Mexico’s monetary policy in the face of COVID-19

The Covid-19 crisis has brought great changes and Mexico’s monetary policy is no exception.

One of the main characteristics of the economic measures adopted around the world to alleviate the severity of the economic crisis derived from the Covid-19 pandemic is the magnitude and aggressiveness of monetary policies.

Phases of monetary policy

First, we will state the theoretical framework of the phases that central banks should go through in their extreme monetary policies.

  • Phase I: Reference interest rates are reduced to zero or negative levels, and money creation programs are announced by buying government bonds and other bonds from commercial banks.
  • Phase ii: A gradual reduction to the expansion of money is announced, keeping the reference rates at minimum levels.
  • Phase III: Money printing stops and referral rates begin to gradually increase.
  • Phase IV: It occurs when the reference rate that has been rising, stops because it is considered to be at a neutral level, and the central bank begins the gradual withdrawal of money.
  • Phase V: It should start when the country’s inflation increases sharply and the central bank will have to act by raising the reference rate to where it is considered contractionary and actions are accelerated to collect excess money in circulation.

Bank of Mexico

The Bank of Mexico (Banxico), which is the Mexican central bank, maintained from December 2018 to August 2019 a reference rate of 8.25%, maintaining Phase IV of its previous expansionary policy, however, since September of that In the same year until September 2020, the Bank of Mexico gradually reduced its reference rate to 4.50%, representing a cut of 375 basis points in one year, returning to a more expansive policy. The same happened with other central banks such as the European Central Bank and the Federal Reserve.

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Today all central banks around the world are in Phase I, as a result of the crisis caused by the Covid-19 pandemic. Central banks have adopted very expansionary monetary policies, which could generate significant distortions in all equity markets due to excess global liquidity and the low cost of money caused by central banks.

Last April 2020, Banxico launched 10 additional measures that would support the operation of the national financial system that involve an amount of 750,000 million pesos (which is equivalent to 3.3 percent of Mexico’s gross domestic product), with this , Banxico seeks to promote an orderly behavior in financial markets, strengthen credit granting channels and provide liquidity for the proper development of the financial system, in the face of the Covid-19 pandemic in the country.

The Covid-19 pandemic and its devastating negative results for global economic activity, coupled with the abrupt drop in oil prices, have had a negative impact on the behavior of the financial markets of our Mexico. Therefore, Banco de México considers that a prompt reopening of some key sectors and regions will propitiate a certain recovery in economic activity.

Additional support measures

Additional support measures adopted by Banco de México have been:

  1. Increasing liquidity during operating hours to facilitate the optimal functioning of financial markets and payment systems.
  2. Expansion of the securities for the Ordinary Additional Liquidity Facility (FLAO). That is, foreign exchange hedging operations and credit operations in dollars.
  3. Expansion of counterparties eligible for FLAOs, with which the central bank decided to expand access to these to development banking institutions.
  4. A window for the repurchase of government securities for term so that financial institutions holding government debt obtain liquidity without the need to dispose of their securities under conditions of high volatility in the financial markets.
  5. A window for the temporary exchange of guarantees.
  6. Corporate Securities Reporting Facility.
  7. Provision of resources to banking institutions to channel credit to micro, small and medium-sized companies and individuals affected by the pandemic.
  8. Facility of financing to multiple banking institutions guaranteed with corporate loans, for the financing of micro, small and medium enterprises.
  9. Swap of government securities.
  10. Exchange hedges payable by difference in dollars with counterparties not domiciled in the country to be able to operate during the hours in which the national markets are closed.
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Will this monetary policy help the Mexican economy?

The impact of the Covid-19 pandemic has been considerable and uncertainty persists for the Mexican economy, with a balance of risks for growth that remains significantly biased downward, since a 12.8% drop in GDP is estimated for the end of 2020, being the worst scenario, then there will be a rebound of 3.2% in 2021 and 3.0% in 2022, however, the uncertainty is high.

The exit from the fall that generated this economic crisis will not be the one desired by the market in a symmetric “V” figure, if not, it will be a prolonged “W” figure, this if we again have a strong rebound in cases of Covid-19 and a return to social confinement, which is already expected given the outbreaks registered in various regions of Europe.

Banco de México must soon reinforce its measures announced a few months ago, since the 750,000 million pesos announced is a priori insufficient amount to support the economic recovery, which leads us to conclude that the current monetary policy seeks to attenuate the depth of the recession and not supporting the next recovery of the Mexican economy.

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