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Mexico will probably boost debt sales 46 percent in the third quarter to finance a budget deficit that is widening as the U.S. recession throttles exports and oil production slumps, according to Metanalisis SA.

The Finance Ministry will issue 455 billion pesos ($34 billion) of bills and bonds in the quarter, up from 312 billion pesos a year earlier, said Manuel Galvan, a fixed-income strategist at the Mexico City-based firm that provides economic analysis to the government. The jump in issuance follows a 30 percent increase in the first half.

Mexico’s peso bond yields are rising even as the central bank reduces the benchmark overnight lending rate to a five-year low amid speculation Standard & Poor’s may cut the country’s credit rating after changing the outlook to negative in May. The budget deficit may grow to 4 percent of gross domestic product this year from 2.1 percent in 2008, S&P says.

“There is this looming threat that rating agencies may cut the credit rating,” Galvan said in a telephone interview. “This concern has prevented a decline in long-term bond yields.”

The Finance Ministry is scheduled to publish its third- quarter debt sale plan on June 25.

The deficit in Mexico, while less than half the gap in neighboring U.S. as a percentage of GDP, is more of a concern because 37 percent of the budget is funded by oil, a revenue source that “is very volatile,” Galvan said.

‘Binding’ Problems

Crude, Mexico’s biggest export, has tumbled over the past year while output at Petroleos Mexicanos, the state-owned oil monopoly, has declined. The price of oil is down 52 percent from a record high in July. Production dropped 6.5 percent in May from a year earlier after falling 9.2 percent in 2008, the fastest drop since World War II.

Mexican exports to the U.S. fell 9.8 percent to $211 billion in the 12 months through April, according to the nation’s statistics agency. The U.S. buys 80 percent of Mexico’s exports and is the biggest source of foreign direct investment, migrant worker remittances and tourism revenue.

Mexico’s “structural vulnerabilities are not new, but they are more binding now than they were before,” Lisa Schineller, an analyst in New York at S&P, said in a telephone interview.

S&P rates Mexico BBB+, the third-lowest investment grade rating and seven levels below the U.S.’s AAA rating. The U.S. budget gap is projected to swell to $1.85 trillion in the year ending Sept. 30, equal to 13 percent of GDP, according to the nonpartisan Congressional Budget Office. The deficit equaled 3 business cards sale.2 percent of GDP in the 12 months through September.

‘Huge Differential’

Mexico forecasts its public sector deficit, which includes debt from a 1990s bank bailout, will reach 3 percent of GDP this year.

“There is a huge differential with the U.S. deficit,” Galvan said. “But we have to remember that Mexico is a small country in a global context. It’s a developing country with elements of risk.”

While Mexico collected 5.7 percent of its revenue from income taxes in 2007, the second-lowest rate among members of the Organization for Economic Cooperation and Development after Turkey, the U.S. took in 13.9 percent, an October report shows.

Mexican Finance Minister Agustin Carstens said last week that the country needs a “sense of urgency” to approve legislation that will shore up the government’s finances.

“Mexico has never considered, and will never consider, exceeding the prudent limits of a temporary fiscal deficit,” Carstens said at a Mexico City conference.

Recession

Yields on Mexico’s peso bonds due in 2024, the country’s benchmark securities, have risen 0.71 percentage point in the past nine weeks, staunching a rally that had sent them to a two- month low in April. Banco de Mexico cut its key lending rate half a percentage point on June 19 to 4.75 percent, bringing it down 3.5 points this year.

Latin America’s second-biggest economy will shrink 5.5 percent in 2009, according to the government, the first decline since 2001 and the biggest since 1995, following a peso devaluation that sparked capital outflows throughout the region.

Galvan said the rise in Mexican bond yields may be overdone and that the securities are “attractive” because slowing inflation will preserve the value of their fixed payments. He predicts yields on Mexican bonds maturing in more than 10 years will fall by 1 percentage point by September.

Markets Last Week

Mexico’s Bolsa index fell 4.7 percent last week, its first decline in five weeks. Cemex SAB led declines, dropping 17 percent. Bank of America Corp. last week cut its rating on the stock of the largest cement maker in the Americas to “underperform” from “neutral.”

The peso gained 0.3 percent to 13.3604 per U.S. dollar, from 13.4037 percent on June 12. Yields on the government’s bonds due in 2024 rose 11 basis points, or 0.11 percentage point, to 8.5 percent, according to Banco Santander SA.

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