NEWS ANALYSIS : Finance Reports, Confidence Boost Peso : Mexico: Stocks have also rebounded on government’s handling of economic crisis.

Perceptions that the Mexican government is doing a better-than-expected job of managing the nation’s economic crisis--along with better-than-expected quarterly financial reports from leading banks--have sparked a sustained rally in the peso and Mexican stocks.

The peso, which had dipped as low as 7.4 to the dollar in the weeks after it devalued on Dec. 20, has continued to gain steadily, closing Tuesday in Mexico City at 5.87. The Mexican Stock Exchange Index slipped 16.05 points, but stayed above the psychologically important 2,000 mark at 2,001.15. The index had surged 5.09% on Monday, closing above 2,000 points for the first time since Jan. 31.

“Any time there is a crushing of a currency, there tends to be overshooting,” said Brian Barish, an analyst at Lazard Freres & Co. “In the case of Mexico, the selling got to be emotional toward the bottom.”

Now both the stock market and the currency appear to be returning to more reasonable levels as government policies start to show results. But the question remains whether those levels can continue to improve or even be sustained.

A stronger peso is essential to the success of President Ernesto Zedillo’s economic emergency plan. That plan, which many analysts consider overly optimistic, is based on a peso that settles at 5 to the dollar--still a long way from current levels. A weaker peso is likely to mean higher inflation and a longer recovery time.

But for the moment, key economic indicators are encouraging, hinting that Zedillo’s plan may not be as unrealistic as some analysts believed when it was introduced.

March trade figures, released last week, show a $383-million trade surplus, the second month in a row that Mexico has reversed last year’s burgeoning trade deficit, which helped spark the crisis.

The Bank of Mexico’s decision to pay out mature tesobono government bonds in dollars also appears to have eased pressure on the peso. Previously, investors had been cashing in tesobono s and putting their money in dollars, in order to take it out of Mexico. The demand for dollars drove the peso down.

Now the central bank is using part of a $20-billion loan package from the United States to pay those bonds directly in dollars on maturity.

Mexico’s two major banks--Banamex and Bancomer, which together account for about 50% of the nation’s banking market--also showed quarterly results that indicate they will probably be able to survive the crisis without government aid.

“That means that problems are confined to the smaller banks and the expenses relating to the bailout of the Mexican financial system won’t be that bad,” Barish said.

The peso and stock market are also taking heart from the launch Tuesday on the Chicago Mercantile Exchange of a peso futures contract designed to ease the risks for investors and companies doing business in Mexico.

The contract allows them to lock in an exchange rate with the dollar in advance, thereby minimizing the risk of a falling peso.

Mexican government officials hope the new contract will help stabilize the peso. That in turn could lure more foreign investors back into Mexico’s capital markets. Mexico badly needs foreign investment, both to moderate the economic downturn it now faces and to ensure future growth.

However, Mexico City economic analyst Jonathan Heath cautioned against overly optimistic hopes that the economy has completely stabilized.

Recently released inflation figures for the first half of April showed prices rising at an annualized rate of 20.2%, the highest since 1988.

Bloomberg Business News contributed to this report.