Mexico’s Peso Troubles And You
You may have already heart that on Oct. 9 Comercial Mexicana, one of Manzanillo's major Mexican retailers, filed for bankruptcy after racking up over $2 Billion in debt, $1 Billion of which is related to Mexico currency. They have taken this measure in an effort to restructure their obligations with creditors according to El Financiaro.
On Oct. 27 they encountered a bit of a setback according to Mexico Law Blog:
A Mexico City judge rejected the petition of Mexico’s third-largest retailer Controladora Comercial Mexicana (CCM) for bankruptcy protection (concurso mercantil), which would have allowed it to renegotiate the terms of its debt with creditors, according to a report in El Economista.
The report said CCM will file a new petition in the next few hours.
Commercial Mexicana is not the only company to face financial troubles due to the recent drop in the value of the peso. Companies including Cemex SAB, Gruma SAB and Grupo Industrial Saltillo SAB also reported derivative losses, mostly tied to the currency. More major Mexican companies are expected to be reporting losses as well.
Why did this happen?
How exactly this kind of debt can appear so quickly may leave some of us scratching our heads. The reason for all of this is due to some bad investments made by these companies. Essentially, these companies were gambling by holding foreign currency-denominated debt and purchasing foreign exchange rate derivatives (basically betting on the future value of the peso against the dollar). This was a bad bad bet. With the sudden crash of the peso in these past few weeks, these companies have all racked up enormous debts in the process.
Here to explain all of this is The Narcosphere:
The companies' losses have two principal causes: the companies' dollar-denominated debt and their positions in foreign exchange rate derivatives.
Holding debt in a foreign currency is a gamble. The numerical value of the foreign currency-denominated debt stays constant despite fluctuations in the value of the local currency against the foreign currency in question. For example, if a Mexican company takes out a USD$1 million loan when the dollar is worth 10 pesos, the debt is worth 10 million pesos at the time of the loan. However, if the peso suddenly falls to 13 pesos to the dollar while the company still owes USD$1 million, that million-dollar debt is now worth 13 million pesos, meaning the company instantly owes 3 million pesos more than it did before.
However, the gamble of holding foreign currency-denominated debt is nothing compared to the risks associated with the purchase of foreign exchange rate derivatives, one of the numerous forms of capitalist gambling on the global economy. Derivatives are calculated using a complex formula that is based on the value of underlying financial instruments--in this case, the exchange rate between the dollar and the peso. With foreign exchange rate derivatives, investors can literally bet on the value of the financial instrument.
In Mexico's case, investors bet wrong. When the dollar unexpectedly rose two weeks ago, Mexican companies posted enormous losses. Comercial Mexicana, Mexico's third-largest retailer, declared bankruptcy after racking up a USD$2 billion debt, $1 billion of which is due to bad "positions" (bets) in foreign exchange rate derivatives.
The government in Mexico has been taking steps to stabilize the peso, pouring around 11% of their federal reserve into the economy, and we've seen the peso hovering around 13 pesos to $1 this week. What does this mean for the poor in Mexico? That remains to be seen. Suffice it to say, many will be hurting as a result of the global recession.
However, an article today on Market Watch had some of the first good news we've seen yet on the economy down here in a brief article stating that the the outlook looks stable for Mexico's economy. Depending largely on investment by oil firm Pemex over the next several years.
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