In a recent report, Fitch forecast that total financing needs across Latin America will amount to $398.5 billion in 2011, or 8% of regional GDP, which is a decline of about 9% compared to 2010. Fitch expects only about $15.7 billion of this total to be covered by international bond issuance, down from $20.6 billion in 2010. “This decreased reliance on foreign lending and external issuance reduces vulnerabilities stemming from external market volatility, financial shocks and foreign exchange risks, while contributing to an improving debt structure.”
Reduced funding requirements are dovetailing neatly with demonstrable improvements in economic fundamentals and credit quality throughout the region. In 2010, Moody’s upgraded no fewer than 10 Latin American sovereigns, with another three ending the year with a positive outlook, which as the agency says, suggests further potential rating improvements this year.
The picture is not, of course, universally bright. Concerns about inflation are rising in some of the region’s economies, all of which inevitably also remain vulnerable to volatile commodity prices. They are also exposed to any slowdown in the US economic recovery as well as to risk aversion arising from external events such as the European debt crisis and turmoil in the Middle East and North Africa.
Nevertheless, with economic growth projected to remain robust in the region, Latin America’s leading sovereign borrowers can expect to attract continued solid support from international investors. On Friday, a number of these gathered at the Emerging Markets roundtable to exchange their views on the prospects for the region at a macroeconomic level and to discuss their funding requirements and borrowing strategies for the year ahead.
Participants in the HSBC-sponsored roundtable were:
German Arce, Director General of Public Credit and National Treasury, Ministry of Finance and Public Credit, Republic of Colombia
Katia Bouazza, Head of Global Capital Markets, Latin America, HSBC Securities (USA) Inc, New York
Adrian Cosentino, Undersecretary of Finance, Ministry of Economy and Public Finances, Republic of Argentina
Alejandro Díaz de León Carillo, Deputy Undersecretary for Public Credit, United Mexican States
Paulo Valle, National Treasury Deputy Secretary and Head of Debt Management Office, Republic of Brazil (participated separately by telephone)
Moderator: Phil Moore, Roundtable Editor, Emerging Markets
EM: Across the entire region, sovereign funding requirements are falling and reliance on external borrowing is declining. Can we start by discussing the main macroeconomic and structural drivers of this reduction?
Díaz de León, Mexico: Clearly, Mexico has aimed to follow a consistent macroeconomic strategy over the last 10 to 15 years, which has involved maintaining a low and manageable level of debt and a sound monetary policy.
Some of the steps we’ve taken in that direction have already started to pay off. Following the crisis of 2008 and 2009, debt management became part of the solution and not part of the problem for the first time ever in Mexico. We had a severe contraction of GDP in 2008 and 2009, accompanied by a sharp downturn in revenues, and the lesson learned from the crisis is that it is essential to have as many financing alternatives available as possible.
In the early 2000s, Mexico relied heavily on domestic markets, but in recent years the relevance of external funding has increased as a complementary vehicle to domestic financing. This year, for example, of the total financing needs of the Mexican economy, P375 billion ($31.3 billion) is the ceiling for domestic financing, while the maximum for external financing is $5 billion. Today 80% of the government’s stock of debt is in the domestic market with 20% in external markets, which highlights the complementary role played by international markets. I think it has been very healthy for the economy that the domestic market has been able to bear a significant share of the financing needs of the country. It has also been able to do so with a longer average duration in nominal terms than before, when liabilities were linked to exchange rates or short-term interest rates.
Valle, Brazil: It is correct that Brazil’s funding needs have come down, in part because the maturity of the debt has been lengthened, with the stock of short-term debt dramatically reduced over the last 10 years. We finished last year with just 23.9% of the debt maturing in the next 12 months, which is slightly below the 24% which was the lower end of the 24-28% limit we set out in our annual borrowing plan for 2010. To put that into perspective, in 2004 our short-term debt was 39.3% of the total, and in 2002 it was above 40%. 2002 was an exceptional year marked by very high volatility around the time of the election of President Lula.
