HANDELSBLATT EXCLUSIVE Mexico Central Banker: Peso Plunge Fueled by Uncertainty

Agustin Carstens, the head of Mexico’s central bank, said in an interview that the peso's plunge has been fueled by uncertainty in the wake of Donald Trump's election victory. He expressed hope that the U.S. and Mexico would find a way to negotiate.
Agustin Carstens, head of Banco de Mexico.

Agustin Carstens, the head of Banco de Mexico, has spent the past two months battling economic uncertainty in the wake of Donald Trump’s surprise victory in the U.S. presidential election.

The peso has plunged on concerns that the U.S. administration will follow through with Mr. Trump’s hard-line rhetoric and build a border wall, levy a 20-percent tax on imports from Mexico and tear up the NAFTA trade agreement.

Diplomatic relations also took a hit after Mr. Trump issued an ultimatum to Mexican President Enrique Pena Nieto ahead of the two leaders’ first scheduled meeting. Mr. Trump sent a Tweet that Mr. Pena Nieto shouldn’t come to Washington if he won’t pay for the border wall.

Mr. Pena Nieto canceled the meeting. Mr. Trump has since agreed to not discuss payment for the border wall in public.

Despite the economic and political volatility, Mr. Carstens is hopeful that Mexico and the United States will reach an accommodation once negotiations actually begin. He believes that the exchange markets have overreacted by selling the peso.

The U.S. administration has softened some of its rhetoric. The White House said that Mr. Trump’s threat to impose a border tax was only one of several options. Mr. Trump also appeared to soften his stance on a border wall after the election, saying some areas could be fencing.

Handelsblatt: You recently said that Donald Trump is like a horror show for the Mexican economy. Why?

Agustin Carstens: The U.S. is the main trading partner for Mexico and every important industry like the auto industry depends a lot on their relationship with it.

In the campaign in particular President Trump made very serious pronouncements which can have strong effects on the Mexican economy. Since he came into power, some more positive statements have been made from his side. Mexican and U.S. officials have just started their discussions. We will see what the result is.

What would be the main effect?

If Mexico has more difficult access to the U.S. market that would affect the manufacturing sector, but that is up to the negotiations. We have to wait and see what the final result will be.

The Mexican currency has depreciated quite a lot against the dollar. How do you assess that?

I think the markets have overreacted. The exchange rate has moved more than I would say is justified by fundamentals. That is basically a reflection of uncertainty.

As the talks between Mexico and the U.S. continue, I have strong hopes that a framework for the discussions will evolve. That would give more clarity to the market so that a correction of the exchange rate can take place. But for now the uncertainty persists as a meeting between Mexico’s President Pena Nieto and Donald Trump has been cancelled.

The Banco de Mexico has started to intervene in the exchange market. Can this really re-establish confidence?

We have done these selective interventions more than anything to avoid very volatile conditions in which small transactions can move the exchange rate a lot. But we do not have a policy to defend a particular level of the exchange rate through interventions.

In other countries interventions on the foreign exchange market were not successful.

Absolutely. That is why we are not using it as a key instrument. The main policy instrument that we are using to anchor the value of the currency is the fiscal and monetary policy stances.

What do you mean?

We have been tightening monetary policy since December 2015. First we started to react in line with the Fed when we raised rates from 3 to 3.25 percent at the end of 2015. Since then we have raised rates up to 5.75 percent right now.

That certainly means a tighter monetary policy in Mexico than in the U.S. and part of that has been a response to the depreciation of the exchange rate. We are acting basically to anchor the value of the Peso. In addition we also have a tighter fiscal policy.

But inflation is already rising significantly in Mexico. In January the annual rate probably will be higher than four percent.

The increase in inflation is mainly due to a rise in gasoline prices. The reason for that rise is a structural reform. There was a gap between the global price of gasoline and the price of gasoline in Mexico. Once you have closed that gap the price of gasoline in Mexico increased and that is reflected in inflation.

In the short-term it has a transitory impact on inflation. But in the medium-term that will strengthen Mexico because it will ease the budgetary burden, and this will anchor inflation. Of course the central bank will follow this process very carefully and if it is causing secondary effects on inflation, we will adjust further our monetary policy stance.

On the one hand, inflation is rising in Mexico. On the other hand, there is the risk that new measures by U.S. President Trump could harm the country’s growth. This seems to limit the room of manoeuvre for the central bank.

Mexico has been doing very aggressive structural reforms during the last years. We have opened the oil sector to private participation, the oil sector as well as the electricity sector. We have done a labor market reform and an anti-trust reform.

I think those reforms are slowly kicking in and increasing productivity and competitiveness. So I think that will be shown in the rates of growth as we move forward. And hopefully we will get an agreement with the U.S. that will not be harmful for growth.

Do you see the danger of a self-reinforcing upward spiral of inflation?

I would say the situation is manageable. But we have to be very watchful of the following developments. Today medium and long-term inflation expectations are anchored. Expectations for 2017 are higher than our objective.

We think the combined effect of the adjustment in gasoline prices and in the exchange rate will be transitory. We focus on medium and long-term expectations and if we see any evidence that they are being de-anchored we will adjust our monetary policy stance.

At the moment the situation in Mexico is quite challenging. Why have you decided to leave the Banco de Mexico at such a critical moment to become the head of the Bank for International Settlements (BIS)?

First, even though I am the governor, decisions are taken by the board of governors. In the board I have four very strong colleagues that will be able to take the decisions in an adequate way.

The other aspect is that central banking and the world economy are going through challenging times. I think to be the general manager of the BIS at that time would be very, very interesting. These types of opportunities do not come every day and to get the opportunity as somebody coming from an emerging market to lead an institution like the BIS is a big honor.

At the same time, I will start at the BIS in October so I still have many months ahead of me in which I can contribute to help the situation in Mexico.

What do you want to achieve as the new general manager of the BIS?

The mandate of the BIS is to be supportive of the different activities of central banks. I want to foster the fact that the BIS is a primary venue for central banks to come and achieve co-operation and collaboration at the global level.

Central banks are very likely to enter a new cycle. This change in cycle from one where central banks are in a crisis-solving mode to enter into a situation where you prepare for more normal circumstances will be a very interesting process. Also, the BIS has to continue contributing to the reform of the financial regulatory system.

But a recent review of the research activities of the BIS highlighted that there was a “house view that was only justified by rather flimsy theory or limited evidence.” How do you assess these findings?

I think the content of the review is not captured by those phrases. If you read the review it is far broader and more positive about the BIS: it praised the BIS a lot in different areas. It says that it punches above its weight with respect to comparable peers. That does not take away that certain aspects need to be enhanced, but my sense is, that there is a strong platform. My opinion is that the media coverage was more critical than what the report really is.

But the phrase is a quote from the review.

It is very different to review the research from an institution than to review research in a university for example. Institutions have a mandate. Everything is geared towards achieving that mandate. So sometimes some people say you should challenge that mandate and think more out of the box. But these institutions have to serve their purpose. So sometimes that limits the degree of openness, the degrees of opinions that can be made public. That is a constant issue and an issue the BIS will have to reflect about it. But I would not make a big deal out of it.

The BIS is well known for its critical stance towards unconventional monetary policies. What is your position on that?

Many countries were confronted with extraordinary circumstances in the past eight years. Monetary policy had the capacity to react very quickly and to help bring financial stability back and to establish the conditions for an economic recovery. Monetary policy has provided some breathing space for other policies to be implemented but it cannot by itself solve all the problems. So I think we are close to what monetary policy can do and other policies should kick in.


Jan Mallien covers monetary policy for Handelsblatt out of Frankfurt. To contact: [email protected]