As risk appetite among global fixed income investors returned in the early months of 2012, new issuance from sovereign borrowers in Latin America exploded. According to data published by EuroWeek, in the first six weeks of the year alone, Latin America accounted for 43% of all emerging market debt issuance, with 35 deals issued across a wide range of credits. Many of these transactions were heavily oversubscribed, and several were priced at impressively modest new issue premiums.
Investors’ enthusiasm certainly seems to be warranted by the region’s economic fundamentals, with the IMF forecasting output growth in Latin America and the Caribbean of 3.6% and 3.9% in 2012 and 2013 respectively, compared with a tepid 1.2% and 1.9% for so-called ‘advanced economies’.
The strength of demand has also been supported by Latin America’s improving debt metrics. In sharp contrast to Europe, debt levels across Latin America are low and falling, reducing borrowers’ financing requirements. According to Moody’s, reduced fiscal deficits have helped to decrease average financing needs across the region from 9.2% of GDP in 2009 to 5.8% in 2011.
The region does, however, face a number of challenges. The recent news of China’s biggest trade deficit for 22 years, for example, may have unnerved some investors concerned about the perceived dependence of the region on commodity exports.
In spite of vulnerabilities such as this, the consensus is that the outlook for Latin America remains positive. Against this backdrop, representatives from a number of sovereign borrowers gathered at the Emerging Markets IADB roundtable to discuss the prospects for Latin American economies and capital markets.
Participants in the HSBC-sponsored roundtable that took place in Montevideo on Saturday, March 17, 2012, were:
Azucena Arbeleche, Director, Debt Management Unit, Ministry of Finance, Republic of Uruguay
Katia Bouazza, Co-Head of Global Capital Markets, Latin America, HSBC Securities (USA) Inc, New York
Alejandro Díaz de León Carrillo, Deputy Undersecretary for Public Credit, United Mexican States
Carlos Linares Peñaloza, Director General, Public Debt Office, Ministry of Finance, Republic of Peru
Maria Fernanda Suarez, Director of Public Credit, Republic of Colombia
Paulo Fontoura Valle, Deputy Treasury Secretary, Brazilian National Treasury, Republic of Brazil (participated separately remotely)
Moderated by Phil Moore, Roundtables Editor, Emerging Markets (EM)
EM: Starting with the largest economy in the region, how significant was the news that Brazil’s rate of growth for 2011, of 2.7%, was well below expectations?
Valle, Brazil: It’s important to recognise how volatile the global economy has been. We had a very strong year in 2010, with growth of 7.5%, and we entered 2011 under considerable inflationary pressure, which the central bank addressed by increasing interest rates. The process of monetary tightening was reversed when the external situation worsened in the middle of 2011, and this year we expect growth of between 3.5% and 4.5%.
It’s also important to recognise how much Brazil has achieved since the Real Plan of 1994 in terms of controlling inflation, building our international reserves, reducing external debt, attracting FDI and generating a primary surplus.
EM: What has been the impact on sovereigns around the table of other external events? Looking at Peru, the multiannual macro framework for 2012-2014 says that “despite a weaker and more uncertain world economy, during the period 2012-2014, Peru [has] the capacity to remain the fastest growing economy in the region and grow at sustained rates of about 6% yearly.” This framework was published last summer. Have external events since then led this forecast to be revised?
Linares, Peru: As you said, our projections were published before the crisis in Europe became more serious in the second half of last year. In response to external factors, we originally reduced our forecasts for growth in 2012 to 5.5%.
However, following strong growth of 6% in December, which brought growth for the year to 6.9%, these projections have been revised again and we are now expecting growth this year of 5.9%.
Last year the government put in place a number of measures to encourage public investment as a way of countering the possible impact of the international crisis.
EM: Given that 20% of Uruguay’s exports go to Brazil, what will the impact of a prolonged slowdown there be on the Uruguayan economy?
Arbeleche, Uruguay: We haven’t yet been impacted by events in Brazil. 15 years ago around half of our exported goods went to Brazil and Argentina. We’ve done a lot of work in recent years to diversify not only our products but also our export markets, so that today, less than 30% of our exports go to those countries.
Of course the slowdown in Brazil will have an effect, because it still accounts for 20% of our exports. But it won’t be as harmful as it may have been in the past.
