thestreet.com. Back to 1982? Latin America's Debt Mountain Is Daunting
By Peter Eavis
Senior Writer
9/1/98 11:07 AM ET
Latin America could soon find itself in the
midst of its second full-blown debt crisis
in two decades, which would deal another
hard blow to already ravaged U.S.
markets.
Brazil, Mexico and Argentina face
estimated external debt obligations totaling over $120 billion
through the end of 1999.
Lenders, petrified by the protracted emerging markets
shakeout, may refuse to roll over a large part of that debt,
causing an almighty credit squeeze that could force these
countries into default.
Latin America spent the '80s in the wilderness after a series
of sovereign defaults sparked by Mexico's refusal to pay its
bank debt in 1982.
Some pundits are publicly voicing deep concern over the
current debt overhang. "It's going to be a very tough task for
Latin America to meet its external obligations," says Walter
Molano, head of emerging markets research at Warburg
Dillon Reed.
Fears of default, and the economic and political mess that
would entail, have already prompted an exodus from Latin
American stocks and bonds, with benchmark equity indices
off 40%-50% for the year. Meanwhile, long-term government
bonds have nosedived in price and their soaring yields
suggest default probabilities of over 70%, according to
Goldman Sachs.
If the panic continues, foreign reserves will be rapidly
depleted, bringing the dollar-pegged exchange rates of Brazil
and Argentina under immense pressure and dragging the
Mexican peso to new lows.
The governments of Brazil, Mexico and Argentina have to
take drastic action to shore up confidence. But the two main
policy options they have -- big hikes in interest rates and
deep budget cuts -- involve great pain and may be deemed
too politically risky.
Governments may not want to swallow such bitter pills
ahead of the important elections scheduled for the next two
years, starting with a presidential and congressional vote in
Brazil on Oct. 4, followed by contests in Argentina in 1999
and Mexico in 2000.
Brazil
Brazil has become the bogeyman of the debt nightmare.
The country faces amortization on medium- and long-term
public and private debt of around $9.8 billion in the remainder
of this year, according to Molano, and $14.3 billion in 1999,
according to Credit Suisse First Boston.
The country also has a short-term (under one year) external
debt stock of $27 billion, according to CSFB. In the current
environment, it has to be assumed that some of that
short-term credit will not be rolled over.
Another call on dollars is the current account deficit, which
could take another $11.6 billion in the remainder of this year,
according to Warburg Dillon Reed. Next year, J.P. Morgan
expects a current account deficit of $15.4 billion.
Assuming half of the debt gets refinanced, then total
obligations come to just over $50 billion. That seems doable
if one also takes into account that reserves are around $65
billion and foreign direct investment inflows could total $20
billion by the end of next year.
But it's not that simple.
First, no one knows how much of Brazil's $250 billion
real-denominated domestic debt is owned by foreigners, who
are probably rushing for dollars in this unstable environment.
The government, rather fishily, is not saying what proportion
non-Brazilians own.
"The numbers coming out of Brazil are muddied compared
with those coming out of other emerging markets," says
Larry Goodman, chief emerging markets economist at
Santander Investment."That only fuels speculation."
Estimates put the foreign share at 10% of the domestic
debt. But it could be higher, especially as the government
has recently been issuing more dollar-linked debt, which has
attracted a lot of foreign buying, according to Ernesto
Martinez-Alas, sovereign analyst at Moody's Investors
Service.
Second, the Brazilian government, led by President
Fernando Henrique Cardoso, is extremely reluctant to
attract new inflows by raising rates. That's because higher
rates would further constrict economic activity ahead of the
elections. And, since over 70% of the total debt has a
floating-rate structure, a rate hike would also increase the
size of the gargantuan budget deficit, already equivalent to
7% of GDP.
For these reasons, Goodman would not be surprised if the
government decided to cut rates at the next central bank
monetary policy meeting on Sept. 9.
But such a move would be risky, as the market may think
the government cares more about winning an election than
shoring up investor confidence. Outflows could accelerate,
especially if the locals also stop buying government debt.
This is already happening: Last week, one of the
government's debt auctions was heavily undersubscribed
because rates were deemed too low.
Brazil could just wriggle through. But to do so, it needs a lot
of grace from the markets and the new government has to
immediately come up with a wide-ranging set of
budget-cutting reforms.
Mexico
Mexico's numbers are hardly more reassuring. Next year,
the country faces external government and private debt
obligations of $30.5 billion and must cover a trade balance of
$10.5 billion. This brings the financing total to $41 billion,
according to Paulo Vieira Da Cunha, Latin economist at
Lehman Brothers.
Da Cunha expects $10 billion in foreign direct investment
next year for Mexico. And he believes that banks making
syndicated loans will probably roll over the $12 billion
coming due next year. The IMF and World Bank will do the
same for the $4 billion they are owed, he predicts.
Concerns center on the up to $12 billion in maturing bond
debt. But Da Cunha is not too worried about that. "This may
be problematic, but I expect the markets to get better," he
says. In addition, Mexico has around $28 billion in hard
currency reserves to act as a cushion.
Still, Mexico will have to pay a lot more if it wants to
refinance in the bond market, as no one expects yield
spreads, currently 12%-13% over Treasuries, to rapidly
narrow back to 4% and under.
Mexico has been forced to hike rates to stop the peso,
which is free-floating, from sliding too fast. The tighter money
is slowing growth. This stance will be difficult for the ruling
PRI party to maintain the closer it gets to the 2000
presidential elections. Any sign of the government putting
politics over debt management could cause steep outflows.
Argentina
Argentina is also not in the clear.
Next year, medium- and long-term debt amortization for the
country comes to $14.3 billion, according to CSFB.
Standard & Poor's calculates short-term debt to be around
$16 billion. On top of that, the current account deficit could
be as high as $12 billion next year, J.P. Morgan calculates.
Total obligations for 1999 could therefore reach $42 billion.
This will be reduced on a net basis by inflows of foreign
direct investment of up to $5 billion as well as some
creditors rolling over. Reserves total around $30 billion.
Another line of protection is the $7 billion pool of emergency
cash that the Argentine government has set up with foreign
banks for times like this. It can draw on this money at low
preset interest rates if investors shun Argentine paper in the
international bond market.
But, again, confidence will ultimately depend on the
government's ability to stomach an economic contraction.
This could be severe under Argentina's currency board, as
money supply is reduced when money leaves the country.
If the government attempts to tinker too much with the
currency board to loosen the domestic economy ahead of
the October 1999 election, the market reaction would be
punishing.
And at that point the ghost of '82 would return to haunt. |
