Download * Director del equipo de Planeación y Evaluación de la Rectoría

Competitiveness and the Exchange Rate in the Mexican Economy
CARLOS ENCINAS FERRER
Economics define international competitiveness as a nation’s ability to offer supplies that will
maintain or increase their share in the external trade market. There are several economic, social,
and political-administrative factors that influence this dynamic capacity. Monetary policy, for
example, plays an effective role in establsihing interest rates and promotes a low inflation
environment when coupled with fiscal policies. Fiscal policies, on the other hand, play a key role in
promoting and directing industrial growth and redistribution of income in a nation, which is
fundamentally essential to strengthening the internal market and balancing social development.
This paper studies the effect of a competitive exchange rate through the relative price of
exportable supply and import price hikes or reductions. Most countries, including Mexico, adopted
a fixed or semi-fixed exchange rate, although the State controlled devaluation to sharply adjust the
parity and reach an external balance. Currently, and for several years now, the Mexican economy
has used a floating exchange rate that is largely determined by market changes, although the
Central Bank, Banco de México, does intervene to a certain degree.
Nevertheless, many years of fixed exchange rates have made it difficult for businesses and the
general public to clearly understand the problems that are created by operating an exchange market
and the limitations it imposes on monetary policy measures determined by the authorities.
The exchange market establishes a balance between the supply and demand of currencies. This
interaction initially includes the price of the currency, or the exchange rate, and secondly, the
amount of currency traded. The problem with understanding the outcome of this balance lies in the
nature of the foreign exchange market — as established by the theory1 — and is comprised of the
following three parallel markets:
1) The market formed by the supply and demand of currencies for import and export
transactions of goods and services;
2) A market in which supply and demand for currency interactions is linked to the purchase or
sale of a nation’s financial assets with a direct investment in real capital, and
1. Supply and demand of foreign exchange operations related to individuals seeking to avoid
losses or create earnings generated by changes in exchange rates.
These three markets operate within the same space and time and one or two might predominate
regardless of the different economic motivations. Thus, in the short and medium terms, exchange
rates may respond to the interests of speculative markets, which increase currency values and affect
individuals and businesses engaged in foreign trade. For example, there might be a strong demand
for pesos from investors who want to operate in the domestic financial market because certificates
and government bonds offer high interest rates. Furthermore, high volumes of remittances from
abroad increase dollar supplies, thus creating a flexible exchange market in which the local
currency appreciates and foreign currencies depreciate. This is part of the normal behavior of a
market in which currency supplies and demand — and not only politics — impose a price.
The problem lies in the different expectations regarding the times in which these forces operate
and create the following three types of market: the short, the medium and long term markets. Flows
of short and medium term foreign currencies that come from both foreign and domestic investors
and target the stock market, and the purchase of government paper or the money market in general,
may lead to an appreciation of the local currency. By the same token, large volumes of direct
Manager of the Planning and Evaluation Team for the Vice-chancellor’s Office, Universidad Iberoamericana, Puebla,
<[email protected]>.
1
Dennis R. Appleyard and Alfred J. Field Jr., Economía internacional, McGraw-Hill Interamericana, Bogotá; 2003, p. 425
foreign investments in Mexico can keep the peso over-valued, although exporters feel this reduces
their competitive margins in the international goods and services markets.
The time factor carries significant weight in exchange rate determinations. The relative prices
of the productive and long-term financial sector depend on variables that affect monetary demand,
and not the production supply.2 Krugman and Obstfeld conclude that exchange rate types reflect the
relative long-term parity of purchasing power when disruptions are of a monetary nature:
In the long run, a monetary disruption only affects a currency’s general purchasing power and
this change in purchasing power also causes the value of a domestic and foreign currency to
fluctuate. It is not very likely to find that an exchange rate’s fluctuation might be based on the
relative purchasing power parity, even in the long term, when disturbances occurs in product
markets.3
However, it bears noting that the exchange market, at least in Mexico, does not operate without
the intervention of the monetary authorities. For example, the Central Bank sterilized dollar
supplies from the elevated oil prices seen in recent years, by not entering the currency market and
being acquired by that institution at the so-called FIX exchange rate, which is calculated on a daily
basis by averaging wholesale volumes and different market prices. The former was an appropriate
monetary policy measure that prevented a higher currency. At the same time, it clearly shows that
the monetary authorities are not convinced that everything should be left to the free play of market
forces. It is important to note that this intervention in the foreign exchange market would not have
taken place if Mexican oil had been in private hands.