Our links with Argentina in the financial area have also declined, with deposits from Argentina having fallen from about 40% to less than 15%. As you saw from the press coverage at the weekend, the government is monitoring ongoing events in Argentina which are a concern because of their impact on certain exports. But Argentina only accounts for 7% of our total exports.
Suarez, Colombia: In recent years we’ve been less impacted by what is happening overseas, and going forward our increased investment in infrastructure will help to offset any slowdown created by external events. Growth in Colombia in 2011 was approximately 5.8%, compared with 5% expected in the Medium Term Fiscal Framework, and FDI reached record levels. Domestic demand was the main contributor to this performance. Household consumption grew at more than 6%, while total investment reached 29% of GDP, the highest value in the history of this variable.
EM: Presumably, Mexico’s economic profile is much more tied to the performance of the US than other Latin American economies?
Díaz de León, Mexico: There are two main sources of risk that have a direct impact on Mexico - a slowdown in the US economy and the potential for another shock from the Eurozone. The news on both has been improving, with the US growing and the ECB’s actions having reduced financial tension in the Eurozone.
It is important to stress that Mexico has engaged in a medium-term strategy to diversify the economy. In this context a large effort has been undertaken to promote and diversify international trade through a number of trade agreements and unilateral tariff reductions.
The government’s efforts to diversify the structure of Mexico’s international trade have led to a gradual but important change. The share of non-oil exports directed to the US has declined from 90% in 2000 to 76% in 2011, and the share of non-oil exports to countries other than the US more than doubled in the same period.
While the US is still the main market for our exports, and will continue to be so in the foreseeable future, the Mexican economy does not share many of the imbalances that have affected the US. The US is unlikely to grow at potential for a while, given that it is still dealing with excess leverage and a fiscal account that will clearly need some consolidation in the near future. The fact that we don’t have these problems has already allowed for the economy to decouple from its traditional links to the US in terms of GDP growth, industrial production and job creation.
The exposure of the Mexican economy to events in Europe is relatively limited, with total exports to Europe representing only 2% of Mexican GDP.
Growth in 2012 and 2013 is expected to be evenly supported by internal and external sources. The strong rebound experienced in the Mexican economy in the second half of 2009 and 2010 was driven by the performance of exports, which are now substantially higher than they were before the global financial crisis.
EM: How would the region be affected by an accelerated slowdown in China?
Suarez, Colombia: Colombia was one of the few countries worldwide that posted positive growth – of 1.5% - in 2009, demonstrating the resilience of our fundamentals in the face of a negative external environment. Following the deterioration in trade relations with Venezuela in 2008, Colombian entrepreneurs supported by the government focused on diversifying their exports to regions such as Central America and Asia. Additionally, free trade agreements with key trading blocks including the EU, the US and Asia have opened up a wider range of markets for our exports.
A worsening of conditions in Europe and a decline in Chinese growth could impact demand for commodities, but the sustainability of our exports has been strengthened by the opening of these new markets.
Valle, Brazil: China is our biggest export market. It accounts for 17% of Brazil’s exports, but that is not a particularly large share.
Although Brazil is a commodity-based economy, it is important to understand that we are talking about a variety of commodities, ranging from agriculture to minerals and, increasingly, oil. So we believe our exports are well-diversified in terms of products and export markets.
Another key point is that Brazil’s economy has historically been regarded as being too closed. External markets account for about 11% of GDP, which has traditionally been seen as a weakness, but in the recent global volatility our reliance on the internal market has been a strength.
A slowdown in China would have an impact on the whole world, but we don’t believe Brazil is overly dependent on the Chinese growth story.
Arbeleche, Uruguay: Like Colombia, our links with China are largely indirect rather than direct. There is a consensus that there will be a slowdown in China, but we believe Uruguay is less dependent than some other Latin American countries on commodity exports.
Linares, Peru: China is one of our main trading partners, so we are obviously concerned about the impact that a slowdown in China would have on demand for imported minerals. However, we don’t expect a sharp slowdown or a hard landing in China that would have a very negative impact on our exports.
Our trading partners have been diversified through a number of free trade agreements. About 20% of our trade is with Asia, 20% with the US and 20% with Europe.
Besides, we feel that confidence is being restored among private investors, especially in the mining sector. We now believe that growth in private investment will reach between 8% and 10% this year, which is higher than we forecast at the start of 2012.
EM: Does this mean that your forecasts for fiscal surpluses of 1% of GDP in 2012 rising to 1.8% in 2014 are still in place?
