Mexican Peso Devaluation

1. The trade and current account balances are negative which means they are in a deficit. This means that they are importing more than they are exporting. This also means that there is an excess supply of pesos in the world market. Since they are on a fixed exchange rate, the government is going to have to intervene and buy back pesos using its official reserves account. If Mexico’s foreign exchange balance is unable to effectively buy back pesos, they will be forced to devalue. 2. Since the private capital account is gradually increasing, it means the peso needs to be devalued. Generally the current account and the capital account balance are inversely related, meaning if the current account is negative then the capital account is positive. This is true because they are borrowing money from other countries to meet their importing demands. In order to pay back the loans they are taking, they are going to have to pay back in pesos. This will put more pesos on the world market, ultimately devaluing the currency because of its excess supply. 3. Since the private transactions balance is positive, it means that the peso is undervalued. Since it is undervalued, this will cause the peso to appreciate. Since the peso is appreciating, this means that it will cost more to export goods and it will in turn make it easier to import. Their current account balance is already in trouble; more importing will only hurt this. In turn, this is a strong indicator that a large devaluation is imminent. 4. Mexico’s total foreign exchange reserves have been gradually increasing since 1970. Since they are on a fixed exchange rate system, it is their responsibility to maintain their fixed rate. My assumption is that since they are increasing their total foreign exchange reserves, they are preparing for the fact that they are going to have to buy back pesos on the open market to prevent it from being devalued. The reason they have to buy pesos on the open