8/11/2019 Argentina and Mexico Crises Cause Similar Problems for Treasury InternationalTreasurer1994Aug8

1/2

nternational

Treasurer

he Corporate Treasurer s

Guide

to Global Financial Management

August 8, 1994

Currency/country risk

Mexico:

Time to

Look for Cover?

Elections

in

Mexico are taking place against a

weakening

economy

and

a

currency that is

ripe for devaluation against the dollar

Treasurers should be looking for cover and to

bring money

out

of Mexico in expectation of

the peso s continuing fall.

Following the elections on August 21, one of

the first

decisions

th e n

ew

president (PAN

candidate de Cevallos?) w ill need to make is

whether to offic iall y deva lue the peso- pro

vided of course, that the out-going adminis

trat ion leaves the dec ision fo r him to take.

Some market observers expect a

mini-d

evalu

ation

of

5-10%

followed

by a

widening of

the

trading band

with

the dollar. An increase in

the daily

ba

nd crawl to .0006% per day

(6

.4%

per year annualized) is anti cipated. Mexicans

as usual are getting their money out of pesos

in anticipation of the elections. In this context,

hedging may oe tn e prudent thing to do .

Stormy fundamentals

Mexico has not put in a ste ll ar economic per

formance in the wake

of

the passage

of

the

North American Free Trade Agreement. Since

the beginning of 1994,

th

e Mexican peso has

devalued by 9.5% ve rsus the

doll

ar. The out

look for econom ic growth is fa lling w ith the

peso. Despite the Bolsa stock index jumping

48% in 1993, GDP expectations for 1994 are

being wh ittled

down

to around 1.4% (fo ll

ow

in g ane

mi

c 0 .4

growt

h l

ast

yea

r .

Presumably, economic v lue li es further out

in Mexico's fu ture .

n the absence of economic growth, treasurers

must ask themselves

how

long

the

Bank

of

Mexico can continue to defend

the

peso.

Num

erous factors shou ld cas t

so

me

doubt

on

Continued on back

p

ge

Regional treasury management

Kodak s

Latin

American Finance

Eastman Kodak

promotes

a group-level per

spective with its local finance managers and

centralizes administrative and financial service

support with sub-regional centers.

W ith

regional

in t

egratio

n

in

the Western

Hemi

sp

here,

corpo

rate f inance

funct

ion s are

looking at h

ow

they ca n apply organizational

in i t i

at

ives em p l

oyed

in

Europ

e to

the

Americas. Kodak' s app roach to this process

has been to first promote group-l eve l objec

tives w ith i

ts

loca l finance man ge rs in La

tin

America and then to centrali ze

tr

eas ury and

financia

l operations in sub-regiona l ce nters

serving clu

sters of

close

ly

int

eg

rated countri

es.

From country-level to group focus

Lat in A m eri can f in ance di rector Paul

Groesche

l,

up

on

returning to

this po sit ion

after a stint wi th Kodak-owned Sterling Drug,

set out to establish a group treas ury mentality

in Latin America. He found that treas ury oper

ations were being managed

to optimize

coun

try r

es

ults rather than group r

esul t

s to share

ho lders.

Often w ithout r

ea

li z ing it, the local finance

manager's

cho

ice to max

imi

ze country-leve l

resul

ts

ca n be detrimenta l to co rporate objec

tives

F

or

exa

mple

,

one

of Kod ak's co

untr

y

ope

rat

ion

s

in

L

at in America

cons

i

stently

maintained a

cas

h surplus

of

th

e eq

uiv

ale

nt

of

2 million. Ra

th

er th an being remitted to the

parent, to invest or pay down the co

mp

any's

debt, the country f inance manager was inves t

ing th

is

cas h loca lly. The investment income

was

being

used to

boost

operating

resu l ts,

he

lpin

g the local entity to meet its perfor

mance targets . With each country engaged in

si mil

ar loca ll y focu

se

d act iv i ties , the excess

cas

h being left unrem itted was significa nt.

To help rectify this problem, Mr . Groeschel

es

tab li shed a regiona l treas

urer

position to

Continued on

p

e 2

Mexico: Time

to

Look

for

Cover?

Com

i

ng

elections

in

Mexico create an air

of

co

n

ce rn

.

page 7

Kodak s Latin

American

Finance

Getting i

ts arms

aro un d

sub-reg

iona l

treasury mana

ge

ment

first.

page

7

New Tax

Rules

for Hedging

Th

e

IRS is

sues

its

hedge

rul es in

final

form

and

proposed

regs

fo

r centra lized

h

edg in

g.

page3

ISDA

Manages

Its Risk

What to lea

rn

from

the ISDA co nference

on

ri

sk manageme

nt.

page 4

FXpress Soon

Ready for

Release

Windows-

ease for

an

FX

mana

ge

ment tool

suited to every

corpo

ra

te's

needs.

page 6

On-line

Foreign

Exchange Services

Citicorp technology

for electronic

trad

i

ng

co

nfirmation,

and

set

tlement.

page

7

8/11/2019 Argentina and Mexico Crises Cause Similar Problems for Treasury InternationalTreasurer1994Aug8

2/2

The Back

Page

ontinu ed from page

7

a peso defense. First off, interest rates 7%

nominal and

10

% effective- are already high.

