MEXICO CITY -- U.S. bankers fear Mexico and other Latin American borrowers will be unwilling to approve an expected surge of applications by lenders to trade loans for equity stakes in local businesses.
Throughout Latin America, these exchanges of foreign loans for local currency have become increasingly appealing as a means of spurring investment, lowering interest payments and reversing capital flight. Yet many countries maintain tight controls on debt swaps, citing fears that a sudden capital influx could worsen their inflation rates.
In a typical swap deal, a foreign lender sells a debt owed by a government to another foreign investor for perhaps 60 percent of its face value. The debt is then converted into the local currency by the debtor government at a rate averaging 90 percent of face value, and the funds are used by the foreign investor in approved local investments.
In some cases, the bank itself exchanges its debt for an equity position. Investors are prohibited from sending swap-generated money abroad or using it to buy foreign currency.
Regulations also seek to prevent what bankers term "round-tripping," whereby speculators illegally use swap funds to purchase dollars rather than financing local investments, pocketing a profit.
Such debt-for-equity swaps are becoming more attractive to banks that are moving to protect themselves against losses on their Third World debt. Citicorp, for example -- which stunned Latin American finance officials two weeks ago by announcing a $3 billion increase in its reserve for losses on loans to the Third World -- said it plans to sell billions of dollars worth of debt and convert others into equity in local businesses.
In Mexico, a bank source said, Citicorp is preparing proposals to exchange loans for equity shares in a dozen local companies, including two state enterprises.
Other Latin loans in the Citicorp portfolio will be sold to investors who will use debt-swap arrangements to convert them into local capital at an average one-third discount.
As other major U.S. banks attempt to swap their Latin American debts, it will greatly expand a secondary loan market that has until now been supplied largely by smaller European, Middle Eastern, and U.S. regional banks, said Carlos A. Gonzalez of London-based Libra Bank, a major debt trader.
Latin debts already are traded at steep discounts, ranging from 59 cents on the dollar in the case of Mexico and Argentina to 63 cents for Brazil and 74 cents for Venezuela. Loans to less solvent borrowers like Peru are sold for as little as 10 percent of face value. Through swaps, however, foreign debts can be redeemed in local currency for close to their official worth.
"With Citicorp's action, there will be an increasing trend toward swaps and other nontraditional debt operations," said Francisco Garces Garrido, a foreign finance director for the central bank of Chile, which pioneered debt-for-equity swaps. Garces said Chile expects swaps to reduce its public commercial debt from $13 billion today to $8 billion in four years.
Mexico, which owes foreign banks about $105 billion, last week reiterated its intention to limit debt trades to about $100 million monthly. "Swaps are not a panacea that will solve our indebtedness problem," Assistant Treasury Secretary Francisco Suarez Davila told bankers attending a conference on swap facilities here.
"Mexico could easily do $2 billion to $3 billion in swap business this year with no significant monetary impact," the chief local representative of a major U.S. bank said. "The market is there. Chile is doing five times that much proportionately. Round-tripping is a real concern, but monetary problems aren't."
Given the logistical difficulties of accurately tracing foreign bank deposits, some bankers here argued, Mexico and other debtors should simply tolerate a "minimal" percentage of round-tripping, as Garces said Chile has done.
Mexico opened the door to debt swaps in April 1986, and within a year received 178 requests from foreign companies to convert $1.49 billion in government debts into pesos for local investments. The officials said they have approved 107 projects, retiring $850 million in debt, and another 55 are nearing completion. The greatest share of this new investment capital -- 41 percent -- has come from the United States, officials said.
Preference is given to projects generating foreign exchange, such as export manufacturing and tourism, officials said. Only 16 applications have been rejected, but bankers contend many more proposals were discouraged before being approved.
Mexican authorities confirmed last week that they are drafting more flexible rules for such swaps, including provisions that will allow Mexican nationals to participate. Until last month's signing of Mexico's new debt accord, Mexican investors were not allowed to participate in swap deals.
The inclusion of Mexicans will more than double the volume of swap requests and could spark speculative dollar trading, said Luis Foncerrada, the treasury secretariat's foreign financing director, who supervises the program. Brazil and Argentina both canceled programs allowing citizens to swap debts because of exchange-rate troubles, he noted. Even Chile's liberal rules now keep nationals from swapping more than $35 million monthly, Chilean officials said.
"The demand for debt-equity conversions is probably greater than the countries' capacity to absorb them," Foncerrada said.
Citicorp's announcement that it is girding itself against defaults shocked Mexican authorities who were privately informed hours beforehand about the move, banking sources said. With $3.2 billion in debts here, Citicorp is Mexico's largest creditor and has coordinated bank strategy in the rescheduling negotiations held continually since the 1982 debt crisis. Its decision was therefore seen as a portent of a tougher bank stance in the next round of debt talks, expected to begin soon after Mexico's next president takes office in December 1988.
Some Mexican finance officials, however, privately welcomed Citicorp's move as a display of "realism" that could point the way to innovative low-cost debt servicing schemes.
Citicorp officials denied they are contemplating a more conciliatory approach, stressing their declared intention to resume Latin American lending and loan collection on a conventional commercial basis. "We expect to continue doing business with countries like Mexico, but only if they show a commitment to structural reform," one said.
A key test of that commitment to economic reform, he added, is receptivity to debt swap deals.
"Some people here may have reacted positively to what we did because they interpreted it as signal that debt relief is on the way, but this is not what Citicorp has in mind," the banker said.