The Mexican Peso Crisis

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The Mexican Peso Crisis

• Joseph Pena
• Yee Borvornsastisuk
• Ricardo J. Grimaldi

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What is the Mexican Peso Crisis?

• Mexican Peso Crisis is the situation where
  Mexico tried to maintain its quasi-pegged
  exchange rate while limiting monetary tightening
  by engaging in massive sterilized intervention -
  a policy that is not sustainable for long. The
  ultimate result was a collapse of the exchange
  rate, soaring interest rates, and probably a far
  worse recession than would have occurred if
  monetary policy had been tightened.

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Origins

• In Sept. 14, 1993 NAFTA was approved, lowering
  trade barriers between the U.S. and Mexico.
• During the early 90s Mexicos exchange rate was
  consistently higher than the sum of U.S.
  inflation and peso depreciation so the real
  exchange rate was rising. This discouraged
  Mexican exports.

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Political Shock

• A series of political shocks were blamed for the
  Dec. 94 devaluation.
• An armed uprising by the Zapatistas.
• PRI presidential candidate Colosio assassinated.,
  heightening fears of political instability and
  set off the a brief financial panic.

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Politics Continued

• As a result of this financial panic the
  Government is forced to intervene heavily to
  maintain the value of the peso, in four weeks
  Mexico lost nearly 11Billion in reserves.

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The Expanding Current Account Deficit

• The Market opening reforms coupled with the
  exchange rate policy of the Salinas
  administration led to increased foreign
  investment that helped finance an increase in
  Mexicos imports.
• The result was an expansion in the current
  account deficit.

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Why did it occurred?

• The Mexican crisis was the result of a
  combination of economic, financial, and political
  factors. At the center of it all, however, was
  the Salinas government's inability and
  unwillingness to implement severe adjustment
  measures in mid-1994, when external conditions
  turned drastically against Mexico.

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Continues

• Instead of taking corrective measures consistent
  with these new external circumstances, the
  Mexican authorities tries to maintain the status
  quo by issuing large amounts of dollar-linked
  short-term debt- the infamous tesobonos- making
  the economic situation particularly vulnerable to
  a speculative attack.

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A look at hypothesis about the causes of the
crisis

• An overvalued currency
• Central bank credit expansion
• Excessive growth of the money supply
• Opaque, incomplete, or asymmetric information
• Excessive stimulus to aggregate demand
• Insufficient savings

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Some effects caused by the crisis
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Mexican International Reserves

• The sharp drop in Mexicos International Reserves
  from February to April of 1994 reflects the loss
  of reserves as the government intervened heavily
  to maintain the value of the peso during this
  time of upheaval.
• Note In 4 weeks Mexico lost nearly 11 billion
  in reserves.

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Mexican International Reserves

• Source International Monetary Fund (IMF),
  International Financial Statistics.

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Mexican Exchange Rate and Target Band Prior to
Devaluation

• The Following chart shows the path of the
  exchange rate, as well as the floor and changing
  ceiling of the band, from the beginning of 1993
  until the peso was devalued late in 1994.

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Muted initial market reaction to devaluation

• Curiously, initial market reaction to the
  devaluation was generally positive. The
  government announced the devaluation before
  markets opened on December 20. The regular weekly
  auction of tesobonos occurred later that day and
  went quite well average yield was 8.61 percent,
  only 38 basis points (bp) above the previous
  week's auction. The amount sold was 416 million,
  about the same as in the previous week.

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Conclusion

• Mexicos crisis is a very good example to show
  the severe constrains on monetary policy that
  arise if a government wants to maintain a fixed
  exchange rate.
• The results were a collapse of the exchange rate,
  soaring interest rates, and probably a far worse
  recession in 1994.

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Macro Indicators (percentage change)