Central Bank Governor: Mexico Ready for Fed’s Potential Rate Hike

Mexican central bank Governor Agustín Carstens says his country is ready to deal with the impacts of a prospective interest rate hike by the Federal Reserve expected to be announced in mid-December. 

When asked by Atlanta Fed President Dennis Lockhart for his advice ahead of a meeting with the Federal Open Markets Committee in Washington Dec. 15-16, Dr. Carstens had a simple response. 

“As Nike says, ‘Just Do It,’” he said to laughter from the audience during a World Affairs Council of Atlanta luncheon at the Federal Reserve Bank of Atlanta.

It wasn’t clear whether Dr. Carstens was explicitly urging a rate hike or just telling Mr. Lockhart that the U.S. should act in its own best interests, but the Mexican central banker did clarify later that whatever is good for the U.S. economy would get Mexico’s backing, despite the potential for short-term fallout south of the border.

“In a way, we’re glad to pay the price in terms of volatility of capital flows to get back to the place of strength in the U.S. economy,” he said. 

He noted that the Banco de Mexico’s board would meet the day after the Fed and plot its course in part based on what happens in Washington. Mr. Lockhart said Wednesday that the case for a rate hike looked “compelling” barring something new showing up in the data over the next few weeks, the Wall Street Journal reported. 

Should months of speculation about a December rate hike prove valid, Dr. Carstens said the prospect of higher returns in the U.S. would likely cause capital to leave some emerging markets that benefited in the past from inflows as the U.S. kept rates at historic lows. He envisioned a period of “transition” that would be tough but worth it in the long run. 

That’s only possible because Mexico has a “healthy economy,” having used the last few years to strengthen its balance sheet and initiate reforms key to its competitiveness, he said.

As most Latin American currencies have slid against the U.S. dollar, impacted by lower commodity prices and slower growth globally, Mexico’s peso has kept relatively steady. The central bank has kept inflation at 2.27 percent, below its 3 percent target.

“We need to send signals that we care about the value of our currency,” Dr. Carstens said of the country’s path forward. 

Earlier in his conversation with Mr. Lockhart, the central banker saw three main challenges facing the global economy and in particular, emerging markets: flagging global growth, falling commodity prices and a coming tightening in monetary policy in advanced economies, which present a key challenge to managing the finances of emerging markets. He added that the effects of a potential rate hike are already being factored into investor decisions.

“In the last 30 years probably 2015 has been the worst in terms of net capital growth into emerging markets,” he said. 

Some developing countries that spent too readily during the boom times are feeling the fiscal pinch, Dr. Carstens said. Mexico has been working to improve its balance sheet and reduce dependence on oil as a source of government revenues, of which it accounts for about 30 percent. But an oil stabilization fund that hedged prices at more than $70 means that in 2015 Mexico has actually been making money as prices hover around $40. 

Oil now only accounts for 20 percent of Mexico’s foreign exchange inflows, as opposed to 80 percent 30 years ago as Mexico has become a “manufacturing-based economy” that will be more insulated from a slowdown in China than other commodity-heavy Latin American countries like Brazil, Dr. Carstens said. 

“Being a manufacturing country, that makes us more than anything a competitor to China,” especially for U.S. investment, he said. 

In that vein, the auto sector has become a particularly bright spot, with Mexico now producing 3.5 million cars per year — 2.5 million of them for export — and hatching plans to reach 5 million by 2019, becoming the third largest car producing country behind China and the U.S., Dr. Carstens said. Investments in “molding” the education system to the needs of industry have helped, as have luck and opportunism: Mexico is next door to the largest economy in the world, and it has taken advantage of cheap U.S. natural gas, for example, to reduce manufacturing costs. 

That said, headwinds have blunted optimism engendered by a raft of reforms promised by the administration of Mexican President Enrique Peña Nieto. Low oil prices have discouraged investment in exploration, but privatizing state-owned oil giant Pemex and allowing private companies to produce power for the Federal Electricity Commission will improve management and cure chronic underinvestment and improve the reliability and reach of the grid, he said. 

And that’s just the beginning. Labor laws have been modernized, and efforts to take on the powerful teachers’ unions, reform the telecommunications industry and tackle corruption are under way, though they’re making slower progress than some investors had hoped. 

“One of the most striking factors of Mexico over the last 20 years is why we haven’t been growing faster than we have been growing,” Dr. Carstens said. “The need for these reforms was recognized already a long time ago, but really nobody had the political force, the political savvy to make them go through Congress, and President Peña Nieto had that ability.”

Still, Mexico has chosen its method for addressing what Dr. Carstens sees as the core balancing act facing countries in today’s global economy: maintaining fiscal soundness while driving sustainable economic growth. For Mexico, it’s about long-term competitiveness through tough structural reforms rather than short-term gains from fiscal stimulus, he said, projecting growth of 2.9 percent this year, 3.5 percent in 2016 and nearly 4 percent the following year.

He also praised the Trans-Pacific Partnership, a 12-nation trade deal signed in Atlanta in October. He characterized it as a reprise of Nafta that made sense given Asia’s newfound ascendance and the need for pact to address changes in modern economic sectors like financial services. If ratified, it would also come as a needed endorsement for global trade, he said. 

“I think it establishes a far better platform to develop trade. I think this is also a very powerful symbol to the world that open trade is the way to go to enhance growth.”