Mexico seen at least risky level since 2014, even as economy sputters

By Abraham Gonzalez

MEXICO CITY (Reuters) - Low inflation, tight public spending and a reduction in the vast debts of loss-making state oil giant Petroleos Mexicanos (Pemex) have helped spruce up Mexico's so-called risk profile, which reached its "safest" level in five years this month.

Risk premiums of investing in Mexico, as measured by traders in credit default swaps (CDS), hit their lowest level since November 2014 despite business and investor concerns about the economic management of the leftist government.

Economic growth has ground to a halt during the first year in office of President Andres Manuel Lopez Obrador, who has repeatedly castigated excessive free market liberalism for ruining Mexico. Analysts expect growth to be weak next year too.

But inflation is below the central bank's 3% target and Lopez Obrador has lowered trade tensions with the United States. Mexico has also avoided the social unrest that has racked many emerging markets in 2019, especially in Latin America.

Against this backdrop, Mexico's five-year CDS - a barometer of a country's default risk - was quoted at 75 basis points earlier this month. On Monday, it stood at 81 basis points.

The current CDS level, also known as the spread, means that an investor pays about $8,100 annually to insure $1 million in Mexican sovereign debt against default.

"The stable debt-to-GDP ratio, contained inflation, a central bank with a good reputation and the government's fiscal discipline" have made Mexican debt very attractive and low risk, said Jose Luis Ortega, director of debt investments at asset management firm BlackRock (NYSE:BLK).

Lopez Obrador's government, which is running a bigger primary budget surplus than planned this year, has promised to lower to 45% the debt-to-GDP ratio, which touched 50% in 2016.

The president has vowed to revive Pemex, the world's most indebted oil company, cutting its financial debt by around $7 billion this year via refinancing operations.

However, Pemex's debt still stands close to $100 billion and is viewed as a major risk to the financial stability and creditworthiness of Latin America's second-largest economy.

LATENT RISK

The CDS risk rating has not always reflected favorably on the administration of Lopez Obrador, who spooked investors by cancelling a part-built $13 billion Mexico City airport five weeks before taking office in December 2018.

At their worst, CDS spreads on Mexico shot to 147 basis points shortly after he assumed power.

The government repaid the airport investors and Lopez Obrador has built relationships with some industry tycoons. But many remain uneasy about his government.

During the six-year term of his predecessor, Enrique Pena Nieto, CDS spreads fluctuated between 64 and 230 points.

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Mexico's 5-year CDS spread level was last week 20 basis points lower than the benchmark CDS Emerging Markets index, made up of 15 developing economies and compiled by data firm Markit. It was Mexico's lowest risk level since October 2014.

"There are social tensions in other countries and the real rates in Mexico are very attractive," said HSBC economist Alexis Milo.

The premium investors demand to own Mexican bonds over U.S. Treasuries has also declined, with the spread on Mexican debt in JP Morgan's EMBI Global Diversified index, a widely used benchmark for emerging market dollar bonds, also falling.

Mexico's spread on the index was 295 basis points over U.S. Treasuries on Monday, down from 357 at the start of 2019. The spread on Brazilian and South African debt stood at 211 and 326 basis points respectively, while Turkey's was 405.

Rating agency Standard & Poor's last week reaffirmed Mexico's credit rating at 'BBB+/A-2', but kept the outlook negative, implying a one-in-three risk of a downgrade in the coming year.