Risk Assessment: Mexico," published Aug. 28, 2015). Commercial banks have capital adequacy of around 15% and remain highly liquid. Nonperforming loans are around 2.5% of total loans and are fully provisioned.
Despite these strengths, Mexico's financial-sector intermediation is among the lowest in Latin America, as well as compared with its peers we rate 'BBB' and compared with other countries with similar levels of per capita GDP. Domestic credit to the private sector and nonfinancial public enterprises was below 28% of GDP in 2015, up from 22% in 2010. We expect that credit growth is likely to exceed nominal GDP growth in the next three years, boosting financial-sector depth, but most small and midsize firms will still lack access to bank lending.
We view contingent liabilities from the financial sector and nonfinancial public enterprises as limited, as our criteria define the term.
Mexico's independent central bank conducts its monetary policy under an inflation-targeting framework and a floating exchange-rate regime. We expect inflation to remain low, around 3% in 2016-2018, despite a substantial depreciation of the Mexican peso in the recent past.
Mexico's external profile is likely to remain strong despite low oil prices. The current account deficit (CAD) is likely to be around 2.7% of GDP in 2016, similar to its level in the previous year. We expect the CAD to remain around 2% of GDP in the next two years, reflecting a similar trade deficit. Net foreign direct investment (FDI) is likely to increase in the coming three years, especially in the energy sector, largely, if not fully funding, the CAD.
We expect Mexico to have gross external financing needs (current account payments and public - and private-sector external debt due by remaining maturity) relative to current account receipts (CAR) and usable reserves of about 92%. We project that narrow net external debt (gross debt net of liquid external assets) will hover around 50% of CAR in the next couple of years (S&P Global Ratings includes nonresident holdings of locally issued debt in its estimates of external debt, as our methodology calculates external debt on a residency basis). Our projections assume that the share of nonresident holdings of Mexico's central government debt remains stable.
OUTLOOKWe expect continuity in economic policies in the coming two years, along with ongoing fiscal adjustment that compensates for lower oil revenues and contains the general government debt burden. We expect that implementation of recent economic reforms, especially in the energy and telecom sectors, should sustain long-term GDP growth, but it may not necessarily increase the growth rate, absent other measures.
We could lower the rating if either the government's debt or interest burden deteriorates beyond our current expectations. Continued low GDP growth, low oil revenues, and diminishing margin for reducing spending on capital projects and personnel costs could make it difficult for the government to stabilize its debt as a share of GDP over the next two years. The debt burden may continue to rise moderately because of fiscal deficits, and potential currency depreciation and financial assistance to nonfinancial public-sector enterprises. The government's interest burden, now around 9% of general government revenues, could rise, reflecting both a limited revenue base and the need to maintain interest rates consistent with the sovereign's reliance on external portfolio inflows. Either outcome would raise the vulnerability of Mexico's public finances to adverse shocks.
Conversely, steps to accelerate private-sector investment, especially in the energy sector, and other measures that increase investor confidence could result in moderately higher GDP growth. Effective implementation of energy reforms, including changes to Pemex and CFE, would reduce the sovereign's potential contingent liabilities. That, along with steps to sustain the recent increase in non-oil fiscal revenues and contain spending, could result in fiscal outcomes that contribute to a stabilization of the government's debt burden. We could revise the outlook to stable as a result.
Over the long term, we could raise the ratings should faster-than-expected and effective implementation of recent reforms strengthen Mexico's growth and fiscal profile rapidly while keeping external vulnerabilities in check.