Pimco Says Brazil, Korea, Mexico Debt ‘Compelling’

By David Yong

Jan. 8 (Bloomberg) -- Bonds sold by Brazil, South Korea, Mexico and Singapore are compelling because emerging markets will avoid a “domino effect” of defaults, according to Pacific Investment Management Co.

Debt sold by countries with strong finances and access to external support, such as the Federal Reserve’s $120 billion currency swap lines, will outperform, the world’s largest emerging-market bond investor said in a report. Ecuador’s default last month diminished the appeal of countries that employ “unorthodox” strategies, it said.

“Default probabilities for countries like Brazil, Korea, Mexico and Singapore remain very low,” Curtis Mewbourne, a managing director and co-head of emerging-market investments, wrote in a note published on Pimco’s Web site. “Current spreads for their debt represent a compelling risk-return opportunity.”

The recommendation shows increased investor appetite for emerging-market debt, allowing the Philippines, Turkey, Brazil and Colombia to raise $4.5 billion selling dollar-denominated bonds this week. The sales will help alleviate a shortage of U.S. currency in the nations, bolstering plans for increased spending to stimulate their economies as exports slump.

Countries in stronger financial positions have their own resources to deal with the global crisis by investing in public works, Mewbourne wrote. He highlighted China’s $585 billion stimulus package and Russia’s $186 billion program.

Default Risk

Brazil’s foreign-currency bonds returned 5.9 percent in 2008, completing a sixth straight year of gains, according to bond indexes compiled by JPMorgan Chase & Co. Ecuador’s debt slumped 73 percent and Argentina’s lost 58 percent. Emerging market local-currency debt rallied a record 8.2 percent in December in U.S. dollar terms, according to Merrill Lynch & Co.’s LDM Plus Index of local-currency sovereign notes.

The Fed in October announced currency swaps of $30 billion each with the central banks of Brazil, Mexico, South Korea and Singapore. The arrangements, due to expire in April, reduce the likelihood of capital outflows that marked the Asian financial crises of 1997, Mewbourne wrote.

Pimco, based in Newport Beach, California, said access to finance will be significantly reduced for Ecuador, Argentina and Venezuela because of their unconventional policies.

Ecuador on Dec. 15 reneged on a $30 million coupon payment, while keeping $5 billion of foreign-exchange reserves. Argentina in November approved plans to nationalize about $26 billion held by 10 private pensions in a move to shore up government finances.

Rating Cut

Investors should expect a “wide range of different outcomes” in terms of default risk in emerging markets, Mewbourne wrote. Ecuador’s credit rating was cut to “selective default” by Standard & Poor’s because of the action.

The cost to hedge a default in Argentina’s five-year bonds rose to 3,713 basis points yesterday from 1,800 basis points three months ago, according to CMA Datavision prices in New York. The cost on similar Venezuela debt jumped to 2,918 from 1,292. A basis point, or 0.01 percentage point, costs $1,000 to protect $10 million worth of debt.

Credit-default swap indexes are benchmarks for protecting bonds against default. The swaps pay the buyer face value in exchange for the underlying securities if a borrower fails to adhere to its debt agreements.

Currency Weakness

Pimco also said that a global credit crunch and an export slump will weaken emerging-market currencies as policy makers follow the U.S., Japan and Europe in cutting interest rates.

China, South Korea, Turkey, Czech Republic and Colombia have cut borrowing costs to counter slumping demand, a response previously reserved for the developed world, Mewbourne said. “We see the scope for even lower policy rates.”

Pimco has tempered its “secular enthusiasm for a generalized strengthening of emerging currencies,” Mewbourne wrote. He didn’t provide any specific currency forecasts.

The Philippines yesterday sold $1.5 billion of 10-year notes to yield 8.5 percent, or six percentage points more than Treasuries, while Turkey sold $1 billion of eight-year bonds to yield 5.01 percentage points above Treasuries. Brazil and Colombia each sold $1 billion of debt this week. Mexico sold $2 billion in bonds on Dec. 18.

Chile, Malaysia, South Korea and Indonesia may also tap the global sovereign debt market later in 2009, according to Brown Brothers Harriman & Co. in New York.

To contact the reporter on this story: David Yong in Singapore at dyong@bloomberg.net.