Wednesday, April 01, 2009

Mexico Goes to the IMF

From Stratfor:

Mexico's currency commission announced April 1 that it will open a one-year line of credit with the International Monetary Fund (IMF) worth $47 billion, which will be used to shore up the Mexican central bank's reserves. The reserves have been stretched thin in the process of supporting the Mexican peso, which has been destabilized by the international financial crisis.

As a result of investors putting most of their money into the U.S. dollar in response to the crisis, the Mexican peso has depreciated 45 percent over the past eight months. In addition to contributing to inflation (about 50 percent of Mexican imports come from the United States, and the strengthening dollar increases the price of imports for Mexican consumers), the devaluation of the peso makes it difficult for Mexico to finance its current account deficit. This has led the Mexican central bank to spend about $21 billion since October 2008 to stabilize the currency.

This is where the IMF comes in. The IMF has recently opened up a new way to borrow from the organization, called the Flexible Credit Line (FCL), which is available to countries with good histories of macroeconomic management. Under the general terms of the FCL, there would be no set upper limit on the amount Mexico would be able to borrow, and Mexico would have the flexibility to draw on the credit line as needed with a repayment period of between three and a half and five years. More important, under the new IMF rules, the FCL is available without the policy revisions the IMF has required in the past, which would otherwise impose strict measures on states to bring macroeconomic policies into line with IMF recommendations in order to qualify for a loan.

Mexico likely will qualify for an FCL. The country has followed a very fiscally responsible path since the 1994 economic crisis (also known as the Tequila Crisis). Mexico has managed to not only get its debt to a manageable 20 percent of gross domestic product, but has also been able to attain a balanced budget every year for the past four years (although Mexico has authorized deficit spending for 2009 in light of the crisis).

Despite Mexico's high level of fiscal responsibility, if it chooses to draw on the IMF loan to help stabilize the country's currency, it will carry some risks. In the first place, money spent to stabilize a currency tends neither to come back to the country of origin, nor is it an investment that will see a return and nor will it directly generate recovery in the real economy. This makes it more of a burden to repay the loan in the future. Secondly, by guaranteeing to support its currency even further, Mexico essentially tips its hand as it seeks to out-game international currency traders who might be interested in betting against the peso.

Mexico is the largest country to seek financing from the IMF since the crisis. It is difficult to say at this point how much Mexico will actually draw from the institution. Opening the line of credit essentially gives Mexico the option of drawing on additional reserves, and the commission has stated that it does not intend to use the financing. However, by floating the possibility of a credit line worth $47 billion, Mexico has greatly increased the IMF's loan disbursement in the wake of the crisis, which already totals approximately $64.4 billion.