Fitch: Reform Implementation Key after Mexico Midterm Elections

The outcome of Mexico's midterm elections should not lead to deviations in Mexico's macro-economic and policy outlook and could limit political risks to fiscal consolidation, Fitch Ratings says. Important structural reforms have been passed during the first three years of the Pena Nieto administration. Implementation, which is less dependent on the composition of Congress, is now the key to their success.

Based on preliminary estimates, President Enrique Pena Nieto's Institutional Revolutionary Party (PRI) and its coalition allies will likely retain control of the 500-seat lower house. This would reduce the potential for congressional opposition to the administration's legislative agenda in the second half of Pena Nieto's presidential term. The elections were held against a backdrop of reduced popularity of the president, which has been dented by subdued growth, episodes of violence and corruption allegations. In this context, the relatively smooth electoral process is a positive outcome.

The administration faces two main challenges in its remaining three years: the fiscal challenge emanating from lower oil prices and output, and the structural challenge of boosting potential growth. A simple congressional majority would smooth the passage of the government's annual budgets, as it continues gradual fiscal consolidation in the face of reduced oil revenues (which make up around one-third of fiscal receipts) and moderate growth.

Hedging arrangements and a weaker peso have contained cheaper oil's budgetary impact this year, but further fiscal adjustments will likely be required to meet medium-term fiscal goals. In January, the government announced spending cuts of approximately 0.7% of GDP to meet this year's non-financial public sector deficit target of 1% of GDP. A preliminary outline of the 2016 budget envisages further spending cuts but no tax increases. The final proposal, due by early September, will be an important indicator of the government's willingness to maintain a prudent fiscal stance and continue with fiscal consolidation.

The subdued recovery in the first quarter of 2015 and continued risks from oil prices and production, spending cuts and prospective Fed tightening present risks to Fitch's current growth forecast of 3% for 2015. Continuity in the legislature after the midterm elections may provide a supportive environment for implementing structural reforms. Many of the Pena Nieto administration's major reforms (such as labor, energy and telecommunications) have already been passed. Therefore, we do not anticipate an aggressive reform agenda that would need congressional approval during the remainder of this administration.

Instead, the focus will shift to implementation. The willingness and capacity of the government and ability of regulatory agencies to deliver reforms already legislated will determine their impact on investment and growth. Implementation of energy reform, which could boost long-term growth, has begun, with the opening of some oil field auctions. However, lower oil prices could affect the results of oil block auctions and some projects may be reassessed, especially those related to deep water and unconventional sources.

Overall, we think the midterm election results are neutral for Mexico's sovereign credit rating. We affirmed Mexico's 'BBB+'/Stable rating in February. Weak economic performance and material fiscal deterioration leading to a sustained worsening of government debt dynamics would be ratings negative. A higher growth trajectory that facilitates debt reduction and reduces Mexico's income gap with higher rated sovereigns would be ratings positive.