Reforms to bring no immediate change to Mexico credit rating - S&P

Monday, August 18, 2014

No short-term upgrade of Mexico's foreign currency credit rating is expected as a result of the country's energy reforms being signed into law this month, said ratings agency S&P.

The legislative approval of the reforms in December led S&P to raise the country's foreign currency credit rating to 'BBB+'.

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The recent approval of the secondary legislation governing the energy reform will not affect Mexico's sovereign debt rating, as the tangible effects of the reform on the country's economy will not be perceived for several years, the firm said in a note.

Mexico's credit rating upgrade in December reflected S&P's opinion that the reforms would increase the country's growth expectations over the next two to five years, while benefiting the oil sector and increasing the country's economic productivity, the firm added.

The reforms will also increase the country's fiscal flexibility by strengthening its oil revenue base, to 10% of GDP, in the newly created sovereign oil fund – as the Mexican government aims to save more of the country's oil revenue than in the past.

Although this may additionally expand the margin of fiscal maneuverability, a significant saving would probably only be seen once production based on new contracts begins to kick in over the next five years, according to S&P.

The government's absorption of state-owned oil firm Pemex and power utility CFE's pension liabilities could lead to a higher debt level, however.

The Mexican government could take on up to 30% of Pemex and CFE's pension liabilities, Moody's Investor Services said earlier this month.

Pemex's pension liabilities amounted to US$87bn as of June, 70% of its revenue, while power company CFE's pension liabilities were US$41bn, 168% of revenue. Total liabilities represent some 10% of the country's GDP, according to Moody's.

It is also probable that the expected private investment in the energy sector will take time to generate greater economic growth and a stronger and less volatile revenue base for the government, S&P said.

Mexico's credit rating could be raised if the implementation of the reforms is faster and more effective than anticipated, and it rapidly strengthens the country's growth and fiscal profile without an increase in external vulnerabilities. However, an ineffective implementation of the reforms could contribute to low growth and a weakening of confidence among investors.

The country's incapacity to lessen its dependency on volatile energy revenue, in combination with unexpected changes in fiscal policies, could increase the vulnerability of Mexico's public finances in the face of adverse shocks. The resulting deterioration of the economy and finances could lead to a lowering of its credit rating, the firm said.

Regarding the country's ability to revert a decline in oil production, S&P said that Mexico needs to stabilize its oil production before it can increase it. Down 25% since 2004, oil production this year is expected to drop slightly to 2.4Mb/d, the lowest level in 24 years, although the decline has moderated to 1% a year over the last four years.

Oil exports dropped 5% in 2013 on the back of a 6% drop in 2012, and are currently 35% below 2004 levels, it said.

S&P does not expect a rapid increase in oil output due to the reform's complex nature and the long-term delivery deadlines of large projects, such as deepwater drilling. Even with significant private investment, it could take between five to 10 years for oil production to see a recovery. And Mexico's oil production could, meanwhile, drop or stabilize.

However, greater foreign direct investment in oil and gas exploration and production, and potentially in refining and petrochemicals, should boost economic activity for local suppliers. And the government hopes that the reform will boost Mexico's GDP by 1% a year by 2018, S&P said.

Mexico's economic growth is expected to be between 2% and 3% in 2014 and just above 3% in 2015, S&P said.

BNamericas will host its second LatAm Oil & Gas Summit in Houston, Texas, on September 10-11. Click here to download the agenda.