Mexican peso appreciation to help contain inflation

It will be an important factor to keep inflation from growing at eight or nine percent. Increased oil exports, the weakening of the dollar against other currencies, and the inflow of remittances to the country are among the factors that strengthen the Mexican currency.

Mexican peso appreciation to help contain inflation
The appreciation of the Mexican peso will help to contain inflation. Chili prices are shown in the market. Photo by Reiseuhu / Unsplash

In 2020, during the confinement caused by the COVID-19 pandemic, the Mexican peso depreciated against the dollar and the exchange rate reached almost 26 pesos. Currently, its price has appreciated or increased to between 19.40 and 19.60 pesos against the U.S. currency, despite the lack of economic growth.

This strengthening will help reduce the inflationary pressures facing our economy, but it will not solve them. It is not known how long it will last nor can it be considered a triumph of Mexico's economic policy, affirmed Eduardo Loría Díaz de Guzmán, founder and coordinator of the Center for Economic Modeling and Forecasts of the Faculty of Economics (FE) of the UNAM, Eduardo Loría Díaz de Guzmán.

For Moritz Alberto Cruz Blanco, an expert at UNAM's Institute of Economic Research, the growth of foreign investment in our country -which in the first quarter of the year reached 20 billion dollars-, and the substantial flow of remittances -of approximately 50 billion dollars in 2021- are factors that help the peso appreciate against the dollar; in addition, as there is an unusual amount of foreign currency, the price of these falls.

"What we have seen since 2020 is that many remittances have arrived, foreign direct investment, that exports have grown and are also foreign currency income. As of the first quarter of 2020 there has been a trend towards depreciation (of the dollar), it has fluctuated in the 20 pesos and now it has dropped below that ceiling, hence the name of the 'super peso'," he expressed.

Loría Díaz de Guzmán explained that the appreciation of approximately 4.7 percent in the dollar is due to multiple factors: an increase in oil exports due to various political conflicts such as those in Russia and Ukraine, an increase in world demand for energy due to the recovery of economies, as well as the weakening of the dollar concerning the euro and other currencies.

Also added to this is the growth of domestic manufacturing exports and the significant inflow of remittances to the country. "We have more dollars in our economy, more are coming in than going out, and the exchange rate is flexible," added the coordinator of the Specialization in Applied Econometrics at UNAM's FE.

"How long can it last? Nobody knows. That is, bad news, an increase in the interest rate in the United States could make capital move quickly and we would have a depreciation; how the conflict in Ukraine evolves, how long it could last; what will happen with the accession of Finland and Sweden to NATO and the Russian response, are some of the many variables in play and combination at the moment," she insisted.

Reducing imports

The Ph.D. in Economics explained that the strengthening of our currency benefits the country, since, in addition to reducing inflationary pressures, it makes imports cheaper. The latter is relevant since the Mexican economy imports food, and intermediate goods to export manufacturing, machinery, equipment, and consumer goods.

"An appreciation of the peso is very good because it reduces the inflationary pressures that we have been suffering for a year. It attenuates it, but it does not solve it. Hopefully, this trend will be a significant factor in containing inflation in the coming months and not continue to grow toward eight or nine percent."

The performance of the Mexican peso may also be an element that attracts foreign investment, more so in the scenario of the trade conflict between the United States and China.

"There is a bet that Mexico can replace Chinese value chains. Even though the federal government is very reluctant toward foreign investment and does not like private investment. Fortunately, it seems that foreign investors are more confident in the global economic cycle," she said.

The investment issue is important because the national economy is stagnant. As of the first quarter of 2022, the level of production was equivalent to that of 2016, but with a larger population, which means that per capita output per capita is lower. "This appreciation is by no means a triumph of our economic policy. If we do not grow, we do not demand as many imports and the exchange rate is not pressured," she clarified.

The increase in remittances, which places Mexico as the second country in the world that receives the most -only surpassed by India- cannot be considered an achievement either. This flow of money represents almost six percent of the gross domestic product and has allowed domestic consumption to be maintained, the economy not to fall further and the peso to appreciate. "If we did not have that amount of dollars, surely the exchange rate would be above 22, 23 pesos," she emphasized.

Yield and security

According to Moritz Alberto Cruz, the strengthening of our currency is also due to other causes such as the country's significant international reserves of approximately 200 billion dollars, as well as the uncertainty generated by the war between Russia and Ukraine, inflation, the lack of growth worldwide, and so on.

"This scenario makes investors move their capital in search of yield and security, and could be a factor in the appreciation of the peso, as capital arrives in Mexico to find a good refuge, with a high-interest rate and relative economic and political stability," said the director of Development Problems, Latin American Journal of Economics.

The specialist in development financing and potential growth of the Mexican economy explained that the factors that make our nation attractive compared to China or Brazil are: its geographic location, proximity to the world's largest market, low wage costs, strengthening of trade agreements such as the T-MEC and political stability, among others.