The trade deficit would have reached 20 billion dollars had we eliminated the last
three year’s oil surcharges and assumed everything else remained constant
On the other hand, Banco de Mexico intervenes on a daily basis by selling dollars from the
international reserves, and this amount of intervention can vary if the movement in the exchange
rate during the day exchange exceeds a certain percentage set out in its policy’s guidelines.
The importance of the currency market and the exchange rate in a nation’s economic variables
depends on the percentage that the sum of the exports and imports represent in the Gross Domestic
Product (GDP). If, like the United States, that amount is equal to 28.65% of the GDP (2007), the
weight of the domestic market will be predominant and external fluctuations have a moderate effect
on the national economy. Trade between Mexico and the United States accounted for 62.15% of
Mexico’s total foreign trade in 2007 (60.3% in 2006) and 40.74% of its GDP, so the exchange rate
is a fundamental variable for the national economy.
There is something that is even worse: 82.12% of Mexican exports are sent to the United States;
consequently, not only will the peso/dollar parity cause many to lose their sleep, but also the
economic slowdown the U.S. could experience.
Although it is true that the monetary authorities do not intervene in a relevant manner in the
exchange market, it is equally true that this is not the only way they can maintain an overvalued
exchange rate. Monetary policy in Mexico, in recent years, has favored inflation control over other
economic considerations, which, coupled with the needs of the public debt, has caused interest rates
in Mexico to surpass those of the United States and this, added to the strength of the Mexican peso,
produces a large number of short and long-term investors that increase the dollar supply and keep
the national currency overvalued.
2
3
Paul R. Krugman and Maurice Obstfeld, Economía internacional: teoría y práctica, Addison Wesley, Madrid, 2001.
Ibid. page 435
For example, in early September 2008, the three-month interest rate paid by short-term U.S.
Treasury bonds (treasury bills) was 1.72% per year, while the Mexican Federal Treasury
Certificates (CETES) paid 8.31% at 91 days – 4.8 times higher than the first rate. The strength of
the Mexican peso and the country’s low-risk rating explains the flow of dollars to the Mexican
foreign exchange market, which has offset and even surpassed the outflows and kept the currency
appreciated.
How can the authorities reduce the flow of the foreign exchange surplus and thus allow the peso
to depreciate? By gradually reducing the restrictions that limit the money supply – such as the
famous cut and the more modern action on monetary conditions and reference rates – so that
interest rates are relatively high when compared to those that prevail in industrialized countries.4
It is important to apply this monetary policy as soon as possible in a selective manner, since
experience has proven that in the long term currency cannot remain overvalued for an indefinite
period of time and that the type of exchange adjusts based on the inflation differentials a country
experiences with its major trading partners. It is crucial to prevent this from happening through a
violent collapse of the exchange rate. The effect that this would have on inflation would depend on
how far it is from reaching the level of potential production or, in other words, the overall level of
utilization of its installed capacity.
What happens when a currency is overvalued and why is the issue of overvaluation in exchange
rates so important? The answer is clear and conclusive: while exports are key to the Mexican
economy, the import of raw materials and industrial manufacturing decreases by reducing economic
activity, and permanent imports and consumer goods prices rise because domestic prices are higher
than external prices, a situation provoked by the overvaluation of domestic currency (see table 1).
It is interesting to note that over the last eight years, the issue of the parity of the peso lost its
relevance in the economic analysis prior to 1999 and the same has happened with the dollarization
issue. Nevertheless, this situation will surely change in the likely event that the U.S. enters a
recession that could affect the lower international oil prices and intensify the problems presented by
the overvalued Mexican currency.
It is easy to remember that right after the 1982 and the 1995 crises in Mexico, all matters
related to the currency exchange rate was of the utmost importance for the economic decisionmaking processes. Even in the late nineties it was believed that the importance of the exchange rate
would continue to capture the attention of specialists and the general public for many years.5
However, the immediate action the Ernesto Zedillo administration took in 1998, before the
international financial crisis and the collapse in oil prices that year, laid the foundation for decisions
made on monetary and financial policy that have maintained financial and exchange rate stability.