Linares, Peru: We will be publishing our new forecasts in May, but these projections are still in place, in part because the assumptions we used for commodity prices were very conservative. Our priority will be to continue to encourage foreign investment, which will be key to underpinning sustained growth and ensuring that its benefits are spread among more people.
EM: Will the delivery of these macroeconomic targets stand Peru in good stead for another ratings upgrade, following the S&P upgrade from BBB- to BBB in August?
Linares, Peru: The agencies have expressed concerns about social problems and about the protests that led to disruption at the Cajamarca mining project. A new ministry has been created to address the problem of poverty, and we have already put in place a number of programmes aimed at assisting people living in poverty and encouraging the development of micro and small enterprises, so we believe important steps are being taken to reduce the danger of social unrest. S&P acknowledged this in its last report, noting that the poverty level in Peru had fallen from almost 50% to below 30% in the last six years.
EM: Moody’s recently changed its outlook on Uruguay’s Ba1 rating from stable to positive. But what does Uruguay need to do to become an investment grade credit?
Arbeleche, Uruguay: We have been asking ourselves and the rating agencies the same question. The agencies have their standard methodologies but they don’t always take into account the peculiarities of individual countries.
We’re conscious that we still have some vulnerabilities which are reflected in the rating. But we also believe that if we compare Uruguay’s economic indicators with those of other emerging economies which already have investment grade status, we compare pretty well. Some of the vulnerabilities mentioned include the dollarization of our debt and our financial system, the dependence on commodities and the lack of diversification in our investor base.
We think we have made a lot of progress in all these areas. We’ve analysed each of the vulnerabilities they tell us we have, and our conclusion is that by now we should have a better rating.
The most recent report, published by Moody’s, cites the external environment as the main reason for not upgrading Uruguay to investment grade. They tell us they’re going to wait 12-18 months to see how Uruguay reacts to the external uncertainty and volatility. We don’t think that is a very appropriate way of measuring where we stand today. We believe we have made a lot of progress towards being prepared to deal with any financial turbulence.
For example, we have built a solid financial cushion by aggressively negotiating contingent credit lines with the multilateral lending agencies such as the IADB, CAF and the World Bank. I’m not sure if any other country has built contingent lines with quite as much depth as Uruguay has. We don’t want to have cash available from them right now. But we do want to have a Plan B in case we are forced out of the market for quite a while. We have sufficient resources in place to cover us if we were out of the market for a whole year.
The other point we make to the ratings agencies is that our bonds are already trading at investment grade levels in the market.
EM: So in terms of your cost of funding, how much difference does the rating really make?
Arbeleche, Uruguay: It does not make a difference today. But it may make a difference in the future if there is major turbulence in the external environment, as it did in 2008 when all of a sudden our spreads rose very dramatically. We’re a very small country. Our policy is to be very conservative, which is why we have a pre-funding policy and why we have negotiated these contingent lines. And it’s why we want an investment grade rating today.
Bouazza, HSBC: It’s important because an investment grade rating would give Uruguay access to the sort of investment grade funds that currently buy Brazil, Mexico, Colombia and Peru.
EM: Mexico has been an investment grade credit for a while. Alejandro, how would you summarize the state of the Mexican economy today?
Díaz de León, Mexico: Two of the agencies downgraded us in 2009 and the other one kept it constant. One of the issues that they raised is on growth. In this regard, there is a tendency to look at the last decade and conclude that Mexico’s potential GDP is below that of other emerging markets. That argument does not go deep enough because it overlooks the fact that we were impacted by two shocks, in 2001 and 2009, that are highly unlikely ever to be repeated. The first was the accession to the WTO of China which had important implications for Mexican competitiveness and the second was the global financial crisis.
As a result of responsible macroeconomic management during recent years, the Mexican economy is currently in a very strong position. It has solid public finances, moderate inflation, a robust financial system, strong external accounts, and considerable liquidity margins to face possible external shocks.
However, although the indications are that the dangers of contagion to the Mexican economy from overseas are limited, we will continue to monitor the situation to guarantee that we are able to adopt any policy response that may be needed in a timely manner.
EM: Colombia’s upgrade to investment grade last year was clearly a vote of confidence in its growth prospects, among other things. Maria, can you comment on how Colombia intends to meet its targets for sustainable annual growth of 6%, reducing the fiscal deficit from 3.6% of GDP in 2011 to 0.7% by 2022, and reducing net debt from 28.4% in 2011 to 10.5% in 2022?
