Emerging market bond markets have had an explosive start to 2010. By mid March, new issuance by sovereign borrowers in emerging markets had reached almost $130 billion, an increase of 42% over the same period in 2009. To date, this record-breaking supply has not been a drag on performance. By mid March, the spread between US Treasuries and the JP Morgan Emerging Markets Bond Index (EMBI) had fallen to a 20-month low, supported by a wall of liquidity flowing into fixed income in general and emerging markets in particular. In the first 10 weeks of this year alone, for instance, more than $5 billion flowed into emerging market bond funds.
From a Latin American perspective, has this strength been justified by economic fundamentals? Are the favourable supply-demand dynamics sustainable, and will they underpin a continued rally in the market for emerging market bonds over the short to medium term?
These were some of the questions put to the panellists at the Emerging Markets-Bank of America Merrill Lynch (BofAML) roundtable, which took place in Cancún on Friday, March 19, 2010.
Participants:
Jerome Booth, Head of Research, Ashmore Investment Management
Brett Diment, Head of Emerging Market Debt, Aberdeen Asset Management
Cathy Hepworth, Portfolio Manager and Emerging Markets Strategist, Prudential Investment Management
Gerardo Rodriguez, Deputy Under-Secretary for Public Credit, Ministry of Finance, United Mexican States
Shelly Shetty, Director of Sovereign Ratings, Fitch Ratings
Daniel Tenengauzer, Head of Global Emerging Markets Fixed-Income Strategy, Bank of America Merrill Lynch (BofAML)
Paulo Valle, Head of Public Debt Operations, National Treasury, Federative Republic of Brazil
Philip Moore, Moderator, Emerging Markets
EM: Let’s begin by talking about the prospects for accelerated economic recovery in the region. Given that its economy suffered so badly during the crisis, what is the outlook now for Mexico?
Rodriguez, Mexico: Now that so much negative news is coming out of Europe and other countries with huge financing needs, we believe Mexico is being seen in an increasingly positive light. We took our medicine early in terms of fiscal consolidation, which makes us more comfortable about the future.
Another source of confidence for us is that, after a drop of 6.5% in GDP last year, things have substantially improved over the last five to six months, driven mainly by rising external demand and a pick-up in manufacturing activity. The automobile and auto parts sector, for example, is now returning to the production levels that we saw in 2008, and that is supporting our growth projection for this year of close to 4%. We’re assuming a growth rate for the year as a whole of 3.8%, but many analysts are pointing towards 5%. We think that, as employment and consumption levels strengthen, domestic sources of growth which have not yet played a key role in the recovery will provide us with an additional impetus in the second half of the year, and more importantly in 2011. Last but not least, we believe that infrastructure development and the stabilization of the housing sector should provide the construction industry with an additional boost towards the second half of the year. So things are looking better, and I think financial markets are already reflecting some of that improved scenario, with spreads back to pre-crisis levels.
EM: What about Brazil’s experience during the crisis and the outlook for its economy?
Valle, Brazil: We believe we had a good stress test during the crisis and that we have come out of it stronger. Last year alone, international reserves increased by $40 billion to $244 billion. Our external debt has also been decreasing. In 2003 our sovereign debt was $77 billion, and we finished last year with around $53 billion.
In 2010 the government expects to see GDP growth of between 5% and 6%, a 3.3% primary surplus and a 1.5% nominal deficit. The forecast for inflation, which we believe is under control, is 4.5%. Gross debt is expected to be stable at around 63% of GDP, while net debt is projected to fall from 43% to 41%.
Hepworth, Prudential: The rebound we’ve seen in Mexico this year has been very impressive. Economists are revising their forecasts upwards, and we are starting to see drivers of domestic demand kick in, which suggests that the recovery is sustainable.
In Brazil, growth levels have of course been breathtaking, driven by strong domestic demand and by the role of credit. One of the things that distinguished emerging from developed markets during the crisis which is supporting recovery is that the emerging world did not become over-leveraged. Because they didn’t have a lot of debt, emerging markets were able to use fiscal stimulus and other drivers of credit to help restore demand, which is now giving them more flexibility than many developed countries.
