The Mexican Peso Crisis

Topics: Monetary policy, Mexico, Central bank Pages: 12 (3767 words) Published: April 3, 2013
crisisThe Mexican Peso Crisis 1994
Globalization Project Report

Report submitted by: Akanksha Agrawal Namit Agrawal Saurabh Harkauli Apurv Jain Gaurav Jain Nikhil Jaiswal Ahamed Moidu Tushar Pandey D001 D002 D021 D023 D025 D028 D039 D046

The Mexican Peso Crisis - 1994

1 2 3 4 5 6 7 8 9 10 11 12 13 Introduction Political Turmoil 1993 – 1994 Scenario In Mexico Foreign Capital Inflow Sterilization Intervention Conversion Of Cetes To Tesobonos Dealing With The Crisis The December Mistake Bailout & Performance Since Crisis Tequila Effect – Brazil And Argentina Current Situation Conclusion References

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The Mexican Peso Crisis - 1994

In the early 1990s the Mexican economy seemed healthy. It was growing again after the “lost decade” of the 1980s, when the 1982 debt crisis and the 1986 collapse of oil prices sent the economy reeling. Moreover, inflation was being reduced substantially, foreign investors were pumping money into the country, and the central bank had accumulated billions of dollars in reserves. Capping the favorable developments was the proposal to reduce trade barriers with Mexico’s largest trade partner, the United States, through the North American Free Trade Agreement (NAFTA). The agreement eventually took effect at the beginning of 1994. The hard times of the 1980s seemed to be history. Less than twelve months after NAFTA took effect, Mexico faced economic disaster. On December 20, 1994, the Mexican government devalued the peso. The financial crisis that followed cut the peso’s value in half, sent inflation soaring, and set off a severe recession in Mexico.

As 1993 drew to a close, the economic outlook for Mexico appeared bright. Recently approved by the U.S. Congress, NAFTA was slated to take effect at the beginning of 1994. By lowering trade barriers between the United States and Mexico, NAFTA was expected to encourage foreign investors to take advantage of Mexico’s privileged access to the U.S. market. Moreover, NAFTA merely culminated a series of reforms the Mexican government undertook during the administration of Mexican President Carlos Salinas. These prior measures included a     restructuring of Mexico’s foreign debt under the Brady Plan sharp reductions in Mexico’s budget deficit and inflation rate unilateral cuts in protectionist trade barriers privatization of various government-owned enterprises

Mexico’s current account deficit had ballooned from $6 billion in 1989 to $15 billion in 1991 and to more than $20 billion in 1992 and 1993. Although the current account deficit was a favorable development, reflecting the capital inflow stimulated by Mexican policy reforms, but the large size of the deficit led some observers to worry that the peso was becoming overvalued, a circumstance that could discourage exports, stimulate imports, and lead eventually to a crisis. There were a number of political factors that led the Peso to be overvalued:  1994 being election year, there was a huge public spending by the PRI. No measures were taken on the much needed devaluation of peso.

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The Mexican Peso Crisis - 1994

 The rebellion in southern province of Chiapas at the beginning of the year which was an armed uprising t h at t o o k p l ac e only seven months before a presidential election, raised doubts about Mexico’s political stability and evoked fear among the foreign investors  A much more severe political shock occurred when the ruling party’s presidential candidate, Luis Donaldo Colosio, was assassinated on March 23. Colosio was seen as an omen of hope and change. His assassination brought about a fear of political instability that set off a brief financial panic. There was a sharp drop in international reserves – which resulted in a loss of $11 billion in about four weeks.  Other political disturbances that made the pressure on the peso more...
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