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Francisco Gil Diaz |
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Not long ago, it looked as if the Mexican peso was becoming the new Swiss franc. Backed by huge capital inflows and underpinned by a fast-growing economy, the currency could do no wrong.
In 2001, the peso was one of just five currencies in the world to appreciate against the US dollar, outperforming in this race upwards the Czech koruna, Polish zloty, Hungarian forint and Peruvian new sol. At the year-end, the Mexican currency had become the strongest in the world, making a total gain of almost 6% against the dollar.
Even by the middle of last year, no-one could quite believe it. “The peso outperformed all our expectations,” says Douglas Muzyka, president and general manager of the DuPont chemical company’s operations in Mexico. “We were waiting for it to fall in value, and it appreciated.”
This year it is expected to lose value, depreciating to above Ps10 to the dollar, currency strategists say. The Mexican central bank predicts a fall to Ps9.99 by the end of 2002, while the Mexican government’s 2002 budget assumes the currency will average Ps10.10 to the dollar this year.
It may be the wonder peso no longer but the currency is set to establish its status as a safe and stable currency for the first time in decades. The real exchange rate is now stronger than at any time since the 1994 Mexican peso crisis, when a devaluation cut the currency’s value in half.
More important, say analysts, the peso’s stability could prompt a change of mindset among investors and traders. “For those who think the peso is an inherently weak currency, waiting for an excuse to destabilize or collapse, its stability is a wake-up call,” says a Mexico City currency trader.
The peso’s strength in 2001 was in part a result of the $12.5 billion purchase last May by Citibank of Banacci-Accival. Around $8 billion of that transaction stayed in Mexico, taking the peso to a record high of 8.97 to the dollar on May 22, having started the year at 10. A record $20 billion total of foreign capital invested in Mexico in 2001 helped the Mexican stock exchange index rise 14.5%, making it the world’s seventh-best performer last year. Foreign investors held $51.4 billion in Mexican stocks at the end of October, or 44% of all publicly traded shares, up from 41% in December 2000 according to the Mexican stock exchange.
A more humble year for the peso is predicted because of the deteriorating macroeconomic climate. Miguel Palomino of Merrill Lynch says factors that kept the peso strengthening in 2001 are being eroded. “Excluding the Citibank deal, foreign direct investment flows in the third quarter of last year were $2.15 billion, the lowest since 1997,” he says.
Whereas interest rates were at 18% at the start of 2001, they are now at historical lows of around 6%. The Mexican economy has slipped into recession, posting flat growth last year, a noticeable shift from the near 7% expansion of 2000.
Low oil prices are also affecting the peso’s outlook. The average price of Mexican oil exported to the US dropped to $13.43 a barrel in mid-December, hovering near its lowest level in three years.
A weak peso would be welcomed by Mexican exporters, many of which have been hit hard by the strengthening currency. Bus and truck manufacturer Grupo Dina went bankrupt in August, blaming the peso. Since Dina began building trucks in 1996, the currency has appreciated 20%. While Mexican companies are accustomed to double-digit inflation, they have traditionally relied on a weak currency to offset a host of uncompetitive conditions, ranging from high interest rates to poor infrastructure.
A flight to quality from Argentina following the debt default there in December will lend a hand to the Mexican peso. But the fate of the peso also depends on domestic issues. “Weak Mexican growth doesn’t dent the case for a strong peso but a failure to pass fiscal reform could do,” says Santiago Milan, analyst at HSBC.
Mexico has one of the shakiest tax systems in Latin America. In a move to begin its overhaul, Francisco Gil Diaz, Mexico’s finance minister, early last year unveiled plans for reform, aimed at boosting the country’s paltry fiscal revenues by 4% of GDP, about $25 billion. But the administration of president Vicente Fox has been unable to pass the reforms in congress, as popular opposition to VAT on food and medicine has mounted.
“Fox must deliver on fiscal reform or the peso could fall to as low as 11 to the dollar,” says Milan. “People were counting on a reform package to increase fiscal revenues by 2% of GDP. Now they are expecting at least 1%. Anything less would be a genuine disappointment.”
Fiscal reform could warrant an investment grade for Mexico from rating agencies. Standard&Poor’s is expected to be the first to come through with a rating, partly because the Mexican balance of payments is proving robust despite the US slowdown. The Mexican current account deficit is less than 3.5% of GDP and foreign exchange reserves have increased to $43 billion in September, from $33 billion at the start of 2000.
A genuine if outside chance for a strengthening peso this year lies with energy reform. As with fiscal reform, Fox’s attempt to revamp the state-owned energy sector has stalled. Energy deregulation could attract capital inflows to rival the Citibank-Banacci deal, if foreign companies are allowed to generate and sell electricity in Mexico.
Companies such as Westcoast Energy and TransAlta of Canada have met Fox and negotiations on reform in congress are expected to begin again in March. The principally gas-fuelled electricity sector needs to double its capacity by 2008.
