Mexico Rate Drop a Confidence Sign

A plunge in Mexico’s benchmark interest rate by 2.4 percentage points Tuesday to its lowest level since 1994 reflects growing confidence in the economy’s ability to withstand the U.S. slowdown and repercussions of problems elsewhere in Latin America, analysts said.

Confidence in Mexico’s economy continues to build in the aftermath of last week’s announcement by Citigroup Inc. that it would acquire for $12.5 billion Grupo Financiero Banamex-Accival, parent company of Banamex, Mexico’s largest independent bank. Mexico’s main stock index is at its highest level since September, after rising 2% on Wednesday, the same day the U.S. stock market declined.

Rates on the 28-day cetes, or treasury bill, a benchmark used to fix rates of an array of consumer and business loans, dipped to 10.21%, down from a high of 18.39% in January.

The drop in the cetes rate was expected after the Mexican central bank took dramatic measures Friday to ease its tight money policy amid signs that inflation was less of a threat. The bank said it would allow more currency to circulate in the financial system, a step designed to lower rates by making money more available. The bank also said it would stop buying dollars in the open market, a move that could boost the peso even more and help bring down interest rates.

The bank had been keeping rates at what many economists thought was an artificially high level in a bid to keep the clamps on inflation, which is close to this year’s target of 6.5%.

But the imminent influx of billions of Citigroup dollars to complete the Banamex deal and the probable continued appreciation of the peso as dollars continue to pour in to Mexico have eased inflation fears, said Alfredo Coutino, a macro-economist with Ciemex-Wefa, a think tank in Philadelphia.

The drop should spur consumer purchases of appliances and autos and possibly reduce the effect of the U.S. economic slowdown on Mexico’s export-driven economy. The U.S. deceleration has caused economists to lower their estimates of Mexico’s economic growth this year to as low as 2% from previous targets of 4% to 5%.

Mexico’s economy grew only 1.9% over the first three months of this year.

Although the peso weakened Wednesday, closing at 9.07 pesos per dollar, from 8.97 pesos Tuesday, it’s 9% stronger versus the dollar this year. And analysts seemed to shrug off Wednesday’s bad news that Mexico’s trade deficit widened during April, a deficit that could increase in coming months because a stronger peso makes Mexican goods more expensive in other countries.

Instead, observers seemed to focus on improving fundamentals of Mexico’s economy. Because of the peso’s appreciation and a 17% loss versus the dollar this year in Brazil’s currency, the real, Mexico has surpassed Brazil as Latin America’s largest economy in dollar terms, said Walter Molano an analyst with BCP Securities in Greenwich, Conn.

Also making Mexico attractive is its safe-haven status in relation to other troubled Latin American economies, said Guillermo Estebanez, currency strategist at Bank of America in San Francisco.

“Mexico has problems, but the rest of the region is in the midst of a storm,” he said, referring to the debt crisis in Argentina and its effect on neighboring Brazil and Chile. Colombia is in the midst of a civil war and Venezuela’s economy is in turmoil because of its populist leader, Hugo Chavez.

There are skeptics. Lewis Alexander of Salomon Smith Barney said Mexico’s fiscal and trade deficits will result in tough challenges unless oil prices stay high and the U.S. economy rebounds this year.

Molano and Estebanez believe the peso is 25% to 30% overvalued and could sink if an internal or external shock slows the flood of foreign capital entering Mexico. “All crises are relative,” Molano said.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Falling Rates

Mexican benchmark interest rates--measured by the 28-day cetes, or treasury bill rate--have steadily fallen this year as Mexico’s economic fundamentals have solidified.

May 22: 10.21%

Source: Bank of Mexico