Booth, Ashmore: If you don’t have 20 years of excessive leverage in an economy, extending all the way down to the consumer, you can’t have a credit crunch. Simply put, not only has Latin America not had a credit crunch, it can’t have one.
In the US and Europe the process of deleveraging will last for years. In a benign scenario, that will lead to sub-par growth for five years, while in a worst-case scenario the outcome will be depression. In that type of scenario, emerging markets will be the safest place to be. That will challenge our traditional view of emerging markets, meaning that they become attractive not just in terms of the returns they generate but also as a means of reducing risk.
Diment, Aberdeen: Of the higher grade sovereigns, Mexico is our highest conviction bet at the moment. We’re long the peso as well as local and hard currency bonds, for a number of reasons. Mexico suffered badly during the crisis, with the currency selling off very heavily. But that is now beginning to benefit the Mexican export sector. In the first half of the 2000s, US imports from Mexico fell from 12% of total US imports to about 10%, largely as a result of competition from China. But in the last 18 months that market share has been regained because of the sell-off in the peso.
Additionally, all the macro data coming out of Mexico has surprised to the upside recently. When I was in the US at the start of the year everybody was negative about Mexico, but you have a cheap currency, a strengthening economy and investors who are very underweight, all of which leaves us pretty bullish on the outlook for Mexico.
Rodriguez, Mexico: The fall in the peso certainly has a positive side to it. Because Mexico is such an open economy with a strong manufacturing base, the depreciation of the currency against pretty much all currencies in the world will contribute to growth. But to date we haven’t seen any evidence that the manufacturing cycle has been driven by new investment coming into Mexico driven by more competitive production costs.
EM: Are inflationary concerns in Mexico a cloud on the horizon?
Rodriguez, Mexico: We’ve seen a one-off spike in prices because of fiscal reform. But we have seen inflation remain within the range that was projected by the central bank last year. More importantly, we’ve seen long-term inflation expectations stabilizing.
Inflation in Mexico did not fall as much as in other countries when energy prices collapsed last year, so as the cycle comes back we think Mexico is going to be one of the countries that has a relatively stable inflationary outlook.
EM: What is the Fitch view on the macroeconomic picture in the markets we have been discussing?
Shetty, Fitch Ratings: There are good reasons why there was such a dramatic difference between the performance of the two economies last year. Mexico’s close links with the US exposed it to one of the main epicentres of the global financial crisis through reduced foreign direct investment, remittances and credit. One of the factors that is important to us is the health of the banking system, and in the case of Mexico we still see that as a very significant strength. Nevertheless, there was credit contraction in Mexico during the crisis which hit consumption.
In Brazil, however, consumption continued to be resilient throughout the crisis, partly because of the credit growth story, and clearly BNDES [the Brazilian Development Bank] played an important role in that. But in Mexico, we saw a double-digit dip in the volume of credit going to the consumer.
Each country has its own vulnerabilities, and these were exposed by the crisis. In the case of Mexico, we thought that the magnitude of the shock that it faced because of the crisis in the US meant that it would suffer much more than Brazil, although when we downgraded Mexico by one notch it was more for structural than cyclical reasons. But this crisis also had a lot to do with how the manufacturing side was hit, and clearly Mexico’s economy is much more dependent on the manufacturing sector than Brazil is.
That’s all in the past. Looking to the future, we believe that Mexico is well positioned to recover. Its macroeconomic fundamentals are still in tact, and it has a track record of macroeconomic stability. It also has a long historical record of low inflation.
I agree with Gerardo that the recovery is being led by exports and that it will take time before domestic demand kicks in. But we think that growth of around 4% is likely this year in Mexico. Our concerns are more about the prospects for medium-term growth, on where US growth is going over the medium term and on how that will affect Mexico. At its stage of development, Mexico should be able to sustain growth rates of 5% and above, but we don’t yet think that is likely, largely because of the US consumer story, the deleveraging taking place there and the decrease in the US savings rate.
We are expecting 5.5% growth for Brazil, underpinned by what we call the three Cs: China, commodities and consumption. Given what is happening in all three areas, we think there is a good chance that the 5.5% may have an upward bias. The bigger question in Brazil is over fiscal policies, and the sustainability of the quasi-fiscal stimulus that has supported domestic demand.