And although the current Mexican government has sent strong signals about its bargaining power vis-à-vis private capital, some companies are used to dealing with tougher governments and therefore bet on political stability.

Regarding whether the appreciation is related to the fact that the Mexican government did not increase its debt during the most critical moments of the pandemic to give support to different sectors, Cruz Blanco considered that investors decide whether to bet on a country by reviewing aspects such as its inflation, the size of the fiscal deficit and the external deficit.

"The fact that the public deficit has not grown so much could have contributed to the fact that not so much capital went out; although they did go out, there was significant bleeding in 2020 and 2021. This factor could have contributed, but as well as they left, others arrived as well", he added.

The good performance of the peso against the dollar, he agreed, has positive effects such as containing inflation and making imports cheaper, but it can also lead to a deficit in the current account or the balance of payments as more purchases are made.

"I believe that what we are going to see, eventually, is an adjustment (in the exchange rate) and we have to be attentive to when it will happen. Sometimes it is very difficult to know when investors will decide to leave and put pressure on the exchange rate," he said.

Cruz Blanco expressed that the COVID-19 pandemic marked a turning point in how the economy develops worldwide and the decisions taken in economic policy. Added to this scenario is the "unexpected war" between Russia and Ukraine and to which more movements will surely be added at a global level, which will affect our nation in one way or another.

"There is no need to panic, Mexico has many tools to face these external effects", concluded the academic from the UNAM's Graduate School of Economics.

Learn more about inflation in Mexico and its main impacts

We frequently hear the word inflation, especially in phrases such as: "for the Bank of Mexico (Banxico) its main objective is to control inflation", "inflation was higher than expected", or "the inflation forecast for next year is so much percent", so it is important to first define this term and what are its main economic implications.

Inflation is the rate of the generalized increase in the prices of goods and/or services by for-profit and non-profit, state-owned and governmental enterprises and the government through its fiscal and economic policies, which affect all sectors of the economy and, directly, the population in the loss of its purchasing power.

The official agency that determines inflation in Mexico is the National Institute of Statistics and Geography (Inegi), which calculates the National Consumer Price Index (INPC), an indicator whose purpose is to estimate the evolution of the prices of goods and services consumed by households in Mexico.

The CPI has national geographic coverage, the quotes used for this calculation are obtained from 46 urban populations or metropolitan areas with more than 20,000 inhabitants, with a sample that includes small, medium and large cities. Each state is represented by at least one city.

Mexicans and inflation

The perception of a large number of Mexicans about inflation in Mexico is that it is not measured properly and is not real, since it is believed that every time we go shopping we acquire fewer goods and services. For those of us who earn our income through a salary or wage, every year that the minimum wage -which is taken into account for most of the increases- increases, not only do we not feel it, but we realize that we cannot recover what we have lost during the year with the increase in prices. One of the greatest difficulties in correctly measuring inflation in Mexico is the great difference in household consumption habits, due to the economic, cultural and social differences between cities, municipalities, states and the Mexican Republic.

Some inflation examples

Inflation is one of Mexico's greatest economic ills; in microeconomics it is known as the income effect, which is a synonym for income. When prices increase and my salary (income) remains the same, it is as if I were paid a lower salary, for example, if the price per liter of gasoline is 15 pesos and I spend 60 liters a fortnight, with my salary of 5000 pesos a fortnight I spend 900 pesos in gasoline and I have 4100 pesos left.

If the price of fuel increases to 20 pesos per liter, then I will now spend 1200 pesos on gasoline and I will have 3800 pesos left, that is, 300 pesos less before the price increase, which is equivalent to a 300 peso reduction in my salary, which is called a loss of purchasing power.

Those 300 pesos that I stopped consuming in other goods and services have a negative multiplier effect on the economy. This means that I stop buying, for example, bread at the corner store, the bread at the corner store from the baker, the baker from several suppliers and the suppliers from other suppliers, this is how it affects the chain and multiplies the loss of consumption and, consequently, they have to produce less, they will obtain less economic benefits and the government will have less tax revenues.

The loss of purchasing power makes me (individual demand), you (individual demand) and the neighbor (individual demand) consume less quantity of goods and/or services. If we add up all the individual demands (purchases) that are made within a territory, the aggregate demand in the domestic market (national or domestic) is formed, and if production has to be reduced and people have to be laid off, all this can generate an economic crisis of production.

For example, if I consume 6 kilograms (kg) of beef (normal good) per fortnight and it costs me 100 pesos per kilo, I spend 600 pesos per fortnight; if I decide to adjust my loss of purchasing power in the consumption of meat, I will buy beef and soybean (inferior good) as a substitute and which has a much lower price, so that I adjust the 6 kg between the consumption of both, spending 600 pesos.

Sources: UASLP, Manuel Gerardo Zulaica Mendoza