Furthermore, the figures seem to justify this lack of interest in the evolution of the currency
exchange parity, upon observing the evolution of the trade balance between 1998 and 2006, which
proved that exports had stopped losing competitiveness in international markets, because the annual
deficit remained constant. However, its development in 2007 along with the results of the first
months of 2008 show that a small deficit that is permanently stable, was overlooked and this will
generate an accumulated increased deficit. This, in itself, is a sign of overvalued exchange from the
perspective of trading in goods and services.
4
The Central Bank has used two key instruments to induce changes in the monetary position: references regarding the monetary conditions published
in press releases on monetary polices and El Corto. Banco de México, FAQ
5
Carlos Encinas Ferrer, "La sobrevaluación del peso mexicano medida a través de su comercio exterior", (The Mexican peso overvaluation measure
through its foreign trade) Mercadotecnia Global, year VI, era 1, Vol. 29, May 2002.
TABLE1
MEXICO: PERFORMANCE OF IMPORTS, 2000 AND 2001 (MILLIONS OF DOLLARS AND
PERCENTAGES)
Imports
Permanent
Raw Materials
Temporary
Total
2000
76 79350
61 70883
35 97062
17447295
2001
80521.58
57 598.53
30 155.92
168276.02
Variation
4.85
– 6.66
– 16.17
– 3.6
Source: compiled with Bancomext Statistics 2001 data <www.bancomext.com>.
Table 2 shows the development of the balances accrued in the 1998 to 2007 period, which is the
result of a trade balance deficit. This is already a constant in the Mexican economy due to the
absence of a devaluation or a depreciation that drastically reduces consumption and investment.
A behavior analysis of the national annual trade deficit (see Graph 1) shows that the negative
annual balances have remained stable over the period studied, with an average of 75 billion dollars
from 1998 to 2006. Fiscal year 2007 relected a changing situation as a result of the increase in the
percentage of overvaluation of the exchange rate.
The central tendency of the behavior did not indicate that the economy’s competitiveness was
deteriorating, but instead, remained constant during the nine-year period. However, care had to be
taken, because the high international price of oil has played a key role in foreign trade and hidden
the effects of the overvaluated exchange rate in recent years.
TABLE2
MEXICO: TRADE BALANCE, 1998-2007
(THOUSANDS OF U.S. DOLLARS)
Year
Exports
Imports
Balance
1998
117 539 292
125 373 059
- 7 833 766
1999
2000
2001
2002
2003
2004
2005
2006
136 361 793
166 120 717
158 779 718
161 045 982
164 766 438
187 998 559
214 232 957
250 292 370
141 974 760
174 457 811
168 396 461
168 678 857
170 545 842
196 809 652
221 819 525
256 130 405
- 5 612 967
- 8 337 094
- 9 616 743
- 7 632 875
- 5 779 405
- 8 811 092
- 7 586 569
- 5 838 036
2007
Total
272 044 287
1 829 182 113
283 233 380
1 907 419 752
- 11 189093
- 78 237 640
Source: compiled with data from Banco de Mexico, Balance of payments, exports and
imports of merchandise, 2008
<www.banxico.org.mx/polmoneinflacion/stats/balanzadepagos>.
It is important to note that the rise in oil prices during the years covered by this study has led to a
steady increase of the percentage share of Mexican exports (see Graph 2).
If we were to remove the oil surcharges of the last three years and everything else had remained
constant, exports would have been around 236 billion dollars and the deficit would have reached 20
billion, which would support the hypothesis of loss in competitiveness of exportable supply,
especially in manufacturing, due to the inflation differential between the Mexican and U.S.
economy, a differential that has reached 36 percent rate in recent years.
Graph 3, in which oil exports have been excluded, reflects the development of the accumulated
annual foreign trade deficit from 2003 to 2008. The results of 2007 as well as the first half of 2008,
show how the overvaluation of a currency in an environment similar to the one described in the
previous paragraph, can lead to finances that sooner or later will lead to the depreciation of the peso
to balance the trade scale.
This concern is not new; the author of this paper had stated that the currency was overvalued,
since 2001 Mexico showed its great dependence that was generated by the integration with the U.S.
market, while the economic slowdown in the U.S. at the time was turning into an early recession in
Mexico.
