Peso crisis could trigger next dollar-debt crisis in Mexico.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
Within hours of Trump’s electoral triumph, the Mexican peso, which has become the number-one hedge against a Trump victory, had slumped a staggering 13% to its lowest point in history and its steepest intraday dive since 1994-5, when the Tequila Crisis came within a hair’s breadth of bringing down Mexico’s financial system, and with it some of the biggest names on Wall Street, including Citi and Goldman, before the Federal Reserve, US treasury, IMF, and Bank of International Settlements hastily intervened.
By the end of Wednesday’s trading, it recovered a little to close at 19.84 pesos to the dollar, down 8% for the day. Today, the peso fell another 4%, ending the day at 20.67 to the dollar. A hurricane — as Mexicans are fond of calling Donald Trump — is approaching. Thanks primarily (but not only) to Trump’s march on the White House, the peso has lost 18% of its value against the dollar this year, more than any other major currency except for the pound sterling. But the peso’s current woes began long before Trump announced his intention to run for president.
At the beginning of 2014, it took just over 13 pesos to buy a dollar. Now it takes more than 20. According to some analysts it could soon be 25.
Since Tuesday, Mexico’s monetary authorities have been on red alert but as yet have done nothing to staunch the peso’s decline, largely because there’s embarrassingly little they can actually do, as Mexican Secretary of Finance José Antonio Meade Kuribreña all but conceded just days before the election.
Last year, the Bank of Mexico (endearing known in Mexico as Banxico) tried to slow the stampede out of pesos by selling a small but growing fraction of its dollar reserves in open auctions, but to little avail. Even as the amount under auction rose from $50 million to $200 million, then to $400 million, the peso continued to crumble, until the central bank finally gave up on the costly but futile exercise.
Earlier this year Banxico upped the ante, raising interest rates, twice. But yet again the exchange-rate effects were short lived. That won’t stop the central bank from hiking rates further. If things get really bad, it may even begin auctioning interest-rate swaps, as it did in the wake of the global financial crisis. In the bank’s own words, such an operation is aimed at bolstering credit institutions “by reducing the duration of [their] assets” so they can “operate in a market with higher volatility and rising interest rates.” In layman terms, it’s more free money for the banks.
In 2008, Banxico carried out interest rate swaps with credit institutions for up to 50 billion pesos ($2.5 billion). Back then the swaps may have been enough to avert disaster, but they also coincided with the release of an unprecedented tsunami of newly created money from the Fed.
Conditions are now markedly different. Rather than being starved of cheap credit, the world is drowning in it. Corporate borrowing costs in dollars, euros, and yen have become farcically cheap in recent years, thanks to the rampant interventions of central banks. But as emerging market firms are discovering, it can be a lethal trap. As the peso swoons against the dollar, the dollar-denominated debt held by Mexican corporations with peso-denominated operating income becomes increasingly difficult to service.
This is not a problem for companies that operate predominantly in dollars, such as the mining groups Peñoles and Grupo Mexico, for whom all their sales are dollar-denominated compared to 83% and 90% of their liabilities, respectively. Nor is it much of a problem for bakery giant Bimbo, whose biggest market is the US, or the Petrochemical conglomerate Mexichem.
But Mexico is full of large companies that earn most, if not all, of their income in domestic currency but have nonetheless stacked up on foreign-denominated debt. Last year we reported that between 2010 and 2015 the external debt held by Mexico’s private businesses (in pesos) had increased by 86%. In nominal terms, the total amount had reached 1.69 trillion pesos (roughly $105 billion), 117% more than at the beginning of 2010.
If anything, the pace has quickened. According to a new report from El Financiero, 79.8% of the short and long-term debt held by 30 of the 35 firms listed on Mexico’s benchmark index, the BMV, is denominated in foreign currencies, mostly the dollar. Only 20.2% is denominated in local currency.
Here are some of the more extreme examples:
- For Mexico’s biggest TV broadcaster, TV Televisa, 65% of its debt is dollar-denominated compared to just 13% of its revenues.
- On the books of Carlos Slim-owned telecoms giant América Móvil, 85% of the debt is denominated in foreign currencies, but only 74% of sales are in foreign currencies, many of them weak Latin American varieties such as the Argentinean peso or the Brazilian real.
- The case of ICA, once Mexico’s biggest construction company, should serve as a cautionary reminder about the risks of stacking up on cheap dollar debt. Roughly fifty percent of its debt is dollar-denominated yet almost all its operations are based in Mexico. As we reported, the situation has become so grim that last year it stopped paying its vendors and defaulted on millions of dollars of debt payments.
- Take the case of Mexican mega-retailer Liverpool whose revenues are earned exclusively in pesos but whose debt is 65% dollar-denominated.
With the peso shedding value at its current rate, this is a recipe for a debt crisis. But during good times, most emerging market companies cannot resist the fatal allure of cheap dollar debt, and most investors don’t bother to think about it.
Just how long these companies will be able to continue servicing their debt in the current context is anyone’s guess. One thing that’s clear: as long as Mexico and its currency continue to bear the brunt of Hurricane Donald, the balance-sheet pressures for companies that have recklessly binged on “cheap,” central bank-peddled foreign-currency debt are only going to grow. By Don Quijones, Raging Bull-Shit.
Mexico could face its worst fiscal and financial crisis in decades. Read… Biggest Threat to Mexico’s Economy isn’t Trump but Pemex