What is going on here?
International Monetary Fund head Dominique Strauss-Kahn issued a rather ominous warning on emerging markets on Monday. Via AFP:
Also worrying, according to Strauss-Kahn, is that foreign capital required by emerging countries such as Mexico, Colombia or Poland has dried up, which could lead to “consequences for the rest of the world.”
Unsurprisingly, the pronouncement sent jitters through the markets. On Tuesday, the peso slid against the dollar, Mexican bond prices fell, the country’s 5-year CDS widened 8bps and speculation that Mexico could face an imminent downgrade of its sovereign rating ran rife. At the moment, the three major ratings agencies have Mexico three notches into investment grade territory — BBB+ at S&P and Fitch, and BAAA1 at Moody’s.
Here’s RBS Latin America economist Benito Berber on the fall-out from Strauss-Kahn’s remarks (emphasis ours):
IMF director Dominique Strauss-Khan said that Mexico, Colombia and Poland face challenging financing deficits that if not corrected soon, could put them at risk of defaulting. The external financing needs of Mexico and Colombia have been met for 2009. In this regard, the comments of Strauss- Khan seem strange and could add noise to the markets. . . .
The comments of IMF’s Strauss- Khan are particularly inopportune but should not be taken seriously. The IMF hasn’t published a formal press release confirming the fund’s view. Mexico is still investment grade and it is very unlikely that any of the three major rating agencies decide to lower it to junk.
Mauro Leos from Moodys said a couple of weeks ago that “it was far fetched to believe that Mexico would lose its invest grade category any time soon”. The view of the rating agencies has been that Mexico needs to pass structural reforms to avoid a downgrade. Shelly Shetty from Fitch commented recently that Mexico would need a plan “B” in case Congress fails to approve a fiscal reform after the July elections in order avoid a downgrade. This amounts to sort of running in order to stand still.
But the prospects for comprehensive fiscal reform are very slim. In fact, the two major political parties: the centre left PAN and centre-left PRI have both said that they are not at all interested in passing a fiscal reform package. While no party is expected to publicly say that it favors increasing taxes particularly before the congressional elections of July, the political climate does not support the passing of any reform.
Mexico will be downgraded by one notch on the back of deteriorating fiscal revenues as the economy contracts to between -5.5% and -7.5% this year. Still the comments of Strauss- Khan add noise to the market. . . .
Small wonder then, that on Tuesday the IMF rushed to backtrack. Via Reuters:
But the Washington-based IMF softened its comments on Tuesday and said in an e-mailed statement that Mexico is “very well positioned to weather the global economic crisis.”
Related links:
John Authers’ Short View on sovereign default – FT
Flows into emerging markets hit 18-month high – FT Alphaville
Mexico-oh-no – FT Alphaville