Since then the volatility has come down and the fundamentals of the Brazilian economy have greatly improved. Our external account has improved considerably, we have kept inflation under control, and we have reduced our net debt to GDP to 40.4% at the end of 2010, compared with around 60% in 2002. We expect this to continue falling to 30.9% by 2013.
Arce, Colombia: One of the main assets enjoyed by the new Colombian administration is the good track record delivered by stable macroeconomic policies during the last eight years.
Today, growth is the principal objective of our strategy. Since the new administration took office, the main emphasis has been on how we can ensure that Colombia can reach its long-term growth potential. The target has been to eliminate all the frictional factors that may prevent Colombia from growing at an annual rate of 6%-plus over the
next decade.
We know that we are going to enjoy a very rich decade in terms of oil and mining. This was an expectation before, but it’s now becoming a reality, and we need to assess how we are going to spend the earnings generated from this bonanza over the next decade in areas such as innovation and education, as well as manufacturing.
We have identified a number of sectors, which we believe are going to be the engines of growth over the long term, because we know this bonanza won’t last forever. For example, we have a shortage of infrastructure compared with some of our peers. That could be seen as a problem. But we see it as an opportunity for growth. There are plenty of private as well as public sector resources that could be invested over the next couple of years and we are trying to make sure that all the frictional regulatory and tax disincentives to this investment are lifted.
We see the agricultural sector as another opportunity, given that Colombia’s long internal conflict prevented growth in that area. Security is an asset nowadays in Colombia, and investors can travel all over the country. So a very clear agenda for the agricultural sector is going to be a priority over the next decade.
In terms of how the macroeconomic story is related to our debt strategy, over the last decade Colombia has managed to move away from a high dependence on international borrowing. The distribution of the debt portfolio is now about 71% in the domestic market and 29% in foreign markets. Looking ahead, I would say that the share of international borrowing will carry on falling. For example, in 2011 the target for all external debt is $3.7 billion, of which $1.5 billion will be from multilaterals, leaving a market requirement of $2.2 billion.
Looking ahead, we want to maintain our commitments in terms of our benchmarks both in US dollars and in local currency. But we believe local-currency financing will continue to be able to cover a large share of our needs.
EM: From a macro and a funding perspective, presumably Argentina has a slightly different story to tell?
Cosentino, Argentina: It’s important to define the starting point for our recent economic story. After the collapse of the currency board system and the consequent default in 2001, Argentina started a new macroeconomic programme, the highlights of which have been to consolidate a sustained annual average growth rate of 8%, with current account and fiscal surpluses. This is the first time in our macroeconomic history that the Republic has been able to consolidate a significant growth cycle while maintaining these twin surpluses. In that sense, fiscal solvency is a key component of our macroeconomic dynamics.
These dynamics have generated very important effects in terms of the evolution, composition and sustainability of our sovereign debt. In 2002, our debt to GDP ratio was around 160%. Now it is 45%. Another indicator that puts this phenomenon in perspective is that when this programme started the external debt was 125% of GDP, now it is 18%. In 2002, net debt represented 155% of GDP, and now it’s 23% .
The sovereign debt performance is the natural consequence of a very healthy economic policy. Today, almost 50% of the total sovereign debt is held by public sector agencies, which is in line with the government’s belief that internal funding sources – fiscal capacity and local institutional investors – play a key role in consolidating a sustainable development process. This helps to prevent the volatility that arises when the economy depends very heavily on short-term inflows, which tend to be the negative counterpart of current account deficits. This is why one of our main priorities has been to protect the economy from these very short-term financial flows, which by definition are very volatile and unpredictable.
In terms of its composition, today our debt has an average maturity of 11 years, and only 25% of our total debt matures in the next three years, 37% of which is held by public sector agencies, which gives us a healthy margin in terms of
refinancing risk.
So it is clear to us that you can consolidate a healthy financial strategy when you have a strong macroeconomic scenario, and this is a big difference to what the Republic suffered during the 1990s. Then, the inconsistency of monetary, fiscal and exchange rate policies generated a current account deficit and a high dependence on short-term inflows, and everybody knows the consequences of those macroeconomic dynamics.
