Look who's borrowing now: government effort to reduce economic vulnerability pays dividends.

The lives of a generation of Mexicans have been marked by the awareness that the size and structure of the foreign debt can demolish their savings and bring an abrupt end to their hopes for prosperity. With the exception of the most recent transition in the year 2000. Mexicans suffered from debilitating devaluations when the presidency changed hands. What made the Dec. 20, 1994, devaluation even more devastating was the fact so many Mexicans had believed that, finally, there wouldn't be a massive devaluation. That there's been only one transition that wasn't accompanied by a "macro-devaluation" in a quarter of a century means the foreign debt has a place in Mexico's collective conscience that is not apparent in many other countries that are also members of the Organization for Economic Cooperation and Development (OECD).

Since the crisis unleashed by the last macro-devaluation in December 1994, there have been significant changes in the level, composition and maturity structure of the foreign debt. This article will discuss those changes and analyze what they imply for the future of the peso.

Since 1996, Mexico's foreign liabilities picture has been a very straightforward one. The public sector and commercial banks are net re-payers of foreign debt. The non-banking private sector borrows. Foreign investors invest in plants and equipment. Portfolio investors aren't particularly interested in the country; and, when Mexicans repatriate capital from accounts abroad, the peso is strong.

PUBLIC SECTOR DEBT

That there's appetite for Mexican debt in the international capital markets is amply demonstrated by the reception accorded Mexican borrowers in the international capital markets. The government has successfully placed 30-year dollar-denominated debt, even during the last three years when international financial markets were channeling less capital into "emerging markets". Demand for Mexican government (United Mexican States or UMS) issues routinely outstripped the amount offered. Additionally, the premiums over the comparable tenor (maturity) U.S. Treasury obligation continued to decline.

Hacienda officials have been working diligently to reduce Mexico's vulnerability to a foreign debt-induced exchange rate crisis. Even though market conditions indicate that Mexico could place more debt in the international capital markets, over the past 10 years Hacienda has striven to reduce the public sector's foreign debt, restructuring and lengthening its maturity profile to create a long-term yield curve. Hacienda's efforts have been very successful.

At the end of 1995, the public sector's foreign debt exceeded 30% of GDP. It declined through 2000, then subsequently flattened out, remaining around 13% of GDP. (See Table 1) On March 31, 2004, the public sector's net foreign debt totaled US$80.5 billion, a modest 12.8% of GDP. (On May 31, the public sector's foreign debt was slightly lower, US$79.5 billion.) By the end of this year, the Mexican public sector foreign debt, which represents a modest percentage of the country's GDP, even by standards of member countries of the OECD (see Table 2), should be US$0.5 billion less than at the end of 2003. This would mark the second consecutive year that the country's foreign debt has declined in absolute terms as well as a percentage of GDP. From the Central Bank to the development banks to the non-banking public sector, the public sector has been consistently reducing its net debt. (See Table 3.)

The total public sector debt to GDP ratio has not changed much over the last four years because of the shift in the structure of the public sector's debt: an increase in the public sector's pesodenominated, internal debt accompanied the decline in foreign debt. (See Table 4) Although the internal debt traditionally has been more expensive than the foreign debt, relying on internal, peso-denominated financing makes Mexico less vulnerable to a debt-triggered exchange rate crisis.

Neither is the maturity structure of the public sector debt a potential stumbling block. In accordance with the amortization schedules of total public debt, in the period 2004-2009 roughly US$18 billion in "capital market debt" comes due (See Table 5).

PRIVATE SECTOR ACCESS

The largest, strongest companies in Mexico's private sector also have had access to the international capital markets: the non-banking private sector has been a steady net borrower in international markets. Even in 1995, the year of the "tequila crisis" when the U.S. Treasury put together an unprecedented emergency financial support package of up to US$50 billion that kept the government out of default, the Mexican private sector borrowed US$2.8 billion (net) in the international capital markets. That didn't stop in the next six years when the non-banking private sector took on net debt, ranging from US$3.0 billion to US$7.9 billion each year. In 2002 and 2003, the pace slowed to US$3.4 billion and US$3.7 billion, respectively.

