An approaching new year always invites a scan of Latin America’s debt markets for potential defaults. There are no soothsayer points on offer for highlighting Argentina’s coming restructuring – the central bank has negative net dollars and the IMF will have no choice but to conclude another restructuring with the country’s new president, Javier Milei. The Fund may find itself in the upside-down world of arguing for less drastic fiscal cuts than the new administration, but a new debt disbursement and debt repayment profile will certainly be needed.
The irony is that the next most likely sovereign candidate for default elsewhere in the region is Ecuador, a country that has dollarized the way the new Argentinian administration would like to.
Ecuador is finding that dollarization is no financial silver bullet. Far from it. The country already restructured in 2020, and the market is pricing in another round – Ecuadorian dollar spreads over US Treasuries are approaching 2,000 basis points – well into distressed trading territory. This reflects precarious public finances, with some 55% of debt denominated in dollars, while dollar assets are around 7%.
Effectively locked out of public markets and unable to print its own currency, the path to recovery is fiscal consolidation to lower debt-to-GDP. That doesn’t look politically possible.
However, with a relatively favourable debt repayment schedule for 2024 and 2025, another default before 2026 is avoidable.
Perhaps Bolivia will be the next Latin American default? The country's financial weakness also stems from the dollar – in its case in the form of a peg – which has become increasingly over-valued over time, leading to a deteriorating current-account position and an increase in capital outflows.
Pemex’s $100 billion in debt gives it the potential for a proper sovereign default episode
The central bank’s defence of its currency has seen it burn through reserves, which now stand at what economists call the “paltry” level of a few billion. And with dollar-denominated debts standing at around 30% of GDP, Bolivian dollar spreads have also blown out – to around the 2,000bp level too, only a couple of hundred basis points below those of Argentina.
However, like Ecuador, a favourable 2024 and 2025 debt repayment schedule pushes back the chances of imminent default for Bolivia.
The rest of the region’s governments learned the lessons of the debt crises of the 1980s and 1990s and have developed deep local debt markets that mean they can largely fund governments in local currencies.
So, the occurrence of rapid debt crises elsewhere seems remote.
Last year, El Salvador was looking like a viable candidate – its spreads blew out to 3,500bp in 2022. However, an improving relationship with the US and debt buybacks have seen its borrowing costs decouple from other problem cases and head towards some sort of viability.
I would argue that the next important default is likely to be Pemex. Although the corporate is clearly a quasi-sovereign, its $100 billion in debt gives it the potential for a proper sovereign default episode.
Pemex’s finances are beyond precarious. That $100 billion debt has built up as its production has fallen – from 3.5 million barrels a day in the mid 2000s to about 1.5 million today. The Mexican government is having to prop up the company with fiscal infusions and its implicit guarantee of Pemex debt. But with that debt now at 7.5% of the Mexican economy – and with unfunded pension liabilities of a further 4.5% of GDP – how much faith should investors place in that implicit sovereign support?
Nervous
Clearly, some are getting nervous. The spread between the yields on Pemex’s 2035 dollar bond and a sovereign dollar bond with a similar maturity has been creeping up: from 100bp in 2015 to over 600bp now. At some point the Mexican government will be forced by the markets to make a choice: make its support for Pemex explicit to force the spread down or let the state-owned company restructure.
But there is little to indicate that Pemex can turn itself around – the company has underinvested in exploration and revenues will be hard to grow. Absent an oil shock, the potential for cutting costs substantially without government labour and pension reform is slim.
Mexico will elect a new president in 2024. In 2025, that incoming administration will face the choice between adding some 10 percentage points on to the sovereign’s debt-to-GDP ratio by explicitly guaranteeing Pemex’s indebtedness or allowing the company to default.
Some forecasts suggest that Pemex’s growing losses will lead the annual cost of the government’s support to rise to 1.5% of GDP during the life of the next government. Pemex debt is 90% in hard currency, and most of it is held offshore. But would a new president be prepared to inflict spending cuts on the population to support the quasi-sovereign oil company?
This scenario may not play out until 2025, but with the situation as it stands, Pemex may well be Latin America’s next ‘sovereign’ default.
