Mexico tariff threat a trigger for Fitch downgrade

Mexico’s sovereign ratings took a one-two punch Thursday, already being dubbed “Mexico’s D-day” by the local media, with Fitch Ratings handing the sovereign a not-entirely unexpected downgrade to ‘BBB’ from ‘BBB+’ and Moody’s changing it’s outlook on the sovereign to ‘negative’ from ‘neutral’.

The stated rationale for both ratings actions centered on weakness in the Mexican economy, deteriorating growth prospects, and the administration’s change in policy toward state oil company Pemex, echoing similar warnings sounded by the agencies in the first quarter.

However, the icing on the cake was the failure of Mexican officials on a diplomatic mission to the US to reach an agreement to halt or delay a 5% blanket tariff on all Mexican imports, which is set to go into effect Monday.

With this in mind, BNamericas asked Charles Seville, Fitch’s co-head of Americas ratings and Mexico lead, how the threat of tariffs alone played into their decision to downgrade.

“The latest trade threats are part of a pattern, which isn’t going away any time soon," replied Seville.

“We try to be forward looking where possible. There are several drivers of this rating action, not just tariffs,” said Seville. “We spelled out triggers when we put the rating on negative outlook.”

It remains  unclear whether the tariffs will go into effect June 10. Mexico’s negotiations may yet succeed at buying the country more time to comply with the US ultimatum to crack down on migrants or face tariffs.

Seville explained that their decision to downgrade the sovereign was independent of what happens with the tariffs Monday. The triggers seen by Fitch for a possible downgrade are:

– A weakening in the consistency and credibility of the macroeconomic policy framework and/or undermining of structural reforms in the process of implementation;
– A trend increase in the government debt burden;
– Materialization of contingent liabilities that undermine the sovereign's balance sheet;

The threat of tariffs represented such a materialization of contingent liabilities, and thus contributed to the decision to downgrade – regardless of what happens Monday.

Seville, however, stressed that the sovereign ratings “continue to be supported by a strong fiscal and monetary policy framework which has helped it absorb shocks from oil production and prices, and also trade.”

“But it will be difficult for the government to keep the debt burden stable in view of pressures from the oil sector and growth risks,” he added.

Seville also outlined the chief causes for Fitch’s concerns on Pemex, stating, “The government has suspended the energy sector reform, which would have allowed more private capital into the oil industry.”

He added, “There is a greater likelihood that the government will step in to provide greater support to Pemex, by cutting its tax bill or other means. And in the absence of greater support, the credit profile of the company is liable to deteriorate.”

Silver lining?

Banorte’s analysis team, in a note, suggested their may be a silver lining to Thursday’s actions at Moody’s and Fitch, suggesting the moves came as little surprise to the markets.

“We believe that the decisions made by the rating agencies have two positive aspects. Somehow the risk of a downgrade of the rating ‘is over’ while Fitch modified the outlook from ‘negative’ to ‘stable’, which takes the pressure off the local markets,” wrote Banorte.

“Looking ahead, we believe that an agreement between Mexico and the United States on trade issues is highly feasible at the end of the month which, together with a new plan for Pemex, will limit the possibilities of having a further deterioration in debt ratings.”