Nov. 3 (Bloomberg) -- Mexico’s peso fell to its weakest level in almost a month on mounting speculation tax measures passed by Congress will fail to stave off the country’s first credit-rating downgrade since 1995.

The currency declined 0.3 percent to 13.2564 per U.S. dollar at 5 p.m. New York time, from 13.2156 yesterday. It earlier touched 13.4050, the weakest since Oct. 7.

Mexico’s opposition-controlled congress approved on Nov. 1 a permanent 1 percentage-point increase in the sales tax to 16 percent after rejecting President Felipe Calderon’s proposal for a 2 percent consumption tax that would have generated more than double the revenue. Standard & Poor’s and Fitch Ratings say they may downgrade Mexico should the government fail to contain the deficit and offset a drop in oil production.

“The compromise solution attained in Congress will not be sufficient to significantly change expectations towards the economy,” Barclays Plc analysts Roberto Melzi and Jimena Zuniga wrote in a note. “It has not dispelled the risk of a downgrade.”

Analysts from S&P and Fitch said yesterday they are waiting to see the spending side of the 2010 budget that the congress approves before making a decision on the country’s rating.

The sales tax increase is a “less optimal solution” to rein in the deficit than the government’s proposal to create a consumption tax, Shelly Shetty, an analyst with Fitch, said yesterday.

Rating Outlook

Mexico’s sales-tax increase fails to resolve “medium- term” fiscal problems and raises the chance ratings companies will downgrade its credit rating and keep a negative outlook, Banco Santander SA analysts led by Gonzalo Fernandez wrote in a note to clients.

“Markets have already started to weigh the possibility of an upcoming credit downgrade,” Fernandez wrote. “The question arising now is, will they go further and downgrade the country’s debt with a negative outlook due to the failure to both significantly reduce its dependence on oil revenues and to expand the taxable base despite the modest increase in the VAT?”

Legislators approved some of Calderon’s measures, such as raising the income tax, increasing the duty on cash deposits and creating a telecommunications tax in the income portion of the 2010 budget that was approved this weekend.

They also raised the forecast for next year’s average oil price to $59 a barrel from $53.90 a barrel in the original bill, boosting projected revenue. Lawmakers have until Nov. 15 to vote on the spending side of the budget.

Peso Plunge

The peso plunged 20 percent in 2008 and sank to a record 15.5892 against the dollar on March 9 of this year amid the global credit crisis, prompting Calderon to turn to the International Monetary Fund for a $47 billion credit line.

The income portion of the budget approved by congress has an estimated deficit excluding investment by state-owned oil company Petroleos Mexicanos, known as Pemex, of 0.75 percent of gross domestic product, up from 0.5 percent in the government’s original bill. The government’s proposed 2010 budget had projected a 2010 deficit, including Pemex investment, of 2.5 percent of GDP, up from 2.1 percent this year.

RBS Securities Inc. estimates the budget gap will equal about 2.8 percent of GDP this year, the widest since 1989.

Credit-default swaps, contracts investors use to protect against non-payment of debt, show Mexico trading as high-yield, or junk -- placing it three levels below the nation’s BBB+ grade from S&P and Fitch -- on concern the tax increases will fail to stave off downgrades.

CDS

The cost of protecting Mexican debt against default for five years is 1.67 percentage points, according to data compiled by CMA Datavision. By comparison, it costs 1.68 points to protect securities issued by Colombia and 1.59 points to protect bonds sold by Panama, countries that S&P rates three levels below Mexico at BB+.

A basis point equals $1,000 on a swap protecting $10 million of debt against default. Credit-default swaps, conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.

Mexico’s dollar bonds lost 2 percent last month, their biggest monthly decline since a 4.4 percent tumble in January, on speculation the government will fail to avoid a downgrade, according to JPMorgan Chase & Co.’s benchmark emerging-market index, known as EMBI+. The drop compares with a 0.5 percent slide for emerging-market debt overall.

The extra yield investors demand to own Mexican bonds instead of U.S. Treasuries has narrowed 1.81 percentage points to 1.95 points this year -- less than the average 3.65-point drop in the spread on emerging-market bonds, according to JPMorgan.

Mexico’s $1.09 trillion economy, the second-biggest in Latin America, shrank 10.3 percent in the second quarter and will contract as much as 7.2 percent this year as the U.S. recession erodes demand for the country’s exports, according to the central bank.

Yields on Mexico’s 10 percent bond due December 2024 were little changed at 8.26 percent, according to Banco Santander SA.

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

Last Updated: November 3, 2009 17:29 EST