Tuesday, January 25, 2011

Mexico Receives the Largest Line of Credit Ever Issued by the IMF

Financial Times: IMF Approves $72bn Credit Line for Mexico
Bloomberg Businessweek: IMF Extends Mexico Credit Line to Record $72 Billion
NASDAQ: IMF Approves Expansion of Mexico Flexible Credit Line

On January 10, the International Monetary Fund (IMF) approved a $72 billion line of credit to Mexico. The credit line, good for two years, is the largest of its kind ever issued by the IMF. The new line will replace a previously issued one-year $48 billion line of credit that is set to expire in April of this year. The line of credit that Mexico is getting is a new type of credit arrangement called a “Flexible Credit Line,” which was established by the IMF in 2009 and is reserved for countries that are pursuing what the IMF considers “strong” economic policies.

Although Mexican officials have stated there is no current need to draw on the line, the line of credit will give Mexico an additional source of reserve assets in the event that additional funds are needed to finance obligations to external creditors arising from possible balance-of-payment problems. Reserve assets, like this line of credit, allow nations to service debt that is denominated in other currencies by giving them the means to purchase the foreign currency.

Assistance from the IMF can sometimes indicate economic trouble, but the issuance of the line is not a signal of weakness in the Mexican economy. Indeed, Mexico has experienced relatively strong economic growth recently. After suffering an economic contraction of over 6% in 2009, the Mexican economy is projected to have grown by more than 5% in 2010. Nevertheless, there are concerns that the Mexican economic recovery is a fragile one, especially given the economic uncertainty that exists in the rest of the world. Mexican officials are particularly concerned about volatile foreign capital flows and pressures in certain industrialized countries to correct fiscal deficit problems. Should these problems cause foreign investors in Mexico to remove their funds (a phenomenon called “capital flight”), it would flood the foreign exchange market with pesos as those investors repurchase their home currencies, which would result in a depreciation of the peso. A cheaper peso means that it will be relatively more expensive for Mexico to pay any foreign denominated debts. Thus, to prevent an excessive devaluation of the peso, the credit line exists to provide Mexico with a ready source of emergency funding to intervene in the foreign exchange market and thereby stabilize the value of the peso and the Mexican economy.

Aside from the record level of the issuance, the line of credit is noteworthy because of its potential impact on trade relations. This additional source of funding has reinvigorated public confidence in Mexico’s ability to handle its debt obligations and stabilize its economy. This has resulted in an appreciation in the Mexican peso versus other currencies. The appreciation of the peso tends to have a positive impact on the current account (i.e. a nation’s net exports) balances of Mexico’s trading partners, including the U.S., since it makes it relatively cheaper for Mexico to import goods and services from those countries.

Discussion Questions:
1.) An IMF report indicated that if Mexico fully utilized the line of credit, the impact on the IMF’s liquidity would be “very large,” and would thus hamper its efforts to meet the funding needs of other nations. Given Mexico’s relatively strong economic performance and its stated intention not to use the line, is it a wise decision by the IMF to extend Mexico the largest line of credit it has ever issued? Wouldn’t those funds be put to better use if they were reserved for countries that have not performed as well?
2.) The flexible line-of-credit arrangement that Mexico received from the IMF is one that the IMF will only issue to those countries that are pursuing “good” economic policies. Therefore, a country that wishes to receive this funding source must necessarily adopt policies that the IMF has determined to be “good.” Does this precondition amount to a strong-arm tactic by the IMF to induce countries to adopt policies that those countries may not have adopted otherwise?

1 comment:

cottasofia said...

Large jumps in the average use of IMF credit between the 1970s and 1980s. These increases are directly attributable to the world debt crisis and its aftermath.

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