GRAPH1
MEXICO: EVOLUTION OF THE BALANCE OF TRADING SCALE, 1998-2007 (MILLIONS
OF U.S. DOLLARS)
0
- 2 000
- 4 000
- 6 000
- 8 000
- 10000
- 12 000
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: compiled with data from the Banco de Mexico. CE2-Balance of payments, exports and
imports of merchandise, 2008
<www.banxico.org.mx/polmoneinflacion/estadisticas/balanzadepagos>.
________________________________________________________________________________
GRAPH2
MEXICO: RELATIVE WEIGHT OF OIL IN EXPORTS, 1998-2007 (PERCENTAGES)
18 16 14 12 10 8 6 4 2 0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: compiled with data from the Banco de Mexico. Balance of payments, exports and imports
of merchandise, 2008 <www.banxico.org.mx/polmoneinflacion/estadisticas/balanzadepagos>
_______________________________________________________________________
GRAPH3
MEXICO: ACCUMULATED BALANCES OF THE PAYMENTS SCALES EXCLUDING OIL,
2003-2008 (MILLIONS OF U.S. DOLLARS)
0
- 2000
- 4000
- 6000
- 8000
-10000
-12000
-14000
- 16 000
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
• 2003
• 2004
• 2005
• 2006
• 2007
• 2008
Source: extracted data from INEGI. Indicators of economic trends, November 2008, trade balance
<www.dgcnesyp.inegi.org.mx /cgi-win/bdieinitsi.exe/consultar>.
_________________________________________________________________
The total volume of imports and exports fell to14.074 billion dollars 2000 and 2001, representing
a 4.13% decrease. However, the fall in exports was higher than in imports (7.877 million versus
6.197 million dollars), which caused the trade deficit to increase by 20.88%.6
Table 1 indicates how imports behaved in 2001 compared with 2000, albeit disaggregated
according to their final destination. The effects of a recession (which would eventually become a
depression) in an overvalued local currency decreased imports for productive processes, but
increased consumption of goods.
The first signs of a situation that may become one similar to the one in the beginning of this
decade are reflected in the statistics found in Table 3.
While non-oil exports rose 8.5%, total imports rose 10.6%. The increase in imports of consumer
goods however, is higher at 16.7%.
Business owners and the public in general public do not understand why the authorities do not
permit a gradual adjustment of the exchange rate of the currency that would cause the domestic
industry to regain its international competitiveness. Moreover, monetary authorities have indicated
time and again that they are not artificially maintaining the price of the Mexican peso and that it is
freely by the supply and demand of dollars traded in the foreign exchange market. The reason
behind these contradictory opinions is found in the nature of the foreign exchange market, which
determines a currency’s short-term exchange rate.
TABLE3
MEXICO: BEHAVIOR OF THE TRADE BALANCE (MILLIONS OF U.S.
DOLLARS AND PERCENTAGES)
At December
2006
6
Ibid.
At
December
2007
Variation
Non-oil
total
exports
211 652.80
229 579.40
8.50
Total
imports
256 058.40
283 233.40
10.60
Imports
consumer
goods
36 901.10
43 068.50
16.70
Source: extracted data from INEGI. Statistic Trends Information Service, Monthly
Business Balance, February 2008.
Some tools will be used to analyze the theory of international finance to determine the
overvaluation or undervaluation a currency can achieve based on the 1990 averages. Mexico’s
foreign trade data refers to the currency basket of major importing and exporting countries in 2007.
Exchange rates are the annual averages these currencies reflected in 1990 and 2007.
EFFECTIVE EXCHANGE RATE
The definition of effective exchange rate (EER), as found in international textbooks on economy, is
the measure of the relative strength or weakness of a currency, taking into account the many
partners with whom the studied country traded, and the exchange rate in each of said countries.
The average of the variables considered during 1990, which the basis of the calculation, is valued
at 100 and all other observations are weighted in relation thereto.
EER = ∑i Rindex wi
where:
∑i = total partner countries selected
Rindex = 2006 exchange rate by the exchange rate of the base year
wi = total trade of country i by the sum of total trade of selected countries.
Table 4 shows those countries with which Mexico has the largest volume of foreign trade.
Imports and exports to these 14 countries total U.S. $ 498.624 billion, representing 89.8% of total
trade by Mexico in 2007 (555.278 billion U.S. dollars). It is important to note that in 2001 this
percentage was 93.16% with the same group of countries. There was a major change in the internal
composition of foreign trade between 2001 and 2007, while the specific weight in 2001 within the
U.S. trade balance was 83.4% of the sample and 77.7% of total, and its participation in 2007 was
reduced to 73 and 65.6 percent respectively.
