What once was highly volatile is now stable as a result of changes in Mexican macroeconomic policy.
As Mexico came out of a severe crisis in 1995, its policymakers began implementing new Mexican macroeconomic adjustments to create a framework for the purpose of making structural changes to its economy. They were of the belief that such changes would secure a more prosperous future for its citizens. Not taking the time, and seizing the moment, to put a market-oriented structure of institutions in place, a continuance of the Mexican economy’s volatile history would impede real growth. Mexico had learned her lessons, and most agreed that making Mexican macroeconomic adjustments was of paramount importance. In fact, over the past couple of decades, the transformation of Mexico’s financial and business climate has been striking, and foreign investment is now pouring in due to several key alterations having been made.
Mexico’s first and possibly most notable move to stabilize the nation’s economy, and shift to an institution-based structure, was to give autonomy to the national bank, Banco de Mexico. With the mandate to manage the nation’s currency, and the rates that determine its purchasing power, Banxico first set its sights on inflation with a goal to limit it to three percent. As a result, the inflation average of thirty-five percent in 1995 has since plummeted to a yearly average of approximately five percent for the past several years. Additionally, the bank improved transparency and communication with the open publication of regular quarterly reports and policy statements.
Another Mexican macroeconomic adjustment targeted fiscal spending and debt. With the enacting of the Fiscal Responsibility Law of 2006, debt and deficit levels have declined to historic lows. Deficit spending now hovers between a consistent two to three percent. The 2006 law mandated that the deficit margin must not exceed +/-1% of total GDP not including investment in the nation’s oil company, PEMEX, which was limited to +/-2% of GDP. Therefore, the total deficit is not to exceed 3% of GDP, and it generally hasn’t in recent years. Additionally, public debt was targeted in order to protect it from exchange rate fluctuations. Whereas public debt amounted to 36% of GDP in 1995, it is now around 10%. As a result, Mexico’s sovereign risk, according to the Emerging Markets Bonds Index, was at 187 basis points as of the end of 2011.
The Foreign Exchange Commission consists of members from both Banxico and the Ministry of Finance and has overseen yet another major macroeconomic adjustment in the form of adopting a free-floating exchange-rate program. Now, the exchange rate is only determined spontaneously by the market, with very few interventions that only occur in the case of dramatic fluctuations, or to reduce extreme market volatility.
Mexico has been aggressively expanding its stockpile of foreign reserves, as well, in an effort to gain further flexibility and capacity for Mexico’s economy. By 2012, international reserves had reached $160 billion in US dollars. The effect of having this much currency of international exchange on hand is that Mexico now has an enhanced capability for economic crisis management and increased investor confidence, particularly when it comes to foreign direct investment.
Photo credit: 401(K) 2012