Brazil’s exports probably mean that it is better placed to leverage off China’s growth than Mexico. The growing links between Latin America and China suggest an increased commoditization of Latin America. That may sound strange, because Mexico used to be held up as a perfect example of what a lot of countries aspired to in the 1990s, when the view was that manufacturing was the way to go. Now the perception among investors is that, if you are linked through your commodity exports to China, then you must have a good growth story.
EM: How would the economies of Latin America be affected by a double dip recession in the US and Europe? Presumably that would lead to another collapse in commodity prices, which would in turn have a devastating impact on Latin American economic growth?
Booth, Ashmore: I believe there is an important countervailing force at work, and that the more the economies of the developed world deteriorate, the more incentive emerging markets will have to absorb capital domestically by investing in infrastructure. That in turn will support commodity prices. A lot of people naturally assume that, if consumer demand in the US and Europe goes down, then so will commodity prices, but I don’t think it’s as simple as that.
Tenengauzer, Bank of America Merrill Lynch: Going back to the topic of Mexico’s credit rating, I don’t understand how a country like Mexico can be downgraded when it is expected to have a deficit to GDP of 2.5%, and a public debt to GDP ratio of about 31% or 32%. On the other hand, we still have countries with debt to GDP ratios of 100% to 150% and fiscal deficits of 10% of GDP, and which can’t print their own money, but are still rated relatively highly.
I don’t understand why emerging markets are ranked and rated the way they are, given that there are so many huge concerns in the developed world. How come nobody is raising red flags more quickly about the disasters that seem to be coming in some of the developed countries?
EM: I guess the argument is simply that Germany will bail out Greece, but that nobody will bail out emerging markets.
Tenengauzer, Bank of America Merrill Lynch: You could say that when Mexico was in trouble President Clinton quickly came to the rescue. I still believe that the US would never let Mexico down because we all know what the consequences of that would be.
Shetty, Fitch Ratings: That illustrates the importance of being part of the eurozone.
Tenengauzer, Bank of America Merrill Lynch: What about the importance of being part of the North American Free Trade Agreement [Nafta]?
My other point is that within a year or two, emerging markets will behave the same way as the developed world in the sense that it won’t make sense to issue so much debt overseas. If you look at countries ranging from Australia to Italy to Greece, they don’t have that much dollar debt. Why issue expensive dollar debt when you can issue locally? I think the future is a move towards a much deeper local debt market.
Latin America is the perfect story for that move because debt and fiscal deficit to GDP ratios are low. People say Brazil has a 60% debt to GDP ratio and a fiscal deficit to GDP ratio of about 2.5% after you take out interest payments and so on. But in my view that makes it a more solid story than Greece.
The nominal debt markets, which are what is most attractive to my clients, are tiny, at about $90 to $100 billion. If you look at the corresponding markets in Asia, the domestic nominal bond market in India is $330 billion. The same market for China is $485 billion. No matter how much you adjust for population sizes or GDP, you still get to ratios that in Latin America are much lower than in Asia, which is a measure of the potential of markets in this region to grow.
I have two other main concerns, the first of which in Mexico is Banxico [Mexico’s central bank]. One of the reasons Mexico came back as quickly as it did was that Banxico behaved in a phenomenal way, both in the currency market and on the monetary policy front. But I now think it’s time to start tightening, because inflation in our view could reach 5% or 6% in the next few months. That requires action from the central bank now. Our core concern is that we might not see Banxico hiking in the next two or three months because they’re watching the Fed.
The risk we see in Brazil is state development bank BNDES [Banco Nacional de Desenvolvimento Economico e Social]. I just don’t think the extra R80 billion [$45.6 billion] that has been given this year to BNDES is required. Last year, it was given R100 billion [$55.52 billion], which is fine. But this is a fiscal burden, because it’s a quasi-sovereign entity that is giving money at 8% when the sovereign is paying 6.5% plus inflation, which is a total of 11%.
