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Drug Crackdown Fuels Guatemala Bond Gain as Taxes Fund Fight

Guatemala's President Otto Perez Molina
Guatemala's President Otto Perez Molina. Photographer: Johan Ordonez/AFP/Getty Images

Guatemalan President Otto Perez Molina is sparking a bond rally by pledging to tame drug violence that has pushed the murder rate up 60 percent in the past decade and cut into economic growth.

Yields on the government’s dollar-denominated bonds due 2013 have tumbled 81 basis points, or 0.81 percentage point, to 3.12 percent since the Nov. 6 election of the ex-army general, according to data compiled by Bloomberg. Yields on similar-maturity debt issued by Costa Rica, whose credit ranking from Fitch Ratings matches Guatemala’s BB+, fell 31 basis points over that time while those on emerging-market sovereign bonds slid 33, according to JPMorgan Chase & Co.

Perez Molina, who was sworn in Jan. 14, says he’ll boost tax collection to fund his push to root out Mexican cartels that slip through Guatemala’s jungles as they ferry U.S.-bound cocaine from South America. Traders’ optimism about Perez Molina’s proposals, which range from a military crackdown to drug legalization, is slashing the government’s borrowing costs after Standard & Poor’s said in December that the violence was limiting growth in the Central American country.

“The fact that he’s an ex-military man obviously gives us assurance,” said Consuelo Palomo, who manages $300 million in assets, including government bonds, at Guatemala City-based Banco G&T Continental. “He wants to use the army to address security issues, which I think is exactly what is needed.”

‘Worst Points’

Guatemala’s dollar bonds due 2034 yield 62 basis points less than El Salvador’s securities with a similar maturity and structure, compared with 30 less on the day of the November vote, according to data compiled by Bloomberg. The 6.20 percent yield on the Guatemalan bonds is 328 basis points over similar-maturity U.S. Treasuries.

Fernando Pontaza, a 33-year-old money manager in Guatemala City, said investors and executives are counting on Perez Molina to curb violence because lawlessness has started to affect their daily routines. Last year, Pontaza was walking to work in Guatemala City’s Zone 10, the district known for luxury hotels and corporate headquarters, when he said a passenger on a motorcycle pulled up beside him, pointed a gun at his head and demanded his iPhone.

Crime “has invaded the lives of everybody,” Pontaza said in a telephone interview from the capital, where he manages fixed-income investments and stocks at Invercorp International. “This has gotten basically to one of the worst points in the country’s history.” He declined to give his assets under management.

Drug Legalization

Perez Molina is also urging Central American neighbors to consider legalizing drugs as a way of curbing violence. The U.S. Embassy in Guatemala issued a statement Feb. 12 that said it opposes legalization “because evidence shows that our shared drug problem is a major public health and safety threat.” Cocaine passing through Central America may equal about 5 percent of the countries’ gross domestic product, according to a report this week from the International Narcotics Control Board, an independent body monitoring implementation of UN drug conventions.

The Zetas drug cartel, spawned in Mexico by former elite members of that country’s armed forces, has been blamed by Guatemalan officials for an increase in crime, including the massacre in May of 27 people in the Peten jungle region near the northern border.

Perez Molina has said he will fund the security spending increase in part with new tax revenue. Congress approved Jan. 26 an anti-tax evasion law that gives the government power to temporarily shutter businesses not in compliance. A separate package of measures approved Feb. 16 includes raising the income tax rate paid by non-salaried workers to 7 percent from 5 percent.

‘Auspicious Start’

The government’s budget deficit will top 3 percent of gross domestic product this year, compared with 3.3 percent in 2011, according to S&P forecasts.

Analysts in a Guatemalan central bank survey conducted last month project the economic expansion will slow to 3.1 percent this year from 3.8 percent last year. Growth will accelerate to 3.3 percent in 2013, they said.

While Perez Molina needs to do more to boost funding, the efforts mark an “auspicious start,” said Boris Segura, a Latin America strategist at Nomura Securities International Inc. in New York. The progress may save the country as much as 75 basis points in financing costs if it borrows in international bond markets this year, he said.

Bond Sale

Segura forecasts Guatemala may sell a dollar bond due 2022, which would yield about 5.5 percent. Rosa Maria Ortega, the head of public credit at the Finance Ministry, said the government won’t rule out a sale “depending on conditions,” according to a Feb. 16 e-mailed response to questions. Guatemala last sold bonds overseas in 2004.

Perez Molina has “a clear diagnosis of what needs to be done,” Segura said in a Feb. 23 telephone interview from New York. Crime “is a weakness not only for the overall welfare of the population but also for the business environment. That’s why the fiscal reform was so sorely needed.”

The homicide rate in Guatemala, Central America’s most populous country with 15 million people, jumped to 41.4 per 100,000 inhabitants in 2010 -- or 5,960 total -- from 25.8 a decade earlier, making it about double the rate in Mexico, according to the most recent United Nations report.

Foreign Investment

The security concerns are deterring foreign investment, S&P analyst Lisa Schineller said in a telephone interview from New York. Perez Molina may struggle to implement reforms and rein in crime, according to Schineller. In Mexico, drug-related killings climbed 11 percent to 12,903 in the first nine months of 2011 even as President Felipe Calderon used the federal police and military to battle gangs.

“The president ran on a platform of an iron fist,” Schineller said. “But this is not an easy problem to tackle given the inherent institutional weaknesses.”

Francisco Cuevas, a spokesman for the Perez Molina, didn’t return an e-mail or telephone calls seeking comment.

Economic growth in Colombia, the world’s biggest supplier of cocaine, is surging after the government scored military victories over drug traffickers and Marxist guerrillas that opened up swathes of the countryside to energy and mining exploration. The central bank forecasts the economy expanded as much as 6 percent in 2011, the most since 2007. Foreign direct investment climbed to a record $14.5 billion, more than quadruple levels a decade ago.

Security Outlook

Guatemala’s bond rally shows “there’s a generally positive sense about the future of the country in various spheres, including that of security,” the Finance Ministry’s Ortega said.

The central bank’s economic confidence index, based on a survey of analysts, climbed to 79.17 in February, the highest in five years. Guatemala’s currency, the quetzal, has gained 0.7 percent since the November vote to 7.7765 per dollar at 8:15 a.m. Guatemala City time, stemming a 3 percent slide in the previous six months.

“Sentiment with almost everyone you talk to is positive,” Pontaza said. “The best possible outcome from the elections was realized.”

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