The Peso has gone through a lot of changes since the crisis in 1994. The peso is now the 8th most traded currency in the world and the the most traded currency in Latin America. After the crisis in 1994, Mexico adopted a floating exchange rate regime. As a result, the currency price is set by the forex market with its supply and demand.
Currently, Mexico is the 15th largest economy in the world. As of 2019, Mexico has a real GDP of 2.45 trillion in dollars and a nominal GDP of 1.15 trillion in dollars. Mexico is not in a recession at the time, but GDP growth has slowed down in recent years. In 2018, GDP growth varied a low of 1.2% to a high of 2.6%. At the moment, GDP growth recorded at 1.8% and does not show signs of jump drastically. The IMF recently projected that GDP growth will be 2.1% in 2019, and 2.2% in 2020. The IMF previously projected growth at 3.5% in 2019 and 3.6% in 2020. Increases in GDP results in an increase in supply of peso in foreign countries which will depreciate the Peso. In light of the slower growth in GDP, Mexico can expect miniscule depreciations in the Peso as real GDP increases.
The current political environment also has an effect on the value of the Peso. On December 1st, Mexico inaugurated a new president, Andres Manuel Lopez. President Lopez promised many changes to the welfare of Mexico in his campaigning. In fact, President Lopez has already proposed a moderate increase in government spending for 2019. Government spending is expected to rise 6.1% in real terms. With an expansionary fiscal policy being implemented in 2019, the value of the peso can be expected to appreciate, thus reducing the exchange rate of the peso and the dollar. Alongside increased government spending, President Lopez has already implemented an increase in the minimum wage to 102.68 pesos a day. These effects can be seen on figure 1a. This increase in the minimum wage can have several effects on Mexico’s economy. One effect is increasing the consumption of the low-wage household thus increasing GDP and inflation. However, the effects of the increase in wage are too early to determine.
Inflation rates have shown signs of softening in 2019. Inflation rates for Mexico have dropped to 4.37% in January of 2019, as opposed to the 4.83% at the end of 2018. With inflation rates decreasing, the supply of peso to foreign countries will decrease and increase the demand for dollars in foreign countries. If the inflation rate continues to decrease, Mexico can expect the peso to appreciate. However, Mexico should expect the inflation rate to jump as the newly elected president has increased the minimum wage. The increase in minimum wage will increase consumer spending and firm costs and ultimately increase the inflation rate. However, inflation will always be challenged by the Central Bank with its monetary policies. As a result of softening inflation rates, the Central Bank of Mexico implemented a monetary policy to keep the interest rate at a constant rate of 8.25% on February 7, 2019.
In fact, 8.25% is a decade high interest rate for Mexico. With no change to interest rate at the start of 2019, the peso’s supply and demand in foreign countries should be unaffected by interest rates. With a floating exchange rate regime, the peso’s value should be unaffected by the recent monetary policy. However with minimum wage increase on the horizon, the Central Bank of Mexico will combat the inflation with an increase in interest rates. With further increases in interest rates in the future, the value of the peso can be expected to increase. The effects can be seen on figure 1b.
With GDP, inflation rate, and interest rates considered, one can expect the value of the peso to appreciate in the future. With inflation rates expected to grow as a result of an increase in minimum wage, the Central Bank of Mexico will be implementing tight monetary policies which will increase the interest rate. President Lopez and his promises of expansionary monetary policy will increase the value of the peso.
With factors considered, it is time to look at the exchange rate between the Peso and the US dollar. Currently, the exchange rate is sitting at 19.42 Pesos for 1 US dollar. Since Mexico has a floating exchange rate regime, the forex market will determine the exchange rate between the peso and the dollar. Considering the effects of monetary policies and fiscal policies on the forex market, the peso value will be highly affected by the policies mentioned previously. The biggest effects on the peso will be the expansionary fiscal policy and the tight monetary policies.
A forecast of the peso can be achieved. The peso is expected to appreciate based on current events and policies. The forecasting determination can be seen on the econometric graphs in the appendix. A structural model and ARMA model were run and compared on STATA. Residuals squared and root mean square errors were the main determinants of choosing the optimal model. After performing many tests on the models, forecasting was able to be performed. The forecast of the Peso in 1 year or by the end of 2019 will be 15.94 Pesos to 1 US dollar. Based on the forecasting model, the Peso will either appreciate or the dollar will depreciate in value. The 3-year forecast of the exchange rate will be 15.35 Pesos to 1 US dollar. The 5-year forecast will be 14.82 Pesos to 1 US dollar. These forecasted values do seem unrealistic since the forecasted values predict that the exchange rate will go down by 4 pesos. The biggest thing to take away with these forecasted exchange rates is that the Peso will go up in value in the future. Maybe not as dramatically as the forecasted exchanges rate, but Mexico can expect the exchange rate between the Peso and the dollar to decrease.
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