EM: Has the crisis in North Africa had an impact on the strategy of regional borrowers in the first quarter of 2011?
Valle, Brazil: No. We believe the performance of our bonds has continued to be strong and stable in recent months, so we don’t think there has been any impact from the crisis in North Africa.
EM: Does this mean there has been a decoupling of Latin America from the broader emerging markets story?
Bouazza, HSBC: If you consider the deal that was done today for Odebrecht of Brazil, with a book north of $3 billion for a $500 million issue, on the surface it looks as though there has been a complete decoupling.
But I would caution that Latin America has not decoupled from the global economic story. We all need to keep an eye on what’s happening to the oil price, because if that goes significantly above the $130 level it will start to affect the global
recovery.
But in terms of the decoupling, Mexico is a very good example of a borrower that issued a highly successful, oversubscribed transaction at a very attractive price in the midst of the crisis in Egypt. We ended up pricing that deal the day after Mubarak resigned, which turned out to coincide with the start of a sharp rally.
Arce, Colombia: I agree with Katia that we need to keep a close eye on the global economy. But I also think that every country in the region has a different story to tell. In the case of Colombia we have so much catching up to do that there are a number of sectors that provide exciting investment opportunities and will help us to rely more on internal demand and internal capacity.
Cosentino, Argentina: What is happening in Europe and the Middle East gives markets in Latin America an opportunity to emphasize the strength of their credit profiles and their medium- and longer-term payment capacity. In a world where it is becoming more complicated to assess sovereign credits, the Latin American region can differentiate itself through offering a strong institutional and macroeconomic environment.
Obviously Argentina is in a particular situation as we are still completing an important sovereign debt normalization process. But we’ve been out of the international market for such a long time, which has meant that we have had to develop internal funding sources as the main component of our financing strategy. We feel comfortable with this strategy because it’s part of the process of building a more sustainable sovereign financing structure.
EM: What sort of questions are investors asking you now? Are they concerned about inflation and about official data on inflation?
Cosentino, Argentina: I think investors are very interested in the question of when Argentina may return to the international market. But the financial strategy that the Republic has consolidated over the last three years has been based on developing the local investor base and establishing the different public sector players as key institutional investors.
Another interesting lesson that Argentina has learned in recent years is the value of developing your own buffers in order to deal efficiently with market volatility. You can build those buffers when you have fiscal solvency, when you’re borrowing in a balanced way and when you have an external sector that provides you with the hard currency you need in order to maintain a consistent programme. These are the basic rules from our point of view that you have to follow in order to be attractive to long-term investors.
EM: This process is about 90% complete, isn’t it?
Cosentino, Argentina: Yes. 92% of the bond debt defaulted in 2001 has now been restructured.
EM: Paulo, what would you say is the outlook for the Brazilian economy this year? Moody’s commented recently that a key challenge will be to manage “an orderly transition towards lower, more sustained, economic growth.” Do you have any concerns about overheating in Brazil?
Valle, Brazil: No. The government has taken a number of measures to ensure that inflation is kept under control and to reduce the availability of credit in the economy. A new monetary cycle has started, with interest rates now at 11.75%, so we believe the Central Bank will be successful in keeping inflation in check. We also believe Brazil will continue to see a good level of growth around its potential of 4.5%.
EM: Returning to Katia’s point about the region’s links with the global economy, presumably for Mexico the key external influence remains the performance of the US economy?
Díaz de León, Mexico: In contrast with some other Latin American economies the most important element in our external account is industrial production, and our exports are mainly in manufacturing. That explains why Mexico is at a very different point in the business cycle to other Latin American countries. Another difference is that we’re clearly not facing inflationary pressures at the moment.
We experienced the most severe downturn in the region during the crisis and we are also now experiencing a very fast recovery, which is expected to be sustained for several years. But as you say, for us the recovery of the US is crucial, in particular for industrial production. The industrial sector in the US is recovering vigorously, which is very important as far as continued economic recovery in Mexico is concerned.
