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Rating Action:

Moody's changes Mexico's outlook to negative from stable; affirms A3 rating

Global Credit Research - 31 Mar 2016

New York, March 31, 2016 -- Moody's Investors Service has today affirmed Mexico's A3 issuer and government bond ratings and changed the outlook to negative from stable. The government's senior secured and senior unsecured government bond ratings were affirmed at A3, as were the senior unsecured MTN and senior unsecured shelf program ratings at (P)A3.

The key drivers of today's rating action are the following:

1) Subdued economic performance and continued external headwinds will challenge the government's fiscal consolidation efforts and increase the risk that rising debt ratios will not stabilize over the rating horizon.

2) Contingent liabilities in the form of possible government support to PEMEX, given liquidity pressures at the state-owned oil producer, could further undermine the fiscal consolidation process.

The negative outlook balances the strong commitment of the authorities to achieving fiscal consolidation and containing liquidity pressures at PEMEX against the challenges from subdued economic activity, the low oil price environment and implementation risks to the authorities' announced measures for limiting spillover effects from PEMEX into the government's balance sheet.

Mexico's long-term local currency country risk ceilings remain unchanged at Aa3. The foreign currency bond ceiling and the foreign currency bank deposit ceilings are also unchanged at A1 and A3, respectively. The short-term foreign currency bond and deposit ceilings remain at P-1 (Prime-1) and P-2 (Prime-2), respectively. These ceilings reflect a range of undiversifiable risks to which issuers in any jurisdiction are exposed, including economic, legal and political risks. These ceilings act as a cap on ratings that can be assigned to the foreign and local-currency obligations of entities domiciled in the country.

RATINGS RATIONALE

RATIONALE FOR THE OUTLOOK CHANGE

-- FIRST DRIVER: FISCAL AND ECONOMIC CHALLENGES TO ACHIEVING CONSOLIDATION OBJECTIVES AND STABILIZING DEBT RATIOS --

The principal driver of Moody's decision to change the outlook to negative from stable is the rising fiscal and economic challenges that the authorities face in achieving further fiscal consolidation. At the time that the structural reforms were adopted, Moody's expected that fiscal consolidation, coupled with much stronger real GDP growth (above 3%), would lead to a stabilization in the debt burden. However, a combination of the oil price shock and the slower than expected growth have undermined the economic outlook. Moody's forecasts only moderate growth of around 2.5% for 2016 and 2017, which will challenge the government's fiscal consolidation efforts.

Lower growth and a low oil price environment will reduce fiscal revenues. While fiscal reform has improved the structure of fiscal revenues, heightening resilience to oil price shocks by strengthening tax collection, Moody's forecasts that overall federal government revenues will decrease to 18.5% of GDP in 2016 from 19.3% in 2015. In response, the authorities have begun implementing expenditure measures to reduce the federal government deficit from 2.8% of GDP in 2015. Moody's forecasts a federal government deficit of 2.5% of GDP for 2016 and a gradual decline through 2018 when the deficit is likely to narrow to 2% of GDP.

Federal government debt reached 34.4% of GDP in 2015 from 27.9% in 2011. Moody's estimates that debt to GDP will continue to increase gradually, but will likely stabilize at around 37% of GDP in 2018. A debt burden of that order of magnitude would be consistent with an A3 rating. However, the negative outlook reflects the risk, which Moody's believes is balanced to the downside, that lower growth and revenues and heightened pressures on expenditures cause the debt burden to continue to rise beyond that horizon.

-- SECOND DRIVER: CONSOLIDATION OBJECTIVES FACE RISKS FROM PEMEX CHALLENGES --

The second driver of the outlook change is the risk that contingent liabilities crystallize on the government's balance sheet in the form of government support to PEMEX, further undermining fiscal consolidation efforts.

Financial challenges at PEMEX from lower oil prices have increased the likelihood that government liquidity support will be needed. PEMEX is implementing an expenditure adjustment of MXN100 billion ($5.7 billion or 0.5% of GDP) in 2016 and plans to increase operational efficiency over the medium term to ensure the sustainability of the company's finances. However, the adjustment measures face significant challenges. In the meantime, PEMEX's deficit stemming from operating and capital expenditures and debt service needs is likely to persist through 2018.

While not Moody's base case, should the state-owned oil producer be unable to finance this deficit in the capital markets, the sovereign would likely provide financial relief to ensure that PEMEX can cover its debt service payments and, potentially, its capital expenditures. Given the size of those financing needs, Moody's believes that the fiscal impact of support could more than offset any progress achieved on fiscal consolidation, preventing a stabilization of government debt ratios by 2018, and pushing federal government debt above 40% of GDP.

WHAT COULD MOVE THE RATING UP/DOWN

Over the coming one to two years, Moody's will evaluate the progress achieved on fiscal consolidation and the implementation of expenditure cuts at PEMEX to confront liquidity pressures.

Moody's would stabilize Mexico's A3 rating were it to conclude that the measures needed to contain government expenditures and PEMEX-related contingent liabilities, even in a low growth environment, will be taken so as to allow fiscal consolidation to proceed as planned.

Upward pressure on Mexico's rating could result from higher than expected growth driven by continuing structural reform efforts, which would result in the creation of fiscal buffers by the government, and a faster than expected reversal of the upward trend in government debt metrics.

Conversely, downward pressure on Mexico's rating could result should stalled fiscal consolidation efforts, and the crystallization of contingent liabilities from PEMEX or indeed from the broader public sector, cause federal government debt ratios to continue to rise beyond 40%. In that event, Moody's would evaluate the clarity and credibility of the government's plans to address the further rise in debt and the lower growth likely to be associated with it, and assess the rating consequences of the lower than expected economic and fiscal strength which that environment would imply.

GDP per capita (PPP basis, US$): 17,950 (2014 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 2.5% (2015 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 2.1% (2015 Actual)

Gen. Gov. Financial Balance/GDP: -2.8% (2015 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -2.6% (2015 Actual) (also known as External Balance)

External debt/GDP: 32.9% (2014 Actual)

Level of economic development: High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 29 March 2016, a rating committee was called to discuss the rating of Mexico, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have decreased. The issuer's fiscal or financial strength, including its debt profile, has decreased.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2015. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Jaime Reusche
Vice President - Senior Analyst
Sovereign Risk Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Anne Van Praagh
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's changes Mexico's outlook to negative from stable; affirms A3 rating
No Related Data.
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