Peso Continues Sharp Drop Over Economy Worries

After nine months of granite-solid stability Mexico’s peso is tumbling again, hit by disappointing news about the government’s privatization program and fears that the currency was growing too strong against the dollar.

In three weeks, the peso has lost 5% of its value, sliding from about 7.5 to the dollar to 7.92 on Friday.

Analysts say it’s highly unlikely that Mexico will suffer the kind of currency meltdown that struck in late 1994, causing a severe recession in 1995. But the peso’s slide is nonetheless making Mexicans and some foreign investors nervous.

“The real reason that explains this increase in dollar demand is the lack of confidence in the government’s ability to manage the economy correctly,” wrote economist Jonathan Heath in the daily Mexico City Times.

For most of this year, the peso had been one of the world’s most solid free-floating currencies, hovering around 7.5 to the dollar. That stability--coming after a chaotic year in which the peso lost more than half its value--was trumpeted as a major government achievement and a sign of Mexico’s recovery.

But the peso suddenly began to slide again about two weeks ago. The reasons are diverse, and have their origins in places ranging from the steamy oil fields of southern Mexico to the hushed academic world of Cambridge, Mass.

One factor is the Oct. 13 announcement that President Ernesto Zedillo’s government was backing off on its plans to fully privatize Mexico’s secondary petrochemical industry. The privatization, one of the key economic reforms planned by the administration, had been fiercely opposed by oil workers and Zedillo’s own Institutional Revolutionary Party, or PRI.

“That was a major factor behind the sell-off of the peso,” said Carlos Asilis, Latin America economist at Oppenheimer & Co. in New York. “The perception here is that dinosaurs within the PRI now have the upper hand in terms of economic policy direction over the medium and long term.”

Another factor behind the peso’s softness is a distinguished economics professor at the Massachusetts Institute of Technology, Rudiger Dornbusch. The professor--famed for predicting currency movements--has recently accused the Mexican government of keeping the peso strong in order to dampen inflation. That policy, he said, was what led to the peso crash in 1994.

Authorities denied Dornbusch’s charge. But in a nation shaken by two devaluations in two years, his comments were front-page news.

Other analysts suggest the peso weakness stems from jitters in the market ahead of the government’s expected release this weekend of its economic plan for the next year.

Whatever the impetus for the sell-off, analysts note the action was not a total surprise. Normally, the peso depreciates against the dollar to reflect Mexico’s higher inflation, expected to hit 25% or more this year. But for months, the peso had strengthened against the dollar in inflation-adjusted terms.

Authorities said the peso was making up for a sudden plunge in October last year. But after nine months of steadily gaining in inflation-adjusted terms, the peso was seen by some as getting too strong. Although a stronger peso improves Mexicans’ buying power, it hurts Mexican exporters by raising the price of their goods in America.

“This devaluation was probably the most-forecast in Mexico’s history,” said Alexander Anderson, director of research at the Abaco brokerage house in Mexico City.

Analysts don’t expect a rerun of the disastrous December 1994 devaluation, or even of the 22% slide in the peso that occurred in a mini-crisis last October.

These days, they say, the Mexican economy is clearly recovering from recession and foreign investment is expected to rise. In addition, the country’s central bank has been carefully monitoring the current slide, forcing up interest rates in order to lure back dollars and buck up the peso.

Komal Sri-Kumar, managing director at Trust Co. of the West in Los Angeles, which has nearly $5 billion invested in emerging markets, noted that the peso could come under attack at any time in a free-floating system. However, he said, “I don’t see any reason for it to weaken more than a few hours or a couple of days. I do not expect a run on the peso.”

Still, after being burned by devaluations in the last two years, investors are watching the government’s actions closely.

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Peso Slide

After months of stability, the Mexican peso is weakening. Pesos per dollar, daily closes since Sept. 18:

Friday: 7.92

Source: Bloomberg Business News