Recipe for a debt crisis.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
In the emerging markets, private-sector debt has become a doozie: In 2014, EM non-financial corporate debt reached a record high of 83% of GDP, up from 67% in 2009. The problem is that part of this debt is denominated in a foreign currency.
Between 2015 and 2017, some $645 billion of non-financial corporate debt will mature in emerging markets, with USD-denominated bonds accounting for around $108 billion, warns the Institute of International Finance. And with non-performing loans already rising while the dollar strengthens, some EM banks, particularly those that have increased their foreign-currency lending, could face serious challenges.
The countries that have seen the largest increases in non-financial corporate indebtedness are China, Brazil, and Turkey. But Mexico is not far behind. According to a new report in El Financiero, in the first half of 2015 the total debt of a sample of 50 publicly listed companies had risen 22% year-over-year.
The main reason? The peso’s decline against the dollar. In the last year alone, the Mexican peso has lost 21% of its value against the dollar. Corporations can borrow more cheaply in dollars. But as the peso falls against the dollar, the dollar-denominated debt held by Mexican corporations with peso-denominated operating income becomes increasingly difficult to service. A recipe for a debt crisis.
A Debt Binge
The Mexican companies most affected include América Móvil (AMóvil), Axtel, Alfa, TV Azteca and ICA, all of which have a large portion of their debt denominated in dollars. According to financial analyst Carlos Ponce, this debt can be expected to continue growing – and not just as a result of the strengthening dollar:
We are still in a context of exceptionally low interest rates and it’s likely that many companies have decided to take advantage of this by applying for more debt with favorable conditions.
In the second quarter of 2015, the debt in dollar terms of América Móvil and Axtel exploded by 37% and 48% respectively. In the case of Alfa, TV Azteca and ICA it grew by 29%, 32%, and 20% respectively. Other companies also increased their debt.
Over the last five years, the external debt held by Mexico’s private businesses (in pesos) has increased by 86%. In nominal terms, the total amount has reached 1.69 trillion pesos (roughly $105 billion), 117% more than at the beginning of 2010. And if anything, the pace is quickening as fears rise that the Federal Reserve may raise rates in September.
It’s an ironic twist: out of fear that the Fed may be about to take away the ZIRP punch bowl, some of Mexico’s biggest corporations are embarking on one last dollar borrowing binge.
For some of those companies it could be a bender to end all benders, as the Swiss-based Bank of International Settlements cautions. In a report ominously titled “When the Financial Becomes Real,” the BIS notes that the external debt in Mexico is the fourth highest of 17 emerging economies. The three economies ahead of Mexico are Chile, Malaysia and Peru.
Yet more worrisome is the report’s warning that the mobilization of international reserves to cover “imbalances” (i.e. liquidity shortfalls) in the financing of the private sector is “limited”. Put another way, the unlimited assistance that U.S. and European banks and corporations enjoyed during the first leg of the Global Financial Crisis will not (indeed cannot) be extended to the banks and corporations of emerging economies like Mexico.
The size of the Bank of Mexico’s arsenal to deal with dollar-based debt problems pales in comparison with that of the Fed. It can’t print dollars. It has to use foreign exchange reserves. Like Chile and South Africa, it has only between 10% and 20% of its GDP in foreign exchange reserves. It can print pesos all it wants to, but that won’t solve a dollar debt crisis.
The unraveling of Mexico’s bloated corporate debt is just one of a number of risks posed by a rising dollar. Arguably the greatest threat is a dramatic reversal of foreign investment flows.
Since the Fed alighted on its madcap scheme to flood the global economy with cheap, easy-come-easy-go dollars, high-yield seeking “hot money” has poured into emerging markets. Much of it ended up in Mexico, one of comparatively few Latin American economies to have completely liberalized its financial sector and whose currency is now the eighth most traded on the planet. In other words, it’s a trader’s paradise.
If the Fed were to do the previously unthinkable and begin raising interest rates, it would significantly temper investor appetite for risky emerging market assets. Just as happened in the 1994 Tequila Crisis, footloose “hot money” would flee countries like Mexico in pursuit of rising U.S interest rates.
In its so-called Article IV consultation with Mexican authorities, the IMF warned that “a surge in financial market volatility, triggered for example by a disorderly normalization of U.S. monetary policy, could lead to a reversal of capital flows and an increase in risk premia.”
If that were to happen, the consequences would be dire, not only for Mexico — a country that has already witnessed its fair share of debt crises — but for the broader Latin American economy. And just like the Latin American crises of 1982 and the mid-nineties, the fallout could even spread northward. Only this time, the amounts would be vastly larger, and the consequences bigger. By Don Quijones, Raging Bull-Shit.
“Everyone got used to playing with free, easy money. Now it’s going to cost us.” Read… Mexican Peso Dives, Fretting Begins About Peso Crisis