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Moody's upgrades Mexico's sovereign rating to A3 from Baa1

February 6, 2014

Moody's Investors Service has today upgraded Mexico's government bond ratings to A3 from Baa1. The outlook is stable. The decision to upgrade Mexico's sovereign ratings was driven by the structural reforms approved last year, which Moody's expects will strengthen the country's potential growth prospects and fiscal fundamentals. As the full impact of the reforms becomes more evident over time, Moody's expects that Mexico's credit metrics will report firm - but gradual - improvements, thereby further reinforcing the country's already robust sovereign credit profile. Specifically, the upgrade of Mexico's sovereign ratings was driven by the following four factors linked to the country's reform package: - Approval of a comprehensive reform agenda, which reflects political will to address longstanding structural issues - Improved medium-term economic prospects associated with higher potential growth that is likely to result from the comprehensive reform package - A strengthened fiscal outlook that incorporates higher government savings and additional buffers - An overall credit profile that is similar to that of other A-rated countries RATIONALE FOR UPGRADE TO A3 First Driver -- Comprehensive Reform Agenda Reflects Political Will And Consensus The main driver of the upgrade is the approval of the government's reform agenda, which the rating agency believes will have important implications for the country's sovereign credit profile. After 20 years of attempts by three different administrations to push through a reform agenda, the approval of reforms not only reflects strong political will and ability to deliver campaign promises, but in some instances also exceeds initial expectations. Overall, the reform process confirms that, despite vested interests, there appears to be sufficient political consensus in Mexico to reach agreements and push for changes to address challenges that have so far acted as constraints on Mexico's sovereign ratings. In Moody's opinion, the approval of a comprehensive package of reforms significantly increases the probability that the Mexican government will achieve a material improvement in economic and fiscal prospects over the medium to long term, providing additional impetus to the so-called " Mexico's momentum" in the near to medium term. Overall, the approval of the reform agenda represents a structural shift, whose significance for Mexico's credit profile is likely to be comparable to that of NAFTA over the years. Second Driver -- Reform Package Will Lead To Higher Potential Growth Prospects Given that the planned changes in Mexico's legal and regulatory frameworks will lead to higher investment and lift the country's growth potential, Moody's anticipates that the country's sustained GDP growth will gradually shift to the 3%-4% range from its pre-reform 2%-3% reference level. Moody's expects that the impact will be particularly significant in two strategic sectors - energy and telecommunications - where the elimination of public monopolies and private quasi-monopolies will lead to the removal of barriers to entry for new competitors. The structural nature of the reforms implies that their economic impact will become more evident over the medium to long term, that is, during the second part of this administration (2016-2018). However, they can also positively influence Mexico's near- to medium-term performance (2014-2015) if the completion of the reform process leads to improved investor sentiment. Although there are risks linked to the need to approve secondary legislation in order to define how the economic reforms will be implemented, Moody's believes that the most likely scenario is one in which, in its final form, the legislation will preserve the spirit of the reforms already approved by congress. Third Driver -- Reform Package Will Result In Increased Fiscal Savings And Buffers A further driver of the upgrade of Mexico's sovereign rating is Moody's expectation that the fiscal chapter of the reform agenda will further strengthen an already robust fiscal profile which, according to Moody's sovereign bond methodology, is assessed as "high" on a global comparative basis. In our opinion, the spending cap on primary current expenditures that is part of the fiscal reform is a step that will contribute to a gradual build-up of fiscal savings, improve the mix between capital and current expenditures, and reduce pro-cyclical elements embedded in the balanced budget rule. Moreover, the constitutionally mandated rules of operation of the newly created Oil Fund will support a declining trend in the share of oil-related government revenues and, by ensuring that an increased portion of total oil revenues are captured in a "stabilization bucket," will create a new fiscal buffer. Fourth Driver -- Sovereign Credit Profile Is Now Aligned With A-Rated Peers In light of its improved economic prospects further to the approval of the reform package, Mexico's sovereign credit profile has now become similar to those of two countries that are solid benchmarks in the A peer group: A2-rated Poland and A3-rated Malaysia . The country's overall sovereign credit profile, as derived from Moody's bond methodology, shows only marginal differences with respect to A-rated Poland and Malaysia . Mexico's income is lower than that of Poland , but roughly similar to that of Malaysia . Mexico's economic growth has been almost identical to that of Poland , but lower than that of Malaysia . Even though Mexico lags behind both Poland and Malaysia in terms of measures of institutional strength, its fiscal strength is stronger than theirs when it comes to debt metrics, particularly so when compared to those of Poland . In terms of credit resilience to shocks, Mexico and Malaysia are similarly positioned in terms of Moody's assessment of Susceptibility to Event Risk, while Poland appears riskier in this respect.

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Source: EMBIN (Emerging Markets Business Information News)

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