Nov. 4 (Bloomberg) -- Mexico passed a “big test” of political maturity by raising taxes to tame its widening deficit during a recession, the World Bank’s chief economist for Latin America said. Whether it’s enough to satisfy ratings companies, which have threatened a downgrade, remains to be seen, he said.

The watered-down version of President Felipe Calderon’s 2010 budget approved by Congress reduces a dependence on oil revenue that previous governments weren’t able to address, Augusto de la Torre said in an interview in Washington.

“No society likes to raise taxes,” said de la Torre, 56, who was Ecuador’s central bank president from 1993 to 1997. “Whether the reform is perfect or not is something we will know as this process unfolds, but the whole direction of the effort is admirable.”

Mexico is seeking to avoid a credit rating cut as falling oil output swells a deficit that Calderon on Sept. 8 said would rise to equal 2.5 percent of gross domestic product next year, including investment by state-owned oil company Petroleos Mexicanos, known as Pemex. This year, the government’s projected deficit is 2.1 percent of GDP.

Standard & Poor’s and Fitch Ratings say they may cut Mexico’s credit rating should the government fail to offset the drop in oil output, which accounts for 38 percent of federal revenue, and contain the deficit.

Income, Sales Taxes

Lawmakers on Nov. 1 voted to increase the sales tax to 16 percent from 15 percent instead of adopting the administration’s 2 percent consumption tax proposal, which would have generated more than double the revenue, according to the government.

They also raised the income tax for wealthier individuals as well as corporations to as high as 30 percent in 2010 to 2012, before dropping to 29 percent in 2013 and returning to 28 percent in 2014.

De la Torre said some investors may be misjudging Mexico’s “courageous” tax changes and forgetting the country’s track record for solid macro-economic management. Mexico’s dollar bonds lost 2 percent last month, their biggest monthly decline since a 4.4 percent tumble in January.

“Markets should also remember that Mexicans were very prudent when they contracted all of these hedges for the oil price,” said de la Torre, referring to the $1.5 billion the government spent last year on put options to gain the right, not the obligation, to sell its oil for $70 a barrel in 2009.

The hedging strategy helped cushion the blow from the recession in the U.S., where 80 percent of Mexico’s exports went last year, and narrow the budget deficit as the price of Mexico’s oil export mix fell as low as $33.71 a barrel on Feb. 18.

‘Stands Tall’

Mexico’s economy tumbled 9.2 percent in the first half of 2009 compared to the same period last year, the worst among Latin America’s 12 largest economies. Next year, the International Monetary Fund expects it to grow 3.1 percent. The World Bank is revising its June forecast for 1.7 percent growth next year, de la Torre said.

De la Torre said that falling debt burdens and flexible exchange rates reduced the region’s vulnerability to the global crisis to the point that “Latin America stands tall after the fall.” As risk aversion subsides, the region should become a popular destination for global capital flows, he said.

“There’s quite a bit of money on the sidelines still,” he said. “When investors feel more comfortable, and think where to put their money, Latin America has become in relative terms a more attractive place.”

Brazil’s Rating

Brazil, with the region’s largest domestic market, should be the main beneficiary and may be in line for a further credit rating upgrade, he said. S&P, Fitch and Moody’s Investors Service rate its long-term foreign currency-denominated debt two notches below Mexico.

“The way markets are reacting, they have already upgraded Brazil even if the ratings agencies have not,” he said. “There are great fundamental reasons to be enthusiastic about Brazil.”

The enthusiasm extends to Argentina, which is offering to swap $20 billion in defaulted bonds in a bid to return to international capital markets for the first time since its $95 billion default in 2001. A successful restructuring would foster economic growth by improving access to trade lines, working capital and encouraging foreign direct investment, he said.

“Investors would be very interested in going into Argentina once a number of clouds move away,” he said, without providing an estimate of how much growth could increase following another swap.

To contact the reporters on this story: Joshua Goodman in Rio de Janeiro at jgoodman19@bloomberg.net

Last Updated: November 4, 2009 15:56 EST