Mexico Central Bank Move Won't Affect Peso

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK (BBH FX Strategy) -- Mexican finance minister Ernesto Cordero commented in an interview Monday that the central bank is considering increasing the pace of foreign exchange reserve accumulation.

In our view, this should not be in anyway interpreted as a change in the bank's foreign exchange policy stance and should have little impact on the Mexican peso (MXN).

Mexican policymakers are part of a select few (along with those in Russia and Indonesia, for example) who have openly endorsed the benefits of currency appreciation in fighting inflation. We remain bullish on the Mexican peso and think that a dollar-Mexican peso (USD/MXN) exchange rate of more than 12 is a good entry point.

Unlike the case for several other emerging-market central banks, we think that the Bank of Mexico's stated intention of accumulating foreign exchange reserves is genuine. This was a lesson learned during the crisis, when the Mexican peso and local assets came under pressure because Mexico's foreign exchange reserves were smaller than those in other emerging-market countries. Mexico's foreign exchange reserves are now around $122 billion (up from $114 billion at the start of the year), compared with $315 billion for Brazil, $448 billion in Russia and $297 billion for South Korea.

Earlier this year, the Bank of Mexico reinitiated its reserve accumulation policy through monthly dollar auctions of as much as $600 million dollars, as it did between 1996 and 2001. However, the most important source of the central bank's foreign exchange reserve accumulation comes from direct dollar purchases from the federal government and the national oil company Pemex. These purchases are estimated at around $20 billion for the 2010-2011 period.

During the financial crisis, Mexico established a foreign exchange swap with the Federal Reserve and signed up for the International Monetary Fund's Flexible Credit Line (FCL) to help shore up confidence. It also sold foreign exchange from reserves in daily auctions starting in October 2008 to defend the Mexican peso during the height of the crisis. It then discontinued the auctions in April 2010.

Earlier this year, Mexico renewed the FCL with the IMF, securing roughly $70 billion in backstop funding for a crisis situation. Free insurance is always a good thing, but even without it, the external funding risks for Mexico are negligible in our view.

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