We separated the years between 1990 and 2001 in order to calculate the European Union’s
currency exchange rates listed in Table (Germany, Spain, Italy and France), prior to the introduction
of the euro, which were adjusted, from 2002 to the conversion rate set by the European Central
Bank.
The fact that the effective exchange rate (EER) is greater than the unit (4.0835 to 1) means that
the Mexican peso was, in relation to the group of selected countries, weaker in 2007 than it was in
1990.7 The results of the EER in column 4 (R index 2007) shows the depreciation of the peso against
7
Dennis R. Appleyard and Alfred J. Field Jr., Economía Internacional, Richard D. Irwin, Madrid, 1995, p. 528
the currencies of its 14 largest trading partners. The depreciation is noticeable as all the figures in
the column, with the sole exception of the Brazilian Real (1995-2007), are superior to the unit.
The Rindex 2007, in the case of the United States, shows that the dollar had appreciated in 2007
and was 4.3998 times higher than the peso in 1990 or, in other words, the Mexican peso cost only
22.73% of what it was worth in 1990 in regard to the dollar. Therefore, the currency had
depreciated 77.27% in absolute terms with respect to the U.S. dollar.
Depreciation for all the countries in the sample was measured by the figures of foreign trade in
Mexico and the currency basket at the end of 2007, was worth 4.0835 times more than in 1990, in
other words, the peso had depreciated with respect to those countries, 75.5% [11 - (1/4.0835) 1 x
100].
TABLE4
MEXICO: CALCULATION OF EFFECTIVE EXCHANGE RATE (FOREIGN CURRENCY /
MEXICAN PESO) AND FOREIGN TRADE (THOUSANDS OF U.S. DOLLARS)
1
2
3
4
5
6
7
8
Mexican
Mexican
Trade
Country R1990 R2007 Rindex
Exports
Imports
total
wi
2007
United
24834
109264 4.3998
223 403 650
140569921
363 973 571
0.7300
States
China
06250
1.4411 2.3058
1 895900
29791 947
31 687847
00636
Japan
00204
00931
4.5642
1 919867
16360248
18280114
0.0367
Germany 38723
15.066 38908
4104815
10699304
14804119
0.0297
2
Canada
25304
102766 4.0613
6494367
7975322
14469689
0.0290
Korea
00042
0.0118 2.7976
683694
12659989
13343683
0.0268
Taiwan
01096
03328
3.0365
271 808
5898522
6 170330
0.0124
Brazil
65120
56695
0.8706
2010730
5 581 923
7592653
0.0152
Italy
48407
15.066 3.1124
482 230
5560530
6042760
0.0121
2
Malaysia 10910
31859
2.9201
122816
4772 955
4895771
00098
Spain
48086
15.066 3.1332
3583743
3833388
7417131
0.0149
2
France
34589
150662 4.3558
557 756
3100854
3658610
0.0073
United
52726
219187 4.1571
1 563248
2300934
3864181
0.0077
Kingdom
Singapor 16279
72730
4.4677
336049
2087121
2423 170
0.0049
e
Total
247430672
251 192958 498623630
1
9
EER
3.2116
01465
01673
01155
01179
00749
00376
00133
00377
00287
00466
00320
00322
00217
40835
1 R1995 in the case of the Brazilian Real.
Source: data from the Bank of Mexico; International Monetary Fund (IMF); National Statistical Institute of Spain
Statistical Information Network; National Statistical Office of Korea: Bureau of Labor Statistics, U.S. Departmen
Labor; and U.S. Federal Reserve
However, the EER analysis excludes an item of utmost importance: the difference in the
cumulative inflation in the years studied. This needs to be considered as it modifies the framework
for change analysis.
REAL EXCHANGE RATE AND REAL EFFECTIVE EXCHANGE RATE
Since prices are subject to different rates of inflation in each of the countries we trade with, in
addition to variations in the exchange rates, we must consider the movements in prices within said
nations.
However, in view of the fact that not all exchange rates have a similar significance, a
mechanism must be created to successfully weigh each value of the exchange rate index. The
weighting most often used is the value of what the country imports and exports based on a given
partner country i, divided by the total exports and imports of the base country.8
The weight assigned to the chosen countries should allow for a correct measure of the
importance of the selected sample in the international trade of a given country.
