COMMENTARY — Watching the `Tequila effect’

We have seen extensive coverage recently in the financial press of the economic — and social — problems in Mexico. In late December, after months of building pressure, the new Mexican government of President Ernesto Zedillo relented and allowed the country’s overvalued currency, which had been pegged at just over 4 pesos to the dollar since January, 1993, to devalue.

The pressure for the devaluation came largely from Mexico’s gaping trade deficit of US$17 billion, coupled with continuing social unrest. The assassination of the man who was effectively president-in-waiting, Donaldo Colosio, was followed last year by the murder of another prominent politician, while the uprising in Chiapas state has found new life in recent weeks.

The currency crisis is far from over, with the government having spent more than US$1 billion in one week to try to shore up the peso and meet foreign currency debts, while Zedillo’s ability to govern is being tested to the hilt. Mexico’s neighbors north of the Rio Grande are obviously watching and reacting to the crisis more strongly than they may have in the past, given the fragility, as yet, of the North American Free Trade Agreement to which Mexico was admitted last year. But to the south, attention is also firmly fixed on the turmoil in Mexico and what sort of knock-on effect it may have. Most Latin American countries have worked hard at getting their economies into shape in the past five years or so, while at the same time ensuring a process of ongoing political change. And this progress has started to bring in results in the form of overseas investor confidence and capital inflows . . .

However far-reaching the Mexican crisis is viewed to be, it would be unfair to tar the entire region with the same brush. Unlike Mexico, Brazil has ample foreign exchange reserves and enjoys a trade surplus; furthermore, its manufacturing industry is booming. Argentina has fought back from the hyperinflation of the past decade, with the rate now down to under 4%; the country’s trade deficit, at US$5.5 billion, is high, but not as high as Mexico’s; and reserves stand at a respectable US$16 billion. Countries such as Argentina, Brazil, Peru and Chile are right to be concerned that the Mexican crisis will have an impact, through what has been dubbed the “Tequila effect,” upon their ability to draw international investor funds. — From a recent editorial in the London-based publication “Metal Bulletin.”