Mexican Peso Devaluation free essay sample

Since it is undervalued, this will cause the peso to appreciate. Since the peso is appreciating, this means that it will cost more to export goods and it will in turn make it easier to import. Their current account balance is already in trouble; more importing will only hurt this. In turn, this is a strong indicator that a large devaluation is imminent. 4. Mexico’s total foreign exchange reserves have been gradually increasing since 1970. Since they are on a fixed exchange rate system, it is their responsibility to maintain their fixed rate. My assumption is that since they are increasing their total foreign exchange reserves, they are preparing for the fact that they are going to have to buy back pesos on the open market to prevent it from being devalued. The reason they have to buy pesos on the open market is because their current account is growing in the negative direction, meaning they are importing more than exporting. We will write a custom essay sample on Mexican Peso Devaluation or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page 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. . 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. 8% 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 tryi ng 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 commercial banks actions were in reaction to the fear of the peso depreciating. Even if it causes the peso to depreciate relative to the USD, their intentions were to strengthen their currency. 7. The PPP is 22. 38 pesos/USD based on formulas given from class. Given the new exchange rate of MP20. 5/U. S$ I would say it is reasonably valued. It’s only slightly undervalued by less than $2 so the new exchange rate can definitely be considered reasonable. . If the Mexican government decided not to devalue the peso, there are some options they could’ve taken to keep their fixed rate. First, they could’ve raised the interest rates. This would make domestic assets more attractive to other countries, which would ultimately strengthen their currency. Raised interest rates, however, could potentially affect income levels and employme nt negatively. This is because when interest rates are higher, people generally tend to keep their money in the bank. Also, companies may be wary of taking out loans because of the high interest rate costs. Consumers keeping their money in the bank will cut spending, which will ultimately lead to less jobs and income. Also, if companies are afraid of taking out loans, they most likely will not expand which could create more income and job opportunities. Another approach is to buy pesos with its reserves of foreign currencies. They would do this because there is an excess supply of pesos in the world markets. This approach could in turn end up increasing its current account which would increase GDP. As GDP increases, so does employment and income. 9. All three factors stated in this question lead for a promising future for the peso. If foreign companies are making investments in Mexican oil fields, the result will be increased exports. If exports increase, their current balance will continue to increase as well which will strengthen the peso. It will strengthen the peso because the amount of pesos in the world market relative to other currencies will be decreased as a result of increased exports. Despite these facts, the above information strongly suggests that the peso is going to depreciate from its 12. 5/1 USD exchange rate. If the oil exports go accordingly, it will definitely help offset the path to extreme devaluation.