Over the past year, the value of Mexico’s peso has fallen to record lows against the dollar. There are various reasons for this. The most prominent is the expectation that U.S. Federal Reserve will raise interest rates. In fact, the Reserve’s Board of Governors recently held a meeting on the subject, and although they voted to keep rates where they are, they are expected to raise them by the end of this year. These expectations are affecting the value of emerging-market currencies like the peso by making investments in dollars more attractive than investments in other currencies. This is for two reasons. The first is that the American economy is inherently more stable than the economies of emerging-market countries. Investors prefer more stability because it decreases the risk that they will lose their investments. The second reason is that higher U.S. interest rates will allow investments in dollars to offer higher returns than investments in emerging-market currencies. This combination of greater stability and higher returns for investments in dollars will weaken the demand for investments in currencies like the peso, decreasing their value. With enough investors making these calculations and moving their investments elsewhere, the value of the peso is dropping even before the Federal Reserve actually raises U.S. interest rates.
The peso’s weakening is also tied to global commodities markets. The economies of many emerging-market countries like Mexico are highly dependent on China’s demand for commodities and raw materials. The decline in China’s economic growth rate, however, and the subsequent decline in its demand for commodities have caused commodities prices to plummet — dragging down the value of the currencies dependent on them as well. This is because the economic growth of emerging-market countries is driven by their exports. If such a country’s exports decrease dramatically, then its domestic industries will struggle, along with the rest of its economy. Mexico depends less on exports than other Latin American countries, but an overall glut of commodities worldwide can eventually affect Mexico by lowering the prices of all commodities, including those that are a significant part of Mexico’s economy.
Another factor is oil. The goal of Mexico’s energy reform is to boost the production and oil-related income of Mexico’s energy industry by opening it up to private and foreign investment. However, low oil prices threaten that goal because they make private investors unsure of how or when their investments will become profitable. Those who have already invested in Mexico’s oil industry — as well as those who have not yet done so — are waiting for oil prices to rise again before investing more or beginning any large operations. They want to be sure that their investments will become profitable before they put more money into them. The uncertainty of Mexico’s oil industry affects the peso because it affects expectations of how the Mexican economy will perform.
The peso’s weakness means different things for Mexico. First, it hints at possible decreases in the demand for Mexican bonds, and reflects concerns that Mexico’s oil industry will not be as profitable as many hope. Both of these can result in less foreign investment in the country. A weak peso can also affect Mexican consumers by raising prices. Mexico imports many of its consumer goods, which a weak national currency will make more expensive. Also, if the money that Mexicans carry in their pocket is losing value, then they will need to spend more of it in order to purchase goods, further decreasing their purchasing power.
Knowing the reasons for the peso’s weakness, how can Mexico respond? Is the value of Mexico’s currency in the hands of Mexican policymakers? Would it benefit Mexico to defend its currency? A weaker peso could benefit the Mexican economy as a whole by making the country more competitive in global manufacturing markets — Mexico’s exports would be less expensive and therefore more attractive to foreign consumers, increasing the demand for Mexican manufactured goods. However, a weaker peso could hurt the purchasing power of Mexicans by decreasing the value of the money they have and by increasing the price of imported goods. This raises the question of what is best for Mexico: letting the peso slide in order to pursue economic growth through more competitive exports, or propping it up in order to protect consumers. From its economic dependence on other countries, to the prices Mexicans face, and the success of its energy reform, the answers to these questions will have large implications for Mexico’s economy and future.
Raul DeLira is a Rice University sophomore and an intern for the Baker Institute Mexico Center.