beyondbrics

While some emerging markets compete to be the next Bric, Mexico appears left behind. Once thought too developed for Bric status, it now struggles to compete with other emerging economies, held back by a lack of reform and a violent image.

But Mexico is now entering a select club where even the Brics cannot tread. In October, it will become the first Latin American country to join Citigroup’s World Government Bond Index. Acronyms may bring more kudos, but Mexico’s inclusion on the Index has helped foreign investment in peso bonds to reach $10bn over the last eleven months, according to bank estimates.

How much of this investment is due to inclusion on the WGBI is difficult to tell, but Citigroup says foreign investors now account for roughly a third of peso-bond purchases, compared to less than 20 per cent in previous years.

“In the history of the market, we haven’t seen such strong inflows,” says Salvador Orozco, an analyst at Santander in Mexico City.

Among the most active newcomers are passive investors from Asia, particularly Japan. Banamex, a Citigroup subsidiary, now trades 24 hours to minimise time-difference problems; competitors may follow suit.

“Mexico’s inclusion in the WGBI has called the attention of [Japanese] investors to the good macro standing of the country,” says Sergio Luna, Citigroup’s chief economist for Mexico. “As a result, they have increasingly focused on operative aspects – settlements, tax, legal issues.”

The “WGBI phenomenon” – as Citigroup calls the index’s capacity to bring in new investors – has coincided with other factors. Globally, investors are attracted to higher yields: between January and August, inflows into emerging market bond funds were triple the previous full-year record, according to EPFR.

Domestically, Mexico’s interest rates are not expected to rise in 2010 (Brazil’s have already risen by 2 per cent), as inflation remains low. The Calderon administration has kept the fiscal deficit moderate and is proposing to balance the budget by 2012. Ratings agencies have reaffirmed their faith in the country, with Moody’s saying last week that it “was hard to come up with a scenario that would lead to a downgrade”.

As a result, Mexican bonds yields have fallen fairly consistently in 2010, notwithstanding a blip last month when fears over the US economy prompted some foreign investors to pull their money out of Mexico and other risky markets. The yield on a 10-year peso-denominated bond is down over 21 per cent this year to 6.28 per cent.

Some say Mexico’s bond success is also a product of longer-term factors. “What Mexico did ahead of other Latin American countries was to develop a longer-dated debt curve,” says Donato Guarino of Barcap. Peso bonds were introduced in 2000, and a 30-year fixed-rate bill was introduced in 2006. Salvador Orozco adds that, “the government has been very transparent in placing bonds, with announcements every three months.”

Citigroup’s Luna says:

One critical feature of Mexico – vis-à-vis other Latin American countries – is the ease of entry: no capital controls, or restrictions on foreign purchases.

The Brazilian [bond] market is quite important, but in order to aim at inclusion in the WGBI it would have to make very significant changes in regulations.

Chile’s bond market is better developed but too small for the WGBI, so Luna expects Mexico to remain the only Latin American country on the index “for a long time”. The only other emerging market member is Malaysia; South Korea’s case is due to be reconsidered.

By the end of 2010, Citigroup expects WGBI inclusion to have brought $15bn of inflows into Mexico. (Its original forecast was above $23bn. However, the bank had overestimated the quantity of funds pegged to the WGBI, believing around $4 trillion worldwide followed the funds – when in fact it is closer to $2 trillion.)

And the arrival of new investors is especially welcome for Mexico, where drugs-related publicity is deterring many foreign businesspeople who don’t have a long-standing relationship with the country.

Related reading:
Violence casts shadow over Mexican business, beyondbrics
Investors shun Mexico – with good reason, beyondbrics