Michael Brandl > Macro Updates > Archives > May 17, 2003

May 17, 2003

The IMF gets snubbed in the bond market. Over the past few years there has been a debate over how emerging-market potential debt defaults should be handled. The International Monetary Fund has proposed its “sovereign-debt restructuring mechanism” (or SDRM), which would create an international bankruptcy system, sort of, with its own elaborate, and expensive bureaucracy. The Bush Administration, on the other hand, has favored a more “market-friendly” approach of “collective action clauses” (or CACs) written into new debt contracts. CACs allow a supermajority of bondholders, usually 75% to 85%, to vote to allow changes to the payment schedules of the bond issuer. CACs have been used in England, under UK law, for along time. The British and the Canadians have long pushed for emerging market bonds to do the same.

Many emerging market governments were hesitant to offer CACs. They feared that since CACs make debt restructuring and/or default easier, the bond market would require a large premium to hold CAC laden bonds. As recently as last October Mexico finance minister Francisco Gil Diaz stated that his government would not use CACs. In February of this year, however, Mexico did a complete 180, issuing $1billion worth of 12-year CAC-laden bonds. The issue was oversubscribed, however there is still some debate over the question of Mexico paid a premium or not. Many seem to think the premium was small, somewhere between 10 and 20 basis points. Mexico has made it clear that from now on all of its sovereign debt will have CACs. Uruguay and South Korea are mostly likely next to offer CACs in their government bonds as well.

The Mexican CAC bonds have basically killed off the IMF’s proposed solution. Did the Bush Administration have a role to play in this? Some have suggested that the Bush Administration needed a “first mover” in offering CACs and had cut a deal with the Mexican government. Rumors suggest that if a deal was made, it may have included an American agreement to cover any premium Mexico would have to pay if the sale did not go well, and/or future agreements between the U.S. and Mexico on trade or migration. It will be interesting to watch for any future developments to come out of this.

One thing that is likely to happen from this is that the IMF has suffered yet another black eye. With CACs being offered across the market, the IMF's SDRM proposals surely seem dead in the water. This is not the first time the Bush administration has snubbed the IMF...and (hopefully) won’t be the last.

Speaking of Mexico…have you seen the run-up in the Peso against the dollar lately? What’s going on? Some of it maybe higher oil prices during the Iraq conflict led to an influx of dollars into the Bank of Mexico. Not wanting to hold onto these additional foreign currency reserves the BofM underwent a sterilized intervention that helped push up the peso even more. So some of the run-up in the peso might be temporary, but maybe not. The BofM has done a good job of controlling inflation in Mexico. Mexican banks are well run, financial markets are deepening, long term bonds are starting to be issued and the derivatives market, while limited, is expanding. Overall the Mexican economy continues to perform fairly well, considering the problems its rather large neighbor to the north is having. 

Mexico certainly has problems it needs to address including a government that does a horrible job of collecting taxes, is far too dependent on oil revenues, and does not do a great job in educating its young people. Political gridlock might also become a problem if Congress continues to block President Fox’s reforms. Over all however, Mexico continues to look like an emerging market financial safe haven for funds.