The Economic Theory has created the calculation for the Real exchange rate (RER) and the Real
effective exchange rate (REER). In the first, the current nominal exchange rate is calculated in
relation to the inflation differentials in the countries with which the nation trades. In the second, the
movement in the exchange rate is multiplied by the weighting factor of each of the country’s
trading partners within the basket of foreign trade in the sample.
8
Ibid. Pp 527 and 528
TABLE5
MEXICO: CALCULATION OF THE REAL EFFECTIVE EXCHANGE RATE (REER)
1
2
3
4
5
6
7
8
9
Country
CPI
1990
CPI 2007
RER 2007
RER INDEX
1990
R 2007
R 1990
wi
REER INDEX
2007
United
States
China
Japan
Germany
Canada
Korea
Spain
Brazil1
Taiwan
Malaysia
Italy
France
UK
Singapore
Mexico2
100
158.64
2.3491
0.9459
10.9264
2.4834
0.7330
0.6905
100
100
100
100
100
100
100
100
100
100
100
100
100
100
227.39
106.38
143.10
142.46
202.78
183.59
235.13
138.38
163.43
169.78
134.64
161.02
126.91
737.89
0.4441
0.0134
2.9219
1.9840
0.0032
3.7485
1.8066
0.0624
0.7056
3.4665
2.7491
4.7831
1.2509
-
0.7106
0.6580
0.7546
0.7841
0.7688
0.7795
0.2774
0.5694
0.6468
0.7209
0.7948
0.9072
0.7684
-
1.4411
0.0931
15.0662
10.2766
0.0118
15.0662
5.6695
0.3328
3.1858
15.0662
15.0662
21.9187
7.2730
-
0.6250
0.0204
3.8723
2.5304
0.0042
4.8086
6.5120
0.1096
1.0910
4.8086
3.4589
5.2726
1.6279
-
0.0636
0.0367
0.0297
0.0290
0.0268
0.0124
0.0152
0.0121
0.0098
0.0149
0.0073
0.0077
0.0049
1.0000
0.0452
0.0241
0.0224
0.0228
0.0206
0.0096
0.0042
0.0069
0.0064
0.0107
0.0058
0.0070
0.0037
0.8799
1.
CPI 1995 and R 1995 in the case of the Brazilian Real. 2. 2007 = 328.6 for the Mexican Peso.
Source: data from the Bank of Mexico; International Monetary Fund (IMF); National Statistical Institute of Spain; China’s Statistical
Information Network; National Statistical Office of Korea: Bureau of Labor Statistics, U.S. Department of Labor; and U.S. Federal Reserve
The calculation formulas for Mexico and the United States are presented as follows:
peso 2007
CPI United States 2007 1990 = 100
RER peso = dollar 2007
CPI Mexico 2007 1990 = 100
dollar
REER = ∑i (RER Index) i (wi)
Both economies considered must begin with the same base year in order to analyze the price
indices; in the example, January 1, 1990 is equivalent to 100 (except when compared to the
Brazilian Real, in which case, 1995 was used as the base year).
∑I represents the sum of the RER Index of each of the partner countries considered in the
analysis. Table 5 contains calculations which allow for a greater understanding of the changing
position of the Mexican Peso in the exchange market, measured by the foreign trade basket.
A REER of 0.8799, less than the unit, indicates that the exchange foreign basket depreciated by
13.64% in real terms from 1990 to 2007 (1 / 0.8799 = 1.1364). Therefore, the real effective
exchange rate average for 2007 was 12.42 pesos per dollar according to the particular weighting of
the value of what the country exports and imports. Given that the REER was 12.28 pesos in 2006, a
slow but constant deterioration is noted, which dictates the exchange terms of the economy and
consequently, those the exporters faced.
It is obvious to find that this relationship will vary according to the start of the base year, but
there is no doubt that the differential between inflation in Mexico and that of its principal partner
countries has not been compensated by an average rate of similar depreciation and this has caused –
regardless of the base year – an overvaluation of the currency, and exporters have experienced
relative growth in their costs and lost competiveness in the international markets.
The analysis ends with another one of the formulas that are used to measure exchange rate
trends. One of the better known formulas used is the relative Purchasing Power Parity (PPPrel),
whose formula is:9
R
= (R
peso/dollar 2007 peso/dollar 1990
)
CPI Mexico 2007 1990
= 100
x
CPI United States 2007 1990 = 100
where:
R is the exchange rate in the year indicated.