Suarez, Colombia: There are four cornerstones to sustainable growth of around 6%. First, Colombia’s growth in the investment rate, of around 30%, underpins the economy’s GDP growth potential. More important, this process is being accompanied by an increase in the savings rate, which is currently 26% of GDP.
Second, infrastructure spending will increase from 0.6% of GDP today to 1.2% over the next three years.
Third, tax reform to be submitted to Congress will generate a more equitable distribution of income. This will have a significant impact on households’ disposable income, leading to higher demand and accelerated growth but with less poverty and inequality.
Finally, the government has undertaken a series of reforms not just in the tax area, but also in a social context. For example, the population with access to the internet is projected to rise from 2.6m in 2010 to 8.8m in 2014.
EM: Fixed income investors have been responding very positively to the macroeconomic data coming out of Latin America. Katia, how would you summarize the activity in the new issue market over recent months?
Bouazza, HSBC: It has been a very constructive market backdrop for issuance out of Latin America. At HSBC, we led a number of transactions in November and December, and the activity we saw at the end of 2011 set the tone for a record volume of issuance from sovereigns and corporates in the early part of 2012.
The market has been open for issues across the maturity curve and credit spectrum. For example, in addition to a number of strong sovereign benchmarks, we’ve seen highly successful issues from borrowers such as Brasil Telecom, Pemex, Banco Estrado, Bradesco and others. Also, in January there was a landmark tier I perpetual from Banco do Brasil which was the region’s first Basel III-compliant issue.
We have also been seeing massive books for many of these deals, with demand for Mexico’s 30 year benchmark, for example, exceeding $6bn.
EM: What is driving this demand? Given what’s been happening in Europe, are Latin American fixed income assets seen as a safe haven?
Bouazza, HSBC: Some of it has been driven by a flight to quality, and some by investors’ hunt for diversification. But the main driver is ample liquidity within an investor base that is comfortable with Latin America’s fundamentals.
EM: Let’s move on to debt. Most Latin American economies now have debt to GDP numbers that Europe would envy and Japan could only dream about. Chile has a debt to GDP ratio of well below 10% and many of the sovereigns around the table have ratios that are comfortably below 50% and are falling fast. What is the outlook for debt to GDP for the sovereigns around the table?
Valle, Brazil: The downward trend in Brazil’s debt is very clear. We expect to maintain annual growth at above 4% over the next few years and to keep the FX rate and inflation under control. And we have a commitment to keep the primary surplus at 3.1% of GDP for the next three years. Achieving these objectives will be more than enough to maintain the downward trend in the debt.
It is also important to look at our net debt, which was 36.5% of GDP at the end of 2012, and where the trend is also clearly downwards. The main difference between our net and gross debt is our international reserves, which we believe will continue to rise for the next few years.
Arbeleche, Uruguay: Our debt to GDP ratio is also heading in the right direction. The gross public sector debt is 56% and the target is to reduce this to 40% of GDP by 2014, which we are on track to achieve. But it’s important to look at what is behind that number. Because of the pre-funding policy that we have been following in recent years, if we look at the net debt to GDP ratio it is much lower, at about 28%.
It’s also important to look not just at the total stock of debt but also at the its redemption profile. Over the next year, the percentage of debt due to be redeemed is less than 2% of our total.
Suarez, Colombia: We are expecting the ratio to reach 25% or 26% at the end of 2012. Looking ahead, we want to maintain a relatively low ratio but at the same time ensure that sufficient resources are channelled into key infrastructure investment.
Linares, Peru: The ratio of public debt to GDP in Peru was about 20.2% at the end of 2011, which is an important reduction compared to the previous year. We expect this downward trend to continue, with the debt to GDP ratio reaching around 15% by the start of 2016. That is assuming we can meet our targets on economic growth and maintain a fiscal surplus of at least 1%.
Díaz de León, Mexico: Very significant progress has been made in Mexico’s public finances during the last decade, with the approval of the Fiscal Responsibility Law in 2006 establishing a credible framework for fiscal policy sustained by a balanced budget rule. Under this rule the deficit should be zero excluding PEMEX capital expenditure. Since then, other reforms have broadened the tax base and increased revenues from non-oil sources, generating a permanent increase in the ratio of non-oil tax revenues to GDP of approximately 2%.
