If Mexico falls, don’t punish Brazil…

Mexico is facing a severe economic crisis, with falling oil prices, decreased exports to the US, and a falling currency.  Brazil has its own challenges, but they are different (outlined in GloboTrends here), and should be distinguished from Mexico´s for foreign investors.Many foreign investors simply lump Latin America together, and assume that their economies behave similarly.  They do not.  Even when looking at the two biggest economies in Latin America, Brazil and Mexico, its clear that their economies are responding differently to the global economic crisis.

Judging by the way currency traders have been trading the Real and Peso, however,  it appears as if traders are not properly distinguishing between the two.  When a crisis hits (as one did in September 2008), it seems as if traders sell Latin American together first, then ask questions later.  Take a look at the following currency graph from yahoo finance..

z?s=MXN=X&t=1y&q=l&l=on&z=m&c=BRL=X&a=v&p=sThe Challenges for Mexico:

The macro economic challenges confronting the Mexican economy are quite serious.

I recently read an excellent (although slightly negative) analysis of the challenges facing Mexico from the source ´RGE monitor` (here).  In this article, the economist  Walter Molano outlined the following challenges (summarized here):

summary of points:

  • The decline in oil prices will hit Mexico hard. The Mexican government will soon face a gaping hole in the fiscal accounts. Oil represents about a third of government revenues.  Unfortunately, the decline in the valuation of crude coincides with a plunge in oil production.
  • Drop in metal prices will weigh heavily on the mining regions, particularly in the north.
  • dramatic fall in remittances expected as the US slows (especially construction)
  • Slow down in the automobile industry is forcing some Maquiladoras to close factories and furlough workers.
  • The current account gap may exceed $24 billion in 2009.
  • This shortfall will be larger if remittances collapse. (which might fall by 50% due to contraction in the US)
  • the capital account will not provide any solace. Foreign direct investment will also decline, due to the downturn in manufacturing. There is a chance that the portfolio flows will be negative, as investors flee the emerging markets.
  • the peso will have to devalue…the Mexican currency could lose another 20% to 25%, which could put it above 17 to 1 against the USD
  • corporate defaults expected; No Mexican CFO is prepared for such a scenario, which could lead to despair on the corporate front. Hence, we could be in for a wave of unexpected defaults.
  • social situation could become explosive. The lawlessness caused by the burgeoning drug trade undermined local institutions, such as the press, judiciary and law enforcement.
  • author:  Walter Molano | Dec 18, 2008

This may be the extreme view to the negative side, but it does throw up the red-flag, and warn investors about the potential for crisis.  Investors should be careful, however, to recognize that Mexico has some unique characteristics that should be highlighted, so that investors dont reflexivly sell `Latin America` on bad news in Mexico.

Brazil is different:

While Brazil and Mexico do share a bond as commodity-exporting Latin American nations, there are some critical differences that investors should keep in mind.

Nearly 80% of Mexicos exports go to the USA, but only 17% of Brazils exports head for North America (Canada, Mexico, and USA included).  This makes Brazil much less export dependent upon the US manufacturing sector (who´s slowdown is driving the slump in Mexico).

Another big difference is that Mexico´s major commodity export is oil, which has dropped from $130+ per barrel, down to $30.52 last week.  Brazil´s exports of commodities are much more food-based and therfore should have support even if the recession turns to depression and lasts longer than analysts predict (so there is less long-term risk for Brazil, as people will continue needing to eat, even if production of material goods doesnt come back for a while).

Also, remittances play a much smaller role in Brazil´s economy than in Mexico´s.

My point is that even if you agree with his analysis (as many traders do), it would be unwise to lump all of Latin America together, and to not distinguish some of the unique characteristics that its economies have.  My fear is that investors seem to lump bad news in Latin America together, and punish all commodity exporting countries together whenever one of them shows signs of weakness.

On the other hand….(or, how Mexico could surprise Mr. Molano!)

