Will Mexico suffer contagion?

Morgan Stanley put out a post today pointing out that Mexico’s banking system is under stress and may well and probably will not have difficulty rolling over its debt obligations this year even if the credit crunch continues. Below are excerpts with my highlighting (Update 12 Mar 2009  – I also struck through parts of this intro paragraph I found revealed a bias in re-reading this post):

With the peso reaching historically weak levels in early March, Mexico watchers are increasingly wondering if the sell-off is overdone or reflects Mexico’s greater vulnerability to the US and global downturn. The list of concerns is a long one, starting with the strong link on the industrial front between the Mexican and the US economies and the impact of lower crude prices on the fiscal accounts, which derive nearly 40% of revenues from oil (see “Mexico: No Oil, No Problem?” EM Economist, February 27, 2009). And more recently, with exports collapsing, capital flows under pressure and remittances declining at double-digit rates, concerns about the sustainability of Mexico’s balance of payments have resurfaced.

Market concerns about the sustainability of Mexico’s balance of payments appear to be overblown, in our view. Indeed, Mexico’s external accounts during 2009 appear to be quite manageable based on our stress-test exercise. On the current account front, plunging demand for Mexico’s manufacturing exports is almost fully offset by lower imports of intermediate goods. Meanwhile, the deterioration due to the collapse in crude prices on the current account front is largely compensated by an inflow in the capital account from the government’s oil hedge. Remittances will be a major drag, but the services deficit is unlikely to deteriorate. Indeed, we estimate that the deterioration in Mexico’s trade account is more than offset by the combination of declines in capital and consumer goods imports (on the current account front) and the inflows from the oil hedge (on the capital account front).

So, on this score, we do not seem likely to have another Tequila crisis just yet.  But what about Mexican banks?  Aren’t companies having difficulties as a result of the lower oil revenues, the lost remittances and the reduced trade with the U.S.?  You should note that the 2nd biggest bank in Mexico, Banamex, is a part of Citigroup – now partially owned by the U.S. government (Is this a takeover target for BBVA, which owns the largest bank there?). Morgan Stanley does not think so and this could mean the weak Mexican Peso is oversold.

The greatest risk likely lies in external private sector debt. According to Finance Ministry data, there is US$27.7 billion in non-financial private sector and an additional US$7.7 billion in financial sector foreign currency obligations coming due this year. Of the non-financial private sector obligations, US$10 billion are in trade financing, which we expect to be fully rolled over. Indeed, there have been no significant problems with trade financing so far; moreover, the US$30 billion Fed swap line more than covers trade financing lines and is ideally suited to support any trade financing difficulties. Although the Fed swap line currently expires in October, we expect that the line will be renewed (or substituted with another instrument) for as long as the current turmoil represents a potential balance of payments threat to Mexico. The remaining US$17.7 billion is split between US$2.1 billion in bonded debt, US$11.8 billion in bank debt and US$3.8 billion in other debt obligations. So far, however, nearly US$6 billion of the bank debt has already been rolled over. As a conservative assumption, we assume no further rollover for the bonded debt or the rest of the bank debt. We further assume that 50% of other non-financial debt is rolled over and there is a 75% rollover of the US$7.7 billion in financial sector obligations, given the relative strength of Mexican banks. The net impact is that the private sector generates an outflow of US$11.7 billion.

Even under very conservative assumptions for net foreign investment, the potential stress on the capital account remains limited…

Bottom Line
Mexico faces a series of long-term structural challenges that need to be addressed. The near-term cyclical challenges in 2009 and into 2010, however, are unlikely to be as severe as they might appear at first glance. Mexico is a small, open economy and relies heavily on trade with the US for manufacturing employment. A prolonged downturn in the US is likely to pose significant risks to Mexico’s labor markets and, in turn, the growth dynamic for the economy. But the narrower question of a balance of payments shortfall that could have an impact on currency markets appears to be limited. Neither Mexico’s balance of payments challenge nor its fiscal challenge appear to justify a significant weakening of the Mexican peso from here. Of course, our fundamental analysis provides little guidance as to how the Mexican peso will trade in the near term. It does suggest, however, that the extreme stress being experienced by the Mexican peso today likely represents an opportunity for reversal, rather than a step to a permanently weaker level.

My take on this is: while everyone seems to be shedding assets, Citigroup included, BBVA seems to be doing relatively well. If they are as strong financially as they indicate despite Spain’s crashing economy, antitrust concerns aside, Banamex would be a good target for increasing their North American footprint.

Stress-Testing the Balance of Payments – Morgan Stanley

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