Footloose hot money that has flooded Mexico can quickly dry up.
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
After several consecutive months of predominantly positive developments, including the governing Institutional Revolutionary Party’s recent electoral victory in its key state, Estado de Mexico, the outlook for Mexico’s economy is no longer negative; it’s stable. That’s according to rating agencies, Fitch and Standard & Poor’s.
But the peso, after plumbing to new depths of 22 pesos to the dollar on January 19, has clawed its way back to 17.8 pesos to the dollar– a 22% surge in just seven months.
Despite its fortifying currency, Mexico’s historic bugbear of inflation continues to grow. Consumer prices, as measured by the national consumer price index, soared 6.44% in July compared to a year ago. It was the sharpest annual inflation rate increase since December 2008. It has now accelerated for the thirteenth month in a row.
This is a big problem for regular Mexicans whose meager wages are failing to keep up. It’s also a big worry for the government and its financial and corporate backers, since widespread public resentment is likely to fuel support for the strongly leftist party Morena whose leader Andrés Manuel López Obrador, a former Mexico City mayor, came within 250,000 votes of winning the 2006 elections.
The government’s reelection prospects rest on two rather flimsy hopes: that the surge of the peso will hang on until the elections next summer, and that it will help curtail inflation. As Wolf Richter pointed out, given the peso’s long history of relentlessly zigzagging lower in fits and starts against the dollar, it’s not exactly a sure bet.
The peso has rebounded in part because the dollar is broadly weaker. A weaker dollar means that dollar-denominated financial instruments are cheaper for currencies that have risen against the dollar. And that means traders and investors are willing to take on more risks. It also means that corporations and governments, such as those in Mexico, have access to cheaper debt — an offer they rarely refuse.
In terms of peso debt, the 10-year yield of Mexican government debt is now around 7% — an indication of how concerned investors are about the prospect of rising inflation in Mexico. It’s a lot cheaper for Mexico and Mexican companies to borrow in euros and dollars.
Many of the companies listed on Mexico’s BNV index are once again issuing dollar-denominated debt like there’s no tomorrow, under the auspices of a cheaper dollar and positive market sentiment. And that could be a very big problem at some not so distant point in the future. From Latin America’s largest soft-drink bottler to the state-owned electricity utility, Mexican companies have issued about $12 billion of bonds this year, almost half of it in June alone, according to Bloomberg. Some $360 billion of bonds are currently outstanding.
This latest expansion of largely dollar-denominated debt, all made possible by central bank-engendered liquidity and the pangs of desperation it has triggered among yield-starved investors, has helped fuel another stock market renaissance — not just in Mexico but across the whole Latin America whose stock exchanges were the world’s biggest movers in July, with Brazil and Mexico’s benchmark indices leading the way.
Mexico’s government too is binging on foreign currency debt even as its public debt has reached unprecedented levels in recent years, having increased from 21% of GDP in 2012 to 47.9% in 2016. Mexico does not have a global reserve currency, and thus it risks running into its next debt or peso crisis — the last one having been the Tequila Crisis of 1994, for which Mexican taxpayers are still paying.
While issuing foreign denominated bonds may be cheaper at the moment, it’s also a lot riskier. If the peso falls against the dollar, the dollar-denominated debt held by the Mexican government and corporations with peso-denominated operating income becomes increasingly difficult to service. A recipe for a debt crisis.
Then there’s the money owed by Mexico’s shrinking state-owned (but to be privatized) oil giant Pemex, whose total debt at last count amounted to $98 billion. In July the company issued $5 billion of fresh bonds. Most of the investors came from the United States and Europe, according to Reuters.
Higher interest rates in the US and Europe would make other asset classes more attractive again, and the hot money in the US and Europe currently piling into foreign-currency-denominated Mexican debt might seek the greener grass elsewhere, all at the same time. Large capital outflows would ensue. And Mexican companies would have trouble securing funding.
This and inflation are the big classic bugbears for Mexico’s economy. Large amounts of external debt makes a country, its companies and residents even more exposed to the vagaries of the global markets. And the footloose hot money that had surged into emerging markets like Mexico will just as quickly dry up. By Don Quijones.
Inflation is becoming ugly before the elections and despite Bank of Mexico’s “monetary shock.” Read… Inflation Spikes Most since 2008 in Mexico. Bad Timing