Nevertheless, internal drivers of growth are also becoming stronger. We are seeing a recovery in consumption and in investment. I would also highlight that a healthy financial system has been very important for us. In contrast with many other countries, commercial banks in Mexico have maintained very high capital ratios and the deterioration of their asset quality during the crisis was very modest. That is allowing the banking system to play a significant role in promoting credit to households and corporations, which in turn has enabled domestic demand to be more resilient.
Coming back to the discussion about infrastructure, I agree that this is an area where Mexico, like other countries in the region, has lagged significantly. But I also agree that it is an area of opportunity for the region as a whole. We have put in place a very aggressive and ambitious programme for infrastructure investment and we are introducing a number of different channels for financing infrastructure with the participation of the private sector.
Arce, Colombia: In Colombia, we had an emergency situation at the end of the year because of the floods, and one of the questions we are asked is how we are going to manage this sort of emergency going forward. Our argument is that you can either respond with temporary measures, or you can think about what you need to do over the long term to improve the infrastructure of the country and therefore to ensure that you don’t have the same discussion again the following year. Our conclusion is that we need to invest in infrastructure not only to fill the gaps but also because we need to start preparing the country for the impact that climate change may have over the much longer term. This is why we have set up the Adaptation Fund, which is our main tool for ensuring our infrastructure is able to meet the challenges of climate change. Roads, tunnels and ports all need to be adapted so they can deal with some of the natural disasters that we have seen all over the world recently. We see this fund as a public down-payment for a longer-term public-private partnership.
Valle, Brazil: Yes, but investment won’t only be driven by the World Cup and the Olympics. The government announced a few years ago that accelerated growth will call for heavy investment in infrastructure, so the intention is to ensure that private-sector participation grows in line with public-sector investment. We believe that in the next few years we will see an increase in investment from the current rate of 19% to 25% of GDP, with 20% coming from the private sector and just 5% from the public sector, which is in line with the government’s target. There is a very good pipeline of investment projects coming through.
Cosentino, Argentina: We also believe that it is strategically important to promote the infrastructure sector. We think a good way of supporting this sector is by promoting the project-finance market because there are many international players who are prepared to participate in this kind of alternative investment opportunity. The public sector can play a key role in this process through public-private partnerships and by encouraging support from local as well as international institutional investors.
In recent years these public-private partnerships have represented around 4% of GDP, which is a huge amount. Most Latin American countries now recognize the importance of supporting this kind of PPP policy. Argentina is really committed to this strategic concept.
Bouazza, HSBC: It is very important that we move the infrastructure discussion on from where it was a few years ago when it was a much smaller part of every country’s needs. Today, it is not just the large countries represented around this table that have significant infrastructure needs. So too do the smaller countries in the region. Whether you’re looking at roads, ports, airports, onshore or offshore drilling, the infrastructure requirement is significant.
In future, the historic methods of funding this requirement cheaply through the public sector via institutions such as BNDES will not be viable on their own. The bank market is now coming back as a means of funding these projects. But it is the broader fixed-income capital market that is going to provide the deepest pockets and act as the natural market for the sort of volumes we’re
talking about.
I think we’re going to need to call upon all three of these sources to support the projects that will need to be funded in the future. We were involved in helping to arrange the first $1 billion-plus project bond in the region, for Odebrecht in Brazil last year, and I would say that the pipeline is building up quite nicely for similar bond financings.
So far, it has been limited to countries like Brazil with large needs in terms of having to complete a large number of projects in a very short period of time. That mentality has to spread to other countries and as the bidders and sponsors start to come in, everybody needs to appreciate the role that capital markets can play and not just rely on traditional sources.
Cosentino, Argentina: I agree. It is up to policymakers to transform these infrastructure requirements into attractive investment opportunities by encouraging the development of a deep project finance market. In our case we’ve been working very hard with the main local institutional investors, fundamentally public sector players, which are important supporters of this kind of initiative. But we have also been encouraging the support of other institutional investors such as insurance companies and mutual funds. We also believe more and more international investors are paying attention to this kind of opportunity.
