Mexico Risks Credit-Rating Cut as S&P Cites Sluggish Growth

(Bloomberg) -- Mexico is at risk of a credit-rating cut after S&P Global Ratings revised its outlook to negative, citing “disappointing” economic growth and a rising debt load.

Stocks and the peso extended losses and the cost to hedge against losses in the country’s bonds rose after S&P said there’s at least a one-in-three chance of a downgrade over the next two years if the government’s debt increases more than forecast. S&P’s BBB+ rating for Mexico, three steps above junk, is already one level lower than Moody’s Investors Service. Fitch Ratings gives Mexico the same grade as S&P with a stable outlook.

Mexico cut its 2016 growth forecast for a second time this year Monday after the economy shrank in the second quarter. Lower expansion could limit tax revenue and boost debt, which has already surged to levels near those during the so-called Tequila Crisis of the mid-1990s, when Mexico needed a bailout from the U.S. Seeking to show its commitment to reducing indebtedness, the Finance Ministry cut its 2016 budget deficit forecast this week.

“Although Mexico’s debt burden is moderate, the government has less fiscal room to maneuver than it had a decade ago,” S&P said in a statement. “Mexico has undertaken more structural reforms than most emerging market countries, but its growth rate has been disappointing.”

The peso, which had been trading about 0.5 percent lower on the day, was down 1.3 percent to 18.5303 per dollar at 3:45 p.m. in New York, while the IPC stock gauge lost 1.2 percent, the most in almost two months.

The cost to insure the country’s debt with credit-default swaps for 10 years rose 1.4 basis point to 210.3 basis points. The cost has topped that of Peru’s, which is also rated BBB+ by S&P, for most of the year. That difference widened to the highest in at least a decade earlier this month, according to data compiled by Bloomberg.

"This is an important move" by S&P, said Marco Oviedo, the chief Mexico economist at Barclays Plc. "If the government fails to deliver a better fiscal outlook for 2017, we could foresee" a rating downgrade.

Mexico’s gross domestic product shrank in the second quarter from the previous three months for the first time in three years, contracting 0.2 percent, after growth in the services sector slowed amid a drop in oil prices that sapped export revenue. Lower crude prices and a decrease in production at the state-owned oil producer have also hurt government revenue.

Growth is slowing after Mexico’s central bank raised benchmark borrowing costs by one percentage point this year to 4.25 percent in an effort to prevent the weak peso from spurring inflation. The peso has fallen 7.1 percent this year, the most among major currencies excluding the British pound.

The broadest measure of debt as a percentage of Mexico’s gross domestic product reached 46.9 percent in the second quarter. Finance Minister Luis Videgaray, in an interview last week, doubled down on his pledge to keep the budget in check, saying Mexico’s credibility is constantly being tested. On Monday, his ministry pledged a budget surplus before interest payments in 2017, the first in eight years.

"Today’s announcement was particularly unfortunate given yesterday’s announcement by the government" to publish more fiscal data and curb the deficit, said Alonso Cervera, the chief Latin America economist at Credit Suisse Group AG.

While President Enrique Pena Nieto has passed reforms to modernize the economy, their benefit has been limited by weaknesses in governance and perceptions of corruption, according to S&P. Mexico has seen a rebound in cartel violence that lifted homicide levels by 15 percent in the first half of the year from a year earlier, and the government has grappled with conflict-of-interest allegations that have involved the president and his wife.

“Mexico faces a greater risk of continued poor governance and subdued economic performance over the long term than the risk of a radical shift in economic policies,” S&P said.

--With assistance from Eric Martin To contact the reporters on this story: Christine Jenkins in Bogota at cjenkins28@bloomberg.net, Nacha Cattan in Mexico City at ncattan@bloomberg.net. To contact the editors responsible for this story: Brendan Walsh at bwalsh8@bloomberg.net, Sebastian Boyd