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Summary Mexican Peso depreciation
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Mexican Peso depreciation
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To what extent might the depreciation in Mexico’s currency improve its economicperformance? (25)
Due to falling oil prices which lead to decrease in demand for Mexican peso and loss of
productivity in Mexico relative to the US, the Mexican peso has depreciated by more than
50 % against the dollar in the last 5 years, 70% in the last 10, 100% in the last 15, 150% in
the last 20, and 500% in the last 25 years.
Fall in exchange rate causes price of imports to rise and exports to fall, making exports more
price competitive, thus improving the current account of balance of payment as demand for
exports is likely to be higher than demand for imports. However, a large share of Mexico’s
manufacturing uses imported goods as production inputs, this means that as price of
imports rises, cost of production rises as well, thus price of exports may rise too, therefore
the current account may not be improved. Furthermore, according to the Marshall-Lerner
condition, the sum of the elasticities of demand for exports and imports must exceed one
for balance of payments to improve following a devaluation in currency. However, the top
exports from Mexico are crude petroleum, cars and vehicle parts, and its top imports are
refined petroleum, vehicle parts and integrated circuits. These are commodities and
essentials that have relatively low price elasticities of demand, therefore fall in exchange
rate of Mexican peso may not have a significant effect on improvement of its current
account. This can be supported by the fact that Mexico has a trade deficit of USD 1.236
billion in January 2021.
Due to lower exchange rate which makes it cheaper for multinational to purchase assets
locally, and more expensive for domestic investors to purchase assets overseas,
depreciation of Mexican peso has led to more inward FDI and less outward FDI which
improves its financial account position, helping it to become the world’s fifteenth largest FDI
recipient. However, there are also other factors that attract inward FDI, such as Mexico's
macroeconomic stability, large domestic market, growing consumer base, rising skilled labor
pool, welcoming business climate, and proximity to the US. However, although increase
inward FDI may help improve Mexico’s financial account position, it will cause exchange rate
to eventually rise due to higher demand for Mexican peso, and will worsen trade deficit due
to loss of its price competitiveness and thus causing demand of exports to fall and imports
to rise. Also, the fact that peso has devaluated after previous promises not to do so led
investors to lose confidence in policymakers and thus may cause inward and local
investments to fall.
In conclusion, the extent to which depreciation in Mexico’s currency can improve its
economic performance depends on many factors, such as whether the increase in demand
for exports cause by falling exchange rate is enough to recover the fall in prices of exports. It
also depends on the extent of the depreciation and whether it is short or long term.
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