Mexico's peso sinks on tax plan doubts

* Peso sinks on worries tax plan may not avoid downgrade

* Stocks gain as investors move from Brazil to Mexico (New throughout, adds comments, closing stock prices)

MEXICO CITY, Oct 20 (Reuters) - Mexico's peso weakened sharply on Tuesday, on doubts that proposed new taxes will do enough to curb the country's dependence on declining oil revenue and avoid a downgrade of the country's debt.

The peso MXN=MEX01 weakened 0.97 percent to 13.056 per U.S. dollar, also hit by a broad rebound in the greenback.

The lower house finance committee approved new taxes to shore up Mexico's paltry tax take, but they rejected a 2 percent sales tax that was seen as the cornerstone of President Felipe Calderon's bid to boost non-oil tax revenue amid falling crude production. [ID:nN20418515]

"This probably won't be enough to avoid a downgrade from S&P," said Igor Arsenin, head of debt and currency strategy for Latin America at Credit Suisse in New York.

Both Standard & Poor's and Fitch Ratings have threatened to downgrade Mexico's debt if the government does not move to compensate for falling oil income, which accounts for nearly one-third of the government's budget.

"There is a medium term problem that is not addressed here and that is implications of the collapse in oil production on government finances," Arsenin said.

Opposition lawmakers were looking at raising the proposed budget deficit as well as counting on higher oil prices next year to cover the expected shortfall between Calderon's proposal and the lawmakers' bill.

"The ratings agencies are not going to like this, they are just covering the gap without adding new permanent revenue," said Rodolfo Navarrete, head of analysis at Vector brokerage in Mexico City.

The full lower house is expected to vote on the proposed taxes later on Tuesday.

Before Tuesday's losses, Mexico's peso had gained around 6 percent this month, helped by hopes lawmakers would approve new taxes that could avoid a downgrade.

The peso initially gained to an eight-week high early on Tuesday on the news the lower house had reached an agreement on new taxes after weeks of debate.

The currency had also been supported by flows into Mexico after Brazil moved to tax capital inflows in a bid to help prevent its currency from appreciating further, traders said.

The government's benchmark 10-year peso bond MX10YT=RR bid up 8 basis points to 8.05 percent, hurt by expectations the new taxes would push up inflation.

The IPC stock index .MXX closed up 0.24 percent at 31,000.94, helped by flows as investors allocated funds to Mexico instead of Brazil.

"We are telling people to short Brazil and go long Mexico," said Kathryn Rooney, an emerging market strategist at Bulltick Capital Markets in Miami.

Wireless giant America Movil dipped after the finance committee passed a 3 percent tax on telecommunications. Its shares (AMXL.MX) lost 0.42 percent to 31.12 pesos.

Shares in Grupo Mexico (GMEXICOB.MX) fell 3.03 percent to 28.81 pesos, hurt by a snag in the court case to decide whether Grupo Mexico or India's Sterlite Industries STRl.BP will gain bankrupt U.S. copper miner Asarco LLC. (Reporting by Michael O'Boyle; Editing by Diane Craft)