Mexican Peso Case Study Essay

1. Take a look at Mexico’s balance of payments over the past few years. Use the schedule I have attached to the case – it is in the same format as we used to examine the U. S. balance of payments. What do the trade and current account balances suggest about the likelihood of a potential devaluation of the peso? Why? a. It suggests that because Mexico is importing twice as much as they are exporting that there is a strong chance that the peso will lose value to counter the constant increase in imports. It is also important to point out that the exports in 1974 and 1975 are practically the same. The current account balance is negative 4 billion U. S. dollars which is 4 times larger than it was in 1972. All this leads me to believe that the peso needs to be devalued in order to raise the amount Mexico exports. 2. What does the private capital account suggest about the need for a devaluation of the peso? Why? a. The private capital account is a positive 3 billion which indicates that there are a lot more imports than exports suggesting that Mexico is either borrowing a larger portion of money or selling some of its assets. Consequently there is a need for the devaluation of the peso. 3. What does the private transactions balance suggest about the valuation of the peso and whether a very large devaluation was imminent? Why? a. By looking at the private transactions balance it suggest that there was not a dire need for a very large devaluation because it is a positive 172 million where as it has been no larger than 222 million and no smaller than 39 million. That is not to say that the peso did not need to be devaluated however. 4. Take a look at Exhibit 5 in the case – Mexico’s international reserves. What has happened to Mexico’s total foreign exchange reserves since 1970? How would you interpret this trend in terms of evaluating the strength or weakness of the peso in the foreign exchange market? Would you conclude that the peso was likely to be substantially devalued from this data? Why? a. With a gradual increase in Mexico’s total foreign exchange reserves since 1970 it looks like they were preparing for the devaluation of the peso for some time now. The increase in reserves is them trying to prevent or delay the devaluation. From just this data alone however I would not believe that the peso is at risk of being devaluated. 5. Take a look at Exhibit 7 and the forward discounts on the peso versus the dollar. On June 18, what did the market think the peso was likely to do over the next three months? On August 27, what did the market think the peso was likely to do versus the dollar over the next three months? Between June and August, what was the market saying about the magnitude and/or probability of a devaluation of the peso over the next three months? a. On June 18th it was believed that over a 3 month period that the peso would depreciate 20% vs. the U. S. dollar and on August 27th it was believed that the peso would only depreciate 9. 08% over the same time frame. During that time frame the market thought there was a less and less chance that the peso was going to get devaluated. 6. Look at the commercial bank lending rates to prime borrowers in Exhibit 8. Based on these nominal prime borrowing rates, would you expect the peso to appreciate or depreciate against the dollar and by how much? Why? a. If using the December 1975lending rates, the peso would depreciate against the dollar by 5. 9% because Mexico’s interest rate is nearly twice as high as the United States’. 7. What should be the PPP Mexican peso/U. S. dollar exchange rate based on price level changes in Mexico and the U. S. between 1954 and 1975. Given your calculation, is the Mexican peso reasonably valued at the new exchange rate of MP20. 5/U. S$? Briefly explain why. a. The PPP for the Mexican peso/U. S. dollar exchange rate should be MP13. 29/$ and I believe that the new exchange rate is too high, especially when compared to the 13. 29 PPP. Another reason to believe that it is not reasonable is that looking at exhibits 5 and 7 indicates that the peso may not have needed to be devaluated much at all considering the increase in Mexico’s reserves and the decrease in the forward discount from June to August. 8. Suppose the Mexican government had decided not to devalue the peso. What would have been some of the economic and financial policies it could have implemented to defend the currency? How would these policies affect employment and income levels in Mexico? a. Financial policies that could have been implemented would be to limit the number of imports and/or raise import taxes and loosen up their taxes on corporations to encourage new business in Mexico. It would raise employment while having a positive effect on income levels compared to if the peso was devaluated. 9. Please evaluate the future of the peso based on your answers to the above questions as well as the following information: (1) Oil production is likely to come on stream shortly and oil is priced in the world markets in dollars. (2) Foreign oil companies will be making substantial investments in Mexican oil fields. (3) The Mexican government will be able to control inflation. a. The future of the peso is going to look bright because they are increasing jobs by having companies invest in their oil fields. Although other countries will be making money so will Mexico. Since the dollar will be stronger than the peso, the money being made off oil would be equal to more pesos since it was devalued. This will increase exports and since they are able to control inflation it gives them greater control