Notwithstanding the very positive transformation that these modifications have implied for public finances in Mexico, challenges lie ahead, mainly related to local public finances. The federal government’s tax revenues are actually higher than in other OECD countries with a federal or quasi-federal structure, such as the US or Japan. However, local government revenues in Mexico, which were 0.7% of GDP in 2009, are close to one-tenth of the OECD average of 6%. So local tax collection is where the main challenge is.
EM: Are declining debt levels, twinned with increased local currency issuance, creating scarcity value in the international market for LatAm sovereign issuance?
Bouazza, HSBC: The market has not been flooded with sovereign paper. In spite of the recent volumes, there has not been enough supply given the amount of money that needs to be put to work among investment grade and emerging market investors.
EM: With overall debt levels falling, has the focus of many of the region’s borrowers in the capital markets been on liability management and debt re-profiling?
Díaz de León, Mexico: We are analysing the possibility of executing a liability management transaction, with the objective of strengthening the current benchmarks, retiring off-the-run bonds, extending the maturity and duration of the portfolio and reducing financing costs.
Bouazza, HSBC: There are two clear trends. The first is that sovereigns are retiring less attractive, smaller issues in favour of longer-dated, more liquid benchmarks. The second is that they are looking to de-dollarize much of their outstanding debt.
EM: An example of this was the 2041 $1.5bn tender offer from Colombia in January. Maria, can you comment on the backdrop to this transaction?
Suarez, Colombia: After the issuance of our 10 year 2021 US dollar benchmark in July 2011, we saw the opportunity to enhance the liquidity of our 30 year benchmark at the lowest yield and spread. It was the first time Colombia had been able to achieve a rate below 5% for a 30 year bond. The combination of a liability management exercise and a new funding transaction provided the best environment in which to achieve the largest long end issuance ever undertaken by the Republic at the lowest cost. We also took into account the strength of investor demand for duration at a time when other LatAm sovereigns weren’t issuing at the longer end of their curves.
EM: We saw another very striking example of these trends last December, with Uruguay’s spectacularly successful transaction involving a tender of $6.2bn of bonds and an exchange of $1.2bn of local currency bonds into a new liquid benchmark. Azucena, what was the significance of this deal from your perspective?
Arbeleche, Uruguay: We had been planning this deal for a while, but the third quarter of last year was a difficult time in which we saw no local currency issuance from any Latin American sovereign borrowers.
A window of opportunity opened for us in December. On the one hand we were issuing local currency linked to CPI. On the other, the objective was to use the proceeds of the transaction to buy back debt denominated in foreign currency, principally dollars but also some euros.
At the same time, in order to maximize liquidity in this new bond we exchanged a 2018 bond that we issued some years ago into the new issue.
This meant that we ultimately had a new bond with a size the equivalent of $2bn, which would be very big for any emerging market borrower, let alone for Uruguay, considering that the total amount of our bonds outstanding in the external market is $11bn. It was certainly one of the biggest local currency transactions ever completed, which was very positive, and its main objective was to continue the process of de-dollarizing our debt, with the new money we raised from this transaction only around $300m. The de-dollarization comes from the issuance of $300m and also from the exchange of $1bn from foreign currency. This is the core of the transaction, and the result was that we increased the share of our local currency debt to 49% of the total compared with 11% in 2004 and 34% at the end of 2010.
EM: This figure of 49% compares with an original target of 45%. So you’re already way above your target. Have you set a revised target for 2014?
Arbeleche, Uruguay: We said when we published this target that it was quite conservative and would be dependent on market conditions. Our aim now is to continue to issue in local currency in order to lift the share to slightly over 50%.
We have no official target for 2014, but let me also comment on the local currency transaction that we closed last week. This gave investors the opportunity to exchange securities issued by the Central Bank with a tenor of no longer than three years for government securities in local currency with maturities of between three and 12 years.
The total amount issued in four auctions was the equivalent of $800m, meaning that more than half our debt is now in local currency. For us the results were surprisingly good, because we ended up issuing double the amount we originally hoped, at yields that were well below our curves.
So we are aiming for an increase in the average life to maturity of the public sector debt, and to build benchmarks in the local market, which is very small and illiquid. This has also slightly increased the total share of debt denominated in local currency.
Bouazza, HSBC: The growth in investor demand for local currency debt has been a prominent theme in Latin America. We led a GDN [Global Depository Note] for Pemex towards the end of last year which was very well-received. Peru has also been focusing on GDN issuance as a way of attracting international investors to the local currency market, and Uruguay’s liability management exercise in December included a successful euro-peso issue.
