Dagong Maintains the Sovereign Credit Ratings of Mexico at BBB with Stable Outlook
Dagong Global Credit Rating Co., Ltd.
April 10, 2018
Dagong Global Credit Rating Co., Ltd. (thereafter referred to as “Dagong”) has decided to maintain both local and foreign currency sovereign credit ratings of the United Mexican States (thereafter referred to as "Mexico") at BBB, each with a stable outlook. Growing political and policy uncertainty put debt repayment environment under pressure, but improved external conditions help Mexican economy grow moderately. Given ongoing fiscal consolidation, the government's fiscal deficit and debt scale are both under control. That, coupled with sufficient foreign exchange reserves, renders government solvency in local and foreign currency stable.
The main reasons for maintaining the sovereign credit ratings of Mexico are as follows:
First, regime changes, reform meeting obstruction and uncertainty over US-Mexico relations place Mexico’s repayment environment under pressure. Given the ruling Institutional Revolutionary Party’s sapped credibility by corruption scandals, a surge in nationalist sentiment - arising from US-Mexico economic and trade tensions - and a possibility of a left-wing "national rejuvenation movement" winning the 2018 presidential election, policy priorities might see major adjustments in the future. Domestic reform faces a gloomy prospect due to regime changes, government corruption, poor public order and the uncertainty of North American Free Trade Agreement (NAFTA) negotiations. Credit supply at home is insufficient and the financial industry does not offer adequate support to the real economy, while inflationary pressures and Federal Reserve’s rate hikes cause a tightening monetary policy in the short term, weakening the financial system's support for the economy.
Second, the short term will see moderate economic growth while long-term growth has yet to gain sufficient potential given the social problems. Owing to a tighter monetary policy and uncertainty over NAFTA, Mexico’s growth fell by 0.4 percentage points to 1.9% in 2017. In the short term, reforms in telecommunications and energy, amongst others, will attract a lot of foreign investment with rising commodity prices and growing demand from trading partners. Thus, Mexico's growth is expected to hit 2.1% and 2.6%, respectively, in 2018 and 2019. In the medium to long term, despite advantages of low labor costs, abundant resources, and a favorable geographical location, Mexico’s economic growth will average 2.6% in the ensuing five years given social problems including government corruption, rampant crime and severe poverty.
Third, in the short term, the fiscal deficit will narrow, yet in the medium term government might slow down the pace of and reduce the scale of fiscal consolidation while the structure of repayment sources is broadly stable. The general government’s fiscal deficit remained 2.9% in 2017, as government slashed spending in response to loss in revenues - stemming from economic slowdown and a decline in oil production. In 2018, the government will continue to reduce capital expenditure and fiscal subsidies while moderate economic growth makes limited contribution to tax revenues, thus general government’s fiscal deficit is projected to narrow to 2.6%. In the medium term, pressure on fiscal revenues will ease, which thereby broadens the scope for government finances, thus allowing the deficit to remain around 2.6%. Given the reasonable balance of government's annual maturing debt and the fact that in the medium term, the ratio of government financing needs to fiscal revenues will average around 30%, debt financing remains the main repayment source.
Finally, though Mexico’s debt burden is slowly rising, yet a reasonable debt structure and adequate international reserves render government solvency stable. According to Dagong's judgment on Mexican economy and government finances, the ratio of general government debt to fiscal revenues is forecasted to slightly improve to 254% and 256.5%, respectively in 2018 and 2019. However, a reasonable debt structure and smooth financing channels spare the government considerable repayment pressure, thus stable local-currency solvency. In 2017, Mexico’s total external debt burden increased slightly to 40.9%, and international reserves coverage on short-term external debt rose to 347%, hence stable foreign-currency solvency. However, due to continuous losses from the state oil company Petroleos Mexicanos, as well as enormous pressure from external debt repayment and downward pressure facing the Mexican peso, the government’s contingent liability risk cannot be ignored.
In the short term, the upcoming presidential election and NAFTA negotiations will fuel policy uncertainty. But ongoing fiscal consolidation cuts government fiscal deficit and controls debt growth. In addition, a reasonable debt structure provides a cushion for the government to deal with uncertainties at home and abroad. Therefore, Dagong has decided to maintain a stable outlook for both local and foreign currency sovereign credit ratings for Mexico for the next one to two years.