Tuesday, March 22, 2011

On Mexico's Hot Money Problems

For anyone interested in currency issues and the details of the 1994-95 crisis, this article by Manuel Perez-Rocha about the recent influx of portfolio cash is interesting:
In the first three quarters of 2010, $27.1 billion of portfolio investment poured into Mexico, up from $7.9 billion during the same period in 2009. This “hot money” flow is five times more than what Mexico received in net foreign direct investment. Although the Bank of Mexico hasn’t published the figures for the fourth quarter of 2010, there are reports of more than $45 billion pouring into the stock exchange and to buy government bonds since the beginning of last year’s final quarter. Both Bank of Mexico and World Bank officials have expressed concern that these flows could suddenly reverse course.

Emerging markets as a whole have become hot money magnets, due to their faster growth and higher interest rates relative to those in the United States or Europe. But Mexico is particularly vulnerable for two inter-related reasons.

Under the North American Free Trade Agreement (NAFTA), the Mexican government is severely restricted in its authority to use capital controls, a policy tool many other governments are using to manage hot money flows. For example, Brazil and India have opted to restrict inflows of hot money through fiscal schemes. Also, Mexico’s economy is highly dependent on exports to the United States, a dependency that NAFTA has intensified. If hot money continues to drive up the value of the peso, these exports will be less competitive.

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