In Latin America, central bankers haven’t had it easy over the past year. A succession of hikes in US interest rates, a stronger dollar and an escalating trade war have spurred capital flight from the region, putting pressure on currencies and inflation.
Mexico took the brunt of it — and more. It had a presidential election this year, and last year a major earthquake and a surge in energy prices.
By all accounts, the Mexican peso could have at any point crashed like Argentina’s, says AJ Mediratta, president of New York-based Greylock Capital Management. “But it didn’t.”
Instead, the peso appreciated this year, gaining 1.6% in the first three quarters of 2018. Argentina’s, by comparison, has tanked more than 100%.
Mexico’s exchange-rate stability is one reason why Banco de México’s Alejandro Díaz de León got the top pick in LatinFinance’s survey of central bank observers and economists for the most effective at managing monetary policy and controlling inflation between July 2017 and June 2018. He wins LatinFinance’s Central Bank Governor of the Year Award, keeping the honor at home for a second year in a row.
Muscling it out
Mexico has faced down significant challenges over the past few years. Lower oil prices and domestic crude output, a main source of dollar flows into Mexico, weakened the peso against the dollar in 2014-15.
The 2016 U.S. election eroded the exchange rate further as the eventual President Donald Trump threatened to pull his country out of the North American Free Trade Agreement, a driver of Mexico’s economic growth for more than two decades. Then a surge in gasoline prices pushed inflation to a 16-year high in December 2017, while this year’s run-up to the election of leftist Andrés Manuel López Obrador as the next president heaped more pressure on the peso.
How did Banco de México respond? It took “a tighter monetary stance,” says Díaz de León. “The approach and the idea has been to run a tight ship through the storm until we see less uncertainty and more clarity.”
In practice, the bank has raised the benchmark interest rate since the U.S. Federal Reserve started increasing its short-term interest rates in December 2015. Mexico’s policy rate has risen 475 basis points to 7.75%, basically mirroring the Fed.
The strategy is paying off. The country’s annualized inflation slowed to 4.81% in July of this year from 6.77% at the end of 2017, when it was at its highest level since 2001.
Díaz de León has hiked the policy rate three times since taking the job last December. He says this was important to do in the run-up to the July presidential election and because a rout in emerging markets has pushed up the risk of capital flight.
“I think for us it was very clear. We needed to provide the amount of monetary stance that the economy required in order to have an orderly adjustment to a very complex and challenging environment, both external and internal. We put the monetary stance that we thought improved our chances of bringing inflation back to our target and having an orderly adjustment through these volatile and different risk factors.”
The bank’s target is to cut inflation to 3%, plus or minus one percentage point. But with higher-than-expected rises in energy and other non-core prices, it may take longer than expected.
“We are still not out of the woods,” Díaz de León says.
When asked if this could bring a change in the policy rate he says that is “a complex call.”
On one side, there’s uncertainty about the health of international financial markets, a stronger dollar and higher US rates — a combination that’s weighing on emerging market currencies.
On the other side, Mexico’s economy is growing less than expected. It shrank a year-on-year 0.1% in the second quarter in seasonally adjusted terms, led by weaker agriculture and manufacturing, according to data from Mexico’s National Institute of Statistics and Geography.
“Given that we are facing different sources of uncertainty, we need to be data-based and take into consideration all the different forces that may impact inflation dynamics.” says Díaz de León.
“The central bank did a great job in communicating to the markets their concerns on inflation and their willingness to do whatever it could take to anchor inflation and the exchange rate,” says Alberto Ramos, a Latin America economist at Goldman Sachs. “They were able to anchor expectations and prevent an overshoot of inflation despite the significant correction of the exchange rate, and without damaging the economy.”
Tough shoes to fill
Díaz de León, 48, had a legacy to follow when he took the job. His predecessor, Agustín Carstens, won LatinFinance’s award twice and now runs the Basel-based Bank for International Settlements, the first emerging market central banker to hold the high-profile post.
On his own award, Díaz de León says the strength of the organization, and “the high quality staff and skillful board” deserve the merits.
Another fortitude is Banco de México’s independence, he adds. “Central banks are more efficient in providing a nominal anchor to their economies if they are autonomous and not influenced by the political cycle.”
Díaz de León started his career at Banco de México after completing a master’s in public administration at Yale, with a specialization in financial engineering and the valuation of derivatives and fixed-income securities. At the bank, he climbed up the ranks for 16 years before taking a post to run Mexico’s pension fund for public employees. He later the Ministry of Finance and held the top post at Mexico’s foreign trade bank, Bancomext, until his return to the central bank.
Díaz de León has taken steps to improve communications and transparency. In February, for example, he launched an inflation forecast for the eight quarters ahead. “It helps provide a benchmark for what we are doing in case we face additional shocks,” he says.
The moves have gained notice in the markets.
After inflation went off the mark last year, the bank “improved its communications with the markets to convey how fast inflation would converge to the target,” says Marcos Buscaglia, founding partner of New York-based Alberdi Partners, a Latin America economic and political consultancy. “At the same time, [Díaz de León] hiked interest rates. Policy rates are well above two-year inflation expectations, so we have a contractionary monetary policy in place. He hasn’t hesitated to do this.”
Not far behind
A strong runner-up for the best central bank governor was Brazil’s Ilan Goldfajn.
The Massachusetts Institute of Technology-trained economist, who has led the central bank since June 2016, won accolades for bringing down inflation from 6.29% in 2016 to 2.95% in 2017, and for keeping the policy interest rate unchanged at 6.5% for much of this year even as inflation picked up after a truck driver’s strike in May.
“A year or two ago, it would be difficult to see how the central bank could actually look through such an inflation shock and leave interest rates unchanged,” says Edward Glossop, Latin America economist at Capital Economics in London. “Markets are pricing in quite aggressive interest rate hikes over the next few years, but I think the central bank has done a good job at bringing down inflation.”
Goldfajn has done this in part by improving communication, which had been short and terse under his predecessor, Alexandre Tombini.
“The central bank has been especially successful at anchoring inflation expectations. It had the help from the recession in Brazil, but the fact that inflation targets reduced during his tenure, that is a pretty big achievement,” says Gustavo Rangel, chief Latin America economist at ING Global Markets.
“They have done a very good job in not only managing the cutting of rates, but also in terms of the expectations of what this means for the exchange market,” says Rafael Amiel, an economist at IHS Markit.
Andrés Abadia, senior international economist at Pantheon Macroeconomics in the UK, says the rate cuts have helped “to bring to life an economy badly hit by the worst recession in decades.”
Peru’s Julio Velarde also got tipped for the award as the cornerstone for the financial system’s credibility amid an El Niño-led inflation surge last year and the Odebrecht corruption scandal, which hit the construction sector and in part led to the resignation of President Pedro Pablo Kuczynski this year.
Despite all this, Peru’s economy is bouncing back, with 3.5% growth expected this year and 3.8% in 2019, up from 2.5% in 2017, according to a forecast from the World Bank.
Another honorable mention went to Colombia’s Juan José Echavarría for improving communication with the markets after getting criticism for giving certain forward guidance and then not following it, says Carlos de Sousa, a Latin America economist at Oxford Economics in London. Echavarría now says that if there is a surprise in the economic cycle, that doesn’t mean he will cut or hike the rate.
The result is that “monetary policy decisions have been easier to predict in the last 12 months than they used to be,” he says. LF
ALBERTO RAMOS, GOLDMAN SACHS. “THEY WERE ABLE TO ANCHOR INFLATION EXPECTATIONS AND PREVENT AN OVERSHOOT”
