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UPDATE 3-Mexico lawmakers pass tax hikes;rating fears remain

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MEXICO CITY, Oct 21 (Reuters) - Mexico’s lower house of Congress passed a watered-down version of President Felipe Calderon’s tax reform proposal on Wednesday in an effort to reduce a dependence on waning oil output in the 2010 budget.

Lawmakers met through the night to approve the income side of the 2010 federal budget and a bill to lift value-added tax, or VAT, to 16 percent from 15 percent. The lower house also approved raising income taxes for high earners to 30 percent from 28 percent.

It was unclear whether that will be enough to stave off threatened debt downgrades by ratings agencies. Analysts at Merrill Lynch and 4Cast on Wednesday both put the probability of a downgrade at above 50 percent.

Mexico’s public finances are under pressure from a slide in oil output since 2004, although Energy Minister Georgina Kessel told Reuters the decline has now stabilized [ID:nN20464082], as the country suffers its worst recession since the 1930s.

“Mexico cannot live off oil any longer,” said lower house deputy Luis Enrique Mercado of Calderon’s conservative National Action Party, or PAN. “Oil is a resource that is running out and we have to replace these revenues with other income.”

Pummeled by the U.S. economic crisis, Mexico sank into one of the world’s deepest recessions last year, though factory orders are beginning to pick up now and Calderon said on Tuesday the economy likely surged nearly 3 percent in the third quarter from the previous three months.

Mexico's peso currency MXN= firmed 0.70 percent to 12.945 per U.S. dollar after the vote in Congress, with markets cheering progress on the tax plan.

“We view the fiscal package that is being approved by Congress as a much-needed step in the right direction to strengthen non-oil tax revenues permanently,” Alfonso Cervera, an economist at Credit Suisse in New York, said in a report.

The budget and tax bills now go to the Senate where they are expected to be approved with at most minor tweaks, and then to Calderon for signing into law.


At the same time, worries remain the measure will not be enough to appease Wall Street credit ratings agencies that have threatened to cut Mexico’s debt ratings a notch if the country does not widen its tax base to offset falling oil output.

Oil revenues fund about a third of the federal budget.

The main opposition Institutional Revolutionary Party, or PRI, which has the most seats in the lower house, rejected a cornerstone of Calderon’s fiscal proposal -- a new 2-percent sales tax levied on all goods, including currently exempt foods and medicines, saying it would unfairly hurt poor families.

In a bid to try to create more revenue without raising taxes as much as Calderon wanted, the house set an estimate for the Mexican oil export price of $59 per barrel for 2010, higher than the government’s estimate of $53.90.

“If the rating agencies focus on that problem there could be a downgrade,” 4cast said in a report. “The reform does not widen tax bases but instead raises rates on current tax bases. We put a 75 percent risk of a credit rating downgrade.”

Mexican oil currently fetches $72 per barrel.

Shelly Shetty, senior director of sovereign credit at Fitch Ratings in New York, said on Tuesday the firm would weigh more than a budget or tax reform debate in its decision.

Lower credit ratings would raise borrowing costs for Mexico, which would be a blow to companies and consumers as the country emerges from recession.

Further watering down Calderon’s proposal, deputies set a new 3 percent tax on telecoms services rather than the 4 percent Calderon had proposed. Deputies also raised taxes on beer, tobacco and cash bank deposits as well as a way to increase the country’s paltry tax take.

The telecoms tax could hurt wireless giant America Movil AMXL.MX and dominant fixed-line provider Telmex TELMEXL.MX, both owned by billionaire Carlos Slim. [ID:nN20454049]

Left-wing lawmakers took over the chamber podium for several hours to protest the tax rises, but the votes were completed within a few hours of the end-Tuesday deadline.

They fixed the federal government deficit for next year at the equivalent of 0.75 percent of gross domestic product, above the 0.5 percent set in the original budget proposal. (For more details on the tax bill, click on: [ID:nN20449438] (Additional reporting by Jason Lange; writing by Catherine Bremer, editing by W Simon)