Shetty, Fitch Ratings: I agree that this leads to an increase in the gross debt burden. Debt is about 70% of GDP, which is not falling even though Brazil is growing at 5.5% or 6%. That is precisely because of the quasi-fiscal stimulus.
The structural issue from our perspective is, what role is BNDES going to play going forward? Was this just a counter-cyclical measure that was taken as a result of the crisis, or is BNDES being groomed to play a bigger role?
Tenengauzer, Bank of America Merrill Lynch: These were exactly the questions I put to BNDES earlier this week. Its role is to try to eliminate or at least to reduce the bottlenecks in the economy, which makes sense. But what concerns me is that the BNDES balance sheet will increase by 40% within two years, and any bank that is given that kind of increase in its balance sheet will inevitably make sloppy loans. One of the key BNDES strengths is that it has traditionally had very low NPLs [non-performing loans], but the danger is that these will now rise.
Valle, Brazil: The BNDES funding issue is structural. There are discussions going on at the moment about how to guarantee a permanent fund for BNDES.
EM: How decisive a role does politics play in shaping economic policy and therefore sovereign creditworthiness elsewhere in the region? In particular, what impact will this October’s presidential elections in Brazil have on the market?
Booth, Ashmore: There is obviously potential for some fiscal slippage ahead of the elections in Brazil. But I don’t see any long-term impact. The point is that the electorate across Latin America has experienced weak economic policy in living memory and therefore knows what it looks like. I expect a high level of political realism in terms of economic policies going forward.
Valle, Brazil: I believe the stabilization of the economy is good for society, so I don’t believe any new government will change this. In terms of reform, we believe the best time to introduce new reforms is at the beginning of a new government’s administration. It is very clear that we need to introduce tax reform, for example.
EM: Moving on to the region’s debt markets, they have had a very good run over the last 12 months. How sustainable is this rally?
Booth, Ashmore: I’m expecting a lot more spread tightening in emerging market bonds. Sovereign risk is insignificant in emerging markets compared with the developed world, and although I don’t think Greece will default, I do believe the chances of that happening are higher than in a country like Argentina or Venezuela.
Shetty, Fitch Ratings: We don’t think Greece will default either. We have the rating at BBB+ with a negative outlook and a 50% chance that it will be downgraded again. By contrast, we have Brazil and Mexico on stable outlooks, so we think the credit trajectory of the three countries is fairly clear.
Tenengauzer, Bank of America Merrill Lynch: Our house view is also that Greece will not default and that it will eventually recover based on the implicit system embedded in the eurozone.
Booth, Ashmore: Returning to the question about the outlook for spreads, not only is the fundamental emerging markets story in favour of further spread tightening to below pre-Lehman levels, there are also very significant technical factors at work in the market. In a deflationary environment in the US and Europe, we’re not going to see an early exit from quantitative easing [QE]. And we’re not going to see asset classes like ABS coming back any time soon. So there is a huge amount of liquidity in the credit space, but a very limited choice of assets for investors to buy.
Additionally, sovereigns in the developed world will be issuing paper worth trillions of dollars or euros over the coming years. That will not be the case in emerging markets, where debt levels are not getting out of hand. So the supply-demand dynamics will remain favourable.
At the same time, investors remain massively underweight in emerging markets. The emerging world accounts for 85% of the world’s population and for about 50% of global GDP on a purchasing power parity basis. So a neutral position would be 50% in emerging markets. But a recent JP Morgan study calculated that US pension funds have a 2% allocation to emerging market debt and equity. That means that an investor with neutral view of markets is 48% underweight, and one who is bullish about emerging markets is even more underweight.
This suggests there is something very seriously wrong with asset allocation at the moment. So I’m expecting a big technical move as a range of investors increase their exposure to Latin America and other emerging markets, which is a process that has already begun. We are also seeing similar trends within emerging markets, underpinned by rising south-south trade and investment flows. That will continue, because if you are a Latin American or south-east Asian economy unable to absorb all your savings domestically, you’re better off investing that liquidity in Brazil or India than in the developed world.
