A depreciation of the peso triggered by rising interest rates in the United States and a strengthening of the dollar is a “risk” to the otherwise positive outlook for the Mexican economy, the country’s deputy central bank governor has told Emerging Markets.
“There is a possibility that financial markets will be too volatile and that it will lead to weaker currencies in several countries. The weaker peso is a risk,” Manuel Sanchez Gonzalez said in an interview.
“We may have some pass-through from a weaker currency during a prolonged period of time towards inflation. So far, the risk has been relatively minor, but we cannot rule out this possibility. The currency depreciation may cause side-effects and affect inflation expectations [negatively] away from the 3% target. You cannot rule out that possibility.”
However, Sanchez Gonzalez said that, overall, Mexico would capitalise on the US economic recovery rather than suffer from the impact of rising interest rates north of the border.
“Mexico will be affected by the higher US interest rate, but the net effect will be a positive development for the Mexican economy,” he said. “The imminent unwinding of the US monetary policy is an important event for Mexico. But at the end of the day, given the fact that the rising of interest rates in the US will come along with a much stronger US economy, we believe that the net effect will be positive.”
Monetary policy unchanged
Mexican officials believe that they have prepared the ground sufficiently to avoid any major shock. “Obviously the gradual normalisation of the US monetary policy is going to affect the world in general,” he said. “There may be some volatility in financial markets because nobody knows how this unwinding of expansionary monetary policy is going to happen.
“But I tend to believe that the US Fed will be very careful and will not surprise the market. It is a phenomenon that is pretty much expected by the market, it should not come as significant surprise. However, one cannot rule out episodes of volatility, or a surprise in the pace of normalisation, but my impression is that this phenomenon has been somewhat announced, and that it should be well handled by the international capital markets.”
The main concern, however, relates to the currency, after a first bout of depreciation that has led the Mexican central bank to intervene in the market to prevent a currency rout. For the time being, Mexico’s monetary policy has remained unaffected. The Mexican central bank has left its base rate unchanged at 3% after this week’s monetary policy meeting, a record low. Meanwhile, economic activity has disappointed so far this year after a modest 2.1% expansion last year.
The decline in oil prices, which account for 40% of Mexico’s fiscal revenues, have already led to budget cuts, equivalent to 0.7% of GDP, earlier this year. “The preventive announcement of these spending cuts has sent investors a strong sign of fiscal responsibility. The cuts were not trivial, in a situation when the oil revenue was almost fully hedged,” said Sanchez Gonzalez.