MEXICO

Apparently it ain't how you pay, it's the way that you pay it, according to credit rating agency, Standard & Poor's.

Unless the Mexican President, Felipe Calderon, can find ways of diversifying away from funding the nation's budget plans through declining oil income, S&P might yet cut Mexico's BBB+ rating.

While nobody really cares that Mexico's rising debt burden is likely to increase to 3.5% of GDP in 2009, they do care about finding ways to plug the deficit. Tax collection is the kingpin in this case.  Public finances will get the better of new found Mexican-wealth unless the government can find a way of broadening the tax base. Even Saudi Arabia found itself in such awkward predicament less than a decade ago despite the fact that its deserts are practically afloat with oil.

Lower oil output and a slide in crude prices have lifted the lid off the fact that the nation's coffers take in no less than 40% of its revenue from the state owned oil monopoly. As such, the nation's more than $200 billion debt might just get a rating-shaving. Already the outlook was lowered from stable to negative at the start of the summer.
 
Because the price of oil rose in the last several years, it has allowed the government to spend around 50% more today as it did just half a decade ago. But with a 10.3% growth contraction in the second quarter this year, naturally the debt barons are coming home with a severed warning. Fix the medium-term problem or ultimately pay a higher price to borrow. 

But the chances of ushering a fiscal revolution are hardly high on the agenda of the main opposition party, the PRI, which lost power nine years ago and hopes to regain status in 2012. Voting for higher taxes hardly seems like a winning platform. The opposition currently advises the government to reign in its spending habits in order to repair state finances.

Still, with a deficit of 3.5% of GDP the government is far more in control of state finances today than in 1999 when it rose to 5.9%. Last year it was 2.1%. The impact has been to frighten investors in Mexican instruments. Some already say that a rating cut is baked into the cake with the yield on the 15-year bond rising from 7.57% to 8.41% since the start of the year regardless of the fact that recovery has accompanied realignment in bond yields.

Now, investors are assaulting the Mexican peso in the expectation the ratings agent will underscore its threat with an actual downgrade. Meanwhile government spending cuts are underway with some $6.4billion equivalent already in action thanks to administration and operational cost cuts enforced since May. Raising the old favorites of alcohol and tobacco taxes is also likely before long.
In the September issue of Global Resources Alert we take a deeper look at the issues confronting the government and what it's likely to mean for the Mexican peso. Join today to activate your subscription by clicking the link below.

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