Fitch upgrades Mexico to BBB-plus on reform momentum

MEXICO CITY Wed May 8, 2013 9:22pm EDT

MEXICO CITY (Reuters) - Fitch Ratings upgraded Mexico's sovereign foreign currency credit rating by one notch to BBB-plus on Wednesday, pointing to the country's solid economic foundations and welcome progress on reforms.

The surprise move will help reduce Mexico's already low borrowing costs. It boosted the peso, which firmed past the 12-per-dollar level for the first time in nearly two years.

Mexico's first ratings upgrade since 2007 came amid optimism about a reform agenda which has already made changes in telecommunications, labor and education laws. Plans for banking reform were announced just hours earlier.

"The reform momentum has surpassed our expectations and we have seen structural reforms that we think would enhance confidence in Mexico as well as investment and growth dynamics in the medium term," Fitch senior ratings analyst Shelly Shetty said.

Shetty also cited surprisingly strong growth in Mexico amid a sluggish global economy and stabilization in oil production in recent years.

Finance Minister Luis Videgaray welcomed the announcement.

"It's good news but there's no doubt it's something that draws more capital to Mexico," he told Mexican radio.

Mexico has attracted large inflows of capital in recent months, and companies are wary that if the peso appreciates too quickly, it could crimp exports.

President Enrique Pena Nieto has promised changes to Mexico's tax system and its state-run energy sector in a bid to attract more investment and boost growth to 6 percent a year, about three times the average of the past decade.

Moody's Investors Service has Mexico at Baa1 with a stable outlook, similar to Fitch, which also has a stable outlook. Standard & Poor's rates Mexico one notch lower at BBB with a positive outlook.

The upgrade means Mexico is just one rung short of A territory on the scales of two ratings agencies. Of major Latin American economies, only Chile is rated in the A category.

"This is really aggressive because the fiscal and energy reforms haven't even been presented," said Nomura analyst Benito Berber. "My view is that once Congress passes fiscal and energy reform Fitch and Moody's will upgrade Mexico to 'A' universe."

But Shetty said to earn another upgrade, Mexico would have to show a material impact from the reforms on trend growth and increased budget flexibility.

"The bar would be a bit higher in moving Mexico from the 'B' category to the 'A' category because the focus of the discussion would be different," she said.

PESO WORRIES

Mexico has attracted investor attention over the last year on buzz about the promised reforms and as the country's economic growth outpaced Brazil's.

Investor sentiment was bolstered by a cut in benchmark borrowing rates in March to a record low of 4.0 percent from 4.5 percent. Rather than reducing the appeal of domestic assets, the decision was seen as boosting Mexico's economic prospects.

Solid U.S. demand has been supporting Mexican factories amid sluggish global growth and the government is sticking with a growth forecast of 3.5 percent this year, accelerating to 4 percent in 2014, despite a slowing at the start of 2013.

But policymakers are concerned the strong peso will dampen growth, and the upgrade intensified speculation that officials may take further steps to check its gains.

Santander economist Rafael Camarena said it was possible the peso, already at its strongest since August 2011, would appreciate further if big reforms were passed.

"We think there's a favorable environment for the peso, although we also think that the Bank of Mexico and the finance ministry could reactivate the mechanism for reserve accumulation now that we are breaking past 12," he said.

Investors are watching to see if Mexico will reinstate a mechanism of auctioning dollar "put" options, which could slow the pace of peso gains. The put options allow banks to sell dollars to the central bank at a better rate when the cost of dollars in pesos falls below its 20-day moving average.

Mexico has absorbed $160 billion in new foreign investment in its financial markets in the last three years, pushing stocks .MXX and bonds to record highs.

Foreign holdings of Mexican peso debt have surged six-fold since 2008 to 1.6 trillion Mexican pesos ($133 billion), nearly 40 percent of the total on issue, central bank data show. ($1 = 12.0362 Mexican pesos)

(Additional reporting by Noe Torres in Mexico and Daniel Bases and Caryn Trokie in New York; Editing by Chizu Nomiyama, Andrew Hay, David Gregorio and Mohammad Zargham)

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