Díaz de León, Mexico: One of the elements that has characterized the recent behaviour of the local debt markets has been the increasing participation of foreign investors, particularly in Nominal Fixed Rate Bonds (M Bonds).
This has been driven by a combination of macroeconomic stability, the consolidation of a free-floating exchange rate regime, the development of the domestic institutional investor base and the increased depth and liquidity of the local debt market. In response to these developments, Mexican government securities have been included in a growing number of global fixed income indices. In particular, Mexico’s inclusion in the Citigroup World Government Bond Index, which was formalized in October 2010, prompted an acceleration in foreign participation in domestic securities. The result was that by the end of November 2011, non-residents accounted for 40.5% of the total placement of nominal fixed rate bonds.
Foreign participation has been mentioned as a possible vulnerability, but much of the capital inflows have been from investors adopting a buy and hold strategy, and has remained stable even during very volatile markets, including during the financial crisis of 2008.
Our aim in the local market is to achieve the same efficiencies in terms of price discovery that exist in international markets.
EM: Brazil has seen a very big increase in its BRL-denominated debt over the last decade, hasn’t it?
Valle, Brazil: Yes. The foreign currency component of Brazil’s debt is now very small. At the end of 2011, only 4.4% of the total debt was in foreign currency. In 2002, almost 46% of the debt was in foreign currency.
EM: Are you comfortable with this level?
Valle, Brazil: In our annual borrowing plan we publish a model on the optimal composition of our debt. This model suggests that somewhere between 5% and 10% of the debt in foreign currency would be the optimal level in terms of risks and cost.
But nowadays, given the size of our international reserves, it makes sense for us to stay below this limit. We will maintain the downward trend in the share of foreign debt because we incur a cost of carry on our $355bn of international reserves, because of the big differential in interest rates between the US and Brazil.
While it makes sense to reduce the international debt because of the cost of carry, it’s important to keep a well-defined yield curve in offshore markets.
EM: What sort of balance is Mexico looking to maintain between local and foreign currency-denominated debt?
Díaz de León, Mexico: The Mexican government recognizes the importance of maintaining a diversified investor base, especially in periods of heightened volatility in financial markets. Taking this into consideration, we will continue to fund primarily in the local markets, but will also aim to maintain a regular presence in the international financial markets. A balance of around 80% in peso-denominated debt and 20% in foreign currency is one that serves both purposes.
EM: Earlier, we mentioned Colombia’s landmark upgrade to investment grade status in 2011. What has this meant for Colombia’s debt management strategy?
Suarez, Colombia: It was very positive. It has meant that we have really had to start behaving like an investment grade country in that we have needed to be more predictable and more consistent about delivering on your promises. This is because we don’t just want to be investment grade. We want to go higher in the scale.
We expect a positive outlook in the next semester, and we already trade well above normal BBB levels. Perhaps the market was pricing in the upgrade some time before it actually took place, because our funding costs have been reduced significantly. Also, the local market has provided fair financing opportunities, with TES bonds being seen as a safe haven at times of turbulence in the international bond market.
EM: What progress has Brazil made in its other debt management objectives?
Valle, Brazil: We have increased the average maturity of our debt year by year, and we finished last year with about 22% of the debt maturing in the next 12 months, compared with 36% in 2005.
In the domestic and offshore market we have improved the profile of our yield curve. Our main focus in the domestic market has been on increasing the share of fixed rate and inflation-linked bonds, while in the offshore market our focus has been on global bonds denominated in US dollars and BRL.
The composition of the debt has improved. In 2002, 90% of our debt was exchange rate-linked or in floating rate bonds, a share which we reduced to 34.5% at the end of 2011, and the rest in fixed rate and inflation-linked bonds. This year we expect the share of fixed rate and inflation-linked bonds to rise to about 70% or 75% of the total.
Since 2006 we have been committed to our buyback programme as a means of building a new and more liquid yield curve. We’ve been creating new bonds with outstanding volumes of between $2bn and $3bn in 10 and 30 year maturities, each with coupons below 6%.
The objective of this programme is to create fewer bonds but with greater liquidity in a very well-defined yield curve in order to expand our investor base. This is the main reason why we have stopped issuing in other currencies and have focused instead on our dollar and BRL yield curves.
EM: So for the time being we can rule out the possibility of a Brazilian benchmark in euros?