The privately owned commercial banks, in contrast, have consistently been repaying their foreign debt on a net basis (see Table 6). That was to be expected, given the magnitude of the crisis in the banking sector unleashed in 1995 and the fact that commercial bank credit to privately owned firms and individuals engaged in business has yet to grow in real terms. Outstanding credits to that group, which constituted 53.1% of the outstanding credit portfolio to the non-banking private sector, totaled $321.4 billion as of May 31, 2004, 2.7% less in real (discounting inflation) terms than a year earlier. On Dec. 31, 1994, the outstanding portfolio of the non-banking private sector totaled 75 billion pesos (See Table 7).

DO PRIVATE SECTOR FIRMS WANT ACCESS?

The capital account statistics for the first quarter of 2004, released at the end of May, paint a slightly different picture of foreign borrowing. For the first time, the central bank disaggregated borrowing by the non-banking private sector: the new presentation distinguishes between borrowing by the non-banking private sector and borrowing by "Pidiregas," energy projects built and financed by the private sector government that enjoy a full guarantee.

As it turns out, all the non-bank private sector net borrowing in 2002, 2003 and the first quarter of 2004, was done for Pidiregas projects. In 2002, Pidiregas' net foreign debt rose US$5.3 billion; the non-banking private sector repaid US$1.9 billion. In 2003, Pidiregas' took on a net US$6.2 billion in foreign debt; the non-banking private sector repaid a net US$2.5 billion. In the first quarter of 2004, Pidiregas' net debt inched up just US$0.1 billion. In the first quarter of 2003, the increase was US$1.3 billion.

Let's hope that it's just because projects got off to a slow start this year, not because of the political and judicial challenges to the legality of co-generation investments and the much less successful MSCs (multiple-service contracts). The non-banking private sector repaid, net, US$1.4 billion in the first quarter of 2004; a year earlier, they repaid US$0.6 billion. Debt re-payment is a good thing--so long as it is by choice and the firms that had been borrowing abroad have not cut back on their investments but, instead, substituted other forms of financing for foreign debt.

Between 1997, the first year for which the Central Bank is reporting Pidiregas borrowing, and 2001, that net borrowing has become an ever important component in the borrowing by the non-banking private sector. In 1997, it was US$1.0 billion; in 2001, it had risen to US$3.4 billion. Net borrowing by what is now defined as the non-bank private sector declined from US$5.4 billion to US$2.6 billion.

CHANGE OF CURRENCY

What we've been seeing since 2001, in fact, is a massive re-adjustment of the currency in which Mexico's private sector firms are choosing to borrow. The last four years saw the blossoming of a long-term, fixed rate peso debt market. The rise of the Certificados Bursatiles market was nurtured by the decline of peso interest rates to historical lows. Those Mexican firms that can borrow as easily abroad as in Mexico have been reducing their foreign debt not related to the Pidiregas energy projects at the same time the Certificados Bursatiles flourished.

The Certificados Bursatiles market was so unimportant that the Mexican Bolsa (stock exchange) didn't keep statistics on it until 2001 (See Table 8). Certificados Bursatiles outstanding at the end of 2001 totaled US$1.5 billion. A year later, they had jumped to US$4.6 billion. At the end of 2003, Certificados Bursatiles outstanding totaled US$8.6 billion and on April 2004, they were US$9.6 billion.

Private firms have taken advantage of the rapid development of the Certificados Bursatiles market to substitute peso debt for dollar debt. The increase in "private sector foreign debt" has been, effectively, public sector-guaranteed borrowing abroad to finance energy projects. For all intents and purposes, public sector debt has been behind the increase in the nonbanking private sector's build-up in liabilities since 2001.

That Mexico's energy sector requires massive investments over the next five years is not news. Whether the figure is US$138 billion--more or less-it's too much to be raised from internal cash flow or in the peso debt markets. It may also be tricky for Pemex or CFE (the Federal Electricity Commission) to issue that amount of debt in the international markets. Remember, in its most recent evaluation of Pemex, Moody's did not downgrade Mexico's state-owned oil company's credit rating because, in Moody's judgment, Pemex enjoys an implicit "full faith and credit" guarantee of its debt by the federal government. (Investors aren't about to lend directly to Luz y Fuerza del Centro, the state-owned electricity company that services Mexico City and the greater metropolitan area. The company is in such bad shape that the federal government won't even let it use the Pidiregas scheme.)