Hepworth, Prudential: I think everybody around the table is comfortable with the drivers of growth going forward for Mexico and Brazil, with their overall levels of debt and with their monetary policy. But it seems to me that it is fiscal policy going forward that might prevent Brazil from reaching high triple-B, or Mexico from getting upgraded again back to high triple-B or higher.
Returning to the BNDES debate, to a certain extent the role that BNDES is playing in the economy is perhaps a substitute for the fiscal reforms that ought to be taking place in Brazil on the revenue side and addressing tax distortions. So there needs to be more work done on the structural side with regard to fiscal adjustment, which will mean that BNDES doesn’t have to play this role.
Valle, Brazil: I believe as interest rates fall we will see the private sector increasing its participation in the economy because the capital market will start to function properly again, and we’re already seeing that in the housing market. The private sector of the banking industry is creating a lot of new lines to the housing sector.
EM: One notable highlight of 2009 was the growing success of long-dated issuance as the year went on. Is this not a perfect opportunity for Brazil, in particular, to term its debt out even further?
Tenegauzer, Merrill Lynch Bank of America: That’s exactly right. It’s pretty clear that if you have a view that your currency is cheap and you’re paying a coupon of 5% or 5.5%, it’s not smart not to be issuing bonds.
Diment, Aberdeen: Certainly, if I was an issuer, now would be a great time for a sovereign like Brazil or Mexico to lock in some very low long-term funding rates. I wonder why they’re not doing more debt service management.
Rodriguez, Mexico: It is very difficult to adjust a public debt management strategy based on a short-term market perspective. Clearly, it would not be wise to incorporate short-term views on currencies as a main driver of your debt policy.
You need to anchor your debt management strategy in much broader goals, which should be based on reducing your external debt. I think a source of strength for emerging markets in general coming into the crisis was the good job that has been done in terms of debt management, reducing external debt and building up long-term domestic debt. That is very different from the past, when weak structures of public debt acted as amplifiers of external shocks. In this crisis it was exactly the opposite. In Mexico we were able to alter the issuance strategy to allow for the changes in market preferences and for the reduction in risk appetite by relying more on the short end of the curve.
EM: In Mexico during the crisis you were able to benefit from the long-term work you have put into building the necessary infrastructure for a deep and sustainable local capital market. Chile perhaps has done the same. But are there concerns that markets elsewhere in the region — Brazil in particular — have not developed their domestic capital markets sufficiently to absorb the sort of external shocks we saw in 2008 and early 2009?
Diment, Aberdeen: You can still buy 10-year Brazilian bonds at yields of almost 13%, which is massive. But it is true that one of the problems in Brazil is that it does not have a strong domestic investor base, whereas in Mexico there is a very well developed local pension fund industry, which creates a natural bid for long-dated local currency assets. The local investor base in Brazil only buys short-dated bonds. So it would be interesting to ask what plans Brazil have to encourage more domestic institutional support for the market.
Valle, Brazil: In terms of liquidity, I believe that Mexico and Brazil were the best performing markets during the crisis. We also saw during the crisis how much more mature our market had become compared to 2005. We introduced spread auctions which attracted very substantial demand from local pension funds. We also implemented a number of measures to improve the liquidity of the market. We are working with our dealers to further improve transparency in the market, and we are looking at ways of developing initiatives such as the securities lending programme.
In terms of demand from local pension funds, we are also seeing a lot more support from the states’ and municipalities’ pension funds, which have assets of R50 billion [$27.76 billion]. They have traditionally been very conservative but we are now trying to encourage them to buy inflation-linked or fixed rates bonds with longer maturities.
Tenengauzer, Bank of America Merrill Lynch: On that point, though, I think the target levels that some of those pension funds in Brazil have are unsustainable. You sit down with some of them and they say their target levels are 5–5.5% plus inflation. These are incredibly ambitious levels.
Valle, Brazil: But at least those targets are coming down, which is very important. And I think it is important to stress that on the secondary market foreign investors used to account for the majority of demand for longer-term fixed rate bonds. Now local pension funds and mutual funds are playing a much bigger role in this market.
For example, we now have R36 billion [$20 billion] outstanding in the 2017s, which trade very actively every day.
