S&P Global Ratings assigns credit ratings to local and regional governments (LRGs) based on its qualitative and quantitative analysis of a range of financial, economic, managerial, and institutional factors. Our analytical framework for rating LRGs is articulated around six major components, resulting from our methodology:

• The institutional framework;
• Economy;
• Financial management;
• Budgetary performance;
• Liquidity; and
• Debt burden.

Our assessment of the institutional framework is an important component of the rating. The institutional and legislative environment in which an LRG operates provides an important context in which to evaluate the LRG's individual credit profile. Therefore, we combine our assessment of the institutional framework and the five other factors listed above to determine an indicative credit level for an individual LRG. We then adjust this level for certain overriding factors to provide the final rating for the respective LRG (see "Methodology For Rating Local And Regional Governments Outside Of The U.S." published July 15, 2019).

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LRG Characteristics By Country And Rating Category

The picture of Latin American LRGs' credit quality is mixed. Even though pressure on expenditure has picked up in fiscal 2023, elevated inflation continues to drive revenue growth at a faster pace. We do not forecast widespread credit deterioration for LRGs in Mexico and Brazil in the next two years, and across the region we have seen fiscal performance of LRGs improve. However, the stronger fiscal picture doesn't account for limited financial flexibility, access to markets, and growth challenges that continue to weigh on local government credit quality in Latin America.

Across the region, debt levels will remain low as a share of operating revenue, but could inch upward as LRGs use up reserves accumulated from extraordinary support and from a strong revenue rebound following the pandemic. We see a growing positive trend for several Mexican LRG ratings as liquidity pressure eases and debt levels remain lower than operating revenue.

In Brazil, greater certainty about stable fiscal and monetary policy led us torevise the outlook on Brazil to positive from stable in June 2023. We believe that this development could benefit Brazil's still-low GDP growth prospects and could translate into some favorable momentum for the rated LRGs. We expect the tax reform, currently under discussion, to be revenue neutral for Brazilian LRGs. If passed, it would simplify the country's complex tax code, potentially supporting growth. It will do little, however, to relieve the fiscal rigidities that constrain LRGs' budgetary performance.

Capital markets remain largely closed to Argentine LRGs following debt restructuring in 2020, exacerbating macroeconomic and fiscal instability that has increased refinancing risk, given that a large share of provinces' debt is denominated in U.S. dollars. We revised downward our transfer and convertibility (T&C) assessment of the sovereign, triggering a downgrade of nine Argentine provinces to CCC-/Negative/-- this year.

Mexico

As has historically been the case, we believe Mexican LRGs we rate will:

• Maintain nominal fiscal balances;
• Avoid borrowing;
• Finance operating and capital expenditure (capex) with cash; or
• Forgo spending altogether.

With a few exceptions, we consider that Mexican LRGs have generally limited budgetary flexibility, as seen in a nearly 10-year trend of declining capital spending. Among rated LRGs in Mexico, we expect generally balanced budgetary performance in 2021-2025, with a small surplus after capital accounts of 0.9% across all rating categories.

This year, the central government issued debt secured by future participaciones (tax-revenue transfers) to finance the shortfall of transfers to local governments, which make up over 80% of their revenues. This has ensured that LRGs will receive the revenue they budgeted for this year. However, slowing inflation and weak economic growth prospects across Mexico could dampen revenue growth and make it more difficult for LRGs to maintain fiscal balance without further cuts to spending. To the extent that LRGs are already limited in terms of revenue and expenditure flexibility, this could put a lid on upward rating momentum of the last 6-12 months.

Despite these pressures, financial conditions have remained largely stable in 2023, and we observe that Mexican LRGs' liquidity is stronger on average than in the last three years. We project median debt levels, already low by international standards, will decline slightly over the next several years, given the political emphasis on low public debt and generally weak capital execution, despite high infrastructure needs.

S&P Global Ratings rates four Mexican LRGs on the global scale (all at BBB/Stable/--):

• The state of Aguascalientes;
• The state of Guanajuato;
• The state of Queretaro; and
• The city of Queretaro.

Following the July 2022 outlook revision on Mexico to stable from negative, we took the same rating action on these entities.

We rate all other rated Mexican federated entities and municipalities on the Mexican national scale only. Mexican national scale ratings of 'mxAA' and higher typically correspond to 'BBB' category global scale ratings (see "Sector And Industry Variables: National And Regional Scale Credit Ratings Methodology" published June 8, 2023). Mexican national scale ratings between 'mxBBB' and 'mxAA' typically correspond to the 'BB' global scale category.

'BBB' category entities and peers rated on the national scale typically have stronger financial management and liquidity than lower-rated peers. Local economic indicators, including GDP per capita, often exceed the national level of $10,750 as of 2022. However, we assess very few Mexican LRGs' economies as stronger than those of global peers given the country's weak overall growth prospects.

Despite historically balanced fiscal accounts and low debt levels, all subnational governments in Mexico contend with a highly centralized form of fiscal federalism that limits their influence on policies that affect their finances and control over revenue. Among lower-rated municipalities, we observe greater political turnover among administrations, which limits administrative and policy continuity and the reasonable horizon for financial planning and execution.