EM: Even more fundamental than infrastructure, housing is very important from a socioeconomic perspective. What are countries in the region doing to address the issue of their housing deficits?
Arce, Colombia: You’re right to identify housing as a key challenge. We had a crisis at the end of the 1990s that originated in the housing market and we don’t want to repeat the mistakes that created those difficulties. The current housing law was enacted in 1999 in response to the crisis, and has helped to create vehicles and instruments to finance a large part of what is needed in the
housing sector.
Developing a more vibrant housing market creates an important multiplier effect. It generates employment, it generates investment, and it generates a very positive momentum. This is why in the case of Colombia, supporting the housing market is one of the pillars of our economic strategy. We have a housing deficit of around one million units that needs to be addressed over the next four years. Much of that can be addressed using public resources, but we also need the private-sector financial system to support the programme. Fortunately, today we have a financial sector that is stronger and has greater capacity than in the past, which helps to create the mix of public- and private-sector investment that we need to tackle the housing shortage.
Díaz de León, Mexico: The housing market is one area where macroeconomic stability has clearly helped to make a difference in terms of social welfare. The development of the housing market goes in tandem with macroeconomic stability in the sense that if you can sustain a vibrant and liquid long-term local-currency debt market it will make it easier for people to access mortgages.
In Mexico we have both the public institutions, Infonavit and Fovissste, which are the largest providers of mortgage credit. But the private sector also has a significant share, both in the commercial banking sector and among savings and loans companies. Today, everybody in Mexico knows that fixed-rate 20- and even 30-year peso mortgage loans are widely available, which was completely impossible 10 years ago. A record number of mortgages have been granted over the last five years, but I believe that this will remain a dynamic sector for the years ahead. The good news is that this market has been developed on a very sound basis without some of the risks that were in place in the early 1990s.
EM: Fundamental to this has been the development of a liquid long-term market for domestic debt. Is Colombia developing something similar?
Arce, Colombia: After the crisis in the 1990s there was a lot of market risk in the mortgage market. We have now moved to a model that is closer to the one developed by Chile, which is an inflation-linked type of product extending to 15 and 20 years. Obviously, having a deep longer-term market both in fixed rate and inflation-linked has been very supportive for the pricing of mortgages.
EM: What are Brazil’s plans for the inflation-linked market, which is such an important source of long-dated funding?
Valle, Brazil: We have a very well developed yield curve in the inflation-linked market in Brazil. In total, inflation-linked and fixed-rate securities reached a historic peak of 63.3% of our total federal public debt at the end of 2010, compared with about 10% in 2002, which has helped to reduce the overall volatility in the market. One of our objectives going forward will be to continue with our programme of gradually replacing floating rate securities with fixed-rate and inflation-linked instruments.
Once a month we issue bonds with 20, 30 and 40 years in the inflation-linked market, where we also have very good levels of participation by foreign investors. Our intention is to maintain this strategy of issuing bonds with tenors out to 2050 once a month, and to continue to stimulate liquidity in this sector.
EM: Let’s move on to discussing the individual sovereigns’ funding strategies in more detail. What will Brazil’s funding requirement and financing strategy be for the rest of 2011?
Valle, Brazil: In 2011, our net borrowing requirement is R$365 billion. But of this total, the external debt is only R$12.8 billion, while the domestic debt held by the public is R$410 billion and interest due to the Central Bank is R$41.4 billion. If you subtract from this the budgetary resources that were allocated exclusively to pay public debt, at around R$98.7 billion, you reach a final requirement of R$365.6 billion.
It’s important to highlight that nowadays the composition of the debt has improved and we finished 2010 with only 5.1% of the debt in foreign currency. Our external needs are very low, and besides extending the maturity we have had a strategy of pre-financing our external debt. In fact, we have already pre-financed 75% of our external debt for the next two years. So in terms of our external debt we are in a very comfortable position.