Tenengauzer, Bank of America Merrill Lynch: You also recently issued some 2050 bonds, didn’t you?
Valle, Brazil: Yes. We started issuing those in February. We issued new inflation-linked benchmarks with 20, 30 and 40 year maturities in February, and we also issued a new 2021 fixed rate benchmark. And we already have R4.5 billion [$2.5 billion]outstanding in the 2021 bond.
Tenengauzer, Bank of America Merrill Lynch: My next personal crusade is going to be on the 2050s. We need to impress on pension funds in the US that they can go to Mexico and lock in a 4% real long-term yield, or go to Brazil and buy a 40-year bond with a 6.5% real yield. Those would be great trades for pension funds in the US. After all, if yields in emerging markets continue to converge towards the developed world, and if local debt markets become more liquid and more active, you have to assume that international pension funds would want to become more involved. So I would do as much as possible to increase liquidity in those bonds, because over the next few years there will be constant flows into them.
But the most important objective should be to encourage local investors to partner with foreigners. I think the moment you go into a market and see that the local investors aren’t with you, you inevitably start to suspect that something is wrong.
Hepworth, Prudential: I would agree that that needs to be a critical priority.
Shetty, Fitch Ratings: I agree that the home bias really matters. Even in the developed world, the countries that had the most jitters during the crisis were those where there was less of a home bias, leaving the markets more exposed to foreign selling.
Our view is that Mexico and Brazil have both done very well in terms of liability management. Brazil’s debt burden is almost twice that of Mexico, but less than 20% of the debt is in foreign currency while less than 10% of Mexico’s debt is in foreign currency. So the steady development of local markets is clearly very positive.
When we look at a country’s domestic debt, one of the things we look at is its average maturity and at the share of fixed rate debt in the total portfolio. We think that one thing Brazil could do is reduce the share of its debt linked to floating rates.
We also think that in the case of Brazil there are some structural issues in that the participation of overseas investors in some of the longer-dated bonds is very high. In some cases more than 50% is held by foreigners.
The other question I have is on the subject of inflow tax: what sort of signal does this give to people in terms of Brazil developing the long end of its bond market?
Tenengauzer, Bank of America Merrill Lynch: One of the things about the IOF [Financial Operations Tax] is that there is so much support for it. It’s a policy option that I am encouraging the Indians to think about because I think the QFII [Qualified Foreign Institutional Investor]system is unsustainable and ridiculous. The same is true for China.
EM: How much of a surprise was the introduction of the IOF last October, and how have foreign investors dealt with the new tax regime?
Hepworth, Prudential: Of course it’s something you’d prefer not to have, but in the case of Brazil you are compensated by incredibly attractive yields. We also have a relatively constructive view on the currency, so the way we’ve handled it is by changing our view along the curve in Brazil, to reflect varying views of what’s going to happen with interest rate policy and so on. But because the market is too attractive to ignore, we have been willing to pay the tax.
Diment, Aberdeen: It was a surprise that they introduced the tax on both debt and equity. As far as we are concerned, you have to pay the tax when you move money into Brazil for the first time, so our view is that once we move money onshore in the market, we will try to keep it there. In other words, if we want to move out of the bond market, we will sell the bonds, move into cash and keep the cash onshore, hedging out our risk using currency forwards.
Tenengauzer, Bank of America Merrill Lynch: Just to put the tax into perspective, let’s say that the 2050s which are now yielding 6.5% converge with Mexico. That would mean a convergence of about 200bp. With that duration, the kind of return you’re earning on that is so good that the 150bp you pay in the tax is nothing.
Going back to the macroeconomic discussion, there is no reason why real yields across the world should not trade very close to each other – perhaps with a 30bp to 50bp differential. But differences of 100bp or 200bp make little sense. Why? Because you can always print money to pay your debt. So at some point we would expect to see real yields compress massively. We’ve already seen that happening. Look at Turkey, which issued linkers at real yields of 10% or 11%. They are now at 3.5%.
Rodriguez, Mexico: As you mention linkers, why do you think foreigners have not got more involved in inflation-linked securities?
