Nov. 23 (Bloomberg) -- Mexico’s investment-grade credit rating was lowered by Fitch Ratings as tumbling oil output and the worst recession since the 1930s swell the budget deficit.

Fitch cut Mexico’s foreign debt rating one level to BBB, the second-lowest investment grade and in line with countries including Russia and Thailand, and changed the outlook to stable from negative. The downgrade was the first by Fitch since it gave Mexico an initial rating of BB in 1995 and the first by any ratings company since Standard & Poor’s cut it in the wake of the 1994 peso devaluation.

Mexico, which in 2000 became the second country in Latin America to win an investment-grade rating as the North American Free Trade Agreement boosted exports, has been the hardest hit in the region by the global recession that began in the U.S. President Felipe Calderon failed to pass a consumption tax aimed at offsetting declining oil proceeds and stemming a deficit that JPMorgan Chase & Co. says will reach the widest in two decades.

“The rating that Mexico got over the last few years, ahead of Brazil and ahead of Colombia and ahead of Peru, which was all right at the time, now seems a bit overblown,” said Claudio Loser, former Western Hemisphere director for the International Monetary Fund. “It stayed at a plateau while the rest of the world was moving forward. That says Mexico has lost.”

Markets Rally

The peso, stocks and bonds advanced after the downgrade as Fitch’s shift back to a stable outlook quelled speculation that the company may look to lower the rating again. The peso jumped 0.8 percent, the most since Nov. 13, to 12.9632 per dollar at 4:01 p.m. while the Bolsa index rose 1.5 percent.

Yields on the government’s benchmark bond fell five basis points, or 0.05 percentage point, to 8.17 percent. The price of the 10 percent security due in December 2024 rose 0.46 centavo to 115.80 centavos per peso, according to Banco Santander SA.

“On the positive side, the outlook is stable, which means Fitch is comfortable with Mexico’s current credit grade,” said Sergio Mendez, who oversees 65 billion pesos in assets as chief investment officer at Afore XXI, a Mexico City-based pension fund. “The downgrade was relatively expected by the market.”

In the credit-default swaps market, where investors buy contracts to protect against non-payment of debt, Mexico has been trading at a higher cost than countries with lower ratings, including Panama, Brazil and Peru.

The cost of protecting Mexican debt against default for five years was 1.4 percentage points at the end of last week while it cost 1.34 points to protect Panama’s, according to data compiled by CMA Datavision. Mexico’s cost held at 1.4 points today while Panama’s dropped to 1.32.

2010 Budget

Standard & Poor’s also has had Mexico’s BBB+ rating on negative outlook since May. Moody’s Investors Service has a stable outlook on the country’s Baa1 rating, which is also the third-lowest investment grade rating.

Lawmakers approved on Nov. 1 a permanent 1 percentage-point increase in the sales tax to 16 percent after rejecting Calderon’s proposal for a 2 percent consumption tax that would have generated more than double the revenue.

The 2010 budget approved last week by congress calls for spending of 3.18 trillion pesos and forecasts a budget deficit of 0.75 percent of gross domestic product. Including spending by state-owned oil company Petroleos Mexicanos, the deficit will reach 2.75 percent of GDP, the widest since 1989, according to JPMorgan.

“The reforms implemented by this administration represent an important advance to deal with the different structural weaknesses pointed out by the ratings agency,” Mexico’s Finance Ministry said in a statement today.

‘Unnecessary Roughness’

The downgrade is “somewhat tough because in a way it overlooks what was still a fiscal adjustment worth close to 1.9 percent of GDP in an economy experiencing a recession,” Paulo Leme, chief Latin America economist at Goldman Sachs Group Inc., said in a telephone interview from Miami. “It’s what we call unnecessary roughness in American football.”

Mexico’s $1.09 trillion economy will shrink as much as 7.5 percent this year, the most since the 1930s, according to the central bank. Oil, which funds 38 percent of Mexico’s budget, has fallen 47 percent from a high of $147.27 a barrel in July 2008. Output at state-owned Petroleos Mexicanos fell last year at the fastest rate since 1942, costing Mexico 300 billion pesos in lost revenue, according to Finance Minister Agustin Carstens.

‘Accentuated Weaknesses’

“The global economic and financial crisis and falling oil production have accentuated weaknesses in the sovereign’s fiscal profile,’ Fitch said in a statement today. “These weaknesses limit Mexico’s fiscal maneuverability in the face of future oil income shocks.”

Mexico nationalized its oil industry in 1938 and enacted a constitutional ban on foreign energy investment to protect its resources. The country’s oil production fell for the 39th month on the year over-year-basis to 2.602 million barrels a day in October, Petroleos Mexicanos said Nov. 20.

Benito Berber, an economist with RBS Securities in Stamford, Connecticut, estimates the 2009 budget gap will equal about 2.8 percent of gross domestic product, the widest since it reached 4.7 percent in 1989. The sales tax increase approved by congress was a “less optimal solution” than the creation of a consumption tax, Shelly Shetty, an analyst with Fitch, said in a Nov. 2 interview.

Political Stalemate

“Everyone has been playing politics so there is a stalemate in the political sphere,” Loser said. “That makes it very difficult to come up with a reasonable set of policies in terms of inviting private-sector investment.”

Mexico, which signed the North American Free Trade Agreement in 1993, received its first investment-grade rating in 2000, when Moody’s boosted the country’s credit ranking to Baa3.

“At the end of the day this cut may be a big favor for Mexico,” Alonso Cervera, a Latin America economist at Credit Suisse Group AG, said in an interview from New York. Mexican politicians may be now more willing to move forward with some of the needed reforms, he said.

To contact the reporter on this story: Carlos M. Rodriguez in Mexico City at carlosmr@bloomberg.net.

Last Updated: November 23, 2009 17:49 EST