Valle, Brazil: In the future if it helps Brazilian companies by creating a benchmark we may reconsider issuing in euros. But for the time being we prefer to focus on liquidity.
EM: Can LatAm sovereign borrowers expect their funding costs to continue to fall?
Valle, Brazil: Yes. Our recent 30 year and 10 year benchmarks achieved record low pricing levels. We issued the 30 year benchmark at 4.69% and our most recent 2021 issue was priced at 3.44%.
In the domestic market we’re also seeing a reduction. We just created a new 10 year fixed rate benchmark and last week we issued R1.5bn at 11.55%. This is still too high, but if you compare it with six months ago it is a fall of 150bp.
EM: A number of other borrowers in the region have also achieved outstanding terms in the primary market recently, issuing at increasingly low new issue premiums. Mexico was a notable example, with its blowout $2bn 30 year benchmark earlier this month priced at 170bp over Treasuries, which was a new issue concession of only about 10bp. Even at the tightened pricing level, this still attracted demand of $6.5bn. Alejandro, can you comment on your recent international benchmarks?
Díaz de León, Mexico: Just to step back, our debt management strategy is as much about developing markets as it is about financing. By developing markets you create a framework that allows you to finance yourself through time. In the last 15 years or so we’ve tried to focus on ensuring that we have access to internal as well as external funding, by building yield curves that are attractive and useful to investors as a way of expressing their views on Mexican securities. The crisis of 2008 was a reminder that even though your local markets may be doing very well and can finance you in a very efficient way, it is essential to diversify your sources of funding as much as possible. So our aim has been to maintain access to funding in dollars, euros and yen.
Of these, the dollar market is the most liquid and efficient, and the objective of our dollar deals this year has been to establish a new 10 year benchmark and a new 30 year benchmark. We issued a $2bn 2020 benchmark in January at a spread to Treasuries of 175bp. This represented a new issue premium of about 20bp, which was clearly in line with market conditions. This transaction was two and a half times oversubscribed, with more than 260 institutional investors from the US, Asia, Europe and Mexico participating.
Earlier this month, the Federal Government was able to access the dollar market a day after the yield on the 30 year bond reached historical lows. The coupon offered to investors, of 4.75%, was the lowest ever in Latin America for this maturity, and the issue was oversubscribed by well over three times. More than 280 investors from all over the world participated.
The trend in new issue premiums reflects how the market has changed from late last year, when it was a buyers’ market. Now it is an issuers’ market.
Bouazza, HSBC: I agree the move we’ve seen is towards a much more balanced market, which is healthy. Supply has been limited and issuers have been very disciplined in their approach to the market. We’re not seeing an issuance frenzy with everyone and anyone trying to tap the market at the same time.
The point about new issue premiums is a good one. The Republic of Colombia was another example of a sovereign borrower that achieved a low new issue premium when it launched the $1.5bn reopening of its 2041 issue in January. The same has been true in the corporate market. Pemex, for example, recently issued with a new issue premium of just 11bp. The pricing trend has been very positive and deals have performed well in the secondary market, which has created a positive momentum for subsequent issues.
EM: Carlos, when Peru tapped its dollar and nuevos soles issues for $1.1bn in January, you also achieved an extremely low new issue premium. Can you comment on this transaction and on the main features of your funding strategy?
Linares, Peru: There was definitely very strong demand for Peruvian risk because it had been 14 or 15 months since our previous international issue. We knew demand for dollars would be strong, but we assumed that the big challenge would be to generate demand for soles. As it turned out, the soles and dollar tranches were oversubscribed by five and almost seven times respectively, at spreads that were very favourable to us.
Looking at our funding plans for 2012, we will be concentrating mainly on increasing investor participation and enhancing liquidity in the domestic market. We believe that this will be supported by the continuation of positive flows into the region, attracted by the strong fundamentals of many of the Latin American economies. But we are also planning to inject more liquidity into the domestic bond market through the development of a local repo market.
We don’t expect to issue any new instruments in the international market this year for funding purposes, although we will continuously monitor opportunities that may arise for liability management exercises. Although we don’t think the average maturity of our debt will be extended this year, some of our bonds at the long end of the curve probably need to become more liquid.
EM: Have new investors been participating in the recent new issues we’ve seen from the region?
Bouazza, HSBC: Yes. Many countries in Latin America became investment grade. As a result, the composition of placement began to change with high-grade investors who typically focus on North America becoming increasingly comfortable with the merits of Latin American sovereign risk. So we have seen more cross-over buyers with very deep pockets coming into this market.
