Mexico Mustn’t Forget 1994

The economists are looking at the Mexican peso again, and many fear it is overvalued. What to do? This is not a decision to be taken lightly, not so soon after the catastrophic recession that befell the country when the currency was devalued three years ago.

President Ernesto Zedillo blamed the earlier debacle on two main factors, a deficit in external current accounts and overvaluation. As we approach the end of 1997, Mexican financial officials have a responsibility to look back, plan and avoid repeating the policy mistakes that sent the peso plummeting in December 1994.

There is plenty of evidence to examine. In July, for instance, Mexico had a monthly trade deficit for the first time since the crisis. The reason is clear. Mexican consumers are tipping the scales, buying more imported products while the country’s businesses are bringing in large amounts of industrial goods. Meanwhile, export growth is flagging. The reason: The peso has held steady in foreign exchange when it should have weakened in the face of steadily high inflation.

What’s happening is growth. The economy is booming, growing last quarter at a surprisingly rapid rate of 8.8% compared to the corresponding 1996 period. Meanwhile, the peso has been pumped up by the massive arrival of foreign capital in search of a better return than other world currencies provide.

Sound good? Not necessarily. Much of the strength of the peso results from Zedillo’s government playing politics through the central bank, keeping the peso high with manipulative policy tools--buying pesos, for example. Instead of exercising its heralded autonomy, the Bank of Mexico has been helping the administration implement a politically inspired stabilization program put in place near the end of the Miguel de la Madrid administration.

In the short term the growth in consumer spending seems to benefit both Mexican consumers and American products that sell there. But in the long term, increased consumption and an artificially strong peso presage serious problems for both countries. Consumer consumption inhibits domestic savings and keeps inflation rates high. It also discourages export growth.

At a time of dramatic political change, it is incumbent upon Mexican financial officials to closely monitor the factors that affect the peso. That includes having a plan ready to avoid a repetition of 1994, whose lessons should remain fresh and frightening.