Challenges have been the norm in Mexico since before Alejandro Díaz de León became governor of Banco de México (Banxico) two years ago. The peso has faced several selloffs since 2017 but has bounced back again and again to hold between 18 and 20 per dollar. By early September, the currency had gained 5.3% from a most recent low of 20.62 per dollar in November 2018, making it one of the best performers in Latin America over that period.
This exchange-rate stability is one reason why Díaz de León wins LatinFinance’s Central Bank Governor of the Year Award, keeping the honor at home for a third year in a row. Voting came from a survey of central bank observers and economists, based on who was most effective at managing monetary policy and controlling inflation between July 2018 and June 2019.
To be sure, Mexico’s challenges are not unique in Latin America. Argentina’s three governors over the past two years have struggled to avoid spooking the markets as the economy falls deeper into crisis. Chile and Colombia, two of the region’s steadiest economies, have sometimes had contradictory chatter in their communications, making it harder to gauge interest rate direction, a key for currency and price stability. Brazil’s two central bank governors over the time period have fought to hold inflation in check.
Still, by all accounts, surprises have been the norm for Banxico in the recent past. The currency, consumer prices, public finances and the economy have been under pressure as Mexico went from an oil-exporting economy to an energy importer. President Donald Trump’s threats of pulling the US out of the North American Free Trade Agreement didn’t help matters, given that NAFTA has been a growth driver for the country for more than two decades.
The blows didn’t stop. The run-up to last year’s election of Andrés Manuel López Obrador, a leftist who became Mexico’s president in December 2018, put more pressure on the peso as investors worried about rising inflation and worsening conditions for investment. Indeed, the scrapping of a major airport project triggered a more than 10% tumble in the exchange rate at the end of 2018. A downgrade of the sovereign’s debt and that of Pemex, the state oil company, heaped on more concerns.
Asked what it has been like to do his job through all this turmoil, Díaz de León says simply, “It has been a couple of very challenging years.”
Indeed, the very month the governor took office in December 2017, inflation surged to 6.8%, the highest since 2001 — and far above a 3% target in place since 2003. His response? “We knew that tighter monetary policy was needed to allow the economy to weather these shocks,” says Díaz de León.
The bank had started to raise the benchmark interest rate from 3% in 2015 after the US Federal Reserve started increasing its short-term interest rates and took it to a peak of 8.25% in December 2018, the highest level in two decades.
The strategy helped to cool inflation — it slowed to 3.2% in August, allowing Banxico to reduce the target rate to 8% that month.
The question now is how fast to reduce rates. Pedro Tuesta, senior Latin America economist at Continuum Economics, a London-based research firm, says the bank is “between a rock and a hard place.” While inflation has come down, the economy has slowed, too. Growth has decelerated from a recent peak of 3.3% in 2015 to 2% in 2018, according to the World Bank. The economy may only grow 0.2% to 0.7% this year, before picking up pace to 1.5% to 2.5% in 2020, according to Díaz de León.
Banxico’s board has faced pressure to do more — or act faster — to lower rates to spur growth. “If somebody was crazy gung-ho, they would have cut rates faster, but they have been cautious and have been very focused on inflation rather than on growth,” Tuesta says.
“We know that we are subject always to different opinions in terms of what monetary policy should be doing, but that is not new and we are sticking to the course,” Díaz de León says. “We are convinced that stability is our best contribution for overall economic performance.”
Asked if the bank will make more rate cuts, as the markets seem to expect, Díaz de León says a lot of variables must be considered. While a slowing world economy is reducing global inflationary pressures and interest rates, he says, trade tensions, particularly between China and the US, have sparked “episodes of acute volatility or flight to quality.”
Unanswered questions make it harder to provide guidance on future policy decisions. Díaz de León says the bank is taking a nuanced approach by looking closely at the data to understand the risks to inflation.
A greater-than-expected slack in the Mexican economy and a response to weaker global growth could push down international commodities prices and inflation. Pressure on the upside could come from domestic wage revisions. Already, Díaz de León says, that while the target is to reach 3% inflation, core inflation is running stubbornly higher at 3.8%.
To help the markets follow the five-member board’s process for setting the target interest rate, Banxico last year started publishing an inflation forecast that looks ahead eight quarters, a move meant to take some of the market’s guesswork out of the equation, Díaz de León says. “It has been very important for us to be clearer about what variables we are reacting to, the risks that we see, what elements are relevant for our decision-making.”
Outlining what steps the board would take “in the case of risk X or Y materializing,” he adds, helps to not “catch the markets off guard.”
One change allows board members who don’t agree with the policy decision or the analysis behind it to explain why in the minutes. Díaz de León says two episodes of dissent have occurred on both sides — in favor and against a rate cut — since the change in government brought on two new board members.
“This illustrates that we have a very committed board with different views,” he says, adding that the diversity “enriches the discussion and decision-making process, and that helps us reach the best decisions.”
Still, Díaz de León is cautious about the immediate future. “We are facing a business cycle that has been getting softer. Adverse conditions and different risks could materialize and prevent inflation from coming down towards target as soon as we would like,” he says. In the meantime, “we will be prudent with the approach we take and mindful of the different tradeoffs that we face.”
Almost as many nods for Central Bank Governor of the Year went to Brazil’s Ilan Goldfajn and his successor, Roberto de Oliveira Campos Neto, who took over on February 28, 2019.
Banco Central do Brasil (BCB) won praise for continuing to bring down inflation from above 10% in 2016 to 3.4% in August 2019, a rate well below Brazil’s historic levels of 6% to 8% — and even below the median targets of 4.25% this year, 4% in 2020 and 3.75% in 2021.
Moderating inflation has allowed BCB to reduce the benchmark Selic rate by 50 basis points to a record low 6% in August. Although that was the first reduction since March 2018, it represented the 13th cut since the Selic hit 14.25% in October 2016.
And like Mexico, Brazil’s central bank has avoided surprising the markets.
The latest rate cut “was well flagged,” says Edward Glossop, Latin America economist at Capital Economics in London. By comparison, under Alexandre Tombini, governor from 2011 to 2016, communications had been “terse and sometimes not very clear,” leading to surprises about when the tightening or loosening cycles would begin, he says. “Now it is much better.”
Goldfajn had to deal with a spike in inflation after a truckers’ strike led to a surge in inflation in the second half of 2018, putting pressure on the currency and interest rates in the run-up to the election of right-wing Jair Bolsonaro as president last October.
Through all of this, Goldfajn “did a good job in risk management, using market language” to help calm the markets, says Wilson Ferrarezi, an economist at TS Lombard, a London-based economic research firm.
At the start of this year, for example, Goldfajn said that while a rate cut was anticipated, a worse-than-expected slowdown in the economy could delay the moves, as could higher inflation and the impact of pension reforms. This context provided the markets with “a grasp on monetary policy steps,” Ferrarezi says.
Both Goldfajn and Campos Neto “managed to anchor inflation expectations,” says Bertrand Delgado, director of global markets at Société Générale. “They have communicated relatively clearly to the markets their achievements and procedures, and what to expect.”
Delgado credits the bank for waiting for data before making its decisions, which has been key to reducing the risk of policy mistakes. “There were a lot of moving parts,” and the BCB’s process has stressed “prudence and maintaining the course. They were under pressure from the markets, but they didn’t act” until they had enough information.