Judging by the way currency traders have been trading the Real and Peso, however, it appears as if traders are not properly distinguishing between the two. When a crisis hits (as one did in September 2008), it seems as if traders sell Latin American together first, then ask questions later. Take a look at the following currency graph from yahoo finance..
The Challenges for Mexico:
The macro economic challenges confronting the Mexican economy are quite serious.
I recently read an excellent (although slightly negative) analysis of the challenges facing Mexico from the source ´RGE monitor` (here). In this article, the economist Walter Molano outlined the following challenges (summarized here):
summary of points:
- The decline in oil prices will hit Mexico hard. The Mexican government will soon face a gaping hole in the fiscal accounts. Oil represents about a third of government revenues. Unfortunately, the decline in the valuation of crude coincides with a plunge in oil production.
- Drop in metal prices will weigh heavily on the mining regions, particularly in the north.
- dramatic fall in remittances expected as the US slows (especially construction)
- Slow down in the automobile industry is forcing some Maquiladoras to close factories and furlough workers.
- The current account gap may exceed $24 billion in 2009.
- This shortfall will be larger if remittances collapse. (which might fall by 50% due to contraction in the US)
- the capital account will not provide any solace. Foreign direct investment will also decline, due to the downturn in manufacturing. There is a chance that the portfolio flows will be negative, as investors flee the emerging markets.
- the peso will have to devalue…the Mexican currency could lose another 20% to 25%, which could put it above 17 to 1 against the USD
- corporate defaults expected; No Mexican CFO is prepared for such a scenario, which could lead to despair on the corporate front. Hence, we could be in for a wave of unexpected defaults.
- social situation could become explosive. The lawlessness caused by the burgeoning drug trade undermined local institutions, such as the press, judiciary and law enforcement.
- author: Walter Molano | Dec 18, 2008
This may be the extreme view to the negative side, but it does throw up the red-flag, and warn investors about the potential for crisis. Investors should be careful, however, to recognize that Mexico has some unique characteristics that should be highlighted, so that investors dont reflexivly sell `Latin America` on bad news in Mexico.
Brazil is different:
While Brazil and Mexico do share a bond as commodity-exporting Latin American nations, there are some critical differences that investors should keep in mind.
Nearly 80% of Mexicos exports go to the USA, but only 17% of Brazils exports head for North America (Canada, Mexico, and USA included). This makes Brazil much less export dependent upon the US manufacturing sector (who´s slowdown is driving the slump in Mexico).
Another big difference is that Mexico´s major commodity export is oil, which has dropped from $130+ per barrel, down to $30.52 last week. Brazil´s exports of commodities are much more food-based and therfore should have support even if the recession turns to depression and lasts longer than analysts predict (so there is less long-term risk for Brazil, as people will continue needing to eat, even if production of material goods doesnt come back for a while).
Also, remittances play a much smaller role in Brazil´s economy than in Mexico´s.
My point is that even if you agree with his analysis (as many traders do), it would be unwise to lump all of Latin America together, and to not distinguish some of the unique characteristics that its economies have. My fear is that investors seem to lump bad news in Latin America together, and punish all commodity exporting countries together whenever one of them shows signs of weakness.
On the other hand….(or, how Mexico could surprise Mr. Molano!)
Before completing this article, I believe its important to first challenge some of Mr. Molano´s assertions…
In response to his article, however, I would say that Mr. Molano forgets to mention that the Mexican government has locked-in oil prices at $70 per barrel throughout 2009 (by purchasing $1.5 billion in derivatives contracts). source: Ft.com
Another factor that Mr. Molano fails to mention is the huge warchest of reserves that Mexico has built up…
`The central bank has accumulated more than $30 billion in foreign currency reserves since Mexico’s own 1995 financial crisis, allowing it to auction off at least $15 billion to prop up the battered peso last year`. source Ft.com
In the mean time, however, I agree with Mr. Molano´s analysis that Mexico will be challenged by a mixture of reduced demand of oil exports, lower level of orders for its manufactured goods, and a reduced level of remittances from abroad, especially from the USA. The danger is that oil prices may stay low beyond one year, at which time, Mexican budget could be serverly challenged.
Join our Forum and our Wiki to discuss…
- Do you disagree with Mr. Molanos analysis of Mexico? Please join our forum to discuss
- Are we missing something? Please visit our wiki for either Brazil or Mexico and add your thoughts…
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Originally published at Globo Trends and reproduced here with the author’s permission.