Online Extra: Mexico's "Important New Maturity"
In December, 1994, Mexico devalued the peso and plunged into a financial crisis as billions in short-term, dollar-denominated bonds held largely by foreigners came due. Unable to pay, Mexico had no choice but to accept a $40 billion bailout from the U.S. Treasury and the International Monetary Fund. Along with the bailout came some tough conditions: Mexico's Central Bank and Finance Secretariat had to shed light on all of their financial transactions and start communicating better with investors and creditors.
The behaviorial turnabout worked wonders: Within seven months, Mexico managed to raise money on international financial markets once again. Thanks to strict fiscal discipline following the 1995 crisis, the country significantly reduced its foreign debt over the next few years and refinance the balance with lower interest rates and longer repayment periods. In 2000, Moody's Investors Service granted Mexican sovereign debt investment-grade status, and Standard & Poor's followed a year later.
BusinessWeek Mexico Bureau Chief Geri Smith recently spoke with Andrés Conesa, now head of public credit at the Finance Ministry, at his offices in the colonial-era National Palace in downtown Mexico City about why investors today differentiate Mexico from other emerging-market economies. Conesa holds a doctorate in economics from the Massachusetts Institute of Technology. Following are edited excerpts of their conversation:
Q: In February, Mexico became the first emerging-market country to issue sovereign bonds with a "collective-action clause" that makes it easier for creditors to renegotiate loans if borrowers run into trouble. Renegotiation can occur if just 75% of the creditors agree. Previously, small groups of creditors could block rescheduling. Why is this clause significant? A:
Q: In February, Mexico became the first emerging-market country to issue sovereign bonds with a "collective-action clause" that makes it easier for creditors to renegotiate loans if borrowers run into trouble. Renegotiation can occur if just 75% of the creditors agree. Previously, small groups of creditors could block rescheduling. Why is this clause significant?
A:This was one of the recommendations that the G-22 made following the financial problems in Asia, Russia, and Brazil about five years ago. This facilitates crisis resolution by making the renegotiation progress more organized. Of course, we are not expecting a problem to occur, but by setting this precedent, Mexico is setting a benchmark for itself and for others.
Since we did it, other countries have launched bonds following Mexico's example. After we placed the 12-year bond at the beginning of this year, countries such as Brazil, Korea, Uruguay, and others have included collective-action clauses. Eventually all of our debt will have this kind of clause.
Q: How have these issues been received by investors? A:
Q: How have these issues been received by investors?
A:We've done three issues that have been very well received by the market, with prices below the sovereign curve. And they've performed very well on the secondary market, the same or better than other bonds that don't feature the collective-action clauses. There was some concern that the first issuer might have to pay a premium, but this wasn't the case. Other emerging markets have included the clause in their issues, and it's becoming a very common practice.
Q: Why did Mexico feel it had to be the first country to do this? You already enjoy investment-grade status. A:
Q: Why did Mexico feel it had to be the first country to do this? You already enjoy investment-grade status.
A:The fact that we are rated investment grade made it easier, because the likelihood of us having problems is more remote. The "first mover" advantage is important because it sets a precedent in the market. For example, we decided to set a benchmark of 75% of creditors, which means that creditors representing 75% of the amount due -- and they cannot include official Mexican creditors from the public sector [such as Mexican development banks] -- are sufficient to carry out a renegotiation.
In the past, you had to have 100% of creditors on board. This prevents small groups of creditors, who see that a country is heading into financial difficulty, from buying up big chunks of the country's debt at big discounts and then blocking the debt-renegotiation process. The advantage of being the first mover is that we were able to set the 75% figure, whereas another country might have set a benchmark of 60% or 90% that we might have had to emulate.
Mexico has tried to play an important role in strengthening the international financial structure. In October we will host the annual meeting of the G-22 group, which is basically the G-7 countries plus the most important emerging-markets countries. Finance secretaries and some central bank governors will come for that meeting, which will [focus on] the international financial architecture.
