ANALYSIS-Mexico faces possible downgrade after tax bill

* Mexican Senate dilutes president's plan to raise taxes

* Mexico downgrade looms after Senate tax vote

MEXICO CITY, Oct 31 - Mexico is running a high risk of getting a downgrade on its debt rating after lawmakers watered down President Felipe Calderon's proposal to raise taxes and reduce a reliance on falling oil output.

Many investors, banks and economists think Wall Street rating agencies will not be impressed by a plan approved by Mexico's Senate that would make public coffers depend more on high oil prices than Calderon had proposed.

Senators approved lifting the value-added tax, or VAT, to 16 percent, raising the income tax for high earners to 30 percent and putting a 3 percent tax on some telecoms services. But Congress threw out Calderon's initial idea of a sweeping 2 percent sales tax that would hit currently exempt food and medicines and be designated for anti-poverty programs.

"I don't think it's enough. They are going to get the downgrade," said Rogelio Gallegos, a fund manager at Actinver-Lloyd in Mexico City.

Battered by a recession that has slammed tax collection and a steady plunge in crude oil output, Mexico has been seen by investors all year as more likely to default on its debt than is Brazil despite Mexico's higher debt rating, according to data on credit default swaps.

Many analysts see this as evidence the market is already betting that Mexico will get a downgrade.

At the same time, other market players think the tax plan approved by the Senate on Friday, which would raise VAT by 1 percentage point from 15 percent currently, could be enough to let Mexico eke by with its current debt rating.

Even optimists see Mexico as running a pretty large risk of receiving a drop in its BBB+ rating, which has been threatened by both Standard & Poor's and Fitch.

"There's still a 25 percent chance of a downgrade," said Gerardo Margolis, vice president for emerging markets at TD Securities in Toronto.

Margolis said the increase in the VAT was a step in the right direction, but pointed out that investors and traders are disappointed that lawmakers diluted Calderon's proposal to get more people paying taxes.

RBC Capital Markets said in a report that "a Fitch downgrade looks very likely, with S&P's still a 50/50 call."

Calderon originally asked lawmakers to put a 2 percent sales tax on all goods and services with no exceptions.

His idea was to get more poor Mexicans paying taxes in exchange for a promise of better government services, but opposition lawmakers would not back the measure with the economy in such poor shape.

"That might not satisfy the rating agencies because they are not expanding the tax base very much," Margolis said.

The bill approved by the Senate will depend on Mexican crude oil selling for $59 per barrel, up from Calderon's proposal of $54.90.

It would also boost the federal budget deficit to the equivalent of 0.75 percent of GDP from Calderon's proposed 0.5 percent.

Some minor points in the tax plan approved by the Senate, which is part of the revenue package for the 2010 budget, are due to be voted by the lower house before the whole package goes to Calderon's desk for signing into law.

"A downgrade looms, perhaps before the end of the year," Marc Chandler, a currency strategist at Brown Brothers Harriman in New York.