We consider that Mexican municipalities operate in an institutional framework that is volatile and unbalanced (see "Institutional Framework Assessment: Mexican Municipalities", published May 26, 2022), while Mexican states operate in an evolving and unbalanced framework (see "Institutional Framework Assessment: Mexican States", published May 23, 2022). One key difference between them is that fiscal transparency is still uneven among Mexican municipalities. In addition, state governments can easily pass on their financial woes to municipalities by delaying fiscal transfers to them.

Argentina

In March 2023, following the lowering of the long-term foreign currency credit rating on the sovereign as well as the downward revision of the T&C assessment to 'CCC-', we lowered the foreign currency ratings on all rated LRGs in Argentina to 'CCC-' and assigned a negative outlook. This is because we cap our long-term ratings on Argentine provinces at the same level as the T&C assessment on the sovereign. Overall, it reflects the increasing vulnerabilities in macroeconomic conditions, including provinces' reduced access to foreign currency to meet obligations.

Local governments' access to foreign currency through official channels has been restricted in recent months, increasing uncertainty about their ability to amass enough dollars to pay upcoming maturities (see "Argentine Provinces Try To Avoid Default After Latest Capital Controls" published June 14, 2023). Even though provinces in general have been improving their financial positions in recent months and interest expenditures will only average 2.3% of operating revenues in 2021-2025, they remain dependent on the increasingly limited availability of foreign currency to service their debt. We view the LRGs' economic growth prospects as very weak based on the pronounced sovereign economic imbalances, coupled with policy uncertainties looming in the context of national elections. Reflecting the slightly improved financial positions, we expect modest after-capital surpluses in 2021-2025, with a median balance after capex of 0.3% of total revenue for the same period.

We believe overall debt levels will remain moderate compared with global peers' over the same period, with our projected median debt burden averaging 29.4% of total revenues in 2021-25. This represents a slight decline from the 2022 median of 36.3% due largely to inflation dynamics in 2022 and 2023 as well as a lack of new debt financing. With 80% of LRG debt denominated in dollars, their debt and debt service profiles remain vulnerable to the Argentine peso's official depreciation.

We view the institutional framework in which Argentine municipalities and provinces operate as very volatile and underfunded. Economic instability and major economic policy shifts render long-term financial planning extremely difficult, at both the federal and local levels. The relationship between LRGs and the federal government, including via the federal fiscal framework, is characterized by frequent reforms and a short track record of compliance with fiscal discipline laws. Furthermore, LRGs' fiscal performance is linked to that of the nation, and a prolonged recession and very high inflation have contributed to structural imbalances at all levels.

Brazil

In Brazil, many states entered 2023 with strong budgetary positions thanks to higher-than-expected economic activity and tax receipts, coupled with payroll freezes that ended in 2022. That fiscal strength will likely ebb in the next two years as inflation slows and spending pressure mounts, in the form of demands to raise public-sector salaries.

Rigid spending rules limit Brazilian states' budgetary flexibility, while wage increases and higher infrastructure spending have started to squeeze some entities' operating margins. Nevertheless, we don't expect fiscal accounts to deteriorate: overall, we project average after-capital fiscal surpluses in 2021-2025 of 3.5% of revenue for entities we rate, a decline from the 2022 average of 4.7%. Given limited new borrowings, we expect five-year average debt to revenue to remain stable at 62.4%, very close to 2022 levels.

We consider proposals to reform Brazil's dual-VAT tax system as potentially favorable for growth, but not likely raise state revenues substantially over the long period of implementation, in part because we expect any package would include compensation mechanisms for LRGs' lost revenues. As expected, a 2022 tax-rate cap on gasoline, cooking gas, and other essential goods has not significantly lowered state and local revenues because lower prices have boosted consumption, and inflation has driven a nominal growth.

We rate four Brazilian LRGs on the global scale:

• The city of Niteroi (BB-/Positive/--; national scale: brAAA/Stable/--);
• The state of Alagoas (BB-/Stable/--; national scale: brAA+/Stable/--);
• The state of Santa Catarina (BB-/Stable/--; national scale: brAA+/Stable/--); and
• The state of Minas Gerais (CCC+/Stable/--; national scale: brBB/Stable/--).

We rate the state of Paraiba at brAA+/Positive/-- on the Brazilian national scale, which could correspond to a global scale rating of either 'BB-' or 'B+' according to our criteria, "Sector And Industry Variables: National And Regional Scale Credit Ratings Methodology", published June 8, 2023.

Brazilian states and municipalities operate in an institutional framework that we consider as volatile and unbalanced (see "Public Finance System Overview: Brazilian States and Municipalities," published Oct. 26, 2021). Although the laws governing the federal fiscal system are well-grounded and relatively stable, with transparent disclosure, the system's rigidity and complexity have prevented LRGs from addressing structural imbalances in their budgets. We believe that lack of progress on this front will translate into a structurally weak budgetary performance, low capex, and higher debt.