Oct. 21 (Bloomberg) -- Mexico’s peso rose for a second time this week after the lower house approved a portion of the 2010 budget, boosting speculation congress will pass a reform package that will strengthen the nation’s fiscal outlook.

The currency climbed 0.8 percent to 12.9447 per U.S. dollar at 5 p.m. New York time, from 13.0434 yesterday. The peso has strengthened 4.4 percent this month, the best performance among the 26 emerging-market currencies tracked by Bloomberg.

Mexico’s lower house approved the income portion of the 2010 budget proposal while scrapping President Felipe Calderon’s plan for an additional 2 percent consumption tax. Deputies instead passed a measure to increase the current sales tax, which excludes food and medicine, to 16 percent from 15 percent.

“There’s a lot of optimism building on this fiscal package,” said Win Thin, a senior currency strategist at Brown Brothers Harriman in New York. “That’s kind of hanging over the peso right now.”

Calderon is seeking to raise taxes and reduce spending to strengthen public finances as revenue and oil production decline. Standard & Poor’s and Fitch Ratings say they’ll cut Mexico’s BBB+ rating, which is three levels above junk, should the country fail to narrow its widening budget gap.

“Lower fiscal concerns and its impact on the balance of payments and the exchange rate could improve the outlook for the Mexican peso,” Cristian Moreno, a Banco Santander SA strategist in New York, wrote in a note to clients today.

Inflation, Interest Rates

The replacement of the 2 percent consumption tax with a 1 percent increase in the sales tax will reduce the budget’s effect on accelerating inflation, Roberto Melzi, a strategist at Barclays Plc in Mexico City, wrote in a note.

“The replacement of the sales tax would require a less significant effort by the central bank to fight inflation expectations,” Melzi said. “It would not necessarily affect the timing of potential hikes.”

Barclays forecasts the central bank will raise its key lending rate in March. Policy makers have cut borrowing costs by 3.75 percentage points this year to 4.5 percent.

The legislation forecasts the economy will grow 3 percent next year, and foresees inflation of 3.3 percent in 2010. The central bank’s inflation target is 3 percent.

The Senate is scheduled to vote on the income part of the budget by Oct. 30 and the lower house is due to pass the spending portion next month.

The measures approved by the lower house will widen the public deficit to 102 billion pesos ($7.88 billion) from the 60- billion-peso deficit the government anticipated in its original proposal, Santander analyst Delia Paredes wrote.

‘Politics Over Economics’

“Oppositions parties favored politics over economics and delivered a fiscal package that, although it saves the day in 2010, does not address the median- and long-term sustainability of fiscal accounts,” Paredes wrote.

Yields on Mexico’s 10 percent bond due December 2024 rose for a third day, gaining 1 basis points, or 0.01 percentage point, to 8.21 percent, according to Banco Santander SA. The price fell 0.09 centavo to 115.47 centavos per peso.

Congress’s revenue plan probably won’t satisfy credit- rating agencies and a “one-notch downgrade is likely,” according to a Bank of America Corp. report.

“If economic recovery falters, international commodity prices retrench and the strong spending inertia, particularly from Mexican states and municipalities, is not properly addressed, a shortfall in tax revenues could remain a latent threat for Mexican public finances,” Bank of America analysts wrote in a report dated Oct. 20.

The peso pared earlier gains of as much as 1.3 percent after Mexico’s unemployment rate rose more than forecast in September from the previous month. The jobless rate was 6.41 percent last month, compared with 6.28 percent in August, the national statistics agency said. Economists estimated a rate of 6.28 percent, the median of 15 estimates compiled by Bloomberg.

To contact the reporter on this story: Catarina Saraiva in New York at asaraiva5@bloomberg.net

Last Updated: October 21, 2009 17:37 EDT