Mas Appeal : Critics Fear an Overpriced Peso, but Defenders Say Its Strength Shows Faith in Mexico

By CHRIS KRAUL

Aug. 27, 1997 12 AM PT

TIMES STAFF WRITER

MEXICO CITY — Is the Mexican economic recovery, especially the strengthening peso, too much of a good thing? That, ironically, is the subject of much debate these days in Mexico, where the stronger peso has some economists fingering their worry beads.

They point to the peso’s rising value against the dollar on currency exchanges, despite Mexican inflation totaling 30% over the last 18 months. They fear that could reignite a Mexican frenzy for imported goods similar to one that helped torpedo the economy in 1994.

Fueling those fears was the news last week that Mexico ran a monthly trade deficit in July, the first since January 1995. Although a mere $20 million, the imbalance showed that for the first time since the crisis, Mexican consumers and businesses are buying more foreign goods and services than the economy is exporting.

The peso closed Tuesday at 7.77 to the dollar, virtually the same since December 1995 and up 20 centavos since early July.

For the peso to be in perfect sync with the dollar, it would have weakened at a rate roughly equal to Mexico’s inflation, leaving the exchange rate at more than nine to the dollar by now. That’s the exchange rate that some economists, including MIT’s Rudy Dornbusch, were predicting last year.

“Mexico is gradually coming back to a situation where you have a significantly overvalued peso,” warned Gary Hufbauer, director of studies at the Council on Foreign Relations in New York. “That’s how it got into trouble before.”

Also concerned about the peso is Bank of America Chairman David Coulter, who on a visit here Monday told reporters that the peso is too strong and that the government should take steps over the next 18 months to ensure that the overvaluation doesn’t continue.

“I used to run the bank’s currency trading room, and it was always tough to determine what a fair value of any currency is,” Coulter said. “But I’d say the peso is slightly overvalued.”

But the peso’s defenders say its strength merely reflects growing international confidence in Mexico’s economy, especially since the orderly July 6 elections. The upshot: stronger foreign demand for Mexican currency to build factories, open stores and buy Mexican stocks and bonds.

Just this week, U.S. video giant Blockbuster announced plans to open 25 more stores in Mexico, citing a 20% jump in sales and rental revenues here this year.

The strength of Mexico’s recovery was highlighted by second-quarter figures released last week showing the economy had grown a startling 8.8% compared with last year, a rebound boosted by renewed consumer spending. The magnitude and breadth of the growth surprised nearly everyone.

“The peso is much stronger than what anyone expected, but there are good reasons,” said Oscar Vera, chief economist at Deutsche Morgan Grenfell in Mexico City. “We’re in a virtuous cycle in which a stable economy attracts more capital, which reinforces the peso’s strength,” he said.

The best evidence of that growing confidence can be found in the Mexican stock market, where the index is up 49% this year, more than any other major exchange in the world, an advance fueled by a torrent of newly arrived foreign cash.

“An important factor has been the election results that brought some certitude to the electoral process. There were no surprises, and that gave confidence to foreign investors,” said Alfredo Couteno, economist with the CIEMEX/WEFA think tank in Philadelphia.

Couteno said $7.5 billion in foreign capital has come into Mexico’s stock and bond market so far this year, in addition to $2 billion in direct investment in factories, stores and other foreign owned facilities. Much of the recent capital has come here from the Far East, where Thailand’s troubles have caused a widespread capital flight.

“There has been a realignment of investment portfolios in the last few months and in relative terms, Mexico and Latin America look less risky to investors now,” said Carlos Zarazaga, a senior economist at the Federal Reserve Bank of Dallas.

In the short run, an overvalued peso helps U.S. companies because it makes their exports cheaper for Mexican customers. And it’s also favorable for Mexican consumers because it expands their purchasing power in an economy where one-third of all goods and services are imported.

But there may eventually be a price to pay, usually after a shock within or outside the country that persuades all those once-confident investors to flee the country, said economist Sidney Weintraub of the Center for Strategic and International Studies in Washington.

“The danger is that a shock will stop the capital flows. That’s what happened in 1994,” said Weintraub, referring to the events leading up to the December 1994 devaluation that cut the peso’s value against the dollar--then less than four--by half.

The July trade deficit is expected to be repeated. Mexico will run a current account deficit--the trade deficit plus the cost of paying off foreign loans--totaling $6 billion for all of 1997, said Smith Barney economist Peter Greenbaum.

That’s much more manageable than 1994’s $29.7 billion, in effect a huge external debt that Mexico couldn’t afford to pay. That is why Mexico had to go hat in hand to the United States and other countries for a $52-billion bailout.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

The Peso: Too Strong?

Less than three years after its collapse sent Mexico into a deep recession, the peso is showing surprising strength. With Mexico’s inflation rate at 30%, the peso would be expected to weaken to roughly 10 to the dollar. Instead, it has gained slightly on the greenback to a current 7.77. That has boosted consumer spending and reflects foreign confidence in the economy, as shown by a 49% surge in the stock market. But analysts worry that the currency is too strong and that Mexico is now attracting too much foreign money and goods--precisely what triggered the crisis.

Pesos per dollar, monthly closes since 1994 and most recent:

Tuesday’s close: 7.77

Sources: Bloomberg News, Mexican government