This is why we have announced that we intend to continue accessing external debt markets but only with the intention of enhancing the efficiency of our liability management. Our intention is to take advantage of windows of opportunity in order to improve the liquidity of our bonds in the external market.
EM: How is Colombia’s strategy evolving?
Arce, Colombia: Making the transition to investment grade is clearly a milestone for us. But we recognize that if we are going to be an investment-grade borrower we must also behave like one. This implies that we need to take long-term views on some of the policies we’re implementing. For example, a proposal we have made to the National Development Plan is to commit the government to following a more medium-term portfolio approach rather than just rolling over our maturities every year. We need to develop the necessary instruments to manage our debt portfolio more efficiently, and we’re working on the legal and regulatory framework to ensure the government has the instruments to take a more long-term, risk-based approach to debt management.
EM: Katia, how have investors been responding to the clear improvement in the credit profiles of sovereign borrowers in the region?
Bouazza, HSBC: We’ve definitely seen an improvement across the board, helped by the prudent measures that have been described by the borrowers around the table, and by the commodities bonanza mentioned by German.
To give you an anecdotal example of the strength of investor demand, when we arranged the first investment grade deal for Brazil, which was a $500 million transaction, within 15 minutes of opening the book it was massively oversubscribed. This even created a problem because one of the first orders that came in was for $500 million, which would have covered the entire issue.
In terms of how investors see the region, there is now definitely a scarcity value associated with dollar issuance from the sovereigns. That means that issuers with the right strategy can have a lot more influence in terms of tightening their pricing. But at the same time they are aware that they need to leave something on the table to ensure that their bonds perform. They know that they need to respond to market demand in terms of size and maturity.
If they do so, it will be remembered by investors, which is important because these sovereigns remain regular borrowers. Whether or not they need the funding, they maintain active curves and they have an interest in ensuring that they trade well. These also serve as benchmarks for quasi-sovereign as well as corporate issuers, which are priced off the sovereign curves. So it is important for them to maintain a commitment to their global investor base, which in dollars spans beyond one region, extending to Asia, Europe and Latin America as well as the US.
Having said that, the local currency story is also a very exciting one for international investors. They are very active in all the local markets that offer size and access, and many Asian investors may be even more focused on local markets than on international markets.
EM: Brazil bought back the equivalent of $4.3 billion in face value of debt in 2010. Do you have a target for 2011?
Valle, Brazil: We don’t have a target, but we intend to continue the buyback programme. In fact we have already bought back more than $1 billion.
Our buyback programme is part of our broader intention of building a new yield curve for Brazil in the external market. Our intention is to buy back old, illiquid, high-coupon bonds. In the last few years we have been replacing these by issuing new bonds with 10- and 30-year maturities with coupons below 6%. Going forward our intention is to build a yield curve with fewer bonds, and a fewer range of maturities but with more liquidity.
EM: How do you plan to set about further enhancing liquidity in your bonds?
Valle, Brazil: Our intention is to guarantee additional liquidity by having a minimum outstanding size for our bonds. We consider $1.5 billion to be the minimum, required to ensure good liquidity in the secondary market. But in fact in the last few years we have aimed for a minimum outstanding in our main benchmarks of between $2 billion and $3 billion.
EM: Katia mentioned scarcity value. Is there a risk that scarcity value can become a liquidity problem?
Arce, Colombia: In the case of Colombia we are very aware that we can’t disregard our commitment to the market. As your economic story strengthens, your borrowing needs diminish, which means that when we draw up our plan for the year we have to be aware of the needs of the investor community when we tap our benchmarks.
It becomes a more balanced discussion, because on the one hand you need to finance the economy, but on the other you can make more strategic funding decisions when you’re not under any pressure to go to the market. That means you can be more selective, but in our case we still need to remember that 29% of our stock of debt is in foreign investors’ hands.
EM: For Brazil, was the pursuit of liquidity the main driver of your highlight deals of 2010, which included the reopening of your Global 2021 and 2041 benchmarks?