Q: During the Asian, Russian, and Brazilian financial crises, there was considerable contagion throughout the emerging markets. Why are we seeing less contagion now? When Argentina collapsed in December, 2001, it didn't drag Brazil and Mexico down. A:
Q: During the Asian, Russian, and Brazilian financial crises, there was considerable contagion throughout the emerging markets. Why are we seeing less contagion now? When Argentina collapsed in December, 2001, it didn't drag Brazil and Mexico down.
A:The investment-grade rating Mexico obtained after the 1998 financial crises helped us. Back in 1998, what happened in Brazil, Russia, and Thailand -- and in other countries with which we didn't even have much of a trade or financial relation -- affected us and the dollar-peso parity. Before Mexico won investment grade it was placed in the overall basket of emerging-markets economies that did not have investment-grade ratings, and when problems would arise, many investors were required, sometimes by regulators, to sell their holdings and move to more secure venues.
But [more recently], when Argentina and Brazil had some problems, there was no contagion in Mexico. On the contrary, we saw some inflows of capital in the past two or three years when there have been troubles in other emerging markets. Our peso has strengthened, and our foreign debt spreads have actually shrunk at these times.
Q: How has Mexico changed since its own 1995 "Tequila" crisis? A:
Q: How has Mexico changed since its own 1995 "Tequila" crisis?
A:Back in 1995, we had an unsustainable current-account deficit of 7% of gross domestic product, and it was being financed with short-term capital flows which made us very vulnerable. So, we let the peso float -- that helps the economy absorb shocks. We have used a solid fiscal policy as our anchor, and our objective has been to have a smaller fiscal deficit each year. Today, our inflation is at the same level of our main trade partners [the U.S. and Canada]. Also, the Bank of Mexico (Central Bank) won independence in 1993, and that was a very important institutional change.
Plus, we have stretched our debt maturities to longer periods, as long as 30 years. In May, we bought back the last remaining Brady bonds [discounted bonds issued for the restructuring of Mexico's foreign debt after the 1982 default, named after then-U.S. Treasury official Nicholas Brady]. We retired the last $5 billion of the initial stock of $30 billion in Brady bonds.
With our external financing resolved, we have been concentrating our efforts on the domestic front. We have placed fixed-rate bonds in pesos at periods of 3 to 10 years and soon will try to extend that curve [to more years]. Now, not just the federal government but private companies in Mexico can get long-term peso financing through asset-backed securities for investment projects, whereas in the past their only alternative was dollar financing. Even some states and cities are financing themselves in pesos this way. In just two years, more than $8 billion has been raised this way.
Q: Are the financial reforms Mexico's congress passed in 2001 responsible for investors' confidence in the country's financial outlook? A:
Q: Are the financial reforms Mexico's congress passed in 2001 responsible for investors' confidence in the country's financial outlook?
A:Yes. The reforms included greater protection for minority shareholders in publicly traded corporations, and they made it easier for banks to collect collateral on past-due loans. There's an important new maturity [in Mexico's political class] -- a realization that you cannot live on borrowed money, that the solution is not public indebtedness and public spending.
Although we've had a split congress [with no clear majority in power] since 1997, we've managed to win approval for smaller budget deficits each year. We no longer have that annual debate over whether we should hike the deficit. The debate is focused on where to spend what money we have -- on agriculture, health, or education. This has set a very important precedent.
Q: Mexico has come a long way in eight years, especially with regard to making information available to investors. A:
Q: Mexico has come a long way in eight years, especially with regard to making information available to investors.
A:Apart from exercising discipline and carefully managing our economic policy, we needed to be more transparent with information, and we have done that since 1995. We have a government office of investor relations that has become a model followed by other countries.
Before 1995, the country's level of foreign reserves would only be made public twice a year. Now it's every week. Other information on public finances and debt that was released quarterly is given monthly. All of our reports and accounts are posted on the Internet, including off-balance-sheet items such as the bank bailout debt, government project investment debt, and the toll highway debts.
This [transparency] is important because today, there are no borders for international capital. With our flexible exchange rate, any irresponsible disequilibrium would be reflected immediately in the market, causing the country no end of problems.