Nomura Predicts $61,000 Default-Swap Discount to Increase

The prospect of tax and energy reforms in Mexico is prompting Nomura Holdings Inc. to predict the nation will become more creditworthy versus Brazil than at any time in seven years.

It costs 0.61 percentage point, or $61,000, less to protect $10 million of Mexican bonds against non-payment for five years with credit-default swaps than Brazilian debt, twice the average in the past year. The gap will swell to 1 percentage point by year-end, which would be the most since 2006, as Mexico passes legislation to open the state-controlled oil industry to more private investment and boost tax revenue, according to Benito Berber, a strategist at Nomura.

While Brazil, where surging inflation triggered the biggest street protests in two decades, is at risk of a downgrade, Mexico won an upgrade from Fitch Ratings and is on review for a ratings boost by Standard & Poor’s as confidence builds that President Enrique Pena Nieto will bring lawmakers together to enact the biggest reforms in 75 years. S&P assigns a BBB rating, the second-lowest investment grade, to Brazil and Mexico, where education and telecommunications bills have passed this year.

“The fiscal reform, in addition to the reforms that have passed, increase the possibility of an upgrade substantially,” Berber said in a telephone interview from New York. “The spread will widen significantly” against Brazil as reforms will probably pass congress, Berber said.

‘Strong’ Fundamentals

At 1.26 percentage points yesterday, Mexico’s five-year credit-default swaps traded lower than those for Latvia and Ireland, which are rated by S&P one level higher at BBB+, and below those of Slovenia, whose A- grade is two levels higher, according to data compiled by Bloomberg.

Fitch Ratings raised Mexico’s rating one level to BBB+ in May, in line with Moody’s Investors Service’s Baal ranking. It cited “strong macroeconomic fundamentals” and “greater than anticipated commitment of the new administration and Congress to pass structural reforms.”

Pena Nieto said in an Aug. 1 radio interview he’ll present his energy overhaul next week. The bill may include a constitutional amendment, according to Senator David Penchyna of the president’s Institutional Revolutionary Party, who heads the upper house’s energy committee.

The opposition National Action Party sent its own proposal to congress July 31 that would offer oil exploration and production concessions for private companies and pave the way for Petroleos Mexicanos, the state-owned oil producer known as Pemex, to sell shares.

‘Widen Further’

Pena Nieto said in a June 17 interview he’ll send a bill to congress in September to increase tax revenue. Taxes and royalties from Petroleos Mexicanos fund about 34 percent of the federal budget.

“The Brazil-Mexico CDS spread could widen further,” Alberto Ramos, a senior economist at Goldman Sachs Group Inc., said in an e-mailed message. “The different macro stories and the positive outlook for reforms definitely justify lower CDS spreads in Mexico.”

Mexico’s economy will grow 2.8 percent in 2013, outpacing Brazil’s for a third year, according to analyst estimates in Bloomberg surveys. At 3.5 percent in early July, annual inflation in Mexico is almost half Brazil’s 6.4 percent rate. Mexico’s public debt as a percentage of gross domestic product is 35.4 percent, compared with 54.9 percent for Brazil, according to an Aug. 1 report by Grupo Financiero BBVA Bancomer SA.

‘Political Fights’

Luis Adrian Muniz, deputy director of economic analysis at Vector Casa de Bolsa, said investors in Mexico may be disappointed as Pena Nieto could water down the bills to ensure negotiations run smoothly with the opposition Democratic Revolution Party, which has opposed changing the constitution to alter energy policies.

“The risk is that they ignore important points in the reform due to political fights,” Muniz said in a telephone interview from Mexico City. “The limit to the economy in Mexico lies in politics.”

Pena Nieto will need a two-thirds majority in both congressional houses and the majority of state legislatures in 31 states and the federal district to pass a constitutional energy bill.

The extra yield investors demand to own Mexican government dollar bonds instead of U.S. Treasuries climbed two basis points to 200 basis points at 1:20 p.m. in New York, according to JPMorgan Chase & Co.

The peso rose 1.5 percent to 12.6333 per dollar. Yields on interbank rate futures due in December, known as TIIE, were unchanged yesterday at 4.34 percent.

‘Continuous Progress’

Barclays Plc recommends selling Mexico’s default swaps and buying Brazil’s as the gap between the two is expected to keep widening, according to Donato Guarino, a fixed-income strategist.

“We remain cautious with Brazil credit where fiscal metrics are degenerating, growth outlook remains uninspiring and policy actions have been questionable,” Guarino said in an e-mailed comment. In contrast, Mexico “is supported by the continuous progress on reforms that eventually will lead to a ratings upgrade.”

More than 1 million Brazilian protesters in June demanded better public services, an end to corruption and a lower cost of living after prices for everything from housing to flour surged in the first half of the year.

“Upside could materialize in Mexico” as reforms are approved, Sergio Luna, the chief economist at Citigroup Inc.’s Banamex unit, said in a phone interview. “You may see a better position relative to Brazil’s case due to the atmosphere in the market.”

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