Bond Market Shows Traders Putting Mexico on the Edge of Junk

(Bloomberg) -- Mexican bonds are teetering on the edge of junk as state-owned Pemex, the world’s most-indebted oil company, threatens to drag down the nation’s finances.

Government-debt spreads are now higher than those paid by emerging markets rated two levels below Mexico’s BBB+, according to data compiled by Bloomberg. After Fitch Ratings cut Pemex last month to just one notch above junk, the bonds took a turn for the worse amid speculation that the country would also be downgraded.

Almost 70 percent of the respondents in a client survey by Bank of America said they expect Mexico to lose its investment grade in “upcoming years.” As President Andres Manuel Lopez Obrador dithers over a rescue package for Pemex, there’s mounting concern that saving the company will require sacrifice. The oil giant, which represented about a fifth of national revenue in 2018, is weighed down by $107 billion of debt and falling output.

“The measures to date have had a fairly minor fiscal impact,” Charles Seville, a senior director at Fitch said in an interview from New York. “The issue is that to provide the scale of support that would be needed to really give Pemex more room to invest and turn around its business, it might require foregoing significant amounts of revenue from the government.”

Bond Market Shows Traders Putting Mexico on the Edge of Junk

Mexico has promised a capital injection of $1.25 billion to Pemex, while Lopez Obrador has floated a plan for $3.5 billion in tax breaks over the next six years. Not only did the measures fail to assuage market fears, they stoked concern that the government hasn’t grasped the extent of Pemex’s problems. Others worried that further capital injections could erode Mexico’s fiscal position.

“There’s risk of contamination as there’s basically one pocket of money,” said Shamaila Khan, the director of emerging-market debt at AllianceBernstein in New York. “To the extent Pemex support comes at the expense of fiscal performance, that is going to impact sovereign ratings.”

Bond Market Shows Traders Putting Mexico on the Edge of Junk

The recent deterioration in the nation’s risk profile becomes even more pronounced when compared with Brazil’s. The Mexican average spread is wider than its regional peer -- even though the latter is rated at junk levels due to its rampant debt.

After Lopez Obrador canceled a partially built airport and suspended reforms in Pemex that had opened the door to foreign investment, some investors seem to be losing confidence in the new administration.

The problem for Mexico isn’t just contamination from Pemex, it’s also the "erosion of the institutional framework that had underpinned investor confidence in the Mexico story over the past three decades," said Roger Horn, a senior emerging-markets strategist at SMBC Nikko Securities America in New York.

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