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Sinking too soon? The Mexican Peso parity...

March 05, 2009. 18:56

In the past 10 years the Peso-Dollar exchange rate variance, under a free flotation policy, has been steady from a 9 to 11 Pesos per Dollar. The former strong Peso stability was grounded on private capital inflows flooding the Mexican financial markets, and the existence of a very moderate macroeconomics management.

On September 14, 2008 the retail parity was $10.54 Pesos per Dollar; just before the beginning of the US financial crisis. However, Black October quickly moved the rate to $13 and by the end of 2008 the retail parity broke through the psychological barrier of $14. Despite months of intervention of the Mexican Central Bank to defend the scruffy Peso, in the first week of March 2009 the exchange rate hit a historic low of $15.55 to the Dollar.

Nowadays, the weakening of the Peso has become a constant as Mexico slides to recession with a predicted contraction close to 2 percent in 2009 GDP. The Mexican government failed on the original estimation of a relatively low impact from the crisis. The infrastructure investment initiatives, a strong domestic market and the job-protection measures taken since the beginning of 2009 were not sufficient to keep the serenity in the markets. The loss of confidence was translated into the currency.

The Mexican Central Bank intervention strategy
With the aim to safeguard the battered Peso, during the second week of October 2008 the Central Bank made “extraordinary” Dollar auctions in the domestic financial markets; adding together almost 10 billion Dollars. As a result, on October 8, 2008 the bank´s Parity Commission created a rule to intervene the market, with daily auctions of 400 million Dollars, whenever the Peso slip in more than 2% off the interbank parity reported on the previous day. This decision is grounded in the “sufficient” Mexican International Reserves (over 80 billion Dollars) intended to be used by the government in order to inject liquidity to the domestic market.

Furthermore, the Central Bank stepped into de marketplace on February 4, 2009 by buying Pesos in the financial markets when the parity hit a record low of $14.70 to the Dollar. This initiative was performed beyond of the auctions system established since October last year. The government officials mentioned that the market response to the auctions was not sufficient, and that more aggressive actions were needed to ease the Peso volatility.

The Central Bank purchases of Pesos were repeated on the following days (February 5, 6, 20, 23 & 27); for the first time in more than a decade, analysts focused their attention on the reflect that these decisions were going to have in the weekly account statements from the Central Bank; particularly in the level of the Mexican International Reserves.

The first week of March 2009 the Peso plunged to new lows at $15.55 to the Dollar. Earlier that week the Finance Minister, Agustin Carstens, stated that the Peso was undervalued. The Mexican Peso slumped as much as 47 percent in the last six months. Then, the Mexican government made the decision to shore up the Peso in a bid to rein in inflation. Since several goods traded in the domestic market were imported and paid in US Dollars, a weaker Peso was fueling the inflation (more or less 7%).

The Mexican Central Bank intervention strategy remastered
On March 5, 2009 the Central Bank announced the modification of the existent policy for intervention to the exchange market. The aim is to revisit the Peso to a more unbiased parity.
From March 9, 2009 three decisions will be in ruling:
1.- A new auction´s system will be implemented to offer, on a daily basis, 100 million Dollars to the market.
2.- The rule to intervene the market, with daily auctions of 400 million Dollars, whenever the Peso slip in more than 2% off the interbank parity reported on the previous day will continue but the auction´s amount is lowered to 300 million Dollars
3.- The “extraordinary” purchases of Pesos will remain possible when dealing with speculative attacks to the exchange market.

The arguments expressed by the Central Bank to shore up this strategy are based on the positive estimations made regarding the Mexican Balance of Payments for 2009 and 2010. With this perspective, the projected expansion of the Mexican International Reserves in 2009 (22 billion Dollars) will be used to gradually stimulate the Mexican Peso parity to the US Dollar.

Light on the horizon
Finally, it is important to mention that the current depreciated Peso is influencing in a positive way the export growth, the attraction of foreign investment for manufacturing in Mexico, and the acceleration in the transfer of multinational inter-company projects to Mexico.

DoingBusinessInMexico Staff
Published: March 05, 2009. 18:56 | Last updated: March 11, 2009. 17:54
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