We have also seen private banking becoming much more involved, not just in the perp market where they have always been active, but in all of the dollar deals across the whole yield curve.
Another interesting trend in terms of investor demand is that we have started to see regional players become more involved in the new issue market. In a new offering for Brazil, for example, it is not unusual to see Chilean and Mexican investors coming in to the book.
European institutions also remain a big buyer of Latin American debt. Led by UK-based institutions, Europeans have typically accounted for about 30% of demand for Latin American primary deals. So demand is very seldom driven by a single investor base, with Latin America enjoying exposure to the high grade and the emerging market investor bases.
Suarez, Colombia: Our upgrade to investment grade has led to a significant increase in participation by international investors, as it has given some players the opportunity to invest in Colombia for the first time. We saw a number of new investors coming into our 10 year deal last year and in our 30 year transaction this year. However, international participation in the TES market remains low, with foreigners holding less than 5% of the market.
EM: What steps are borrowers around the table taking to further diversify their funding sources?
Díaz de León, Mexico: Mexico has a net foreign debt ceiling for 2012 of $7bn, and given that our past two transactions in the dollar market have risen an aggregate of $4bn, we have limited room for further issues in the international capital market.
In 2009 and 2010, the government issued Samurai bonds each raising ¥150bn, or the equivalent of $1.8bn. Both were guaranteed by Japan Bank for International Cooperation (JBIC) and were very well-received, allowing the government to achieve a low funding cost.
The government is now analysing the possibility of issuing its first non-guaranteed public bond in the Japanese market in the last decade. Given that we’ve been out of the market for such a long time, it will take a while to rebuild that relationship. Clearly the JBIC guarantee is a way of fast-forwarding that process, but it is also important to build relationships without the guarantee. It is precisely for that reason that we have recently been to Tokyo to meet investors.
But we’re in no hurry to issue in yen. It’s a medium-term objective and we’ll move when market conditions are right for us.
We are also considering alternative currencies such as euros and sterling, although the financing costs in these markets are currently not very attractive, compared to US dollars.
Suarez, Colombia: The universe of investors participating in our transactions has been widened since we were upgraded to investment grade, but we want to strengthen our communications with investors in other regions, especially in Asia and the Middle East, in order to explain the continued positive evolution of our credit story.
Already, some very influential investors from those regions have started to show an interest not just in Colombian fixed income instruments but also in private equity alternatives. This is something we want to encourage, both for the benefit of the sovereign but also for private and public entities looking for fresh and diversified sources of financing.
Arbeleche, Uruguay: We have expanded our investor base in Asia. Last year we issued a ¥40bn ($491m) Samurai bond guaranteed by JBIC, which we were very happy with. We had good feedback from investors and issued at a low spread of 43bp over yen swaps.
We’re not looking to come back to that market in the near future, but the next target would be to issue a Samurai bond without a JBIC guarantee. We’re waiting to see how the Mexico transaction goes. But we’re a very small issuer and we have to be selective about the markets we issue in.
Suarez, Colombia: A Samurai bond in unguaranteed format could be very interesting, but at this point we don’t think the market is ready. Japanese investors are very cautious and need to become more familiar with our credit. But we will continue to visit Japanese investors on our marketing trips to Asia in order to build long term relationships.
Bouazza, HSBC: We’ve also seen corporate issuers taking advantage of the opportunity to diversify their investor bases by exploring new markets. Last year we saw Petrobras issuing in euros and sterling. This year we’ve seen Braskem taking advantage of demand in the perpetuals market, mainly out of Asia. And America Movil opened a brand new market for Latin American issuers in the offshore RMB sector.
The dollar is generally the currency of choice, because of the attractive funding costs created by low dollar interest rates, but LatAm issuers have a global appeal and have shown that they have access to a variety of markets.
EM: With investment in infrastructure a key priority across the region, are we seeing more infrastructure projects being funded through the capital market in Latin America?
Bouazza, HSBC: Yes. We’ve enjoyed a lot of success in executing key mandates in the project bond space for issuers such as Odenbrecht and Queiroz Galvao in Brazil. We also did a financing for the ENA toll road project in Panama that was sold to institutional investors. This is a market that will continue to develop, locally and internationally.
Traditionally this was an asset class that made more sense to the bank market, but is now appealing to institutional investors in dollars and in local currencies.