When it comes to debt, everything is relative, especially if you don’t have a reserve-currency-denominated printing press.

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

At 49% of GDP, Mexico’s public debt may seem pretty low by today’s inflated standards. It’s a mere fraction of the debt loads amassed by bigger, richer economies such as Japan (229% of GDP), Italy (133%) and the United States (104%). But when it comes to debt, everything is relative, especially if you don’t enjoy the benefits that come from having a reserve-currency-denominated printing press.

In Mexico’s case it’s not so much the size of the debt that matters; it’s the rate of its growth. In the year 2000 the country had a perfectly manageable debt load of roughly 20% of GDP. Today, it is two and a half times that size.

Last year alone the Mexican state issued a grand total of $20.31 billion in new debt, the largest amount since 1995, the year immediately after the Tequila Crisis when the country needed an international bailout to rescue its entire banking system from collapse. The money it received also helped repay a number of giant Wall Street investment banks that had gone all in on Mexican assets.

There are plenty of reasons behind Mexico’s current debt issues. Top of the list is the dramatic reversal of fortunes of the country’s shrinking oil giant Petróleos Mexicanos, A.K.A. Pemex, which until a few years ago provided as much as one-third of the Mexican government’s national budget. After decades of “bad management, lack of vision, negligence, abuse and in many cases, corruption,” in the words of Mexico’s Business Coordinating Council, Pemex is now bleeding losses and buckling under €100 billion of debt.

If Pemex is unable to service its debts, Mexico’s government will have to step in, again. The problem here is that Mexico’s government is also struggling to rein in its own debt addiction, with some states already on the verge of bankruptcy. One state governor, Javier Duarte of Veracruz, did so much fiduciary damage during his mandate that he’s now on the run after allegedly misappropriating vast sums of public funds.

Another reason why Mexico’s debt keeps growing stems from its 1994 rescue of its banking sector (and international bondholders). The debt the government took on was supposed to have been liquidated within 20 years but it continues to grow. Thanks to the wonders of compound interest, the debt is now worth 878 billion pesos ($44 billion), 35% higher than it was in 2000, despite the fact that Mexico has already paid tens of billions of dollars to banks and international financial institutions.

Mexico’s top auditor, the Federal Audit Office (ASF), just came out with a bombshell report showing that a staggering 72.9% of the new debt Mexico’s government issues today is used to repay the principal on its maturing old debt while 13.9% goes toward servicing the interest payments. That leaves just 13.2% for investment projects or productive activities, part of which is no doubt skimmed off by corrupt officials and businessmen.

The debt continues to grow at a much faster rate than Mexico’s economy, whose growth is forecast to slow this year to 1.5%, compared to last year’s 2.4%. To make matters worse, much of Mexico’s new debt is in foreign-denominated currencies. Between 2015 and 2016 alone, the total amount of euro and dollar-denominated debt it issued rose by 46.2%.

Mexico is not the only emerging market that has developed an unhealthy appetite for foreign-currency-denominated debt. In the first two months of 2017, emerging markets issued over $100 billion in USD and EUR bonds, beating a previous record set for the same period in 2014. The main reason for the latest spike is the lower cost of issuing debt in the wake of the US elections, with yields on EM bonds falling by an average of 50 basis points. But that is not likely to last, especially with the Federal Reserve expected to raise rates in the coming months.

However, the prospect of rising rates, much like last orders at the bar, has merely intensified the thirst for dollar-denominated debt. “The yields are attractive and the outlook for rates and bear market risk are pushing issuers to evaluate funding early this year,” said Samad Sirohey, the director of debt capital markets for Central and Eastern Europe, the Middle East and Africa for Citigroup, the bank that’s organized most of the bond sales for the region this year.

Yield-starved investors, after years of central bank-imposed financial repression, can’t resist the higher yields of riskier markets, for now. Offering almost double the 2.5% of the 10-year Treasury yield and many multiples of the 0.335% of Germany’s 10-year yield, EM debt funds have reported $7.4 billion of inflows so far this year, surpassing the combined flows into U.S. junk bonds and loans during the same period.

But if EM currencies fall against the dollar and the euro, the cost of servicing dollar- and euro-denominated debt is going to rise. And that’s when the strains will begin to show.

In Mexico foreign investors hold around $100 billion of the country’s local-currency government debt, the most for any emerging market economy. That’s almost 20 times what it was 20 years ago. They also hold billions of euros worth of corporate bonds, which are also showing signs of strain, prompting some Mexican business leaders to call for “new programs” to be implemented before the situation causes “a large-scale crisis” among Mexican companies.

The most ominous sign yet came last week when Bloomberg reported sources saying that the Bank of Mexico (or Banxico, as it is referred to) had sought a swap line from the Federal Reserve in case of “liquidity problems,” which immediately triggered furious denials from Banxico. “I can say clearly and unequivocally that we are not in the process of asking for any credit line from any authority,” said the central bank’s governor, Agustin Carstens, who has postponed by six months his departure from the bank, initially scheduled for May.

If the allegations are true, they imply that Mexico’s government and/or corporations are beginning to feel the early pangs of a dollar shortage. One thing is resoundingly clear: the Mexican government needs to get a handle on its debt situation. By Don Quijones.

This time, the ECB is already doing “whatever it takes.” And still. Read…  Euro Breakup Rattles Investors Once Again

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