Tenengauzer, Bank of America Merrill Lynch: It may have more to do with ignorance about the market than anything else. Of course it is our job to educate investors, but it will take time to explain that these securities are the same as TIPS [Treasury Inflation Protected Securities].
Rodriguez, Mexico: Maybe then they don’t understand how TIPS work?
Tenengauzer, Bank of America Merrill Lynch: Exactly. During the crisis even TIPS suffered from a big loss of liquidity. So there is a lot of ignorance out there about how they work.
EM: Have sovereign borrowers from the region encountered that ignorance when they’ve been marketing inflation-linked bonds overseas?
Rodriguez, Mexico: Yes. This is why I asked the question. Inflation-linked securities have a very long history in Mexico – probably a longer history than in any other emerging economy.
But everywhere liquidity is a lot lower in inflation-linked securities than it is in nominal bonds. In this respect we have seen a similar picture in Mexico as in developed economies. But the level of participation by foreigners is 25% in the nominal yield curve and yet it’s only about 4% in the inflation-linked market. We have seen, however, that following the crisis and as a result of the outlook for inflation, a lot more people are starting to ask questions about the market and want to get involved.
We’re starting an interesting exercise next week, which is to issue a local inflation indexed-bond through a syndication for the first time ever. That will give us an extended marketing period allowing the banks to explain better to their clients how these instruments work. So it will be interesting to see what the distribution of this issue is, because I agree with Daniel that the potential for this market is very exciting. Absolute yields have not come down as aggressively as some of the nominal yields, so there is a lot of value in the market over the medium term, and it may be an interesting new asset class for some investors who haven’t looked at it before.
Hepworth, Prudential: I agree. And I think we may see strategic rather than just tactical allocations to local markets increase. That’s a medium-term instrument, and as we see more investors committing themselves to the local market for the long haul rather than as a tactical play, we may see more demand for these bonds.
Rodriguez, Mexico: We need to continue to concentrate on the smaller details that will help to improve liquidity. And we need to close the gap in terms of liquidity between the nominal and the real curves if we want to get new players involved, because even if we see more strategic allocations in which liquidity is not as important, at the end of the day when investors go to emerging markets they always think, what if I need to exit? So we need to make sure markets can continue to operate efficiently under stressful scenarios, and we believe that in the case of Mexico we have been able to achieve that to some extent in the nominal market.
Tenengauzer, Bank of America Merrill Lynch: There is a massive difference between the way investors see Brazil and Mexico in that Brazil has these amazing yields and it’s a great transition story. But the problem is access. Mexico has a deliverable currency. Mexico is a market where you can buy a bond and basically hold it in your bank account in the US. But Brazilian bonds aren’t Euroclearable, which is a problem we hear about over and over again. That’s something that could come back to bite Brazil.
Valle, Brazil: We have a group named BEST – Brazilian Excellence in Securities Transactions – that is working among other things on simplifying access to the domestic market for foreign investors. As for Euroclear, we have some concerms because we think we might lose some information about the holders of our bonds. However, there have been a number of agreements between local and international clearing systems. So moving towards an international clearing system is a natural result of the globalization process.
Rodriguez, Mexico: I think the integration of financial markets is only going to get stronger in the future, even though the various regulatory initiatives taken in response to the crisis may slow the process down. But ultimately we will continue moving towards convergence. So to the extent that you can present yourself as an investable market using international infrastructure, that must make a contribution in terms of lowering your overall financing costs. As a debt manager that has to be your ultimate objective.
EM: Another option that Latin American borrowers may want to explore in terms of diversifying their investor base is issuance in alternative currencies. We’ve seen some very healthy use of the euro market by corporates recently, notably by borrowers like Pemex, which issued a very successful E1 billion Pemex 10-year bond last year. Is the government looking at the potential of the euro market?
Rodriguez, Mexico: We believe the euro market in general has been a disappointment. It sounded like a very promising alternative to the dollar market 10 years ago, but it has not lived up to expectations. Although it is a good source of liquidity for European sovereigns and for corporates, for emerging market sovereign borrowers it has been illiquid and fragmented. We are looking at opportunities in the market, but it is not clear how well euros would be able to compete in terms of cost with the dollar market.