Valle, Brazil: Yes. We issued the new Global 2021 in April and reopened it in July at 4.55%, which was the lowest cost ever achieved for a US dollar-denominated Brazilian bond. The reopening of the Global 2041 in September, at 5.2%, was also at a record low level for a 30-year US dollar benchmark from a Brazilian issuer.
Today our 2021 benchmark has $1.6 billion outstanding, so it will make sense to retap that bond and bring it to over $2 billion. And our 30-year 2041 benchmark is now $1.8 billion so it also makes sense for us to retap this issue. But because we are under no pressure to raise funding in the external market we can afford to wait until conditions are right in the international market. When we tap these bonds we intend to do so with a minimum of $500 million.
EM: How has Mexico used its improved credit profile to lengthen maturities, as it did with its 100-year bond, and to explore alternative sources of funding, as it has done in the Samurai market, for example? Is it the case that you have been able to manage your liabilities much more effectively in terms of maturities and currencies?
Díaz de León, Mexico: I think that’s right. In the domestic market we try to ensure that our auctions remain as stable and predictable as possible and give as much guidance as we can to investors about relative value.
On the external side, we have the advantage of still having a significant stock of about $39 billion of debt outstanding even though our needs are low. That allows us to do two things. First, it allows us to ensure that we maintain a liquid yield curve in the dollar market, and to deliver sizeable new benchmarks with a minimum of $3 billion every once in a while, which delivers the liquidity that bondholders appreciate.
Also, as you mentioned the 100-year bond, given that we don’t have a significant financing burden on the external side we can assess market conditions and tap markets when windows of opportunity appear. In September and October last year there was a very good opportunity to issue those types of instruments. Given the volatility we’re now seeing it may be a while before those opportunities come round again, perhaps allowing us to tap our 100-year bond.
Since we issued our 10-year bond in February, for example, there has been a new flight to quality in response to the crisis in North Africa, so circumstances clearly change. The way we have to approach our strategy is to concentrate on our key benchmarks and respond to specific opportunities.
EM: Will Brazil also be looking at the potential for issuing ultra-long bonds, as Mexico has?
Valle, Brazil: Not for the moment, because as I mentioned before our intention is to encourage more liquidity in our existing bonds, so we would prefer to tap our 30-year benchmark than to issue a new very long-dated bond or create new maturities.
EM: Internationally, is it fair to say that Latin American sovereign borrowers’ natural investor base is the US? If so, is this becoming a more crowded market now that so many European SSA borrowers are looking to harness the potential of US real money accounts?
Díaz de León, Mexico: By and large, it is true that the US is our main investor base. But at the margin many other investors are increasing their allocation towards this region. It was notable that in our last placement in February we saw strong demand from Latin American investors, which has not historically been the case. We are seeing more and more interest from pension funds from countries like Chile and Colombia, which are looking to diversify their portfolios and are investing more aggressively abroad.
As Katia said, in Asia there is also a growing number of investors that are developing a larger presence in this region, not only in our international issuance but also on the domestic side. In the case of Mexico the introduction of our bonds into global bond indices that allow our peso securities to be held by a well diversified pool of investors from all over the world has been very important.
Going back to what we were saying about decoupling, I don’t think you can avoid decoupling entirely in global markets, but you can avoid contagion. By contagion, I mean the bunching together of countries that are supposed to have similar characteristics even though they have sharp differences. These days although I don’t think Latin America is decoupling, I do believe that contagion risk is significantly lower.
Because the investor community is now more diverse, we need to put more resources into explaining the fundamentals of our economic story to a much wider investor base. The US is still very important, of course, but so too are the investor communities in Asia, Europe and now in Latin America.
EM: Is this reflected in your roadshows? Are you adding places like Lima and Bogota to your roadshows?
Díaz de León, Mexico: That is going to be the case.
Arce, Colombia: In the case of Colombia this is something we are already seeing. We are seeing more demand from Brazil, Chile and Mexico, for example. That is a natural development, because it is easier for a Colombian or Mexican investor to understand what’s going on in the region than it may be for a European or Asian investor.
