Fitch Affirms Mexico's Investment-Grade Ratings.

NEW YORK -- Fitch Ratings, the international rating agency, today affirmed Mexico's foreign currency rating of 'BBB-' and local currency (Mexican Peso) rating of 'BBB'. The Rating Outlook remains Stable.

'The inability of the Fox administration to implement a revenue-enhancing fiscal reform and/or other structural reforms will limit the improvements in public finances and prevent the economy from accelerating on a sustained basis,' said Shelly Shetty, Director, Sovereign Group, Fitch Ratings. As a result of sluggishness in growth and exports, Mexico's financial indicators during 2001-2003 have not improved dramatically, which has also prevented further improvements in sovereign creditworthiness.

Mexico's ratings are constrained by structural weaknesses in its public finances, such as a heavy dependence on oil revenue and low total taxation of 11% of GDP. Fitch views unfavorably that Mexican authorities have not used the opportunity presented by high oil prices to transfer greater resources to the Oil Stabilization Fund (OSF), which could be used when oil prices decline. Over the medium term, public finances will come under pressure owing to lower oil prices, nonrecurrent revenue, and higher public sector pension costs. In the current political environment, revenue-enhancing tax reforms appear to be unlikely.

While the link between Mexico and the U.S. remains intact, in order for Mexico to fully exploit the gains of trade integration, it has to implement further microeconomic reforms to boost its export competitiveness and increase the investment rate to achieve a higher sustainable growth. Structural reforms in the areas of energy, labor, and taxation are required to increase competitiveness. Higher investment in infrastructure and human capital are also needed for Mexico to diversify its export base into higher value-added products.

On the positive side, with the recovery in the U.S., the Mexican economy and exports have begun to rebound, with growth expected to reach 4% this year. The government has recently passed legislation to simplify the income tax regime in Mexico even though the measures will be broadly revenue-neutral. The government's liability management is laudable, with the federal government already having prefinanced its market amortization for 2005. The government has also been striving to change the make up of public debt in favor of domestic debt by financing the entire budget deficit domestically. The average maturity of domestic debt, as well as the proportion of domestic debt issued on fixed interest rates is also increasing steadily.

Mexico's balance of payments continues to strengthen thanks to the recovery in manufactured exports, a strong growth in overseas workers' remittances, and continued large inflows of foreign direct investment. International reserves have continued to accumulate, with Fitch's international liquidity ratio for Mexico expected to be over 100% in 2004, up from 73% in 2001. The external debt burden is likely to fall owing to stronger exports, albeit less dramatically than the decline in the late 1990s. Net external debt and net public sector external debt as a share of current external receipts are forecasted to reach 45% and 24%, respectively, in 2004, the latter above the 'BBB' median of 9%.

Fitch cautions that political uncertainty may increase during 2005-2006 owing to the presidential and congressional elections in July 2006. But Fitch's base case assumes that the presidential elections will be smooth and that the central bank and the finance ministry will take requisite measures to reduce potential volatility and maintain macroeconomic stability. Fitch believes that Mexico's flexible exchange rate and higher level of foreign exchange reserves and the government's adept prefinancing strategy, together with a more developed domestic debt market, will act as important buffers against a potential political shock.

Mexico's ratings could get a boost from the implementation of the above-mentioned structural reforms or a substantial improvement in its external debt indicators. Furthermore, as long as the macroeconomic policy framework remains robust, credit deterioration will likely be avoided.