By Ira Iosebashvili and Robbie Whelan

Global investors are fleeing Mexico's financial markets, sending the peso to record lows on mounting concerns that Donald Trump's trade policy could end the country's privileged status among developing countries.

The peso tumbled 2% on Tuesday to another all-time low against the dollar, frustrating Mexican central-bank efforts to slow the currency's decline. Bank officials said Tuesday that they spent $2 billion last week to prop up the peso, which has weakened nearly 16% against the dollar since the U.S. election.

The selloff underscores gathering fears that the economic gains Mexico has made over the past two decades could reverse, as the incoming Trump administration takes a confrontational stance that could bring tariffs and border-control measures that until recently appeared unthinkable.

The North American Free Trade Agreement, which in 1994 created a free-trade zone among Mexico, the U.S. and Canada, cracked open the giant American consumer market to Mexican businesses in a way no other emerging market has ever enjoyed. Nafta has also brought relative stability to the peso after a series of currency crises, a crucial factor in reassuring foreign buyers of Mexican bonds and other assets.

Now that advantage could be in jeopardy if Mr. Trump follows through on pledges to renegotiate the agreement. Mexico's benchmark stock index has tumbled 5.3% in the two months since the U.S. election. Yields on 10-year Mexican government debt, which move in the opposite direction of price, have jumped to 7.76% from about 6% before Mr. Trump's victory. Mexican asset prices could come under further pressure in coming weeks, analysts and investors said, as the administration's nominees to government positions spell out their positions in testimony before Congress.

"A renegotiation of Nafta would basically kill Mexico's growth model," said Juan Carlos Rodado, director of Latin American research at investment bank Natixis. "This would be very bad for investor confidence."

This reversal of fortune shows how Mexico may be paying a price for becoming so dependent on one strong trading partner. About 80% of Mexican exports go the U.S.

Foreign investors were net sellers of $1.4 billion in Mexican short-term debt in December, reducing their holdings by 11.3%, according to data from Natixis and Banco de Mexico. That was the biggest one month selloff in nearly 10 years in percentage terms.

Mexico's economy could fall into recession, shrinking by as much 3.3% in 2017 if the U.S. imposes tougher trade terms, Mr. Rodado said. Mexico's economy grew by 2.1%last year. Almost 30% of the country's gross domestic product comes from trade with the U.S., Natixis estimates.

Fitch Ratings in early December cut its rating outlook on Mexico's long-term debt to negative from stable, a sign that currency depreciation resulting from Mr. Trump's victory had increased uncertainty to the point that it could hurt Mexico's public finances.

"No one is willing to stick their neck out and take a shot on Mexican assets right now," said Win Thin, an emerging-markets strategist at Brown Brothers Harriman & Co.

The peso's instability has already sparked inflation in Mexico and caused headaches for small-business owners such as Abraham Bleier, founder of the Garabatos chain of restaurants and bakeries. Mr. Bleier, who has about 35 locations in Mexico City and the central Mexican city of Queretaro, said he wanted to open two new locations each year.

He has put his plans on hold because currency fluctuations boosted costs. Prices of butter and chocolate that he imports from New Zealand and Switzerland -- and pays for in dollars -- rose more than 40% over four months last year, making his cookies and cakes more costly to produce.

"I can raise prices, but if people don't have the money, they won't pay. It's a negative spiral," he said. "To see the value of your business devalued in dollar terms 40% or 50% -- and I didn't have anything to do with it, I didn't make any mistake -- it's very frustrating."

Fund managers that deal in peso-denominated assets are spooked, too. Macquarie Infrastructure & Real Assets, an Australian-owned company that invests in Mexican roads, power plants and wind farms, filed paperwork to raise as much as 10 billion pesos ($459 million) from pension funds and other investors in September.

MIRA's chief executive, Ernesto González, said there was "pause" in fundraising immediately after Mr. Trump's election, and he expects to have a harder time raising money after the peso's further weakening.

"It's definitely in the back of my mind that people will want to delay large investment decisions," he said.

A weak currency often comes with benefits by making a country's exports more competitive. But a falling peso may not boost the Mexican economy as much as a weakened currency did for other developing countries. If Mr. Trump carries out his threat to put new tariffs on Mexican goods if the country doesn't revise trade terms, new duties on Mexican products could partially offset the competitive advantage from a weaker peso, economists say.

"If you impose tariffs, Mexican exporters will be less profitable," said Alberto Ramos, chief Latin American economist at Goldman Sachs Group Inc., adding "it's not going to price them out."

Luis de la Calle, a former top Mexican trade official, said Mr. Trump's statements and policies thathave caused the peso to decline could backfire. They would dent Mexicans' ability to buy U.S. goods, which could expand the U.S. trade deficit. A weaker peso is also likely to spur more illegal immigration if Mexico's economy falters.

"Trump is manipulating Mexico's currency through his tweets -- against the U.S. interest," Mr. de la Calle said.

Gorky Urquieta, co-head of emerging markets debt at Neuberger Berman, said he thinks the Mexican central bank will eventually be able to slow the currency's declines. He recently canceled his negative bets on the peso, believing it is undervalued.

Still, he added, "until we have a better grasp of what trade and U.S. policy are going to be like, it will be difficult to see a meaningful recovery."

For decades, Mexico's economy careened between booms and busts, like many other emerging markets. That began to change in 1994 with Nafta, which boosted Mexico's export revenue and made companies less vulnerable than those in countries like Brazil and Chile to China's slowing appetite for raw goods.

In 1995, the U.S. coordinated a $50 billion bailout of Mexico after the country's botched currency devaluation caused the peso to plunge. Mexico received a $20 billion credit line from Washington but only tapped about $12.5 billion and repaid the loan early.

But Mr. Thin at Brown Brothers Harriman said investors shouldn't count on the U.S. coming to Mexico's aid under the next administration.

"Trump has a very adversarial relationship with Mexico and would likely be much less cooperative in terms of bilateral aid," he said.

--David Luhnow and Anthony Harrup contributed to this article.

(END) Dow Jones Newswires

January 11, 2017 05:44 ET (10:44 GMT)

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