The author is Director of Data Analytics at IMCO and Professor of Macroeconomics at ITAM..
As we have commented in this space, the relationship between fiscal policy and financial markets is abundant. We have talked about the importance of different indicators, such as interest rates or the exchange rate, in influencing the size of the fiscal space available to authorities to make different decisions. Likewise, about the way financial markets capture the perceived risk levels of taking on debt issued by the government.
On this occasion I am interested in adding a new concept that is useful to understand the recent movements that we have seen in the financial markets. It is of vital interest to understand risk premiums, a concept that, in a very general way, and perhaps not so technically precise, refers to the additional cost that a debt issuer must pay for its bonds to be attractive to the markets.
Typically, risk premiums are measured in basis points, each basis point being one-hundredth of a percentage point. As an example, a bond issued by the United States Treasury with a term of 10 years was placed on June 3 at a rate of 4.39 percent. It should be noted that this bond is issued in US dollars and its rate level is considered the zero risk benchmark. Additionally, that same day, a US dollar bond issued by the Mexican government for the same 10-year term was placed at a rate of 6.04 percent. The difference between both rates, equivalent to 1.65 percentage points or 165 basis points, is the premium that the Mexican government must pay so that there are investors interested in acquiring its debt. In relative terms, that additional rate that the Mexican government must pay with respect to a US treasury bond represents the risk that an investor incurs to receive the return on their investment.
The way these premiums behave, more than the rates themselves, gives us a very clear idea of the risk behavior that investors perceive for investing in Mexico. If the premium approached zero, we would be in a situation in which the level of risk for taking on Mexican debt in dollars is equal to that of investing in United States bonds in the same term. On the contrary, if the premiums rise, that means that the level of risk for taking on local debt increases, and that is why they demand a higher rate to finance the Mexican government’s spending.
This explanation serves to put into context two risk premiums that are of interest. Firstly, the premium that results from comparing a bond in dollars issued by the United States with respect to a bond in dollars issued by Mexico, which we will call country risk. Additionally, the premium that results from comparing a bond issued in dollars by the Mexican government with a bond issued in Mexican pesos by the same government, which we will call local risk. The first approaches the country’s idiosyncratic risk from a more structural perspective, while the second is more useful to understand the perspective with respect to the local panorama, such as the responsible conduct of fiscal policy, and which are of interest to a person. who invests in pesos, especially if they operate from abroad.
What do the figures show? The country risk began the year at a level of 164 basis points, and although it experienced certain episodes of volatility during the year, it observed a downward trend until April, when it reached its minimum level at 145 basis points. The last figure, from June 19, showed a level of 174 basis points. With respect to local risk, it began the year at 344 basis points, gradually increasing throughout the year to a maximum of 426 basis points, a value from which it was reduced to 407 basis points registered on June 19.
How do we read these numbers? The country’s risk perception decreased before the election, but then resumed an upward trend. Particularly between May 31 and June 12, that is, around the electoral process, it increased by 25 basis points. On the other hand, local risk has increased steadily, with an increase of 50 basis points in the same period around the election.
The risk premiums denote that concern about the management of public finances and other internal factors is not recent, but has been brewing since the beginning of the year and gained greater notoriety after the election result. On the other hand, the country risk had moderated before the electoral process, but the surprise of the qualified majority pressured it upwards.
The above means that the configuration of an environment in which the country’s system of checks and balances is weakened does create a relevant concern in the markets that should not go unnoticed, since this will create an additional cost in the management of the debt that It will limit the space available to undertake different tasks from the Federal Government as soon as its first months in office. For an administration that is just beginning, the positioning regarding the proposed changes must be precise and forceful to contain these risks.
