Essay on Mexican Peso Devaluation

1009 WordsOct 23, 20125 Pages
1. The trade and current account balances are negative which means they are in a deficit. This means that they are importing more than they are exporting. This also means that there is an excess supply of pesos in the world market. Since they are on a fixed exchange rate, the government is going to have to intervene and buy back pesos using its official reserves account. If Mexico’s foreign exchange balance is unable to effectively buy back pesos, they will be forced to devalue. 2. Since the private capital account is gradually increasing, it means the peso needs to be devalued. Generally the current account and the capital account balance are inversely related, meaning if the current account is negative then the capital…show more content…
The money they spent on imports is more than the money they are taking in from exports, creating an excess supply of pesos. In order to eliminate this, the only way is to buy them back. 5. On June 18 the market for forwards on pesos was anticipating a 20% discount on the peso. This means that investors are willing to essentially pay 5 pesos for 6 pesos in 3 months because they anticipate that their value will be discounted 20%. On 8/27, this number was down to 9.08%. This shows optimism that the peso will not be devalued relative to the dollar as much as initially anticipated on June 18. This shows that the market was implying the probability of devaluation over a three month period had gone down, although there is still an expected discount of 9.08% relative to the USD. 6. Since the lending rates to prime borrowers is declining in the U.S. and increasing in Mexico, this shows that Mexico is trying to strengthen the peso relative to the USD. By raising interest rates, they are trying to make domestic assets more attractive in order to raise capital. If other countries start buying their domestic assets, the peso should consequently appreciate vs. the USD. My analysis, however, is that this attempt may be unsuccessful. They are going to have to pay back more so then under lower interest rates. In order to pay back, they are going to be putting more pesos in the world market, ultimately depreciating the value of them. Regardless, the
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