CPI is the Consumer Price Index in the selected year, with the base year stated in the sub-index.
This calculation can be used for the relationship with each currency Mexico trades with. The
PPPrel on currency is solely calculated based on the dollar. The data is taken from Table 4.
R peso/dollar 2007 = 2.4834 (737.89/158.64)
R peso/dollar 2007 = 11.55
9
Ibid. P. 533
If the PPPrel is calculated in a longer series, for example from 1950 to 2007, a different figure is
obtained:
R peso/dollar 2006= 8.65 (1309.552/871.21)
R = 13 peso/dollar 2007
However, use of the method the author has created to standardize long series for the calculation
of PPPrel, which simply converts the polynomial trend of order 2 at zero vertical axis of the graph,
the result varies significantly:10
R peso/dollar 2006 = 11.42
Graph 4 shows the analysis of the long series of PPPrel of the Mexican peso against the United
States dollar before converting to zero the polynomial trend of order 2 shown in red. The
calculations were made taking the annual averages of both inflation and the exchange rate into
account.
The formula for grade 2 of the polynomial trend of the series is:
y = 0.000105544200562407x2
- 0.00671852116602578x + 0.179767722125021
Graph 5 converts the polynomial trend to zero. This system allows a rather stable reference point
in the long series of time in reference to the relative purchasing power parity, without doing the
calculation for a specific year. The percentage difference on the specific calculation is very small
and does not reach 1.4 percent in this case.
GRAPH4
MEXICO: THE PURCHASING POWER PARITY ON PESO / DOLLAR, 1950-2006,
POLYNOMIAL TREND ORDER 2 (PERCENTAGE)
50
40
30
20
10
0
-10
-20
-30
-40
1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006
Source: extracted from personal files. Original data from Penn World Table and Banco de Mexico,
Annual Reports, daily exchange rates and annual inflation
<www.banxico.org.mx/PortaIesEspeciaIizados/tiposcambio/inicadores>.
GRAPH5
MEXICO: THE PURCHASING POWER PARITY ON PESO / DOLLAR 1950-2007,
POLYNOMIAL TREND = O (PERCENTAGES)
50
40
30
10
Carlos Encinas Ferrer. “Integración económica internacional y tipo de cambio”, El Heraldo de León, June 8, 2003
20
10
O
- 10
- 20
- 30
- 40
1950 1956 1962 1968 1974 1980 1986 1992 1998 2004
1953 1959 1965 1971 1977 1983 1989 1995 2001 2007
Source: extracted from personal files. Original data from Penn World Table and Banco de Mexico,
Annual Reports, daily exchange rates and annual inflation
<www.banxico.org.mx/PortaIesEspeciaIizados/tiposcambio/inicadores>.
The graph shows that the parity over the 57 years studied has moved in a ± 30% margin, which
coincides with the Rudiger Dornbusch observations made when he proposed that the economy
should be dollarized.11
It is interesting to corraborate that the data provided by PPPrel regarding the U.S. dollar
measured in the short series 1990-2007 (11.55 pesos) is very close to that obtained by applying the
method to normalize larger series; in this case that of 1950-2007 (11.42 pesos). However,
international trade competitiveness depends not only on trade between the United States and
Mexico, or the inflation differentials in both countries, but on all of Mexico's trade relations with all
its trading partners and the specific weight each of them carries in the grand total.
The results obtained from Table 5 show that the PPPrel peso / dollar towards the end of 2007 and
in relation to the base year (1990), recorded a rate of 11.55 pesos per dollar [2.4834 * (737.890352
/ 158.64)]. However, the weight of the exchange rate appreciation of the currency basket of the 14
countries with higher trade volumes, shows that the exchange rate should be 12.42 pesos. This
implies a difference of more than 7.5%, which, if applied to the 1950-2007 series would yield a real
effective exchange rate of 12.28 pesos.
All calculations indicate that from a foreign trade perspective, there is a significant overvaluation
of the currency that the market will correct, sooner or later, as the financial movements start to
become negative in the payment balance.
11
Rudiger Dornbusch, “Throw away the Peso” from the Gabriel Széleky’s interview with Rudiger Dornbusch, CNI Channel 40,
Mexico, 1997.