UPDATE 3-Mexico Senate committees approve VAT tax hike

* Senate committees pass increase in value-added tax

* VAT hike may not be enough to stave off rating downgrade (Adds quotes from analyst and lawmaker, peso level)

MEXICO CITY, Oct 30 - Mexican Senate committees have approved a watered-down version of President Felipe Calderon's proposal to raise consumption taxes in order to reduce Mexico's dependence on its waning oil industry.

The vote late on Thursday marks a partial victory for Calderon, whose original plan would have broadened Mexico's tax base by taxing currently exempt food and medicine.

It was unclear if a hike in Mexico's value-added tax, or VAT, would be enough to stave off a looming credit rating downgrade, however.

After clearing the lower house last week, the measure now goes to the Senate floor for final debate ahead of an Oct. 31 deadline for passing the tax legislation. The VAT plan is part of the revenue portion of the 2010 budget.

"The plan is that the drafts for all the bills will be finished during the floor session on Friday in order to meet the deadline," said ruling party Sen. Jose Reyes.

Mexico's peso <MXN=> initially strengthened after the committee votes, but later fell more than 1 percent against the U.S. dollar after weak U.S. economic data.

Mexican government revenues have plunged this year because of a severe recession and a slump in oil production, which is down by about a quarter from 2004 levels.

The fall in oil output has removed a long-time crutch for public finances that for decades allowed Mexico to keep its tax take at one of the lowest levels in Latin America. A legacy of corruption has also left Mexicans sceptical about taxes.

Lawmakers worry the tax hike could anger voters suffering from a recession. Mexico's economy could contract the most this year since 1932 because of a drop in U.S.-bound exports.

"People are mad not just about the higher taxes but because they don't see the hikes having a beneficial impact on them," ruling party Sen. Teresa Ortuno said on Friday.

DOWNGRADE LOOMS

Mexico only collects about 10 percent of gross domestic product in taxes -- roughly on a par with Haiti -- and debt rating agencies are threatening a downgrade if Mexico's government doesn't boost non-oil revenues.

Calderon's conservatives lack a majority in both houses of Congress, and were unable to convince the main opposition party to back a 2-percent sales tax on all goods without exception.

Instead, the opposition Institutional Revolutionary Party, or PRI, supported a government counterproposal in the lower house to raise the VAT tax to 16 percent from 15 percent.

That compromise would raise less revenue than would Calderon's original proposal, leaving the 2010 budget to rely more on deficit spending and hopes of strong oil revenues.

Investors now await Standard & Poor's and Fitch's decisions on whether the bill, if approved on the Senate floor, will let Mexico keep its BBB+ ratings. A one-notch downgrade would still leave Mexico two levels above junk bond status.

"I think this still makes it even money -- it could go pretty much either way," said Enrique Alvarez, an economist with IDEAglobal in New York.

After days of internal debate, the PRI's senators abstained from the committee votes on Thursday on worries that their fingerprints on a tax hike could hit their popularity.

Sitting out the vote on the Senate floor as well would allow the VAT hike to pass with just votes from Calderon's National Action Party, or PAN. The PRI's spokesman in the Senate said on Thursday they would abstain on the VAT bill.

The legislation would set the 2010 federal budget deficit at the equivalent of 0.75 percent of gross domestic product. Calderon's original proposal asked for a 0.5 percent deficit.

It would set a budget forecast that estimates Mexican crude exports will sell for an average $59 per barrel in 2010 -- higher than the forecast in Calderon's original plan.

The committees also backed a hike in the income tax rate for top earners to 30 percent from 28 percent.

The deficit, oil price estimate and income tax hike were all approved by the lower house last week.

A proposed new tax for telecoms services was not voted in the committees and instead left for debate on the Senate floor on Friday. The committees decided not to make the VAT hike temporary -- a possibility on the negotiating table in recent days as a way of enticing PRI support.