By Tomas Sarmiento and Christine Murray
MEXICO CITY Feb 5 (Reuters) - Mexico became only the second country in Latin America to earn a coveted "A" grade sovereign rating after Moody's upgraded it on Wednesday, citing major economic reforms that President Enrique Pena Nieto has pushed through Congress.
Mexican debt rallied and the peso currency also firmed after the upgrade, which should help to lower the country's borrowing costs, and could also underpin local assets amid a global emerging market sell-off.
The Moody's Investors Service decision comes after President Enrique Pena Nieto broke through gridlock in a divided Congress to push through Mexico's most significant economic reforms since the NAFTA trade deal with the United States and Canada in the 1990s.
Moody's upgraded Mexico's sovereign rating to A3 from Baa1, with a stable outlook. Only a handful of other emerging markets such as Chile, Poland and Malaysia have earned an 'A' rating.
Mexico's upgrade came even after battles between armed vigilantes and drug gangs in the western state of Michoacan spooked some investors and underscored the country's struggle to reduce drug violence that has dragged down growth.
Moody's expects last year's reforms, which include opening the state-run energy sector to private investment and a tax overhaul, to "strengthen the country's potential growth prospects and fiscal fundamentals."
Mauro Leos, the Moody's senior analyst, told Reuters the rating agency sees no further significant changes in Mexico's sovereign rating for two to three years.
Fellow ratings agencies Standard and Poor's and Fitch Ratings are expected to follow suit with upgrades.
"Confidence in Mexico in the world is growing," President Nieto said after the upgrade.
He is hoping that sweeping overhauls of the telecommunications and energy sectors will boost competition and economic growth in Mexico, which has been a regional laggard.
"I think it's very well deserved and to a large extent reflects the recognition of the major structural reform drive that was undertaken by the authorities last year," said Alberto Ramos, an economist at Goldman Sachs in New York.
The upgrade could not come at a better time for Mexico, which has suffered alongside other emerging nations as investor jitters over the winding down of U.S. monetary stimulus and the deceleration of the Chinese economy set off a massive sell-off of emerging market assets
The yield on the country's benchmark 10-year peso bond fell 13 basis points to 6.52 percent in its biggest one-day drop since the end of December, pushing its price up sharply. Bond prices move inversely to their yields, and the emerging market sell-off drove the 10-year peso bond's yield to its highest in over two years last week.
The upgrade comes even after battles between armed vigilantes and drug gangs in the Western state of Michoacan spooked some investors and underscored the country's struggle to reduce crime that has dragged down growth.
The peso firmed and the leading share index shook off early losses. Still, the peso is down nearly 2 percent so far this year, while the IPC stock index is down more than 6 percent.
The upgrade comes after Standard & Poor's raised its own sovereign long-term foreign currency credit rating for Mexico by one notch to BBB-plus in December. However, that upgrade only brought S&P in line with both Moody's and Fitch at the time.
Brazil, by comparison, is expected to be downgraded amid an increase in public spending and as revenues erode because of sluggish growth.
"This is a seal of approval on the Mexican economy," Finance Minister Luis Videgaray told local radio. He noted it has set Mexico apart from other emerging markets, and should help lower government and corporate borrowing costs.
Benito Berber, a senior Latin America strategist at Nomura Securities in New York, said the upgrade would help Mexico distinguish itself from other emerging markets. However, there was a risk the reforms might not be implemented properly.
"This is a stamp of approval, but the reforms have to deliver growth and they have to deliver investment," he said.
Moody's maintained a more positive outlook on Mexico in the aftermath of the 2008-2009 financial crisis, even as S&P and Fitch cut their ratings. Berber now expects, "S&P and Fitch to upgrade Mexico in the last quarter of the year or first quarter of 2015."
In December, Standard & Poor's raised its sovereign long-term foreign currency credit rating for Mexico to BBB-, one notch shy of its equivalent of an "A" grade. Fitch rates Mexico BBB-plus, also one notch below "A".