The Peso Is Falling! The Peso Is Falling!
But this election year, it probably won't collapse

Investors in Mexico have grown accustomed to election-year economic crises. There have been four major currency collapses linked to presidential transitions in the past 25 years. So it's no surprise that the peso began to drop ahead of the hotly contested July 2 vote. After holding steady at 9.4 pesos to the U.S. dollar for most of the past year, the exchange rate tumbled about 6% in June, hitting 10.1 on June 28.

Few analysts fear that the slide is the prelude to a full-fledged crisis. The peso, which has floated freely since it lost more than half its value in December, 1994, is sustained by foreign direct investment flows that reached $11.6 billion in 1999. Besides, the economy is growing solidly: a 7.9% clip in the first quarter, with growth of at least 5% expected over the year. Exports, 85% of which go to the U.S., are about a third higher this year than last and could exceed $160 billion.

Higher oil prices are a big help, too. With Mexican oil fetching around $25 a barrel, vs. $14 a year ago, the country will have no trouble meeting its goal of running a fiscal deficit of just over 1% of gross domestic product. ''I don't see any reason, unless there's a collapse in oil prices or in the Nasdaq, that we will have financial turbulence in Mexico,'' Energy Secretary Luis Tellez told investors in New York on June 27.

All the same, there's a wild card that could turn such optimism on its head. Investors fear a serious dispute over a very close result in the Presidential vote could spark political unrest and economic jitters. The race, between Francisco Labastida of the long-ruling Institutional Revolutionary Party (PRI) and Vicente Fox of the center-right coalition of the National Action Party (PAN) and the Green Party, is Mexico's tightest ever.

Besides, worries are growing that the economy may be overheating. A 9.2% surge in consumer spending in the first quarter could aggravate inflation, currently just under 10%. Plus, recent annual wage hikes for teachers, airline employees, and others have averaged 12%. If consumer demand remains strong, Mexico's current account deficit, now running at 3.4% of gross domestic product, could increase; imports in May were 49.2% higher than a year earlier.

DEFICIT SCENARIOS. Indeed, if oil prices collapse or the U.S. economy falters badly, Mexico's current account deficit could balloon to an uncomfortably big 4.5% of GDP next year. ''There doesn't appear to be any reason for panic,'' says Deborah Riner, chief economist for the American Chamber of Commerce in Mexico. ''But this situation could turn around quickly. What's not a balance-of-payments problem now could be next year.''

Much will depend on what happens during the long transition period between presidencies. Incumbent President Ernesto Zedillo will remain in power for five months after the election. Mauricio Gonzalez, head of independent consultants Grupo de Economistas y Asociados in Mexico City, believes Zedillo should clamp down on government spending during that time. ''It would make sense for him to show real discipline, so that the economy doesn't unravel at the end of his term,'' Gonzalez says. That advice shouldn't surprise Zedillo, who knows first-hand what it's like to inherit a myriad of financial problems. After all, the Yale-trained economist had to devalue the peso just three weeks after his own 1994 inauguration and spent his first year in power mopping up the mess.

The central bank certainly isn't taking any chances. Unlike the U.S. Federal Reserve, it does not set interest rates, which are determined by the market in weekly auctions of treasury notes, called Cetes. But the Banco de Mexico can influence the market by tightening or easing liquidity in the banking system. That's what happened on June 26 when it cut the amount of cheap money available to banks. The next day, rates on 28-day Cetes shot up 1.25 percentage points, to 17%.

Mexico may be able to shake its election-year curse. But currency traders aren't about to tempt fate. They're preparing for the worst. Everyone else can hope for the best.

By Geri Smith in Mexico City

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The Peso Is Falling! The Peso Is Falling!

CHART: Mexico's Wobbly Peso

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