Corporate and International Finance

...

After the devaluation of the Mexican peso in 1994, the country adopted a Floating exchange rate which means that the government of Mexico has no responsibilities to peg its foreign exchange rate (Carstens & Werner, 2000).

[pic 3]

Fig.2

As seen in Fig.2, Mexico has higher interest rates than most of the major countries in the world. It even has a higher interest rate than the US. Inspite of that, the peso’s value has declined against the dollar over most years. Thus it appears that the higher Mexican interest rates do not attract substantial US investment in Mexico’s securities. This is mainly because as we can see from Fig.2, the interest rates of Mexico are constantly fluctuating with remarkable significance. This immense volatility creates insecurity for the foreign investors. The interest rates in Mexico is far more volatile than other industrialised countries.

Majority of the investments in Mexico is not financed with domestic bank credits or share issuance. They are rather financed with other sources such as firms’ savings, dollar debts or with suppliers. This advocates that the interest rates would not have a probable noteworthy direct impact on investment resolutions (Gallardo & Arriaga, 2015).

The economy of Mexico has a history of high inflation resulting in its Central Bank to adopt an inflation targeting policy. Mexico has a higher rate of inflation than the US. Mexico has also been pressurised by international lending agencies like the IMF and World Bank to decrease its rate of inflation in order to amplify the economic growth. Mexico’s impact on inflation uncertainty has been harmful to the economic growth of Mexico. So inspite of having higher interest rates, Mexico fails to attract substantial investors since the high interest rates result from expectations of high inflation. Which means, the pesos may virtually appear to have a higher interest rate, but considering the expectations of high inflation, the real interest rate in Mexico may not be more than the real interest rate in the US. Other issues like corruption, unemployment, drug trafficking also form critical blockade for the Mexican economic growth (Risso & Sánchez Carrera, 2009).

[pic 4]

Fig.3

The rate of the peso has significantly been the highest as well as the lowest in the year 2009 as seen in fig.3. It has also shown significant increase in the years 2012 and somewhere between 2013 and 2014. Since 2015, a steady drop is more significant than a rise in the rate.

From the standpoint of the US, the value of the Mexican peso is conventionally more turbulent than the currencies of other industrialized countries. The Mexican peso has significantly depreciated down the years, but the level of depreciation has differed at a noteworthy rate. The bid/ask spread tends to be higher for the peso than for currencies of industrialized countries. It is because currencies such as the peso is so volatile that its value can collapse rapidly any moment. Hence the banks that provide foreign exchange services are greatly concerned when it comes to currencies like the peso.

A greater bid/ask spread unfavourably exerts influence on the U.S. firm that does business in Mexico because there is a significant rise in the transaction costs that are correlated with the conversion of dollars to pesos or vice versa.

REFERENCING

Carstens, A., & Werner, A. (2000). Monetary Policy and Exchange Rate Choices for Mexico*. Cuadernos de Economía; Santiago, 37(110), 139–175.

Gallardo, J. L., & Arriaga, R. V. (2015). Macroeconomic effects of high interest rate policy: Mexico’s experience. PSL Quarterly Review; Rome, 68(274).

Risso, W. A., & Sánchez Carrera, E. J. (2009). Inflation and Mexican economic growth: long-run relation and threshold effects. Journal of Financial Economic Policy; Bingley, 1(3), 246–263.