Mexico Interest Rates at Highest Level Since 1996

Driven by global uncertainty and a plunging peso, Mexico’s interest rates have soared to their highest levels since 1996, threatening to undercut this year’s hard-won recovery among consumers.

At Tuesday’s weekly central bank auction, rates on the government’s bellwether 28-day Cetes, or Treasury bill, leaped 5.16 percentage points to 27.16%. The main inter-bank lending rate also rose Tuesday to 29.61%, up from a rate of 21.62% as recently as Aug. 3.

Most analysts see the current rate surge as a straightforward reaction to global uncertainty unrelated to Mexico’s healthy economy. But some are starting to worry about the potential impact if rates remain high for long.

“It’s hard to imagine that such rates could be sustained,” said independent economist Jonathan Heath. “What we’re seeing is a short-term policy response to a short-term noise from abroad.”

Observers here note the spillover from the Asia crisis is afflicting all emerging markets, including the rest of Latin America. But some cite Mexico as uniquely positioned to prosper because of the North American Free Trade Agreement.

Eduardo Cabrera, chief Latin American strategist for Merrill Lynch in New York, said Mexico’s close ties with the United States through NAFTA are proving a valuable support amid the global uncertainty.

“Mexico’s export market is the United States, and the U.S. is the last man standing. It’s the healthiest economy out there,” Cabrera said. “In some ways, Mexico is viewed as a safe haven in Latin America, and that is largely because of NAFTA.”

The central bank has further tightened money supply in recent weeks to keep inflationary pressures from growing as a result of the sharp weakening of the peso. The peso, which floats freely, closed slightly firmer Tuesday at 9.61 to the dollar from its record-low close of 9.74 on Friday.

Some critics have questioned whether the central bank has tightened the money supply enough. Other analysts, however, say the bank’s scope for action is limited in the face of global nervousness toward emerging markets.

“There is not much the central bank can do,” said Javier Maldonado, a senior economist at Bank of Montreal. “If you increase interest rates, that creates problems for the recovery of the banking system.”

If the rates remain high, businesses would presumably avoid taking on new debt and borrowers could be forced to default. That would put Mexico’s banks under renewed pressure just when they have begun to recover from the 1994-95 peso crisis and recession.

Higher interest rates also would dampen consumer spending just when the recovery has finally led to increases in real wages and given consumers money to buy things.

Indeed, Carlos Gomez y Gomez, head of the Mexican Banking Assn., on Tuesday cautioned consumers against taking on new debt until the markets settle and interest rates subside.

“To those who are planning to take out a loan or spend on their credit cards right now, I would say, just be prudent,” he said, adding that such foresight might help the country avoid “what happened to us in 1994, when people were unable to repay their loans.”

The stock market fell 1.3% Tuesday, and consumption-oriented companies took the hardest hits. Appliance retailer Elektra fell 4.84%, and supermarket chain Organizacion Soriana was down 5.49%.

Carlos Samano, chief market analyst for Bancomer, said the basic health of the economy doesn’t justify such high interest rates. “The current rates should represent the ceiling,” he said, but added: “It is inevitable that such high interest rates are going to impact strongly on consumption. I believe the impact won’t be immediate, but will affect the fourth quarter and first quarter of next year.”

He said Bancomer, Mexico’s second-largest bank, had downgraded its projection of economic growth for 1998 from 4.8% to 4.3%.

Yet economist Heath noted that Mexico’s economy has proved surprisingly resilient this year despite falling revenue from oil exports, three government budget cuts and the banking system’s drawn-out problems. Manufacturing exports have remained strong, offsetting lost oil revenue, and private consumption has rebounded firmly.

“The most important thing to keep in mind is we’ve had volatility for almost a year, and yet the economy remains strong and keeps on growing,” Heath said. “We should see a slowdown, but I think people are overreacting.”

The government said Monday the July trade deficit was $695 million, higher than most analysts’ projections. That brought the cumulative trade deficit for the year to $3.7 billion, still within what most economists regard as an acceptable range. Much of the higher July deficit resulted from a 40% drop in oil revenue, as well as the impact in Mexico of the General Motors strike, which reduced exports of auto parts made here by GM.