MF Aid Boosts Mexico's Credibility

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New credit line is beneficial for both parties.

Mexico's request for an IMF Flexible Credit Line (FCL) during President Felipe Calderon's state visit to the United Kingdom, just before his participation in the G-20 Leaders' Summit in London Friday, came as a shock to markets. However, initial reaction has been relatively positive and this is likely to continue as concerns ease about potential balance of payments and budget difficulties next year.

Unprecedented amount. During a press conference in London, Finance Minister Agustin Carstens on Thursday announced that Mexico would request a precautionary credit line equivalent to 1,000% of its quota--31.5 billion special drawing rights (SDRs), currently equivalent to $46.55 billion. This greatly exceeds the 22.8 billion SDRs (then $30.4 billion) granted to Brazil in September 2002--an IMF record--and will be valid for a full year.

Peso impact. The impact on markets was immediate, with the peso appreciating 2.9% in two days, to 13.93 pesos per dollar yesterday (Calderon on March 31 announced that Mexico would request the FCL). Adding a $30 billion swap line with the U.S. Federal Reserve, which the Bank of Mexico (Banxico) also indicated willingness to activate, the country practically doubles international reserves, which stood at $79 billion on March 27.

Low cost. Moreover, the cost of activating the FCL is low, particularly compared with the cost of accumulating international reserves:

--Mexico currently receives a relatively low interest rate for reserves (mostly invested in liquid U.S. Treasury bonds), while paying a much higher rate to issue peso debt to obtain domestic currency to buy dollars--the difference currently stands at around six percentage points.

--Mexico will pay the IMF a 0.27% per year commitment fee, according to the Finance Ministry.

New chapter. FCL activation marks a new chapter in relations between the IMF and Mexico, which paid in advance all loans to the institution at the end of 2000:

--Although the relationship at times has been rocky (with at least five IMF programs between 1976-95), the acrimony that exists between the Fund and some Asian countries is not present.

Mutual benefit. The credit line request is mutually beneficial for Mexico and the IMF:

--Mexico. Mexico significantly boosts its standing as a country with a solid policy record and prospects; only countries that meet such prerequisites can request the FCL. As the FCL has no conditionality, it can use part or all of the credit line without changing economic policy. (Carstens emphasized during the press conference that Mexico had no plans to use the FCL.)

--IMF. Mexico breaks the stigma attached to countries requesting resources from the IMF, which has pushed countries in relative good economic health to seek to avoid the institution, borrowing massively from the World Bank and regional development banks. It boosts the Fund's position just before the G-20 Leaders' Summit, showing that recent reforms are working as intended.

The request highlights the case for significantly boosting IMF resources. The Fund had $140.5 billion to lend at the end of February, though access to credit lines and a recent Japanese government loan have increased this to $290 billion.

The IMF credit line and U.S. Federal Reserve swap arrangement practically double Mexico's international reserves at low cost. The initial reaction, particularly in exchange markets, has been positive. Triggering the FCL boosts Mexico's economic standing, but also is a welcome boost to IMF credibility on the eve of the G-20 Leaders' Summit.