Latin Finance - September/October 2009 - 44

Mexico outlook congress and highlight the difficulties that the Calderón administration might face in the second half of its term.” Conversely, approval of a fiscal reform package could be the “detonator” that would renew capital flows to Mexico, not just in financial markets, but also in direct investment, says Santander’s Orozco. Ratings Risk If no agreement can be reached, the likelihood of ratings downgrades increases. This would force pension funds and other wealth managers that are required to limit risk exposure to sell Mexican government debt. The bond market has largely regained much of its footing since investors fled following the collapse of Lehman. Mexican bonds were hit especially hard by the capital flight, with yields on its benchmark 10-year peso bond shooting past 11.3% last October from 8.3% before the bankruptcy. Yields on the bonds, with a coupon of 8.5%, are now close to pre-Lehman levels. As of late July, both domestic and international participants had returned, and demand was relatively robust says Cervera at Credit Suisse. “I don’t think that there’s a worry in the market about [the Mexican government’s] capacity to place debt,” he says. “There’s a growing pension system in Mexico, banks are well-capitalized and [the banks] can also buy debt.” He adds that the government gauges demand well and is flexible with the bonds offered. “Long-dated, middleofthe- curve, short-dated, UDI denominated, floaters, fixed rate . . . They are very capable, very smart in designing their financing program so I think they should continue to be successful.” “There’s appetite and there’s a large pool of resources domestically that will buy significant chunks of the paper that the government has to issue,” Cervera says. UBS Pactual’s Casillas says Mexican pension funds, or Afores, currently have a lot of funds in the short part of the curve due to limits on risk exposure set by Consar, the industry’s regulating body. As of late June, the Afores managed more than 1 trillion pesos in assets, with 68% of it in Mexican government debt. However, if regulations change, Casillas predicts Afores will “buy significantly in the long part of the curve and make it flatten.” “The yield is very good, it’s attractive, but if I’m going to buy, long-term interest rates are probably going to continue climbing, and this will hurt me,” Casillas says. “So I want to get on the horse when it’s going to run.” However, AEGON’s Sidhu takes a different tack: “With general concerns of Mbono curve steepness, staying invested in short-term paper would be prudent,” he says. The central bank cut the benchmark lending rate 25 basis points to 4.50% in July and signaled it has ended its easing cycle. The benchmark rate was 8.25% at the start of 2009. In late July, yield curves showed the market expecting a pause of around six months, followed by 75-100 basis points of hikes starting in the second half of 2010. “Most of the data still coming out of Mexico show that the economy is pretty weak,” Osses says. “So we think that in the US we’re not going to get hikes as soon as the market is expecting them. We think that the same will happen in Mexico.” Cervera predicts that rate cuts “are going to materialize later than the market expects and [they] are not going to be as pronounced in 2010 as the market expects. So I’m looking at fewer rate hikes in 2010 and starting later rather than sooner.” Casillas, meanwhile, notes that Mexico has recently trended towards increasing short-term peso debt issues while reducing long-term placements, because it is cheaper to finance that way. “The problem is that they send everything to the short term and it turns into financing a house with a credit card, to use a simple example,” he says. Santander’s Orozco attributes lack of long-term paper to an uncertain global economy and concerns over Mexico’s public finances. “It seems there’s an unspoken pledge to not increase amounts of long-term issuance while this situation persists,” he says. A New Regional Rival Further clouding Mexico’s horizon is the fact that a number of regional rivals – especially Brazil – seem to be weathering the global downturn surprisingly well. The IMF forecasts Brazil’s economy will contract 1.3% in 2009 to Mexico’s expected 7.3% plunge. The peso has gained 0.9% against the dollar in 2009 and appears to have stabilized at around 13.0 to 13.5 against the greenback following bouts of volatility. Last year the currency plunged to near 14 in October from 9.9 against the dollar in August, wreaking havoc on Mexican firms with risky derivatives positions and large amounts of dollar debt. The peso’s value briefly nosedived to over 15 to the dollar in early March before Mexico’s currency exchange commission began daily dollar auctions. The Brazilian real, meanwhile, has appreciated over 18% against the greenback over the same period while demonstrating less volatility, and most emerging markets investors favor it over Mexico. Alfredo Coutiño, an economist at Moody’s Economy.com, says that compared to Mexico, Brazil and Peru are “far, far away in terms of attractiveness for international investors.” Meanwhile, Orozco says heightened interest in Brazil will not cut off capital flows to Mexico. Instead, he expects wealth managers to reduce Mexico in favor of Brazilian assets holdings. Messmacher says the progress of regional rivals should be an added incentive for lawmakers to approve structural reforms to improve tax collection and loosen up labor market regulations. “It’s important to pass reforms simply so you don’t fall behind relative to your peers,” says the official. LF 44 LatinFinance September/October 2009

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Latin Finance - September/October 2009

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