TBY talks to Agustín Carstens, Governor of Banco de México, on monetary policy, the forex market, and foreign investment.
TBY How would you rate the success of Mexico’s monetary policy in recent years, and what elements have contributed to the stability we now see in the economy and financial system?
AGUSTÍN CARSTENS Mexico has made great progress in achieving macroeconomic stability in recent years. A monetary policy framework committed to price stability, supported by prudent fiscal policy, relatively low levels of public debt, a flexible exchange rate regime, and a sound financial system have helped to reduce both inflation and its volatility and to anchor inflation expectations. That is, the progress made in terms of inflation in Mexico has been reached in the context of a strong macroeconomic policy framework and, in general, in an environment of solid economic fundamentals. In this setting, Mexico has significantly moved forward in the process of convergence toward the 3% permanent inflation target and it is expected to follow this direction. Furthermore, in order to reinforce the compromise with price stability, the authorities have strengthened the monetary policy framework in recent years. Since the communication strategy is an important element of the monetary policy regime, Banco de México’s Board of Governors considered it convenient to expand the communication mechanisms with the public. From 2011 onwards, the minutes of the Board of Governors’ meetings with respect to monetary policy decisions have been published. This aims to increase the central institute’s transparency even more, and thereby offer more information to market participants and the public about the monetary policy decision-making process, highlighting the most important factors in the decisions of the Board of Governors. This measure has had a favorable impact on investor sentiment and consequently it has strengthened Banco de México’s commitment to price stability. In summary, the increasing credibility of the macroeconomic policy framework and the solid economic fundamentals have significantly improved market participants’ confidence in the Mexican economy. These elements have contributed to the stability we currently see in Mexico.
What policy measures have been most successful in helping to control the volatility of the peso in the dynamic international foreign exchange market?
First, it is important to remember that the foreign exchange policy in Mexico is set by the Foreign Exchange Commission (FEC), which is formed by officials from the Ministry of Finance and from Banco de México, and that since December of 1994 we operate with a free-floating exchange rate regime, which is an important element of the macroeconomic policy framework in Mexico. It can partially absorb external shocks and consequently attenuate the adverse impact on the domestic economy. In this context, due to its stabilizing properties, the floating exchange rate regime has played a key role during the recent period of fluctuation in the international foreign exchange market. In particular, given the confidence in this regime, the depreciation of the nominal exchange rate has allowed a depreciation of the real exchange rate without an effect on inflation or its expectations. Furthermore, in light of the adverse conditions prevailing in international financial markets and with the aim of preserving the orderly functioning of the foreign exchange market, the FEC, decided to implement some preventive measures. First, the FEC decided to temporarily suspend the monthly auction of put options for $600 million among credit institutions that was put in place in March of 2010 to foster the process of the accumulation of international reserves. Second, on November 30, 2011 Banco de México started carrying out daily auctions for a total amount of $400 million among credit institutions with a minimum price of 2% above the immediate previous working day’s exchange rate. This mechanism was successfully used in the past to provide liquidity to the foreign exchange market with minimum market distortions. At this point, it is worthwhile to remember that a very important characteristic of all the mechanisms to sell and buy dollars that the Mexican authorities have put in place is that at all times they have never targeted any specific level for the exchange rate. The consistency in terms of the free-floating regime by limiting the interventions in the market to rule-based mechanisms has helped to control volatility over the long run. In fact, this consistency has helped develop a very liquid peso-dollar market, which according to the last triennial survey conducted by the Bank for International Settlements (BIS) in 2010. places the Mexican peso as the second most liquid emerging market currency, just below the Korean won. In addition, a tool that has also helped contain volatility has been the communication policy that the authorities have maintained with the market. In that respect, the FEC has made a very important effort to be as transparent as possible in terms of its policy actions. Furthermore, Mexico has a sound macroeconomic framework and solid economic fundamentals, which in the end has determined the performance of the Mexican peso in the long run.
Mexico is seeing a steady increase in capital flows. In your opinion, what makes foreign investors confident in directing investments to the country?
Since the second half of 2009, the Mexican economy has received important flows of external financial resources. The stock of government bonds held by non-residents increased from Ps260 billion ($19.7 billion) in June 2009 to Ps973 billion ($69.8 billion) at the end of 2011. The pattern of foreign investment flows is explained by structural factors, such as the solid economic fundamentals of the Mexican economy. Another factor is the inclusion of Mexican government long-term bonds into the World Government Bond Index (WGBI) in November 2010. The incorporation of Mexico’s government bonds into the WGBI increased these bonds’ holdings by non-residents due to the fact that, among other reasons, a considerable number of investment funds worldwide use this index as a reference for their investment portfolio formation. There are other elements related to recent developments that have also supported these flows of foreign financial resources. First, the extraordinary quantitative easing in the US has implied elevated interest rate spreads between Mexico and the US, which led to substantial foreign capital inflows, mainly channeled to government security purchases. Second, in 2009 and 2010, the improvement in the financial systems of the main advanced economies led to increased levels of liquidity in the international financial markets. It is important to mention again that in September 2011 the increasing uncertainty in financial markets as a result of economic and financial problems in the eurozone produced a temporary reversal of investment flows to the Mexican economy. This situation was short lived, and in November and December 2011 the Mexican economy once again received positive flows of external financial resources. These recent events contrast with those at the end of 2008 and beginning of 2009, when a widespread sale of medium- and long-term government securities led to a significant decrease in non-residents’ financial savings. Since then, the strengthening of the fundamentals of the Mexican economy has contributed to the expansion of investors in the base that participates in the Mexican bond market. In particular, the number of institutional investors with a longer-term profile has increased. Regarding FDI flows, which are a relevant source of long-term funding for the economy, they have been flowing to Mexico over recent years, despite lower levels of global economic activity. In 2010, FDI amounted to $19.8 billion, up from $15.8 billion the previous year. The trade openness of our economy, the resumption of economic growth in Mexico, and a stable domestic macroeconomic environment have been factors that have supported these flows of FDI.
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