World Economy

Mexico Slays Inflation Dragon

Mexico Slays Inflation DragonMexico Slays Inflation Dragon

By most traditional economic gauges, little is going right today for Mexico. Growth is sluggish, oil exports are falling and credit markets have started to dry up.

Yet beneath the surface, a surprising and little-understood transformation is ushering in one of the country’s most important developments in years: the peso’s age-old grip on inflation has been broken. No longer does a plunge in its value trigger an automatic surge in consumer prices. In fact, the most recent data suggest that it causes almost no inflation at all, Bloomberg reported.

It may seem like an obscure, wonky topic–”pass-through” is the term used by analysts–but it’s hard to underestimate the significance in an emerging-market nation like Mexico that’s trying to climb into the ranks of the world’s developed economies. First, it protects the purchasing power of consumers in a country where about half the population lives below the poverty line. What’s more, it gives central bankers the kind of policy flexibility they never had before. Without having to worry about inflation, they can avoid the classic trap that afflicts so many developing nations.

It’s a transformation that Mexico’s top officials began touting over a year ago. Economists and investors, though, were skeptical. As Credit Suisse Group AG’s Alonso Cervera says, “we had to see it to believe it.” Now they have. Over the past 12 months, as the peso plunged 17% against the dollar, Mexico’s annual inflation rate fell to a record-low 2.5% from 4.3%.

“They slayed the inflation dragon,” said Goldman Sachs Group Inc.’s Alberto Ramos. Others are a bit more tangible: greater competition in the retail industry is making it harder for companies to pass the higher cost of imports onto consumers; the country’s sluggish consumer demand, and weak overall economic expansion, are accentuating that trend.

Gross domestic product has grown at an annual clip of less than 3% this year, not even half the long-term goal that President Enrique Pena Nieto set when he pushed through legislation to open up the energy and telecom industries.

That last point, of course, would be more of a negative than a positive, a reflection in part of the sluggish growth and almost non-existent inflation plaguing much of the developed world.