Dollar Holding Strong Against Mexico’s Peso : Exchange: Political unrest south of the border and rising U.S. interest rates are factors.

Although the dollar is tumbling in Europe and Japan, it is still formidable in Mexico, where it has gained 9% in value against the peso since December.

A dollar officially will now buy 3.39 new pesos, compared with 3.11 new pesos at the end of last year. The drop in the peso reflects the fact that money is leaving this country because of a combination of political and financial factors.

The Jan. 1 uprising in the southern state of Chiapas and the March 23 assassination of ruling party presidential candidate Luis Donaldo Colosio introduced an element of political instability that has undermined confidence in the Mexican economy. That uncertainty has been exacerbated by the closest presidential race the country has seen in 60 years.

Also, because Mexico relies heavily on U.S. investment in its stock and bond markets, it is vulnerable when interest rates rise in the United States, as they have this year. Higher interest rates north of the border tend to siphon off part of the money that would otherwise be used to buy Mexican stocks and debt instruments.

In addition, Mexican inflation is officially about 8% a year, considerably higher than the U.S. inflation rate of about 3%. So foreigners need added incentive to invest in Mexican assets.

Officials have attempted to stem the outflow of capital by raising domestic interest rates and offering investors dollar-denominated Mexican Treasury bills. The government also has used an unspecified portion of its international reserves to buy pesos for dollars, thus keeping the peso’s slide from becoming too steep.

Nonetheless, because the government can’t afford to drive interest rates too high in an already sluggish economy, or draw down international reserves too far, it has used those tools only to stem the peso’s decline, not to arrest it.

“It is a balancing act,” explained one government official.

Besides its international reserves, Mexico can draw on a $6 billion line of credit from the U.S. Treasury to defend the peso, if necessary. “While we have not used that line, it is extremely important psychologically,” said a government official, who asked not to be named. “It is like a second reserve.”

Peso devaluation is a sensitive issue in Mexico, especially in an election year. In 1976 and 1982, also election years, the government announced deep devaluations that wiped out the life savings of many Mexicans and left companies that had dollar debt on the verge of bankruptcy.

Officials are hopeful that allowing a moderate slide will relieve fears of a deeper devaluation, however. It could also boost tourism and exports and ease the country’s trade deficit by making it cheaper to travel in Mexico or to buy Mexican goods.