Does Mexico want the cash needed to finance its energy investments to come in the form of debt or direct foreign investment? Now that what appeared to be private sector debt turns out not to be, Mexico's foreign debt to GDP ratio isn't quite as attractive as it seemed. Yes, the government has been disclosing the contingent liabilities represented by the Pidiregas projects in the broader measure of the public sector deficit, the PSBR. But, those liabilities didn't show up in the foreign debt to GDP ratio. It's not the end of the world. It does, though, point out the cost of not opening up Mexico's energy sector to private investment.

DEVALUATION RISK REDUCED

Over the last 10 years, the Mexican government has made a conscientious effort to reduce the country's vulnerability to a balance of payments crisis. The first step was the adoption of a floating exchange rate regime. Complementing the decision to let the market, instead of the government, set the exchange rate was the decision to continue reducing the government deficit and to shift away from financing that deficit with foreign debt to financing it with peso-denominated debt.

In the first half of the last decade, those Mexican companies that had the ability to borrow in the international capital markets did. Financing was available and the terms were more attractive. However, the emergence of the Certificados Bursatiles market at the turn of the century allowed those same companies enjoying high credit ratings to borrow long-term peso-denominated debt at single-digit rates. It was a reasonable premium to pay for eliminating exchange rate risk.

The floating exchange rate and the turn to the peso debt market have helped reduce the risk that the peso will suffer a macro-devaluation to its lowest level in decades.

Table 1 Net Public Sector Foreign Debt (%GDP)

Year   External Debt

1993        17.2
1994        18.2
1995        31.5
1996        27.0
1997        19.8
1998        19.5
1999        17.3
2000        13.2
2001        12.3
2002        12.0
2003        12.8
2004*       12.5

* projected total

Table 2 Gross Public Sector External Debt/GDP (2003)

Country  %GDP

Italy     117.1
Canada     75.6
Spain      63.3
France     69.5
Germany    65.3
USA        63.4
UK         53.5
Mexico     27.5

Table 3 Public Sector Debt by User (billions of US$)

Year  Development Banks  Banco de Mexico  Non-Public Bank Sector

1993        3.8              -1.2              -1.2
1994        4.4              -1.2              -0.8
1995        0.1              13.3              14.4
1996       -2.1              -3.5               2.1
1997       -2.2              -3.5              -5.5
1998       -0.7              -1.1               2.4
1999       -1.8              -3.7               1.7
2000       -0.2              -4.3              -6.6
2001       -1.2               0.0              -0.1
2002       -1.2               0.0              -3.2
2003       -1.6               0.0              -2.7

Table 4 Structure of Public Sector Debt (%GDP)

Year   Internal Debt  External Debt

1993        9.8          17.2
1994        7.6          18.2
1995        5.9          31.5
1996        6.8          27.0
1997        8.0          19.8
1998        8.2          19.5
1999        9.9          17.3
2000       10.8          13.2
2001       12.1          12.3
2002       12.2          11.7
2003       13.2          12.3
2004*      11.7          12.1

* projected total

Table 5 Annual Amortization of External Public Debt (billions of US$)

Year  Capital Markets  Commercial Banks

2002       3.6               0.4
2003       2.7               1.4
2004       3.2               0.5
2005       3.0               0.3
2006       2.8               0.3
2007       3.1               0.3
2008       3.3               0.04
2009       2.6               0.03
2010       2.9               0.027
2011       2.5               0.028
2012       1.5               0.012
2013       0.3               0
2014       0                 0

Table 6 Annual Amortization of Total External Debt (billions of US$)

Year  Public Sector  Private Sector

2002       6.8          11.2
2003      11.1          12.1
2004       7.9          10.3
2005       6.1           9.1
2006       5.7           5.1
2007       5.4           6.1
2008       5.2           8.7
2009       4.7           1.0
2010       4.1           0.5
2011       3.5           0.1
2012       2.1           0.2
2013       1.0           0.1
2014       0.4           0.04

Table 7 Outstanding Credit Portfolio of the Non-Banking Private Sector
(in billions of pesos, at year's end)

1994   75.8
1995  141.3
1996  160.0
1997  184.9
1998  270.4
1999  283.9
2000  320.7
2001  332.7
2002  367.3
2003  367.6
2004  343.1

Table 8 Mexican Government Certificates in Capital Markets
(at year's end)

Year   Millions of US$

2001       1,500
2002       4,600
2003       8,600
2004*      9,600

* projected total

By Dr. Deborah L. Riner

Dr. Deborah L. Riner is the AMERICAN CHAMBER/MEXICO'S chief economist.