I agree that there is now more competition in the US dollar market. But I don’t think that is making access to the market more difficult. For us, investor diversification remains key, not so much for the effect it has on pricing. In Colombia, for example, the market has already priced in our transition to being investment grade. When we look at the opportunities that lie ahead, it is more about being able to go to Asia and to build longer-term relations with investors there. And regardless of short-term political issues, the Middle East will also be an increasingly important source of investor diversification for us in the future.
Another point worth making about regional demand is the initiative that has been made towards integrating stock exchanges in Latin America. Of course, that is an equity rather than a debt story, but it is helping to strengthen investors’ focus on the region.
EM: Katia, from a banker’s perspective what is the main motive for investors in Latin America to diversify across the region?
Bouazza, HSBC: There is ample liquidity throughout the region. We’ve reached the stage where there is interest from emerging market buyers, from high-grade funds, from regional investors and from private banks. In the past private banks could only buy up to a certain maturity – some were limited to three years, some to five years. We’re now seeing them coming into 30-year deals. This rising demand is certainly helping issuers to tighten their pricing over time.
The liquidity we’re now seeing is unprecedented because it is also less narrow in its outlook than it used to be. There is demand across the board, as we have seen from the strength of demand for issues like the recent $6 billion Petrobras deal and the $1 billion Cemex issue. High-grade investors are coming into these deals. In the case of Petrobras, the largest ticket was for $1 billion, while in the deal we did last year for Chile the largest order came from a London-based investor. So we’re seeing interest from across a very broad spectrum.
EM: Will Brazil’s focus purely be on US dollars or are you also looking at alternatives such as euros?
Valle, Brazil: We announced at the start of the year that our focus would be on building our dollar yield curve and also on extending our Brazilian real global yield curve. We now have three Brazilian real bonds in the offshore market in the 2016, 2022 and 2028. We reopened the Global 2028 bond in October, which brought our total outstanding issuance in Global BRL to $7.4 billion equivalent at the end of 2010.
Our intention is to create a new 10-year benchmark in the Global BRL market. But again, this will depend entirely on market conditions because as I said before, we don’t need to raise money. The intention is to stimulate liquidity.
EM: Where is the investor base for your offshore real deals?
Valle, Brazil: Mainly in the US, but we also have good demand among Latin American investors and in Europe. We have seen some participation from London-based accounts.
EM: Has the IOF [the tax on foreign investment in fixed income securities] had any meaningful impact on international demand for your issuance in Brazilian real?
Valle, Brazil: The intention of the Brazilian government was to reduce short-term inflows and the measure has proved to be very efficient. Since October, when the IOF was increased from 2% to 6%, short-term investment has declined but we have seen no evidence of a decline in overall demand from overseas investors. In fact, demand from long-term investors has continued to increase gradually since October. In January 2011, around 12% of our total debt was held by foreign investors.
EM: Do you have any target for total foreign participation in the market for Brazilian debt, and are there any geographical regions where you are aiming to encourage more participation?
Valle, Brazil: We believe the participation of long-term investors is important and one of our priorities for 2011 is to continue to broaden and diversify our investor base, but we don’t have any specific target.
Over the last year, we have successfully reached out to new investors, mainly in Asia and Latin America. But we still believe we have room to increase the participation of some of the more conservative, long-term investors from Europe and the US. This would include sovereign wealth funds, insurance companies and pension funds.
EM: Is it too early for Argentina to be talking about a similar broadening of its investor base?
Cosentino, Argentina: In our specific case, as we have been out of the market for a long time, we haven’t had the same sort of contacts with international investors that the other borrowers around the table have had.
Bouazza, HSBC: But there is demand out there. Investors are always asking when Argentina is going to return to the market.
EM: What’s the answer?
Cosentino, Argentina: This is a long process, but we believe we are taking the right steps in running the necessary policies to continue consolidating a sustainable sovereign funding strategy.