With economic recovery firmly established in Mexico, the government plans to consolidate its success in foreign debt markets and focus on the development of a peso-denominated yield curve. The immediate new horizon, though, is the presidential election due in 2000. The finance ministry is working overtime to overthrow the unfortunate Mexican tradition of capital flight and devaluations accompanying changes of administration. So current policy aims to clean house before the elections in both external and internal debt management.
The government largely completed its mission in external financing last year with a massive debt restructuring that included a $6 billion bond issue and a Brady bond exchange. As a result, government financing requirements have fallen dramatically. The United Mexican States (UMS) will borrow $1.5 billion next year, with a further $2 billion in maturities facing the state agencies, including some $600 million in bonds for development bank Nacional Financiera. This year the government concentrated on bonds that offered currency swap opportunities, particularly in lire and yen. The UMS also hit the market with two $1 billion issues.
Aside from refinancing, the government will continue to search for ways to reduce the cost of financing. Although the average cost of financing for the entire $70 billion in debt held by the UMS is still 6.5%, that includes Brady bonds and multilateral credit, which lower the figure. In general, finance ministry officials are confident the country's debt will benefit from improving economic fundamentals. "If you weigh the high yield against the fundamentals, in the long term it's the fundamentals that count. The technicals count in the short term," says Martin Werner, general director of external credit at the finance ministry.
Setting debt goals
Werner and his team have completed Mexico's dollar yield curve with benchmarks set from five to 30 years. Now the government will set its goals for fixed-rate debt. A five-year fixed-rate bond is in the pipeline. Other options include issues in local currencies from Portugal, Austria and Spain, among others, as well as maintaining a presence in the German and Japanese markets.
Now the whiz team that brought Mexico from the brink of collapse in the peso crisis will use its talents to create a peso yield curve. The government currently issues peso instruments in 28-day and three-, six-, and 12-month treasury certificates, or two-year bonds whose interest rates mature every 28 days (Cetes). As a start, the first long-term bonds will be denominated in the inflation-indexed UDI unit for five to 10 years. "As the US economic bloc becomes a reality, the peso market will be more compelling," says Eduardo Cepeda, director at JP Morgan Mexico. "There is a tremendous potential in pesos."
The recent pension reform is key to the evolution of local long-term instruments. In July, Mexico's new privatized pension system opened its doors for the first time with overwhelming approval from the country's workers. Some of the confidence in the new funds, known as Afores, derives from the workers' well-earned mistrust of the former system, run by the ill-reputed Mexican Social Security Institute (IMSS). Not only are the funds out of government hands, but the management is shared with foreigners who lined up quickly to form joint ventures with the majority of the 17 funds.
By September next year, the pension system will command the equivalent of some $3 billion in funds. Given investment limitations, fund managers will be hungry for longer-term peso instruments. Starting this September, the pension funds were allowed to invest 65% of their liquidity in public securities with the remaining 35% in private-sector debt. Of the government paper they purchase, 51% must be based in the inflation-indexed UDI unit. They can also invest in Mexican government dollar instruments such as Bradys and UMS international bonds on a limited basis. "It's just a matter of time until they force the creation of a liquid and diverse bond market," says Richard Segal, head of fixed- income research at Santander Investment, who predicts there will be a significant difference perceived as soon as next year.
The government's ongoing sales of banking assets will be another factor to accelerate local market instruments, particularly secondary market securities. In all, the government's saving guarantee fund Fobaproa plans to sell some $40 billion in assets, of which 95% corresponds to bank portfolios and the rest to real estate. The first auction was a direct sale to buyers. Upcoming sales include a mortgage securitization and other bond issues, although these will take a while to develop.
"The market is still worried about the speed with which this is done given the large amount of assets," says Eduardo Fernandez, president of the National Banking and Securities Commission (CNBV). "So Fobaproa will be careful not to depress the markets and to stretch out the sales for the next five years. If we look at the RTC [the US's Resolution Trust Corporation], it took 10 years in a much more profound market."
Mortgage securitization is particularly sticky since there is little standardization in the diverse portfolios Fobaproa has bought from the banks in the last two years. Since the loans converted into the UDI unit form the most uniform portfolio, UDI mortgages are the most likely securitization candidates. Of the entire $40 billion, $5 billion corresponds to mortgage portfolios formerly held by the then three largest banks - Banamex, Bancomer and Serfin.
Investors normally buy short-term peso instruments because of their relatively high yields. Proven economic stability is expected to bring more non-traditional investors across the border. "Mexico is the natural market to attract non-traditional investors because it's close to home and part of the Nafta [North American Free Trade Area] bloc," says Cepeda at JP Morgan. "We're seeing an arbitrage in nominal ratings. They're better returns for the buck with the same risk profile, which is a healthy trend. We'll be seeing even more capital flows into Mexico in the next two years."
With that in mind, earlier this year the Mexican government established one of the first long-term economic programmes in Latin America, known as Pronafide. For this year, the plan targeted GDP growth at 5% and inflation at 15% with external borrowing limited to $5 billion and a current account deficit equivalent to 3% of GDP. Economists such as Ernest Brown at Morgan Stanley Dean Witter are even more optimistic about growth. Brown recently increased his forecast for 1997 from 5.2% to 6.2% and for next year from 4% to 5%.