Before completing this article, I believe its important to first challenge some of Mr. Molano´s assertions…

In response to his article, however, I would say that Mr. Molano forgets to mention that the Mexican government has locked-in oil prices at $70 per barrel throughout 2009 (by purchasing $1.5 billion in derivatives contracts).   source: Ft.com

Another factor that Mr. Molano fails to mention is the huge warchest of reserves that Mexico has built up…

`The central bank has accumulated more than $30 billion in foreign currency reserves since Mexico’s own 1995 financial crisis, allowing it to auction off at least $15 billion to prop up the battered peso last year`.  source Ft.com

In the mean time, however, I agree with Mr. Molano´s analysis that Mexico will be challenged by a mixture of reduced demand of oil exports, lower level of orders for its manufactured goods, and a reduced level of remittances from abroad, especially from the USA.  The danger is that oil prices may stay low beyond one year, at which time, Mexican budget could be serverly challenged.

Join our Forum and our Wiki to discuss…

More on this topic (What’s this?)

Scariness South of the Border (When Giants Fall, 12/30/08)
Mexican Oil Production, Exports Continue Down (Jim Kingsdale’s Energy Investmen…, 12/10/08)
Fresh Looks at Old Deals (When Giants Fall, 1/1/09)
Mexico: Cantarell Production Down 33% This Year (Jim Kingsdale’s Energy Investmen…, 11/26/08)

Read more on Investing in Mexico, Investing in Brazil at Wikinvest

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Originally published at Globo Trends and reproduced here with the author’s permission.

6 Responses to "If Mexico falls, don’t punish Brazil…"

  1. Anonymous   January 20, 2009 at 1:27 pm

    Is 30 billions a warchest?Brazil alone has around 200 billions in reserves to play with. I believe even Chile has more than 30 billions right now.

  2. RL   January 21, 2009 at 7:17 am

    Yes, Mexico and Brazil have experienced similar currency depreciation, but this doesn’t mean that the drop of the Real is caused by a myopic comparison with Mexico by investors. Several emerging markets with different but also challenging outlooks have experienced large depreciations in the past months and we could draw very similar graph as this with them. I agree that Mexico’s problems are worse than those of Brazil. Nevertheless the real was clearly overvalued in 2008, specially taking into account the slump in commodities prices. In addition, we all expect both countries to suffer important problems in the coming years, less growth and a need to adjust fiscal policies, although I think both will avoid a debt or liquidity crisis.

  3. Juan   January 21, 2009 at 10:30 am

    Mr. Butler,Good point on Mexico’s oil hedging. One observation though, you say that there may be a wave of defaults in Mexico that could take investors by surprise. But is this more likely in Mexico than in Brazil? Both JP Morgan Corporate EMBI indices are highly elevated, and have been so for the past three months. In Brazil, beef producers are going bankrupt at an alarming pace. Thus, my question is:What makes widespread corporate loan defaults and bankruptcies that much more likely in Mexico than in Brazil, besides linkages to the U.S. from Mexico? What’s the evidence that balance sheets are that much worse in Mexico than in Brazil if cash flows keeps disappearing amidst an evaporation of demand?Thanks,RS

    • Brian Butler
      Brian Butler   January 22, 2009 at 1:13 pm

      I agree with your point. Brazil’s corporate sector is definitely facing an equal (or perhaps greater) challenge in the near future with potential defaults. While the Brazilian government may be in a (relatively) comfortable balance sheet situation, the corporate sector is not. I agree with your analysis that Brazil’s corporate sector is facing trouble, and I didnt mean to imply that they were better off than Mexico’s. That was NOT one of the key differences that I was referring to, and Im sorry if that point was confusing.Im actually working on an upcoming posting specifically about the challenges to the corporate sector in Brazil: “Brazil’s central bank President Henrique Meirelles unveiled plans last week to provide more than $20 billion to help 4,000 or more companies meet international debt payments this year.” was recently in Bloomberg.thanks again for your comments!cheers,Brian Butlerwww.globotrends.com

  4. Anonymous   January 21, 2009 at 6:48 pm

    There is an error in the article – Mexico’s hard currency reserves total over $90 billion.

  5. Brian Butler
    Brian Butler   January 22, 2009 at 12:58 pm

    Yes, the $30bn was supposed to be $90bn…thanks for the catch.Sincerely,Brian Butlerhttp://blog.globotrends.com