Even without go ing higher, they are choking

eco

nomic

activity

whil

e they increase the gov

ernment defic it.

Meanwhile,

Mexico's foreign exc han ge

reserves

re

dec

l inin

g. Some estimates

put

them at 10 billion tod ay, which is down sig-

nificantly from 17

billion

at the end

of April.

This lack of treasury resources makes it both

mor

e diffic

ult

to defend the p

eso

and stay cur

re

nt

on its non-peso debt. The spread over US

treasury rates for Mexican Brady bonds h

as

risen

100 basis points from 1993 leve

ls

.

To conserve its

dwindlin

g reserves, yet con

tinue to prop up the peso, the Bank

of

Mexico

is sa id to be se

llin

g tesobonos and buying

back ce tes. Like cetes Tesobonos are short

te

rm

sec uriti

es

(28-360 day te

rm s);

but, w hil e

denominated in pesos, they are indexed to the

dollar. Th e peso amount paid at maturity -

set by

dollar

spot two-days

prior compen

sates

holders for princ ipal and interest we ll in

excess of Libor (over 250 bps) . Still , they are a

cheaper source of funding than cetes.

By co nv

er

ti n g its short-term peso

debt

to

tesobonos the Bank

of

M exico is

borrowing

against the future value

of

the currency, hop

ing that the markets will come back so that the

peso strengthe

ns

as its over 13 bill ion-wort h

of

tesobonos exp

ir

e. If it does not, growi ng

tesobono exposure

will

pr

ess

for an accelera

ti o n

of

the

peso

de c li n e; particularly, i f

tesobonos come due in the wake of a govern

ment-initiated

devaluation. More

borrowing,

sp iraling inter

es

t rat

es,

infl ation , and even the

prospect, albeit slim, of convertibility

prob

lems may result.

Time to

hedge

Under an accelerat ing

devaluation

scenario,

n

ow

is the time to hedge. An offic ial devalua

tion could come shortly before or shortly after

the elect ion s.

Of

the few available hedges,

one

of

the most attractive in the p

ast

has been

coberturas Coberturas

are similar to conven

tional forwards

only

the premium is paid up

front in cas h.

At

settlement, delivery reflects

the peso ga in or loss of the fowa rd rate versus

actual spot.

Historicall y the premium has reflected some

thing l

ess than a traditional forward market's

expectations

of

devaluati on.

Whil

e the

cobe

r-

turas

market is expected to come back, the

current cost of s

hortin

g cetes and buying

8

tesobonos-arbitraging the in ter

est

-rate parity

curve where fo rwa rd rates provide equiva lent

t reasu ry

yields-is

mu ch less.

However, for

most corporates , the approva l process for such

an action may take treasurers beyond the cur

rent window of opportunit

y.

Desp ite

being

relat ive ly expens

iv

e at

the

moment, coberturas have severa l

redeeming

qualities. Execution is 1apid (just one phone

ca

ll away) and the contracts are sta ndardized

for desired liqu idi ty. Another imp

or

tan t feature

is that they are approved in Mexico, w hi ch

means they ca n be booked w ith a Mexican

subsidiary and n

ot with

the parent. This is not

something that can be done

with

other

more

sophisticated

in str

um

ents being touted

by

banks in the US .

Buy

now

:

the

market

will

grow

increasingly

unsettled in the days leading up to elections on

August 21.

If

short selling cetes for tesobonos

is

not possible, one corporate we spoke with

recommends a 268-day

cobertura

at a premi

um of around 7.0 or a 178-day

cobertura

at

a premium of 5.1 .

Other

risks

Naturall y, the

buyer

of

cobe

rturas ass um es

cou nte rparty cred

it

ri sk. Credit risk can

be

co

nt

a

in

ed

by dealing

with only

top

grade

banks.

Th ese

banks in

c lude , for

inst

ance,

Citibank Mexico , Banamex ( 40 bil l ion in

assets) or Banco M ex ica

no

( 13 bil l ion in

assets).

Whil

e Ven ezuela has demonstrated that the

prospect of exc hange co ntro l s in Lat in

Ameri

ca

is not as outdated as it once seemed,

inco nvert ibility risk

with

M ex ico is

not

very

real. However, uncertainty surrounding deval

uation prospects is r

ea

l. Accord in gly, corpo

r

ates

should fo

llo

w traders in

st

in

cts

and avo id

exc

hange transactions, cobe

rturas

or

tesobonos

that

come

clue

in

t he

period

between the elect ion s and the first month of

the president's new term January 1995).

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